First Bancorp /Pr/ Q4 FY2021 Earnings Call

Hello. My name is Bailey, and I will be your conference operator today. At this time, I would like to welcome everyone to the First BanCorp. Fourth Quarter 2021 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Ramon Rodriguez, Head of Investor Relations, you may begin the conference.

Thank you, Bailey. Good morning, everyone, and thank you for joining First BanCorp.'s conference call and webcast to discuss the company's financial results for the fourth quarter and full-year 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 the 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.

Thanks, Ramon. Good morning to everyone, and thanks for joining our earnings call today. Let's start by moving to Slide 4. We closed 2021 with another record quarter for the company, clearly reflecting the strength of the franchise and the improved economic backdrop in our operating markets. During the quarter, we generated $73.6 million in net income or $0.35 per diluted share and importantly, I think a record $104.9 million in adjusted pre-tax pre-provision income. Asset quality continued its improvement trend that we had during the year, now non-performing assets reaching a decade low of 0.76% as a percent of total assets, driven by repayment of several non-accrual loans, OREO sales, and less migration. The ratio of the ACL for loans and finance leases to total loans decreased to 2.43% during the quarter, driven by a combination of factors such as reduction in the residential mortgages as well as improvements in macroeconomic factors impacting qualitative reserves. In terms of expenses, the efficiency ratio continued to trend down, now to 52%. This is a historical low, compared to 53% registered during the third quarter. On the capital front, we executed our capital plan, returning capital to shareholders. During the fourth quarter, we raised the common dividend by 43% to $0.10 per share. We repurchased 4.6 million common shares amounting to $63.9 million. We also executed the announced redemption of $36.1 million of outstanding preferred shares. Happy to say that we ended the year with a very strong capital position of 17.8% common equity Tier-1, leaving ample room for further capital deployment initiatives during 2022. Let's move to Slide 5 to provide some detail on the deposit and loan performance. The loan portfolio slightly decreased in the quarter by $75 million, mostly driven by a $73 million reduction in SBA PPP loans. We experienced four large commercial repayments from relationships in Florida and the Virgin Islands, which amounted to $125 million. We also experienced a reduction of $112 million in the residential mortgage loans in the portfolio. These reductions were partially offset by strong auto and commercial originations, both in Puerto Rico and Florida. Despite this slight repayment, the commercial portfolio grew by $59 million, turning the corner as we continue into 2022. Loan originations for the fourth quarter were also strong at $1.4 billion, including credit card utilization activity. It's the best quarter we have had this year again with strong originations in Puerto Rico and Florida. We closed the year with a very strong pipeline coming into the first quarter. Definitely, loan portfolio balances remain impacted by excess liquidity and these paydowns. With rate markets moving up, this should diminish. On the other hand, loan originations continue to be strong. We're focused on our strategy for growing the portfolio centered around increasing consumer and commercial books while continuing to focus on conforming residential mortgages, as we have done over the past year. In terms of deposits, core deposits continued to grow, but as expected, at a slower pace compared to prior quarters. Over the next few quarters, we expect a reduction of approximately $150 million in government deposits from the recent bankruptcy settlement, likely happening in the second quarter. Excluding brokered and government deposit core deposits, we registered an increase of $64 million during the quarter. I'd like to take this opportunity before handing over to Orlando to provide a summary of the year, so let's move to Slide 6. Definitely, the core results for the company reflect the transformational progress we made on multiple fronts in 2021. We generated $281 million of net income or $1.31 per diluted share compared to $102.3 million in the prior year. We registered a 30% increase in adjusted pretax pre-provision income. We grew total loan originations and renewals by 20% excluding PPP and credit card activity compared to 2020. Moreover, new money commercial originations, including closed and unfunded commercial and construction loans, grew by 50% when compared to the prior year. It is important to mention that over 75% of the construction loans we made in 2021 are expected to partially fund in 2022. During the year, we returned capital equivalent to 112% of earnings in the form of repurchase of common shares, redemption of preferred shares, and dividends. Key to the efficiency ratio, we completed the timely integration of the acquired operations during the year. We executed on all the operational efficiencies planned as part of the transaction and achieved the established financial targets of the transaction. The transaction allowed us to expand our footprint and strengthen our leadership position in the market in Puerto Rico. Importantly, we invested significantly in our digital capabilities. The pandemic accelerated the adoption of digital channels, which continued to grow significantly, improving digital engagement across all our digital functionalities. We also reengineered the auto lending origination process by deploying a fully digital platform to our dealer network, allowing us to offer a complete digital experience. Additional investments in technology and digital operations are planned for 2022 to continue improving our competitive position in an increasingly digital environment. On the macro front, we are in the initial stages of a growth cycle in Puerto Rico. The recent announcement of the resolution of the debt restructuring process should allow the government to focus their efforts on supporting economic growth initiatives and capitalizing on a large amount of obligated disaster relief funds that need to be deployed. Like in other jurisdictions, COVID cases have increased recently, driven by the Omicron variant. However, our high vaccination rate provides an important safety net to withstand any impact on healthcare infrastructure and economic activity. We are confident that the positive backdrop in our pre-operating region should result in increased loan demand in 2022. With that summary, I'd like to turn the call over to Orlando for more details on the financial results. Thanks.

Good morning, everyone. Aurelio mentioned we had very strong 2021 results. Net income was $281 million, $1.31 a share. This includes improvements of $130 million in net interest income and a $10 million increase in other non-interest income. Remember that the Santander operation, the acquisition, was completed on September 1, 2020. So we had four months of Santander versus this year we had the full year. As he also mentioned, it reflected on pre-tax pre-provision improvement, with significant increases. We went from about $300 million in 2020 to $392 million in 2021, marking a significant pickup. Fourth quarter results were also very strong. We made reference to $73.6 million in net income or $0.35 a share. The provision for the quarter was, in fact, a net benefit. We had a $12.2 million benefit, very similar to the $12.1 million we had in the third quarter. This was overall driven by improvements in macroeconomic variables, which are both actual and expected. I'll touch a little more on the reserve later. Expenses for the quarter were $2.6 million lower than the third quarter. However, we did experience an increase in income tax expense, with a higher level of income resulting in a change in or an increase in the mix of taxable to exempt income. Effective tax rates went up by 7 basis points for the full year, resulting in an increase in taxes throughout the year. Net interest income for the quarter was $184.1 million, slightly lower than last quarter, but the margin improved by 1 basis point to 3.61%. The yield on the portfolio, the GAAP yield, was 6.34% for the quarter, very similar to the 6.33% we had last quarter. Loans continue to represent approximately 55% of average interest-earning assets. The cost of interest-bearing deposits, excluding brokers, is now 30 basis points, which is 3 basis points lower than last quarter. The recent increase in market rates will provide an increase in yields for variable-rate loans. Approximately 40% of our commercial portfolio is tied to LIBOR, and another 19% is tied to prime. We have already seen some pickup on the three-month LIBOR. The reinvestment of maturing securities should also provide some pickup. Comparing current rates with what we reinvested, we foresee an increase of 40 to 50 basis points on reinvested money compared to the fourth quarter. This doesn't mean the whole portfolio will go up by this amount, but it will help increase the overall yield. Assuming the mix of interest-earning assets remains at these levels and the expected trend on interest rates, we foresee some increases in margin in the next few quarters. However, as Aurelio mentioned, we had a reduction in the mortgage portfolio as we continue to originate a higher percentage of conforming loans, affecting the margin mix. Non-interest income for the quarter was similar, with a slight increase compared to the third quarter. We had increases in fee income and service charges, which were offset by some decreases in mortgage banking revenue due to selling less of the conforming portfolio based on the level of originations in the prior quarter. Our expenses for the quarter totaled $100.5 million, compared to $114 million in the third quarter. In the fourth quarter, merger expenses were $1.9 million related to ongoing costs for the consolidation of four additional branches we will complete during the first half of 2022. Last quarter, merger and restructuring expenses were $2.3 million. We have now completed all merger expenses, and there shouldn't be any components of this going forward. Expense levels have been decreasing in the last couple of quarters as we eliminated conversion and integration-related expenses, continuing to achieve or implement savings from the acquisition. However, expense levels have been running lower than what we expected would be a normalized level. Two main factors contribute to this, one being a higher level of personnel vacancies that we have faced over the last few quarters. At this point, we're running twice as high in vacancies from a normal level, partly due to the government support funding that has created a market shortage. To compensate, we began raising the minimum salary to branch and call center personnel at the end of 2021. The impact of that increase will be approximately $1.4 million per quarter starting this first quarter of 2022. We expect that, combined with our ongoing recruiting efforts, should help normalize the vacancy levels. Once these levels are normalized, compensation expenses should increase by about $1.5 million per quarter. We don't expect to achieve these levels until later in the year, most likely toward the end of 2022. Additionally, we have benefited from the increase in property prices in the Puerto Rico market, which has allowed us to improve the disposition value of OREO properties, offsetting OREO operating expenses. In fact, we achieved a $2.3 million net gain in OREO in the third quarter and an additional $1.6 million net gain in this quarter. This is not typical, as operating costs usually increase when handling and disposing of repossessed properties, but the market has provided favorable conditions. Realistically, this will eventually return to more normalized levels. We're also reconfiguring centralized facilities to complete the physical integration of all operating units, which is ongoing but not yet complete and will take a few months. As mentioned, we continue with several ongoing technology projects. Many of these costs are not yet reflected in quarterly expenses. Therefore, we still believe that normalized expenses will fall in the $117 million to $119 million range, though we won’t achieve this until later in the year. The first couple of quarters of 2022 should run at a lower rate. The efficiency ratio for the quarter, as Aurelio referenced, was 52%, which is lower than anticipated. However, even normalized expense levels will allow us to reach our target ratio of 55%. We feel comfortable regarding expense levels and efficiencies achieved, not considering any further improvements on the income side that should also contribute positively. On asset quality, as Aurelio mentioned, non-performing assets decreased by $14 million, continuing the trend. Non-performing assets now stand below 1%, at 76 basis points of assets. Of that reduction, $6.8 million was in non-accrual commercial construction loans. We sold a $3.1 million non-performing construction loan in Puerto Rico. Inflows continued to be low, at $15 million this quarter compared to $17 million last quarter. At the end of the quarter, the allowance was $180 million, down by $20 million from the third quarter. The allowance on loans and finance leases was $269 million, down by $19 million. The allowance reduction reflects continued improvements projected based on macroeconomic variables used to calculate ACL. However, we are closely monitoring the impact of the Omicron variant, particularly on customers in the hotel, transportation, and entertainment industries. This will be included in our qualitative assessment for reserve establishment. The reserve ratio continues to be strong, standing at 2.43% last quarter. Regarding capital, we continue executing our capital plan. For the fourth quarter, common stock repurchases and the redemption of preferred shares amounted to $100 million. Throughout 2021, we repurchased 16.7 million common shares and redeemed $36 million in preferred shares, totaling $150 million in capital actions for the year, in addition to the $65 million paid in dividends. Even with these capital actions, strong earnings maintain our capital ratios at a significantly well-capitalized level. Tier-1 common equity moved slightly up from 17.7% at the end of the first quarter, just before we started with the capital repurchase, to 17.8% at the end of the year. Tier-1 capital decreased just two basis points from 18% to 17.8%. Thus, we continue to have ample space for capital actions, as Aurelio previously mentioned. With that, I would like to open the call for questions.

Thank you. We have our first question from Ebrahim Poonawala from Bank of America. Ebrahim, please go ahead.

Good morning, Ebrahim.

Yes. So, I guess Orlando, I just wanted to first start with expenses. There should be a $1.4 million increase in 1Q from the minimum salary and wage increases. And then you talked about getting to a $117 million to $119 million range by the back half of 2022. Is that correct?

Yes. If you take the numbers, the $111 million this quarter, it was really about $110 when you take out the restructuring costs. And you can hear me?

Yes, I can hear you.

We are expecting about a $1.4 million increase. This is already accounted for, but we typically see a slight rise in the first quarter due to payroll-related expenses, particularly payroll taxes, as everything resets at the start of the year. Additionally, the $1.9 million benefit we previously observed in occupancy, particularly concerning OREO expenses, should not be expected to persist consistently. This change is largely connected to properties that were transferred when prices were lower based on appraisals at that time, and now we are executing at better prices. That's the rationale behind the message; we're anticipating a gradual increase. As we address the high vacancy rates, we also expect some additional expenses in this quarter.

I understand. To clarify, you mentioned that you believe the efficiency ratio can improve to 55% from the approximately 52% reported for the fourth quarter of 2021. Is the 55% merely a target, while your actual operations will be at a lower rate? I'm trying to understand the outlook for net interest income. Do you anticipate growth in net interest income from this point? Additionally, how much margin expansion do you foresee as a result of the rate hikes? I recognize you've addressed the floating rate portfolio, but you've also noted the challenges of increasing mortgage loans on the balance sheet. Please provide insight into the direction of net interest income and how we should interpret the 55% efficiency ratio.

Yeah, I just want to comment, this is Aurelio, Ebrahim. I think the 55% obviously it's a performance target we always work towards doing better than that, which has been the case for the last couple of quarters. Obviously, we don't want to mislead there's still expenses coming into the line. Some of them are related to new business volume. Revenues should move in parallel, obviously, not at the same proportion. We model the business and pricing to ensure we meet competitive targets. Again, the performance metric of 55% is a high-level one, but we always strive to do better than that, which again has been the case. Orlando provided detail on the variances showing this relatively lower number. As mentioned before, we don't want to under-invest in the franchise and the growth opportunities.

Right.

So this is a balancing act. Hopefully at the end of the day we would like to stay better than the 55% but, obviously, the business is modeled considering that's the target.

Yes. Regarding the 55%, if you consider the guidance of $117 alongside current revenues, we are essentially on track. You raised a valid point about the impact of changing rates; we expect to see assets re-priced more rapidly than liabilities. It will take some time. Naturally, the investment gains we will realize will assist, but our portfolio is still smaller compared to what we typically invest each quarter. Additionally, we have some regular repayments coming from higher-yielding investments we've made earlier. The re-pricing of the commercial portfolio will start to reflect the increases in SOFR or LIBOR as we transition to using SOFR, which will be the primary variable for our calculations. As for the margin pickup, I'm reluctant to provide a specific number right now. I am confident it will increase, but the extent will depend on how the residential components adapt and the pace of reinvestment.

Understood. Can you provide the outstanding balances for PPP at the end of the year and the remaining fees that will be accrued as those balances are forgiven?

I don't remember the number, Ebrahim. This quarter was about $1.5 million lower than last quarter. Part of this is also because of the acceleration with fewer repayments. I can get you that number, but I don’t recall the quarterly amount of normal amortization of the fees at the moment because it’s…

That's fine.

...mixed up a bit sometimes with the repayments. But I’ll provide that information and ensure everyone gets it.

That's fine. And just one final question around capital return, I know you've submitted the plan. Maybe you're talking to the regulators. Should we expect a bigger buyback over the next 12 months relative to what you completed over the last 12 months?

Our timeline is similar to last year. We should announce our capital actions sometime during April when we report next time, as we did last year. It's in progress. Obviously, you've seen what happened over the last 12 months. We’re completing the plan of $300 million, and we are basically in the same position where we started. It’s logical to assume that going forward, our goal is to sustain what we accomplished during 2021, but I cannot provide an answer on whether it will be larger or better yet. We have to wait until we announce, and we conclude the process in April. Remember, we also aim to achieve balance sheet growth in 2022.

Got it. Noted. I'll leave it here. Thanks for taking my questions.

Thank you, Ebrahim. The next question comes from Timur Braziler from Wells Fargo. Timur, please go ahead. We seem to have lost Timur, so we'll go to our next question, which comes from Alex Twerdahl from Piper Sandler. Twerdahl, please go ahead.

Thanks. Good morning.

Good morning, Alex.

I just wanted to drill in on some of your comments, Aurelio, on the outlook for growth. To start, I believe you said that 75% of the commercial loans originated in 2021 will fund in 2022. I was wondering if you could provide a bit more clarity on how we should think about the progression of disbursements and sizes that are potential based on what you've done so far?

Yes, I did say construction loans, okay? Seventy-five percent of construction loans. And we did about $200 million in 2021 in construction loans. We expect most of them to be funded by the end of 2022.

Okay. Have you started some of the projects related to the community development block grant by the IPG and the R3 and the passed credit? Have any of those started to be disbursed, or could you update us on when we might expect some of those disbursements?

Yes. Some of those programs have been approved by credit already, and we passed the filter and the careful evaluation. They’re in the stages of beginning to close. I believe we will see some of that throughout this year, but it's tough to pinpoint the exact quarters.

Okay. We all look forward to seeing some of those loans come online. A couple more questions from me. When I look at the net fee income, it appears that the service charge fee has kind of popped up. Is that due to seasonality, or is that at a more sustainable level?

That's not so much seasonality, right? The one on deposit accounts you mean, or the other one? The credit card fee kind of income has a little bit of seasonality, due to increased purchases in the last quarter. The deposit accounts are more of an ongoing normalization depending on the operation and the type of transactions. We’re witnessing that, which is combined with an increase in deposit accounts, indicating a more normalized fee generation.

Okay. Then just back to expenses. You're running at double the level of vacancies. I know you don’t want to under-invest in the franchise. But even with an elevated level of vacancy, are all these positions necessary to fill? Could you maintain a leaner workforce?

Well, it's part of our day-to-day operation to be as efficient as possible. So, believe me, there's a lot of discipline behind how we go about hiring and the quantitative and qualitative factors behind it. We definitely look for opportunities, and some of it could be linked to volumes. If volume comes or doesn't, it’s a whole series of decisions that inform this approach. But we design it to achieve those targets if those will be needed in part.

Keep in mind that we deal with the challenge of the Omicron variant; we lose personnel for a few days now and then, impacting service levels. We need to account for that to ensure our quality of service is maintained.

Got it. Also, on expenses, I know you expect that normalized run rate towards the back half of the year. You mentioned that some tech investments haven't started to amortize yet. Do you have a sense of when those will come online so that we can gauge the pace of expenses over the next couple of quarters?

There are two fronts there. The facility projects we've completed will be done probably by the end of this month, beginning of February. A second component will be completed in the second half. Therefore, the full effect on facilities will likely be seen in the second half of the year. In the case of technology projects, it varies as some start at the end of February or early March, while ones that are capitalized won't show an impact until the fourth quarter or end of the third quarter. We still believe the first couple of quarters of 2022 will reflect lower expenses than the guidance, and we’ll start receiving our guidance by the end of the year.

Okay. One final question regarding loan growth and the residential portfolio. Do you know or can you indicate the portion of that residential runoff that was due to refis versus the normal amortization of that portfolio?

I’m trying to remember the numbers, Alex. Keep in mind that what's happening with refis is that a lot of loans qualify for FHA programs now with current rates. But I can't recall that from the top of my head. I will need to provide that also to give you a clearer indication.

Okay. Thanks for taking my questions.

Thank you, Alex.

Thank you, Alex. Our next question comes from Timur Braziler from Wells Fargo. Timur, please go ahead.

Hi. Good morning. Sorry about the technical difficulties earlier.

No problem. How are you?

Maybe just circling back to the last question. More broadly on the resi runoff when does that subside? Are we getting pretty close to a cycle where we can expect that the portfolio will shift from being a headwind to overall loan growth?

Let me take that. Many factors contribute to the movement of the overall portfolio. In the residential segment, rates have shifted significantly over the last 30 days. This has led to a change; there’s a shift from refinancing now. At some point, we saw around 55% for refinancing and 45% for new money. That will shift now regarding the refi side, driven by rates and speed. We've observed significant movement since late December to January. We expect that in the origination side this quarter and can provide more detail next quarter. Additionally, levels of conforming mortgages are adjusted up, causing some non-conforming mortgages to now also be conforming. The dynamics will take time; however, we expect record levels of prepayments on the mortgage portfolio shouldn't persist into 2022, also true for the commercial book. Last year, we dedicated significant management focus to integration; now, our focus shifts to growth, increasing confidence that we will achieve loan growth this year.

Thank you for the information. Changing topics, can you share your thoughts on the allowance ratio in relation to the anticipated acceleration in loan growth? How do you view the potential for further economic improvement in the context of CECL? We are hoping that the recent slowdown due to Omicron is just a short-term setback, and how will the increase in new loan growth impact the reduction of allowances?

The challenge is Omicron, to be honest. However, regarding the qualitative aspects of our reserves, if Omicron is indeed temporary, as the market expects, and assuming no new variants emerge, it should help in maintaining or returning trends toward improvement. If that happens, we will likely see a decrease in reserve needs for existing portfolios, of course, as we prepare for next year. We expect not to see the same releases as last year. Many of 2021's releases were due to the significant potential impacts from COVID in 2020. Still, we believe that provisioning levels will be lower than what would normally be expected in 2022. Nevertheless, we do not anticipate the same level of releases as we observed this year.

Okay. Last question from me on credit. We had some NPL sales in the third quarter. Broader asset prices continue to do well and receive favorable attention. Is there incremental opportunity to sell off some troubled assets here at these levels and further improve the asset quality of the franchise, or has that been taken care of in the prior quarter?

It's something we always monitor closely. There has been a lot of activity over the last few years. The investor interest remains quite positive on the island, and this is reflected in the asset values. Our policy remains to sell at the right price in general. We don't have much more to dispose of, to be honest. We will continue to evaluate as prices fluctuate on assets tagged for sale individually.

Great. Thank you for the questions.

Thank you, Timur. We have a follow-up question from Ebrahim Poonawala from Bank of America. Ebrahim, please go ahead.

Thanks. Hey, just one quick follow-up. Aurelio, you mentioned a $150 million runoff coming out of the restructuring that you expect sometime in the second quarter. Is that essentially the magnitude of runoff expected from the bankruptcy, or are there more deposits that could leave the balance sheet once all is said and done?

No, regarding the bankruptcy, that's it. We don't have any more information. The Department of Treasury of Puerto Rico is not included in our balance sheet. Only a few agencies and small balances could have an impact. Our primary focus is on the government strategy as part of core transaction services.

All right. Thank you.

Thanks, everybody. We will likely be participating in the KBW conference in February, so if any participants would like to meet with us, we are available. Thank you for your time.

Thank you.

Thank you.

Thank you. This concludes today's First BanCorp.'s Fourth Quarter 2021 Results Conference Call. You may now disconnect your lines.