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OFG > SEC Filings for OFG > Form 10-Q on 9-May-2014All Recent SEC Filings

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Form 10-Q for OFG BANCORP


9-May-2014

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 2013 Form 10-K for the year ended December 31, 2013 (the "2013 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.

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 the 2013 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 2013 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. As part of the Company's continuous enhancement to the allowance for loan and lease losses methodology, during the quarter ended March 31, 2014, an assessment of the look-back period and historical loss factor was performed for auto and leasing and consumer loan portfolios based on the trends observed and their relation with the economic cycle as of the period ended March 31, 2014. As a result, the period was changed to 24 months from the previously determined 12 months. This change in the allowance for loan and lease losses' look back period for the consumer and auto and leasing portfolios is considered a change in accounting estimate as per ASC 250-10 provisions, where adjustments should be made prospectively. Apart from this change, there have been no other material changes in the methods used to formulate these critical accounting estimates from those discussed in our 2013 Form 10-K.


OVERVIEW OF FINANCIAL PERFORMANCE



SELECTED FINANCIAL DATA

                                                            Quarter Ended March 31,
                                                                                     Variance
                                                      2014              2013             %
EARNINGS DATA:                                       (In thousands, except per share data)
Interest income                                   $     123,074     $     114,172         7.8%
Interest expense                                         19,676            20,556        -4.3%
   Net interest income                                  103,398            93,616        10.4%
Provision for non-covered loan and lease losses          10,062             7,916        27.1%
Provision for covered loan and lease losses, net          1,629               672       142.4%
   Total provision for loan and lease losses, net        11,691             8,588        36.1%
     Net interest income after provision for loan
       and lease losses                                  91,707            85,028         7.9%
Non-interest income                                       5,278            10,099       -47.7%
Non-interest expenses                                    61,453            66,809        -8.0%
   Income before taxes                                   35,532            28,318        25.5%
Income tax expense (benefit)                             11,785             7,126        65.4%
   Net income                                            23,747            21,192        12.1%
Less: dividends on preferred stock                      (3,465)           (3,465)       153.0%
   Income available to common shareholders        $      20,282     $      17,727        14.4%
PER SHARE DATA:
Basic                                             $        0.45     $        0.39        15.4%
Diluted                                           $        0.42     $        0.37        13.5%
Average common shares outstanding                        45,329            45,595        -0.6%
Average common shares outstanding and equivalents        52,598            52,898        -0.6%
Cash dividends declared per common share          $        0.08     $        0.06         0.0%
Cash dividends declared on common shares          $       3,657     $       2,737        33.6%
PERFORMANCE RATIOS:
Return on average assets (ROA)                             1.18%             0.96%       22.9%
Return on average tangible common equity                  12.86%            11.92%        7.9%
Return on average common equity (ROE)                     11.13%            10.20%        9.1%
Equity-to-assets ratio                                    11.41%             9.98%       14.4%
Efficiency ratio                                          50.03%            57.46%      -12.9%
Interest rate spread                                       5.87%             4.91%       19.6%
Interest rate margin                                       5.90%             4.90%       20.4%


SELECTED FINANCIAL DATA - (Continued)

                                                     March 31,       December 31,    Variance
                                                       2014              2013           %
PERIOD END BALANCES AND CAPITAL RATIOS:              (In thousands, except per share data)
Investments and loans
   Investments securities                         $    1,482,090     $  1,614,809       -8.2%
   Loans and leases not covered under shared-loss
     agreements with the FDIC, net                     4,654,749        4,662,458       -0.2%
   Loans and leases covered under shared-loss
     agreements with the FDIC, net                       347,865          356,961       -2.5%
     Total investments and loans                  $    6,484,704     $  6,634,228       -2.3%
Deposits and borrowings
   Deposits                                       $    5,300,992     $  5,383,265       -1.5%
   Securities sold under agreements to repurchase      1,012,240        1,267,618      -20.1%
   Other borrowings                                      463,513          439,816        5.4%
     Total deposits and borrowings                $    6,776,745     $  7,090,699       -4.4%
Stockholders' equity
   Preferred stock                                $      176,000     $    176,000        0.0%
   Common stock                                           52,714           52,707        0.0%
   Additional paid-in capital                            538,287          538,071        0.0%
   Legal surplus                                          64,292           61,957        3.8%
   Retained earnings                                     147,919          133,629       10.7%
   Treasury stock, at cost                              (90,743)         (80,642)      -12.5%
   Accumulated other comprehensive income                  8,022            3,191      151.4%
     Total stockholders' equity                   $      896,491     $    884,913        1.3%
Per share data
   Book value per common share                    $        16.23     $      15.74        3.1%
   Tangible book value per common share           $        14.07     $      13.60        3.5%
   Market price at end of period                  $        17.19     $      17.34       -0.9%
Capital ratios
   Leverage capital                                         9.51%            9.11%       4.4%
   Tier 1 risk-based capital                               14.76%           14.35%       2.9%
   Total risk-based capital                                16.56%           16.14%       2.6%
   Tier 1 common equity to risk-weighted assets            10.79%           10.44%       3.4%
Financial assets managed
   Trust assets managed                           $    2,797,778     $  2,796,923        0.0%
   Broker-dealer assets gathered                  $    2,576,991     $  2,493,324        3.4%


FINANCIAL HIGHLIGHTS

Income available to common shareholders for the quarter ended March 31, 2014, increased to $20.3 million, or $0.42 per diluted share, when compared to the same period in 2013.

During the quarter ended March 31, 2014, the Company's return on assets was 1.18% and its return on equity was 11.13%. The Company improved its efficiency ratio, which decreased to 50.03% from 57.46% when compared with the same period in 2013.

Operating revenues for the quarter ended March 31, 2014 increased 4.8%, or $5.0 million, to $108.7 million when compared to the same period in 2013.

                               Quarter Ended March 31,
                                 2014           2013
                                   (In thousands)
OPERATING REVENUE
   Net interest income       $    103,398    $   93,616
   Non-interest income              5,278        10,099
     Total operating revenue $    108,676    $  103,715

Interest Income

Total interest income for the quarter ended March 31, 2014 increased 7.8% to $123.1 million, as compared to the same period in 2013. This was mainly related to an increase in interest income from loans of $7.6 million, or 7.5% when compared to the same period in 2013. The yield on covered loans increased from 20.98% in the quarter ended March 31, 2013 to 26.68% for the quarter ended March 31, 2014. 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 pools. The covered portfolio is having cost recoveries on pools with lower carrying amounts, and these have the effect of increasing net interest income. In addition, the yield on non-covered loans increased from 6.98% in the quarter ended March 31, 2013 to 7.43% for the quarter ended March 31, 2014.

Interest income from investments reflects a 9.9% increase for the quarter ended March 31, 2014, as compared to the same period in 2013. The increase is mainly due to the increase in the investments yield to 2.79% for the quarter ended March 31, 2014 as compared to 2.0% for the same period in 2013 driven by lower premium amortization.

Interest Expense

Total interest expense for the quarter ended March 31, 2014, decreased 4.3% to $19.7 million, as compared to the quarter ended March 31, 2013. This reflects the lower cost of deposits (0.68% vs. 72%) for the quarter ended March 31, 2014, as compared to the same period in 2013. Such lower cost reflects continuing progress in the repricing of the Company's core retail deposits.

Net Interest Income

Net interest income for the quarter ended March 31, 2014, was $103.4 million, an increase of 10.4% when compared with the same period in 2013. The increase was mostly due the net effect of a 7.8% increase in total interest income and a decrease of 4.3% in interest expense due to lower cost of funds. Net interest margin of 5.90% for the quarter ended March 31, 2014, increased 100 basis points when compared to the quarter ended March 31, 2013.

Provision for Loan and Lease Losses

Provision for non-covered loans losses for the quarter ended March 31, 2014 increased $2.1 million when compared to the quarter ended March 31, 2013. Provision for covered loans losses for the quarter ended March 31, 2014 increased $957 thousand when compared to the quarter ended March 31, 2013.


Non-Interest Income

During the first quarter of 2014, core banking and financial services revenues decreased 14.3% to $19.4 million as compared to the quarter ended March 31, 2013, primarily reflecting a $1.2 million decrease in both, banking services revenue to $10.6 million and mortgage banking activities to $2.0 million for the first quarter of 2014. Decrease in banking services revenues is mostly due to the reclassification of loan late charges into interest income. Decrease in mortgage banking activities is mainly due to higher losses in repurchased loans, lower cost or market adjustment made to mortgage loans held for sale during such quarter of 2014 and decrease in sales, when compared to same period in 2013.

The FDIC shared-loss expense of $18.5 million for the first quarter of 2014 compared to $12.9 million for the first quarter of 2013, 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 ended March 31, 2014, the net amortization included $3.5 million of additional amortization of the FDIC indemnification asset from stepped up cost recoveries on certain construction and leasing loan pools.

Results from the quarter ended March 31, 2014 included a gain on sale of securities of $4.4 million. During the quarter ended March 31, 2013, the Company did not have any gain or loss on sale of securities. Losses from derivative activities were $478 thousand for the quarter ended March 31, 2014, compared to $788 thousand for the same period in 2013. There was no gain or loss on extinguishment of debt for the quarter ended March 31 2014, compared to a gain of $1.1 million for the same period in 2013.

Non-Interest Expense

Non-interest expense for the quarter ended March 31, 2014 decreased to $61.5 million, compared to $66.8 million for the same period in 2013. During the quarter ended March 31 2014, there were no merger and restructuring charges compared to $5.5 million for the same period in 2013. The efficiency ratio for the first quarter of 2014 was 50.03% compared to 57.46% for the same period in 2013 driven mostly by a decrease in non-interest expenses and an increase in net income.

Income Tax Expense

Income tax expense was $11.8 million for the first quarter of 2014 compared to $7.1 million for the first quarter of 2013. The increase for the first quarter of 2014 was primarily due to the recent amendments to the Puerto Rico tax code that increases the corporate income tax rate to 39% from 30%.

Income Available to Common Shareholders

For the first quarter of 2014, the Company's income available to common shareholders amounted to $20.3 million compared to $17.7 million for the first quarter of 2013. Income per basic common share and fully diluted common share was $0.45 and $0.42, respectively, for the first quarter of 2014, compared to income per basic common share and fully diluted common share of $0.39 and $0.37, respectively, for the first quarter of 2013.

Interest Earning Assets

The loan portfolio declined to $5.003 billion at March 31, 2014, compared to $5.019 billion at December 31, 2013, primarily due to the early pay down of some commercial loans. The investment portfolio of $1.482 billion at March 31, 2014 decreased 8.2% compared to $1.615 billion at December 31, 2013. During the quarter ended March 31, 2014, the Company sold $110.8 million of mortgage-backed available for sale securities taking advantage of market opportunities to realize gains and reduce some interest rate sensitivity.

Interest Bearing Liabilities

Total deposits amounted to $5.301 billion at March 31, 2014, a decrease of 1.5% compared to $5.383 billion at December 31, 2013. Non-maturing deposit balances increased 3.7%, to $3.5 billion, while higher-priced time deposits declined 10.0% as part of efforts to reduce the cost of deposits, which averaged 0.68% at March 31, 2014 compared to 0.72% at March 31, 2013. Securities sold under agreements to repurchase decreased 20.1%, or $255.3 million, as the Company used available cash to pay off $255.0 million of repurchase agreements at maturity.


Stockholders' Equity

Stockholders' equity at March 31, 2014 was $896.5 million compared to $884.9 million at December 31, 2013, an increase of 1.3%. This increase reflects the net income for the first quarter of 2014 and an increase in other comprehensive income, partially offset by treasury stock repurchases.

Book value per share was $16.23 at March 31, 2014 compared to $15.74 at December 31, 2013.

The Company maintains capital ratios in excess of regulatory requirements. At March 31, 2014, Tier 1 Leverage Capital Ratio was 9.51%, Tier 1 Risk-Based Capital Ratio was 14.76%, and Total Risk-Based Capital Ratio was 16.56%.

Return on Average Assets and Common Equity

Return on average common equity ("ROE") for the quarter ended March 31, 2014 was 11.13% compared to 10.20% for the quarter ended March 31, 2013. Return on average assets ("ROA") for the quarter ended March 31, 2014 was 1.18% compared to 0.96% for the same period in 2013. The increases in ROE and ROA are mostly due to 12.1% increase in net income from $21.2 million in the quarter ended March 31, 2013 to $23.7 million in the quarter ended March 31, 2014, and to the decrease of 8.0% in average assets and 4.8% in average common equity from the same period in 2013.

Assets under Management

At March 31, 2014, total assets managed by the Company's trust division and CPC remained leveled at $2.798 billion compared to December 31, 2013. At March 31, 2014, total assets managed by the securities broker-dealer subsidiary from its customer investment accounts increased 3.4% to $2.577 billion, compared to $2.493 billion at December 31, 2013. Changes in trust and broker-dealer related assets primarily reflect a slight increase in portfolio and differences in market values.

Lending

Total loan production of $212.0 million for the quarter ended March 31, 2014 decreased 22.8% from the quarter ended March 31, 2013. Generally, loan demand for the quarter ended March 31, 2014 was lower compared to the same period of 2013. Total commercial loan production of $39.8 million for the quarter ended March 31, 2014, decreased 46.3% from $77.1 million in the quarter ended March 31, 2013.

Mortgage loan production of $50.8 million for the quarter ended March 31, 2014 decreased 34.1% from the quarter ended March 31, 2013. The Company sells most of its conforming mortgage loans in the secondary market and retains the servicing rights.

In the aggregate, consumer loan and auto and leasing production for the quarter ended March 31, 2014, totaled $121.4 million, a slight decrease of 1.8% from the quarter ended March 31, 2013.

Total loan portfolio declined by $16.8 million from $5.019 billion at December 31, 2013 to $5.002 billion at March 31, 2014, mostly as the result of scheduled pay downs and maturities in both the non-covered and covered loan portfolios.

Credit Quality on Non-Covered Loans

Net credit losses, excluding acquired loans, increased $1.8 million to $5.2 million for the quarter ended March 31, 2014, representing 0.86% of average non-covered loans outstanding versus 1.06% for the quarter ended March 31, 2013. The allowance for loan and lease losses on non-covered loans at March 31, 2014, increased to $56.2 million compared to $54.3 million at December 31, 2013. The allowances for loan and lease losses, excluding acquired loans, increased to $49.5 million (1.95% of total non-covered loans, excluding acquired loans) at March 31, 2014, compared to $49.1 million (2.4% of total non-covered loans, excluding acquired loans) at December 31, 2013. The allowance for loan and lease losses on acquired loans accounted for under ASC 310-20 increased to $3.6 million at March 31, 2014, compared to $2.4 million at December 31, 2014.

Non-performing loans ("NPLs"), which exclude loans covered under shared-loss agreements with the FDIC and loans acquired in the BBVAPR Acquisition accounted under ASC 310-30, increased to $88.2 million at March 31, 2014 compared to $86.2 million at December 31, 2013. The increase is due mainly to increase in non-performing consumer and auto loans.


Non-GAAP Measures

The Company uses certain non-GAAP measures of financial performance to supplement the unaudited consolidated financial statements presented in accordance with GAAP. The Company presents non-GAAP measures that management believes are useful and meaningful to investors. Non-GAAP measures do not have any standardized meaning, are not required to be uniformly applied, and are not audited. Therefore, they are unlikely to be comparable to similar measures presented by other companies. The presentation of non-GAAP measures is not intended to be a substitute for, and should not be considered in isolation from, the financial measures reported in accordance with GAAP.

The Company's management has reported and discussed the results of operations herein both on a GAAP basis and on a pre-tax pre-provision operating income basis (defined as net interest income, plus banking and financial services revenue, less non-interest expenses, as calculated on the table below). The Company's management believes that, given the nature of the items excluded from the definition of pre-tax pre-provision operating income, it is useful to state what the results of operations would have been without them so that investors can see the financial trends from the Company's continuing business.

During the quarter ended March 31, 2014, the Company's pre-tax pre-provision operating income was approximately $61.4 million, an increase of 11.6% from $55.0 million for the same quarter in 2013. Pre-tax pre-provision operating income is calculated as follows:

                                                        Quarter Ended March 31,
                                                          2014           2013
                                                            (In thousands)
PRE-TAX PRE-PROVISION OPERATING INCOME
   Net interest income                                $    103,398    $   93,616
   Core non-interest income:
     Banking service revenue                                10,606        11,838
     Financial service revenue                               6,867         7,660
     Mortgage banking activities                             1,950         3,153
       Total core non-interest income                       19,423        22,651
     Non-interest expenses                                  61,453        66,809
     Less merger and restructuring charges                       -       (5,534)
                                                            61,453        61,275
         Total pre-tax pre-provision operating income $     61,368    $   54,992

Tangible common equity consists of common equity less goodwill, core deposit intangibles and customer relationship intangible. Tier 1 common equity consists of common equity less goodwill, core deposit intangibles, net unrealized gains on available for sale securities, net unrealized losses on cash flow hedges, and disallowed deferred tax asset and servicing assets. Tangible book value per common share consists of tangible common equity divided by common stock outstanding at the end of the period. Ratios of tangible common equity to total assets, tangible common equity to risk-weighted assets, total equity to risk-weighted assets, and Tier 1 common equity to risk-weighted assets and tangible book value per common share are non-GAAP measures.

At March 31, 2014, tangible common equity to total assets and tangible common equity to risk-weighted assets increased to 8.06% and 12.54%, respectively, from 7.61% and 12.10%, respectively, at December 31, 2013. Total equity to risk-weighted assets and Tier 1 common equity to risk-weighted assets at March 31, 2014 increased to 17.75% and 10.79%, respectively, from 17.23% and 10.44%, respectively, at December 31, 2013.

Ratios calculated based upon Tier 1 common equity have become a focus of regulators and investors, and management believes ratios based on Tier 1 common equity assist investors in analyzing the Company's capital position. Furthermore, management and many stock analysts use tangible common equity in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations. Neither Tier 1 common equity nor tangible common equity or related measures should be considered in isolation or as a substitute for stockholders' equity, total assets or any other measure calculated in accordance with GAAP.


ANALYSIS OF RESULTS OF OPERATIONS

The following tables show major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the quarters ended March 31, 2014 and 2013:

TABLE 1 - QUARTERLY ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE QUARTERS ENDED MARCH 31, 2014 AND 2013
. . .
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