First Bancorp /Pr/ Q4 FY2022 Earnings Call

Good morning. Thank you for joining today’s First BanCorp fourth quarter 2022 financial results conference call. My name is Alexis, and I will be your moderator. I will now hand over the call to Ramon Rodriguez, the Corporate Strategy and Investor Relations Officer. You may proceed.

Thank you, Alexis. 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 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. Good morning to everyone and thanks for joining our earnings call today. Please turn to page four to discuss the highlight for the quarter. We got a solid return of 158%. We earned $73.2 million or $0.40 per share in net income achieved, or $122.2 million in pretax provision income and reached an efficiency ratio of 48%, even lower than the prior quarter. The margin expanded by 6 basis points, while on the other hand, net interest income decreased by $2.3 million primarily related to an increase in the interest expense portion. Stable credit trends continue, supporting asset quality improvement with non-performing assets decreasing by $14.1 million to $129.2 million, which is a decade low at 69 basis points of total assets. Also, good news from the early delinquency side which also improved during the quarter and remains below pre-pandemic levels. In terms of capital deployment, we continue our plan. During the fourth quarter we repurchased 3.5 million shares of common stock for a total purchase price of $50 million and paid $22 million in common stock dividends. Our consistent earning generation capacity discipline and sales management have definitely allowed us to continue returning capital while allocating resources to organically grow. Let’s move on to the balance sheet on page 5, to discuss deposit trends. On the asset side, total loans and leases grew by $254 million. Now the portfolio stands at $11.6 billion during the quarter. This really happened across all business segments: commercial, consumer, and actually residential. This was our strongest quarter in terms of loan portfolio performance. Excluding PPP loans, which are almost finished now, commercial and construction grew by $141 million or 3% linked quarter. Total originations, including renewals and credit card related activities, were very healthy at $1.4 billion, up 15% versus the prior quarter. That is our priority: deploying capital to achieve profitable loan growth and capitalize on market share across all lending segments. We are encouraged by the trends we see in the main market and also by the pipeline we have today for 2023. In line with industry trends, core deposits decreased by $250 million or 2.3% during the quarter, which was actually slightly better than the local market trend for the quarter. I expect we will continue to see excess liquidity gradually tapering off within household balance sheets. However, our deposit balances for both retail and commercial customers remain above pre-pandemic levels. We are focused on leveraging our expanded sales distribution channels and digital channels to grow our market share in the deposit market and related products and services. That said, liquidity levels remain high with a ratio of cash plus liquid securities to total assets above 19%. Let's move to page six to discuss the highlights for the full year. We are really proud of the work that the team performed during 2022. Over the course of 2022, our team worked very hard to deliver outstanding results for the franchise. We raised our organic loan growth to $762 million when we had two PPP loans on the strategic reduction of residential mortgage. We earned $5 million in net income and achieved a record pretax pre-provision income of $475.3 million, which is up 21% when compared to 2021, reaching a decade low non-performing asset ratio of 0.69%. In terms of the franchise, we continued our investments in people, technology, and process improvement. We made great progress by moving forward with our omnichannel outreach strategy with investment in data service and self-service platforms to optimize execution capabilities and products. When we look at some of the metrics, data engagement continues to improve; retail banking registrations were up 4% during the quarter and 17% during the year. Offshore, our newly launched business digital banking applications continue to increase. Our new Visa digital lending functionality has improved our penetration in the small to medium business and SBA segments. We continue to capture over 40% of all deposits through this channel. All these milestones have been achieved within the context of a more efficient traditional branch network. During 2022, we also consolidated five additional branches, including two during the fourth quarter. Moreover, our efficiency ratio reached a historic low of 48.3 during the year, highlighting our ability to execute ongoing capital investments in technology, improve digital channels, and attract top talent, all without compromising the operating leverage of the organization. These efforts have translated into one of our best performing years on record for the franchise while strongly supporting our communities, our colleagues, and returning approximately $363 million or 119% of ‘22 earnings to our shareholders through both common stock buybacks and the payment of a very competitive common dividend. Our strong capital position enables us to continue delivering value to our shareholders while at the same time providing strong loss absorption capacity in the event of an economic downturn. Please, let's move to page seven to discuss some highlights on the outlook of our macroeconomic environment. Global expectations point to an economic slowdown in the U.S. But we remain cautiously optimistic about economic conditions in our main market in Puerto Rico. Labor market performance continues to sustain our trend based on employment reaching a decade high in November 2022 at 4% year over year. Our economic activity index, which tracks the economy closely, is at quarter 2021 levels, even when accounting for the impact of Hurricane Fiona in September, which disrupted the market for a couple of weeks. Most importantly, our growth thesis continues to be sustained by the large amount of Federal disaster relief funds still planned to be disbursed. Over $45 billion in obligated funds have been earmarked to support broad-based economic development and rebuilding initiatives designed to improve infrastructure and overall capital stock. Public data shows that disbursement reached $3.2 billion during the 11-month period ending in November, which is actually 96% above what was raised during 2021. The timely disbursement of these funds, coupled with a government improvement fiscal position focusing on economic development, is really driving the tailwinds we are seeing. Finally, and most importantly, this year we commemorate our 75th anniversary for the institution. We are proud of our people and all that we have accomplished over this period. I look forward to many more years of collaborating to protect our clients and communities and growing our franchise. We do have multiple initiatives to celebrate this accomplishment and show our gratitude to the community's employees and customers. I will now turn the call to Orlando to go into more detail on the financial results. Thanks to all for your support.

Thanks, Aurelio. And good morning, everyone. As Aurelio mentioned, net income for the quarter was $73.2 million. That compares with $74.6 million last quarter. Our earnings per share in the quarter were $0.40, which is the same as we had last quarter. What we saw in the quarter was a benefit on interest income from the increase associated with the award repricing of variable rate loans, along with the higher average balances in the loan portfolios for the quarter. However, as anticipated, we have also continued to see an acceleration in deposit betas, which is driving deposit costs higher. In addition, we did increase the level of wholesale funding in the quarter, which combined with an increase in cost ultimately resulted in a reduction in net interest income. The provision for credit losses in the quarter was $15.7 million, which is basically the same that we had last quarter. However, our allowance for credit losses increased by $2.5 million. I will touch upon that a little bit later. Just to mention, for the allowance, we continue to use two scenarios to determine the allowance: we weigh them against a baseline scenario and a downside economic scenario. In terms of net interest income, as you all know it’s a challenge at this time with interest rate movements. The net interest income was down $2.3 million from $207.9 million in the third quarter to $205.6 million this quarter. Interest income was up $11 million, but interest expense grew by $13 million. In interest income, commercial loan interest income grew by $8.2 million; $8 million resulted from repricing during the quarter, and we also had about $1.1 million associated with higher loan balances. On the other hand, we had a $20 million reduction in average balance on PPP loans, which resulted in a reduction of $1.3 million in interest income on those loans. The yield on commercial and construction loans grew by 63 basis points in the quarter. In the case of the consumer portfolio, interest income grew by $3.7 million, mostly related to the increase in average balances; we had a $111 million increase in average balances. The yield on this portfolio grew 11 basis points, as you know that it is basically a fixed portfolio. So yield improvement comes in the pricing of new originations. Regarding interest expense, looking at the balance sheet, interest expense grew by $11 million, a 45 basis points increase from 37 basis points we had last quarter to 82 basis points this quarter. Approximately 60% of this increase in interest expense was related to public fund deposit cost increases. Deposit betas for the quarter for the dollar portfolio was approximately 32%; core deposits were about 18%, but this increase in betas was mostly driven by the betas on public deposits, which was about 75% for the quarter. We do expect that betas on public deposits will remain high, and these rates obviously will move up or down depending on where the market is moving. In addition, in the quarter, we did have a $2 million increase in the cost of borrowings; $700,000 relates to the repricing of loans through debentures, and the other $1.4 million involves increases in the size of the borrowing portfolio, FHLB advances, and repos. The margin increased six basis points in the quarter from 431 to 437. The change was primarily a shift in asset mix. The average balance of cash and investment securities, which are lower yielding, decreased by $600 million, while loans increased by $146 million for the quarter. Looking forward, we see interest income growing from the repricing of loans that will happen during the year and from loan growth. For example, if you look at balance as at the end of the year, loans were $187 million higher than the average balances for the quarter. So that should give us a pickup in the first quarter on interest income. We also have approximately $130 million in commercial loans that reprice now in January; some of them are quarterly repricing loans. However, we do expect net interest income pressure to continue in the near term as rates on deposits continue to increase, with some normalization later in the year based on the expectation that rates will start to come down towards the middle of the year. If you just look at our current balance sheet structure, our expectation is that net interest income for the next couple of quarters should remain at close to current levels, with improvements in net interest income coming from future growth in the loan portfolios. In terms of non-interest income, it remained relatively similar to last quarter. We had improvements in credit and debit card transaction fees based on seasonality, but that was offset by lower mortgage banking income. We also reversed $700,000 of previously recognized fees on non-sufficient funds related to some changes in fee structure that we are implementing just towards the end of the year. In terms of expenses for the quarter, they stood at $112.9 million, which compares to $115.2 million in the third quarter, a $2.3 million decrease. The decrease primarily reflects a $1.5 million increase in net gains on OREO operations. Excluding OREO, expenses for the quarter were $115.5 million, which compares to $116.3 million last quarter, also excluding the OREO impact. This reduction includes a $700,000 reduction in occupancy, primarily energy costs, and a $700,000 decrease in payroll expenses, as all bonus accruals and incentives were finalized based on results. These reductions were partly offset by some increase of $500,000 in business promotion, sponsorship, and public relations activities that we had during the quarter. Overall, the expenses for the quarter were very much in line with our estimates of $115 million and $116 million, excluding OREO obviously. And our efficiency ratio continues to be very low at 48%. Looking at the first quarter, we do expect some increases in expenses. Payroll taxes will increase in the first quarter as all limits are reset. This will increase payroll expenses by a good margin in the first quarter. Also, during the quarter at the end of the year, we saw significant increases in or some increases in contract renewals, with inflation rising; some of the removals are coming up. There are several technology improvement projects that we have ongoing that are picking up speed this quarter. Based on this, if we exclude OREO expenses, we believe expenses for the first couple of quarters should be closer to the $120 million range. In terms of asset quality, as Aurelio mentioned, we continue to see very stable asset quality; non-performing loans decreased $14 million in the quarter, standing at $129 million, which is 69 basis points of assets. That reduction includes $9.3 million in non-accrual commercial loan reductions, along with $5 million in loans that were restored to accrual status. We also had a $7 million reduction which mostly drove it on the commercial side. Additionally, we had a $5 million reduction in OREO properties based on an increase in sales of repossessed residential properties in the Puerto Rico market. Inflows for the quarter increased $3.8 million to $24 million, primarily from the consumer portfolio that grew $2.6 million. Early delinquencies, again defined as 30 to 89 days, continue to be good, down $9 million in the quarter with reductions across all portfolios. In terms of net charge-offs for the quarter, they were $13 million, which is 46 basis points of loans compared to 31 basis points last quarter, mostly related to the consumer portfolio. We also had a $1.7 million charge-off that we took in the fourth quarter on the sale of non-accrual classified commercial loan participation in the quarter. Consumer loan charge-offs were 144 basis points of loans in the quarter, and 107 basis points for the year, and these figures are significantly lower than pre-pandemic levels, as you can see in prior filings. The allowance for credit losses at the end of 2022 was $273 million, which is $2.5 million higher than the third quarter and about $7 million lower than the previous year. I meant to say $2.5 million higher than the third quarter and $7 million lower than last year. I'm sorry about that. The ACL was on just loans was $260 million, which is $2.6 million higher than last quarter. The ACL reflects the increase in the portfolio we had in the quarter, as well as some less favorable outlook that we have in the models for several macroeconomic components. The ratio of the allowance for credit losses on loans and finance leases to total loans held for investment was 2.25% as of the end of the year, compared to 2.28% in the third quarter. In terms of capital, as Aurelio mentioned already, we continue with the execution of our plan. We repurchased 19.4 million shares for $275 million during the year and paid $88 million in dividends. Our capital ratios continue to be very strong, with a small reduction in Tier 1 and an improvement in the leverage ratio. Tangible book value per common share increased from $6.46 to $6.93 in the fourth quarter related to a $60 million improvement in other comprehensive loss adjustments as the fair value of the investment portfolio improved in the quarter. Our tangible common equity ratio stands at 6.81 compared to 6.55 last quarter. Adjusting for the OCI impact, our non-GAAP tangible book value per share would be about $11.30, and the tangible common equity ratio would be approximately 10.6%. Those are strong numbers. As we have mentioned in the past, we believe this impact is temporary since we do have the ability to hold the securities through the end of the maturity process. Securities continue at a similar pace, and we expect approximately $40 million to $50 million cash flow coming from the investment portfolio. We will continue to see some of that cash flow redeployed to the lending side or to compensate for funding needs. With that, I would like to open the call for questions.

The first question comes from Timur Braziler with Wells Fargo. You may proceed.

Hi, good morning. Thanks for the questions. I wanted to follow up on the NII guidance, just to make sure I got it clear. Did you say that you're expecting some level of pressure here in the near term, but for it to remain at your current levels?

Yes, there will be some pressure still on deposit pricing, and that's going to offset some of the impact from loan growth and the repricing of loans already in the portfolio. So with those two components, we expect net interest income to be similar to this quarter. Improvements will come from movement in the loan portfolio going forward; that's what's going to drive improvements in net interest income in the near term.

Okay, understood. And looking again at the balance sheet in the third quarter, securities cash flows were used to fund deposit outflows and some loan growth. In the fourth quarter, you opted to go with borrowings, and assets increased for the first time in over a year. How should we think about the funding of future deposit outflows to the extent that there are any and the funding of 2023 loan growth? Are you going to be looking to lean on borrowings a little more heavily in support of the balance sheet, or should we expect most of that funding to come from the bond books?

Again, the securities portfolio gives us approximately $150 million per quarter in cash flows. So that will clearly be used for funding growth and deposit implications. During the fourth quarter, we lost deposits at a higher rate than the $150 million, and we also grew the loan portfolio, so we ended up taking some additional funding. Clearly, it’s a function of what happens in those two components: how much we originate based on the pipeline; we feel strong about it; and the trends in deposits going forward, which have been a bit more inconsistent. We see interest rate changes in 2023 likely being less dramatic than in 2022. So that may create some stability on deposit movement. However, there could be some increases in wholesale funding based on that.

Right. Okay. And then just looking at deposits and understanding it's hard to quantify the remaining balances of commercial accounts or dollars that are potentially at risk for leaving for higher rates. Can you try to kind of ring-fence the remaining deposits that are still at risk? As we think about the overall size of the balance sheet, are you expecting to keep it here at current levels, using wholesale to bridge the gap? Or could we still see some decline in the balance sheet in the first half of 2023?

No, we believe the balance sheet should stay at similar levels. In reality, we do expect growth in the loan portfolios going forward. Again, that will be offset with some reductions on the investment portfolio side. It's tough to answer; there are positives. Clearly, there was excess liquidity that has been redeployed for different purposes; people are using, and obviously the movement of market rates has shifted some disposable money into high-cost kind of treasury or higher-yielding treasury securities. With interest rate expectations for the first half of the year being lower, that should slow down but it's difficult to say.

Great, thanks for the color.

Thank you for your question. The next question comes from the line of Kelly Motta with KBW. You may proceed.

Thanks for the question. Good morning. Are there any pick up on the loan side? We've had really strong growth this quarter. That seems to be one of the factors that helps offset some of the other areas of pressure we've been talking about. Can you speak to your pipeline and how demand has been holding up as we've experienced quite a few rate hikes? A view on the outlook for growth and color around categories would be helpful.

Yes, if you look by segment, we obviously do not expect any growth in residential mortgages; I started with that portfolio. If we saw last quarter, we had slight growth; it was really a mix of repayments and originations at the end of the day because of how the market is performing. The more conforming rates go down, the more we'll see movement. We’re forecasting that segment to remain flat. However, we continue to see strong demand for consumer auto businesses and credit cards, and the pipeline for construction and commercial remains very strong, actually probably very similar to the prior quarter that we started. Some fluctuations from one quarter to the other depend on the consumer; we did see close to 10% growth last year; the commercial was less than that—it varies based on larger deals. On a blended basis, for the year, we should expect 5% to 6% mid-single digits as a close estimate based on what we see, which could include larger participations in public-private partnerships that the government is structuring. Timing on these can be complex to predict as they are part of the fiscal plan and are in negotiation with different bidders, but they could help the banks locally participate in supporting the infrastructure and economy. So, Kelly, mid-single digits is our closest estimate.

Got it, that's helpful. And to circle back on NII and NIM, as we consider the potential for expansion in the latter part of the year, how should we think about the churn threshold of NII reaching the bottom? Should we anticipate similar levels of deposit pricing pressures this quarter, is it heating up? If you could provide any numbers around the core deposit base, excluding government deposits, and how betas are trending on that would be helpful in understanding this.

This quarter, we still expect some pressure. Remember that we were seeing the average impact last quarter for rates movement throughout the quarter. However, the ending number in the quarter is higher than the average we had because of that. There is quite a bit of volatility within the government component, which had very large betas. We expect that to impact the second quarter, although future impacts may not proceed at the same pace. For the rest of the portfolio, we expect the average cost of all other deposits to be around 40 basis points in September compared to about 66 basis points in the fourth quarter. The beta there has been a little over 18%. We’re not seeing dramatic movement; it’s probably going to be somewhere between 18% and 22% for that portfolio. The government deposits will remain at similar levels as we saw in the quarter.

Got it. Thank you. I turn to the expenses and then step back. I appreciate the guidance of about $120 million of expenses? I understand you had some OREO gains this quarter; excluding that, it looks like you would have been more around $115 million. So that implies a $5 million step up. In terms of cadence, do you think, in the next quarter or two, there's going to be a build towards that run rate, or should we anticipate all the moving parts you laid out will lead us to enter 2023 with $120 million and kind of build on that number?

A large component of what I mentioned regarding payroll taxes are reset, will lead to significant impacts in the first couple of quarters and that tapers down towards the end of the year as some limits are reached. We do see lower impact on that. But we also have federal technology projects on the way, which will lead to capital increases; that’s why we feel that $120 million should be the benchmark for the next couple of quarters.

Thank you. The next question comes from the line of Alex Twerdahl with Piper Sandler. You may proceed.

Good morning, guys. Just going back to deposits quickly. Can you remind us if there's any seasonality we should be considering over the next couple of quarters, or if you have any line of sight on some deposit wins, maybe early in '23 related to taxes?

You always see a bit of movement at that season, with people using their money, but it's never been a significant component in deposit movement at the institution. So I wouldn’t attribute a lot of seasonal movement for the year. It’s more dependent on other factors.

And regarding the buyback, the $125 million you outlined, I think is good until June, if I'm not mistaken. How are you thinking about using that today? Some banks are saying they’re seeing more uncertainty, and other banks are getting back in the market. I'm curious how you're viewing this. Should we expect additional commentary in April, which has been your cadence over the last two years regarding capital returns?

Yes, to your first question, we want to maintain optionality. We have done so while adjusting how much we do on a quarter-by-quarter basis based on several factors, including macro uncertainty. At this stage, we continue to execute; I would say the most probable number for this quarter is similar to last quarter, based on our current outlook. However, things can change if they become a concern to the market. We do not have a limit to when we will use the $125 million; we can execute now, or over the next quarters, as there’s no expiration. Regarding your second question, yes, we expect to provide an updated announcement on capital in April, correct.

Great, thanks for clarifying that. Finally, as you think about credit, net charge-offs, and provisioning, we're all trying to figure out what the normalized level of charge-offs will be for you guys. Do you have any more insights? Clearly, charge-offs have been running much lower than expected; is 46 basis points getting closer to what you consider normalized?

We have different levels of normalization. We use pre-pandemic as a metric but recognize that things have changed; unemployment is better and lower. So when we discuss normalizing, it has to be a number between where we are today and where we were in 2019. Not sure if we're reaching those, but early delinquencies and classified assets are strong indicators. The asset quality metrics show that we are very disciplined in not accumulating classified assets. Every time we see something that requires delay in action, we move quickly to prevent it from affecting our overall performance.

The key components, as Aurelio mentioned, are stable at this point. We don’t foresee any movements unless there is a significant change in our expectations that trends will shift.

Can you give us some color on the pricing you're seeing on new loan generation?

Pricing is reasonable, being adjusted by the funding costs and the curve. Commercial CRE is in the mid-six range; for larger segments or multivariable, it moves to the mid-sevens and closer to eight for middle-market loans. Consumer products are approximating the mid-nines. I think competition has been fair, adjusting for the increasing cost of funding. Thus, we see more competitive pressure on deposit pricing now versus loan pricing.

On fees, you alluded to some changes in the fee structure during the fourth quarter. Is that going to have a material impact in '23?

No, the different changes won't create significant impacts. Some are going down, while others are going up. Ultimately, the end result will be normal fees based on deposit size more than anything.

Great. Thanks for taking my questions.

Thank you for your question. The next question comes from Brett Rabatin with Hovde Group. You may proceed.

Good morning. I wanted to follow back on credit for a second and just talk about auto performance which seems to be continuing to do well, but charge-offs related to consumers are up. Can you maybe break out auto charge-offs from the consumer bucket and how you think about the normalization in auto charge-offs over the next year?

While I don't have specific numbers here, there is definitely a correlation with size. The portfolio has continued to grow over the last few years. We're seeing increases in charge-offs, which we expected. The auto charge-offs in the market run much higher; we are currently under 2%, significantly less than the market. Puerto Rico's public transport system is not robust, making vehicles a necessity.

Can you share any color on expected maturity in your securities portfolio this year to give some flexibility for loan growth funding or deposit base?

The cash flow from the investment portfolio has been consistent over recent months. We're expecting around $45 million a quarter between $40 million and $50 million. That amounts to approximately $500 million to $600 million of cash flow from the investment portfolio that can be used for loan funding. We don't anticipate making any movement on the portfolio right now as it has remained stable.

You mentioned technology spending; all Puerto Rico banks are spending on technology and digital channels. Can you elaborate more on your tech spend and what you hope to achieve in the next year or so?

Some of this is competitive data, but in terms of investment, we're continuing to move more functions into the cloud. The investment levels this year are likely similar, possibly a little higher, as some projects are amortized over time, so we don’t see full investment in one year. We’re continuing to transition to more efficient hardware environments with reduced operational risks. We aim to optimize our services across the omnichannel strategy, emphasizing the importance of branches, call centers, and digital channels to enhance client services.

Thank you for your question. We now have a follow-up question from Kelly Motta with KBW. You may proceed.

Hi, my question was answered, so I'm stepping back. Thank you.

Thank you.

Thank you. We now have a follow-up question from Timur Braziler with Wells Fargo. You may proceed.

Hi, thanks for the follow-up. Again, on the securities book, it seems like for the last couple of quarters, the average balances have been pretty meaningfully higher than the period-end balances. I'm just wondering what's driving that dynamic mid-quarter.

You need to be careful with valuation. The balances have been decreasing; however, OCI valuations have changed. This quarter, balances dropped by over $140 million but increased by about $60 million in valuation adjustments. Additionally, we were required to invest approximately $40 million in Federal Home Loan Bank stock as we drew on advances. So if you separate that, the portfolio actually did decline by $140 million.

Got it. Thank you for the clarification. Makes sense.

Thank you for your question. There are currently no further questions waiting at this time. There are no further questions, so I will now pass the line back to Ramon Rodriguez for closing remarks.

Thanks to everyone for participating in today's call. We will be attending Bank of America's financial services conference in New York on February 14 and KBW's conference in Boca on February 16. We look forward to seeing many of you at these events, and we greatly appreciate your continued support. At this point, we will end the call. Thank you.

That concludes the conference call. Thank you for your participation; you may now disconnect your lines.