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OFG > SEC Filings for OFG > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for OFG BANCORP


9-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

INTRODUCTION

The following discussion of the Company's financial condition and results of operations should be read in conjunction with the "Selected Financial Data" and the Company's unaudited consolidated financial statements and related notes. This discussion and analysis contains forward-looking statements. Please see "Forward-Looking Statements" and the risk factors set forth in our 2012 Form 10-K for discussion of the uncertainties, risks and assumptions associated with these statements.

The Company is a publicly-owned financial holding company that provides a full range of banking and financial services through its subsidiaries, including commercial, consumer , auto and mortgage lending; checking and savings accounts; financial planning, insurance and securities brokerage services; and corporate and individual trust and retirement services. The Company operates through three major business segments: Banking, Financial Services, and Treasury, and distinguishes itself based on quality service. The Company has 56 branches in Puerto Rico and a subsidiary in Boca Raton, Florida. The Company's long-term goal is to strengthen its banking and financial services franchise by expanding its lending businesses, increasing the level of integration in the marketing and delivery of banking and financial services, maintaining effective asset-liability management, growing non-interest revenue from banking and financial services, and improving operating efficiencies.

The Company's diversified mix of businesses and products generates both the interest income traditionally associated with a banking institution and non-interest income traditionally associated with a financial services institution (generated by such businesses as securities brokerage, fiduciary services, investment banking, insurance agency, and retirement plan administration). Although all of these businesses, to varying degrees, are affected by interest rate and financial market fluctuations and other external factors, the Company's commitment is to continue producing a balanced and growing revenue stream.

The BBVAPR Acquisition, the deleveraging of the Company's investment securities portfolio, and the continued organic growth of its banking operations have transformed the profitability of the Company in line with its strategic direction. The Company has begun to realize the anticipated benefits of the BBVAPR Acquisition as reflected by its significantly larger and higher yielding loan assets, a significantly larger deposit base and balances, and a sharply reduced size of its investment securities portfolio. It expects to continue to benefit from a more diverse business portfolio as well as increased scale and leadership in its market.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in "Note 1-Summary of Significant Accounting Policies" of our annual report on 2012 Form 10-K for the year ended December 31, 2012 (the "2012 Form 10-K").

In the "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" section of our 2012 Form 10-K, we identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition:

Business combination
Allowance for loan and lease losses
Financial instruments

We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. Management has reviewed and approved these critical accounting policies and has discussed its judgments and assumptions with the Audit and Compliance Committee of our Board of Directors. There have been no material changes in the methods used to formulate these critical accounting estimates from those discussed in our 2012 Form 10-K.


OVERVIEW OF FINANCIAL PERFORMANCE



SELECTED FINANCIAL DATA

                                                                                        Quarter Ended June 30,                                      Six-Month Period Ended June 30,
                                                                                                                              Variance                                                Variance
                                                                                  2013                           2012            %                2013                   2012             %
EARNINGS DATA:                                                                                               (In thousands, except per share data)
Interest income                                                  $                               125,808    $       60,788      107.0%   $               239,436    $      130,708        83.2%
Interest expense                                                                                  20,439            27,632      -26.0%                    41,485            58,566       -29.2%
   Net interest income                                                                           105,369            33,156      217.8%                   197,951            72,142       174.4%
Provision for non-covered loan and lease losses                                                   37,527             3,800      887.6%                    45,443             6,800       568.3%
Provision for covered loan and lease losses, net                                                   1,211             1,467      -17.5%                     1,883             8,624       -78.2%
   Total provision for loan and lease losses, net                                                 38,738             5,267      635.5%                    47,326            15,424       206.8%
     Net interest income after provision for loan
       and lease losses                                                                           66,631            27,889      138.9%                   150,625            56,718       165.6%
Non-interest income                                                                                7,796            17,836      -56.3%                    18,930            30,995       -38.9%
Non-interest expenses                                                                             68,822            29,710      131.6%                   135,632            59,109       129.5%
   Income before taxes                                                                             5,605            16,015      -65.0%                    33,923            28,604        18.6%
Income tax expense (benefit)                                                                    (31,934)             1,057    -3121.2%                  (24,808)             2,994      -928.6%
   Net income                                                                                     37,539            14,958      151.0%                    58,731            25,610       129.3%
Less: dividends on preferred stock                                                               (3,466)           (1,201)      153.0%                   (6,931)           (2,401)      -188.7%
   Income available to common shareholders                       $                                34,073    $       13,757      147.7%   $                51,800    $       23,209       123.2%
PER SHARE DATA:
Basic                                                            $                                  0.75    $         0.34      120.9%   $                  1.14    $         0.57       100.0%
Diluted                                                          $                                  0.68    $         0.34      101.1%   $                  1.05    $         0.57        84.8%
Average common shares outstanding                                                                 45,630            40,703       12.1%                    45,613            40,873        11.6%
Average common shares outstanding and equivalents                                                 52,968            40,808       29.8%                    52,929            40,986        29.1%
Cash dividends declared per common share                         $                                  0.06    $         0.06       20.0%   $                  0.12    $         0.12         0.0%
Cash dividends declared on common shares                         $                                 2,742    $        2,444       12.2%   $                 5,479    $        4,887        12.1%
PERFORMANCE RATIOS:
Return on average assets (ROA)                                                                      1.77%             0.91%      94.5%                      1.36%             0.79%       72.2%
Return on average common equity (ROE)                                                              18.56%             8.69%     113.6%                     14.29%             7.38%       93.6%
Equity-to-assets ratio                                                                             10.34%            10.86%      -4.8%                     10.34%            10.86%       -4.8%
Efficiency ratio                                                                                   53.24%            66.55%     -20.0%                     55.35%            62.16%      -10.9%
Interest rate spread                                                                                5.55%             2.24%     147.8%                      5.11%             2.38%      114.7%
Interest rate margin                                                                                5.56%             2.29%     142.8%                      5.13%             2.45%      109.4%


SELECTED FINANCIAL DATA - (Continued)

                                                      June 30,                December 31,     Variance
                                                        2013                      2012            %
PERIOD END BALANCES AND CAPITAL RATIOS:               (In thousands, except per share data)
Investments and loans
   Investments securities                  $                    1,860,660    $    2,233,265      -16.7%
   Loans and leases not covered under
shared-loss
     agreements with the FDIC, net                              4,621,649         4,773,923       -3.2%
   Loans and leases covered under
shared-loss
     agreements with the FDIC, net                                369,380           395,307       -6.6%
   Securities sold but not yet delivered
                                                                   16,732                 -      100.0%
     Total investments and loans           $                    6,868,421    $    7,402,495       -7.2%
Deposits and borrowings
   Deposits                                $                    5,665,038    $    5,689,559       -0.4%
   Securities sold under agreements to
repurchase                                                      1,313,870         1,695,247      -22.5%
   Other borrowings                                               421,261           792,425      -46.8%
     Total deposits and borrowings         $                    7,400,169    $    8,177,231       -9.5%
Stockholders' equity
   Preferred stock                         $                      176,000    $      176,000        0.0%
   Common stock                                                    52,689            52,671        0.0%
   Additional paid-in capital                                     538,105           537,453        0.1%
   Legal surplus                                                   57,906            52,143       11.1%
   Retained earnings                                              111,292            70,734       57.3%
   Treasury stock, at cost                                       (80,834)          (81,275)        0.5%
   Accumulated other comprehensive income                          15,766            55,880      -71.8%
     Total stockholders' equity            $                      870,924    $      863,606        0.8%
Per share data
   Book value per common share             $                        15.45    $        15.31        0.9%
   Tangible book value per common share    $                        13.49    $        13.31        1.4%
   Market price at end of period           $                        18.11    $        13.35       35.7%
Capital ratios
   Leverage capital                                                  8.54%             6.42%      33.0%
   Tier 1 risk-based capital                                        13.96%            12.94%       7.9%
   Total risk-based capital                                         16.02%            15.15%       5.7%
   Tier 1 common equity to risk-weighted
assets                                                               9.97%             9.11%       9.5%
Financial assets managed
   Trust assets managed                    $                    2,638,787    $    2,514,401        4.9%
   Broker-dealer assets gathered           $                    2,822,395         2,722,196        3.7%


Financial Highlights

Income available to common shareholders for the quarter and six-month period ended June 30, 2013, increased to $34.1 million and $51.8 million, or $0.68 and $1.05 per diluted share, respectively. The income available to common shareholders are a significant improvement over the $13.8 million and $23.2 million for the quarter and six-month period ended June 30, 2012, respectively.

Interest income from loans for the quarter and six-month period ended June 30, 2013, increased 205.1% and 178.5% when compared with the same periods in 2012, while net interest margin expanded to 5.56% from 2.29% in the second quarter of 2012, and to 5.13% for the six-month period ended June 30, 2013, from 2.45% for the same period in 2012.

During the quarter ended June 30, 2013, the Company's return on assets was 1.77%, and its return on equity was 18.56%, all of which represent improvements from the second quarter of 2012. The Company improved its efficiency ratio, which decreased to 53.24% from 66.55% when compared with the same quarter in 2012. For the six-month period ended June 30, 2013, the Company's return on assets was 1.36% and its return on equity was 14.29%, both of which also represent improvements from the same period in 2012. The efficiency ratio decreased to 55.35% from 62.16% when compared with the same period in 2012.

Operating revenues for the quarter ended June 30, 2013 increased 121.9%, or $62.2 million, to $113.2 million when compared to the same period in 2012. Operating revenues for the six-month period ended June 30, 2013 increased 110.3%, or $113.7 million, to $216.9 million when compared to the same period in 2012.

                                                  Quarter Ended June 30,                     Six-Month Period Ended June 30,
                                                2013                    2012                    2013                    2012
                                                      (In thousands)                                  (In thousands)
OPERATING REVENUE
   Net interest income                 $               105,368    $          33,156    $               197,951    $         72,141
   Non-interest income, net                              7,796               17,836                     18,930              30,995
     Total operating revenue           $               113,164    $          50,992    $               216,881    $        103,136

Interest Income

Total interest income for the quarter and six-month period ended June 30, 2013 increased 107.0% to $125.8 million and 83.2% to $239.4 million, respectively, as compared to the same periods in 2012. This was a result of an increase in interest income from loans of $77.0 million, or 205.1%, and $137.8 million, or 178.5%, when compared to the quarter and six-month period ended June 30, 2012, respectively. This increase was partially offset by a decrease in interest income from investments of $12.0 million, or 51.8%, and $29.1 million, or 54.5%, compared to the quarter and six-month period ended June 30, 2012, respectively. This result was related to the BBVAPR Acquisition in which the non-covered loans portfolio increased by approximately $3.4 billion when compared to same period in 2012. In addition, the yield on covered loans increased from 17.75% and 17.64% for the quarter and six-month period ended June 30, 2012, respectively, to 25.62% and 23.10% for the quarter and six-month period ended June 30, 2013. This increase in yield is the result of higher projected cash flows on certain pools of covered loans, as credit losses have been lower than initially estimated for these loan pools. The covered portfolio is beginning to have cost recoveries on pools with lower carrying amounts, and these have the effect of increasing net interest income. Such cost recoveries for the quarter ended June 30, 2013 amounted to $6.2 million in the leasing and the construction loan pools. The accretable yield amounted to $167.1 million at June 30, 2013 compared to $188.0 million at December 31, 2012.

Interest income from investments reflects a 51.8% and 54.5% decrease for the quarter and six-month period ended June 30, 2013, as compared to the same period in 2012, primarily related to the lower balance in the investment securities portfolio due to the sale of investments securities as part of the deleverage executed during the third and fourth quarters of 2012 in connection with the BBVAPR Acquisition


Interest Expense

Total interest expense for the quarter and six-month period ended June 30, 2013 decreased 26.0% to $20.4 million and 29.2% to $41.5 million, respectively, as compared to the same periods in 2012. This reflects the lower cost of both securities sold under agreements to repurchase (2.10% vs. 2.16%; 1.99% vs. 2.23%) and deposits (0.71% vs. 1.40%; 0.73% vs. 1.48%) for the quarter and six-month period ended June 30, 2013, respectively, as compared to the same periods in 2012, which reflects continuing progress in the repricing of the Group's core retail deposits and further reductions in its cost of funds, in addition to the reduction in the repurchase agreements as a result of the deleverage executed during the third and fourth quarters of 2012 in connection with the BBVAPR Acquisition.

Net Interest Income

Net interest income for the quarter and six-month period ended June 30, 2013 was $105.4 million and $198.0 million, respectively, an increase of 217.8% and 174.4%, respectively, when compared with the same periods in 2012. The increase was mostly due to the net effect of an increase of 426.1% and 383.4% for the quarter and six-month period ended June 30, 2013, respectively, in interest income from non-covered loans as a result of higher loan balances following the BBVAPR Acquisition. It is also due to a decrease of 26.0% and 29.2% in interest expense for the same respective periods due to lower cost of funds, partially offset by a decrease of 51.8% and 54.5% for the same respective periods on interest income from investments, related to lower balances from aforementioned deleverage transactions and a lower yield in the investment securities portfolio.

Net interest margin of 5.56% and 5.13% for the quarter and six-month period ended June 30,2013, respectively, increased 327 basis points and 268 basis points when compared to the quarter and six-month period ended June 30, 2012.

Provision for Loan and Lease Losses

Provision for non-covered loans losses for the quarter and six-month period ended June 30, 2013 increased $33.7 million and $38.6 million, respectively, when compared to the same periods in 2012. The increased is mostly due to the net impact of $21.0 million in additional provision for loan and lease losses due to reclassification to held-for-sale of non-performing residential mortgage loans with unpaid principal balance of $59 million and the increase in loan averages balances in 2013. Provision for covered loans losses for the quarter and six-month period ended June 30, 2013 decreased $56 thousand and $6.7 million when compared to the same periods ended June 30, 2012, as some covered construction and development and commercial real estate loan pools underperformed during the second quarter of 2012, which required a provision amounting to $7.2 million, net of the estimated reimbursement from the FDIC , compared to the recorded net provision of $1.2 million resulting from this quarter's assessment of actual versus expected cash flows on the covered portfolio accounted for under the provisions of ASC 310-30.

Non-Interest Income

During the quarter and six-month period ended June 30, 2013, core banking and financial services revenues increased 108.0% to $23.9 million and 105.1% to $47.1 million, respectively, as compared to the same periods in 2012, primarily reflecting a $10.2 million and $19.5 million increase in banking services revenue to $13.3 million and $25.7 million for the quarter and six-month period ended June 30, 2013, respectively, attributed to an increase of 157.6% in deposits from June 30, 2012, which is principally attributed to the BBVAPR Acquisition.

Net FDIC shared-loss expense of $20.0 million and $32.8 million for the quarter and six-month period ended June 30, 2013, respectively, compared to $5.6 million and $10.4 million for the same periods in 2012. Such increase resulted from the ongoing evaluation of expected cash flows of the loan portfolio acquired in the FDIC-assisted acquisition. As a result of such evaluation, the Company expects a decrease in losses to be collected from the FDIC and the improved re-yielding of the accretable yield on the covered loans. This reduction in claimable losses amortizes the shared-loss indemnification asset through the life of the shared-loss agreements. This amortization is net of the accretion of the discount recorded to reflect the expected claimable loss at its net present value. During the quarter ended June 30, 2013 the net amortization included $7.1 million of additional amortization of the FDIC indemnification asset from stepped up cost recoveries on certain construction and leasing loan pools.

There was no gain or loss on the sale of securities in the quarter and six-month period ended June 30, 2013 as compared to gains of $12.0 million and $19.3 million in the same periods in 2012.


Non-Interest Expense

Non-interest expense increased to $68.8 million and $135.6 million for the quarter and six-month period ended June 30, 2013, respectively, compared to $29.7 million and $59.1 million in the same periods of the previous year, due to the Company's expanded operations as a result of the BBVAPR Acquisition, including merger and restructuring costs of $5.3 million and $10.8 million for the quarter and six-month period, respectively. Also, the quarter and six-month period ended June 30, 2013 reflects a $2.0 million impact of the new 1.0% tax on gross revenues, recently enacted in the amendments to the Puerto Rico tax code.

The efficiency ratio for the quarter and six-month period ended June 30, 2013 was 53.24% and 55.35%, respectively, compared to 66.55% and 62.16% for the quarter and six-month period ended June 30, 2012, respectively.

Income Tax Expense

Income tax benefit was $31.9 million and $24.8 million for the quarter and six-month period ended June 30, 2013, respectively, compared to an expense of $1.1 million and $3.0 million for the same periods in 2012. The income tax benefit of $31.9 million for the quarter ended June 30, 2013 includes three items resulting from the recent amendment to the Puerto Rico tax code: (i) a $37.0 million benefit from an increase in the Company's deferred tax asset as a result of the increase in corporate income taxes to 39% from 30%; (ii) the Company's income tax expense at the Company's higher effective rate of 35.5% for the second quarter of 2013; and (iii) the increase in the Company's income tax expense for the first quarter of 2013 as a result of the increase in the effective tax rate to 35.5% from the previously reported 25.2%.

Income Available to Common Shareholders

For the quarter and six-month period ended June 30, 2013, the Group's income available to common shareholders amounted to $34.1 million and $51.8 million, respectively, compared to $13.8 million and $23.2 million for the same periods in 2012. Earnings per basic common share and fully diluted common share were $0.75 and $0.68 for the quarter ended June 30, 2013, respectively, compared to earnings per basic and fully diluted common share of $0.34 for the quarter ended June 30, 2012. Income per basic common share and fully diluted common share were $1.14 and $1.04, respectively, for the six-month period ended June 30, 2013, compared to income per basic and fully diluted common share of $0.57 for the six-month period ended June 30, 2012.

Interest Earning Assets

The loan portfolio declined to $4.991 billion at June 30, 2013 compared to $5.169 billion at December 31, 2012 primarily due to the early pay down of some commercial loans and the reclassification of non-performing residential mortgage loans with a book value of $55 million to held-for-sale, at fair value. The investment portfolio of $1.861 billion at June 30, 2013 decreased 9.2% compared to $2.233 billion at December 31, 2012. The decrease in the investment portfolio is mainly due to redemptions and maturities of investments securities available for sale.

Interest Bearing Liabilities

Total deposits decreased slightly to $5.665 billion at June 30, 2013, compared to $5.690 billion at December 31, 2012. Core deposits, including brokered deposits, increased 2.7% compared to December 31, 2012, while brokered certificate of deposits decreased 16.6%. Securities sold under agreements to repurchase decreased 22.5%, or $381.4 million, as the Company used available cash to pay off $380 million repurchase agreements at maturity. During the six-month period ended June 30, 2013, the Company settled, prior to maturity, a former BBVAPR subordinated note of $50 million.

Stockholders' Equity

Stockholders' equity at June 30, 2013 was $870.9 million compared to $863.6 million at December 31, 2012, an increase of 0.8%. This increase reflects the net income for the quarter, partially offset by the change in other comprehensive income.

Book value per share was $15.45 at June 30, 2013 compared to $15.31 at December 31, 2012.

The Company maintains capital ratios in excess of regulatory requirements. At June 30, 2013, Tier 1 Leverage Capital Ratio was 8.54%, Tier 1 Risk-Based Capital Ratio was 13.96%, and Total Risk-Based Capital Ratio was 16.02%.


Return on Average Assets and Common Equity

Return on average common equity ("ROE") for the quarter and six-month period ended June 30, 2013 was 18.56% and 14.29%, respectively, up from 8.69% and 7.38% for the quarter and six-month period ended June 30, 2012, respectively. Return . . .

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