Earnings Call Transcript - FBP Q2 2024

Operator, Operator

Good morning, everyone. My name is Kiki, and I will be your conference operator today. I would like to welcome everyone to the First BanCorp's Second Quarter 2024 Financial Results Call. Operator Instructions. I will now hand you over to Ramon Rodriguez, Corporate Strategy and Investor Relations for First BanCorp, to begin. Ramon, please go ahead.

Ramon Rodriguez, Corporate Strategy and Investor Relations

Thank you, operator. 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 2024. 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.

Aurelio Aleman, CEO

Thank you, Ramon. Good morning to everyone and thanks for joining today. Let's turn to Page 4 to go over the highlights of the quarter. We posted another solid quarter for the franchise with strong profitability and positive operating leverage, earning $76 million in net income and delivering a strong return on assets of 1.61%. Adjusted pre-tax pre-provision income moved upward, reaching $113 million, up 2.4% versus the prior quarter, mostly driven by net interest income and lower expenses. In terms of the balance sheet, total loans grew by 2.4% in the quarter, annualized driven by growth across all business segments. We've seen a slight delay in some of the construction funding during the year, but we expect to close this gap during the second half of the year. The loan pipeline remains healthy and is mostly supported by the stable environment that we continue to experience in our operating regions. We continue to sustain our mid-single-digit loan growth guidance for the year, primarily due to commercial construction and auto loan activity that we continue to experience. In terms of our deposit franchise, we had a positive quarter. We were very pleased to see improvement in the core deposit flow during the quarter, particularly in the non-interest bearing account, which now represent 34% of our total deposits. Core deposit growth and broker and government deposits were up $132 million during growth across all three regions. We are highly encouraged by the accretive nature of our balance sheet position for the remainder of the year, as it will benefit from the sizable bond book repricing opportunities coupled with the expected gradual easing in deposit costs. The credit environment continues to play out as expected; even though NPA decreased to $127 million, we continue to see early delinquency and charge-off trends within our consumer book returning to historical levels consistently with our expectations. On the capital front, we sustain our commitment to preserve shareholder value during the quarter by returning 100% of earnings in the form of buybacks and dividends while continuing to execute our organic loan growth strategy. We maintained a very strong CET1 ratio of 15.8%. Once again, this has been really a great quarter, another great quarter of strong financial results. We thank our teams for making this possible. They are the backbone of the organization, and we're extremely proud of what we have accomplished over the past few years. Let's go to Slide 5 for some additional highlights of the macro. Our team has a proven track record of delivering consistent performance and adapting to changing market conditions, particularly in our main market. In Puerto Rico, the macro backdrop continued to reflect stabilization across most economic fronts, with labor market trends sustaining their overall trajectory, passenger activity in the main airport reaching record levels, and strong consumer confidence evidenced by year-to-date sales tax collections. As we stated in the past, the unprecedented level of our support continues to drive economic activity on the island. This year, close to $2.5 billion of these asset relief funds have been distributed during the first five months, representing a 35% increase compared to the prior year. In terms of our franchise build, our teams continue to manage multiple capital projects aimed at advancing the evolution of the IT infrastructure and enhancing digital capabilities. In particular, we're excited to deploy our new commercial lending platform in the coming months, which will provide a more seamless interaction with commercial clients and support additional growth in the business. Finally, I want to provide an update on our capital strategy. Our approach to capital management has always been thoughtful and centered on making capital decisions that best serve the long-term interests of the franchise and shareholders. With this in mind, and given our strong capital position, as we announced yesterday, our board approved a new authorization of up to $250 million in capital that can be used either to repurchase our common stock or redeem existing loan securities. This is in addition to the $50 million remaining from the prior approval. Over the next few quarters, we will focus our efforts on redeeming our outstanding trust preferred debentures, which at this moment will represent an immediate EPS accretion opportunity and result in a simplified capital structure. Our 100% capital return goal remains intact for 2024, and really, the strategy has not changed. We will continue to capitalize on organic growth opportunities in our markets and deploy excess capital into opportunistic buybacks, or in this case, focus initially on redeeming our outstanding preferred stock. Now I will turn it over to Orlando to go over more details of the financial results. Thanks very much.

Orlando Berges, CFO

Good morning to everyone. As Aurelio mentioned, we reported net income of $75.8 million for the second quarter. That's $0.46 a share, which compares with $73.5 million last quarter or $0.44 per share. We're extremely pleased with the results as we have continued to generate a strong return on assets, which reached 1.61% this quarter. The results for this quarter have been very consistent with the discussions we've had with the market. NIM for the quarter expanded 6 basis points, and net interest income grew by $3 million, with expenses having been within the guidelines we've provided. Provision for the quarter was similar to last quarter at $11.6 million, which compares to $12.2 million. The provision for this quarter reflects benefits from the lower recent historical loss levels on the residential mortgage portfolio, as well as lower projected losses on the commercial real estate portfolios. These have been driven by macroeconomic variables being better than they had been previously forecasted. These two combined have offset the impact of the higher level of charge-offs we've had on the consumer portfolio, which have affected the provision for those portfolios. The effective tax rate for the quarter was 24.1%, very similar to last quarter, and we have continued to work on tax positioning. As I mentioned, net interest income for the quarter improved by $3 million to $199.6 million. Total interest income grew $3.7 million, which includes a $2.8 million interest income growth in the loan portfolios, while interest expense only grew by $600,000. The yield on total earning assets grew 7 basis points in the quarter, which is a combination of a 5 basis point growth in the loan portfolio yields and higher levels of interest-bearing cash balances at the Fed. When combined with the investment portfolio, the higher cash balances resulted in approximately 7 basis points higher yields on the portfolio. Funding costs increased only 1 basis point for the quarter as we continue to see more stability in deposit pricing. The increase in interest expense was mostly on time deposits, where average balances grew by $110 million, and we saw a 16 basis points increase in the average cost of these deposits. During the quarter, overall deposits grew; in the quarter we were able to replace some of our higher cost broker deposits. The average balance of broker deposits decreased by $73 million for the quarter. Quarter-end to quarter-end, it's about $100 million and the average cost of this deposit is down 9 basis points. As we mentioned in prior quarters, assuming current interest rates, the net interest margin reached an inflection point in Q1, and we saw an expansion of 6 basis points this quarter, reaching 4.22%. Again, all the composition of our earning assets continues to shift towards higher yielding assets, which more than offset any increase in the cost of deposits. Similar to what we said before, we continue to benefit from repricing opportunities on the investment portfolio either into loans or ultimately into higher yielding securities. Our most recent estimates of cash flow are about $720 million to $730 million for the last six months, with $250 million of that in the third quarter and $470 million to $480 million in the fourth quarter. The combined cash flows from agency and treasury papers with contractual maturities would be about $500 million. So the full impact of this repricing will be seen in Q1 of 2025. The other income components, non-interest income components were fairly consistent. We did have a reduction of $2 million, mainly due to $3.2 million in seasonal contingent insurance commissions that we collected in Q1. On the other hand, we had some pickup on mortgage banking activity income for the quarter. In terms of expenses, expenses were $118.7 million, which is $2.2 million lower than last quarter. This reduction includes a $2.3 million gain realized on the disposition of a large commercial other real estate owned (OREO). We also saw a $2.1 million decrease in compensation expenses, mostly payroll taxes and stock-based compensation. However, we did have an increase of $1.8 million in credit and debit card processing expenses. In reality, last quarter, we received $1.3 million in expense reimbursement incentives from the networks, which lowered our expense base in Q1. If we exclude OREO and the FDIC expenses, expenses for the quarter were $122.3 million, which compares to $121.5 million last quarter, very much in line with the $120 million to $122 million expense range that we have been guiding, and we continue to maintain this guidance for the next couple of quarters. The efficiency ratio for the quarter was 51.2%, which is also in line with our 52% guidance, and we should continue to see the efficiency ratio at this level based on current interest rates and margins. In terms of asset quality, non-performing assets decreased by $2.7 million in the quarter to $126.9 million, which is 69 basis points of total assets. Most of the reduction was in the other real estate owned segment, which decreased by $7.2 million due to the sale of a $5.3 million commercial real estate owned in Puerto Rico. Non-performing loans, however, did increase by $3.2 million, primarily in commercial and construction during the quarter. We recall that a commercial relationship in Puerto Rico with a total exposure of $16.5 million migrated to non-performing status. However, we also had a Florida case that went to non-performing last quarter but was restored to accrual status based on the payment status of the case and restructuring. Loans in early delinquency increased by $13.76 million, all of which was in consumer. We continue to see trends gradually returning to our historical levels. The allowance for credit losses was $254.5 million at the end of the quarter, which is $2.9 million lower than the prior quarter. The reduction came from the mortgage and commercial real estate portfolios, while consumer reserves showed an increase. The allowance coverage on loans decreased to $206 million from $214 million, still healthy, and the allowance for unfunded loan commitments and debt securities was $261 million versus $270 million we had last quarter. Net charge-offs for the quarter were $21.1 million, or 69 basis points of average loans, compared to 37 basis points last quarter. However, if you remember last quarter, we included $9.5 million in recovery from the sale of previously charged-off loans. Excluding this recovery, net charge-offs in Q1 were 68 basis points, which is consistent with this quarter. On the capital front, our ratios continue to remain very strong and significantly above well-capitalized levels. We continue to deploy capital through share repurchases and dividend payments. Repurchases and dividends for the quarter amounted to $76 million, which is essentially 100% of the earnings we had in the quarter. The tangible book value per share and tangible common equity ratio increased to $8.81 and 7.7%, respectively. Basically, we had an improvement in the fair value of the investment portfolio, which improved these ratios since earnings were offset by the capital actions. The adjusted other comprehensive loss now represents over $3.89 in tangible book value and over 300 basis points on the TCE ratio. Assuming stable rates in the market, we expect to continue to recover the adjusted other comprehensive loss based on the short duration of the portfolio. This concludes our remarks. Operator, we would like to now open the call for questions.

Operator, Operator

Operator Instructions. The first question is from Brett Rabatin from Hovde Group. Brett, your line is now open. Please go ahead.

Brett Rabatin, Analyst

Hey. Good morning, everyone. Wanted to start with just the macro in Puerto Rico, and it sounded to me like you were kind of intimating that, you know, it's steady state is what you were seeing most recently. But you mentioned the $2.5 billion distribution, and then I saw Core 3 had actually distributed a $1 billion here so far this year. When I look at the GDB-EAI index, it's down actually in April a little under 124, but that looks to be mostly concrete and gasoline. As you guys think about the back half of the year from an economic perspective, is there anything that you would point out as drivers for either growth or maybe some atrophy in the economy?

Aurelio Aleman, CEO

Well, we continue to see I think the $2.5 billion is through the first five months of the year, and that is actually higher than last year. You can see that the bulk part is actually CDBG construction elements, which primarily involve significant projects in what they call the low-income housing affordable housing category. We have some of those in the books, and they are being approved with initial disbursement. We expect those to show in the second half of the year as we originally planned. We continue to see foreign investors bringing capital to Puerto Rico through incorporations, along with more deals, some of which have required financing. There are more projects in the pipeline regarding the IPG funds. They include additional hotels and additional housing, where there's still high demand for the middle-income segment. Unemployment continues to remain stable and labor participation is improving. So we do not expect any decrease; rather, we see more opportunities for improvement. Of course, we should take into consideration that the excess liquidity brought by the pandemic has already been utilized, which has an impact, but when you look at sales tax, it is not really shown there; it's probably reflected in some other form of consumption. The fiscal plan recently published indicates positive GDP growth in the projections. I believe when we analyze all that, it demonstrates positive indicators. Ramon, could you provide some insights on the specific analysis of the indicator, which is historically volatile and can have some quarterly variances?

Ramon Rodriguez, Corporate Strategy and Investor Relations

Yes, Brett. Most of the reduction you mentioned regarding the economic activity index is related to gas consumption, which has been trending down over the last few quarters. But when you consider the other three components, payroll employment, in particular, is reaching decade highs. In April, it was up by about 2% year-over-year. So looking at the broader components, we remain fully encouraged about the economic activity index going forward.

Brett Rabatin, Analyst

Okay. That's great color on that and then, maybe Orlando on the margin, you know, it would seem like with what you have coming with securities portfolio and kind of the stabilization of funding costs in Q2, that the margin should continue to move higher. Any thoughts on the pace of the margin from here and just how you see that playing out?

Orlando Berges, CFO

Well, we haven't provided a very specific margin number, but clearly we have said that our margin will continue to go up. Again, if you only think about the $720 million or so of cash flows that are now yielding about 1.5% on a GAAP basis, that number would be replaced with something close to loan yields or at the worst, the investment portfolio yields. So we would be picking up 4 to 5 basis points easily on that portfolio. This should start to translate into higher margin starting next year. The funding cost side is starting to stabilize. The increase, as I mentioned, in time deposits has a lot to do with all the things maturing and being renewed at current rates, but the Puerto Rico market is not as high as the U.S. market. We still see some pressure in Florida, but we are experiencing less pressure in Puerto Rico. Exceptionally pressed pricing in time deposits, but generally, many of the time deposit numbers are not generated at those rates in Puerto Rico. That will slowly start to result in improved margins. New loans are also coming in at current slightly higher rates, which is why we ended with that 5 basis points increase on loan portfolio yields on average. So the expectation is to continue experiencing upward trends in net interest margins for the next few quarters.

Brett Rabatin, Analyst

Okay. Fair enough, and then if I could sneak in one last one, just on the reduction of the commercial real estate reserve due to macro factors. Would that be mostly or entirely just the term structure of interest rates, or would there be other factors that would have reduced your commercial real estate outlook?

Orlando Berges, CFO

It's a combination. The CRE price index deterioration that we have is to some extent based on national information, while the reality is Puerto Rico is performing significantly better. What we observe is that as we adjust for the market on those numbers, the CRE price index is not suffering the same impact that some U.S. markets are encountering. This adjustment is part of the reason for the improvements we're seeing on the commercial real estate side.

Brett Rabatin, Analyst

Okay, great. Very helpful. Thanks for all the color.

Operator, Operator

The next question we've got is Steve Moss from Raymond James. Steve, your line is now open. Please go ahead.

Steve Moss, Analyst

Hi. Good morning.

Aurelio Aleman, CEO

Good morning, Steve, and welcome to the call.

Steve Moss, Analyst

Thank you, Aurelio. Appreciate it. Maybe just starting with the continuing with the loan loss reserve, I was just curious regarding the decline in the residential mortgage reserve quarter over quarter, was that just kind of a component of historical charge-offs that have declined being the primary driver? And could we see a further reduction in that reserve over time?

Orlando Berges, CFO

It is driven by the updated information on charge-offs on that portfolio. We've seen significantly low trends. The mortgage portfolio is a longer-lived portfolio, therefore we use longer lives in estimating some of the factors, and as you've seen, the loss ratios over recent years have been very low. This trend continues to influence our charge-off ratios. So we have observed improvements and assuming we remain stable, I do expect that eventually, we'll see some additional improvements in that reserve, given the current size of the portfolio. Obviously, the portfolio has also been coming down, but it has stabilized recently as the mix of conforming and non-conforming has changed somewhat based on market rates. However, losses on the portfolio have been significantly lower, and we've seen values that remain high, aiding in any kind of disposition of property. So that's why we've seen this trend of reduced losses, which translates into lower reserve requirements.

Steve Moss, Analyst

Okay. Appreciate that. And then just with regard to the loan growth this quarter, I saw that floor plan growth was one of the drivers. Just curious if there's a seasonal dynamic or any reasons for that growth, and how to think about whether we continue to see this pace of CRE growth as well?

Aurelio Aleman, CEO

There are a couple of considerations. We did sign new relationships on the floor plan, so most part of the increase came from a large new relationship that was acquired by First Bank. There's also some seasonality I would acknowledge. Auto sales have contracted from the prior year as expected, but they are slightly better than we forecasted. The market continues to remain active in that regard.

Steve Moss, Analyst

Okay. And then on the commercial real estate side, you guys had another good quarter of growth here. Just curious, do we expect that cadence to continue? I know you mentioned construction but that would likely pick up in the second half. Just curious on the outlook for CRE.

Aurelio Aleman, CEO

Yes, on the CRE side, some increases were conversions from construction. So that's why the timing of the reduction in construction is visible this quarter: some cases were converted to permanent loans. We do expect to see conversions come through towards the end of the year. We also anticipate disbursements on construction loans to pick up with the typical cycle of construction projects, which have experienced some delays, but it's not unexpected.

Steve Moss, Analyst

Okay. Appreciate that, and one last one for me. Just on the non-performing commercial loan in the restaurant or food sector, any color you could provide on that credit, whether it's a shared national credit or related to something along those lines?

Aurelio Aleman, CEO

No, it's a relationship that we have. We do expect resolution of that relationship. Though some developmental initiatives have faced delays, we anticipate recovering the situation sometime in the future.

Orlando Berges, CFO

And that encompasses two components, one in construction and the other in the commercial side.

Steve Moss, Analyst

Okay. Great. Appreciate all the color and a nice quarter. Thank you.

Operator, Operator

Thank you. The next question we've got is from Timur Braziler from Wells Fargo. Timur, your line is now open. Please go ahead.

Timur Braziler, Analyst

Hi, good morning. I'm just wondering about the securities cash flows. It looks like it's accelerating in the back-end of the year. Just your appetite for either putting that right back into the bond book or waiting to invest that into loans. How quickly are you anticipating those bonds to be reinvested or those bond cash flows?

Orlando Berges, CFO

Reinvestment can happen differently. We base it on the pipelines on the lending portfolio and the institution's liquidity composition, which drives such decisions. Based on those pipelines, we do see some amounts of the Fed account, which at this point is yielding 540, which is significantly higher than the portfolio. If we don’t foresee that to be the case, we could remove some wholesale funding that matures or return to the investment portfolio. That would be the order. The lending option remains the key factor here. If we see it’s longer term, we may choose to revert to market options. It’s a mix, and it’s largely dependent on how we view the various components, primarily the pipelines and liquidity, which dictate where we allocate our money. The effect would be immediate. As cash flows come in, we can either leave them in the Fed account or eliminate some hotel funding while loans are processed. Therefore, not every cash inflow will immediately lead to loan yields; however, would likely move to market investments or cash yields.

Timur Braziler, Analyst

Okay. That makes sense. And then just looking at the incremental Board authorization of $250 million for the reduction of some preferreds, I guess, what does that portend for future buybacks? Is that a hindrance maybe, or can you kind of use the capital for the redemption, and then that puts buybacks on hold? Or can both proceed simultaneously?

Aurelio Aleman, CEO

Well, for this quarter, we will focus exclusively on redeeming the debt securities. Starting with that, we again have the same number in mind in terms of the plan to achieve a 100% capital return, which would likely amount to around $50 million per quarter, similar to what we did in the first half of the year. This action provides immediate accretion and improves revenues without any EPS dilution. So we will prioritize that activity during this half of the year. However, we are maintaining our optionality for buybacks whenever possible; that is the important takeaway.

Timur Braziler, Analyst

Got it. So the near-term priority is on redemption, but buybacks are still potentially on the table?

Aurelio Aleman, CEO

Yes, that's correct.

Operator, Operator

We've now got a question from Kelly Motta from KBW. Kelly, your line is now open. Please go ahead.

Kelly Motta, Analyst

Hi. Good morning. Thanks for the question. You've continued to have a pipeline of OREO gains here that's really, you know, to the benefit of expenses. I think you reiterated your guide of $120 million to $122 million, excluding these gains, but I wonder based on the activity we've seen so far, what are you seeing in the pipeline in terms of the potential for further OREO gains to reduce that overall expense number?

Orlando Berges, CFO

This quarter, we had a large case, a commercial OREO that we sold at a good profit, but we don’t have too many of those. On the commercial side, there are not many options available. However, we continue to see residential mortgages being disposed of. The steady market prices have allowed pricing on these OREOs on the residential side to remain viable. At this point, as I have mentioned, it's been longer than we expected, but we'll take it. Our group continues to receive better offers than appraisals suggest regarding what's available. This is partly due to higher employment levels on the island and a need for properties. For a long time, we didn't see much in terms of residential construction in Puerto Rico. We still feel that in the near term, the numbers won't be as large as what we observed this quarter, but we expect that operating costs would definitely be offset by sales over the next few quarters. However, it's difficult to predict, Kelly, how long this trend will last; it may not continue indefinitely.

Kelly Motta, Analyst

Got it. I keep putting in zero there, and you guys keep beating me. On the deposit side, it was really encouraging to see non-interest-bearing accounts stabilize, actually up slightly this quarter. I wonder, given that we've obviously finished with rate hikes, what you guys are seeing on the deposit side and the pipeline for deposits, especially with the relief money picking up year-to-date. Fair to say that we can expect continued modest growth off this number? How are you guys thinking of that? What are you seeing?

Aurelio Aleman, CEO

Well, the number one priority of the franchise is to continue growing the core deposits. It’s a combination of products, digital functionality, and I would say commercial activity and the commercial products we've invested in over the past year. That is really our main priority. It's very challenging to predict trends in the market, as market data remains relatively flat in terms of overall trends. There's substantial analytics behind how to execute successfully, but our goal is truly to maintain growth in that core deposit area. Staying at 34% non-interest-bearing is a challenge, but it remains our focus. Government deposits have a different strategy; they are more opportunistic and transactional. However, we do have a core business providing various types of transaction banking services to government entities, not only large corporations but also municipalities. For those two areas staying at similar levels, we don’t expect significant growth. We do expect to continue making progress on the commercial and retail side.

Kelly Motta, Analyst

Got it. That's helpful. Maybe last one for me. Given your outlook for expenses to remain at this level and for margin expansion, you've been consistently achieving efficiency ratios in the low 50s and below long-term mid-50 range. Given that you expect margin expansion, would it be fair to expect that efficiency could continue to improve and potentially run lower in the near term, based on your outlook for investing in the franchise and kind of NII growth outpacing that? Or could you potentially increase your expenses and reinvest some of those gains as you think about it? I realize it's early to start discussing 2025, but a high-level view would be really helpful.

Aurelio Aleman, CEO

Yes. Investments will continue; technology is a key component of our priority investments. Infrastructure and facilities have been significant areas for ongoing investments. We guided at a 52% efficiency ratio for 2024, and I believe that we'll stay around that. It's very tough, as sometimes it varies, and these past two quarters are perfect examples. Opportunities tend to fluctuate within those numbers. Overall, I think a 52% efficiency ratio is probably the best estimate we can provide at this point.

Orlando Berges, CFO

Clearly, margin expansion could assist in that respect and offset any additional investments we might make. However, the 52% efficiency ratio is where we think it will remain based on current investments.

Kelly Motta, Analyst

Great. Thank you.

Aurelio Aleman, CEO

Thank you, Kelly.

Operator, Operator

Thank you. We currently have no further questions. Operator Closing Remarks.