First Bancorp /Pr/ Q3 FY2020 Earnings Call

Good morning, and welcome to the First BanCorp Third Quarter Earnings Conference Call and Webcast. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to John Pelling, IRO. Please go ahead.

Thank you, Debbie. Good morning, everyone, and thank you for joining First BanCorp’s conference call and webcast to discuss the company’s financial results for the third quarter 2020. Joining you today from First BanCorp are Aurelio Alemán, President and Chief Executive Officer; and Orlando Berges, Executive Vice President and Chief Financial Officer. Before we begin today’s call, it is my responsibility to inform you that this call may involve certain forward-looking statements such as projections of revenue earnings and capital structure as well as statements on the plans and objectives of the company’s business. The company’s actual results could differ materially from the forward-looking statements made due to important factors described in the company’s latest SEC filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the webcast presentation or press release, you can access them at our website, 1firstbank.com. At this time, I’d like to turn the call over to our CEO, Aurelio Alemán. Aurelio?

Thank you, John. Good morning, everyone, and thanks for joining our earnings call today. Please let’s move to Slide 4 of the presentation. It was a very important quarter for our corporation and I would like to go over some key highlights and then expand on certain matters. First of all, we’re extremely pleased that we completed our strategic acquisition by closing the Santander transaction on September 1. This transaction not only solidifies our position in the market, but strengthens our competitiveness in commercial, retail, as well as residential sectors. We’re very pleased to welcome our 150,000 new customers. We look forward to supporting them with our expanded branch network, expanded service channels, and enhanced technological offerings. On the economic front, the relief funds from the pandemic, combined with 2017 hurricane funds, have bolstered liquidity in our market, and we’ll continue to drive economic activity. We’ll touch on that later. On the balance sheet side, even following the completion of the acquisition, we truly sustain a fortress balance sheet; our liquidity, reserve, and capital levels are among the highest in the banking sector. FirstBank was strong for the quarter, generating $28.6 million of net income pre-tax. Pre-provision income was $77 million with only one month of earnings from the acquired operations, and loan originations were strong at $971 million for the quarter. We basically increased originations in all categories throughout the quarter. Total deposits, including broker and government, increased to $12.5 million. Lastly, our capital ratios remain among the highest in the banking sectors, and capital actions remain a priority as we see the economic environment stabilizing. Now let’s cover more closely, as you can see on Slide 6, starting with the transaction itself, which was a long time in the making. As you see, we have improved our market position in all key areas. The transaction was announced back in October 2019 and its closing was impacted by the COVID pandemic. Since then, our metrics have improved since the announcement. We still expect a 35% EPS accretion to consensus estimates. The revised TBV at closing is estimated to be 4% lower than our estimate, and we expect to earn back in less than two years. This improvement is driven by a slightly smaller loan portfolio, additional reserves delivered at closing, and the right marks due to the rate environment. While cost savings are estimated at $48 million, we are working hard to identify areas where we can achieve more. We’re also focused on growing the franchise, and it’s a balancing act as we move forward to achieve our goal of becoming more efficient and increasing market share. Together, we have an excellent team, and we’re working diligently to integrate and turn on the growth engines as opportunities arise in the economy. I want to touch on the integration; we have made a lot of progress in the first 45 days. Integration is underway. In those 45 days, we completed the conversion and integration of the mortgage business, the insurance agency, and several administrative functions. The plan is to complete the integration process by the end of the second quarter of 2021. Remember that we continue to operate under COVID limitations and distancing, and a process of this magnitude takes time. We also announced a voluntary separation program that provides an opportunity for early retirement to approximately 160 employees of the combined institution. This program will be executed over the next three quarters, starting in the fourth quarter. Other potential synergies identified include consolidating 8 to 10 branches; the incremental utilization of data channels could drive other efficiencies. But again, we don’t want to hamper our potential to grow our market share within our expanded market distribution. So we will continue to report on this effort. Now let’s move to Slide 7. The new combined balance sheet is solid and well diversified. The $2.6 billion acquired loan portfolio complements ours nicely, and the deposit books improve our funding. The loan-to-deposit ratio now stands at 78%. We also have an expanded customer base to cross-sell and move to other products. Moving on to Slide 8 to discuss the economy, we clearly saw the correlation of the reopening markets and the trends of economic recovery, which was reflected in the third quarter. In the case of Puerto Rico, we had severe tightening in the second quarter, and some of those rules were relaxed later. While still operating under certain lockdowns, the market has reacted very well and is getting used to operating under this scenario. Importantly, to support this economy, over $60 billion in pandemic and hurricane relief remains available, which is significant for this economy. A lot of reconstruction is ongoing, and the funds being deployed are showing liquidity and activity. Employment figures continue to improve, with recent numbers as of August being 92% of 2019 levels. We are seeing a recovery on the employment side. From our client base perspective, 100% of our corporate clients are operating, and close to 99% of business banking clients have reopened. There are sectors that are more sensitive, such as the hospitality industry, which continues to reflect lower occupancy but is showing improving trends. Our hotel portfolio is below typical occupancy levels, and airport traffic is low at close to 50%. These segments require a longer recovery period, and we are closely monitoring them. On the other hand, lending activity for the quarter was near pre-pandemic levels, and digital activity has increased significantly. Retail lending was especially strong for both auto and mortgage lending, reaching pre-pandemic levels. We are optimistic about recovery and potential additional stimulus, but we are also vigilant about possible economic hurdles if future COVID-related restrictions are needed. Thus, we have to remain watchful. Now let’s move to Slide 9. I wanted to give you an update on the relief program trends. The relief trends are positive; our active moratoriums reduced to only 0.8% of the portfolio as of October 21. We are seeing positive post-moratorium payment performance with 98% of commercial clients scoring and 94% of retail clients as of October 21. This data reflects only the due dates prior to October 21 regarding payment patterns. We will have to wait until the end of the month to see the final trend. We do have a segment of the commercial portfolio that belongs to more sensitive industries, including hospitality, retail, and entertainment, that may need additional support during the longer stabilization period. These are being evaluated for potential modification of terms provided by Section 14 of the CARES Act. Moving on to Slide 8, we have all the trends of the balance sheet, and how we compare to peers. Our liquidity levels, reserve collaborations, and capital positions provide us with opportunities to take advantage of growth opportunities. We will be good stewards of our capital position, and capital deployment opportunities remain a priority once our economic environment stabilizes. Moving to Slide 9, I wanted to talk about the trends of core metrics. This graph shows the positive impact of the acquired operation. We generated incremental PPNR net income with only one month of earnings contribution from core operations. The enhanced funding profile should help drive additional revenues. Looking at the level and international adoption rates, they continue to improve during this pandemic. We will continue to work harder now with more clients and distribution points to improve our level of service to all our customers. I am really proud of my team and what we have accomplished in managing the challenges posed by the pandemic, and we are excited about the future growth prospects of our institution. We are also eager to show our patient investors what we are able to accomplish. With that, I will turn the call over to Orlando to cover the details of some of the financial metrics. Thanks to all.

Good morning, everyone. As Aurelio referenced, net income for the quarter was $28.6 million, or $0.13 a share, compared to $21 million last quarter. Breaking down the components, the corporation’s legacy core basis achieved net income of $44.3 million, which is mostly the result of reductions in the required provision for credit losses. Last quarter, we had a provision of $39 million compared to $8 million this quarter. The improvement in macroeconomic projected variables affected most portfolios except for commercial real estate. Changes in portfolio balances led to this reduction. The acquired Santander operation contributed $3.5 million of after-tax net income, excluding the Day 1 CECL adjustments, which I will touch upon. These results include amortization of the fair value marks on all assets and liabilities and the amortization of the resulting intangibles. For example, regarding the investment portfolio, Santander had U.S. treasuries that, after marks, resulted in a portfolio with yields only at 15 basis points. We decided to sell this portfolio and reinvest in other securities according to our policies, which yield around 94 basis points, which will improve results going forward. The amortization of some other discounts and intangibles resulted in a $1 million improvement in net interest income from the combination of loan and deposit. Our initial fair value adjustments have been moved. Concerning some large components of transactions this quarter, the CECL, I referenced earlier, requires that for business combinations, we set up an allowance for credit losses on non-purchase credit deteriorated loans on top of any fair value measurements. This resulted in recognition of an allowance of almost $39 million for the quarter, in addition to those fair value marks. The non-purchase credit deteriorated portfolio is about $1.7 billion after marks. During the quarter, we also decided to sell about $116 million of MBS that were experiencing significant prepayments, resulting in a gain of about $5.1 million from the transaction, which is being reinvested in other instruments. The merger and restructuring costs, as Aurelio mentioned, amounted to $10.4 million this quarter compared to $2.9 million in the last quarter. This increase was mostly due to legal and financial consulting fees, as well as some conversion-related costs as we prepare for the conversion. So far, we have incurred about $25 million in expenses related to the transaction over the last few quarters. In the fourth quarter, we expect to incur additional amounts associated with the voluntary separation program Aurelio mentioned, as well as costs tied to branch consolidations as we finalize decisions on those processes. Finally, another large item to highlight is our analysis of the DTA, including the Santander operation, resulting in a reversal of approximately $8 million of deferred tax asset valuation allowance we had on the books. Net interest income for the quarter was $148.7 million, which is $13.5 million higher than last quarter; $14 million of that was attributed to the Santander operation. Conversely, the legacy FirstBank operation saw a reduction of $500,000 in income as compared to last quarter. The reduction in rates obviously accelerated prepayments on the investment portfolio, leading to a larger proportion of cash and investment securities to total earning assets, resulting in a reduction in income on FirstBank. Last quarter, we had a 4.22% NIM, which decreased to 3.94% this quarter. Some of the components contributing to this were commercial loan repricing with a reduction of 4 basis points whereas the cash and investment securities growth, along with larger prepayments on the alternative for reimbursement, affected this number by 18 basis points more. Santander, on a standalone basis, had a margin of about 3.89% considering the purchase accounting adjustments, resulting in a combined margin of 3.93% with FirstBank. Non-interest income improved to $29.9 million; this $9 million increase includes $5 million in the gains on sales that I mentioned before. We had a $3.4 million increase in revenue from mortgage banking activities, mostly related to sales of residential mortgages. We had a much more active quarter for originations than in the second quarter, selling $98 million more in conforming paper than last quarter, resulting in that revenue increase. The reopening of businesses during this quarter led to a significant increase in credit and debit card activity, improving merchant fees and other components, contributing an additional $2.8 million to our income. Deposit service fees associated with the Santander transaction brought in $1.1 million of additional deposit fees to the operation. On the expense side, total expenses were $107 million, which includes $10.7 million in expenses from the Santander operation and $96.8 million for the legacy FirstBank operation. This $96 million is $7 million higher than the almost $90 million we had last quarter. The merger and restructuring costs for the quarter were $10.4 million, which is $7.5 million higher than last quarter and contributed most to that increase. Excluding merger and restructuring costs, FirstBank expenses were $86.4 million. COVID-related expenses were approximately $1 million this quarter, which is down about $2 million from last quarter. However, as we saw improvements in transaction volumes and fees, we also experienced higher expenses associated with that increase. The allowance for credit losses increased significantly as of September 30; the allowance for loans and leases was up $65 million to $385 million compared to June. This increase was primarily due to the initial allowance for credit losses required by the Santander operation. Total allowance for credit losses, including bonded commitments and debt securities, now totals $403 million. We recorded $38.8 million in allowance for credit losses this quarter, with $37.5 million related to loans. This builds up the allowance management touched on with the portfolio. Additionally, for PCD loans, we established an allowance of almost $29 million, which represents the fair value marks on these loans. These two combined were about $65 million. The ratio of allowance for credit losses on loans to total loans was 3.25% in September, slightly down from 3.40% in June, but still a significant coverage considering the large amount of portfolios that also includes fair value marks and discounts. On a non-GAAP basis, if we exclude the PPP loans, which don’t carry much reserve, the ratio of the allowance to total loans was 3.38%, down from 3.55% last quarter. Asset quality remained good during the quarter; non-performing loans are down $10.5 million to $293 million, with most of the reduction occurring in the OREO portfolio, which decreased by $7.3 million due to completed sales during the quarter. Migrations to non-performing loans were higher this quarter as moratoriums expired, returning to more normal levels. We can continue pursuing some foreclosure processes that were paused during the last couple of quarters while we provided moratoriums to customers. Inflows were $18.4 million this quarter, which is $10 million higher than last quarter. Capital ratios remain very strong. Even with the acquisition's impact, we still have a Tier 1 ratio of 17%. The leverage ratio is about 13% for the quarter, but we only had the Santander operation for one month in the quarter, so average assets were lower. Normalizing for a full quarter of average assets, that ratio would be closer to 11%, which we expect. That is still a very significant ratio despite the acquisition of $5 billion plus in assets this quarter. With that, I will open the call for questions.

We will now begin the question-and-answer session. The first question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Good morning, guys.

Good morning, Ebrahim.

Good morning, Ebrahim.

So in your prepared remarks, Aurelio, you mentioned a bunch of times your focus on capital return and optimism about things getting better, barring any sort of negative developments in COVID. By my math, your largest competitor has a Tier I leverage ratio of about 8%; you’re at 11% with about 300 basis points of excess capital, very conservatively. As a shareholder, you would want the bank to act now given where the stock is. Can you talk to us about the level of urgency with the deal being done? Do you think the regulators are onboard? I know you can’t discuss regulatory discussions, but there should be a sense of urgency in executing this given where the stock is. Can you talk about that?

Yes, Ebrahim, thank you for the question. We do have a sense of urgency. We understand the importance of the customer. On the other hand, it’s really about the environment. We must look at what’s happening around the world and in the U.S. with the elections. Regarding that, Puerto Rico is also positioned with Congress to benefit either way, so things will continue independently of whichever party wins, in our belief. However, the COVID risk is still out there. Hopefully, we don’t have to return to more lockdowns or closures. We have seen the impact. Yes, there’s another stimulus that will be a high priority moving forward, but I think we will have better visibility in the first quarter on this. There are also regulatory guidelines regarding this matter that will be issued through the end of the year. So, there is a priority for the management team. Yes, we recognize the excess capital. We just need to get through the year-end, assess the economic trends in the next round. We have a couple of quarters where we increased provisions materially. We are well covered, but all of this hinges on the economic forecast. We need a bit more time to ensure everything is prudent and that the economy is stabilizing. As we learn to operate within the COVID environment, we understand that operations will continue and that we must spend some money to facilitate that, but we are watchful of potential additional restrictions.

Understood, and thanks for that. Moving on, Orlando, on Slide 11, looking at pre-provision earnings, if you get the full quarter impact for some candor impacts, I see about $87 million in quarterly pre-provision earnings. Outside of the $48 million in cost saves that you expect, can you talk to us about your outlook on PPNR or revenue relative to third quarter levels, specifically relating to fee income and margin outlook?

I think we have several levers here, namely loan growth. We will aim for some loan growth, but again that is dictated by the economy and opportunities. We have seen positive numbers in the mortgage business; commercial loans are solid, and auto lending continues to sustain. On the other hand, we still face some risk of margin compression. Liquidity is growing, and we have other components in the investment portfolio that Orlando covered. However, we are also experiencing high prepayment rates. The expenses improve due to synergies, but those levers regarding PPNR do not factor in provisions. We have more control over some levers than before closing the deal. Now it boils down to execution and achieving integration goals that we set out. The estimates for duration and costs of achieving those synergies are still holding steady; that forms our plan moving ahead. Of course, the right environment remains a challenge.

Keep in mind that the savings are also partially tied to the integration process. They won’t materialize immediately, but should become apparent over a two to three quarter timeline as we fully benefit from both savings we can achieve. For now, we are still running systems independently and incur costs related to operating both Santander and our own system. Thus, there are a number of adjustments and improvements expected as we work through the integration over the next three quarters as Aurelio mentioned. The margin remains a challenge. The expectation is not necessarily interest rate reductions but rather the mix and how that impacts us. Increased deposits lead to liquidity but also affect margin. Overall, the prepayment rates we are seeing in the portfolio are significantly higher than anticipated compared to a few quarters back.

I appreciate the challenge with the margin, Orlando. Do you think NII, around $177 million on a full quarter basis for the combined bank, can at least hold steady or trend higher from here, or do you anticipate pressure on NII as well?

We hope to keep NII flat to slightly higher than current levels moving forward. As we integrate, we can pursue additional business opportunities. We do see some aspects of our operation that need to be taken into account, such as good mortgage originations, but we’re largely selling conforming paper, which leads to income generation but also reductions in the portfolio size. Thus, the mix could become a factor. Rates may not be the primary concern either; it will rather depend on layers of assets coming due that may have been issued at higher rates previously.

Got it. Thanks for answering all my questions.

Thank you.

Our next question comes from Alex Twerdahl with Piper Sandler. Please go ahead.

Hi, good morning, guys.

Good morning, Alex.

Good morning, Alex.

I wanted to circle back on your comments about capital return. I understand there are many shifting dynamics in the economy right now, and we’re not out of the woods yet on COVID. But when we are through this, is there a formal process you all need to go through to initiate a buyback? Can you elaborate on what that might look like?

All capital actions have a formal process that is defined either by regulation or our capital plans. After completing your analysis and recommendations, you have to go through the designated procedures to execute actions like a buyback. I don’t think that process is what's holding us back currently; it's about ensuring we do it at the right moment as conditions develop. Our priorities include integration and sustaining asset quality, which are still challenging under the current COVID context. We must see further stabilization evidence before we conclude on that decision, Alex.

Understood. As I review the pro forma balance sheet, it appears you have a lot of liquidity, yet higher costing brokered CDs and some FHLB advances currently are a bit more costly. Do you see opportunities to deleverage some of this inefficient leverage?

Clearly, the level of broker deposits has been decreasing. We have not renewed any broker deposits and are allowing them to mature. They are not as expensive, but we have some money market accounts that fluctuate each quarter. We are not renewing any broker CDs or FHLB advances that are maturing, so those are areas of opportunity as well. Additionally, we have factors like the repricing of time deposits that also play a role in achieving a better balance financially.

Are there significant tranches of either brokered CDs or advances maturing in the near term?

We structured our brokered CDs in such a way as to avoid having a big chunk maturing at the same time in the market. We don’t face a large maturity issue; it’s a bit every quarter instead.

Can you help us understand the loan mark including the credit adjustment that would come back through NII over the lifetime of the loan? How do you project that purchase accounting accretion over the next few quarters?

The marks on the PCD portfolio are part of the research, and those marks do not accrete back. Their values will fluctuate based on the CCL sequel analysis performed moving forward. Excluding the PCD portfolios, about $30 million to $36 million of the mark will be both credit and rates, and that will materialize over the loan period. The mortgage loans will take longer to see returns because commercial loans typically experience a quicker turnaround due to shorter maturity terms—basically, we’ll see a combination of impacts within three months to three years, regarding commercial and consumer portfolios, and then the mortgage loans will take longer over their five to seven-year term.

Great. Lastly, can you shed light on expenses and the phasing in of cost savings? Can you provide a sense of how those cost savings will roll in over 2021? Is the voluntary retirement program part of the $48 million in cost savings or separate?

The cost savings will come from rationalizing operations and technology costs, as well as reducing expenses tied to the Santander operation. The voluntary program will create immediate cost saves; these are positions that generally will not be replaced. The savings are part of our initial assumptions, so we should start to see those benefits from the voluntaries starting January. Technology-related savings will begin at the end of this year, while other savings will take time due to remaining operations and branch consolidations. Most of the gains will emerge in the first half of 2021. Some benefits have already been realized in this quarter, thanks to the integration of operations and systems, as we have completed two significant business integrations early in October; thus some benefits will start reflecting in this quarter. Our focus remains on these priorities, including marketing, legal, and consulting costs, contributing to the total projected savings.

Thank you for addressing all my questions.

Thank you, Alex.

At this time, there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to John Pelling for any closing remarks.

Thank you, Debbie. On the IR front, we have a couple of virtual conferences coming up in November—the 9th conference with Piper Sandler and a panel conference on the 10th. We look forward to chatting with you then. We appreciate your continued support, and this concludes the conference call. Thank you.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.