First Bancorp /Pr/ Q1 FY2021 Earnings Call

Good morning, and welcome to the First BanCorp. First Quarter 2021 Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to John Pelling, IR Officer. Please go ahead.

Thank you, Betsy. Good morning, everyone, and thank you for joining First BanCorp's conference call and webcast to discuss the company's financial results for the first quarter 2021. 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 to everyone, and thanks for joining our call today. Please let's move to Slide 5 to discuss some of the highlights. Before I go into detail of the quarter, as you have hopefully seen, we're really very pleased to announce earlier today the Board's approval of a $300 million share repurchase program. The repurchase may be in the open market or in privately negotiated transactions. Timing and exact amount will be subject to market conditions. Given our excess capital position and the continued earnings accretion, we are committed to returning excess capital to our shareholders, and we're very pleased to move forward with this announcement. Now before talking about financial results, I'd like to touch on the macroeconomic environment, the integration, and how the pandemic is progressing in Puerto Rico. On the macro front, there was significant stimulus flowing into the Island through the CARES Act and subsequent programs, most recently approved in February. When you add all the programs, the latest estimates from the Fiscal Board amount to around $45 billion, which is a significant amount, constituting over 60% of the Island's annual GDP. Clearly, the significant stimulus continues to support the recovery, bolstering our customers, driving growth in deposits, but conversely, it is also softening loan demand in the near term. We're very pleased that we've been able to deploy the stimulus in the Island and observe how the post-pandemic recovery trends are evolving. We believe a similar trend should continue this quarter and improve later in the year as the reopening takes place and as reconstruction efforts gain momentum. When we examine the individual metrics, the economy in Puerto Rico and actually Florida also continues to demonstrate clear signs of recovery—tourism, hotel occupancy, airline passengers, and cement sales all showing improving trends. Recently, the government disclosed their financials. Interim net revenue to the Commonwealth General Fund is up 21% for the first 8 months, and that's probably the first time in many years we've seen the government exceed their budget revenues. Having expanded our position in Puerto Rico and our significant presence in Florida, we're definitely very optimistic about our positioning to benefit from these improving economic conditions, and we're pleased to observe that the reconstruction efforts are finally gaining traction. We must mention that the government has successfully managed the pandemic challenges. As you might know, we recently experienced a tightening in safety protocols in Puerto Rico and travel rules due to a spike in cases following spring break. While cases have surged, the number of vaccinations is a positive factor sustaining the potential for recovery trends. As reported by the Health Department, the Island has made significant progress in the vaccination campaign, with 27% of the eligible population fully vaccinated and approximately 48% receiving the first shot. We believe these figures provide a solid foundation for the continued recovery. Moving to the integration, I’m pleased to announce that we are progressing according to schedule. This past quarter, we converted the consumer and commercial lending platforms, and we just completed the credit card conversion in April. We’ve also made progress in branch rationalization, consolidating 3 branches during the quarter. Additionally, we implemented our second phase of the voluntary separation program, which was previously announced. We are quite satisfied with our progress and are on track to complete full integration by the end of summer. Looking ahead to that date. Finally, with regards to the PPP program, it was a focal point of the quarter in terms of number of applications, and we have made significant efforts to benefit our clients. We originated $209 million and processed forgiveness remittance for $176 million of loans that were originated in the prior year. We will continue originating PPP loans. The pipeline has been decreasing, and the program will expire at the end of May, so we will keep processing PPP loans until the program concludes. Additionally, for the remainder of the year, we will continue to support our clients in processing the forgiveness applications, which are expected to continue until the end of the year. So, let’s move to Slide 6 for some highlights of the quarter. I'm not going to cover this in detail; instead, Orlando will provide comprehensive information. We generated $61 million of earnings or $0.28 per share compared to $50 million last quarter. Undoubtedly, the improving macroeconomic trends and forecasts are key drivers for the reserve release of $50 million for the quarter. Pretax pre-provision earnings remained relatively stable at close to $86 million, even though this quarter had 2 fewer operational days. We are pleased to see that asset quality metrics remained stable. We mentioned in the last call our expectation of some peak in non-performing assets as the moratoriums expired, but with substantial liquidity supporting the market, it is encouraging to see these metrics sustain or improve. Notably, liquidity has been a significant contributor, and core deposits, excluding government and broker deposits, grew by $472 million, which is about 4%. Therefore, we are very pleased with this development. Regarding the capital ratios, they remain strong and provide a solid baseline to support our buyback moving forward. Please let’s move to Slide 7 to elaborate on loans. Certainly, loan origination is challenging as we see this economy being supported by all this additional liquidity, which is positive. However, we perceive some solid developments considering the seasonality and concurrent programs, managing to reach $1.2 billion in the quarter, including credit card originations close to $1.3 billion. There’s always inherent seasonality in commercial deals as they tend to materialize more in the latter half of the year. If we consider year-over-year, it's apparent in the seasonality graph on the right side of the slide. Clearly, we expect in the second half of the year a reduction in stimulus, alongside a full reopening of the economy and a noticeable increase in reconstruction projects that are gaining momentum. Thus, we are more optimistic about the second half of the year for commercial activity than our current outlook. As mentioned, the PPP loan focus was also prominent. Year-to-date, the loan portfolio experienced a 1% decline, primarily in the mortgage segment. We remain committed to originating conforming mortgages which we subsequently sell in the secondary market. This quarter has been productive regarding mortgage originations providing non-interest income from the gains. There have also been some repayments on commercial credit lines due to the liquidity available. It’s worth noting that the credit line utilization is likely on the lower side compared to prior years, contributing to the overall reduction. On the positive side, the consumer portfolio continues on the rise, both in unsecured loans, credit cards, debit, and particularly in the auto and lease finance sector, with which we are actively competing. We are quite optimistic about achieving additional growth in this market segment. Florida's performance has also been significant; we will keep focusing on opportunities in that region as it diversifies our geographic reach. The Florida commercial and construction portfolio increased by $23 million this quarter, indicating that activity should continue to rise. On the digital front, engagement remains strong. Our investments to enhance the platforms are paying off, with digital banking registrations and active users growing 6% and 9%, respectively, during the quarter. I will now turn the call over to Orlando, and I will be back for questions later. Thank you.

Good morning, everyone. Aurelio touched on this, but just to start, the net income for the quarter was $61 million and $0.28 a share, which compares with the $50 million or $0.23 a share we had last quarter. The quarter results had, on the positive side, a $15 million provision release for loans compared to a $7.7 million provision we had last quarter. That $0.04 per share impact was as compared to this quarter. The results also include the $11 million we incurred in transaction expenses associated with the Santander acquisition. As we've seen in the quarter, the expectations of some macroeconomic deterioration have not reflected as aggressively as was originally projected. We've observed less impact from unemployment and lower effects on the home price index as well as the commercial real estate index. Consequently, provisioning needs in the market, along with general banking conditions, have declined significantly from what we encountered in 2020. Regarding net interest income, we still see some pressure. Clearly, net interest income fell by $1.5 million in the quarter. Part of this is due to 2 fewer days in the quarter which adversely impacted results by $2.2 million. However, we recognized about $2.5 million more in accelerated fee income recognition on the PPP loans that were repaid in the quarter, totaling $175 million as Aurelio mentioned. The mortgage portfolio declined, as he also noted. On average, the portfolio was down $121 million, resulting in a $2.4 million reduction in interest income for the quarter. Conversely, the consumer portfolio rose by $45 million, increasing net interest income by $1 million in the quarter. We've continued efforts on the liability side. The cost of our interest-bearing liabilities decreased by 8 basis points, leading to a $2.6 million reduction in interest expense for the quarter. Considering all deposits, the total cost of deposits decreased from 41 basis points in the fourth quarter of 2020 to 32 basis points this quarter. The margin for the quarter fell by 4 basis points to 3.91% compared to the 3.95% we had last quarter. Prepayments on the investment portfolio have caused accelerated amortization of premiums, which, combined with a reduced rate of reinvestment alternatives, has led to a decrease in yield. The yield of the investment portfolio reduced from 97 basis points in the fourth quarter to 91 basis points this quarter, subsequently impacting the margin. However, the funding mix has improved considerably due to an increase in non-interest-bearing accounts and low-cost assets, which mitigated some of the margin impact. Liquidity levels remain very high, even though our investment portfolio grew approximately $700 million from last quarter. At the end of the quarter, cash was still $80 million higher than what we had in December. This significant reliance on funding at a very low interest rate undeniably puts pressure on the margins for the quarter. Non-interest income remained relatively stable. This quarter, we collected contingent insurance commissions, which is an annual occurrence based on the previous year’s volumes, amounting to $3.3 million. This offset the $1.4 million in fee income recorded last quarter from the sale of loans under the Main Street lending program. Mortgage banking income held steady but fell by $300,000 compared to last quarter. We have continued to originate and sell mortgages as Aurelio mentioned, but we have observed some compression of spreads in the market on those sales, resulting in lower gains this quarter. On the expense side, expenses totaled $133 million, including $11.3 million in merger expenses alongside ongoing COVID-related expenses of $1.2 million. Last quarter, merger expenses amounted to $12.3 million. On a non-GAAP basis, excluding these items, expenses were $120 million for the first quarter compared to $121 million last quarter. The primary components included a reduction in employee compensation by $800,000. During the first quarter of each year, we experience a higher level of payroll taxes as employees have not yet reached their limits. This quarter, payroll taxes were $3.4 million higher than the previous quarter. However, the quarter having 2 fewer days resulted in reduced expenses of $1.1 million, which offset some of that. We also had higher deferred loan origination costs resulting from the volume of PPP loans originated during the quarter, leading to a combined reduction of $800,000. On the credit card side, we received $1.6 million in incentive payments related to volumes originated last year. Though we have seen volumes begin to normalize, impacts from the pandemic during 2020 still linger. However, we are starting to see normalization of volumes. These savings were slightly offset by a $1.3 million increase in OREO expenses due to some property valuations. The allowance for credit losses decreased by $28 million. Following this, we had a $373 million allowance for credit losses for loans, specifically down $27 million from the prior $386 million. Examining commercial loans, the allowance declined by $15.9 million. This represents a $14.6 million reserve release alongside $1.3 million in charge-offs. The release reflects improvements in macroeconomic variables which correlate to this reserve, particularly unemployment, GDP, and other indicators. On the residential mortgage front, the allowance decreased by $6.3 million, driven mostly by macroeconomic shifts and, specifically, reductions in the portfolio size. For the consumer sector, we had a provision of $4.3 million, but a charge-off of $9.1 million resulting in a net decrease in the allowance of $4.8 million. The allowance ratio remains relatively healthy at 3.08% as of March 31, compared to 3.28% at the end of the previous year. If we exclude PPP loans on a non-GAAP basis, that number stands at 3.20%, representing a healthy coverage on the allowance. In regard to asset quality, nonperforming loans decreased $8.6 million in the quarter, down to $285 million. Non-performing loans declined by $4 million. As Aurelio previously mentioned, we are anticipating a spike in nonperforming loans in the first half of the year as loans come out of moratoriums. However, thus far, trends have remained normal. Migration to non-performing loans for the quarter stood at $32 million compared to $32.9 million last quarter. The only increase we saw was in the residential mortgage migration increase of $4.6 million, but the commercial side saw a drop of $4.8 million. Early delinquency has also exhibited positive trends, as the 30- to 89-day delinquency decreased by $5 million from $149 million last quarter to $144 million. We also saw reductions in TDRs of $19 million compared to last quarter. On the capital front, regulatory capital ratios have remained robust. While we did observe a decline in tangible common equity and book value per share during the quarter due to changes in the market value of available-for-sale investment securities, this is clearly a reflection of rising rates at the longer end of the curve during February and March, which negatively impacted the market value of some of the securities acquired over the previous few months. However, we possess the capability and intention of holding these securities to maturity, thus rendering this impact temporary. With that, I would like to open the call for questions.

Our first question comes from Alex Twerdahl from Piper Sandler.

First off, wanted to just ask about the buyback, the $300 million authorized. It looks like it expires in a little over a year. Is the intention to utilize that as like $75 million a quarter or would you consider an accelerated share repurchase program?

As we mentioned, Alex, all alternatives are on the table. As we continue to move forward and disclosures are required, we will proceed accordingly. Obviously, market conditions will drive the exact timing and amount. So, as soon as we have something to disclose, you will be informed immediately.

Okay. And when can you actually start being in the market repurchasing shares?

We expect to be in the market by May 1.

Okay, great. And then I wanted to drill in a little bit more on your commentary regarding the potential rebound for loan growth in the second half. I believe you alluded to some reconstruction projects that may help drive that, along with the economy reopening. Could you elaborate more on those projects? Additionally, many believe that as pandemic-related stimulus wanes, loan growth may significantly increase, potentially later this year or early next year. How are you positioning the balance sheet over the next few quarters to maximize this loan growth?

First of all, it comes down to market conditions and execution. Within the mortgage business, we anticipate continuing our trend of hybrid refinancing. We've observed an increase in purchases, and new construction efforts in Puerto Rico are finally underway after many years; these projects are closing and being delivered now. Although this may not directly translate to growth in our portfolio, the runoff will eventually stabilize. As for the consumer segment, liquidity among consumers is exceptionally high, evidenced by strong deposit levels. Auto sales are growing and show sustainable increases, and we expect this trend to continue. Looking into unsecured consumer lending, we see positive traction this quarter and expect further recovery. The PPP loan disbursements will finish this quarter, so this liquidity will also channel back into small business lending, particularly for small commercial groups. We anticipate improved utilization of credit lines following this. Commercial deals require proactiveness and competition—deals exist, but they take time to finalize. We have a substantial portfolio that we need to protect while also seeking out opportunities. Renovation projects are ongoing in Puerto Rico, focusing on infrastructure as well as private endeavors like schools and new housing developments. Municipalities are engaged in multiple projects, benefiting from funds released for post-hurricane relief. The CDBG funds, approximately $8 billion, were recently restated with simplified rules. Therefore, our focus remains on executing while maintaining our ongoing integration efforts; notably, we've successfully completed the commercial team’s integration this quarter. In Florida, we continue our active market participation using the strategies that proved successful in prior years; it’s essential to remain vigilant and seek competitive opportunities for portfolio growth. However, I don’t expect to see significant growth this quarter based on current market indications.

Our next question comes from Glen Manna from KBW.

Congratulations on the buyback. It's been a long time coming, and this recognizes all the efforts you’ve put into the bank over the last 10 years.

Thanks, Glen.

Some of your competitors have suggested that long-term capital ratios, specifically CET1, on the Island might be entering a new phase due to all the stimulus and the market revamp. It's a shift from a prolonged recession. While we recently initiated the buyback, how do you perceive long-term capital on the Island? Could it potentially drop into the 12% CET1 range over time?

Evaluating economic cycles has always been crucial. Puerto Rico has historically had favorable banking conditions. After facing difficult circumstances for the last 15 years, we're now entering a recovery phase. Assuming the momentum continues, it’s plausible to reach the levels that you mentioned, based on the available designated funds and the activity we are witnessing. Predicting it is challenging, but given the current evidence and conditions, it remains a possibility.

Yes, I don’t see any reason why not. There have been significant improvements over the years, and in several key components. As this trend continues, we anticipate reduced necessity for high capital ratios compared to the past. Therefore, we recognize a potential opportunity to achieve more favorable Common Equity Tier 1 ratios.

As we assess credit, we have been adjusting our banks down to that kind of CECL day 1 level. How would you compare the assumptions in your current reserve levels with those assumed at CECL day 1 back in January 2020?

We need to examine the components closely. The CRE index remains weaker than what we observed on CECL day 1. The HPI is moving upward, and new projections align with this trend. We anticipate reaching those levels eventually. Unemployment expectations suggest it will remain consistent going forward. Overall, we want to ensure that trends continue progressing in the anticipated direction before finalizing these projections.

Just a quick follow-up: You’ve recognized around $36 million in pretax merger charges, while the original projection was $48 million. Is that still a reasonable estimate?

I didn’t catch your first question. You referenced merger taxes?

No, I meant pretax merger charges. When you announced the merger, there was mention of $48 million, and I think you have reached about 75% of that now. Is that still an accurate figure?

What we had announced was about $76 million of expenses associated with the transaction. The $48 million figure likely refers to your calculative analysis of the anticipated synergies. Our expectations were $76 million in total expenses.

That was initiated in 2019, Glen.

Right. So that $76 million is still a good estimate?

Yes, both figures—the $76 million and the $48 million—remain valid.

Regarding premium amortization, how much remains in the securities portfolio? Could we expect a decline?

By premium amortization, are you referring to the investment portfolio or something else?

Yes, I was referencing the investment portfolio.

Most recent purchases within the portfolio have associated levels of premium due to the prevailing coupons available in the market. Thus, changes in trends in rates could affect these premiums. While we might see reductions with rates moving downward, I don’t have the precise figures for the premiums in our portfolio at this time, but I will check and include something in the Q to disclose those exact releases since we haven't specified numbers on that yet. There are indeed premiums since most of our recent purchases have levels associated with them.

Our next question comes from Jonathan Krautmann from Rubric Capital Management.

There’s a lot happening in Washington, D.C., with the new administration, and it seems Puerto Rico has a supportive partner in the White House and Congress. This includes initiatives related to increasing pharmaceutical manufacturing and infrastructure investment. Which key areas are you keeping an eye on that could impact your business, considering the situation in Washington?

Without a doubt, we remain alert every time tax reforms are discussed. This has been a long-standing issue. The benefits for corporations involved in manufacturing remain a potential risk. However, I believe this time around there is more visibility around the challenges Puerto Rico faces and how these changes could impact us. It's critical that we uphold proper communication and education as private sector stakeholders to ensure our feedback reaches Congress. Manufacturing still represents 45% of the GDP and is a key element, aside from the associated supply chains. Tourism is also growing and presents future opportunities. Foreign investment from Act 20/22 is another pathway for growth. In summary, those two areas—the manufacturing sector and tourism—are essential for us to monitor and provide the necessary feedback regarding potential implications for Puerto Rico.

That concludes our question-and-answer session. I would like to turn the conference back over to John Pelling for any closing remarks.

Okay. Thank you, Betsy. On the Investor Relations front, we will be participating in the Seaport Financial Virtual Conference on May 15. Do you have any comments to add?

Yes. I just want to express how pleased we are to reach this milestone and to initiate our share buyback program and execute these capital deployment initiatives. Thank you to all our investors.

Thank you. At this point, we'll conclude the call.

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