First Bancorp /Pr/ Q2 FY2021 Earnings Call

Thank you, Sara. Good morning and thank you for joining First BanCorp's earnings conference call and webcast to discuss the company's financial results for the second 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, at 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 us today. Please, let's move to slide five to cover some of the highlights. Before we go into the highlights for the quarter, I would like to touch on the macro environment, on the progress we made on the integration and the support to our customers through the pandemic. On the macro front, pandemic relief funds continue to play a very important buffer for economic activity on the island and in all our three regions. Macro indicators continue to show month-over-month improvements. Passenger movement outside Juan in Puerto Rico is above pre-pandemic levels since April, and despite a recent slight increase in reported cases as of June, vaccination rates on the island are well over 60% now. The significant amount of stimulus continues to strengthen our customers, driving growth in deposits and also softening loan demand in the near term. The economies in Puerto Rico and Florida continue to show strong signs of recovery with economic activity approaching pre-pandemic levels. We have seen improved consumer confidence, evidenced by increasing retail sales, credit card activity, debit card activity, and auto sales. Additionally, in the case of Puerto Rico, hotel occupancy and ADRs are now at pre-pandemic levels. Government collections were also on the rise, continuing to show improvement in economic activity. We have also seen parallel progress from the fiscal board on government debt restructuring, which I believe is positive for the macro outlook in Puerto Rico. Regarding digital adoption, our registered users continue to increase. We experienced a 4% increase this recent quarter and a 20% increase on a year-over-year basis, which is a good number. Our digital channels continue to play an important role in deposit gathering. We do see branch transactions across the network. A very important milestone for us was our integration and conversion process. We are on schedule to complete the full integration now during this quarter. A few weeks ago, in early July, we completed all system conversions. This was really a huge milestone for us to move forward and this final conversion allowed us to finalize the branch consolidation in Puerto Rico. We actually consolidated six branches in this phase. We are quite pleased with the progress and look forward to capturing additional market share going forward through our fully integrated franchise. We have certainty that most of the pending benefits regarding synergies will be reflected in the fourth quarter numbers. Finally, regarding the PPP program, it ended in May and final transactions were processed in June. Throughout the life of the program, we originated $245 million or over 14,000 loans supporting commercial clients across the three regions. Now, the focus through our fully integrated digital platform self-service, we processed forgiveness for 81% of clients that participated in round one, equivalent to $377 million. Also, during this quarter, we disbursed the last $74 million in new SBA PPP loans and received principal forgiveness remittance of approximately $151 million. This was a great product that was competing with our day-to-day core business of small business lending. Now, let's move to slide six to really cover the highlights for the quarter. It was definitely a solid quarter for the franchise generating $70.6 million in net income or $0.33 per share compared to $61 million last quarter. The improving macroeconomic trends are a contributor, driving a reserve release of $26 million this quarter. The core earnings, pre-tax pre-provision income increased over $10 million to a new high of $96.6 million. Our efficiency ratio for the quarter improved to 60.6 and if we adjust for merger and COVID-related expenses, we were at a 55% level, which is actually our goal. Asset quality metrics improved on all fronts. NPAs increased $29 million, now at 1.2% of assets. Inflows to non-accrual also decreased and delinquencies improved across all products. A significant amount of stimulus continued to strengthen customer liquidity. The deposits, excluding government, grew $558 million or 4% during this quarter. On the capital front, capital ratios are very strong and improving; during the second quarter, we repurchased 7.96 million shares for approximately $100 million under the previously announced $300 million repurchase program. So we are very pleased with how the quarter has turned out.

Pardon me. This is your operator. You may proceed with your presentation.

Thank you. Our apologies. Not sure what happened, but hopefully we're back. I just want to make sure that everybody's dialed in, and it's only with the system, John, please.

It looks good.

Okay, thank you. So I was saying that the consumer portfolio grew nicely, driven by auto loans of $98 million, increasing the overall portfolio. We also have some increase in the Florida market. When you look at the commercial and construction pipeline, it looks promising compared to earlier in the year. There's a lot of moving parts on the loan portfolio side driven by macro factors. In the mortgage business, higher payouts are driven by rates, and the increasing limits on the conforming side that happened some time ago are also having an effect; most of the loans are now performing. The floor plan utilization is at its lowest level due to inventory issues in the auto business. We expect that to change as new inventories come into the pipeline. Another contributor is construction, which is good news. Absorption of housing units has accelerated, creating repayment opportunities in those lines we have available. Again, regarding the deposit side, as I said, we saw nice growth. $1.5 billion grew in the government segment, in the public bonds tied to Puerto Rico and the ECR regions. In a nutshell, the franchise continues to execute well, driving key initiatives in parallel. Achieving consumer growth, supporting our commercial borrowers, accelerating digital transformation, and making great progress on the conversion and integration of acquired operations. We are delivering on expense efficiencies, and PPNR continues to improve. Credit results and delinquency trends continue to perform well, given the economic boom, and we are well positioned for the second half of the year, optimistic on the positive impact of economic activity in our loan portfolio. I am grateful to all First Bankers for their dedication and commitment, overcoming pandemic challenges while managing integration activities over the past year. I am also really proud of how my teams were able to support our customers through this pandemic. So with that, I will turn the call over to Orlando to cover the financials in more detail.

Good morning everyone. Aurelio mentioned net income for the quarter was $70.6 million or $0.33 a share compared to $61 million or $0.28 a share last quarter. Pre-tax pre-provision was $96.1 million, which compared with $86.4 million last quarter. As you saw in the release, results for the quarter include a benefit of $26.2 million on the provision for credit losses as compared to a $15.3 million benefit last quarter. The after-tax benefit of this provision on results represents approximately $0.08 this quarter, compared to about $0.04 last quarter. Results also include $11 million in merger and restructuring costs associated with the acquisition. While this quarter we had $11.3 million in the last quarter. Looking at components, net interest income for the quarter increased by $8.5 million. We saw interest income on investment securities and interest-bearing cash balances increased by $4 million, mainly driven by the $1.4 billion increase in average balances, which is linked to the increase in deposits this year. The combined yield of the investment and interest-bearing cash is 95 basis points, up 4 basis points this quarter compared to the last quarter. Investments and cash represent about 44% of all interest-earning assets, which is 5% higher than last quarter's 39%. On commercial and construction loans, interest income grew $2.5 million, which includes $2.9 million recognized from deferred interest on a loan paid off during the quarter, improving the margin by about 6 basis points. Fee income acceleration on PPP loans paid off was about $1.5 million, which is $1.7 million lower than last quarter, reducing the margin by about 4 basis points. Interest expense for the quarter was down $1.7 million. The average cost of interest-bearing liabilities dropped from 63 basis points in the first quarter to 55 basis points this quarter. The total cost of brokers was 24 basis points, down from 30 basis points last quarter. The margin was 10 basis points lower at 381, despite the increase in net interest income, but we continue to see pressure on the change in deposit mix. Securities continued to grow due to deposit flows and construction is also contributing significantly on the residential mortgage side. We focus on conformity, and loans have come down in our portfolio. Non-interest income was fairly stable, with three main factors affecting it: First, last quarter we had a $3.3 million contingent insurance commission received based on prior year volumes; we didn't have any of that last quarter. Mortgage banking revenue declined based on lower originations, but we still see transaction volumes on debit and credit cards approaching pre-pandemic levels increasing our fee income. On the expense side, expenses decreased by $3 million, totaling $130.2 million. This includes $11 million in merger expenses compared to $11.3 million last quarter, as well as $1.1 million in COVID-related expenses, which is similar to $1.2 million in the first quarter. On a non-GAAP basis, excluding these items, expenses were $118 million for the second quarter compared to $120 million in the first quarter, a reduction of $2.8 million. Employee compensation is down $1.5 million as we start to achieve savings from the voluntary and involuntary separation programs implemented at the end of last year and during the first quarter, resulting in additional savings of about $800,000. Total savings for the quarter were $1.7 million, compared to $900,000 in the first quarter. We also saw a decrease in payroll taxes of $1.5 million as employees reached payroll limits. Our OREO expenses were down $2 million, primarily due to a $2.2 million write-down related to our commercial property in the first quarter, with reductions in professional fees of $900,000 associated with the PPP origination platform. However, we experienced an increase in debit and credit card costs due to higher volumes and incentive payments received in the first quarter related to 2020 volumes. Our efficiency ratio, as Aurelio mentioned, is 60.6%, but if we exclude merger-related costs, the ratio improves to 55.5%. As we approach the completion of conversion processes, these merger-related expenses will start to decline significantly this quarter. A frequently asked question has been about the savings we continue to achieve. We provide indications on BSPs and voluntary separations. We anticipate expenses, excluding OREO and transaction expenses, will normalize to a range of $117 million to $119 million per quarter in the near term. Keep in mind we have several ongoing technology projects that will influence these costs. Regarding reserve levels and credit quality, we've observed significant improvements in projected macroeconomic variables over the last two quarters, both nationally and in Puerto Rico. We expect an improvement in the unemployment rate, as well as the home price index and commercial real estate index, which are both leading indicators. The total allowance for credit losses as of June 30 was $339 million, which is down $34 million from the prior quarter. This reduction led to the $26 million provision benefit I mentioned earlier. During the quarter, we had a $5 million recovery on a non-performing commercial loan paid off, resulting in net charge-offs of $7.6 million compared to $12.5 million last quarter. Looking at the allowance just on loans, it was $325 million, which is also down $34 million from last quarter. By portfolio, the allowance for commercial loans decreased by $22 million, while for residential mortgages it was down $1.2 million and for consumer loans, it decreased by $10.7 million, which reflects charge-offs taken during the quarter. We did not have a need to add much in terms of provision; just a small provision for the consumer side. The ratio of allowance to total loans held for investment was 285 as of June 30, compared to 308 as of March 31. We did not allocate any allowance towards PPP loans since they are fully guaranteed and exclude those on a non-GAAP basis. The ratio allowance to loans was 294 compared to 320 in March. We still have significant reserve coverage ratios in the portfolio. On asset quality, we continue to execute our strategy to reduce non-performing levels. Total non-performing assets decreased by $29.3 million in the quarter to $256 million and total non-accrual loans decreased by $18.4 million to $183 million. This reduction includes the sale of a $10 million commercial property and we also experienced decreases of $10.6 million in non-accrual residential mortgage loans, primarily due to collections of non-performing loans. Inflows to non-accrual were down to $16.8 million compared to $32 million last quarter, and all categories had reductions. Improvements were also noted in early delinquencies; 30 to 89 days was down by $60 million from $144 million last quarter to $84 million this quarter. Resulting non-performing assets now represent 1.2% of total assets and non-performing loans 2%, at 1.6% of total loans in the portfolio. PDRs continue to decline; they were under $450 million as of June, which is $10 million lower than in March. On the capital front, Aurelio made reference to this, but to avoid being repetitive, capital remains strong. We completed the $100 million acquisition, and overall, capital decreased less due to revenues generated in the quarter and OCI improvement on the value of the securities. As of a couple of days ago, we have repurchased $118 million, including the $100 million repurchase as of June and an additional $18 million. This includes approximately $0.10 per share or close to 1%. Overall, all of this was supported by revenue, earnings during the quarter, and OCI improvement, resulting in tangible book value per share increasing by $0.30 in the quarter. With that, I would like to open the call for questions.

Thank you. Our first question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Hey! Good morning.

Good morning, Ebrahim.

I guess the first question is around expenses. Thanks for putting guidance out for $117 to $119 million. How quickly do you think we could reset down to that level? And once we get to that expense level, how long should we expect growth from that point on? Or do you think that is relatively steady state, absent obviously any revenue growth-driven expenses.

We're expecting that by the fourth quarter we will still have some transaction expenses in the third quarter. If you take those out, we would be at similar levels. We will start realizing more savings now in the fourth quarter and we are expecting to be at those levels by the fourth quarter. Obviously, I'm excluding OREO because of the volatility that could impact some of those components. However, we see that in 2022 there is a little bit of impact from some of the projects I mentioned on the technology side that will come in. Nonetheless, we feel it will remain in that range. So we hope to achieve a normal expense base by the end of the year, where we can note some of those savings already implemented. As Aurelio mentioned, we are closing some branches now, and we have also been eliminating certain services while maintaining two systems.

Understood. And remind me, what were the merger expenses outstanding that you expect to record in the back half of the year?

The merger restructuring charges are anticipated in the back half of the year.

We still expect that between $4 million and $5 million will remain.

Understood. Regarding capital, you still have a significant amount of excess capital. You've conducted a substantial number of buybacks. Can you discuss your willingness to accelerate buybacks or increase your $300 million target as we look towards next year? Additionally, could you remind us about the ultimate goals concerning targeted capital ratios, especially CET1?

The capital plan is a living document that we will monitor constantly. When we built the plan, we had certain expectations for the year. We are actually performing better than that. We will revisit the plan again next quarter and it could change. It could change depending on the franchise performance. We want to finalize the integration, which takes a lot of resources, time, and ensures the franchise continues to perform well. As we enter the third quarter, we have much more confidence in future prospects over the next few quarters. Everything is on the table as we progress. We didn't expect to buy back shares so quickly after the acquisition, so we moved a little faster than anticipated and also to a higher number than we expected. This continues to be the case, and we continue to reevaluate our decisions. Furthermore, target capital ratios are influenced by the environment, macroeconomic conditions, credit quality, and all components of the economy will evolve.

Got it. Regarding asset quality metrics, the loan loss reserves ex-PPP at 3.2%, remind us, Orlando, if we reach a steady state, what are the normalized reserve levels you foresee, where NPAs and NPLs are at a much lower rate? Where do you see that number bottoming out?

Hopefully, at zero. At this point, it’s one step at a time. If you refer to our day one CECL reserves, we calculated we would be around 2.6%. We believe we can reach that target soon based on economic trends and projected macroeconomic variables. We see potential with investor inflow in the market in Puerto Rico and consider possibilities for further reductions in non-performing loans. 1.2% of assets looks promising compared to previous figures, but we would prefer our non-performing loan side, ideally around 1% in the future. We are continuing to address challenges stemming from the pandemic, particularly regarding foreclosures, especially on the residential side, which represent a significant portion of our non-performing loans. However, we are seeing better prices during chart sale offers, leading to improved loan resolutions.

Got it. Thanks for taking my questions.

Thank you.

Thanks, Ebi.

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

Hey! Good morning, guys.

Hey Alex!

First off, I want to hone in on one comment from the prepared remarks. You said that loan pipelines look promising. I hope you can elaborate on what you are seeing. In the past, you've been very optimistic about potential construction loan disbursements later this year. Are you still optimistic about that? Please help us understand the timing behind some of those projects coming online.

Yes, we do expect the construction pipeline to improve. It's linked to investor interest in the island, housing demand, and approved CDBG projects that are kicking off. Each quarter should show improvement moving forward, particularly in 2022, as housing demand remains strong. Other construction elements may take longer, but given the significant funds pending for deployment that are pre-construction, this is a trend we are building upon. We expect to improve our volume of originations quarter by quarter.

That's very helpful. Next question for you, Orlando. Regarding cash deployment to securities made during the second quarter and its impact on NII, has the full effect of the security purchases been felt in the second quarter, or is there carry through that might reduce that level of NII? Should we expect to see that in the third quarter?

Alex, the situation is tied to market conditions. We had $1.5 billion of government deposits come in, some of which are temporary and related to certain efforts, so part of it will go away. We still maintain $2.5 billion in cash, mostly in the fed account, which yields some interest, albeit a small amount. Caution is warranted when extending the investment portfolio's life within our policy guidelines. We're trying to keep risks low, but we anticipate some pressure on the margin will persist into the third quarter.

Noted. I also noticed the $100 million buyback you executed in the second quarter. Should we expect another $100 million to be repurchased in the third quarter?

We set a goal of $100 million in the first quarter, and we achieved that. We haven't disclosed anything further. We have internal targets for each quarter and will evaluate them as we progress. However, I cannot definitively state that we will buy back another $100 million.

Thank you for your clarity. Regarding the tax rate expectations, specifically the $64.6 million of DTA valuation allowance at FirstBank mentioned in the press release, could you provide insights?

As discussed previously, tax laws in Puerto Rico compel us to regard exempt income as a contributing factor. A significant portion of what exists there correlates to that. While we might see minor utilization, we don't anticipate much realization unless there's a shift in tax laws. The increased level of cash investments, not all exempt, raised the tax rates somewhat. However, I cannot confidently affirm that $64 million will be realized. Our ongoing efforts aim to maximize usage amidst the factors challenging the valuation allowance.

For modeling the tax rate, should we expect it to be closer to that 36% for the third and fourth quarter based on current trajectories?

This quarter, the effect was about 33%. We're seeing that it should be similar, around 33% to 34%. Even with reserve releases and reduced charge-offs, we can expect this taxable component to increase as we proceed. We’ve moved from an estimated 30% to nearly 30.5%.

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, Sara. On the IR front, we have Piper Sandler coming down for an investor field trip in person September 23 and 24. We greatly appreciate your continued support, and with that, we will conclude the call. Thank you.

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