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OFG > SEC Filings for OFG > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for OFG BANCORP

Form 10-Q for OFG BANCORP


8-Aug-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, Wealth Management, 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. Same analysis was performed for the commercial portfolio during the quarter ended June 30, 2014. As a result, the period was changed to 24 months from the previously determined 12 months for auto and leasing and consumer. For the commercial portfolio, a look back period of 12 months was maintained. In addition, during the quarter ended June 30, 2014, an assessment of environmental factors was performed for commercial, auto, and consumer portfolios. As a result, more weight is been given to the environmental factors related to the economy, taking into consideration current evolution of the portfolio and expected impact, due to recent economic developments. These changes in the allowance for loan and lease losses' look back period for the consumer and auto and leasing portfolios, and economic factors for the commercial, auto, and consumer portfolios are considered a change in accounting estimate as per ASC 250-10 provisions, where adjustments should be made prospectively. Apart from these changes, 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 June 30,               Six-Month Period Ended June 30,
                                                              Variance                                 Variance
                                    2014          2013            %          2014          2013            %
EARNINGS DATA:                                        (In thousands, except per share data)
Interest income                  $  125,900    $   126,302        -0.3%   $  248,974    $   240,474         3.5%
Interest expense                     19,822         20,007        -0.9%       39,498         40,565        -2.6%
   Net interest income              106,078        106,295        -0.2%      209,476        199,909         4.8%
Provision for non-covered loan
and lease losses                     13,220         37,527       -64.8%       23,282         45,443       -48.8%
Provision for covered loan and
lease losses, net                     1,595          1,211        31.7%        3,224          1,883        71.2%
   Total provision for loan and
lease losses, net                    14,815         38,738       -61.8%       26,506         47,326       -44.0%
     Net interest income after
provision for loan
       and lease losses              91,263         67,557        35.1%      182,970        152,583        19.9%
Non-interest income                     507          6,735       -92.5%        5,736         16,638       -65.5%
Non-interest expenses                59,848         68,687       -12.9%      121,252        135,298       -10.4%
   Income before taxes               31,922          5,605       469.5%       67,454         33,923        98.8%
Income tax expense (benefit)         10,613       (31,934)       133.2%       22,398       (24,808)       190.3%
   Net income                        21,309         37,539       -43.2%       45,056         58,731       -23.3%
Less: dividends on preferred
stock                               (3,466)        (3,466)       153.0%      (6,931)        (6,931)       153.0%
   Income available to common
shareholders                     $   17,843    $    34,073       -47.6%   $   38,125    $    51,800       -26.4%
PER SHARE DATA:
Basic                            $     0.40    $      0.75       -46.7%   $     0.84    $      1.14       -26.3%
Diluted                          $     0.38    $      0.68       -44.1%   $     0.80    $      1.05       -23.8%
Average common shares
outstanding                          45,014         45,638        -1.4%       45,170         45,613        -1.0%
Average common shares
outstanding and equivalents          52,352         52,968        -1.2%       52,476         52,929        -0.9%
Cash dividends declared per
common share                     $     0.08    $      0.06        33.3%   $     0.16    $      0.12        33.3%
Cash dividends declared on
common shares                    $    3,560    $     2,742        29.8%   $    7,217    $     5,479        31.7%
PERFORMANCE RATIOS:
Return on average assets (ROA)         1.10%          1.76%      -37.5%         1.14%          1.35%      -15.6%
Return on average tangible
common equity                         10.96%         22.75%      -51.8%        11.89%         17.35%      -31.5%
Return on average common equity
(ROE)                                  9.54%         19.50%      -51.1%        10.32%         14.86%      -30.6%
Equity-to-assets ratio                12.00%         10.32%       16.2%        12.00%         10.32%       16.2%
Efficiency ratio                      47.89%         52.49%       -8.8%        48.99%         54.80%      -10.6%
Interest rate spread                   6.05%          5.65%        7.1%         5.91%          5.26%       12.4%
Interest rate margin                   6.10%          5.66%        7.8%         5.96%          5.26%       13.3%


SELECTED FINANCIAL DATA - (Continued)

                                                     June 30,        December 31,    Variance
                                                       2014              2013           %
PERIOD END BALANCES AND CAPITAL RATIOS:              (In thousands, except per share data)
Investments and loans
   Investment securities                          $    1,471,723     $  1,614,809       -8.9%
   Loans and leases not covered under shared-loss
     agreements with the FDIC, net                     4,601,696        4,662,458       -1.3%
   Loans and leases covered under shared-loss
     agreements with the FDIC, net                       334,344          356,961       -6.3%
     Total investments and loans                  $    6,407,763     $  6,634,228       -3.4%
Deposits and borrowings
   Deposits                                       $    5,141,233     $  5,383,265       -4.5%
   Securities sold under agreements to repurchase      1,012,233        1,267,618      -20.1%
   Other borrowings                                      464,874          439,816        5.7%
     Total deposits and borrowings                $    6,618,340     $  7,090,699       -6.7%
Stockholders' equity
   Preferred stock                                $      176,000     $    176,000        0.0%
   Common stock                                           52,730           52,707        0.0%
   Additional paid-in capital                            538,936          538,071        0.2%
   Legal surplus                                          66,438           61,957        7.2%
   Retained earnings                                     160,055          133,629       19.8%
   Treasury stock, at cost                              (90,712)         (80,642)      -12.5%
   Accumulated other comprehensive income                 21,755            3,191      581.8%
     Total stockholders' equity                   $      925,202     $    884,913        4.6%
Per share data
   Book value per common share                    $        16.87     $      15.45        9.2%
   Tangible book value per common share           $        14.71     $      13.27       10.9%
   Market price at end of period                  $        18.41     $      17.34        6.2%
Capital ratios
   Leverage capital                                        10.26%            9.11%      12.6%
   Tier 1 risk-based capital                               15.49%           14.35%       7.9%
   Total risk-based capital                                17.30%           16.14%       7.2%
   Tier 1 common equity to risk-weighted assets            11.47%           10.44%       9.9%
Financial assets managed
   Trust assets managed                           $    2,866,576     $  2,796,923        2.5%
   Broker-dealer assets gathered                  $    2,651,291     $  2,493,324        6.3%


FINANCIAL HIGHLIGHTS OF THE SECOND QUARTER OF 2014

Income available to common shareholders for the quarter ended June 30, 2014 was $17.8 million, or $0.38 per diluted share. In the quarter ended June 30, 2013, the Company earned $34.1 million or $0.68 per diluted share, which included a net positive impact of $16.3 million from non-recurring items. Such non-recurring items included a $37.0 million deferred income tax benefit as result of the change in tax rate from 30% to 39%, $13.6 million of additional provision for non-performing mortgage loans transferred to held for sale, $8.5 million for the catch up of the first quarter of 2013 income tax expense as a result of the increase in effective income tax rate from 25% to 35%, and a $1.4 million net gain on the sale of a claim on insolvency proceeding.

Net interest margin expanded to 6.10% from 5.66% primarily as a result of an increase in the yield of the Company's interest earning assets.

The Company's return on assets was 1.10%, and its return on equity was 9.54%, each of which were decreases from 1.76% and 19.50%, respectively, from the second quarter of 2013. The Company improved its efficiency ratio, which decreased to 47.89% from 52.49% when compared with the same quarter in 2013, primarily as a result of a decrease in the Company's non-interest expenses.

Interest Income

Total interest income slightly decreased 0.3% to $125.9 million. This was mainly related to the decrease in interest income from loans of $2.2 million, or 1.9%, in the second quarter of 2014. The yield on non-covered loans decreased from 7.80% to 7.55% when compared to the same period in 2013 as a result of a decrease in the yield of acquired loans accounted for under ASC 310-20 from 6.29% to 6.20%, as this portfolio continues to decrease due to scheduled repayments and maturities. Nevertheless, the yield on covered loans increased from 25.70% to 29.06%. 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 and results mainly from favorable workout resolutions with borrowers.

Interest income from investments reflects a 15.7% increase. The increase is mainly due to the increase in the investments' yield to 2.66% as compared to 1.81%, driven by lower premium amortization.

Interest Expense

Total interest expense slightly decreased 0.9% to $19.8 million, as compared to the same period in 2013. Such decrease reflects the lower cost of deposits before purchase accounting adjustments (0.76% vs. 0.96%). Such lower cost reflects continuing progress in the repricing of the Company's core retail deposits and other reductions in its cost of funds.

Net Interest Income

Net interest income remained level at $106.1 million for the second quarter of 2014. Net interest margin of 6.10% increased 45 basis points when compared to the second quarter of 2013.


Provision for Loan and Lease Losses

Provision for non-covered loans losses decreased $24.3 million when compared to $37.5 million for the second quarter of 2013, which included the impact of a $21.0 million additional provision due to the reclassification to held-for-sale of $59 million non-performing residential mortgage loans. Excluding this effect, the provision would have been $16.5 million, compared to $13.2 for the second quarter of 2014. Provision for covered loans losses increased $384 thousand when compared to the same period in 2013.

Non-Interest Income

Core banking and financial services revenues decreased 23.2% to $18.9 million as compared to the same period in 2013, primarily reflecting a decrease of $2.7 million in banking services revenue to $10.0 million, and a decrease of $2.3 million in the mortgage banking activities to $1.6 million. Decrease in banking services revenues is mostly due to the reclassification of loan late charges into interest income during the last quarter of 2013. For the quarter and six-month period ended June 30, 2013 these revenues were included as part of banking activities, since the reclassification was not reflected until late 2013. Decrease in mortgage banking activities is mainly due to higher losses in repurchased loans and decrease in sales, when compared to same period in 2013.

The FDIC shared-loss expense of $18.4 million, compared to $20.0 million for the same period in 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.

Losses from derivative activities were $247 thousand, compared to $164 thousand for the same period in 2013.

Non-Interest Expense

Non-interest expense, decreased to $59.8 million, compared to $68.7 million for the same period in 2013, mainly because during the second quarter of 2014, there were no merger and restructuring charges compared to $5.3 million for the same period in 2013. As a result of such decrease, the Company's efficiency ratio improved to 47.89%, compared to 52.49% for the same period in 2013.

Income Tax Expense

Income tax expense was $10.6 million, compared to an income tax benefit of $31.9 million for the same period in 2013. The income tax benefit for the quarter ended June 30, 2013 included a $36.9 million benefit from the effect in deferred taxes due to the increase in tax rates from 30.0% to 39.0%.

Income Available to Common Shareholders

The Company's income available to common shareholders amounted to $17.8 million, compared to $34.1 million for the same period in 2013. Income per basic common share and fully diluted common share was $0.40 and $0.38, respectively, compared to income per basic common share and fully diluted common share of $0.75 and $0.68, respectively, for the second quarter of 2013.

Interest Earning Assets

The loan portfolio declined to $4.936 billion at June 30, 2014, compared to $5.003 billion at March 31, 2014, primarily due to the pay down of some commercial loans. The investment portfolio of $1.472 billion at June 30, 2014 decreased slightly 0.7% compared to $1.482 billion at March 31, 2014.

Interest Bearing Liabilities

Total deposits amounted to $5.141 billion at June 30, 2014, a decrease of 3.1% compared to $5.301 billion at March 31, 2014. Securities sold under agreements to repurchase remained at $1.012 billion.


Stockholders' Equity

Stockholders' equity at June 30, 2014 was $925.2 million compared to $896.5 million at March 31, 2014, an increase of 3.2%. This increase reflects the net income for the quarter and an increase in other comprehensive income. Book value per share was $16.87 at June 30, 2014 compared to $16.23 at March 31, 2014.

The Company maintains capital ratios in excess of regulatory requirements. At June 30, 2014, Tier 1 Leverage Capital Ratio was 10.26% (March 31, 2014 - 9.51%), Tier 1 Risk-Based Capital Ratio was 15.49% (March 31, 2014 - 14.76%), and Total Risk-Based Capital Ratio was 17.30% (March 31, 2014 - 16.56%).

Return on Average Assets and Common Equity

Return on average common equity ("ROE") was 9.54% compared to 19.50% for the quarter ended June 30, 2013. Return on average assets ("ROA") was 1.10% compared to 1.76% for the same period in 2013. The decreases in ROE and ROA are mostly due to a 43.2% decrease in net income from $37.5 million to $21.3 million in the second quarter of 2014.

Assets under Management

At June 30, 2014, total assets managed by the Company's trust division and CPC increased 2.5% to $2.867 billion compared to $2.798 billion at March 31, 2014. At June 30, 2014, total assets gathered by the securities broker-dealer subsidiary from its customer investment accounts increased 2.9% to $2.651 billion, compared to $2.577 billion at March 31, 2014. 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 $221.6 million decreased 32.3% from the second quarter of 2013. Total commercial loan production of $45.4 million decreased 56.6% from $104.5 million for the same period in 2013.

Mortgage loan production of $52.0 million decreased 48.7% from the same period in 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 totaled $124.2 million, a slight increase of 2.3% from the same period in 2013.

Total loan portfolio declined by $66.6 million from $5.003 billion at March 31, 2014 to $4.936 billion at June 30, 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, decreased $26.3 million to $6.3 million, representing 0.96% of average non-covered loans outstanding versus 8.89% in the same period in 2013.The credit losses for the quarter ended June 30, 2013, included a $27 million charge-off from nonperforming mortgage loans reclassified as held-for-sale. The allowance for loan and lease losses on non-covered loans at June 30, 2014, increased to $60.4 million compared to $56.2 million at March 31, 2014. The allowances for loan and lease losses, excluding acquired loans, increased to $50.6 million (1.92% of total non-covered loans, excluding acquired loans) at June 30, 2014, compared to $49.5 million (1.95% of total non-covered loans, excluding acquired loans) at March 31, 2014. The allowance for loan and lease losses on acquired loans accounted for under ASC 310-20 decreased to $3.4 million at June 30, 2014, compared to $3.6 million at March 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 $94.1 million at June 30, 2014 compared to $88.2 million at March 31, 2014. The increase is due mainly to increase in non-performing mortgage 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 June 30, 2014, the Company's pre-tax pre-provision operating income decreased 3.5% to $65.1 million as compared to $67.4 million for the same period in 2013. Pre-tax pre-provision operating income is calculated as follows:

                                   Quarter Ended June 30,         Six-Month Period Ended June 30,
                                    2014           2013             2014                       2013
                                       (In thousands)                      (In thousands)
PRE-TAX PRE-PROVISION OPERATING
INCOME
   Net interest income           $   106,078    $  106,295    $       209,476     $         199,909
   Core non-interest income:
     Banking service revenue           9,995        12,705             20,552                24,345
     Financial service revenue         7,336         8,030             14,203                15,690
     Mortgage banking activities       1,554         3,827              3,249                 6,963
       Total core non-interest        18,885        24,562             38,004                46,998
income
     Non-interest expenses            59,848        68,687            121,252               135,298
     Less merger and                       -       (5,273)                  -              (10,808)
restructuring charges
                                      59,848        63,414            121,252               124,490
         Total pre-tax           $    65,115    $   67,443    $       126,228     $         122,417
pre-provision operating income

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 June 30, 2014, tangible common equity to total assets and tangible common equity to risk-weighted assets increased to 8.59% and 13.26%, respectively, from 8.06% and 12.54%, respectively, at March 31, 2014. Total equity to risk-weighted assets and Tier 1 common equity to risk-weighted assets at June 30, 2014 increased to 18.52% and 11.47%, respectively, from 17.75% and 10.79%, respectively, at March 31, 2014.

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 . . .

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