First Bancorp /Pr/ Q2 FY2022 Earnings Call

Hello, and welcome to today's First BanCorp 2Q 2022 Financial Results. My name is Elliot, and I'll be coordinating your call today. I'd now like to turn the call over to Ramon Rodriguez, Corporate Strategy and Investor Relations Officer. The floor is yours. Please go ahead.

Thank you, Elliot. Good morning, everyone and thank you for joining First Bancorp's conference call and webcast to discuss the company's financial results for the second quarter of 2022. Joining you today from First Bancorp are Aurelio Aleman, 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 fbpinvestor.com. At this time, I'd like to turn the call over to our CEO, Aurelio Aleman.

Thanks, Ramon, and good morning everyone and thanks for joining us today for this earnings call. Let's please move to slide four to discuss the highlights of the quarter. As we reported, we continue to perform exceptionally well during the second quarter, we earned $74.7 million in net income or $0.38 per share and delivered our fifth consecutive increase in adjusted pre-tax, pre-provision income by reaching a record of $118.8 million during the quarter. This result was achieved under a quite challenging global economic backdrop and definitely demonstrates our capacity to execute and responsibly grow regardless of the operating environment. I would like to thank all our teams in Puerto Rico, Florida and the ECR for their commitment and execution during the first half of the year. Net interest income increased 5.7% linked quarter to $196.2 million and the margin expanded by 21 basis points to 4.02%. Also, we recorded a provision for credit losses of $10 million, primarily reflecting an overall increase in the loan portfolio and increased uncertainty that is reflected in the forecast of certain macroeconomic variables and the impact on qualitative reserve. Asset quality continued to improve during the quarter with nonperforming assets decreasing by $9 million, now to $147 million, driven by reductions in non-accrual residential mortgage loans and pay downs of non-accrual commercial loans. The ratio of the ACL for loans and finance leases to loans held for investment slightly increased to 2.25% during the quarter. On the capital front, we continue to execute on our capital deployment plan and repurchased approximately 7 million shares of common stock for a total purchase price of $100 million. This was done under the previously announced $350 million stock repurchase program. We ended the second quarter with a 17.2% common equity Tier 1, quite strong, leaving room to execute on our established capital plan over the next quarters, obviously, taking into consideration any change in market conditions. Let's move to slide five to review deposit and loan performance. We continue to register loan growth across our targeted business segments during the quarter, which are consumer and commercial. Loan portfolio balances, other than PPP loans grew by $144 million when compared to the first quarter, driven by increases of $131 million in consumer loans and $59 million in construction on commercial loans, offset by a decrease of $45 million in residential mortgages. Total loan originations for the quarter were strong and, excluding credit card utilization activities, reached $1.4 billion, an increase of $281 million when compared to the first quarter. This is primarily attributed to higher commercial and consumer loan originations. I have to say that quarterly loan origination activity is above pre-pandemic levels and we expect that this will continue to be sustained under the current market conditions, which still result in additional loan growth through the second half of the year. Core deposits net of government and broker decreased by $360 million when compared to the first quarter. On the other hand, government deposits increased to $176 million. Deposit market growth in Puerto Rico decelerated during the first half of the year after significant increases in 2020 and 2021. However, when we look at average deposit balance, it is still 31% above pre-pandemic levels. When we look at the uncertainty in the global macro conditions with all geopolitical tensions, inflation, and what's going to happen with future interest rates, this has an impact on any operating backdrop. Notwithstanding our enhanced capital position and liquidity profile, coupled with strong economic tailwinds in Puerto Rico continue to support our growth thesis. The labor market in Puerto Rico improved again with the labor force above pre-pandemic levels, and the unemployment rate reached a multi-decade low of 6.2% in May. The economic activity index, which is an indicator that is highly correlated to GMP, has continued to sustain an upward trend and already surpassed pre-pandemic levels. The resolution of the government debt process will definitely allow government officials to achieve their efforts through facilitating the deployment of the $50 billion still obligated disaster and pandemic fund pending to be disbursed. The adequate use of these funds will be key to resolve the longstanding structural issues and support the economy going forward. Our strategic focus remains centered around providing the best omnichannel experience to our clients. During the quarter, we continued our investment in our digital tools and services; digital engagement across all our platforms continue to improve. Retail banking users grew by 3.8% linked quarter and mobile banking business, digital banking users increased by 50% since the application was launched in April. We continue to capture over 40% of all deposit transactions through digital and self-service channels. Additionally, this quarter we began a partnership with an established FinTech firm to provide a fully detailed commercial lending platform for small business loans. We can now process consumer mortgages and small business loan applications through self-service digital platforms. All digital initiatives allowed us to expand our distribution reach beyond physical infrastructure, while still optimizing our existing branch network, which will include the execution of two additional branch consolidation opportunities during the second half of 2022. In summary, we are very pleased; we continue to make great strides at balancing the franchise and achieving our strategic objectives. Our fortress balance sheet, complemented by positive tailwinds in our main market, should contribute to mitigating the rising market challenges across the globe and should allow us to continue supporting our clients and delivering value to shareholders. With that, I would like to turn the call over to Orlando to provide more details on our results. Thanks to all.

Good morning, everyone. As Aurelio mentioned, results for the quarter were strong. We reached $74.7 million, $0.38 a share, slightly down from the $82.6 million we achieved last quarter, but there were two major components in the quarter. First, the impact of the rising market interest rates on the loan growth led to an increase of $10.6 million in net interest income. We also had a technical difficulty. The provision for credit losses this quarter was an expense of $10 million, which compares with a net benefit of $13.8 million. The provision reflects an increase in the portfolio, as well as increased uncertainty included in the forecasted economic macro variables that we use for the calculation of reserves and provisioning. Charge-offs in the quarter were better than last quarter and that helped on the other hand. The net interest income totaled $196 million in the quarter, which is an increase of $10.6 million compared to $185 million we had last quarter. The margin expanded 19 basis points from 3.81% to 4%. If we look at components, loan repricing in the quarter represented approximately $3.5 million of the increase in interest income for the quarter, and the increase in the portfolio balances, if we exclude the PPP reduction, represents an additional $1.9 million in interest income. The reduction in PPP decreased interest income by $1.2 million in the quarter. The investment securities and cash based on repricing and investments at higher rates improved by $5.3 million, leading to an increase in yields and a reduced premium amortization as prepayments have come down on the portfolio. This quarter also had one more day than last quarter, adding about $1.5 million to net interest income. As I mentioned before, the yield on earning assets improved, going from 4.06% last quarter to 4.25% in the second quarter, while the cost of interest-bearing liabilities decreased by 1 basis point from 44 basis points to 43 basis points. Deposit costs for the quarter were fairly consistent, but we are expecting some increases in the third quarter tied to the Fed adjustments, interest rate adjustments that happened in June and the ones that are expected to happen in July once the Fed meets. However, overall, we do expect to achieve some additional margin improvement in the third and fourth quarters of the year. Looking at non-interest income, it shows a reduction in the second quarter, mainly due to the collection of annual contingent commissions that happen in the first quarter of the year. However, the other large component that we have seen decreases in mortgage banking income as the level of originations of conforming mortgages being sold in the market has come down, driven by higher conforming mortgage interest rates leading to a shift in originations. On the expense side, non-interest expense for the quarter was $108.3 million, which compares with $106.7 million in the first quarter. Expense levels continue to benefit from the gains achieved on the OREO disposition. This quarter we had a $1.5 million gain on OREO properties, net of operating expenses of OREO. As we have mentioned in prior quarters, we expect that eventually this will revert to having a net expense from handling reprocessed properties rather than lease gains, but still, we have some properties on the OREO portfolio that were moved at lower values than sold to date. So there is still some positive impact expected in the next quarter. During the second quarter, we also had a $1.7 million in expense reductions considered with the resolution of matters that had been previously accrued, which improved the expense base. Looking at some other large components, we saw employee compensation and benefit increased by $1.7 million this quarter, and we expect some additional increases in the third quarter as we continue to fill vacant positions and execute the salary merit increases planned for the third quarter of the year. In reality, we are still running at a higher level of vacancies and it is taking longer than we had anticipated to fill those positions, but we continue to pursue that. The other component is that, we saw an increase of $600,000 in professional service fees in the quarter. As we mentioned in the past, we expect some additional increases in both technology costs and professional fees as we continue to execute and implement some of the ongoing technology projects that are underway. We have discussed in the past looking at expense trends. If we exclude OREO and the other two items I mentioned on expense adjustments, the second quarter expenses would have been about $111.5 million in the quarter. I project that compensation and technology costs for the third quarter, excluding OREO, to be around the $113 million range. Obviously, any benefit from OREO would offset some of that. For the fourth quarter, we see expenses, excluding the OREOs, in a range of $114 million to $115 million, slightly lower than we had originally mentioned on the last call. We continue to pursue options on improving the cost base. As you saw, we have a couple of branches that are underway. The benefit of those is not large, but it will mostly start happening next year, not this year. On efficiency, the efficiency ratio for the quarter was extremely good at 47.7%, which is lower than last quarter and a lot has to do with improvement in the revenue component. If we look at the normalized expense levels I just mentioned and the possible improvements in revenue components, we believe that by the end of the year we will be closer to 50% as opposed to the 52% target we had given last quarter based on the combination of the expense base and the revenue components. In terms of asset quality, trends continue to be positive. Non-performing assets decreased $9 million in the quarter to $147 million compared to $156 million in the first quarter. NPA now stand at 76 basis points of assets. We had reductions in OREOs from sales and reductions in commercial and residential from collections, so it's been pretty consistent. Inflows to non-performing loans decreased in the quarter by $5.2 million; last quarter, we had $21.6 million in inflows, and this quarter was only $16.4 million on the overall portfolio. Early delinquency, defined as 30 days to 89 days past due, also decreased in the quarter by $8.2 million, primarily for commercial relationships that ended up being renewed that matured last quarter and will renew this quarter. They will consistently occur in terms of payment. Net charge-offs for the quarter were lower, standing at 21 basis points, including a $1.2 million in commercial loan recoveries, compared to 24 basis points we had in the first quarter. The allowance for credit losses at the end of the second quarter was $264 million, which is $4 million higher than the last quarter. The allowance on loans is $252 million, it's up $7 million, which reflects an increase in portfolio balances, as well as the additional uncertainty reflected as part of the forecasted economic variables mentioned before. A large component on the consumer portfolio where we had a $131 million increase, as Aurelio mentioned, is very sensitive to any changes in unemployment rates that are part of the macroeconomic variables. The allowance ratio stands at 2.25%, which compares to 2.21% last quarter. On the capital front, Aurelio mentioned that we have continued with the execution of the capital plan. Capital ratios continue to be very strong. As you can see on the chart, the Tier 1 common, for example, only decreased 5 basis points from 17.7% last quarter to 17.2%. The impact on the other capital ratios was similar. Tangible book value continues to be affected by the OCI adjustment, decreasing from 8.63% to 7.80%. The $176 million adjustment on the OCI this quarter impacted most of that, combined with the repurchase and dividends. OCI now represents just over $3 a share on tangible book value. As we have mentioned, we believe this impact will reverse over time as we have the liquidity and ability to hold these securities until maturity. With that, I would like to open the call for questions.

Thank you. Our first question comes from Brett Rabatin from Hovde Group. Your line is open. Please go ahead.

Hey, good morning, everyone.

Good morning, Brett. How are you?

I'm good. Thanks. Wanted to first just ask about the commercial strength in originations and maybe whatever additional color you could provide on the fintech partnership and what that entails and what that might mean for loan growth going forward?

Okay. I'll take it separately. Over the year, we've been discussing the capital we are building. There's a lot happening in terms of M&A activity, companies buying other companies, investors coming in, some private deals, some public-private partnerships, and some hotels changing hands. Deal flow is very active and we continue to see new capital coming in. This is obviously the primary source of it. Secondly, commercial activity continues, and construction activity is ongoing. If we look at the first five months of the year, some funds deployed were close to $900 million if you look at the public data. We believe by the end of the year that should reach over $2 billion. That is contributing. We continue to see requests for line of credit supporting the contractors. Obviously, like everywhere else in the world, there are delays due to supply chain issues and materials not coming on time. So timing is always a consideration. We feel, in our main market in the U.S., which is Florida, the balance was also very strong. Florida continues to see inflows. Looking at public demographics, demand for office space is strengthening, which is not happening anywhere else, but it is happening in Florida. Companies are moving their headquarters, and residents are looking for homes. We think it's stable. We're not discussing double-digit growth; we're talking about prudent growth, which we continue to support. Remember, last year, after the acquisition, we achieved some selective renewal of the portfolio in certain cases just to ensure it fits our risk profile targets. This will impact our volumes. So we feel optimistic about our position on the commercial side. Secondly, we've been working with this fintech for some time and we just launched small business lending, which is going to be supported by clients, very similar to the platform we used for PPP loans that received positive feedback from clients regarding its self-service capabilities. This will increase our capacity to penetrate the small lending and small business segments, which perform well in the metro area based on our branch concentration. We believe we have opportunities in other regions of the island as well. So that's rolling out now.

Okay. That's great. Yes, that's helpful. And I wanted to make sure I understood the guidance. I think I heard $113 million and $114 million to $115 million for the fourth quarter in expenses for the 3Q and 4Q. The efficiency ratio maybe to tick back up towards 50% going forward or maybe for the back half of the year, and given the additional NIM expansion, it would seem like it would stay under 50%. Is there anything I'm missing with the balance sheet or fee income that makes that number move up a little bit?

No, you're right. The NIM expansion along with the expense components that are expected should take us close to 50%, maybe just under the 50%. I should clarify one thing; the only component affecting this guidance is the volatility seen in OREO results, which has been positive. While we appreciate that, I am trying to exclude it due to the expectations that at some point were not there. We still see some opportunities in the third quarter to offset expenses, maybe not at the level of gains that we saw in the second quarter, but it will offset some of the expenses. But clearly, you’re correct that with the expectation of NIM expansion and those expense levels, we feel just under the 50% or very close to it.

Okay. And then maybe just one last question from me. I find the chart in the deck with the EAI index interesting, and it shows it's a bit higher than it was before the pandemic. Do you think the economy is currently better than it was before the pandemic? Also, what is your perspective on how the funds coming into the island are helping to improve the local market in Puerto Rico?

I think there are sectors that are better than pre-pandemic. When you look at the construction sector and those benefiting from the supply chain, suppliers, engineers, and everything related to construction, it is more advanced. Obviously, the employment market is stronger. The unemployment rate has decreased, and the workforce numbers have returned to pre-pandemic levels. So, when I say it's strong, everyone is still hiring. The impact of inflation in oil and excess liquidity compared to average balances, which are still over 30% pre-pandemic, should support and mitigate inflation. Overall, conditions today look better than they were pre-pandemic. The uncertainty rests on how hard the impact of inflation will be, but presently all metrics suggest improvements over pre-pandemic levels.

Our next question comes from Timur Braziler from Wells Fargo. Your line is open.

Hi, good morning, gentlemen.

Hi, good morning.

Maybe just starting on the funding side, can you talk through the expectation for funding second half loan growth? Should we see additional usage of the bond books and cash to fund that growth, or is the expectation that deposit growth resumes here in the back end of the year?

Well, it's a combination. We have a high level of investment portfolio at this point. There is a normal cash flow component coming out of that portfolio that we believe is going to be offsetting any cash needs for the lending side. As Aurelio mentioned, we believe that in the second half, deposit growth is going to stabilize; it won't be like we saw in 2021 or 2020. We're already seeing some reductions in movements. So that's part of what's reflected in the quarter. However, we do not foresee needing wholesale funding based on current liquidity levels and the existing liquidity we get every month from the investment portfolio. It depends on how much ends up in investments versus loans.

Okay. And then it looks like Florida government deposits had a nice quarter. I guess, what's the outlook there? Is the effort there to self-fund Florida production on the loan side? Also, as you expect deposit betas to increase in the back of the year, I'm just wondering what the driver of that expectation is, because the results so far seem very strong, and it doesn't seem like your competitors are really pushing the envelope as far as deposit costs yet?

First, let’s quantify that; the government deposit growth is happening really in Puerto Rico, not in Florida. Just to clarify that, as that's where we have the large government business. In fact, we see that as stable funding. There are some funds deposited that are typical operating funds from municipalities, which we believe are going to be stable. We mentioned in the past that we do have some funding from reconstruction activity due to the energy authority. That would be more volatile depending on ongoing project statuses. So government funding will be present and stable. As for the betas mentioned under deposits, when the market dropped dramatically, like it happened in the states after the 75 basis point increase last month, those were expected. We're also seeing customers opting for other investment options tied to treasury. We compete with credit unions as well, so we anticipate that this will pressure interest rates. There is a customer retention component we have to keep in mind. The higher the Fed increases rates, the more reaction we’re likely to see from customers. So, we feel it's reasonable to assume betas will start moving based on what's recently transpired.

Okay. Thank you for that clarification. And then just finally for me on credit. Can you talk through a little bit about the uptick in auto delinquencies on the early stage? Is that indicative of us reaching the bottom for how good credit has been? As you look at your allowance ratio, I think you guided well that we're going to see a positive provision here in the second quarter. We observed a positive provision in the second quarter. Assuming the environment remains stable, could we expect further reductions going forward? Or is this a level that you’d like to maintain?

Well, we feel we're at a very low level of delinquencies in the market. Have we reached the bottom? Maybe we have. The market overall has remained stable for some time. We've seen that some of the dollar increases on the delinquency side relate to the portfolio size increase, not necessarily percentage-wise. However, the provisioning and reserves on the consumer side reflect growth, as I mentioned, but also reflect expectations for deterioration that could occur, including fluctuations in unemployment rates and several key macro indicators on consumer portfolios. So, assuming nothing happens, yes, eventually we may not need as many reserves. But we can't assume that there won't be any impact from inflation, and that's why we continue to incorporate environmental components and qualitative inputs, along with stress scenarios, as part of our reserves calculation to ensure we reflect any trends the market may show in the future.

Great. Thank you for that color.

Our next question comes from Alex Twerdahl from Piper Sandler. Your line is open.

Good morning, guys.

Good morning, Alex.

Hi, Alex.

I'm just wondering, it made a lot of sense. Our mortgage banking is a pretty big driver of the fee income. It's made a lot of sense to sell all the production with rates being where they were over the last couple of years. But now with rates pushing above 5%, I'm just wondering if the thought process surrounding mortgages changes and if potentially that could go from being a drag on overall balances to maybe even flat or contributory in the next couple of quarters?

Have you seen this quarter; you saw some positive trends on prepayments also in the portfolio. And when we look at the originated activity, the reality is, when the conforming rates are somewhat paired to portfolio rates, that tends to happen, and it's happening in the recent months. So I would not say we're in line to achieve growth in the mortgage portfolio. However, I think the contraction experienced should reduce moving forward. I'm not sure when we'll achieve full coverage of prepayment and repayment of the portfolio, but we can get back to you on that later.

Keep in mind, Alex, that overall originations and market originations of mortgages have decreased. It reflects a shift in the mix of what's been originated, but it's also a lower level of originations. We just don't have the level of refinancings that we saw during the previous years when rates were very low.

Okay, thanks. And just to be clear, the uptick in the ACL and the consumer portfolio, that's not being driven by anything you're specifically seeing. That's just to get ahead of some concerns in the market and maybe putting a little bit more weight in an otherwise good quarter. Is that the right way to think about that?

Yes, if you look at the uptick, it's mainly two components that we've seen; it went up by about $6 million related to growth on the consumer side, and about $3 million relates to macroeconomic assumptions. Other than that, it reflects normal movement depending on repayments and inflows. But we haven't seen anything other than the projected macroeconomics that are relevant in the portfolio. Changes in projections of unemployment on the consumer side move the needle on the reserves.

Okay. And then just a final question for me. I think you alluded to the projection of around $2 billion of federal money by the end of the year flowing into the island. Can you help us sort of connect the dots on how this will impact loan growth or how it potentially impacts loan growth at First Bank?

It's difficult to determine the correlation, but generally speaking, economic activity supports loan growth and sustains the economy. In eight months, I think the right number to reference is that, in five months, they’ve done $160 million of disbursements. Their goal is to reach $2 billion, which we believe is achievable. So, it's just additional support in the economy overall, difficult to quantify how much that translates into specific loan numbers. For us, we expect to achieve growth in the commercial book through the remainder of the year.

Great. Thanks for taking my questions.

Thank you, Alex.

Our next question comes from Kelly Motter from KBW. Your line is open. Please go ahead.

Hi, good morning. Thank you so much for the question.

Hi, Kelly.

Maybe turning to the balance sheet, you had a nice deployment of cash once again this quarter. Just wondering any updated thoughts on what a normalized level of cash looks like at this point in the cycle and where you may be comfortable taking it, given the puts and takes of the macro backdrop? Thanks.

Normal levels of cash should reflect reserve requirements. Other than that, keeping higher levels is leaving money on the table. There was too much liquidity, so we held a much higher level than what we would typically keep. As you mentioned, we saw a significant reduction from one quarter to the other, decreasing from $1.7 million to $1.3 million by the end of this quarter. A more normalized basis should be around $800 million or more depending on the options available and deposit movement. Some government deposits are also collateralized and the cash usually goes toward any needs, but it hasn't been significant. Some amounts remain as part of our liquidity component.

Got it. So it seems like you're still running pretty high there, and you mentioned you expect deposit betas to pick up from here. Fair to say that we're still going to see some nice NIM expansion from here, albeit maybe at a slower rate than what we saw in the second quarter? Is that a fair assumption as we look ahead?

It is a reasonable expectation. Overall, assuming 75 basis points from the Fed would also create some pressure, and remember that increases in June will start to reflect in July. We do expect some expansion in that area.

Thank you so much for the questions. I appreciate it.

We have a follow-up question from Brett Rabatin. Your line is open. Please go ahead.

Hey, guys. I just wanted to ask about the tax rate. What's a good number going forward, just kind of given the movement in the past few quarters?

The tax rate reduction occurred because we've been implementing some strategies to shift from taxable to exempt income on the investment side. Overall, it still depends on portfolio growth, as if the loan portfolio grows, it will impact taxable income. The current rate of 32% to 33% should be representative for the rest of the year.

Okay. And then wanted to follow up on the balance sheet in general. My presumption is, we'll see more of what we saw in the second quarter in the third and fourth quarters, where you use liquidity to fund loan growth, and so maybe the balance sheet stays the same or maybe shrinks a little bit depending on deposits. Is that a fair assumption, or do you think you'll actually grow the balance sheet?

No, that is a fair assumption, Brett. We're seeing it the same way.

Okay. Great. Appreciate the additional color.

Thanks.

This concludes our Q&A session and today's conference call. We'd like to thank you for your participation. You may now disconnect your lines.