Earnings Call Transcript - FBP Q2 2023

Operator, Operator

Good morning and welcome to the First Bancorp second quarter 2023 financial results call. My name is Candice and I will be your moderator for today's call. I would now like to turn the call over to our host Ramon Rodriguez, Investor Relations Officer. Please go ahead.

Ramon Rodriguez, Investor Relations Officer

Thank you, Candice. 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 2023. 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, I must 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.

Aurelio Aleman, CEO

Thank you, Ramon. Good morning to everyone and thanks for joining our call today. Once again, I must say that we're very pleased to report strong results for our franchise. We earned $70.7 million or $0.39 per share during the quarter, which translated into a solid 1.51% return on assets. Pretax pre-provision was flat, continued strong when compared to the previous quarter. A slight reduction in net interest income was offset by lower expenses and higher non-interest revenues. The provision for credit losses increased to $22.2 million and credit quality remained stable with non-performing assets representing just 63 basis points of total assets. Overall, it was a great quarter with most KPIs moving in the right direction. This year, we just began the celebration of our 75th anniversary for the company, which we will celebrate during the second half of the year. I want to take this opportunity to thank all my teams across the three regions for their work and ongoing commitment to our organization, our clients, and the communities we serve. It's been a great first half of the year to continue moving forward. On the capital front, we completed our capital planning process during the second quarter and we are very pleased that our board approved an additional $225 million common share repurchase program. We expect to repurchase $150 million in common stock during the second half of 2023, of which $75 million relates to the remaining amount of the previously approved stock purchase program that was resumed early in July. Our ample capital position remains significantly above well-capitalized thresholds, which allows us to continue growing the franchise in the current operating environment while preserving shareholder value. Now, let’s please move to page five to discuss some highlights of the balance sheet. The loan portfolio grew for the sixth consecutive quarter, underscored by solid consumer and commercial loan growth. Growth was actually in line with our mid-single-digit growth guidance that we provided earlier in the year. Consumer loans grew by $88 million or 10% linked-quarter annualized, and commercial loans increased by $71 million or 5% linked-quarter annualized. This loan growth was partially offset by the expected reduction in the residential mortgage portfolio, which was $90 million for the quarter. Loan production activity remained consistent during the first half of the year. The good news is we continue to see strong pipelines for the remainder of the year, particularly in the main market. It's important to mention that we continue to operate with our conservative risk appetite despite the optimistic environment that we see. We have not changed our risk appetite in our main market. We have stated in the past that we operate a well-diversified and balanced portfolio, managed within the guardrails established by our risk management function and overseen by our Board. Our commercial loan book is specifically comprised of borrowers across multiple industries with minimal exposure to office space. As you can see in the graph on the right side, there's limited real estate exposure and I would say minimal refinancing risk over the next two years. That said, we remain vigilant to the potential impact of monetary policy or a potential slowdown in the US economy that may have on credit and loan demand, but we are very encouraged by the ongoing business activity in the island and economic growth over the short and medium term. Let's turn to page six to discuss our funding profile and review an important element of today's deposit performance. Overall, total deposits increased by $768 million during the quarter, excluding brokered CDs and government deposits, which decreased by $104 million, mostly driven by a reduction in demand deposit accounts across all regions, offset by increases in the time deposit category of $149 million. Customers continue to reallocate cash into higher-yielding alternatives. Government deposits, which are fully collateralized, increased by $761 million, primarily in Puerto Rico. Overall, deposit growth allows us to continue to repay some of the borrowings we took out in the first quarter to provide additional liquidity. Our liquidity position remains very strong, with total unused liquidity available increasing to $5.6 billion during the quarter, now representing over 117% of uninsured deposits. The deposit base composition is solid, with a 36% non-interest-bearing ratio and an average balance per account of approximately $25,000. We expect that industry-wide core deposit trends will remain relatively stable over the second half of the year. We continue to focus on our core deposit strategy centered around increasing client share, launching new products, attracting new customers, and providing superior quality service. An expanded branch network and self-service digital channels are already part of the offering. Now let’s move to Slide 7 to discuss how we see the operating environment. The economic backdrop in Puerto Rico continues to be supported by a strong labor market compared to prior years and a consistent flow of federal disaster funds and foreign investment. Preliminary employment figures for June showed that payroll employment was up 2.4% compared to the prior year, and unemployment stayed at 6.1%. An important statistic that we continue to monitor is passenger activity, which at the main airport continues to increase. Traffic in June was up 22% compared to June last year. The Economic Activity Index, the coincident indicator of economic growth in the island registered in May, its highest reading since June 2015 and it was up 1.8% compared to the prior year. Business activity continues to be solid. The manufacturing sector is stable. Strong consumer confidence is reflected in strong auto sales and strong retail sales that have been reported during the first half of the year. I think it's important to highlight that we're very encouraged to see the accelerated deployment of disaster relief funds. We have actually doubled the pace of disbursements compared to the first five months of last year. From January to May, we distributed $1.8 billion versus approximately $900 million the prior year. These funds are moving, and we see it reflected in the construction activity. During the quarter, we also continued to make progress in our omni-channel strategy, deploying our small business digital lending offering to our regions and we relaunched a new corporate portal, which serves as a very important tool for expanding digital sales capabilities and enhancing the digital experience for our customers. Now, I will turn the call to Orlando to go over some of the details of the financials, and we'll come back for questions.

Orlando Berges, CFO

Thank you, Aurelio. Good morning, everyone. The second quarter was a very stable quarter. During the quarter, we faced net interest income pressures that we had mentioned in the prior quarter earnings discussion. We also saw some increases in the provision for credit losses but ended up with a lower expense base. Net income, as Aurelio mentioned, was $70.7 million or $0.39 per share. If we exclude some non-recurring gains we had in the quarter, non-GAAP net income was $66.8 million or $0.37 a share. Adjusted pre-tax pre-provision income was $118 million, basically the same as last quarter, and as Aurelio mentioned, there was a strong return on assets at 1.51%. The provision for the quarter was $7 million higher. It's mostly related to the growth in the portfolios and the impact of the projected deterioration in commercial real estate values at a national level, which could potentially affect our markets even though we don't see it at this point. Still, it has been incorporated as part of the analysis of the provision. The effective tax rate for the quarter decreased to 30.1%, which is 1% lower than last quarter's 31.2%. This decrease is mostly related to reduced federal tax estimates as funding costs have grown in our US operations. In terms of net interest income for the quarter, it was $199.8 million, which is $1.1 million lower than last quarter. Interest income was higher by $9.8 million, but interest expense grew by $10.9 million during the quarter. In the commercial portfolio, interest income grew by $3.4 million, primarily driven by repricing and higher-yielding new loan originations. The yield of the commercial portfolio grew by 15 basis points this quarter, and the average balance was up by $27.1 million. As Aurelio mentioned, the ending balance growth in loans was about $140 million this quarter. For consumer loans, the interest income increased by $3.9 million, mostly related to the $71.8 million growth in average balances. We also noted a 13 basis points increase in yield. In addition, the quarter reflects a $2.4 million increase in interest on cash balances as we had averaged higher cash balances for the quarter. Interest expense on interest-bearing deposits grew by $11.7 million during the quarter, primarily due to increases in the cost of time deposits and government deposits. The average cost of non-brokered time deposits grew by 63 basis points to 2.5% during the quarter, and the average cost of all interest-bearing checking and savings accounts, which include government and retail and commercial customers, increased by 24 basis points, primarily driven by government deposits. If we exclude government deposits, the average cost of interest-bearing checking and savings accounts increased by only 10 basis points. Over the last 12 months, our cumulative data on interest-bearing government deposits in Puerto Rico was 75%. However, for this quarter, with a lag effect, it was 100%. On the other hand, the cumulative data on interest-bearing deposits, which exclude government and time, was 14% over the last year. Net interest margin for the quarter decreased by 11 basis points to 423, mainly reflecting the effect of the higher rates paid on deposits and not the increasing migration from non-interest-bearing and other low-cost deposits into time deposits that exceeded the benefits of the increases in rates on the lending side. We expect that interest income will continue to grow during the next couple of quarters due to several main factors: the repricing of loans and cash balances that will occur during the next couple of quarters, the projected loan growth at higher yields, and the repricing of the cash flows from the low-yielding investment portfolio maturities over the next two quarters, specifically $380 million in investment securities mature from the existing portfolio. Interest expense, on the other hand, is also expected to increase. Maturing time deposits will reprice at higher rates, and non-interest-bearing and other low-cost deposits likely will continue to shift into higher-cost deposits, with the cost of public deposits increasing along with rate hikes. These components led us to state last quarter that we felt stable net interest income would have some growth associated with portfolio growth, and we still feel that it will be the case. In terms of other income, it increased by $4 million this quarter. We collected $3.6 million on a settlement of an old legal case and also recognized a $1.6 million gain from the repurchase at a discount of $21.4 million in junior subordinated debentures. These gains basically offset the $2.3 million we recognized last quarter in contingent insurance commissions collected in the first quarter based on prior year productions. In terms of expenses, we saw operating expenses decrease by $2.4 million to $112.9 million during the quarter, compared to $115 million last quarter. Both quarters include approximately $2 million in net gains from the disposition of OREO properties. The second quarter also includes $1 million in legal and operational reserve releases, while the first quarter included $1.2 million in annual credit card expense incentives that reduced our processing costs for the quarter. Excluding these items, expenses were approximately $115.9 million, compared to $118 million last quarter, reflecting a $2.5 million reduction. Most of this reduction relates to payroll taxes as employees reached the maximum taxable amounts for some of these tax components. Expenses in general have remained below our guidance in part due to delays in the timing of some of our capital projects but also due to the continuation of our expense management initiatives. What we expect for the third quarter is some increases in compensation based on the merit increases that have been granted. These will take effect in July, and we will see some increases in business promotion related to several events planned for the second half of the year as part of our 75th anniversary celebration. These expenses will bring us closer to the guidance we have provided, but we expect to be slightly under the guidance at this point. Our efficiency ratio remains very low at 47.8%. Excluding some of the other income items I mentioned, it would be closer to 49%, which is still very low and below the 50% threshold mark. Asset quality has continued to perform very well. Non-performing assets decreased by $7.9 million to $121 million, representing just 63 basis points of assets. Commercial non-performing assets declined by $4.4 million, driven by a $6.2 million charge we recorded on a Florida loan that was moved to non-performing last quarter. Residential mortgage non-performing assets also decreased by $3.1 million, and properties in OREO are down $1.3 million. Inflows to NPLs decreased by $4.8 million to total $24 million for the quarter, primarily related to the C&I loan that was moved to non-performing last quarter. We did see some uptick in early delinquency in the quarter, with early delinquency refinances totaling $289 million, an increase of $24 million. If we break it down by components, on the commercial side, most of it was temporary since we had a $4.5 million loan that matured and is in the process of being renewed, but it remains current. On the consumer side, early delinquency represents 2.24% of consumer loans, which, although higher than March, is very similar to what we had in December, at 2.11%, and much lower than the 3.01% we experienced pre-pandemic in these portfolios. Finally, net charge-offs for the quarter increased again due to the $6.1 million we took in the commercial case, which represents 67 basis points of average loans, up from 46 basis points compared to last quarter. The allowance for credit losses stands at $281 million, which is $3 million higher than last quarter. For just loans and leases, it sits at $267 million, which is $1.5 million higher than last quarter. This increase reflects again the growth in the portfolio and the impact of the commercial real estate value forecasted deterioration at the national level, which does impact the allowance for CRE loans in our case, even though we realize and consider that the future impact in Puerto Rico and our Florida market at this point is lower than the national outlook. The ACL to loans was flat at 2.28% compared to 2.29% last quarter. On the capital front, capital continues to be very strong, as Aurelio mentioned. We continue to execute our capital plan. At the end of the quarter, regulatory capital ratios remain significantly above well-capitalized thresholds and our tangible book value per share decreased only by $0.03, driven by the decrease in the fair value of the securities, which also led to a nine basis points reduction in TCE, which is now at 703. As of the end of the second quarter, the OCI adjustment was $772 million, which represents about $4.30 on a tangible book value per share and decreases the TCE ratio by about 361 basis points. Again, as we mentioned last quarter, the investment portfolio has not been growing. Based on our current analysis, we expect repayments of $713 million over the next 12 months, including $380 million over the next six months that I mentioned. We continue to pick up cash flow and reduce the OCI adjustments associated with it. With that, operator, I would like to open the call for questions.

Operator, Operator

Thank you. Our first question comes from Brett Rabatin of Hovde Group. Your lines are open. Please go ahead.

Brett Rabatin, Analyst

Hey. Good morning, guys. I wanted to start with …

Aurelio Aleman, CEO

Good morning, Brett.

Brett Rabatin, Analyst

…the charge offs. Hey Aurelio, I wanted to start with the charge offs in the quarter. I was having a little difficulty hearing, but the C&I charge-offs. Can you go back over that, what the C&I charge-offs were?

Orlando Berges, CFO

The C&I charge-offs you might remember last quarter when we moved a $7.1 million loan into non-performing in the Florida market, which is in the energy industry and had some specific issues associated with the hurricane that happened the prior year. That case ended up non-performing at this point, and the collectibility of the case isn't clear. So we ended up charging the amounts that are expected not to be collected, which was approximately $6.1 million. That case was the only large item; everything else was more or less in line, slightly lower on the consumer side but consistent with the prior quarter.

Brett Rabatin, Analyst

Okay. And then if I heard you correctly, you said the NNI dollars would be higher in the back half than the first half. It sounded like from what I was trying to write down, you mentioned $280 million of securities maturing. Are you guys assuming the margin reverts higher in the back half of the year, and any thoughts on the magnitude?

Orlando Berges, CFO

Well, on the back half, that's what I was saying. There are positives and negatives. We see increases on the earnings side, as you mentioned, from the investment portfolio, repricing of some loans, and the expected portfolio growth. We feel that this growth is what will push net interest income up. Margins may be flat to slightly down in the next quarter, but volume will push us higher. Some of the investment portfolio repricing doesn’t happen right away; it spreads out over the quarter. Government deposits will reprice with rate increases, which might offset some of the benefits.

Brett Rabatin, Analyst

I didn't quite understand it. It seemed like you utilized some brokered CDs during the quarter, and by the end of the quarter, the balance sheet had more liquidity in cash. I realize you were trying to eliminate some higher-cost items as well, but could you share your thoughts on the use of brokered CDs and how that relates to using liquidity from the balance sheet to support loan growth?

Orlando Berges, CFO

Yes, the brokered CDs we've been using mostly in our Florida market, not in Puerto Rico. We use the balance sheet sometimes, depending on a mix of tax implications. In Puerto Rico, we want to maintain cash levels due to the volatility of government deposits. All of that is taken into account, but at the end, it's a function of how much we want to fund operations from Puerto Rico or through some direct costs in this case through brokers. The Florida market has been very expensive, and we are not aiming for long-term solutions here. We’re managing this to balance what we want to see in the future of the balance sheet.

Brett Rabatin, Analyst

Okay. Great. I appreciate all the color.

Orlando Berges, CFO

Thanks.

Operator, Operator

Thank you. Our next question comes from the line of Timur Braziler of Wells Fargo. Your line is now open. Please go ahead.

Timur Braziler, Analyst

Hi, good morning.

Orlando Berges, CFO

Good morning, Timur.

Timur Braziler, Analyst

Following up on the question regarding net interest income, it appears that the securities book at period-end is smaller than the average balance. I'm curious if this is a timing issue, as it suggests that the balance sheet may be smaller towards the end of the year, which could lead to some pressure due to the seasonal decline of public funds. Is the expectation that loan growth will counteract this, allowing the balance sheet to remain stable or increase, thereby supporting net interest income growth? It seems there are some fundamental challenges regarding the size of the balance sheet and raising net interest income.

Aurelio Aleman, CEO

Well, it's important to note, Orlando mentioned the $380 million for example of cash flows in the second half of the year that comes from the investment portfolio yielding about 1.5%. The objective is actually to replace that with loans on the books, which are coming in at an average blended yield of about 7.5%. So there's definitely an improvement to NII. The offset to that is how much will be the delta on the deposit side. We do not expect government deposits to decline due to continues inflows. Overall, we think we should be able to maintain our performance and achieve our goals around loan growth, which has been consistent in the mid-single digits.

Orlando Berges, CFO

Specifically, on what you mentioned, the investment portfolio in actual dollars decreased about $111 million in the quarter. The risk reduction that doesn't contribute to average is related to the OCI valuation. However, when considering the lending side, the loan portfolio grew by approximately $140 million this quarter; however, the average growth reflected on the portfolio was less than that. So we don't see the balance sheet coming down because of that, it's reallocating into the lending components coming in at higher yields. We don't foresee a reduction on the balance sheet given the mix of government deposits which encourage us to hold higher levels of cash.

Timur Braziler, Analyst

Okay, that's helpful color. Thanks for that. And then maybe just looking at the actual securities yields in the quarter; it looks like MBS yields declined significantly quarter on quarter. Is that just a mix shift of what's rolling off? Additionally, if there isn't an expectation to reinvest future maturities, could you share what those bond yields look like as some of this $380 million rolls off over the next two quarters?

Orlando Berges, CFO

The investment on the CMO side, especially, there are two factors: it’s the running off securities and also a function of changes in prepayments from quarter to quarter. Changes affect the average calculation of repayment assumptions. The $380 million maturing consists primarily of contractual maturities, so we don't expect significant changes in yield for the remaining portfolio based on what we have seen over the past quarters.

Timur Braziler, Analyst

Got it. And then switching to the expense side, there was a comment in the prepared remarks that delayed capital expenditures are partially responsible for the better expense run rate. Can you remind us what the timeline looks like for those capital expenditures? Does this mean that when initial spending starts, it will be a larger amount?

Orlando Berges, CFO

When I mention delays, I mean that some of these projects aren’t on hold, they are ongoing but taking longer than expected. So it won't hit all at once — it will happen over time, and that’s why it will continue to be lower than we initially anticipated for the next couple of quarters.

Timur Braziler, Analyst

Got it. And lastly, do you have the average balance of public funds for the quarter?

Orlando Berges, CFO

The average balance, I don’t have it handy, but we ended up with $2.9 billion of government deposits in Puerto Rico, up from about $2.2 billion at the end of last quarter. I can get you the average number.

Timur Braziler, Analyst

Thank you very much.

Operator, Operator

Thank you. Our next question comes from the line of Alex Twerdahl of Piper Sandler. Your line is now open. Please go ahead.

Alex Twerdahl, Analyst

Good morning, guys.

Aurelio Aleman, CEO

Good morning, Alex.

Alex Twerdahl, Analyst

First off, I was just curious what your expectations are for the balances of those government deposits over the next couple of quarters. If you expect those to sort of flow out, I guess with seasonality, or maybe where you expect them to end the year.

Aurelio Aleman, CEO

I would say most probably we'll stay around where we are today. We may see some in-and-outs. There are a couple of initiatives related to energy that are linked to deposits as part of the energy plan. If those move ahead of the timeline, those deposits for this year should move out, but we do expect them to bounce back early next year. I know it's not a firm answer, but that's the volatility associated with those deposits. For this quarter, based on what we know, we should be okay. Overall, the timing of projects associated with the energy plan will play a part here.

Alex Twerdahl, Analyst

Okay. And then I assume that those are going to peak out at some level below Fed funds despite the high bid nature. Can you tell us where those might peak out in terms of cost? Also, do you have the betas for the various buckets of interest-bearing public funds, time deposits, and core deposits?

Orlando Berges, CFO

The average cost of government deposits in Puerto Rico for the quarter was 2.70%. Not all accounts fall into the same classification. Thus, this figure excludes some non-interest bearing accounts or accounts with very low interest rates. The average cost is also 50 basis points higher than last quarter.

Alex Twerdahl, Analyst

Okay. What about for non-public fund deposits?

Orlando Berges, CFO

I don’t have that one broken down. I would have to include that in our disclosures. I cannot provide that right now.

Alex Twerdahl, Analyst

Okay. Understood. Going back to your comments on loan outlook, I believe you mentioned strong pipelines through the remainder of the year. Based on your comments on the new loan yields being in the 7.5% range, are you suggesting that the bulk of what you're looking at is commercial in nature, or can you elaborate on the expected composition of loan growth and any significant paydowns we should consider for the third quarter?

Aurelio Aleman, CEO

Yes. The third quarter should align with the normal run rate we experienced in the first half. There are a few chunky loans that should close in the fourth quarter. This year, the loan production has been consistent, and yes, the new yields are being driven by both consumer and commercial productions. The blended yield is slightly higher depending on the mix between consumer versus commercial.

Orlando Berges, CFO

To answer your question, the cost of deposits excluding government and time deposits was 68 basis points for the quarter.

Alex Twerdahl, Analyst

That’s great. Thank you.

Aurelio Aleman, CEO

In the presentation, we include the average cost of all funding sources, and the average cost was 123 basis points, which reflects on the trends across the last four quarters.

Alex Twerdahl, Analyst

Got it. The securities maturity you alluded to is around $440 million for the back half of the year. Can you break that out by quarter?

Orlando Berges, CFO

It was about $170 million in the third quarter and the rest in the fourth quarter.

Alex Twerdahl, Analyst

You mentioned returning to your expense guidance. If I recall, that was about $116 million per quarter.

Orlando Berges, CFO

The guidance was $120 million, excluding OREO. If you include OREO assumptions of a $2 million equivalent gain, it would have been around $118 million. We exclude OREO because of the volatility associated with it. We expect to see positive numbers in the third quarter, though probably a bit lower than what we had this quarter.

Alex Twerdahl, Analyst

Great. Thank you for your time.

Aurelio Aleman, CEO

Thank you, Alex.

Orlando Berges, CFO

Thanks.

Operator, Operator

Thank you. Our next question comes from the line of Kelly Motta, KBW. Your line is now open. Please go ahead.

Kelly Motta, Analyst

Hey, everyone. Good morning.

Aurelio Aleman, CEO

Good morning.

Orlando Berges, CFO

Good morning, Kelly.

Kelly Motta, Analyst

Circling back to the expenses again, as you’ve mentioned, the lower expense run rate is partially due to special projects you are undertaking and their timelines. Can you shed some light on the strategic focuses over the next year or two that are tied to these projects that you are able to share?

Ramon Rodriguez, Investor Relations Officer

Well, I think the largest component is the migration to cloud of all IT components, and that encompasses a significant number of projects. The second largest is process improvement – investments in technology that will enhance efficiency, including automation and robotics.RPA. So it really is primarily technology-focused, with some components associated with facilities. But I would say it's probably an 80-20 split, leaning toward technology. It's taking longer than we initially predicted.

Kelly Motta, Analyst

Got it. That's very helpful. I’ll step back. Thank you.

Ramon Rodriguez, Investor Relations Officer

Thanks, Kelly.

Operator, Operator

I see there are no additional questions at this time. Ladies and gentlemen, that concludes today's call. Thank you for joining First BanCorp's second quarter 2023 earnings results call. You may now disconnect your lines.