Earnings Call Transcript - FBP Q1 2020

Operator, Operator

Good morning and welcome to the First BanCorp 1Q 2020 Results Conference Call. After today's presentation, there will be an opportunity to ask questions. And I'd like to turn the conference over to Mr. John Pelling, Investor Relations Officer, First BanCorp. Thank you and over to you, sir.

John Pelling, Investor Relations Officer

Thank you, Vikram. Good morning, everyone and thank you for joining First BanCorp's conference call and webcast to discuss the company's financial results for the first quarter 2020. 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, 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, 1firstbankpr.com. Additionally, we filed a COVID pandemic response investor deck on our website as well. At this time, I'd like to turn the call over to our CEO, Aurelio Aleman. Aurelio?

Aurelio Aleman, CEO

Thank you, John. Good morning, everyone. Hope you're all safe and healthy. Before going into the detail of the quarter, I think we need to discuss the more present matter at hand, which is the impact of this pandemic on our customers, employees and how we have managed through the lockdowns which were put in place in Puerto Rico and ECR around mid-March and subsequently in Florida with actually less restrictive operating rules. So let's please move to Slide 5. First of all, our hearts go out to all those families impacted by the crisis, both from humanitarian and economic standpoints. This has been hard on many families and I want to take the opportunity to personally acknowledge the excellent work done by my team and thank my dedicated frontline employees, who have been supporting our clients every day during this pandemic and the general lockdown. I have to say really no one was prepared for this type of event, but based on our recent experiences managing natural disasters, we felt prepared to act safely, adjust our plans accordingly, as we learned through the process and moved our teams in the right direction. Going just back a couple of years, having endured a decade-long recession and unprecedented modern natural events, including earthquakes, our teams truly learned how to respond to crises, and we did so immediately. We implemented remote work, divided teams, and set up working areas to limit contact with each other and with customers, and implemented strict cleaning and safety protocols. Most recently, we instituted contact tracing and began COVID-19 testing for our employees that are working on-premises, which yielded very positive results. I have been extremely pleased with our operating strength and digital readiness. Our digital channels are supporting our customers amidst the limitations of social distancing. We swiftly implemented our moratorium programs, contacting borrowers, and providing a certain level of automation to the process. We also achieved what I consider a very strong performance in rolling out the SBA PPP program with the support of the FIS numerated platform. As of yesterday, we approved over 2,500 loans and over $219 million, which is actually more than our fair share of the commercial lending market in Puerto Rico and that covers all the regions. The rollout of federal products like PPP and the moratorium should definitely help mitigate credit quality deterioration in the short term. I want to emphasize that we're entering this crisis from a position of institutional strength to really support our people, clients, and shareholders. And today, obviously, we all remain vigilant as certain markets begin to open. Please, move into Slide 6 now. Looking at the results, they were obviously impacted by the lockdown that was first initiated in Puerto Rico and ECR and then in Florida, as I mentioned. The fact that we implemented CECL, which Orlando will cover in greater detail. In spite of that, we generated some net income of $2.3 million or $0.01 a share. When you look at the reserve build of almost $60 million driven by the deteriorated economic forecast under COVID. It is also important to highlight that loan origination was disrupted toward the end of the quarter. Origination reached over $100 million, even though we actually started that with a very strong pipeline. The loan portfolio grew slightly by $9.3 million, driven by commercial and construction in Florida and consumer in Puerto Rico, offset by our strategy to reduce the residential portfolio. During the last two weeks of lockdown there was very limited origination and most products were halted. We were not closing mortgages in Puerto Rico, and no auto sales were taking place, so the auto lending and mortgage volumes were not present. I'll talk more about this later. NPAs remained relatively flat, and deposits grew by $91 million and they actually continue to grow this quarter, primarily driven by increases in Puerto Rico and slight reductions in Florida and ECR. Again, I think the bottom line is that yes, there were results, but the main message here is that we really feel we're well prepared to handle the cycle. We have significant experience managing crises and we're entering this crisis from a position of strength. Our capitals are among the highest of any bank in the country. Our retail coverage for CECL is among the highest of any bank, so we are up there with a lot of capital reserves to support the crisis. We generated pre-provision income a little bit above $68 million this quarter, and this along with strong capital and reserves supports our current dividend. Let's talk about the quarter in a bit more detail on Slide 7. Loan originations were really strong, coming in at a great pace. Obviously, the last two weeks are always important in every quarter for closings. The Puerto Rico and ECR rules are strict: no mortgage closings, no auto sales, and limited commercial activity focused mostly on PPP. In Florida, they were less restrictive, so we continued to originate mortgages along with some pending commercial activity and obviously PPP loans. Looking forward into the second quarter, I think the reopening timelines will be fine. While we cannot give specific guidance on volumes, we will keep you updated as reopening timelines are developed. We're learning from outside markets like China about what to expect in different lines of business. We are continuing to manage renewals and support growth on revolving lines. The USVI is actually set to announce reopening next week. We are all waiting for an announcement from the Puerto Rico Government which should happen in the next few days, and there are high expectations in the private sector that Puerto Rico will reopen and ease some lockdown rules early next week. Additionally, and not surprisingly, we have also experienced reduced volumes in ATM, POS, debit ATH, and credit card transactions. Internet and mobile transactions are increasing and this trend will likely continue until our markets gradually begin to reopen. I want to cover some credit quality matters. This time around, I think it’s different than prior crises, from a credit standpoint. There are strong mitigants in place for the next 90 to 180 days supported by the CARES act, which includes regulatory guidance for moratoriums as well as local Puerto Rico incentives. We've learned a lot from prior experiences managing crises and have honed our efficiency in the moratorium process. We immediately began contacting our borrowers in March, analyzing their situations and implementing the program. We've done significant analysis on every large borrower as well as our consumer portfolios. As of yesterday, we offered relief products to 38% of the portfolio, approximately $3.5 billion. We approved 2,576 Paycheck Protection Program loans totaling over $290 million. It's worth noting that 90% of these loans are for amounts below $250,000, and 63% are below $50,000, so we are fully supporting the small business segment. We continue receiving applications until funds are depleted, but we are monitoring this daily. Our borrowers’ credit quality should be supported by these product offerings in the near term. Additionally, the Puerto Rico government and fiscal board allocated approximately $900 million to stimulate the economy and support those impacted by the pandemic. Overall, these three large initiatives provide positive mitigants. Now I'm going to hand the call over to Orlando to cover the financial details, and we will come back for questions later. Thank you all.

Orlando Berges, CFO

Good morning, everyone. Aurelio mentioned we generated $2.3 million of net income this quarter, which is $0.01 per share. That compares with $36.4 million, or $0.16 a share, in the fourth quarter. We did have several unusual items in all quarters, but you'll remember from last quarter that this included expenses associated with the transaction that resulted in a non-GAAP adjusted net income of $42.8 million or $0.19 a share. He also referenced tax pre-provision income of $68 million, which compares to $72 million last quarter. This quarter's results include two large items: first, an $8.2 million tax-exempt gain on the sale of securities that contributed to earnings per share by approximately $0.04; and second, we had a reserve build for loans and debt securities of $59.8 million, driven by the COVID pandemic's effects on Moody's forecasted economic scenarios. This reserve build had an after-tax impact of $39.8 million, roughly $0.18 a share for the quarter. Important for this quarter is the adoption of CECL, which, as you know, refers to the new accounting rules for expected credit losses. When we discuss credit losses, it's crucial to clarify that it includes a wide range of loans as well as unfunded commitments and estimated losses on debt securities. As of January 1, we recorded a general allowance for overall credit losses of $93 million upon adopting the CECL standard. For this quarter, the total provision came in at $77.3 million, which includes the reserve build I just mentioned of $59.8 million and approximately $17.5 million, which corresponds to charge-offs for the quarter. This provision calculation is based on Moody's economic projections. The reasonable and supportable time frames cover a period of around two years for Puerto Rico and four years for the Florida market, after which we revert to historical losses. The projections incorporate the impact of the pandemic and the federal economic stimulus on macroeconomic variables, which are key for determining expected losses. Overall, the CECL allowance as of March stands at $308 million, which includes $293 million related to loans, about $6 million related to unfunded commitments, and another $10 million related to debt securities. The allowance for credit losses on loans represents 3.24% of loans at quarter-end, which has significantly increased from the $172 million allowance we had as of December. In terms of net interest income for the first quarter, we saw a decrease of $1.3 million. The net interest income for the quarter was $138.6 million, compared to $139.9 million for the last quarter. This reduction is due to one less day in the quarter, along with the impact of repricing, primarily on variable rate commercial loans during the quarter. One day for us in the quarter represents approximately $900,000 in impact on net interest income. This quarter, we did experience some growth in average earning assets compared to the last quarter. However, loan originations in the second half of the quarter were limited, as Aurelio mentioned due to lockdowns, which affected the overall average earning assets for the quarter. Margin stood at $463 million compared to $470 million in the fourth quarter of 2019. Going forward, it's still challenging to make estimates; we expect some decrease as the full effect of the rate changes is reflected in the second quarter. Meanwhile, moratoriums on loans for clients should slow reductions in the size of the portfolio, but in reality, there is a component of uncertainty regarding the reopening of Puerto Rico and how that will impact higher-yielding consumer portfolios on our balance sheet. Overall, we continue to work on reducing our interest costs on deposit accounts and have evidence of an overall reduction of 6 basis points for the quarter. Time deposits represent 40% of interest-bearing deposits, and adjustments on these products take longer to show since maturation of the time deposits is a factor. In the quarter, we also managed to lower the cost of funding, such as accessing Fed discount windows as a method of securing lines and waiting for market rates to stabilize. We experienced disruptions with Federal Home Loan Bank advances as well as on brokered CDs in the latter part of the quarter. From a liquidity perspective, we maintain very high levels of liquidity, with cash and pre-liquid securities constituting about 17.5% of assets. We expect to continue having comfortable liquidity levels based on inflows from the local and federal stimulus packages that we are observing. If we move to non-interest income, it was up $30.2 million, representing an increase of $5.8 million from the last quarter. Notable components of this included the $8.2 million tax-exempt gain we generated from the sale of securities. During the quarter, we sold, at the end of the quarter, a portion of our portfolio that we believed was exposed to significant prepayment risk. So we sold about $276 million of available-for-sale US agency MBS that we had in the portfolio. Additionally, we saw an increase of $2.7 million in insurance income, mostly stemming from seasonal contingent commissions we received in the first quarter each year based on volumes produced in previous years. That being said, we did see some reductions at the quarter's end in lower volumes of mortgage, auto, and similar originations, which affected some components of insurance income. Transaction fees from credit cards, debit cards, and POS all experienced declines, which led to a $1.3 million decrease in fee-based income in this category. This drop is part seasonal, but in reality, the disruptions caused by the lockdown were significant. It's essential to remember that last quarter, we recognized a $2.1 million gain from the sale of a non-accrual commercial mortgage loan, which impacts the variance on this side. In terms of expenses, non-interest expenses amounted to $92.2 million, which is $10 million lower than the last quarter, primarily due to a decrease in merger and restructuring costs connected to the pending acquisition of Santander. Last quarter, we had $10.8 million, which included advisory fees, legal fees, and valuations. We also saw a decrease of $2 million in OREO expenses, primarily $1.5 million related to write-downs on the value of OREOs. Employee compensation and benefit expenses increased by $2 million, largely driven by higher seasonal payroll taxes and bonuses that appear in the first quarter, partially offset by one less day in the quarter. Some keynotes for us at this point: we are all doing a full reassessment of all expense line items to reduce discretionary spending in line with the business volume adjustments we anticipate. Essentially, we are ready to make adjustments based on our volume estimates. In terms of asset quality, non-performing assets remained relatively flat, with only a $400,000 increase in the quarter, totaling $317.8 million as of March. Non-accrual loans increased slightly by $1.6 million due to a $3.4 million increase in non-accrual consumer loans, primarily in auto loans. Keep in mind, our portfolio has grown significantly over the last couple of years; however, we witnessed a decrease of $3.3 million in commercial and construction non-accruals, mainly due to successful collections. As Aurelio mentioned earlier, we have been implementing moratoriums on loans that were current or less than 89 days past due, depending on the type of portfolio. Migration to non-performing status in the second quarter will come from those loans, primarily those that do not meet the criteria for moratoriums or are not considered for moratoriums based on financial reasons. However, we don't expect substantial changes in this category for the second quarter. The same applies for charge-offs. Charge-offs for the quarter were $1.3 million lower than the previous quarter, standing at 78 basis points on average loans, and we don't anticipate significant changes in charge-offs for the second quarter, as we implemented moratoriums for basically all of that period. At this time, I'd like to open the call for questions.

Operator, Operator

Thank you, sir. We will now begin the question-and-answer session. We have a first question from the line of Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

So I guess, just in terms of the reserve build, if we can start with that during the quarter. I guess, about 3.2%. One, just from a modeling standpoint, Orlando, if you can talk about whether the loss rates you've experienced over the last five to ten years led to a much higher loss number than you would otherwise expect. And secondly, Aurelio, could you talk about how this compares when you look at your borrowers, both C&I and CRE relative to the hurricane and previous crises that we've had regarding the balance sheet capacity of these borrowers and the ability of the island to navigate through this?

Orlando Berges, CFO

Okay. Let's start with the calculation. As you know, we implemented CECL. Our CECL methodology takes into account, as required, what is called a reasonable or supportable timeframe. In Puerto Rico, we defined that as two years because we believe the economy in Puerto Rico has been very difficult to predict over a longer timeframe. Using that, we’re more comfortable with projections. We use Moody's for those calculations. Moody's estimates the impact of macroeconomic variables that are key for the different portfolios, such as unemployment, house price index, and so forth. The key ones are unemployment and housing price index. After the two years, we revert to our historical loss components, which likely exceed what we see in those metrics today. For unemployment, for example, we're projecting rates above 12%. The economic factors posed under reasonable and supportable terms change significantly from what we had at the end of the previous year when we first ran CECL estimates. The reversion time frames to historical losses are similar since we fallback to those levels that are historically higher than our current rates. Combining those elements influences our estimation significantly. Moody's is projecting that the immediate impact on unemployment will be significant over the first one to two quarters and will then start to decrease. Those shifts notably affect the estimated loss forecasts. Regarding commercial portfolios, the last time the commercial business handled the hurricanes effectively and returned to operations more quickly than expected. They had reserves that covered the damages resulting from the hurricane, and those weren't overly damaging overall. The real challenge now is assessing the reopening timeline and its implications for various business sectors. If you refer to the presentation, a breakdown of the commercial portfolio by major industries is available for your review.

Aurelio Aleman, CEO

Okay. You have a second part of your question, Ebrahim. If I understand correctly, you want me to comment on how this compares to our processes during Maria.

Ebrahim Poonawala, Analyst

Yeah. And if you could just speak to the significance of the stimulus for Puerto Rico coming from both federal and local levels. How significant is that in terms of bridging this time period of the lockdown?

Aurelio Aleman, CEO

So, to compare this with Maria, the provision we had back then was about $70 million, and we based our expectations on recovery curves for different industries. With the prior storms, we had clearer predictions for reopening because they were based on damage assessments regarding the recovery of infrastructure, such as the electrical grid. In contrast, we faced more uncertainty this time around, and we initially didn't have the moratoriums in place for around a month. However, by March 16, we were able to implement programs in response as regulatory guidance emerged. The CARES Act has additionally provided additional flexibility on troubled debt restructurings. Therefore, we have many more tools today than previously available. We believe the incoming government stimulus and support for individuals and businesses will significantly impact. However, we should also be mindful that during the hurricane we had payouts from insurance companies, which is not a factor we see now. Overall, we need to assess the second quarter closely, working with clients to ensure they receive support as we adapt to reopening curves as they evolve.

Ebrahim Poonawala, Analyst

Very helpful. Thanks for taking my questions.

Operator, Operator

Thank you. We have next question from the line of Glen Manna from Keefe, Bruyette & Woods. Please go ahead.

Glen Manna, Analyst

So I just had a question on the Santander acquisition. There was some language in the press release that suggested it was unlikely to close by the middle of 2Q '20. Could you describe the process right now, given the quarantines? Would you say the project is stalled, or just moving forward at a slower pace?

Aurelio Aleman, CEO

Sure. Our statement is fairly clear about the transaction's status. The pandemic has impacted our timelines. While people continue to work, the pace has slowed. We had initially projected a mid-2020 closing. However, it appears less likely at this stage. Regarding your second question, yes, the agreement provides a 90-day extension option. It includes various provisions related to pricing, NPAs, and other closing dates, which I will not delve into during this call.

Glen Manna, Analyst

Okay. Thank you. Orlando, when we last spoke, I think you mentioned that net NII trends were tracking the simulations provided in your K. Is that still the case?

Orlando Berges, CFO

Yes. Some of that has already happened. Keep in mind that our prior K was based on December 31 metrics. While some trends are relevant, closure timing and reopening impact new loan originations significantly.

Glen Manna, Analyst

Okay. And just lastly, looking back to the last crisis, what has been done to eliminate some of the soft spots in the portfolio that may have hurt us during that crisis? How have you strengthened the portfolio for the future?

Aurelio Aleman, CEO

We've improved our risk profile and quality substantially since then. Not only in terms of reserves and capital, but also with a better diversification of our portfolio across different regions and lines of business. Our construction portfolio is much more moderate now, and we have fewer bulky relationships, contributing to a stronger risk profile than prior years. If you compare the end of 2019 asset quality metrics with earlier periods, you'll see much lower delinquency levels.

Orlando Berges, CFO

Additionally, remember that back in 2008, the crisis triggered significantly high market rates that directly influenced loan-to-values. We've adjusted origination policies accordingly since then, and currently, the loan-to-values are much more favorable compared to the prior crises.

Operator, Operator

Thank you. We have a question from the line of Alex Twerdahl from Piper Sandler. Please go ahead.

Alex Twerdahl, Analyst

Regarding the Santander transaction, if I recall correctly, you mentioned that you're not acquiring any NPLs. Can you help us put into context what's happening today with loan modifications and whether their policies are similar to yours regarding who receives modifications?

Aurelio Aleman, CEO

We're still early in this process. There are many aspects to consider. Our focus remains on the current opportunities we have at hand today.

Orlando Berges, CFO

The agreement specifies that they must follow their established policies, and any deviations must be reviewed. We’re treating this the same way as any other normal business interactions. Moratoriums pose challenges that we must navigate at this point.

Alex Twerdahl, Analyst

Okay. But drawing from experiences with them post-Hurricane Maria, do you have a sense of their criteria? Should we expect policy consistency?

Orlando Berges, CFO

Yes.

Alex Twerdahl, Analyst

On the CECL reserve, can you explain if unemployment is a more significant input compared to GDP in Puerto Rico? If so, what would lead to different outcomes for the provision in the second quarter?

Orlando Berges, CFO

Correct, unemployment is a critical variable in Puerto Rico. Each portfolio reacts to different variables, with unemployment and housing price index being the main ones. We are monitoring them closely. The CECL framework allows for changes in estimations based on economic conditions, meaning that varying scenarios could present different projected losses. For the second quarter, it will ultimately depend on the economic context.

Alex Twerdahl, Analyst

Okay, that's helpful. Could you help us think through the loan balances, especially since origination is essentially halted in Puerto Rico for the last month and a half? What is the pace of amortization in the portfolio?

Aurelio Aleman, CEO

Certainly. There are both positive and negative aspects. We need to factor in the level of moratoriums, which we believe will mitigate retail contraction as it currently stands at close to 40% of the portfolio. Florida continues to see loan activity, although at lower levels. The PPP program initially had low yield loans but has now surpassed $320 million. As we gradually reopen, we expect to refresh activity levels, particularly in the mortgage and commercial sectors.

Alex Twerdahl, Analyst

Can you break down the weighted average fee associated with the PPP loans based on their sizes?

Aurelio Aleman, CEO

We don't have that data available right now, but we will update the investor deck in due time. We are still processing applications initially favored by more sophisticated borrowers, while we’re now observing smaller businesses also seeking assistance. Hopefully, funds continue to flow, and our average loan size is fairly granular at 63% below $50,000.

Orlando Berges, CFO

Yes, the estimated fee is important, as are the anticipated loan lives. The loan with no interest during the first six months poses challenges, as this factor influences our yields on loans and how they will be represented over the years.

Aurelio Aleman, CEO

The expectation is high for forgiveness regarding this loan program. We estimate that between 60% to 80% will be forgiven, while determining the terms for those remaining loans is a process yet to finalize.

Alex Twerdahl, Analyst

Thanks for taking my questions.

Operator, Operator

Thank you, sir. This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. John Pelling for any closing remarks. Over to you, John.

John Pelling, Investor Relations Officer

Thank you, Vikram. On the investor front, we are scheduled to attend the Deutsche Bank Conference on May 26th, and Sandler will host our Investor Tour in Puerto Rico on June 11. We will be conducting both sessions telephonically. We want to thank you for your continued support and look forward to seeing all of you again when the markets reopen. At this point, we will conclude our call. Thank you.

Operator, Operator

Thank you, sir. The conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.