First Bancorp /Pr/ Q3 FY2023 Earnings Call

Hello, everyone, and welcome to the First BanCorp Third Quarter 2023 Financial Results. My name is Bruno, and I will be the host for your call today. I will now turn it over to Ramon Rodriguez, Investor Relations Officer.

Thank you, Bruno. Good morning, everyone, and thank you for joining First BanCorp's conference call and webcast to discuss the company's financial results for the third quarter of 2023. Joining you today from First BanCorp are Aurelio Alemán, President and Chief Executive Officer; 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 Alemán.

Thank you, Ramon. Good morning to everyone, and thanks for joining the call today. Please let's turn to Page 4 to go over the financial highlights. We posted another good quarter with $82 million in net income or $0.46 per share, which translated into a fairly strong return on asset of 1.72%. Net interest income registered a slight decrease during the quarter, mainly due to the expected upward pressure on deposit pricing and increase in the mix of interest-bearing deposits to total deposits. Expenses were quite in line with guidance at $160 million, and the efficiency ratio reached 50.7% during the quarter, continuing to be very top of the industry. These variances were mostly offset by a lower provision for credit losses during the quarter. In terms of asset quality, NPA increased slightly by $9 million during the quarter, primarily attributed to the inflow of a single commercial loan in Puerto Rico. Notwithstanding, NPA levels remain at multi-year lows and now represent just 70 basis points of total asset. As anticipated, we believe excess liquidity in the market has continued to taper off, and we're starting to see normalization in delinquency trends. However, they are still way below pre-pandemic levels. On the capital front, we continue the repurchase plan, and we repurchased $75 million in common shares during the quarter. That finalizes the remaining of the authorization under the '22 capital plan. Given a strong capital position, liquidity, and outlook for the remainder of the year, we do expect to continue repurchasing shares of common stock during the fourth quarter, but now under the 2023 capital plan authorization. Please let's move to Slide 5 to go over the portfolio. This quarter, we were really pleased with the loan production activity that we experienced across the three regions. Total loans increased by 6% on a linked quarter annualized basis and reached $12 billion, with healthy levels of both commercial and consumer loan origination. The loan portfolio has been expanding since the third quarter of 2022, reflecting organic growth of over $150 million or 8% increase during this period. Again, our loan growth strategy is supported by the increased business activity and economic activity that we see in the island, particularly in this market, coupled with timely focused execution of the sales teams across the three regions. Going forward, we expect loan growth to remain in line with our mid-single-digit growth guidance as we continue to redeploy a portion of the investment portfolio cash flows into higher-yielding assets in the loan portfolio. Also, we do expect the facilities of the construction loan that were approved this year to begin to accelerate into disbursements. Let's go over to Page 6 to go over the funding. We're moving in line with industry trends. The recently released deposit market assessment of the FDIC as of June shows an overall contraction in total deposits in Puerto Rico as of June 2023. Our results basically reflect that we are retaining our market share, so we're basically remaining flat to the market. This quarter, other than broker and government deposits, it decreased by $159 million or 1.2%. This reduction was primarily driven by erosion of liquidity in the overall market and migration of retail customers to higher rate options actually outside the traditional banking sector, particularly credit unions and the U.S. treasury market. On the other hand, that was offset by stabilization in commercial deposit balances, still representing 34% of our deposit base in non-interest-bearing deposits. We remain focused on retaining our market share in this segment we serve, pricing our products competitively. Again, it's a function of the market environment and the rates, and definitely retaining our most valuable relationships is key to the strategy. The funding profile of the institution remains very attractive. It's a very well-diversified deposit base, composed of a balanced mix of core and retail customers. When we combine average balances of these accounts, it's really around $19,000. We have ample liquidity available through various funding options that allow us to continue to strategically manage our balance sheet growth plans. Just move to Page 7 to go over the macro. We continue to see the Puerto Rico economy as very stable, performing fairly well considering the interest rate environment and the emerging geopolitical events. The economic activity index of Puerto Rico reached its highest level in eight years during the third quarter. Passenger traffic at the main airport continues to hit all-time highs. Consumers continue to adapt to rising rates and prices as evident by retail sales, household spending, and auto sales. More importantly, the labor market remains stable with unemployment around 6.2%. The pace of disaster relief funding for the first eight months of the year is 72% above the same period last year, which is driving construction activity on the island. We have started to see an increasing number of low-income housing projects and, obviously, rebuilding of important infrastructure. Additionally, we continue to see private investors allocating support to the island. There is a recently announced transaction where a private investor was awarded a concession of South Expressway under the P3 structure at a total concession where the investor allocated $2.9 billion, plus there would be an additional $2.4 billion in improvements. That's a good example of what we are seeing. We said in the past, we have the experience to continue operating under this challenging and changing market, and we continue to leverage our proven risk framework and franchise to support our customers through the cycle. Now I will turn the call over to Orlando to go over the financials in more detail. Thanks to all.

Thanks, Aurelio, and good morning, everyone. As you saw in the release, the results for the third quarter show an increase of $11.4 million in net income, which is primarily associated with the lower provision and a lower effective tax rate. We earned $82 million for the third quarter or $0.46 a share, which compares to $70.7 million in the second quarter or $0.39 per share. Adjusted pretax pre-provision did come down by $4.6 million to $113.4 million. The provision for credit losses in the quarter decreased to $4.4 million, which compares to the $22.2 million we had in the second quarter. When we look at the components, the projected macroeconomic variables last quarter deteriorated, especially in the commercial real estate side and some on the unemployment side, which resulted in additional provisioning mix in the quarter. This quarter, the projection still shows a deterioration on the longer term. However, current values of some of these variables are more favorable than they were originally estimated, which led to a slower pace of deterioration and thus a lower reserve impact. Additionally, this quarter, we booked $1.4 million in recoveries on a commercial loan that was previously charged off a few years ago and was collected. We had a refinancing of a municipal bond that we sold in our held-to-maturity securities portfolio, which resulted in some reserve releases since the new structure is that of a commercial loan, which has a much shorter timeframe. The estimated tax rate for the quarter came down but the impact in the quarter came down to 28.2% from 30.1% as a result of a higher proportion of tax-exempt income to total income and additional business activities we conducted under tax advantages under the Puerto Rico code. Looking at interest income for the quarter, it was $199.7 million, relatively flat when we compare it to the prior quarter. As we have discussed in prior calls, deposit pricing pressures, especially on the public sector have offset the improvement in interest income resulting from loan growth and loan repricing. Total interest income for the quarter grew by $11.2 million for a 12 basis points improvement in yields on interest-earning assets. However, interest expense grew by $11.3 million, representing a 28 basis points increase in cost, offsetting the growth in interest income. On the commercial loans, interest income grew by $6.1 million, reflecting loan repricing based on rate changes, higher yielding new loans, and an increase of $104.5 million in average balances. The increase also includes $1.2 million in interest collected on the previously charged-off loan that I mentioned. Commercial loan yields for the quarter are up 24 basis points compared to last quarter. In the case of consumer loans, interest income was up by $4 million, again reflecting higher yields on new loans, and we grew the portfolio on average by $94.5 million. Overall, yields on the consumer portfolio increased 6 basis points during the quarter. On the other hand, interest expense on interest-bearing deposits increased by $12.7 million higher this quarter than last quarter. Most of this increase is driven by a combination of higher rates paid on checking and savings accounts, mostly public sector deposits, migration we have faced over the last few quarters from non-interest-bearing to interest-bearing, especially on time deposits. If we exclude broker deposits, the average cost of deposits increased 37 basis points this quarter. However, the average cost of interest-bearing checking and savings accounts other than public deposits increased by only 7 basis points. Time deposits increased by 41 basis points overall from the prior quarter. The time deposit portfolio is now on average $197 million more than we had in the second quarter. You can see on the chart on the top right-hand, the cumulative betas on deposits since September of '22. Due to the repricing lags, public sector deposits had much higher betas this quarter than what we had in the overall cumulative period since September of '22. Net interest margin for the quarter was down to 4.15% from 4.23% last quarter. As we mentioned last quarter, we expect some normalization in the margin towards the beginning of '24 based on the expectation that our interest rate increases will stabilize, thus normalizing some of the deposit pricing pressures we've had. We continue to redeploy cash flows from the investment portfolio into either higher yielding loan growth or in some cases, a reduction in wholesale funding. We project that investment portfolio cash flows over the next quarter will be approximately $160 million and looking through the middle of 2025, it should amount to about $1.6 billion more. What this will allow us to do is maintain a yield of $133 million in the investment portfolio. In essence, we would be replacing through these cash flows either into loans that are going to yield around 600 basis points more or reductions in wholesale funding or keeping it in cash, which would yield around 400 basis points more than we have on the investment portfolio. So that would offset any impact we had from the migration to the time deposit side. In terms of other income, this quarter we had $6 million less in other income, mostly related to certain nonrecurring gains we had in the second quarter, which amounted to $5.2 million that were on legal settlements and a couple of other items. If we exclude these gains on a non-GAAP basis, net interest income decreased by $700,000 in the quarter. Expenses increased by $3.7 million, mostly driven by $2.2 million in additional payroll expenses as we implemented our merit increases and salary adjustments in July of this year. We did achieve some gains on the disposition of OREO properties, but we include these gains; operating expenses for the quarter were $118.8 million, which falls within the guidance of $118 million to $120 million we provided. The efficiency ratio for the quarter was 50.7%, slightly higher as expenses grew and some of the other income decreased, which compares to 47.8% in the last quarter. However, the second quarter efficiency ratio was actually 48.9% if we exclude those nonrecurring gains I mentioned. As previously stated, we continue to maintain a very disciplined expense management framework and our target is to remain close to that 50% efficiency ratio in the near term. In terms of credit quality, as Aurelio mentioned, NPAs increased by $9.1 million during the quarter, primarily driven by a $9.5 million commercial case, while there was a $2.9 million increase in NPAs on the consumer side, offset by a $3 million reduction in OREOs and lower residential mortgage NPLs. Even with this increase, our NPA levels remain at 70 basis points of total assets. In terms of inflows, they're up by $15.6 million compared to the prior quarter, including a $1 million increase in commercial, which is the case I just mentioned, and a $6 million increase in consumer. Also, early delinquency in the quarter, which is defined as 30 to 89 days for this purpose, increased by $18.5 million, mostly on the consumer side. However, I'd like to point out that September 30 fell on a weekend, affecting collections, and approximately $11.5 million of this delinquency was collected by October 2. So the increase was much less than reflected. We have mentioned on prior calls that we anticipate delinquency levels in consumer should eventually start behaving more like historical trends, as excess liquidity from the pandemic-related funds decreases. However, so far, consumer delinquency as a percentage of loans remains below pre-pandemic levels. In terms of the allowance, we stand at about $271 million, a decrease of $10 million from the prior quarter. $6 million of the reduction relates to lower reserves from held-to-maturity securities due to the refinancing of the $46 million long-term municipal bond I mentioned, which went into a shorter-term loan structure. There were also significant improvements in the underlying financials of certain Puerto Rico government municipalities held in the held-to-maturity portfolio. Looking at the reserve on just loans and leases, it decreased by $3.5 million, which reflects that projected slower deterioration on the macroeconomic variables, as I previously noted. The reserve stands at 2.21% of the portfolio compared to 2.28%, still a healthy reserve coverage in our portfolio. In terms of capital, regulatory capital ratios continue to be significantly above well-capitalized levels at the end of the quarter. The tangible common equity ratio did decrease in the quarter to 6.74%, and the tangible book value per share decreased to $7.16. That was driven by the $79 million decrease in the fair value of available-for-sale securities, as well as the repurchase of $75 million in common shares during the quarter and the payment of $25 million in dividends, all partially compensated by the earnings in the quarter. At the end of the quarter, net unrealized securities losses, including capital, were $151 million, which is about $4.88 in tangible book value per share and also represents a reduction in the TCE ratio of approximately 409 basis points. As we have said in the past, we believe these unrealized losses are temporary in nature since we have the ability to hold the securities. The investment portfolio had a duration of 3.2 at the end of September, so it's a manageable timeframe on the portfolio. With that, operator, I would like to open the call for questions.

Hi, good morning.

Good morning, Alex.

Good morning, Alex.

First, I just want to start on the last comment that you made, Orlando, on the securities portfolio. I'm just curious, I think we're going to see a lot more companies looking at restructuring their securities portfolios into the next quarter, just given what's happened with rates. And obviously, the new outlook out there, and I think one of the big factors is how much capital companies have with whether or not they're going to be looking at that more seriously. You guys clearly have a lot of regulatory capital. As you think about the uses of that regulatory capital, is restructuring of the securities portfolio in these small pieces of it on that radar at all?

Well, we obviously have looked into it, but in reality, we have concluded, Alex, that once you consider the tax benefit nature of the portfolio and the immediate impact, the timeframe where we feel that this is going to affect, we don't feel there is pressure to do that immediately, and we are not considering it at this point because of that.

And then on deposits, is it safe to say now that the government deposit piece is pretty close to having fully repriced now that the Fed is presumably done?

I think it is safe to say that, yes.

And then as you think about sort of the expectations for the remaining portfolio, which has been much lower beta, maybe you can walk through some of the expectations over the next couple of quarters in terms of how you're thinking about how those betas might trend, I guess, as you see excess deposits and excess liquidity come out of the system?

Yes, we believe the betas on other deposits will remain relatively stable based on our observations so far. There is still potential for ongoing migration into time deposits. Additionally, some of our maturing time deposits are set to reprice at slightly higher rates. The average cost was around 2.91%, and while the current cost is somewhat higher due to repricing others, we expect one-year CDs to be in the range of 3.75% to 4%. This should create some impact. Assuming we agree that there is stability on the public sector side concerning costs based on current rates, the cash flows from our portfolio would be utilized to create better deals that could offset a significant portion of that impact. Therefore, we anticipate stability in the margin starting in 2024.

And that's important. Yes, I just want to add that that expectation of the cash flow from the investment portfolio is going to be increasing as we go forward. Obviously, the pressure of the betas on the government was significant. So we do expect to see some of that benefit of converting those cash flows to much higher yielding loan portfolios that will benefit us in 2024 to mitigate what we have seen in the NIM and NII.

So I guess, just boiling it down, do you expect this to sort of be the inflection point on NII and the NIM? And starting in the fourth quarter, we could start to see both of those go higher?

We feel that we see the inflection point starting next year, early next year, in the first quarter where we'll see still the repricing on the time deposit side happening this fourth quarter of the year. Again, going back to statements we have made in the past, that the growth of the investment portfolio could be a factor to offset some of that, helping keep that net interest income going up a bit from where we are or maintaining the levels where we are.

Okay. And then just final question from me. Just the highway deal that you referenced in your prepared remarks, can you just talk about how that — I'm not sure if it's been disclosed how big the bank financing piece is exactly, but just how that might actually impact your balance sheet, both in the fourth quarter when that deal is expected to close as well as if there's a piece of it that might be sort of a go-forward piece?

Yes. Well, it was publicly announced this week, on Tuesday, by the government and the winner of the bid. They're working together to close it towards the end of the year. Most of the benefit will come to the balance sheet for really 2024, some this year, but mostly 2024. Local banks committed around $600 million of the financing required for the initial payment of 2.850. Our position is that we committed $150 million to the transaction, which will be disbursed at closing, yes.

Thanks for the comment on that. Thank you for taking my questions.

Thank you.

We currently have no further questions registered. I would like to hand the call back to Ramon Rodriguez for closing remarks. Ramon, over to you.

Thanks to everyone for participating in today's call. We will be attending Hovde's financial services conference in Palm Beach on November 2 and Piper Sandler's conference in Miami, November 16. We look forward to seeing a number of you at these events, and we greatly appreciate your continued support. Have a great day. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.