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OFG > SEC Filings for OFG > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for OFG BANCORP


12-Nov-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 the year ended December 31, 2012 (the "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 55 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 despite challenging economic conditions in Puerto Rico. In the third quarter of 2013, the Company completed the conversion of all former BBVAPR businesses to its technology platform in line with its original integration plan. The Company expects that this will enable it to roll out new technology enhanced products and services to its current and target customer base.


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 other than the one described below.

During the quarter ended September 30, 2013, management changed the methodology of the general reserve calculation in order to adapt the calculation to the new Company structure after the BBVAPR Acquisition, and better capture the risk characteristics of the different portfolio segments. Principal changes are concentrated in the commercial, consumer and auto and leasing portfolios, as follows:

The commercial portfolio was further segmented by business line (corporate, institutional, middle market, corporate retail, floor plan, and real estate), by collateral type (secured by real estate and other commercial and industrial), and by risk rating/classification (pass, special mention, substandard, doubtful, and individually measured for impairment). The loss factor used for the general reserve of these loans is established considering the Bank's past 12-month historical loss experience of each segment and the consideration of environmental factors. The sum of the loss experience factors and the environmental factors will be the GVA factor to be used for the determination of the allowance for loan and lease losses on each category.

The consumer portfolio consists of smaller retail loans such as retail credit cards, overdrafts, unsecured personal lines of credit, and personal unsecured loans. The allowance factor, consisting of the historical loss factors and the environmental risk factors will be calculated for each sub-class of loans by delinquency bucket.

The allowance factor on auto and leasing portfolio is impacted by the historical losses, the environmental risk factors and by delinquency buckets. For the determination of the allowance factor, the portfolio will be segmented by FICO score.

The methodology explained before will apply to originated and other loans and to acquired loans accounted for under ASC 310-20.


OVERVIEW OF FINANCIAL PERFORMANCE



SELECTED FINANCIAL DATA

                                  Quarter Ended September 30,            Nine-Month Period Ended September 30,
                                                          Variance                                        Variance
                                 2013          2012           %            2013              2012             %
EARNINGS DATA:                                        (In thousands, except per share data)
Interest income               $  120,642    $   65,686        83.7%   $      360,077     $     196,393        83.3%
Interest expense                  22,010        24,942       -11.8%           62,573            82,482       -24.1%
   Net interest income            98,632        40,744       142.1%          297,504           113,911       161.2%
Provision for non-covered
loan and lease losses              9,900         3,600       175.0%           55,343            10,400       432.1%
Provision for covered loan
and lease losses, net              3,074           221      1291.0%            4,957             8,845       -44.0%
   Total provision for loan
and lease losses, net             12,974         3,821       239.5%           60,300            19,245       213.3%
     Net interest income
after provision for loan
       and lease losses           85,658        36,923       132.0%          237,204            94,666       150.6%
Non-interest income                3,821        14,381       -73.4%           21,828            44,349       -50.8%
Non-interest expenses             63,273        31,649        99.9%          198,903            90,756       119.2%
   Income before taxes            26,206        19,655        33.3%           60,129            48,259        24.6%
Income tax expense (benefit)       6,585         1,894       247.7%         (18,223)             4,888      -472.8%
   Net income                     19,621        17,761        10.5%           78,352            43,371        80.7%
Less: dividends on preferred
stock                            (3,465)       (3,039)       153.0%         (10,396)           (5,440)      -188.7%
   Income available to common
shareholders                  $   16,156    $   14,722         9.7%   $       67,956     $      37,931        79.2%
PER SHARE DATA:
Basic                         $     0.35    $     0.36        -2.7%   $         1.49     $        0.93        60.0%
Diluted                       $     0.34    $     0.35        -2.2%   $         1.38     $        0.92        50.8%
Average common shares
outstanding                       45,927        40,738        12.7%           45,717            40,827        12.0%
Average common shares
outstanding and equivalents       53,322        47,978        11.1%           53,053            43,316        22.5%
Cash dividends declared per
common share                  $     0.06    $     0.06         0.0%   $         0.18     $        0.18         0.0%
Cash dividends declared on
common shares                 $    2,740    $    2,445        12.0%   $        8,219     $       7,331        12.1%
PERFORMANCE RATIOS:
Return on average assets
(ROA)                               0.94%         1.11%      -15.4%             1.22%             0.89%       36.7%
Return on average common
equity (ROE)                        9.20%         9.35%       -1.6%            12.96%             8.06%       60.9%
Equity-to-assets ratio             10.50%        12.75%      -17.7%            10.50%            12.75%      -17.7%
Efficiency ratio                   52.39%        60.87%      -13.9%            54.24%            61.27%      -11.5%
Interest rate spread                5.30%         2.75%       92.7%             5.24%             2.54%      106.3%
Interest rate margin                5.31%         2.82%       88.3%             5.24%             2.60%      101.5%


SELECTED FINANCIAL DATA - (Continued)

                                                   September 30,     December 31,    Variance
                                                       2013              2012           %
PERIOD END BALANCES AND CAPITAL RATIOS:              (In thousands, except per share data)
Investments and loans
   Investments securities                         $     1,703,907    $  2,233,265      -23.7%
   Loans and leases not covered under shared-loss
     agreements with the FDIC, net                      4,767,259       4,762,331        0.1%
   Loans and leases covered under shared-loss
     agreements with the FDIC, net                        361,564         395,307       -8.5%
     Total investments and loans                  $     6,832,730    $  7,390,903       -7.6%
Deposits and borrowings
   Deposits                                       $     5,611,133    $  5,689,563       -1.4%
   Securities sold under agreements to repurchase       1,267,423       1,695,247      -25.2%
   Other borrowings                                       452,001         792,423      -43.0%
     Total deposits and borrowings                $     7,330,557    $  8,177,233      -10.4%
Stockholders' equity
   Preferred stock                                $       176,000    $    176,000        0.0%
   Common stock                                            52,691          52,671        0.0%
   Additional paid-in capital                             538,231         537,453        0.1%
   Legal surplus                                           59,867          52,143       14.8%
   Retained earnings                                      122,747          70,734       73.5%
   Treasury stock, at cost                               (80,642)        (81,275)        0.8%
   Accumulated other comprehensive income                  10,832          55,880      -80.6%
     Total stockholders' equity                   $       879,726    $    863,606        1.9%
Per share data
   Tangible book value per common share           $         15.63    $      15.31        2.1%
   Market price at end of period                  $         16.19    $      13.35       21.3%
Capital ratios
   Leverage capital                                          8.74%           6.42%      36.1%
   Tier 1 risk-based capital                                14.24%          12.94%      10.0%
   Total risk-based capital                                 16.03%          15.15%       5.8%
   Tier 1 common equity to risk-weighted assets             10.24%           9.11%      12.5%
Financial assets managed
   Trust assets managed                           $     2,671,432    $  2,514,401        6.2%
   Broker-dealer assets gathered                  $     2,509,656    $  2,722,196       -7.8%


FINANCIAL HIGHLIGHTS

Income available to common shareholders for the quarter and nine-month period ended September 30, 2013, increased to $16.2 million and $68.0 million, or $0.34 and $1.39 per diluted share, respectively, when compared to the same periods in 2012. The income available to common shareholders shows a significant improvement over the $14.7 million and $37.9 million for the quarter and nine-month period ended September 30, 2012, respectively.

Interest income from loans for the quarter and nine-month period ended September 30, 2013, increased 170.5% and 175.8% when compared with the same periods in 2012, while net interest margin expanded to 5.31% from 2.82% in the third quarter of 2012, and to 5.24% for the nine-month period ended September 30, 2013, from 2.60% for the same period in 2012.

During the quarter ended September 30, 2013, the Company's return on assets was 0.94% and its return on equity was 9.20% . The Company improved its efficiency ratio, which decreased to 52.39% from 60.87% when compared with the same quarter in 2012. For the nine-month period ended September 30, 2013, the Company's return on assets was 1.22% and its return on equity was 12.96% both of which represent improvements from the same period in 2012. The efficiency ratio decreased to 54.24% from 61.27% when compared with the same period in 2012.

Operating revenues for the quarter ended September 30, 2013 increased 85.9%, or $47.3 million, to $102.5 million when compared to the same period in 2012. Operating revenues for the nine-month period ended September 30, 2013 increased 101.8%, or $161.1 million, to $319.3 million when compared to the same period in 2012.

                                   Quarter Ended September 30,        Nine-Month Period Ended
                                                                           September 30,
                                      2013              2012           2013            2012
                                          (In thousands)                   (In thousands)
OPERATING REVENUE
   Net interest income           $        98,632     $    40,744    $   297,504     $   113,911
   Non-interest income, net                3,821          14,381         21,828          44,349
     Total operating revenue     $       102,453     $    55,125    $   319,332     $   158,260

Interest Income

Total interest income for the quarter and nine-month period ended September 30, 2013 increased 83.7% to $120.6 million and 83.3% to $360.1 million, respectively, as compared to the same periods in 2012. This was a result of an increase in interest income from loans of $68.6 million, or 170.5%, and $206.5 million, or 175.8%, when compared to the quarter and nine-month period ended September 30, 2012, respectively. This increase was partially offset by a decrease in interest income from investments of $13.7 million, or 53.7%, and $42.8 million, or 54.2%, compared to the quarter and nine-month period ended September 30, 2012, respectively. This result was related to the BBVAPR Acquisition in which the non-covered loans portfolio increased by approximately $3.6 billion when compared to same period in 2012. In addition, the yield on covered loans increased from 20.37% and 18.50% for the quarter and nine-month period ended September 30, 2012, respectively, to 23.62% and 23.28% for the quarter and nine-month period ended September 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 and nine-month period ended September 30, 2013 amounted $3.3 million and $10.4 million, respectively from certain the leasing and the construction loan pools. The accretable yield amounted to $168.5 million at September 30, 2013 compared to $188.0 million at December 31, 2012.

Interest income from investments reflects a 53.7% and 54.2% decrease for the quarter and nine-month period ended September 30, 2013, as compared to the same periods 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 nine-month period ended September 30, 2013 decreased 11.8% to $22.0 million and 24.1% to $62.6 million, respectively, as compared to the same periods in 2012. This reflects the lower cost of both securities sold under


agreements to repurchase (2.27% vs. 2.03%; 2.08% vs. 2.17%) and deposits (0.80% vs. 1.21%; 0.73% vs. 1.33%) for the quarter and nine-month period ended September 30, 2013, respectively, as compared to the same periods in 2012. Such lower cost reflects continuing progress in the repricing of the Company'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 nine-month period ended September 30, 2013 was $98.6 million and $297.5 million, respectively, an increase of 142.1% and 161.2%, respectively, when compared with the same periods in 2012. The increase was mostly due to the net effect of an increase of 385.4% and 384.1% for the quarter and nine-month period ended September 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 11.8% and 24.1% in interest expense for the same respective periods due to lower cost of funds, partially offset by a decrease of 53.7% and 54.2% for the same respective periods on interest income from investments, related to lower balances from the aforementioned deleverage transactions and a lower yield in the investment securities portfolio.

Net interest margin of 5.31% and 5.24% for the quarter and nine-month period ended September 30, 2013, respectively, increased 249 basis points and 264 basis points when compared to the quarter and nine-month period ended September 30, 2012.

Provision for Loan and Lease Losses

Provision for non-covered loans losses for the quarter and nine-month period ended September 30, 2013 increased $6.3 million and $44.9 million, respectively, when compared to the same periods in 2012. The increase during the nine month period 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 a book value of $59.2 million which most were sold during the quarter ended September 30, 2013 and the increase in loan average balances in 2013. Provision for covered loans losses for the quarter and nine-month period ended September 30, 2013 increased $2.9 million and decreased $3.9 million, respectively, when compared to the same periods in 2012. During the third quarter of 2013, an agricultural loan pool and loans secured by 1-4 single family residential properties registered impairment due to delayed estimated timing of the cash flows on these pools from delayed foreclosure efforts and particular customers declaring bankruptcy.

Non-Interest Income

During the quarter and nine-month period ended September 30, 2013, core banking and financial services revenues increased 96.7% to $22.1 million and 102.3% to $69.2 million, respectively, as compared to the same periods in 2012, primarily reflecting a $9.6 million and $29.1 million increase in banking services revenue to $12.6 million and $38.4 million for the quarter and nine-month period ended September 30, 2013, respectively, attributed to an increase of 153.3% in deposits from September 30, 2012, which is principally attributed to the BBVAPR Acquisition.

The FDIC shared-loss expense of $48.8 million for the nine-month period ended September 30, 2013, respectively, compared to $18.5 million for the same period in 2012, resulted from the ongoing evaluation of expected cash flows of the covered loan portfolio, which resulted in reduced projected losses expected to be collected from the FDIC and the improved accretable yield on the covered loans. During the quarter and nine-month period ended September 30, 2013, the net amortization included $3.3 million and $10.5 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 nine-month period ended September 30, 2013, as compared to gains of $36.4 million and $55.7 million in the same periods in 2012.

Non-Interest Expense

Non-interest expense increased to $63.3 million and $198.9 million for the quarter and nine-month period ended September 30, 2013, respectively, compared to $31.6 million and $90.8 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 $2.3 million and $13.1 million for such periods in 2013, respectively. BBVA integration process is substantially completed. Also, the nine-month period ended September 30, 2013 reflects a $4.1 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 nine-month period ended September 30, 2013 was 52.39% and 54.24%, respectively, compared to 60.87% and 61.27% for the same periods in 2012.

Income Tax Expense

Income tax expense was $6.6 million for the quarter ended September 30, 2013, compared to $1.9 million for the same periods in 2012. Income tax benefit of $18.2 million for the nine-month period ended September 30, 2013 compared to an income tax expense of $4.9 million for the same period in 2012. The income tax benefit of $18.2 million for the nine-month period ended September 30, 2013, was due to the recent amendments to the Puerto Rico tax code that resulted in a $38.6 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% partially offset by the Company's resulting higher effective rate of 36%. The same increase in enacted tax rate from 30% to 39% resulted in the increased quarterly income tax expense for this quarter as compared to the same quarter of 2012.

Income Available to Common Shareholders

For the quarter and nine-month period ended September 30, 2013, the Company's income available to common shareholders amounted to $16.2 million and $68.0 million, respectively, compared to $14.7 million and $37.9 million for the same periods in 2012. Earnings per basic common share and fully diluted common share were $0.35 and $0.34 for the third quarter of 2013, respectively, compared to earnings per basic and fully diluted common share of $0.36 and $0.35 for the third quarter of 2012. Income per basic common share and fully diluted common share were $1.49 and $1.39, respectively, for the nine-month period ended September 30, 2013, compared to income per basic and fully diluted common share of $0.93 and $0.92 for the same period in 2012.

Interest Earning Assets

The loan portfolio declined to $5.129 billion at September 30, 2013 compared to $5.158 billion at December 31, 2012 primarily due to the early pay down of some commercial loans and the sale during the quarter ended September 30, 2013 of non-performing residential mortgage loans with a book value of $59.2 million. The investment portfolio of $1.704 billion at September 30, 2013 decreased 23.7% compared to $2.233 billion at December 31, 2012. The decrease in the investments portfolio is mainly due to redemptions and maturities of investment securities available for sale.

Interest Bearing Liabilities

Total deposits decreased slightly to $5.610 billion at September 30, 2013, compared to $5.690 billion at December 31, 2012. Core deposits, including time deposits, increased 1.1% compared to December 31, 2012, while brokered deposits decreased 14.4%. Securities sold under agreements to repurchase decreased 25.2%, or $427.8 million, as the Company used available cash to pay off $428 million of repurchase agreements at maturity. During the nine-month period ended September 30, 2013, the Company settled, prior to maturity, a former BBVAPR subordinated note of $50 million.

Stockholders' Equity

Stockholders' equity at September 30, 2013 was $879.7 million compared to $863.6 million at December 31, 2012, an increase of 1.9%. This increase reflects the net income for the nine-month period ended September 30, 2013, partially offset by the change in other comprehensive income.

Book value per share was $15.63 at September 30, 2013 compared to $15.31 at December 31, 2012.

The Company maintains capital ratios in excess of regulatory requirements. At September 30, 2013, Tier 1 Leverage Capital Ratio was 8.74%, Tier 1 Risk-Based Capital Ratio was 14.24%, and Total Risk-Based Capital Ratio was 16.03%.

Return on Average Assets and Common Equity


Return on average common equity ("ROE") for the quarter and nine-month period ended September 30, 2013 was 9.20% and 12.96%, respectively, up from 9.35% and 8.06% for the quarter and nine-month period ended September 30, 2012, respectively. Return on average assets ("ROA") for the quarter and nine-month period ended September 30, 2013 was 0.94% and 1.22%, respectively, from 1.11% and 0.89% for the same periods in 2012. The decrease in ROE and ROA for the . . .

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