UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2017
or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
For the transition period from ______________ to ______________
Commission File Number 001-12647
OFG Bancorp
Incorporated in the Commonwealth of Puerto Rico, IRS Employer Identification No. 66-0538893
Principal Executive Offices:
254 Muñoz Rivera Avenue
San Juan, Puerto Rico 00918
Telephone Number: (787) 771-6800
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☐ Accelerated Filer ý Non-Accelerated Filer ☐ Smaller Reporting Company ☐ (Do not check if a smaller reporting company)
Emerging Growth Company ☐
If an Emerging Growth Company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x
Number of shares outstanding of the registrant’s common stock, as of the latest practicable date:
43,947,442 common shares ($1.00 par value per share) outstanding as of July 31, 2017
TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
Page
Item 1.
Financial Statements
Unaudited Consolidated Statements of Financial Condition
1
Unaudited Consolidated Statements of Operations
3
Unaudited Consolidated Statements of Comprehensive Income
5
Unaudited Consolidated Statements of Changes in Stockholders’ Equity
6
Unaudited Consolidated Statements of Cash Flows
7
Notes to Unaudited Consolidated Financial Statements
Note 1 – Organization, Consolidation and Basis of Presentation
10
Note 2 – Restricted Cash
12
Note 3 – Investment Securities
13
Note 4 – Loans
21
Note 5 – Allowance for Loan and Lease Losses
51
Note 6 – FDIC Indemnification Asset and True-Up Payment Obligation
61
Note 7 – Derivatives
62
Note 8 – Accrued Interest Receivable and Other Assets
64
Note 9 – Deposits and Related Interest
65
Note 10 – Borrowings and Related Interest
66
Note 11 – Offsetting of Financial Assets and Liabilities
69
Note 12 – Income Taxes
71
Note 13 – Regulatory Capital Requirements
72
Note 14 – Stockholders’ Equity
74
Note 15 – Accumulated Other Comprehensive Income
75
Note 16 – Earnings per Common Share
78
Note 17 – Guarantees
79
Note 18 – Commitments and Contingencies
80
Note 19 – Fair Value of Financial Instruments
82
Note 20 – Business Segments
90
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
93
Critical Accounting Policies and Estimates
Overview of Financial Performance:
Selected Financial Data
94
Financial Highlights of the Second Quarter of 2017
96
Analysis of Results of Operations
Analysis of Financial Condition
114
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
143
Item 4.
Controls and Procedures
147
PART II – OTHER INFORMATION
Legal Proceedings
148
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Default upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
149
SIGNATURES
150
EXHIBIT INDEX
FORWARD-LOOKING STATEMENTS
The information included in this quarterly report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements may relate to the financial condition, results of operations, plans, objectives, future performance and business of OFG Bancorp (“we,” “our,” “us” or the “Company”), including, but not limited to, statements with respect to the adequacy of the allowance for loan losses, delinquency trends, market risk and the impact of interest rate changes, capital markets conditions, capital adequacy and liquidity, and the effect of legal proceedings and new accounting standards on the Company’s financial condition and results of operations. All statements contained herein that are not clearly historical in nature are forward-looking, and the words “anticipate,” “believe,” “continues,” “expect,” “estimate,” “intend,” “project” and similar expressions and future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may,” or similar expressions are generally intended to identify forward-looking statements.
These statements are not guarantees of future performance and involve certain risks, uncertainties, estimates and assumptions by management that are difficult to predict. Various factors, some of which by their nature are beyond the Company’s control, could cause actual results to differ materially from those expressed in, or implied by, such forward-looking statements. Factors that might cause such a difference include, but are not limited to:
· additional credit defaults or a restructuring by the Commonwealth of Puerto Rico or any of its agencies, municipalities or instrumentalities;
· possible legislative, tax or regulatory changes;
· the rate of growth in the economy and employment levels, as well as general business and economic conditions;
· the relative strength or weakness of the consumer and commercial credit sectors and of the real estate market in
Puerto Rico;
· competition in the financial services industry;
· the fiscal and monetary policies of the federal government and its agencies;
· changes in interest rates, as well as the magnitude of such changes;
· changes in federal bank regulatory and supervisory policies, including required levels of capital;
· the impact of the industry regulations on the Company’s businesses, business practices and cost of operations;
· the performance of the securities markets; and
· additional Federal Deposit Insurance Corporation (“FDIC”) assessments.
Other possible events or factors that could cause results or performance to differ materially from those expressed in these forward-looking statements include the following: negative economic conditions that adversely affect the general economy, housing prices, the job market, consumer confidence and spending habits which may affect, among other things, the level of non-performing assets, charge-offs and provision expense; changes in interest rates and market liquidity which may reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets; adverse movements and volatility in debt and equity capital markets; changes in market rates and prices which may adversely impact the value of financial assets and liabilities; liabilities resulting from litigation and regulatory investigations; changes in accounting standards, rules and interpretations; increased competition; the Company’s ability to grow its core businesses; decisions to downsize, sell or close units or otherwise change the Company’s business mix; and management’s ability to identify and manage these and other risks.
All forward-looking statements included in this quarterly report on Form 10-Q are based upon information available to the Company as of the date of this report, and other than as required by law, including the requirements of applicable securities laws, the Company assumes no obligation to update or revise any such forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.
ITEM 1. FINANCIAL STATEMENTS
OFG BANCORP
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF JUNE 30, 2017 AND DECEMBER 31, 2016
June 30,
December 31,
2017
2016
(In thousands)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
470,841
504,833
Money market investments
6,467
5,606
Total cash and cash equivalents
477,308
510,439
Restricted cash
3,030
Investments:
Trading securities, at fair value, with amortized cost of $667 (December 31, 2016 - $667)
294
347
Investment securities available-for-sale, at fair value, with amortized cost of $649,280 (December 31, 2016 - $749,867)
649,327
751,484
Investment securities held-to-maturity, at amortized cost, with fair value of $549,595 (December 31, 2016 - $592,763)
555,407
599,884
Federal Home Loan Bank (FHLB) stock, at cost
16,616
10,793
Other investments
Total investments
1,221,647
1,362,511
Loans:
Loans held-for-sale, at lower of cost or fair value
47,691
12,499
Loans held for investment, net of allowance for loan and lease losses of $132,295 (December 31, 2016 - $115,937)
4,044,175
4,135,193
Total loans
4,091,866
4,147,692
Other assets:
FDIC indemnification asset
-
14,411
Foreclosed real estate
50,223
47,520
Accrued interest receivable
19,798
20,227
Deferred tax asset, net
116,199
124,200
Premises and equipment, net
69,836
70,407
Customers' liability on acceptances
22,739
23,765
Servicing assets
9,866
9,858
Derivative assets
957
1,330
Goodwill
86,069
Other assets
66,288
80,365
Total assets
6,235,826
6,501,824
See notes to unaudited financial statements
AS OF JUNE 30, 2017 AND DECEMBER 31, 2016 (CONTINUED)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits
1,844,996
1,939,764
Savings accounts
1,169,002
1,196,232
Time deposits
1,568,688
1,528,491
Total deposits
4,582,686
4,664,487
Borrowings:
Securities sold under agreements to repurchase
453,492
653,756
Advances from FHLB
137,540
105,454
Subordinated capital notes
36,083
Other borrowings
177
Total borrowings
627,292
795,354
Other liabilities:
Derivative liabilities
1,881
2,437
Acceptances executed and outstanding
Accrued expenses and other liabilities
62,259
95,370
Total liabilities
5,296,857
5,581,413
Commitments and contingencies (See Note 18)
Stockholders’ equity:
Preferred stock; 10,000,000 shares authorized;
1,340,000 shares of Series A, 1,380,000 shares of Series B, and 960,000
shares of Series D issued and outstanding,
December 31, 2016 - 1,340,000 shares; 1,380,000 shares; and 960,000
shares) $25 liquidation value
92,000
84,000 shares of Series C issued and outstanding (December 31, 2016 -
84,000 shares); $1,000 liquidation value
84,000
Common stock, $1 par value; 100,000,000 shares authorized; 52,625,869 shares
issued: 43,947,442 shares outstanding (December 31, 2016 - 52,625,869;
43,914,844)
52,626
Additional paid-in capital
541,005
540,948
Legal surplus
79,460
76,293
Retained earnings
194,687
177,808
Treasury stock, at cost, 8,678,427 shares (December 31, 2016 - 8,711,025
shares)
(104,502)
(104,860)
Accumulated other comprehensive (loss) income, net of tax of $569
(December 31, 2016 $983)
(307)
1,596
Total stockholders’ equity
938,969
920,411
Total liabilities and stockholders’ equity
2
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016
Quarter Ended June 30,
Six-Month Period Ended June 30,
(In thousands, except per share data)
Interest income:
Loans
77,238
79,675
154,888
160,827
Mortgage-backed securities
7,276
7,220
14,482
16,217
Investment securities and other
1,426
1,013
2,748
2,170
Total interest income
85,940
87,908
172,118
179,214
Interest expense:
Deposits
7,652
7,367
15,005
14,491
1,734
4,258
4,979
10,358
Advances from FHLB and other borrowings
607
2,098
1,202
4,337
384
873
751
1,741
Total interest expense
10,377
14,596
21,937
30,927
Net interest income
75,563
73,312
150,181
148,287
Provision for loan and lease losses, net
26,536
14,445
44,190
28,234
Net interest income after provision for loan and lease losses
49,027
58,867
105,991
120,053
Non-interest income:
Banking service revenue
10,458
10,219
21,084
20,337
Wealth management revenue
6,516
7,041
12,731
13,193
Mortgage banking activities
959
1,024
1,546
1,879
Total banking and financial service revenues
17,933
18,284
35,361
35,409
FDIC shared-loss benefit (expense), net
(3,420)
1,403
(7,449)
Net gain (loss) on:
Sale of securities
6,891
211
12,207
Derivatives
22
(10)
103
(13)
Early extinguishment of debt
(80)
(12,000)
Other non-interest income
120
282
504
Total non-interest income, net
24,886
15,155
43,960
28,658
FOR THE QUARTERS AND SIX-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016 (CONTINUED)
Non-interest expense:
Compensation and employee benefits
19,317
18,441
39,664
38,696
Professional and service fees
3,225
2,810
6,462
5,795
Occupancy and equipment
8,690
8,107
16,057
15,929
Insurance
1,183
3,155
2,783
6,305
Electronic banking charges
5,450
4,947
10,352
10,536
Information technology expenses
2,069
1,606
4,068
3,262
Advertising, business promotion, and strategic initiatives
1,361
1,294
2,722
2,588
Loss on sale of foreclosed real estate and other repossessed assets
1,787
4,163
3,113
6,094
Loan servicing and clearing expenses
1,270
1,966
2,459
4,096
Taxes, other than payroll and income taxes
2,393
2,330
4,764
5,001
Communication
761
581
1,506
1,400
Printing, postage, stationary and supplies
665
600
1,303
1,325
Director and investor relations
274
301
554
579
Credit related expenses
2,217
2,203
4,843
4,458
Other
2,154
1,321
3,850
2,618
Total non-interest expense
52,816
53,825
104,500
108,682
Income before income taxes
21,097
20,197
45,451
40,029
Income tax expense
3,993
5,858
13,197
11,519
Net income
17,104
14,339
32,254
28,510
Less: dividends on preferred stock
(3,466)
(6,931)
Income available to common shareholders
13,638
10,873
25,323
21,579
Earnings per common share:
Basic
0.30
0.25
0.58
0.49
Diluted
0.57
Average common shares outstanding and equivalents
51,100
51,095
51,093
51,081
Cash dividends per share of common stock
0.06
0.12
See notes to unaudited consolidated financial statements
4
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive (loss) income before tax:
Unrealized gain on securities available-for-sale
3,454
3,719
5,319
12,364
Realized gain on investment securities included in net income
(6,891)
(211)
(12,207)
Unrealized (loss) gain on cash flow hedges
(102)
663
81
652
Other comprehensive (loss) income before taxes
(3,539)
4,171
(1,491)
809
Income tax effect
(116)
(650)
(412)
999
Other comprehensive (loss) income after taxes
(3,655)
3,521
(1,903)
1,808
Comprehensive income
13,449
17,860
30,351
30,318
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS’ EQUITY
Preferred stock:
Balance at beginning of period
176,000
Balance at end of period
Common stock:
Additional paid-in capital:
540,512
Stock-based compensation expense
515
698
Stock-based compensation excess tax benefit recognized in income
(100)
Lapsed restricted stock units
(358)
(505)
540,705
Legal surplus:
70,435
Transfer from retained earnings
3,167
2,830
73,265
Retained earnings:
148,886
Cash dividends declared on common stock
(5,277)
(5,272)
Cash dividends declared on preferred stock
Transfer to legal surplus
(3,167)
(2,830)
162,363
Treasury stock:
(105,379)
358
505
(104,874)
Accumulated other comprehensive (loss) income, net of tax:
13,997
Other comprehensive (loss) income, net of tax
15,805
915,890
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of deferred loan origination fees, net of costs
1,455
1,977
Amortization of fair value premiums, net of discounts, on acquired loans
39
Amortization of investment securities premiums, net of accretion of discounts
4,362
4,356
Amortization of core deposit and customer relationship intangibles
737
839
Amortization of fair value premiums on acquired deposits
189
FDIC shared-loss (benefit) expense, net
(1,403)
7,449
Depreciation and amortization of premises and equipment
4,231
5,025
Deferred income tax expense, net
7,570
3,543
Stock-based compensation
(Gain) loss on:
Sale of mortgage loans held-for-sale
(517)
(809)
(103)
88
12,000
3,453
7,287
Sale of other repossessed assets
(153)
(1,235)
Sale of premises and equipment
Originations of loans held-for-sale
(74,806)
(90,052)
Proceeds from sale of mortgage loans held-for-sale
24,020
32,212
Net (increase) decrease in:
Trading securities
53
(60)
429
628
(8)
(477)
12,493
(4,872)
Net increase (decrease) in:
Accrued interest on deposits and borrowings
(370)
(373)
(45,858)
8,253
Net cash provided by operating activities
5,635
31,255
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016 (CONTINUED)
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale
(114,595)
(302)
Investment securities held-to-maturity
(51,717)
FHLB stock
(26,730)
(8,512)
Maturities and redemptions of:
57,714
74,208
41,920
34,304
20,907
9,457
Proceeds from sales of:
212,203
300,483
Foreclosed real estate and other repossessed assets, including write-offs
21,754
25,779
Proceeds from sale of loans held-for-sale
478
Premises and equipment
44
Origination and purchase of loans, excluding loans held-for-sale
(384,211)
(373,927)
Principal repayment of loans, including covered loans
367,834
386,477
(Repayments to) reimbursements from the FDIC on shared-loss agreements, net
(10,125)
738
Additions to premises and equipment
(3,660)
(3,077)
Net change in restricted cash
319
Net cash provided by investing activities
183,011
394,752
8
FOR THE SIX-MONTH PERIODS ENDED JUNE 30, 2017 AND 2016 – (CONTINUED)
Cash flows from financing activities:
(41,900)
(87,864)
(199,466)
(320,000)
FHLB advances, federal funds purchased, and other borrowings
32,194
(25,951)
350
Dividends paid on preferred stock
Dividends paid on common stock
(5,674)
Net cash used in financing activities
(221,777)
(445,668)
Net change in cash and cash equivalents
(33,131)
(19,661)
Cash and cash equivalents at beginning of period
536,709
Cash and cash equivalents at end of period
517,048
Supplemental Cash Flow Disclosure and Schedule of Non-cash Activities:
Interest paid
21,386
30,454
Income taxes paid
15
3,642
Mortgage loans securitized into mortgage-backed securities
49,648
53,872
Transfer from loans to foreclosed real estate and other repossessed assets
28,293
21,865
Reclassification of loans held-for-investment portfolio to held-for-sale portfolio
33,647
Reclassification of loans held-for-sale portfolio to held-for-investment portfolio
112
182
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION, CONSOLIDATION AND BASIS OF PRESENTATION
Nature of Operations
OFG Bancorp (the “Company”) is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. The Company operates through various subsidiaries including, a commercial bank, Oriental Bank (the “Bank”), a securities broker-dealer, Oriental Financial Services Corp. (“Oriental Financial Services”), an insurance agency, Oriental Insurance, LLC. (“Oriental Insurance”) and a retirement plan administrator, Oriental Pension Consultants, Inc. (“OPC”). Through these subsidiaries and their respective divisions, the Company provides a wide range of banking and financial services such as commercial, consumer and mortgage lending, auto loans, financial planning, insurance sales, money management and investment banking and brokerage services, as well as corporate and individual trust services.
On April 30, 2010, the Bank acquired certain assets and assumed certain deposits and other liabilities of Eurobank, a Puerto Rico commercial bank, in an FDIC-assisted acquisition. On February 6, 2017, the Bank and the FDIC agreed to terminate the shared-loss agreements related to the Eurobank Acquisition. On December 18, 2012, the Company acquired a group of Puerto Rico-based entities that included Banco Bilbao Vizcaya Argentaria Puerto Rico (“BBVAPR”), a Puerto Rico commercial bank, as well as a securities broker-dealer and an insurance agency, which is referred to herein as the “BBVAPR Acquisition.” The businesses acquired in these acquisitions have been integrated with the Company’s existing business.
Recent Accounting Developments
Scope of Modification Accounting. In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-09 that clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. Entities will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. ASU No. 2017-08 is effective for fiscal years, and interim periods, beginning after December 15, 2018, with early adoption permitted. The Company's Omnibus Plan provides for equity-based compensation incentives through the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, and dividend equivalents, as well as equity-based performance awards. If any change occurs in the future to the Omnibus Plan, the Company will evaluate it under this guideline.
Premium Amortization on Purchased Callable Debt Securities Receivables. In March 2017, the FASB issued ASU No. 2017-08, which requires the amortization of the premium on callable debt securities to the earliest call date. The amortization period for callable debt securities purchased at a discount would not be impacted by the ASU. This ASU will be applied prospectively for annual and interim periods in fiscal years beginning after December 15, 2018. The ASU is not expected to have a material impact on the Company's consolidated financial position or results of operations. At June 30, 2017, the Company does not have callable debt securities.
Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): Employee Benefit Plan Master Trust Reporting (a consensus of the Emerging Issues Task Force). In February 2017, the FASB issued ASU No. 2017-06, which intended to reduce diversity and improve the usefulness of information provided by employee benefit plans that hold interests in master trusts. This ASU will be applied prospectively for annual and interim periods in fiscal years beginning after December 15, 2018. The ASU is not expected to have a material impact on the Company's consolidated financial position or results of operations.
Simplifying the Test for Goodwill Impairment. In January 2017, the FASB issued ASU No. 2017-04, which simplifies the measurement of goodwill impairment. An entity will no longer perform a hypothetical purchase price allocation to measure goodwill impairment. Instead, impairment will be measured using the difference between the carrying amount and the fair value of the reporting unit. This ASU will be applied prospectively for annual and interim periods in fiscal years beginning after December 15, 2019. We are currently assessing the impact that the adoption of ASU 2017-04 will have on our consolidated financial statements and related disclosures.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Restricted Cash. In November 2016, the FASB issued ASU No. 2016-18, which amends Topic 230 (Statement of Cash Flows) and requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. ASU No. 2016-18 is intended to reduce diversity in practice in how restricted cash or restricted cash equivalents are presented and classified in the statement of cash flows. ASU No. 2016-18 is effective for fiscal years, and interim periods, beginning after December 15, 2017, with early adoption permitted. The standard requires application using a retrospective transition method. The adoption of ASU No. 2016-18 will change the presentation and classification of restricted cash and restricted cash equivalents in our consolidated statements of cash flows.
Measurement of Credit Losses on Financial Instruments. In June 2016, the FASB issued ASU No. 2016-13, which includes an impairment model (known as the current expected credit loss (CECL) model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses. ASU No. 2016-13 is effective for fiscal years, and interim periods, beginning after December 15, 2019. While we continue to assess the impact of ASU No. 2016-13, we have developed a roadmap with time schedules in place from 2016 to implementation date. The Company is in the process of assessing the methodology and the software to be used.
Leases. In February 2016, the FASB issued ASU No. 2016-02, which requires lessees to recognize a right-of-use asset and related lease liability for leases classified as operating leases at the commencement date that have lease terms of more than 12 months. This ASU retains the classification distinction between finance leases and operating leases. ASU No. 2016-02 is effective for fiscal years, and interim periods, beginning after December 15, 2018. We are currently assessing the impact the adoption of ASU 2016-02 will have on our consolidated financial statements and related disclosures.
Revenue from Contracts with Customers. In May 2014, the FASB issued ASU No. 2014-09, which supersedes the revenue recognition requirements Topic 605 (Revenue Recognition), and most industry-specific guidance. ASU No. 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU No. 2014-09 permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (modified retrospective method). In August 2015, the FASB issued ASU No. 2015-14 to defer the effective date of ASU No. 2014-09 by one year to fiscal years beginning after December 15, 2017. ASU No. 2015-14 also permits early adoption of ASU No. 2014-09, but not before the original effective date, which was for fiscal years beginning after December 15, 2016. While the new guidance does not apply to revenue associated with loans or securities, the Company has been working to identify the customer contracts within the scope of the new guidance and assess the related revenues to determine if any accounting or internal control changes will be required for the new provisions. While the assessment is not complete, the timing of the Company’s revenue recognition is not expected to materially change. Overall, the Company does not expect the new guidance to have a material impact on its consolidated financial position or results of operations. The next phase of the Company’s implementation work will be to evaluate required disclosures to be in compliance with the standard.
Other than the accounting pronouncements disclosed above, there are no other new accounting pronouncements issued during the first quarter of 2017 that could have a material impact on the Company's financial position, operating results or financial statements disclosures.
11
NOTE 2 – RESTRICTED CASH
The following table includes the composition of the Company’s restricted cash:
Cash pledged as collateral to other financial institutions to secure:
1,980
Obligations under agreement of loans sold with recourse
1,050
At June 30, 2017, the Bank’s international banking entities, Oriental International Bank Inc. (“OIB”) and Oriental Overseas, a division of the Bank, held an unencumbered certificate of deposit and other short-term highly liquid securities in the amount of $300 thousand and $325 thousand, respectively, as the legal reserve required for international banking entities under Puerto Rico law. At December 31, 2016, they held an unencumbered certificate of deposit and other short-term highly liquid securities in the amount of $300 thousand as the required legal reserve. The certificate of deposit and other securities cannot be withdrawn or sold by OIB or Oriental Overseas without prior written approval of the Office of the Commissioner of Financial Institutions ("OCFI").
As part of its derivative activities, the Company has entered into collateral agreements with certain financial counterparties. At both June 30, 2017 and December 31, 2016, the Company had delivered approximately $2.0 million of cash as collateral for such derivatives activities.
As part of the BBVA Acquisition, the Company assumed a contract with FNMA which required collateral to guarantee the repurchase, if necessary, of loans sold with recourse. At both June 30, 2017 and December 31, 2016, the Company delivered as collateral cash amounting to approximately $1.1 million.
The Bank is required by Puerto Rico law to maintain average weekly reserve balances to cover demand deposits. The amount of those minimum average reserve balances for the week that covered June 30, 2017 was $163.2 million (December 31, 2016 - $161.0 million). At June 30, 2017 and December 31, 2016, the Bank complied with the requirement. Cash and due from bank as well as other short-term, highly liquid securities are used to cover the required average reserve balances.
NOTE 3 – INVESTMENT SECURITIES
Money Market Investments
The Company considers as cash equivalents all money market instruments that are not pledged and that have maturities of three months or less at the date of acquisition. At June 30, 2017 and December 31, 2016, money market instruments included as part of cash and cash equivalents amounted to $6.5 million and $5.6 million, respectively.
Investment Securities
The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the securities owned by the Company at June 30, 2017 and December 31, 2016 were as follows:
June 30, 2017
Gross
Weighted
Amortized
Unrealized
Fair
Average
Cost
Gains
Losses
Value
Yield
Available-for-sale
FNMA and FHLMC certificates
346,388
2,102
1,797
346,693
2.35%
GNMA certificates
145,538
1,633
487
146,684
2.93%
CMOs issued by US government-sponsored agencies
92,622
1,078
91,554
1.89%
Total mortgage-backed securities
584,548
3,745
3,362
584,931
2.42%
Investment securities
US Treasury securities
55,031
54,990
1.13%
Obligations of US government-sponsored agencies
3,353
27
3,326
1.38%
Obligations of Puerto Rico government and
public instrumentalities
4,680
339
4,341
5.55%
Other debt securities
1,668
1,739
3.00%
Total investment securities
64,732
410
64,396
1.51%
Total securities available for sale
649,280
3,819
3,772
2.33%
Held-to-maturity
212
6,024
549,595
2.11%
14
December 31, 2016
422,168
6,354
3,036
425,486
2.59%
163,614
2,241
620
165,235
2.95%
103,990
2,223
101,831
1.88%
689,772
8,659
5,879
692,552
2.57%
49,672
618
49,054
1.73%
3,903
19
3,884
4,073
1,840
1,921
60,095
1,244
58,932
2.04%
Total securities available-for-sale
749,867
8,740
7,123
2.53%
145
7,266
592,763
2.15%
The amortized cost and fair value of the Company’s investment securities at June 30, 2017, by contractual maturity, are shown in the next table. Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Cost
Fair Value
Due from 1 to 5 years
8,102
8,185
Total due from 1 to 5 years
Due after 5 to 10 years
70,850
70,047
69,364
69,403
Total due after 5 to 10 years
140,214
139,450
Due after 10 years
268,922
269,105
21,772
21,507
Total due after 10 years
436,232
437,296
Due less than one year
45,092
45,095
Total due in less than one year
9,939
9,895
Obligations of US government and sponsored agencies
17,972
17,562
Due from 5 to 10 years
Total
16
During the six-month period ended June 30, 2017 the Company retained securitized GNMA pools totaling $49.8 million amortized cost, at a yield of 3.15% from its own originations while during the six-month period ended June 30, 2016 that amount totaled $54.2 million, amortized cost, at a yield of 3.01%.
During the six-month period ended June 30, 2017, the Company sold $166.0 million of mortgage-backed securities and $39.3 million of US Treasury securities, and recorded a net gain on sale of securities of $6.9 million. During the six-month period ended June 30, 2016, the Company sold $277.2 million on mortgage-backed securities and $11.1 million of Puerto Rico government bonds, and recorded a net gain on sale of securities of $12.2 million.
Six-Month Period Ended June 30, 2017
Book Value
Description
Sale Price
at Sale
Gross Gains
Gross Losses
Sale of securities available-for-sale
107,510
102,311
5,199
65,284
63,704
1,580
39,409
39,297
205,312
Six-Month Period Ended June 30, 2016
293,505
277,181
16,324
Obligations of PR government and public instrumentalities
6,978
11,095
4,117
288,276
The following tables show the Company’s gross unrealized losses and fair value of investment securities available-for-sale and held-to-maturity, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position at June 30, 2017 and December 31, 2016:
17
12 months or more
Loss
Securities available-for-sale
30,309
342
29,967
Obligations of Puerto Rico government and public instrumentalities
38,342
708
37,634
Securities held to maturity
6,753
164
6,589
Less than 12 months
61,115
736
60,379
164,473
162,676
30,437
29,950
US Treausury Securities
10,263
266,288
3,064
263,224
Securities held-to-maturity
FNMA and FHLMC Certificates
471,100
5,860
465,240
91,424
90,346
304,630
300,858
477,853
471,829
18
33,883
793
33,090
38,563
37,163
67,777
1,430
66,347
184,782
181,746
29,445
28,825
49,172
48,554
335,079
5,723
329,356
525,258
517,992
101,660
99,437
373,642
366,519
The Company performs valuations of the investment securities on a monthly basis. Moreover, the Company conducts quarterly reviews to identify and evaluate each investment in an unrealized loss position for other-than-temporary impairment. Any portion of a decline in value associated with credit loss is recognized in the statements of operations with the remaining noncredit-related component recognized in other comprehensive income (loss). A credit loss is determined by assessing whether the amortized cost basis of the security will be recovered by comparing the present value of cash flows expected to be collected from the security, discounted at the rate equal to the yield used to accrete current and prospective beneficial interest for the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is considered to be the “credit loss.” Other-than-temporary impairment analysis is based on estimates that depend on market conditions and are subject to further change over time. In addition, while the Company believes that the methodology used to value these exposures is reasonable, the methodology is subject to continuing refinement, including those made as a result of market developments. Consequently, it is reasonably possible that changes in estimates or conditions could result in the need to recognize additional other-than-temporary impairment charges in the future.
Most of the investments ($777.8 million, amortized cost, or99.4%) with an unrealized loss position at June 30, 2017 consist of securities issued or guaranteed by the U.S. Treasury or U.S. government-sponsored agencies, all of which are highly liquid securities that have a large and efficient secondary market. Their aggregate losses and their variability from period to period are the result of changes in market conditions, and not due to the repayment capacity or creditworthiness of the issuers or guarantors of such securities.
The sole exposure to PR bond ($4.7 million, amortized cost, or0.6%) with an unrealized loss position at June 30, 2017 consists of an obligation issued by the Puerto Rico Highways and Transportation Authority ("PRHTA") secured by a pledge of toll revenues from the Teodoro Moscoso Bridge operated through a public-private partnership. The decline in the market value of this security is mainly attributed to the significant economic and fiscal challenges that Puerto Rico is facing, which is expected to result in a significant restructuring of the government under the supervision of a federally created Fiscal Oversight Board. All other Puerto Rico government securities were sold during the first quarter of 2016. The PRHTA bond had an aggregate fair value of $4.3 million at June 30, 2017 (93% of the bond's amortized cost) and matures on July 1, 2018. The discounted cash flow analysis for the investment showed a cumulative default probability at maturity of 6.4%, thus reflecting that it is more likely than not that the bond will not default during its remaining term. Based on this analysis, the Company determined that it is more likely than not that it will recover all interest and principal invested in this Puerto Rico government bond and is, therefore, not required to recognize a credit loss as of June 30, 2017. Also, the Company’s conclusion is based on the assessment of the specific source of repayment of the outstanding bond, which continues to perform. PRHTA started principal repayments on July 1, 2014. All scheduled principal and interest payments to date have been collected. On July 1, 2017, the Company received a scheduled principal payment of $2.2 million. As a result of the aforementioned analysis, no other-than-temporary losses were recorded during the period ended June 30, 2017.
As of June 30, 2017, the Company performed a cash flow analysis of its Puerto Rico government bond to calculate the cash flows expected to be collected and determine if any portion of the decline in market value of this investment was considered an other-than-temporary impairment. The analysis derives an estimate of value based on the present value of risk-adjusted future cash flows of the underlying investment, and included the following components:
· The contractual future cash flows of the bond are projected based on the key terms as set forth in the official statements for the investment. Such key terms include among others the interest rate, amortization schedule, if any, and maturity date.
· The risk-adjusted cash flows are calculated based on a monthly default probability and recovery rate assumptions based on the credit rating of the investment. Constant monthly default rates are assumed throughout the life of the bond which is based on the respective security’s credit rating as of the date of the analysis.
· The adjusted future cash flows are then discounted at the original effective yield of the investment based on the purchase price and expected risk-adjusted future cash flows as of the purchase date of the investment.
The following table presents a rollforward of credit-related impairment losses recognized in earnings for the six-month periods ended June 30, 2017 and 2016 on available-for-sale securities:
1,490
Reductions for securities sold during the period (realized)
(1,490)
20
NOTE 4 -LOANS
The Company’s loan portfolio is composed of two segments, loans initially accounted for under the amortized cost method (referred to as "originated and other" loans) and loans acquired (referred to as "acquired" loans). Acquired loans are further segregated between acquired BBVAPR loans and acquired Eurobank loans. Acquired Eurobank loans were purchased subject to loss-sharing agreements with the FDIC, which were terminated on February 6, 2017.
The composition of the Company’s loan portfolio at June 30, 2017 and December 31, 2016 was as follows:
Originated and other loans and leases held for investment:
Mortgage
699,290
721,494
Commercial
1,270,844
1,277,866
Consumer
314,267
290,515
Auto and leasing
807,204
756,395
3,091,605
3,046,270
Allowance for loan and lease losses on originated and other loans and leases
(69,666)
(59,300)
3,021,939
2,986,970
Deferred loan costs, net
6,574
5,766
Total originated and other loans loans held for investment, net
3,028,513
2,992,736
Acquired loans:
Acquired BBVAPR loans:
Accounted for under ASC 310-20 (Loans with revolving feature and/or
acquired at a premium)
5,350
5,562
30,233
32,862
Auto
33,661
53,026
69,244
91,450
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-20
(3,348)
(4,300)
65,896
87,150
Accounted for under ASC 310-30 (Loans acquired with deteriorated
credit quality, including those by analogy)
544,325
569,253
266,002
292,564
2,163
4,301
58,078
85,676
870,568
951,794
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-30
(37,494)
(31,056)
833,074
920,738
Total acquired BBVAPR loans, net
898,970
1,007,888
Acquired Eurobank loans:
Loans secured by 1-4 family residential properties
70,329
73,018
66,894
81,460
1,256
1,372
Total acquired Eurobank loans
138,479
155,850
Allowance for loan and lease losses on Eurobank loans
(21,787)
(21,281)
Total acquired Eurobank loans, net
116,692
134,569
Total acquired loans, net
1,015,662
1,142,457
Total held for investment, net
Mortgage loans held-for-sale
14,044
Other loans held-for-sale
Total loans, net
Originated and Other Loans and Leases Held for Investment
The Company’s originated and other loans held for investment are encompassed within four portfolio segments: mortgage, commercial, consumer, and auto and leasing.
The following tables present the aging of the recorded investment in gross originated and other loans held for investment at June 30, 2017 and December 31, 2016, by class of loans. Mortgage loans past due include delinquent loans in the GNMA buy-back option program. Servicers of loans underlying GNMA mortgage-backed securities must report as their own assets the defaulted loans that they have the option (but not the obligation) to repurchase, even when they elect not to exercise that option.
Loans 90+
Days Past
Current
Due and
30-59 Days
60-89 Days
90+ Days
Total Past
in Non-
Still
Past Due
Due
Accrual
Accruing
Total Loans
Traditional (by origination year):
Up to the year 2002
193
1,406
2,930
4,529
43,252
47,781
168
Years 2003 and 2004
333
3,162
6,319
9,814
299
76,028
86,141
Year 2005
106
2,247
3,500
5,853
284
39,796
45,933
Year 2006
262
1,641
5,882
7,785
185
56,871
64,841
Years 2007, 2008
and 2009
435
1,693
8,653
10,781
38
60,375
71,194
335
Years 2010, 2011, 2012, 2013
324
6,845
8,675
124,191
132,866
Years 2014, 2015, 2016 and 2017
184
1,380
1,564
115,824
117,388
1,653
11,839
35,509
49,001
806
516,337
566,144
667
Non-traditional
161
4,303
4,464
16,011
20,475
Loss mitigation program
11,348
7,291
13,806
32,445
2,921
67,744
103,110
1,217
13,001
19,291
53,618
85,910
3,727
600,092
689,729
1,884
Home equity secured personal loans
332
GNMA's buy-back option program
9,229
62,847
95,139
600,424
Commercial secured by real estate:
Corporate
226,979
Institutional
254
46,806
47,060
Middle market
3,601
634
224,571
228,806
Retail
1,350
1,242
8,301
10,893
4,496
230,863
246,252
Floor plan
2,916
Real estate
15,783
12,156
14,748
5,130
747,918
767,796
Other commercial and industrial:
161,839
128,479
881
1,227
84,158
86,266
327
848
1,300
2,475
695
85,673
88,843
37,568
37,621
1,208
1,353
3,409
1,922
497,717
503,048
2,558
2,090
13,509
18,157
7,052
1,245,635
23
24
Credit cards
442
288
636
1,366
26,308
27,674
Overdrafts
29
167
229
Personal lines of credit
59
2,188
2,276
Personal loans
2,693
1,752
1,096
5,541
699
262,728
268,968
Cash collateral personal loans
216
219
14,901
15,120
3,439
2,056
1,781
306,292
45,914
20,458
8,205
74,577
732,537
64,912
43,895
86,342
195,149
11,568
2,884,888
25
196
2,176
3,371
5,743
44,542
50,285
158
156
3,872
7,272
11,300
181
79,226
90,707
1,952
4,306
6,258
180
43,571
50,009
506
2,905
6,261
9,672
59,534
69,300
409
1,439
11,732
13,580
111
63,038
76,729
398
349
1,772
10,417
12,538
126
127,196
139,860
583
Years 2014, 2015 and 2016
47
123
1,357
1,527
106,672
108,199
1,663
14,239
44,716
60,618
692
523,779
585,089
1,139
498
4,730
5,228
17,631
22,859
8,911
7,205
16,541
32,657
3,599
67,272
103,528
1,724
10,574
21,942
65,987
98,503
4,291
608,682
711,476
2,863
337
9,681
75,668
108,184
609,019
242,770
26,546
26,800
60
3,319
3,379
1,304
230,298
234,981
154
6,594
7,098
4,638
237,992
249,728
2,989
16,395
10,167
10,731
5,942
756,990
773,663
136,438
180,285
1,278
80,355
81,633
930
100
969
1,999
71,412
73,705
32,073
32,142
938
1,030
2,068
1,572
500,563
504,203
1,092
510
11,197
12,799
7,514
1,257,553
26
527
283
525
1,335
25,023
26,358
33
174
207
41
32
77
2,327
2,404
2,474
1,489
1,081
5,044
259
240,969
246,272
240
264
15,010
15,274
3,298
1,647
283,503
42,714
19,014
8,173
69,901
686,313
57,678
43,274
96,685
197,637
12,245
2,836,388
At June 30, 2017 and December 31, 2016, the Company had carrying balance of $132.2 million and $136.6 million, respectively, in originated and other loans held for investment granted to the Puerto Rico government, including its instrumentalities, public corporations and municipalities as part of the institutional commercial loan segment. All originated and other loans granted to the Puerto Rico government are general obligations of municipalities secured by ad valorem taxation, without limitation as to rate or amount, on all taxable property within the issuing municipalities. The good faith, credit and unlimited taxing power of each issuing municipality are pledged for the payment of its general obligations. On June 30, 2017, the Company was opportunistic and entered into an agreement to sell a performing originated municipal loan, which was due in July 2018, for $28.8 million. The sale reduced near-term risk associated with a likely refinancing. The loan was moved to other loans held-for-sale at June 30, 2017 with a balance of $33.7 million, and included a principal payment of $4.8 million received by the Company in July 1, 2017. The sale transaction settled in July 5, 2017. In addition, on July 1, 2017, the Company received $3.7 million principal payments from the remaining municipal loans.
28
Acquired Loans
Acquired loans were initially measured at fair value and subsequently accounted for under either ASC 310-30 or ASC 310-20 (Non-refundable fees and Other Costs). We have acquired loans in two acquisitions, BBVAPR and Eurobank.
Acquired BBVAPR Loans
Accounted for under ASC 310-20 (Loans with revolving feature and/or acquired at a premium)
Credit cards, retail and commercial revolving lines of credits, floor plans and performing auto loans with FICO scores over 660 acquired at a premium are accounted for under the guidance of ASC 310-20, which requires that any contractually required loan payment receivable in excess of the Company’s initial investment in the loans be accreted into interest income on a level-yield basis over the life of the loan. Loans accounted for under ASC 310-20 are placed on non-accrual status when past due in accordance with the Company’s non-accrual policy, and any accretion of discount or amortization of premium is discontinued. Acquired BBVAPR loans that were accounted for under the provisions of ASC 310-20 are removed from the acquired loan category at the end of the reporting period upon refinancing, renewal or normal re-underwriting.
The following tables present the aging of the recorded investment in gross acquired BBVAPR loans accounted for under ASC 310-20 as of June 30, 2017 and December 31, 2016, by class of loans:
Commercial secured by real estate
98
1,148
2,107
1,057
1,085
2,233
Other commercial and industrial
50
45
127
2,988
3,115
129
3,117
1,104
1,214
4,136
676
203
489
1,368
26,206
27,574
133
190
2,469
2,659
213
536
1,558
28,675
2,435
1,231
325
3,991
29,670
3,322
1,476
1,965
6,763
62,481
110
929
2,390
329
362
2,533
97
34
121
252
2,775
3,027
3,029
130
452
616
4,017
369
1,813
28,280
30,093
48
2,587
2,769
784
383
828
1,995
30,867
3,652
1,355
517
5,524
47,487
4,566
8,135
944
82,371
Acquired BBVAPR Loans Accounted for under ASC 310-30 (including those accounted for under ASC 310-30 by analogy)
Acquired BBVAPR loans, except for credit cards, retail and commercial revolving lines of credits, floor plans and performing auto loans with FICO scores over 660 acquired at a premium, are accounted for by the Company in accordance with ASC 310-30.
The carrying amount corresponding to acquired BBVAPR loans with deteriorated credit quality, including those accounted under ASC 310-30 by analogy, in the statements of financial condition at June 30, 2017 and December 31, 2016 is as follows:
Contractual required payments receivable:
1,569,855
1,669,602
Less: Non-accretable discount
366,762
363,107
Cash expected to be collected
1,203,093
1,306,495
Less: Accretable yield
332,525
354,701
Carrying amount, gross
Less: allowance for loan and lease losses
37,494
31,056
Carrying amount, net
30
At June 30, 2017 and December 31, 2016, the Company had $66.6 million and $66.2 million, respectively, in loans granted to the Puerto Rico government, including its instrumentalities, public corporations and municipalities as part of its acquired BBVAPR loans accounted for under ASC 310-30. These loans are primarily secured municipal general obligations and a $10.6 million participation in a loan to the Puerto Rico Housing Finance Authority ("PRHFA") legally required to be repaid from abandoned or unclaimed funds at financial institutions that revert to the government under a Puerto Rico escheat law. Such loan defaulted on an annual principal payment in the third quarter of 2016. On July 1, 2017, the Company received $5.2 million principal payments from acquired BBVAPR loans to municipalities.
The following tables describe the accretable yield and non-accretable discount activity of acquired BBVAPR loans accounted for under ASC 310-30 for the quarters and six-month periods ended June 30, 2017, and 2016:
Quarter Ended June 30, 2017
Accretable Yield Activity:
276,817
46,902
6,583
3,058
333,360
Accretion
(7,694)
(4,513)
(1,776)
(556)
(14,539)
Change in expected cash flows
15,993
16,142
Transfer (to) from non-accretable discount
(2,344)
(52)
(1,066)
(2,438)
270,148
56,038
4,853
1,486
Non-Accretable Discount Activity:
309,993
14,803
22,564
18,159
365,519
Change in actual and expected losses
(2,465)
(280)
1,344
206
(1,195)
Transfer from (to) accretable yield
(1,024)
2,344
52
1,066
2,438
306,504
16,867
23,960
19,431
31
292,115
50,366
8,538
3,682
(15,584)
(9,494)
(3,923)
(1,158)
(30,159)
16,191
86
16,429
(6,385)
(1,025)
(1,124)
(8,446)
305,615
16,965
22,407
18,120
(5,496)
(1,123)
187
(4,791)
6,385
1,025
(88)
1,124
8,446
Quarter Ended June 30, 2016
260,557
57,258
17,587
5,261
340,663
(8,294)
(6,579)
(3,616)
(870)
(19,359)
2,654
630
(1)
3,283
Transfer from (to) non-accretable discount
31,560
(1,026)
(498)
495
30,531
283,823
52,307
14,103
4,885
355,118
370,155
18,148
21,938
18,735
428,976
(2,442)
(1,173)
(315)
(15)
(3,945)
Transfer (to) from accretable yield
(31,560)
1,026
(495)
(30,531)
336,153
18,001
22,121
18,225
394,500
268,794
65,026
21,578
6,290
361,688
(16,601)
(14,287)
(7,827)
(1,808)
(40,523)
2,982
631
3,612
31,630
(1,414)
(279)
404
30,341
374,772
18,545
22,039
18,834
434,190
(6,989)
(1,958)
(197)
(205)
(9,349)
(31,630)
1,414
279
(404)
(30,341)
Acquired Eurobank Loans
The carrying amount of acquired Eurobank loans at June 30, 2017 and December 31, 2016 is as follows:
June 30
December 31
201,564
232,698
9,010
12,340
192,554
220,358
54,075
64,508
Less: Allowance for loan and lease losses
21,787
21,281
The following tables describe the accretable yield and non-accretable discount activity of acquired Eurobank loans for the quarters and six-month periods ended June 30, 2017, and 2016:
Loans Secured by 1-4 Family Residential Properties
Construction & Development Secured by 1-4 Family Residential Properties
Leasing
44,697
12,743
1,871
59,311
(1,923)
(4,061)
(5)
(11)
(37)
(6,037)
543
(22)
(68)
43,012
9,157
1,906
7,426
2,471
10,236
(520)
(529)
(29)
(1,045)
(219)
68
(34)
(33)
37
(181)
6,687
2,010
45,839
16,475
2,194
(3,827)
(8,571)
(43)
(195)
(12,647)
43
(165)
1,683
900
(288)
176
(189)
531
8,441
3,880
(854)
(1,938)
(183)
(2,799)
(900)
(176)
(531)
35
50,787
33,203
2,237
86,227
(2,263)
(4,528)
(76)
(6,898)
(198)
1,619
(77)
1,425
(1,152)
(1,072)
48,336
29,142
2,204
79,682
12,703
(1,138)
(2,220)
1,152
(75)
1,072
11,555
36
51,954
26,970
2,255
3,213
84,392
(4,529)
(8,623)
(47)
(1,261)
(14,458)
786
12,712
(23)
(1,947)
11,451
125
(1,917)
(1,703)
12,869
8,287
21,156
Change in actual and expected cash flows
(1,189)
(8,292)
(11,304)
(125)
1,917
(19)
1,703
Non-accrual Loans
The following table presents the recorded investment in loans in non-accrual status by class of loans as of June 30, 2017 and December 31, 2016:
Originated and other loans and leases held for investment
2,824
3,336
6,809
7,668
3,890
4,487
6,067
6,746
Years 2007, 2008 and 2009
8,633
11,526
6,680
10,089
1,404
36,283
45,256
18,082
20,744
58,668
70,730
4,236
4,682
11,561
18,729
16,243
2,108
2,629
1,950
4,790
3,289
23,519
19,532
1,420
2,687
1,981
8,295
9,052
Total non-accrual originated loans
93,169
101,295
Acquired BBVAPR loans accounted for under ASC 310-20
1,149
1,086
1,292
1,133
1,415
552
Total non-accrual acquired BBVAPR loans accounted for under ASC 310-20
1,994
2,795
Total non-accrual loans
95,163
104,090
Loans accounted for under ASC 310-30 are excluded from the above table as they are considered to be performing due to the application of the accretion method, in which these loans will accrete interest income over the remaining life of the loans using estimated cash flow analyses or are accounted under the cost recovery method.
Delinquent residential mortgage loans insured or guaranteed under applicable FHA and VA programs are classified as non-performing loans when they become 90 days or more past due, but are not placed in non-accrual status until they become 18 months or more past due, since they are insured loans. Therefore, these loans are included as non-performing loans but excluded from non-accrual loans. In addition, these loans are excluded from the impairment analysis.
At June 30, 2017 and December 31, 2016, loans whose terms have been extended and which are classified as troubled-debt restructurings that are not included in non-accrual loans amounted to $98.7 million and $98.1 million, respectively, as they are performing under their new terms.
Impaired Loans
The Company evaluates all loans, some individually and others as homogeneous groups, for purposes of determining impairment. The total investment in impaired commercial loans that were individually evaluated for impairment was $58.1 million and $54.3 million at June 30, 2017 and December 31, 2016, respectively. The impairments on these commercial loans were measured based on the fair value of collateral or the present value of cash flows, including those identified as troubled-debt restructurings. The allowance for loan and lease losses for these impaired commercial loans amounted to $1.9 million and $1.8 million at June 30, 2017 and December 31, 2016, respectively. The total investment in impaired mortgage loans that were individually evaluated for impairment was $87.0 million and $91.6 million at June 30, 2017 and December 31, 2016, respectively. Impairment on mortgage loans assessed as troubled-debt restructurings was measured using the present value of cash flows. The allowance for loan losses for these impaired mortgage loans amounted to $8.6 million and $7.8 million at June 30, 2017 and December 31, 2016, respectively.
The Company’s recorded investment in commercial and mortgage loans categorized as originated and other loans and leases held for investment that were individually evaluated for impairment and the related allowance for loan and lease losses at June 30, 2017 and December 31, 2016 are as follows:
Unpaid
Recorded
Related
Principal
Investment
Allowance
Coverage
Impaired loans with specific allowance:
21,475
19,486
1,940
10%
Residential impaired and troubled-debt restructuring
95,821
87,042
8,630
Impaired loans with no specific allowance:
44,367
37,842
N/A
0%
Total investment in impaired loans
161,663
144,370
10,570
7%
13,183
11,698
1,626
14%
100,101
91,650
7,761
8%
Impaired loans with no specific allowance
49,038
41,441
162,322
144,789
9,387
6%
40
Acquired BBVAPR Loans Accounted for under ASC 310-20 (Loans with revolving feature and/or acquired at a premium)
The Company’s recorded investment in acquired BBVAPR commercial loans accounted for under ASC 310-20 that were individually evaluated for impairment and the related allowance for loan and lease losses at June 30, 2017 and December 31, 2016 are as follows:
Impaired loans with specific allowance
926
Specific
141
15%
221
1,184
1,150
12%
The Company’s recorded investment in acquired BBVAPR loan pools accounted for under ASC 310-30 that have recorded impairments and their related allowance for loan and lease losses at June 30, 2017 and December 31, 2016 are as follows:
to Recorded
Impaired loan pools with specific allowance:
567,845
544,326
4,141
1%
224,838
217,495
25,614
58,132
7,739
13%
Total investment in impaired loan pools
850,815
819,899
5%
December 31 , 2016
595,757
569,250
2,682
199,092
195,528
23,452
92,797
4,922
887,646
850,454
4%
The tables above only present information with respect to acquired BBVAPR loan pools accounted for under ASC 310-30 if there is a recorded impairment to such loan pools and a specific allowance for loan losses.
The Company’s recorded investment in acquired Eurobank loan pools that have recorded impairments and their related allowance for loan and lease losses as of June 30, 2017 and December 31, 2016 are as follows:
83,293
13,651
19%
56,193
53,389
8,131
139,500
124,974
17%
Impaired loan pools with specific allowance
88,017
11,947
16%
81,992
72,140
9,328
170,038
146,530
The tables above only present information with respect to acquired Eurobank loan pools accounted for under ASC 310-30 if there is a recorded impairment to such loan pools and a specific allowance for loan losses.
42
The following table presents the interest recognized in commercial and mortgage loans that were individually evaluated for impairment, which excludes loans accounted for under ASC 310-30, for the quarters and six-month periods ended June 30, 2017 and 2016:
Interest Income Recognized
Average Recorded Investment
Originated and other loans held for investment:
14,908
194,759
Residential troubled-debt restructuring
723
87,615
791
91,007
44,528
29,579
1,299
147,051
1,015
315,345
Acquired loans accounted for under ASC 310-20:
763
789
Total interest income from impaired loans
147,814
316,134
385
13,859
195,777
1,427
88,579
1,591
90,650
766
44,211
298
31,603
2,578
146,649
2,039
318,030
840
147,489
318,658
Modifications
The following tables present the troubled-debt restructurings in all loan portfolios during the quarters and six-month periods ended June 30, 2017 and 2016.
Number of contracts
Pre-Modification Outstanding Recorded Investment
Pre-Modification Weighted Average Rate
Pre-Modification Weighted Average Term (in Months)
Post-Modification Outstanding Recorded Investment
Post-Modification Weighted Average Rate
Post-Modification Weighted Average Term (in Months)
(Dollars in thousands)
3,349
6.00%
382
3,313
4.21%
367
2,155
5.96%
55
5.12%
477
12.83%
10.87%
6.39%
12.91%
7,353
6.29%
387
7,328
4.26%
378
3,373
6.44%
3,374
5.41%
67
869
11.98%
907
10.62%
70
7.41%
113
12.48%
2,670
5.69%
372
4.54%
494
668
6.65%
5.91%
364
12.73%
10.20%
6,628
5.90%
365
7,525
4.73%
493
1,323
6.73%
1,324
6.31%
556
13.27%
603
10.56%
The following table presents troubled-debt restructurings for which there was a payment default during the twelve month periods ended June 30, 2017 and 2016:
Twelve Month Period Ended June 30,
Number of Contracts
Recorded Investment
2,293
84
9,869
563
134
Credit Quality Indicators
The Company categorizes originated and other loans and acquired loans accounted for under ASC 310-20 into risk categories based on relevant information about the ability of borrowers to service their debt, such as economic conditions, portfolio risk characteristics, prior loss experience, and the results of periodic credit reviews of individual loans.
The Company uses the following definitions for risk ratings:
Pass: Loans classified as “pass” have a well-defined primary source of repayment very likely to be sufficient, with no apparent risk, strong financial position, minimal operating risk, profitability, liquidity and capitalization better than industry standards.
Special Mention: Loans classified as “special mention” have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard: Loans classified as “substandard” are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as “doubtful” have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, questionable and improbable.
Loss: Loans classified as “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be effected in the future.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.
As of June 30, 2017 and December 31, 2016, and based on the most recent analysis performed, the risk category of gross originated and other loans and BBVAPR acquired loans accounted for under ASC 310-20 subject to risk rating by class of loans is as follows:
46
Risk Ratings
Individually
Balance
Special
Measured for
Outstanding
Pass
Mention
Substandard
Doubtful
Impairment
Commercial - originated and other loans held for investment
210,369
14,640
1,970
34,882
10,675
1,503
189,754
9,624
3,640
25,788
215,629
8,796
4,891
16,936
669,333
33,060
19,206
46,197
67,119
11,266
124
7,757
83,331
837
1,301
34,328
3,240
475,096
15,343
1,478
11,131
1,144,429
48,403
20,684
57,328
Commercial - acquired loans
(under ASC 310-20)
850
198
3,109
3,959
1,276,194
1,148,388
48,701
21,016
58,089
226,768
16,002
16,067
9,090
1,643
194,913
9,437
514
30,117
221,687
7,860
4,318
15,863
678,819
42,389
4,832
47,623
180,185
63,556
16,150
1,778
68,529
731
740
3,705
29,267
2,814
477,975
19,795
917
5,516
1,156,794
62,184
5,749
53,139
905
3,014
3,919
1,283,428
1,160,713
62,521
5,905
54,289
For residential and consumer loan classes, the Company evaluates credit quality based on the delinquency status of the loan. As of June 30, 2017 and December 31, 2016, and based on the most recent analysis performed, the risk category of gross originated and other loans and acquired BBVAPR loans accounted for under ASC 310-20 not subject to risk rating by class of loans is as follows:
Delinquency
0-29 days
30-59 days
60-89 days
90-119 days
120-364 days
365+ days
Traditional
(by origination year)
42,873
1,346
585
1,972
633
75,434
3,023
744
3,103
2,077
1,760
39,918
591
1,421
1,257
499
55,454
1,523
972
1,585
2,852
2,455
59,629
1,447
524
1,462
5,325
2,807
Years 2010, 2011, 2012
2013
123,813
242
340
1,251
3,279
2,514
122
432
512,945
3,665
9,839
17,427
10,829
16,009
895
3,381
17,823
1,640
2,512
471
958
3,493
76,213
546,777
1,882
13,870
4,165
11,692
24,301
Home equity secured
personal loans
GNMA's buy-back
option program
1,383
3,776
4,070
547,109
5,548
15,468
28,371
234
402
Unsecured personal lines of credit
Unsecured personal loans
263,427
1,083
306,991
1,322
457
Auto and Leasing
732,627
6,181
2,006
1,820,761
1,586,727
51,235
36,384
13,051
17,931
28,391
Acquired loans (accounted for under ASC 310-20)
308
186
260
63,894
58,345
3,244
1,444
446
415
1,884,655
1,645,072
54,479
37,828
13,497
18,346
49
44,248
2,095
368
1,315
1,552
707
78,501
3,712
1,767
2,675
2,100
43,177
561
2,181
1,114
57,271
2,397
353
2,210
3,410
3,577
61,547
83
865
6,459
4,006
127,375
1,451
1,459
1,667
3,584
4,264
Year 2014, 2015 and 2016
386
210
518,791
225
13,169
5,759
11,431
20,047
15,667
366
1,263
3,101
17,814
2,304
1,681
388
1,599
3,759
75,983
554,236
2,529
15,348
6,513
14,293
26,907
2,440
3,141
4,100
554,573
8,953
17,434
31,007
191
334
241,227
1,074
283,761
1,273
371
686,493
6,253
1,768,404
1,524,827
48,541
36,170
16,479
19,726
31,011
28,281
227
480
99
30,868
248
47,503
101
85,888
78,371
4,436
1,738
680
1,854,292
1,603,198
52,977
37,908
17,142
20,406
NOTE 5 – ALLOWANCE FOR LOAN AND LEASE LOSSES
The composition of the Company’s allowance for loan and lease losses at June 30, 2017 and December 31, 2016 was as follows:
Allowance for loans and lease losses:
18,664
17,344
17,279
8,995
14,981
13,067
18,742
19,463
Unallocated
431
Total allowance for originated and other loans and lease losses
69,666
59,300
169
2,623
3,028
684
1,103
3,348
4,300
Total allowance for acquired BBVAPR loans and lease losses
40,842
35,356
Total allowance for acquired Eurobank loan and lease losses
Total allowance for loan and lease losses
132,295
115,937
The Company maintains an allowance for loan and lease losses at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent risks. The Company’s allowance for loan and lease losses policy provides for a detailed quarterly analysis of probable losses. The analysis includes a review of historical loan loss experience, value of underlying collateral, current economic conditions, financial condition of borrowers and other pertinent factors. While management uses available information in estimating probable loan losses, future additions to the allowance may be required based on factors beyond the Company’s control. We also maintain an allowance for loan losses on acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition, and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition.
Allowance for Originated and Other Loan and Lease Losses Held for Investment
The following tables presents the activity in our allowance for loan and lease losses and the related recorded investment of the originated and other loans held for investment portfolio by segment for the periods indicated:
Allowance for loan and lease losses for originated and other loans:
18,578
9,888
13,394
18,621
60,483
Charge-offs
(2,162)
(4,841)
(4,012)
(7,775)
(18,790)
Recoveries
63
136
780
4,176
5,155
Provision for originated and other loans and lease losses
2,185
12,096
4,819
3,720
(2)
22,818
(4,541)
(5,697)
(7,368)
(15,339)
(32,945)
119
226
945
7,470
8,760
5,742
13,755
8,337
7,148
(431)
34,551
Allowance for loan and lease losses on originated and other loans:
Ending allowance balance attributable
to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
10,034
15,339
59,096
Total ending allowance balance
612,248
1,213,516
2,947,235
Total ending loan balance
18,784
64,206
11,414
18,716
118
113,238
(1,374)
(833)
(2,811)
(8,100)
(13,118)
228
3,243
Provision (recapture) for originated and other loan and lease losses
1,091
(457)
3,035
5,400
(17)
18,537
63,144
11,771
19,259
112,812
18,352
64,791
18,261
112,626
(3,036)
(1,844)
(5,138)
(16,462)
(26,480)
316
235
6,222
6,954
3,040
(119)
5,477
11,238
76
19,712
9,583
7,369
49,913
629,844
1,224,727
2,901,481
Allowance for BBVAPR Acquired Loan Losses
Loans accounted for under ASC 310-20 (Loans with revolving feature and/or acquired at a premium)
The following tables present the activity in our allowance for loan losses and related recorded investment of the associated loans in our BBVAPR acquired loan portfolio accounted for under ASC 310-20, for the periods indicated:
Allowance for loan and lease losses
for acquired BBVAPR loans
accounted for under ASC 310-20:
183
2,591
841
3,615
(126)
(771)
(1,102)
295
597
894
Provision (recapture) for acquired BBVAPR
loan and lease losses accounted for
under ASC 310-20
(18)
508
(549)
(59)
54
Balance at beginning of year
(132)
(1,656)
(483)
(2,271)
359
1,049
1,411
892
(985)
(92)
Balance at end of year
4,589
68,483
1,727
4,993
(12)
(1,013)
(571)
(1,596)
542
Provision (recapture) for acquired
(138)
548
3,002
1,464
3,429
2,087
5,542
(1,825)
(1,308)
(3,152)
1,044
1,253
(26)
1,229
(359)
844
4,159
4,412
90,300
56
Loans Accounted for under ASC 310-30 (including those accounted for under ASC 310-30 by analogy)
For loans accounted for under ASC 310- 30, as part of the evaluation of actual versus expected cash flows, the Company assesses on a quarterly basis the credit quality of these loans based on delinquency, severity factors and risk ratings, among other assumptions. Migration and credit quality trends are assessed at the pool level, by comparing information from the latest evaluation period through the end of the reporting period.
The following tables present the activity in our allowance for loan losses and related recorded investment of the acquired BBVAPR loan portfolio accounted for under ASC 310-30 for the periods indicated:
Allowance for loan and lease losses for acquired BBVAPR loans accounted for under ASC 310-30:
3,573
23,528
7,829
34,930
Provision for BBVAPR loans and
lease losses accounted for
under ASC 310-30
2,735
3,365
Allowance de-recognition
(62)
(649)
(90)
(801)
Provision (recapture) for BBVAPR loans
and lease losses accounted for
2,958
3,186
7,696
(93)
(796)
(369)
(1,258)
57
1,762
20,430
5,555
27,747
Provision (recapture) for acquired BBVAPR loans and lease losses accounted for under ASC 310-30
(163)
3,977
3,814
Loan pools fully charged-off
(14)
(202)
(216)
(8,544)
5,353
22,801
1,678
21,245
2,862
25,785
Provision for acquired BBVAPR loans and lease losses accounted for under ASC 310-30
(79)
3,228
5,842
(66)
(282)
Allowance de-recogntion
58
Allowance for Acquired Eurobank Loan Losses
The changes in the allowance for loan and lease losses on acquired Eurobank loans for the quarters and six-month periods ended June 30, 2017 and 2016 were as follows:
Allowance for loan and lease losses for acquired Eurobank loans:
14,168
7,833
22,006
Provision for (recapture) acquired Eurobank loans and lease losses, net
474
412
(991)
360
(631)
2,872
(840)
2,032
(1,168)
(357)
(1,526)
Loans secured by 1-4 Family Residential Properties
23,961
68,089
243
92,293
Provision for (recapture) acquired Eurobank loan and lease losses, net
237
801
(7)
1,031
951
(14,133)
(57,794)
(232)
(72,159)
11,016
11,096
22,116
Allowance for loan and lease losses for Eurobank loans:
22,570
67,365
90,178
1,659
1,836
FDIC shared-loss portion of provision for covered loan and lease losses, net
2,395
(134)
NOTE 6- FDIC INDEMNIFICATION ASSET, TRUE-UP PAYMENT OBLIGATION, AND FDIC SHARED-LOSS EXPENSE
On February 6, 2017, the Bank and the FDIC agreed to terminate the single family and commercial shared-loss agreements related to the FDIC assisted acquisition of Eurobank on April 30, 2010. As part of the loss share termination transaction, the Bank made a payment of $10.1 million to the FDIC and recorded a net benefit of $1.4 million. Such termination payment took into account the anticipated reimbursements over the life of the shared-loss agreements and the true-up payment liability of the Bank anticipated at the end of the ten year term of the single family shared-loss agreement. All rights and obligations of the parties under the shared-loss agreements terminated as of the closing date of the agreement.
Pursuant to the terms of the shared-loss agreements, the FDIC would reimburse the Bank for 80% of all qualifying losses with respect to assets covered by such agreements, and the Bank would reimburse the FDIC for 80% of qualifying recoveries with respect to losses for which the FDIC reimbursed the Bank. The single family shared-loss agreement provided for FDIC loss sharing and the Bank’s reimbursement to the FDIC to last for ten years, and the commercial shared-loss agreement provided for FDIC loss sharing and the Bank’s reimbursement to the FDIC to last for five years, with additional recovery sharing for three years thereafter.
The following table presents the activity in the FDIC indemnification asset and true-up payment obligation for the quarters and six-month periods ended June 30, 2017 and 2016:
FDIC indemnification asset:
20,923
22,599
Shared-loss agreements reimbursements from the FDIC
(332)
(737)
Increase in expected credit losses to be
covered under shared-loss agreements, net
FDIC indemnification asset benefit (expense)
(1,405)
(4,269)
Net expenses incurred under shared-loss agreements
(1,711)
(1,562)
Shared-loss termination settlement
(15,814)
18,426
True-up payment obligation:
25,235
26,786
24,658
Change in true-up payment obligation
537
(26,786)
25,772
The Company recognized an FDIC shared-loss (benefit) expense, net in the consolidated statements of operations, which consists of the following, for the quarters and six-month periods ended June 30, 2017 and 2016:
FDIC indemnification asset expense (benefit)
1,405
4,269
Reimbursement to FDIC for recoveries
2,066
Total FDIC shared-loss expense (benefit), net
3,420
NOTE 7 —DERIVATIVES
The following table presents the Company’s derivative assets and liabilities at June 30, 2017 and December 31, 2016:
Derivative assets:
Interest rate swaps not designated as hedges
893
1,187
Interest rate caps
Derivative liabilities:
Interest rate swaps designated as cash flow hedges
923
1,004
139
107
Interest Rate Swaps
The Company enters into interest rate swap contracts to hedge the variability of future interest cash flows of forecasted wholesale borrowings attributable to changes in a predetermined variable index rate. The interest rate swaps effectively fix the Company’s interest payments on an amount of forecasted interest expense attributable to the variable index rate corresponding to the swap notional stated rate. These swaps are designated as cash flow hedges for the forecasted wholesale borrowing transactions, are properly documented as such, and therefore, qualify for cash flow hedge accounting. Any gain or loss associated with the effective portion of the cash flow hedges is recognized in other comprehensive income (loss) and is subsequently reclassified into operations in the period during which the hedged forecasted transactions affect earnings. Changes in the fair value of these derivatives are recorded in accumulated other comprehensive income to the extent there is no significant ineffectiveness in the cash flow hedging relationships. Currently, the Company does not expect to reclassify any amount included in other comprehensive income (loss) related to these interest rate swaps to operations in the next twelve months.
The following table shows a summary of these swaps and their terms at June 30, 2017:
Notional
Fixed
Variable
Trade
Settlement
Maturity
Type
Amount
Rate
Rate Index
Date
35,856
2.4210%
1-Month LIBOR
07/03/13
08/01/23
An accumulated unrealized loss of $923 thousand and $1.0 million was recognized in accumulated other comprehensive income (loss) related to the valuation of these swaps at June 30, 2017 and December 31, 2016, respectively, and the related liability is being reflected in the consolidated statements of financial condition.
At June 30, 2017 and December 31, 2016, interest rate swaps not designated as hedging instruments that were offered to clients represented an asset of $893 thousand and $1.2 million, respectively, and were included as part of derivative assets in the consolidated statements of financial position. The credit risk to these clients stemming from these derivatives, if any, is not material. At June 30, 2017 and December 31, 2016, interest rate swaps not designated as hedging instruments that are the mirror-images of the derivatives offered to clients represented a liability of $893 thousand and $1.2 million, respectively, and were included as part of derivative liabilities in the consolidated statements of financial condition.
The following table shows a summary of these interest rate swaps not designated as hedging instruments and their terms at June 30, 2017:
Interest Rate Swaps - Derivatives Offered to Clients
12,500
5.5050%
04/11/09
04/11/19
Interest Rate Swaps - Mirror Image Derivatives
Interest Rate Caps
The Company has entered into interest rate cap transactions with various clients with floating-rate debt who wish to protect their financial results against increases in interest rates. In these cases, the Company simultaneously enters into mirror-image interest rate cap transactions with financial counterparties. None of these cap transactions qualify for hedge accounting, and therefore, they are marked to market through earnings. As of June 30, 2017 and December 31, 2016, the outstanding total notional amount of interest rate caps was $135.6 million and $136.1 million, respectively. At June 30, 2017 and December 31, 2016, the interest rate caps sold to clients represented a liability of $65 thousand and $139 thousand, respectively, and were included as part of derivative liabilities in the consolidated statements of financial condition. At June 30, 2017 and December 31, 2016, the interest rate caps purchased as mirror-images represented an asset of $64 thousand and $143 thousand, respectively, and were included as part of derivative assets in the consolidated statements of financial condition.
NOTE 8 — ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS
Accrued interest receivable at June 30, 2017 and December 31, 2016 consists of the following:
Loans, excluding acquired loans
16,835
16,706
Investments
2,963
Other assets at June 30, 2017 and December 31, 2016 consist of the following:
Prepaid expenses
17,117
17,096
Other repossessed assets
3,224
Core deposit and customer relationship intangibles
5,424
6,160
Mortgage tax credits
6,277
Investment in Statutory Trust
Accounts receivable and other assets
33,162
46,525
Prepaid expenses amounting to $17.1 million at both June 30, 2017 and December 31, 2016, include prepaid municipal, property and income taxes aggregating to $11.7 million and $12.5million, respectively.
In connection with the FDIC-assisted acquisition and the BBVAPR Acquisition, the Company recorded a core deposit intangible representing the value of checking and savings deposits acquired. At June 30, 2017 and December 31, 2016 this core deposit intangible amounted to $3.8 million and $4.3 million, respectively. In addition, the Company recorded a customer relationship intangible representing the value of customer relationships acquired with the acquisition of the securities broker-dealer and insurance agency in the BBVAPR Acquisition. At June 30, 2017 and December 31, 2016, this customer relationship intangible amounted to $1.6 million and $1.9 million, respectively.
Other repossessed assets totaled $3.2 million at June 30, 2017 and December 31, 2016, respectively, include repossessed automobiles amounting to $3.0 million, respectively, which are recorded at their net realizable value.
At June 30, 2017 and December 31, 2016, tax credits for the Company totaled $6.3 million for both periods. These tax credits do not have an expiration date.
NOTE 9— DEPOSITS AND RELATED INTEREST
Total deposits, including related accrued interest payable, as of June 30, 2017 and December 31, 2016 consist of the following:
Non-interest bearing demand deposits
845,375
848,502
Interest-bearing savings and demand deposits
2,115,290
2,219,452
Individual retirement accounts
238,345
265,754
Retail certificates of deposit
607,910
563,965
Institutional certificates of deposit
206,855
190,419
Total core deposits
4,013,775
4,088,092
Brokered deposits
568,911
576,395
Brokered deposits include $515.6 million in certificates of deposits and $53.3 million in money market accounts at June 30, 2017, and $508.4million in certificates of deposits and $68.0 million in money market accounts at December 31, 2016.
The weighted average interest rate of the Company’s deposits was 0.65% and 0.62% at June 30, 2017 and December 31, 2016 respectively. Interest expense for the quarters and six-month periods ended June 30, 2017 and 2016 was as follows:
Demand and savings deposits
2,939
3,184
5,848
6,026
Certificates of deposit
4,713
4,183
8,465
At December 31, 2016, demand and interest-bearing deposits and certificates of deposit included uncollateralized deposits of Puerto Rico Cash & Money Market Fund, Inc. ("the Fund”), which amounted to $15.3 million, with a weighted average rate of 0.77%. On April 3, 2017, the Fund was liquidated in anticipation of its dissolution.
At June 30, 2017 and December 31, 2016, time deposits in denominations of $250 thousand or higher, excluding accrued interest and unamortized discounts, amounted to $360.9 million and $344.0 million, respectively. Such amounts include public funds time deposits from various Puerto Rico government municipalities, agencies, and corporations of $16.8 million and $2.1 million at a weighted average rate of 0.63% and 0.50% at June 30, 2017 and December 31, 2016, respectively.
At June 30, 2017 and December 31, 2016, total public fund deposits from various Puerto Rico government municipalities, agencies, and corporations amounted to $123.3 million and $170.7 million, respectively. These public funds were collateralized with commercial loans amounting to $215.8 million and $209.2 million at June 30, 2017 and December 31, 2016, respectively.
Excluding accrued interest of approximately $1.9 million, the scheduled maturities of certificates of deposit at June 30, 2017 and December 31, 2016 are as follows:
Within one year:
Three (3) months or less
262,406
277,621
Over 3 months through 1 year
590,861
534,548
853,267
812,169
Over 1 through 2 years
444,176
488,440
Over 2 through 3 years
195,287
154,545
Over 3 through 4 years
38,872
29,701
Over 4 through 5 years
35,145
41,949
1,566,747
1,526,804
The table of scheduled maturities of certificates of deposits above includes brokered-deposits and individual retirement accounts.
The aggregate amount of overdrafts in demand deposit accounts that were reclassified to loans amounted to $761 thousand and $575 thousand as of June 30, 2017 and December 31, 2016, respectively.
NOTE 10 —BORROWINGS AND RELATED INTEREST
Securities Sold under Agreements to Repurchase
At June 30, 2017, securities underlying agreements to repurchase were delivered to, and are being held by, the counterparties with whom the repurchase agreements were transacted. The counterparties have agreed to resell to the Company the same or similar securities at the maturity of these agreements. The purpose of these transactions is to provide financing for the Company’s securities portfolio.
At June 30, 2017 and December 31, 2016, securities sold under agreements to repurchase (classified by counterparty), excluding accrued interest in the amount of $642 thousand and $1.5 million, respectively, were as follows:
Fair Value of
Borrowing
Underlying
Collateral
Nomura
37,001
38,900
PR Cash and Money Market Fund
70,010
74,538
JP Morgan Chase Bank NA
239,781
257,976
350,219
376,674
Federal Home Loan Bank
110,000
115,881
Credit Suisse Securities (USA) LLC
232,000
249,286
Goldman SachsCredit Suisse Securities (USA) LLC
66,068
70,653
452,850
483,410
652,229
700,498
The following table shows a summary of the Company’s repurchase agreements and their terms, excluding accrued interest in the amount of $642 thousand, at June 30, 2017:
Weighted-
Year of Maturity
Coupon
Settlement Date
1.65%
6/27/2017
7/3/2017
57,281
1.55%
6/28/2017
7/5/2017
1.50%
7/7/2017
2018
182,500
1.42%
12/10/2012
4/29/2018
2019
50,000
1.72%
3/2/2017
9/3/2019
2020
60,000
1.85%
3/2/2020
1.56%
All the repurchase agreements referred above with maturity up to the date of this report were renewed by the Company.
A repurchase agreement in the original amount of $500 million with an original term of ten years was modified in February 2016 to terminate, before maturity, $268.0 million of this repurchase agreement at a cost of $12.0 million, included as a loss on early extinguishment of debt in the consolidated statements of operations. The remaining balance of this repurchase agreement of $232.0 million matured on March 2, 2017. At June 30, 2017, repurchase agreement in the original amount of $25.0 million and $75.0 million, respectively, with original term of June 2019 and December 2019, respectively, were terminated before maturity at a cost of $80 thousand, included as a loss on early extinguishment of debt in consolidated statement of operations.
The following table presents the repurchase liability associated with the repurchase agreement transactions (excluding accrued interest) by maturity. Also, it includes the carrying value and approximate market value of collateral (excluding accrued interest) at June 30, 2017 and December 31, 2016. There was no cash collateral at June 30, 2017 and December 31, 2016.
Market Value of Underlying Collateral
FNMA and
US Treasury
Repurchase
FHLMC
GNMA
Treasury
Liability
Certificates
Notes
Less than 90 days
160,350
1.57%
170,851
Over 90 days
292,500
312,467
92
312,559
483,318
349,729
3.35%
248,288
75,536
48,954
372,778
302,500
1.44%
327,627
327,720
2.47%
575,915
75,629
Advances from the Federal Home Loan Bank of New York
Advances are received from the Federal Home Loan Bank of New York (the “FHLB-NY”) under an agreement whereby the Company is required to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At June 30, 2017 and December 31, 2016, these advances were secured by mortgage and commercial loans amounting to $1.3 billion and $1.4 billion, respectively. Also, at June 30, 2017 and December 31, 2016, the Company had an additional borrowing capacity with the FHLB-NY of $935.5 million and $1.2 billion, respectively. At June 30, 2017 and December 31, 2016, the weighted average remaining maturity of FHLB’s advances was 5.2 months and 10.6 months, respectively. The original terms of these advances range between one day and seven years, and the FHLB-NY does not have the right to exercise put options at par on any advances outstanding as of June 30, 2017.
The following table shows a summary of these advances and their terms, excluding accrued interest in the amount of $308 thousand, at June 30, 2017:
1.20%
6/1/2017
37,000
1.24%
6/30/2017
72,856
30,000
2.19%
1/16/2013
1/16/2018
25,000
2.18%
55,000
9,376
7/19/2013
7/20/2020
137,232
1.70%
All of the advances referred to above with maturity dates up to the date of this report were renewed as one-month short-term advances.
Subordinated Capital Notes
Subordinated capital notes amounted to $36.1 million at June 30, 2017 and December 31, 2016, for both periods.
NOTE 11 – OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES
The Company’s derivatives are subject to agreements which allow a right of set-off with each respective counterparty. In addition, the Company’s securities purchased under agreements to resell and securities sold under agreements to repurchase have a right of set-off with the respective counterparty under the supplemental terms of the master repurchase agreements. In an event of default, each party has a right of set-off against the other party for amounts owed in the related agreements and any other amount or obligation owed in respect of any other agreement or transaction between them. Security collateral posted to open and maintain a master netting agreement with a counterparty, in the form of cash and securities, may from time to time be segregated in an account at a third-party custodian pursuant to a an account control agreement.
The following table presents the potential effect of rights of set-off associated with the Company’s recognized financial assets and liabilities at June 30, 2017 and December 31, 2016:
Gross Amounts Not Offset in the Statement of Financial Condition
Gross Amounts
Net Amount of
Offset in the
Assets Presented
Gross Amount
Statement of
in Statement
Cash
of Recognized
Financial
of Financial
Net
Assets
Condition
Instruments
Received
2,027
(1,070)
Net amount of
2,003
(673)
Liabilities
Presented
Provided
(99)
(30,560)
454,731
(30,659)
(48,269)
654,666
(47,812)
NOTE 12 — INCOME TAXES
At June 30, 2017 and December 31, 2016, the Company’s net deferred tax asset amounted to $116.2 million and $124.2 million, respectively. In assessing the realizability of the deferred tax asset, management considers whether it is more likely than not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of the deferred tax asset is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax asset are deductible, management believes it is more likely than not that the Company will realize the deferred tax asset, net of the existing valuation allowances recorded at June 30, 2017 and December 31, 2016. The amount of the deferred tax asset that is considered realizable could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.
At June 30, 2017 and December 31, 2016, Oriental International Bank Inc. (“OIB”), the Bank’s international banking entity subsidiary, had $6 thousand and $109 thousand, respectively, in income tax effect of unrecognized gain on available-for-sale securities included in other comprehensive income. Following the change in OIB’s applicable tax rate from 5% to 0% as a result of a Puerto Rico law adopted in 2011, this remaining tax balance will flow through income as these securities are repaid or sold in future periods. During the quarters ended June 30, 2017 and 2016, $95 thousand and $8 thousand, respectively, related to this residual tax effect from OIB was reclassified from accumulated other comprehensive income (loss) into income tax provision. During the six-month period ended June 30, 2017 and 2016, $103 thousand and $16 thousand, respectively, related to this residual tax effect from OIB was reclassified from accumulated other comprehensive income (loss) into income tax provision.
The Company classifies unrecognized tax benefits in other liabilities. These gross unrecognized tax benefits would affect the effective tax rate if realized. At June 30, 2017 the amount of unrecognized tax benefits was $2.1 million (December 31, 2016 - $2.0 million). The Company had accrued $80 thousand at June 30, 2017 (December 31, 2016 - $229 thousand) for the payment of interest and penalties relating to unrecognized tax benefits.
The Company is subject to the dispositions of the 2011 Puerto Rico Internal Revenue Code, as amended (the "Code"). The Code imposes a maximum corporate tax rate of 39%. The Company maintained a lower effective tax rate for the six-month periods ended June 30, 2017 and 2016 of 29.0% and 28.8%, respectively.
Income tax expense for the quarters ended June 30, 2017 and 2016 was $4.0 million and $5.9 million, respectively. Income tax expense for the six-month periods ended June 30, 2017 and 2016 was $13.2 million and $11.5 million, respectively.
NOTE 13 — REGULATORY CAPITAL REQUIREMENTS
Regulatory Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and Puerto Rico banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Pursuant to the Dodd-Frank Act, federal banking regulators adopted capital rules that became effective January 1, 2015 for the Company and the Bank (subject to certain phase-in periods through January 1, 2019) and that replaced their general risk-based capital rules, advanced approaches rule, market risk rule, and leverage rules. Among other matters, the new capital rules: (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to prior regulations. The current capital rules prescribe a new standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, and resulting in higher risk weights for a variety of asset classes.
Pursuant to the current capital rules, the minimum capital ratios requirements are as follows:
4.5% CET1 to risk-weighted assets;
6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets;
8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
4.0% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known
as the “leverage ratio”).
As of June 30, 2017 and December 31, 2016, the Company and the Bank met all capital adequacy requirements to which they are subject. As of June 30, 2017 and December 31, 2016, the Bank is “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” an institution must maintain minimum CET1 risk-based, Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios as set forth in the tables presented below.
The Company’s and the Bank’s actual capital amounts and ratios as of June 30, 2017 and December 31, 2016 are as follows:
Minimum Capital
Minimum to be Well
Actual
Requirement
Capitalized
Ratio
Company Ratios
As of June 30, 2017
Total capital to risk-weighted assets
896,927
20.42%
351,306
8.00%
439,132
10.00%
Tier 1 capital to risk-weighted assets
840,704
19.14%
263,479
Common equity tier 1 capital to risk-weighted assets
643,607
14.66%
197,609
4.50%
285,436
6.50%
Tier 1 capital to average total assets
13.69%
245,577
4.00%
306,971
5.00%
As of December 31, 2016
876,657
19.62%
357,404
446,756
819,662
18.35%
268,053
627,733
14.05%
201,040
290,391
12.99%
252,344
315,430
Bank Ratios
887,024
20.20%
351,244
439,055
831,012
18.93%
263,433
197,575
285,386
13.59%
244,618
305,773
857,259
19.23%
356,596
445,745
800,544
17.96%
267,447
200,585
289,734
12.75%
251,200
314,000
73
NOTE 14 – STOCKHOLDERS’ EQUITY
Additional Paid-in Capital
Additional paid-in capital represents contributed capital in excess of par value of common and preferred stock net of the costs of issuance. As of both periods, June 30, 2017 and December 31, 2016 accumulated issuance costs charged against additional paid in capital amounted to $13.6 million and $10.1 million for preferred and common stock, respectively.
Legal Surplus
The Puerto Rico Banking Act requires that a minimum of 10% of the Bank’s net income or loss for the year be transferred to a reserve fund until such fund (legal surplus) equals the total paid in capital on common and preferred stock. At June 30, 2017 and December 31, 2016, the Bank’s legal surplus amounted to $79.5 million and $76.3 million, respectively. The amount transferred to the legal surplus account is not available for the payment of dividends to shareholders.
Treasury Stock
Under the Company’s current stock repurchase program it is authorized to purchase in the open market up $7.7 million of its outstanding shares of common stock. The shares of common stock repurchased are to be held by the Company as treasury shares. During the six-month periods ended June 30, 2017 and 2016, the Company did not purchase any shares under the program.
At June 30, 2017 the number of shares that may yet be purchased under the $70 million program is estimated at 773,085 and was calculated by dividing the remaining balance of $7.7 million by $10.00 (closing price of the Company common stock at June 30, 2017).
The activity in connection with common shares held in treasury by the Company for the six-month periods ended June 30, 2017 and 2016 is set forth below:
Dollar
Shares
(In thousands, except shares data)
Beginning of period
8,711,025
104,860
8,757,960
105,379
Common shares used upon lapse of restricted stock units
(32,598)
(45,810)
End of period
8,678,427
104,502
8,712,150
104,874
NOTE 15 - ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income, net of income taxes, as of June 30, 2017 and December 31, 2016 consisted of:
Unrealized gain on securities available-for-sale which are not
other-than-temporarily impaired
1,617
Income tax effect of unrealized gain on securities available-for-sale
209
592
Net unrealized gain on securities available-for-sale which are not
256
2,209
Unrealized loss on cash flow hedges
(923)
(1,004)
Income tax effect of unrealized loss on cash flow hedges
391
Net unrealized loss on cash flow hedges
(563)
(613)
Accumulated other comprehensive (loss) income, net of income taxes
The following table presents changes in accumulated other comprehensive income by component, net of taxes, for the quarters and six-month periods ended June 30, 2017 and 2016:
Net unrealized
Accumulated
gains on
loss on
other
securities
cash flow
comprehensive
available-for-sale
hedges
(loss) income
income
Beginning balance
(502)
15,089
(2,805)
12,284
Other comprehensive loss before reclassifications
(3,618)
(3,807)
3,060
(949)
2,111
Amounts reclassified out of accumulated other comprehensive income (loss)
128
152
(64)
1,474
1,410
Other comprehensive income (loss)
(3,594)
(61)
2,996
Ending balance
18,085
(2,280)
16,924
(2,927)
Other comprehensive income (loss) before reclassifications
(1,911)
(227)
(2,138)
(1,266)
(2,406)
(3,672)
(42)
277
2,427
3,053
5,480
(1,953)
1,161
647
The following table presents reclassifications out of accumulated other comprehensive income for the quarters and six-month periods ended June 30, 2017 and 2016:
Amount reclassified out of accumulated other
comprehensive (loss) income
Affected Line Item in
Consolidated Statement
of Operations
Cash flow hedges:
Interest-rate contracts
1,354
Net interest expense
Tax effect from increase in capital gains tax rate
Available-for-sale securities:
Residual tax effect from OIB's change in applicable tax rate
95
(71)
(72)
2,804
249
Other-than-temporary impairment losses on investment securities
2,557
Net impairment losses recognized in earnings
(145)
(146)
NOTE 16 – EARNINGS PER COMMON SHARE
The calculation of earnings per common share for the quarters and six-month periods ended June 30, 2017 and 2016 is as follows:
Less: Dividends on preferred stock
Non-convertible preferred stock (Series A, B, and D)
(1,629)
(3,256)
Convertible preferred stock (Series C)
(1,837)
(3,675)
Effect of assumed conversion of the convertible ' ' preferred stock
1,837
3,675
Income available to common shareholders assuming conversion
15,475
12,710
28,998
25,254
Weighted average common shares and share equivalents:
Average common shares outstanding
43,947
43,914
43,931
43,906
Effect of dilutive securities:
Average potential common shares-options
Average potential common shares-assuming ' ' conversion of convertible preferred stock
7,138
Total weighted average common shares ' 'outstanding and equivalents
Earnings per common share - basic
Earnings per common share - diluted
In computing diluted earnings per common share, the 84,000 shares of convertible preferred stock, which remain outstanding at June 30, 2017, with a conversion rate, subject to certain conditions, of 86.4225 shares of common stock per share, were included as average potential common shares from the date they were issued and outstanding. Moreover, in computing diluted earnings per common share, the dividends declared during the quarters and six-month periods ended June 30, 2017 and 2016 on the convertible preferred stock were added back as income available to common shareholders.
For the quarters ended June 30, 2017 and 2016, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 967,041 and 957,743, respectively. For the six-month period ended June 30, 2017 and 2016, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 890,472 and 957,783, respectively.
NOTE 17 – GUARANTEES
At June 30, 2017 and December 31, 2016 , the unamortized balance of the obligations undertaken in issuing the guarantees under standby letters of credit represented a liability of $13.4 million and $4.0 million, respectively.
As a result of the BBVAPR Acquisition, the Company assumed a liability for residential mortgage loans sold subject to credit recourse, pursuant to FNMA’s residential mortgage loan sales and securitization programs. At June 30, 2017 and December 31, 2016, the unpaid principal balance of residential mortgage loans sold subject to credit recourse was $6.6 million and $20.1 million, respectively.
The following table shows the changes in the Company’s liability for estimated losses from these credit recourse agreements, included in the consolidated statements of financial condition during the quarters and six-month periods ended June 30, 2017 and 2016.
570
710
439
Net (charge-offs/terminations) recoveries
(111)
(251)
(277)
459
162
The estimated losses to be absorbed under the credit recourse arrangements were recorded as a liability when the credit recourse was assumed, and are updated on a quarterly basis. The expected loss, which represents the amount expected to be lost on a given loan, considers the probability of default and loss severity. The probability of default represents the probability that a loan in good standing would become 120 days delinquent, in which case the Company is obligated to repurchase the loan. The recourse obligation will be fully extinguished before the end of 2017.
If a borrower defaults, pursuant to the credit recourse provided, the Company is required to repurchase the loan or reimburse the third party investor for the incurred loss. The maximum potential amount of future payments that the Company would be required to make under the recourse arrangements is equivalent to the total outstanding balance of the residential mortgage loans serviced with recourse and interest, if applicable. During the quarters ended June 30, 2017 and 2016, the Company repurchased approximately $66 thousand and $83 thousand, respectively of unpaid principal balance in mortgage loans subject to the credit recourse provisions. During the six-month periods ended June 30, 2017 and 2016, the Company repurchased approximately $107 thousand and $288 thousand, respectively of unpaid principal balance in mortgage loans subject to the credit recourse provisions. If a borrower defaults, the Company has rights to the underlying collateral securing the mortgage loan. The Company suffers losses on these mortgage loans when the proceeds from a foreclosure sale of the collateral property are less than the outstanding principal balance of the loan, any uncollected interest advanced, and the costs of holding and disposing the related property. At June 30, 2017, the Company’s liability for estimated credit losses related to loans sold with credit recourse amounted to $459 thousand (December 31, 2016– $710 thousand).
When the Company sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. The Company's mortgage operations division groups conforming mortgage loans into pools which are exchanged for FNMA and GNMA mortgage-backed securities, which are generally sold to private investors, or are sold directly to FNMA or other private investors for cash. As required under such mortgage backed securities programs, quality review procedures are performed by the Company to ensure that asset guideline qualifications are met. To the extent the loans do not meet specified characteristics, the Company may be required to repurchase such loans or indemnify for losses and bear any subsequent loss related to the loans. During the quarter ended June 30, 2017, the Company repurchased $1.4 million (June 30, 2016 – $817 thousand) of unpaid principal balance in mortgage loans, excluding mortgage loans subject to credit recourse provision referred above. During both the six-month periods ended June 30, 2017 and June 30, 2016, the Company repurchased $2.3 million of unpaid principal balance in mortgage loans, excluding mortgage loans subject to credit recourse provision referred before.
During the quarters ended June 30, 2017 and 2016, the Company recognized $254 thousand and $92 thousand, respectively, in losses from the repurchase of residential mortgage loans sold subject to credit recourse, and $283 thousand and $329 thousand, respectively, from the repurchase of residential mortgage loans as a result of breaches of the customary representations and warranties. During the six-month periods ended June 30, 2017 and 2016, the Company recognized $354 thousand and $111 thousand, respectively, in losses
from the repurchase of residential mortgage loans sold subject to credit recourse, and $590 thousand and $830 thousand, respectively, from the repurchase of residential mortgage loans as a result of breaches of the customary representations and warranties.
Servicing agreements relating to the mortgage-backed securities programs of FNMA and GNMA, and to mortgage loans sold or serviced to certain other investors, including the FHLMC, require the Company to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. At June 30, 2017, the Company serviced $845.7 million in mortgage loans for third-parties. The Company generally recovers funds advanced pursuant to these arrangements from the mortgage owner, from liquidation proceeds when the mortgage loan is foreclosed or, in the case of FHA/VA loans, under the applicable FHA and VA insurance and guarantees programs. However, in the meantime, the Company must absorb the cost of the funds it advances during the time the advance is outstanding. The Company must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Company would not receive any future servicing income with respect to that loan. At June 30, 2017, the outstanding balance of funds advanced by the Company under such mortgage loan servicing agreements was approximately $366 thousand (December 31, 2016 - $334 thousand). To the extent the mortgage loans underlying the Company's servicing portfolio experience increased delinquencies, the Company would be required to dedicate additional cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.
NOTE 18—COMMITMENTS AND CONTINGENCIES
Loan Commitments
In the normal course of business, the Company becomes a party to credit-related financial instruments with off-balance-sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby and commercial letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of financial condition. The contract or notional amount of those instruments reflects the extent of the Company’s involvement in particular types of financial instruments.
The Company’s exposure to credit losses in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit, including commitments under credit card arrangements, and commercial letters of credit is represented by the contractual notional amounts of those instruments, which do not necessarily represent the amounts potentially subject to risk. In addition, the measurement of the risks associated with these instruments is meaningful only when all related and offsetting transactions are identified. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Credit-related financial instruments at June 30, 2017 and December 31, 2016 were as follows:
Commitments to extend credit
434,051
492,885
Commercial letters of credit
1,501
2,721
Commitments to extend credit represent agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Company upon the extension of credit, is based on management’s credit evaluation of the counterparty.
At June 30, 2017 and December 31, 2016, commitments to extend credit consisted mainly of undisbursed available amounts on commercial lines of credit, construction loans, and revolving credit card arrangements. Since many of the unused commitments are expected to expire unused or be only partially used, the total amount of these unused commitments does not necessarily represent future cash requirements. These lines of credit had a reserve of $667 thousand at June 30, 2017 and December 31, 2016.
Commercial letters of credit are issued or confirmed to guarantee payment of customers’ payables or receivables in short-term international trade transactions. Generally, drafts will be drawn when the underlying transaction is consummated as intended. However, the short-term nature of this instrument serves to mitigate the risk associated with these contracts.
The summary of instruments that are considered financial guarantees in accordance with the authoritative guidance related to guarantor’s accounting and disclosure requirements for guarantees, including indirect guarantees of indebtedness of others, at June 30, 2017 and December 31, 2016, is as follows:
Standby letters of credit and financial guarantees
13,420
4,041
Loans sold with recourse
6,640
20,126
Standby letters of credit and financial guarantees are written conditional commitments issued by the Company to guarantee the payment and/or performance of a customer to a third party (“beneficiary”). If the customer fails to comply with the agreement, the beneficiary may draw on the standby letter of credit or financial guarantee as a remedy. The amount of credit risk involved in issuing letters of credit in the event of nonperformance is the face amount of the letter of credit or financial guarantee. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The amount of collateral obtained, if it is deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the customer.
Lease Commitments
The Company has entered into various operating lease agreements for branch facilities and administrative offices. Rent expense for the quarters ended June 30, 2017 and 2016, amounted to $2.5 million and $2.3 million, respectively. For the six-month periods ended June 30, 2017 and 2016, rent expense amounted to $4.5 million and $4.4 million, respectively, and is included in the "occupancy and equipment" caption in the unaudited consolidated statements of operations. Future rental commitments under leases in effect at June 30, 2017, exclusive of taxes, insurance, and maintenance expenses payable by the Company, are summarized as follows:
Minimum Rent
Year Ending December 31,
6,969
6,928
6,201
2021
5,371
Thereafter
7,881
37,015
Contingencies
The Company and its subsidiaries are defendants in a number of legal proceedings incidental to their business. In the ordinary course of business, the Company and its subsidiaries are also subject to governmental and regulatory examinations. Certain subsidiaries of the Company, including the Bank (and its subsidiary OIB), Oriental Financial Services, and Oriental Insurance, are subject to regulation by various U.S., Puerto Rico and other regulators.
The Company seeks to resolve all litigation and regulatory matters in the manner management believes is in the best interests of the Company and its shareholders, and contests allegations of liability or wrongdoing and, where applicable, the amount of damages or scope of any penalties or other relief sought as appropriate in each pending matter.
Subject to the accounting and disclosure framework under the provisions of ASC 450, it is the opinion of the Company’s management, based on current knowledge and after taking into account its current legal accruals, that the eventual outcome of all matters would not be likely to have a material adverse effect on the consolidated statements of financial condition of the Company. Nonetheless, given the substantial or indeterminate amounts sought in certain of these matters, and the inherent unpredictability of such matters, an adverse outcome in certain of these matters could, from time to time, have a material adverse effect on the Company’s consolidated results of operations or cash flows in particular quarterly or annual periods. The Company has evaluated all litigation and regulatory matters where the likelihood of a potential loss is deemed reasonably possible. The Company has determined that the estimate of the reasonably possible loss is not significant.
NOTE 19 -FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company follows the fair value measurement framework under U.S. Generally Accepted Accounting Principles (“GAAP”).
Fair Value Measurement
The fair value measurement framework defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. This framework also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The fair value of money market investments is based on the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.
The fair value of investment securities is based on quoted market prices, when available, or market prices provided by Interactive Data Corporation ("IDC"), and independent, well-recognized pricing company. Such securities are classified as Level 1 or Level 2 depending on the basis for determining fair value. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument, and such securities are classified as Level 3. At June 30, 2017 and December 31, 2016, the Company did not have investment securities classified as Level 3.
Derivative instruments
The fair value of the interest rate swaps is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of derivative instruments on earnings. This will depend, for the most part, on the shape of the yield curve, the level of interest rates, as well as the expectations for rates in the future. The fair value of most of these derivative instruments is based on observable market parameters, which include discounting the instruments’ cash flows using the U.S. dollar LIBOR-based discount rates, and also applying yield curves that account for the industry sector and the credit rating of the counterparty and/or the Company.
Certain other derivative instruments with limited market activity are valued using externally developed models that consider unobservable market parameters. Based on their valuation methodology, derivative instruments are classified as Level 2 or Level 3. In the past, the Company offered its customers certificates of deposit with an option tied to the performance of the S&P Index and used equity indexed option agreements with major broker-dealers to manage its exposure to changes in this index. Their fair value was obtained through the use of an external based valuation that was thoroughly evaluated and adopted by management as its measurement tool for these options. The payoff of these options was linked to the average value of the S&P Index on a specific set of dates during the life of the option. The methodology used an average rate option or a cash-settled option whose payoff was based on the difference between the expected average value of the S&P Index during the remaining life of the option and the strike price at inception. The assumptions, which were uncertain and required a degree of judgment, included primarily S&P Index volatility, forward interest rate projections, estimated index dividend payout, and leverage. At June 30, 2017 and December 31, 2016, there were no options tied to the S&P Index outstanding.
Servicing assets do not trade in an active market with readily observable prices. Servicing assets are priced using a discounted cash flow model. The valuation model considers servicing fees, portfolio characteristics, prepayment assumptions, delinquency rates, late charges, other ancillary revenues, cost to service and other economic factors. Due to the unobservable nature of certain valuation inputs, the servicing rights are classified as Level 3.
Impaired loans are carried at the present value of expected future cash flows using the loan’s existing rate in a discounted cash flow calculation, or the fair value of the collateral if the loan is collateral-dependent. Expected cash flows are based on internal inputs reflecting expected default rates on contractual cash flows. This method of estimating fair value does not incorporate the exit-price concept of fair value described in ASC 820-10 and would generally result in a higher value than the exit-price approach. For loans measured using the estimated fair value of collateral less costs to sell, fair value is generally determined based on the fair value of the collateral, which is derived from appraisals that take into consideration prices in observed transactions involving similar assets in similar locations, in accordance with the provisions of ASC 310-10-35 less disposition costs. Currently, the associated loans considered impaired are classified as Level 3.
Foreclosed real estate includes real estate properties securing residential mortgage and commercial loans. The fair value of foreclosed real estate may be determined using an external appraisal, broker price option or an internal valuation. These foreclosed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.
Other repossessed assets include repossessed automobiles. The fair value of the repossessed automobiles may be determined using internal valuation and an external appraisal. These repossessed assets are classified as Level 3 given certain internal adjustments that may be made to external appraisals.
Assets and liabilities measured at fair value on a recurring and non-recurring basis are summarized below:
Fair Value Measurements
Level 1
Level 2
Level 3
Recurring fair value measurements:
(1,881)
648,697
665,030
Non-recurring fair value measurements:
Impaired commercial loans
111,537
(2,437)
750,724
766,188
105,033
The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the quarters and six-month periods ended June 30, 2017 and 2016:
Derivative
asset
liability
(S&P
Purchased
Servicing
Embedded
Level 3 Instruments Only
Options)
assets
9,688
New instruments acquired
540
Principal repayments
(164)
Changes in fair value of servicing assets
(326)
(740)
85
772
7,819
(746)
7,845
Gains (losses) included in earnings
(585)
557
(28)
717
(121)
Amortization
7,932
7,938
1,171
7,455
(1,095)
7,531
(984)
886
(98)
1,275
(225)
(573)
During the quarters and six-month periods ended June 30, 2017 and 2016, there were purchases and sales of assets and liabilities measured at fair value on a recurring basis. There were no transfers into and out of Level 1 and Level 2 fair value measurements during such periods.
The table below presents quantitative information for all assets and liabilities measured at fair value on a recurring and non-recurring basis using significant unobservable inputs (Level 3) at June 30, 2017:
Valuation Technique
Unobservable Input
Range
Cash flow valuation
Constant prepayment rate
4.18% - 9.07%
Discount rate
10.00% - 12.00%
Collateral dependant
impaired loans
25,242
Fair value of property
or collateral
Appraised value less disposition costs
22.20% - 36.20%
Other non-collateral dependant impaired loans
32,847
4.15% - 10.50%
Estimated net realizable value less disposition costs
32.00% - 68.00%
Information about Sensitivity to Changes in Significant Unobservable Inputs
Servicing assets – The significant unobservable inputs used in the fair value measurement of the Company’s servicing assets are constant prepayment rates and discount rates. Changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or offset the sensitivities. Mortgage banking activities, a component of total banking and financial service revenue in the consolidated statements of operations, include the changes from period to period in the fair value of the mortgage loan servicing rights, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, including changes due to collection/realization of expected cash flows.
Fair Value of Financial Instruments
The information about the estimated fair value of financial instruments required by GAAP is presented hereunder. The aggregate fair value amounts presented do not necessarily represent management’s estimate of the underlying value of the Company.
The estimated fair value is subjective in nature, involves uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could affect these fair value estimates. The fair value estimates do not take into consideration the value of future business and the value of assets and liabilities that are not financial instruments. Other significant tangible and intangible assets that are not considered financial instruments are the value of long-term customer relationships of retail deposits, and premises and equipment.
87
The estimated fair value and carrying value of the Company’s financial instruments at June 30, 2017 and December 31, 2016 is as follows:
Carrying
Financial Assets:
Cash and cash equivalents
Federal Home Loan Bank (FHLB) stock
Financial Liabilities:
Total loans (including loans held-for-sale)
3,955,910
3,917,340
8,669
4,560,586
4,644,629
451,933
651,898
138,002
106,422
31,743
30,230
The following methods and assumptions were used to estimate the fair values of significant financial instruments at June 30, 2017 and December 31, 2016:
• Cash and cash equivalents (including money market investments and time deposits with other banks), restricted cash, accrued interest receivable, accounts receivable and other assets and accrued expenses and other liabilities have been valued at the carrying amounts reflected in the consolidated statements of financial condition as these are reasonable estimates of fair value given the short-term nature of the instruments.
• Investments in FHLB-NY stock are valued at their redemption value.
• The fair value of investment securities, including trading securities and other investments, is based on quoted market prices, when available or prices provided from contracted pricing providers, or market prices provided by recognized broker-dealers. If listed prices or quotes are not available, fair value is based upon externally developed models that use both observable and unobservable inputs depending on the market activity of the instrument.
• The fair value of the FDIC indemnification asset represented the present value of the net estimated cash payments expected to be received from the FDIC for future losses on covered assets based on the credit assumptions on estimated cash flows for each covered asset and the loss sharing percentages. The FDIC shared-loss agreements were terminated on February 6, 2017. Such termination takes into account the anticipated reimbursements over the life of the shared-loss agreements and the true-up payment liability of the Bank anticipated at the end of the ten year term of the single family shared-loss agreement. Therefore, at June 30, 2017, the Company had no FDIC indemnification asset.
• The fair value of servicing asset is estimated by using a cash flow valuation model which calculates the present value of estimated future net servicing cash flows, taking into consideration actual and expected loan prepayment rates, discount rates, servicing costs, and other economic factors, which are determined based on current market conditions.
• The fair values of the derivative instruments are provided by valuation experts and counterparties. Certain derivatives with limited market activity are valued using externally developed models that consider unobservable market parameters. In the past, the Company offered its customers certificates of deposit with an option tied to the performance of the S&P Index and used equity indexed option agreements with major broker-dealers to manage its exposure to changes in this index. Their fair value was obtained through the use of an external based valuation that was thoroughly evaluated and adopted by management as its measurement tool for these options. The payoff of these options was linked to the average value of the S&P Index on a specific set of dates during the life of the option. The methodology used an average rate option or a cash-settled option whose payoff was based on the difference between the expected average value of the S&P Index during the remaining life of the option and the strike price at inception. The assumptions, which were uncertain and required a degree of judgment, included primarily S&P Index volatility, forward interest rate projections, estimated index dividend payout, and leverage. At June 30, 2017, there were no options tied to S&P Index outstanding.
• Fair value of derivative liabilities, which include interest rate swaps and forward-settlement swaps, are based on the net discounted value of the contractual projected cash flows of both the pay-fixed receive-variable legs of the contracts. The projected cash flows are based on the forward yield curve, and discounted using current estimated market rates.
• The fair value of the loan portfolio (including loans held-for-sale) is estimated by segregating by type, such as mortgage, commercial, consumer, auto and leasing. Each loan segment is further segmented into fixed and adjustable interest rates and by performing and non-performing categories. The fair value of performing loans is calculated by discounting contractual cash flows, adjusted for prepayment estimates (voluntary and involuntary), if any, using estimated current market discount rates that reflect the credit and interest rate risk inherent in the loan. This fair value is not currently an indication of an exit price as that type of assumption could result in a different fair value estimate. Non-performing loans have been valued at the carrying amounts.
• The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is based on the discounted value of the contractual cash flows, using estimated current market discount rates for deposits of similar remaining maturities.
• The fair value of long-term borrowings, which include securities sold under agreements to repurchase, advances from FHLB, and subordinated capital notes is based on the discounted value of the contractual cash flows using current estimated market discount rates for borrowings with similar terms, remaining maturities and put dates.
89
NOTE 20 – BUSINESS SEGMENTS
The Company segregates its businesses into the following major reportable segments of business: Banking, Wealth Management, and Treasury. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Company’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Company measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production, and fees generated. The Company’s methodology for allocating non-interest expenses among segments is based on several factors such as revenue, employee headcount, occupied space, dedicated services or time, among others. These factors are reviewed on a periodical basis and may change if the conditions warrant.
Banking includes the Bank’s branches and traditional banking products such as deposits and commercial, consumer and mortgage loans. Mortgage banking activities are carried out by the Bank’s mortgage banking division, whose principal activity is to originate mortgage loans for the Company’s own portfolio. As part of its mortgage banking activities, the Company may sell loans directly into the secondary market or securitize conforming loans into mortgage-backed securities.
Wealth Management is comprised of the Bank’s trust division, Oriental Financial Services, Oriental Insurance, and OPC. The core operations of this segment are financial planning, money management and investment banking, brokerage services, insurance sales activity, corporate and individual trust and retirement services, as well as retirement plan administration services.
The Treasury segment encompasses all of the Company’s asset/liability management activities, such as purchases and sales of investment securities, interest rate risk management, derivatives, and borrowings. Intersegment sales and transfers, if any, are accounted for as if the sales or transfers were to third parties, that is, at current market prices.
Following are the results of operations and the selected financial information by operating segment for the quarters and six-month periods ended June 30, 2017 and 2016:
Wealth
Total Major
Consolidated
Banking
Management
Segments
Eliminations
Interest income
77,019
8,903
Interest expense
(6,820)
(3,557)
(10,377)
70,199
5,346
Provision for loan and lease losses
(26,526)
(26,536)
Non-interest income
11,776
6,329
6,781
Non-interest expenses
(47,402)
(4,100)
(1,314)
(52,816)
Intersegment revenue
346
417
(417)
Intersegment expenses
(254)
8,322
1,993
10,782
5,490,287
22,531
1,692,603
7,205,421
(969,595)
8,217
(7,300)
(7,296)
(14,596)
72,375
921
(14,445)
8,214
6,910
(47,097)
(4,908)
(1,820)
(53,825)
389
438
(438)
(49)
(286)
19,387
1,732
(922)
5,829,987
19,054
1,800,838
7,649,879
(937,283)
6,712,596
91
154,592
17,496
(13,634)
(8,303)
(21,937)
140,958
9,193
(44,168)
(44,190)
Non-interest income, net
25,003
12,257
6,700
(93,456)
(8,320)
(2,724)
(104,500)
810
142
952
(952)
(142)
(565)
(245)
29,005
3,402
13,044
18,353
(14,107)
(16,820)
(30,927)
146,720
1,533
(28,234)
12,930
(281)
(97,786)
(7,853)
(3,043)
(108,682)
787
936
(936)
(149)
(577)
(210)
Income (loss) before income taxes
37,347
4,534
(1,852)
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the “Selected Financial Data” and the Company’s consolidated financial statements and related notes. This discussion and analysis contains forward-looking statements. Please see “Forward-Looking Statements” and the risk factors set forth in our Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”), for discussion of the uncertainties, risks and assumptions associated with these statements.
The Company is a publicly-owned financial holding company that provides a full range of banking and financial services through its subsidiaries, including commercial, consumer, auto and mortgage lending; checking and savings accounts; financial planning, insurance and securities brokerage services; and corporate and individual trust and retirement services. The Company operates through three major business segments: Banking, Wealth Management, and Treasury, and distinguishes itself based on quality service. The Company has 48 branches in Puerto Rico and a subsidiary in Boca Raton, Florida. The Company’s long-term goal is to strengthen its banking and financial services franchise by expanding its lending businesses, increasing the level of integration in the marketing and delivery of banking and financial services, maintaining effective asset-liability management, growing non-interest revenue from banking and financial services, and improving operating efficiencies.
The Company’s diversified mix of businesses and products generates both the interest income traditionally associated with a banking institution and non-interest income traditionally associated with a financial services institution (generated by such businesses as securities brokerage, fiduciary services, investment banking, insurance agency, and retirement plan administration). Although all of these businesses, to varying degrees, are affected by interest rate and financial market fluctuations and other external factors, the Company’s commitment is to continue producing a balanced and growing revenue stream.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a summary of our significant accounting policies in “Note 1—Summary of Significant Accounting Policies” of our 2016 Form 10-K.
In the “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” section of our 2016 Form 10-K, we identified the following accounting policies as critical because they require significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition:
•
Loans and lease receivables
Financial instruments
We evaluate our critical accounting estimates and judgments on an ongoing basis and update them as necessary based on changing conditions. Management has reviewed and approved these critical accounting policies and has discussed its judgments and assumptions with the Audit Committee of our Board of Directors. There have been no material changes in the methods used to formulate these critical accounting estimates from those discussed in our 2016 Form 10-K.
OVERVIEW OF FINANCIAL PERFORMANCE
SELECTED FINANCIAL DATA
Variance
%
EARNINGS DATA:
-2.2%
-4.0%
-28.9%
-29.1%
3.1%
1.3%
83.7%
56.5%
Net interest income after provision for loan
and lease losses
-16.7%
-11.7%
64.2%
53.4%
-1.9%
-3.8%
Income before taxes
4.5%
13.5%
-31.8%
14.6%
19.3%
13.1%
(3,467)
0.0%
10,872
25.4%
17.4%
PER SHARE DATA:
20.0%
18.4%
16.3%
0.1%
Cash dividends declared per common share
Cash dividends declared on common shares
2,640
2,639
5,277
5,272
PERFORMANCE RATIOS:
Return on average assets (ROA)
1.09%
0.85%
28.2%
1.02%
0.83%
22.9%
Return on average tangible common equity
8.01%
6.70%
19.6%
7.51%
6.69%
12.3%
Return on average common equity (ROE)
7.06%
5.86%
20.5%
6.61%
5.85%
13.0%
Equity-to-assets ratio
15.06%
13.64%
10.4%
Efficiency ratio
56.49%
58.76%
-3.9%
56.32%
59.16%
-4.8%
Interest rate spread
5.10%
4.55%
12.1%
5.07%
4.60%
10.2%
Interest rate margin
5.18%
4.65%
11.4%
5.14%
4.68%
9.8%
SELECTED FINANCIAL DATA - (Continued)
PERIOD END BALANCES AND CAPITAL RATIOS:
Investments and loans
-10.3%
Loans and leases, net
-1.3%
Total investments and loans
5,313,513
5,510,203
-3.6%
Deposits and borrowings
-1.8%
-30.6%
173,800
141,598
22.7%
Total deposits and borrowings
5,209,978
5,459,841
-4.6%
Stockholders’ equity
Preferred stock
Common stock
4.2%
9.5%
Treasury stock, at cost
0.3%
Accumulated other comprehensive (loss) income
-119.2%
Total stockholders' equity
2.0%
Per share data
Book value per common share
17.59
17.18
2.4%
Tangible book value per common share
15.51
15.08
2.9%
Market price at end of period
10.00
13.10
-23.7%
Capital ratios
Leverage capital
5.4%
Common equity Tier 1 capital ratio
4.3%
Tier 1 risk-based capital
Total risk-based capital
4.1%
Financial assets managed
Trust assets managed
2,943,559
2,850,494
3.3%
Broker-dealer assets gathered
2,275,589
2,350,718
-3.2%
FINANCIAL HIGHLIGHTS OF THE SECOND QUARTER OF 2017
• Net income available to shareholders increased. The Company reported $13.6 million, or $0.30 per share fully diluted, compared to $11.7 million, or $0.26 per share fully diluted, in the first quarter of 2017 and $10.9 million, or $0.25 per share fully diluted, in the year ago quarter.
• Puerto Rico municipality exposure reduced. The Company opportunistically sold a $38.0 million performing term loan with a municipality, resulting in a $4.3 million pre-tax loss. The sale reduced its exposure to this sector by approximately 27% from March 31, 2017, to $140.8 million after scheduled principal payments in July.
• Balance sheet de-levered further. The Company unwound a 1.48% $100.0 million repurchase agreement, in line with its strategy to reduce borrowings. Related to this, the Company sold $166.0 million of mortgage backed securities. These transactions resulted in a tax-advantaged gain of $6.9 million.
• Effective tax rate optimized. The Company now forecasts its 2017 effective tax rate to be 29.15% as compared to its previously stated 38% estimate. The new rate is similar to its 2016 rate and resulted in a $2.1 million beneficial adjustment to estimated income tax in the second quarter of 2017.
• Net interest margin (NIM) improved. Due to a significant reduction in the cost of borrowings and higher yields on variable rate commercial loans and on cash, NIM increased 8 basis points from the first quarter of 2017 to 5.18%.
• Credit quality and major performance ratios remained solid. The non-performing loan and total delinquency rates fell to the lowest levels in the last five quarters. Return on average assets was 1.09%, return on average tangible common stockholders’ equity was 8.01%, and the efficiency ratio was 56.49%.
• Capital buildup continued. All major capital metrics advanced compared to the preceding and year ago quarters. Tangible book value per common share at $15.51 was up 1.2% and 3.7%, respectively, while tangible common equity ratio at 11.09% was up 43 and 117 basis points, respectively
ANALYSIS OF RESULTS OF OPERATIONS
The following tables show major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the quarters and six-month periods ended June 30, 2017 and 2016:
TABLE 1 - ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
FOR THE QUARTERS ENDED JUNE 30, 2017 AND 2016
Interest
Average rate
Average balance
June
A - TAX EQUIVALENT SPREAD
Interest-earning assets
5.89%
5.57%
5,848,525
6,328,161
Tax equivalent adjustment
1,302
1,422
0.09%
Interest-earning assets - tax equivalent
87,242
89,330
5.98%
5.66%
Interest-bearing liabilities
0.79%
5,293,848
5,751,529
Tax equivalent net interest income / spread
76,865
74,734
5.19%
4.64%
554,677
576,632
Tax equivalent interest rate margin
5.27%
4.74%
B - NORMAL SPREAD
Interest-earning assets:
7,746
7,621
1,334,938
1,311,468
Interest bearing cash and money market investments
956
612
1.00%
0.48%
384,037
512,916
8,702
8,233
2.03%
1.81%
1,718,975
1,824,384
Non-acquired loans
9,411
9,851
5.40%
5.31%
698,782
743,516
16,688
15,824
5.33%
4.43%
1,256,827
1,433,944
8,075
6,548
11.06%
10.68%
292,739
246,003
19,275
16,885
9.63%
9.59%
803,201
706,107
Total non-acquired loans
53,449
49,108
7.03%
3,051,549
3,129,570
Acquired BBVAPR
7,694
8,294
5.52%
545,490
602,184
4,517
6,572
7.31%
7.69%
247,815
342,752
2,847
3,173
18.19%
60,317
69,949
2,694
5,605
11.27%
10.44%
95,857
215,321
Total acquired BBVAPR loans
17,752
23,644
7.50%
7.71%
949,479
1,230,206
Acquired Eurobank
6,037
6,923
18.84%
19.29%
128,522
144,001
7.10%
4,129,550
4,503,777
Total interest earning assets
Interest-bearing liabilities:
NOW Accounts
1,051
1,518
0.39%
0.51%
1,080,135
1,195,895
Savings and money market
1,485
1,308
0.52%
1,151,650
1,103,808
380
464
0.63%
0.69%
242,009
269,417
Retail certificates of deposits
1,769
1.26%
571,266
468,750
4,685
0.62%
3,045,060
3,037,870
Institutional deposits
653
1.17%
223,788
243,592
2,084
1,816
1.45%
1.19%
575,642
612,137
Total wholesale deposits
2,737
2,436
1.39%
1.14%
799,430
855,729
7,422
7,200
0.77%
0.74%
3,844,490
3,893,599
Non-interest bearing deposits
0.00%
835,026
810,177
Deposits fair value premium amortization
(91)
Core deposit intangible amortization
230
258
0.66%
4,679,516
4,703,776
1.47%
2.72%
472,338
627,693
2.30%
2.65%
105,911
317,191
4.27%
3.40%
102,869
2,725
7,229
1.78%
2.77%
614,332
1,047,753
Total interest bearing liabilities
Net interest income / spread
Excess of average interest-earning assets
over average interest-bearing liabilities
Average interest-earning assets to average
interest-bearing liabilities ratio
110.48%
110.03%
C - CHANGES IN NET INTEREST INCOME DUE TO:
Volume
Interest Income:
(476)
469
(7,363)
4,926
(7,839)
5,871
(1,968)
Interest Expense:
(38)
323
285
Repurchase agreements
(1,054)
(1,470)
(2,524)
(1,967)
(1,980)
(3,059)
(1,160)
(4,219)
Net Interest Income
(4,780)
7,031
2,251
TABLE 1A - ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
5,887,429
6,352,229
0.05%
0.08%
173,540
181,802
5.95%
5.74%
1.06%
5,346,194
5,861,471
151,603
150,875
541,235
490,758
4.76%
15,415
17,110
2.31%
2.49%
1,347,160
1,380,489
8.50%
12.33%
309
1,801
1,258
0.89%
0.50%
407,442
507,817
17,230
18,387
1.98%
1.95%
1,754,934
1,888,615
18,932
19,456
5.20%
705,167
749,904
32,685
31,238
4.38%
1,251,179
1,429,638
15,722
12,734
11.08%
10.63%
286,149
240,251
38,065
33,595
9.70%
9.69%
791,008
695,071
105,404
97,023
7.01%
6.25%
3,033,503
3,114,864
15,585
16,601
552,177
597,212
9,500
14,268
7.56%
8.73%
253,286
327,810
5,779
6,276
19.04%
18.20%
61,207
69,164
5,973
12,175
11.52%
106,895
211,986
36,837
49,320
7.63%
8.20%
973,566
1,206,172
12,647
14,484
20.33%
20.37%
125,425
142,578
7.23%
4,132,494
4,463,614
5,887,428
2,092
2,600
0.44%
1,086,228
1,173,975
2,966
2,706
0.49%
1,157,811
1,109,680
966
0.72%
247,785
268,238
3,418
2,813
1.27%
556,568
443,371
9,282
9,085
0.65%
0.61%
3,048,392
2,995,264
1,274
1.16%
223,991
256,699
3,969
3,804
575,098
673,231
5,263
5,078
1.33%
1.10%
799,089
929,930
14,545
14,163
0.76%
3,847,481
3,925,194
833,852
792,564
460
4,681,333
4,717,758
1.92%
2.91%
523,272
713,653
2.66%
105,506
327,278
4.20%
102,782
6,932
16,436
2.10%
2.88%
664,861
1,143,713
Excess of average interest-earning assets over
average interest-bearing liabilities
490,759
110.12%
108.37%
(1,301)
144
(1,157)
(12,374)
6,435
(5,939)
(13,675)
6,579
(7,096)
(112)
626
(2,763)
(2,616)
(5,379)
(4,077)
(48)
(4,125)
(6,952)
(2,038)
(8,990)
(6,723)
8,617
1,894
Net interest income is a function of the difference between rates earned on the Company’s interest-earning assets and rates paid on its interest-bearing liabilities (interest rate spread) and the relative amounts of its interest earning assets and interest-bearing liabilities (interest rate margin). The Company constantly monitors the composition and re-pricing of its assets and liabilities to maintain its net interest income at adequate levels.
Comparison for the quarters ended June 30, 2017 and 2016
Table 1 above shows the major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the quarters ended June 30, 2017 and 2016.
Net interest income of $75.6 million increased 3.1%, or $2.3 million, from $73.3 million, reflecting a decrease in interest expenses of 28.9%, or $4.2 million, partially offset by a decrease in interest income of 2.2%, or $2.0 million.
The decrease in interest expenses was primarily a result of the repayment at maturity of (i) a $232.0 million 4.78% repurchase agreement in March 2017 that generated interest expense savings of $2.5 million and (ii) $227.0 million of short term FHLB advances during the second quarter of 2016 that generated interest expense savings of $1.5 million. The decrease in interest expenses was partially offset by an increase in the deposit interest expense of $285 thousand.
The decrease in interest income was caused primarily by a decrease of $6.8 million in the interest income from the acquired BBVAPR and Eurobank loan portfolios as such loans continue to be repaid. This decrease was partially offset by an increase of $4.3 million in the interest income from originated loans from higher yields in the commercial and retail loan portfolios and an increase of $469 thousand in the interest income from investments as a result of increased yields on interest bearing cash and money market investments.
Interest rate spread increased 55 basis points from 4.55% to 5.10%. This increase is mainly due to the net effect of a 32 basis point increase in the average yield of interest-earning assets from 5.57% to 5.89% and to 23 basis point decrease in average costs of interest-bearing liabilities from 1.02% to 0.79%.
Interest income decreased to $85.9 million from $87.9 million. Such decrease reflected a decrease of $7.8 million from a lower volume of interest-earning assets, partially offset by an increase of $5.9 million from higher interest rates on interest-earning assets. Interest income from loans decreased 3.1% to $77.2 million, reflecting a decrease of $7.4 million from a lower volume of loans, partially offset by an increase of $4.9 million from higher interest rates. Interest income from investments increased 5.7% to $8.7 million, reflecting an increase of $945 thousand attributable to higher interest rates on cash balances and a decrease of $476 thousand attributable to a lower volume.
The average balance of total interest-earning assets was $5.849 billion, a decrease of 7.6% from the same period in 2016. The average balances of loans and investments decreased 8.3% and 5.8%, respectively, reflecting a decrease in the average acquired loan portfolio of $296.2 million due to repayments and maturities and the sale of $166.0 million mortgage-backed securities and $39.2 million US Treasury securities during the quarter ended June 30, 2017.
Interest expense decreased to $10.4 million from $14.6 million, due to the decreases of $3.1 million and $1.2 million in the volume and interest rate of interest-bearing liabilities, respectively. The decreased volume and rate of repurchase agreements decreased interest expenses by $1.1 million and $1.5 million, respectively, and the decrease in the volume of other borrowings decreased interest expenses by $2.0 million. The decrease in interest expenses was partially offset by an increase of $285 thousand in deposit interest expenses from higher interest rates. The total cost of borrowings decreased 99 basis points to 1.78% from 2.77%. The cost of deposits slightly increased 6 basis point to 0.66%, when compared to 0.60% for the same period in 2016.
Comparison of six-month periods ended June 30, 2017 and 2016
Table 1A above shows the major categories of interest-earning assets and interest-bearing liabilities, their respective interest income, expenses, yields and costs, and their impact on net interest income due to changes in volume and rates for the six-month periods ended June 30, 2017 and 2016.
Net interest income of $150.2 million increased 1.3%, or $1.8 million, from $148.3 million, reflecting a decrease in interest expense of 29.1%, or $9.0 million, partially offset by a decrease in interest income of 4.0%, or $7.1 million.
The decrease in interest expenses was primarily a result of the repayment (i) of $268.0 million in part in February 2016 and $232.0 million at maturity in March 2017 of a 4.78% repurchase agreement that generated interest expense savings of $5.4 million and (ii) of $227 million at maturity of short term FHLB advances classified as other borrowings during the quarter that generated interest expense savings of $3.1 million. The decrease in interest expenses was partially offset by an increase in the deposit interest expense of $514 thousand.
The decrease in interest income was caused primarily by a decrease of $14.3 million in the interest income from the acquired BBVAPR and Eurobank loan portfolios as such loans continue to be repaid. This decrease was partially offset by an increase of $8.4 million in the interest income from originated loans from higher yields in the commercial and retail loan portfolios. Interest income from investments decreased $1.2 million in the as a result of a decrease in the investment securities portfolio volume.
Interest rate spread increased 47 basis points from 4.60% to 5.07%. This increase is mainly due to the net effect of a 24 basis point increase in the average yield of interest-earning assets from 5.66% to 5.90% and to 23 basis point decrease in average costs of interest-bearing liabilities from 1.06% to 0.83%.
Interest income decreased to $172.1 million from $179.2 million. Such decrease reflects a decrease of $13.0 million from a lower volume of interest-earning assets, partially offset by an increase of $5.9 million from higher interest rates on interest-earning assets. Interest income from loans decreased 3.7% to $154.9 million, reflecting a decrease of $11.7 million from a lower volume of loans, partially offset by an increase of $5.8 million from higher interest rates. Interest income from investments decreased 6.3% to $17.2 million, reflecting a decrease of $1.3 million attributable to a lower volume and an increase of $144 thousand attributable to higher interest rates on interest bearing cash and money market investments.
The average balance of total interest-earning assets was $5.887 billion, a decrease of 7.3% from the same period in 2016. The average balances of loans and investments decreased 7.4% and 7.1%, respectively, reflecting a decrease in the average acquired loan portfolio of $250.0 million due to repayments and maturities, a decrease in the average originated loan portfolio of $81.4 million as a result of the sale of the $200 million participation in the PREPA line of credit in the fourth quarter of 2016. The decrease in average investments reflects the sale of $166.0 million mortgage-backed securities and $39.2 million US Treasury securities during the second quarter of 2017.
Interest expense decreased to $21.9 million from $30.9 million, due to the decreases of $7.0 million and $2.0 million from decreases in the volume and interest rate of interest-bearing liabilities, respectively. The decreased volume and rate of repurchase agreements decreased interest expenses by $2.8 million and $2.6 million, respectively, and the decrease in the volume of other borrowings decreased interest expenses by $4.1 million. The decrease in interest expenses was partially offset by an increase of $514 thousand in deposit interest expenses from higher interest rates. The total cost of borrowings decreased 78 basis points to 2.10% from 2.88%. The cost of deposits slightly increased 3 basis point to 0.65%, when compared to 0.62% for the same period in 2016.
102
TABLE 2 - NON-INTEREST INCOME SUMMARY
2.3%
3.7%
-7.5%
-3.5%
-6.3%
-17.7%
Total banking and financial service revenue
-0.1%
100.0%
118.8%
Sale of securities available for sale
3165.9%
-43.5%
320.0%
892.3%
-100.0%
99.3%
33.3%
-44.0%
6,953
(3,129)
322.2%
8,599
(6,751)
227.4%
Non-Interest Income
Non-interest income is affected by the level of trust assets under management, transactions generated by clients’ financial assets serviced by the securities broker-dealer and insurance agency subsidiaries, the level of mortgage banking activities, and the fees generated from loans and deposit accounts.
Comparison of quarters ended June 30, 2017 and 2016
As shown in Table 2 above, the Company recorded non-interest income, net, in the amount of $24.9 million, compared to $15.2 million, an increase of 64.2%, or $9.7 million.
Banking service revenue, which consists primarily of fees generated by deposit accounts, electronic banking services, and customer services increased 2.3% to $10.5 million from $10.2 million. The increase is mainly due to an increase in account analysis services fees of $163 thousand and an increase in debit card interchange income fees of $81 thousand.
Wealth management revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, decreased 7.5% to $6.5 million, as compared to $7.0 million in the same period in 2016. Such decrease reflects a reduction in securities brokerage activities and the liquidation of the Puerto Rico Cash & Money Market Fund on April 3, 2017. Client trading volume in the broker-dealer subsidiary continued its downward trend due to the general investor uncertainty in the Puerto Rico market.
Income generated from mortgage banking activities decreased 6.3% to $959 thousand, compared to $1.0 million, mainly from the decrease in price of the mortgage servicing asset.
During the second quarter of 2017, the Company took advantage of the market conditions and sold $166.0 million of its mortgage-backed securities, generating a gain of $6.9 million. As a result of this sale, the Company repaid before maturity $100 million of repurchase agreements at a cost of $80 thousand.
The Company recorded non-interest income, net in the amount of $44.0 million, compared to $28.7 million for the same period in 2016, an increase of 53.4%, or $15.3 million.
Banking service revenue, which consists primarily of fees generated by deposit accounts, electronic banking services, and customer services, increased 3.7% to $21.1 million, from $20.3 million for the same period in 2016. The increase is mainly due to increases in account analysis services fees of $426 thousand, debit card interchange income of $230 thousand, and card management service fees of $106 thousand.
Wealth management revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, decreased 3.5% to $12.7 million, as compared to $13.2 million in the same period in 2016. Such decrease reflects a reduction in securities brokerage activities and the liquidation of the Puerto Rico Cash & Money Market Fund on April 3, 2017. Client trading volume in the broker-dealer subsidiary continued its downward trend due to the general investor uncertainty in the Puerto Rico market.
Income generated from mortgage banking activities decreased 17.7% to $1.5 million, compared to $1.9 million, mainly from the decrease in price of the mortgage servicing asset.
During the six-month period ended June 30, 2017, the Company entered into an agreement with the FDIC to terminate two shared-loss agreements covering certain assets, resulting in a benefit of $1.4 million, recorded in the consolidated statement of operations. During the six-month period ended 2016, the Company recorded expenses of $7.4 million related to the FDIC shared-loss agreement.
During the six-month period ended June 30, 2017, the Company took advantage of market conditions and sold $166.0 million of its mortgage-backed securities, generating a gain of $6.9 million. As a result of this sale, the Company unwound $100 million of repurchase agreements at a cost of $80 thousand, included as a loss on early extinguishment of debt in the consolidated statements of operations. During the same period in 2016, the Company sold $277.2 million in mortgage-backed securities and $11.1 million in Puerto Rico government bonds, resulting in a gain of $12.2 million. This transaction resulted in the repayment before maturity of $268.0 million of a repurchase agreement at a cost of $12.0 million, included as a loss on early extinguishment of debt in the consolidated statements of operations.
104
TABLE 3 - NON-INTEREST EXPENSES SUMMARY
Variance %
4.8%
2.5%
14.8%
11.5%
7.2%
0.8%
-62.5%
-55.9%
-1.7%
28.8%
24.7%
5.2%
-57.1%
-48.9%
-35.4%
-40.0%
2.7%
-4.7%
31.0%
7.6%
Printing, postage, stationery and supplies
10.8%
-9.0%
-4.3%
0.6%
8.6%
Other operating expenses
63.1%
47.1%
Total non-interest expenses
Relevant ratios and data:
Compensation and benefits to
non-interest expense
36.57%
34.43%
37.96%
35.71%
Compensation to average total assets owned (annualized)
1.23%
1.25%
Average number of employees
1,449
1,460
Average compensation per employee
13.21
12.80
27.4
26.6
Average loans per average employee
2,825
3,104
2,854
3,057
105
Non-Interest Expenses
Non-interest expense was $52.8 million, representing a decrease of 1.9% compared to $53.8 million.
Loss on sale of foreclosed real estate and other repossessed assets decreased 57.1% to $1.8 million, as compared to $4.2 million in the second quarter of 2016 due to lower markdowns, $1.5 million in savings resulting from the loss-share termination, and to fewer losses on the sale of foreclosed real estate and other repossessed assets.
Insurance expense decreased $2.0 million, to $1.2 million, as a result of a change in the calculation method of the FDIC Savings Association Insurance Fund (SAIF) insurance that became effective during the third quarter of 2016.
Loan servicing and clearing expenses decreased $696 thousand, mainly due to a reduction of $611 thousand in mortgage servicing expense from the migration to in-house servicing during 2016.
The decreases in the foregoing non-interest expenses were partially offset by increases in compensation and employee benefits, in occupancy and equipment expenses, and in electronic banking charges.
Compensation and employee benefits increased $876 thousand, mainly due to an increase in provision for bonus of $936 thousand from an increase in average employees.
Occupancy and equipment expenses increased $583 thousand, primarily due to costs associated with consolidating office space during the second quarter of 2017.
Electronic banking charges increased $503 thousand, primarily as a result of an increase of $538 thousand in credit cards processing services.
The efficiency ratio improved to 56.49% from 58.76%. The efficiency ratio measures how much of the Company’s revenues is used to pay operating expenses. The Company computes its efficiency ratio by dividing non-interest expenses by the sum of its net interest income and non-interest income, but excluding gains on the sale of investment securities, derivatives gains or losses, FDIC shared-loss benefit/expense, losses on the early extinguishment of debt, other gains and losses, and other income that may be considered volatile in nature. Management believes that the exclusion of those items permits consistent comparability. Amounts presented as part of non-interest income (losses) that are excluded from efficiency ratio computation for the quarters ended June 30, 2017 and 2016 amounted to $7.0 million income and a $3.1 million loss, respectively.
Non-interest expense for the six-month period ended June 30, 2017 was $104.5 million, representing a decrease of 3.8% compared to $108.7 million.
Insurance expense decreased $3.5 million, to $2.8 million, as a result of a change in the calculation method of the FDIC Savings Association Insurance Fund (SAIF) insurance. The change was effective beginning with the June 30, 2016 invoice, which was received during the third quarter of 2016.
Loss on sale of foreclosed real estate and other repossessed assets decreased 48.9% to $3.1 million, as compared to $6.1 million in the same period for the previous year due to lower markdowns, $2.2 million in savings resulting from the loss-share termination, and to decrease in losses on the sale of foreclosed real estate.
Loan servicing and clearing expenses decreased $1.6 million, mainly due to a reduction in the mortgage servicing expense of $1.6 million from the migration to in-house servicing during 2016.
The decreases in the foregoing non-interest expenses were partially offset by increases in compensation and employee benefits, professional and service fees, information technology expenses, and other operating expenses.
Compensation and employee benefits increased $968 thousand, mainly due to an increase in provision for bonus of $1.1 million, mainly related to an adjustment made in the second quarter of 2016 from a decrease in average employees.
Professional and service fees increased 11.5% or $667 thousand to $6.5 million, mostly due to increases of $570 thousand and $168 thousand in collection agencies expense, and in consulting and outsourcing expenses, respectively.
Information and technology expenses increased $806 thousand to $4.1 million, mostly due to $703 thousand increase in data processing expenses.
Other operating expenses increased $1.2 million, mainly from an increase of $200 thousand in broker-dealer legal contingencies, and $534 thousand from a commercial loan repurchased during the six-month period ended June 30, 2017.
The efficiency ratio was 56.32% compared to 59.16% for the same period in 2016. The efficiency ratio measures how much of the Company’s revenues is used to pay operating expenses. The Company computes its efficiency ratio by dividing non-interest expenses by the sum of its net interest income and non-interest income, but excluding gains on the sale of investment securities, derivatives gains or losses, FDIC shared-loss expense, losses on the early extinguishment of debt, other gains and losses, and other income that may be considered volatile in nature. Management believes that the exclusion of those items permits consistent comparability. Amounts presented as part of non-interest income (losses) that are excluded from the efficiency ratio computation for the six-month period ended June 30, 2017 amounted to income of $8.6 million, compared to losses of $6.8 million for the six-month period ended June 30, 2016.
Provision for Loan and Lease Losses
Provision for loan and lease losses increased 83.7%, or $12.1 million, to $26.5 million. Based on an analysis of the credit quality and the composition of the Company’s loan portfolio, management determined that the provision for the quarter was adequate to maintain the allowance for loan and lease losses at an appropriate level to provide for probable losses based upon an evaluation of known and inherent risks.
Provision for originated and other loan and lease losses increased 152.2%, or $13.8 million, to $22.8 million from $9.1 million, mainly from the increase in the provision for commercial loans. The increase reflects the provision for commercial loans of $12.1 million, compared to a recapture of $457 thousand for the same quarter in 2016. Provisions for mortgage and consumer loans increased $1.1 million and $1.8 million, respectively. Increases in provision for originated and other loan and lease losses were partially offset by a decrease in provision for auto loans of $1.7 million.
On June 30, 2017, the Company was opportunistic and entered into an agreement to sell a performing originated municipal loan, which was due in July 2018, for $28.8 million. The sale, which closed on July 5, 2017 upon receipt of the sales proceeds, reduced near-term risk associated with a likely refinancing. A provision of $4.3 million was recorded in second quarter of 2017 to charge-off the loss on sale. The loan was moved to other loans held-for-sale at June 30, 2017 with a balance of $33.7 million, and included a principal payment of $4.8 million received by the Company in July 1, 2017. Based on the Company's allowance for loan and lease losses methodology for originated loans, the Company has a general reserve for the municipal loan portfolio, as they have particular risk characteristics. A loss in any of the loans in this portfolio will impact directly the general valuation reserve ("GVA") factor to be used for the determination of the allowance for loan and lease losses. As a result of the aforementioned loss on sale, another provision of $5.9 million was recorded for the general allowance on the municipal loan portfolio. The sale reduced the Company's exposure to this sector by approximately 27% from December 31, 2016, to $140.8 million after the municipal loan sale and scheduled principal payments received after the quarter-end. Such municipal loan exposure represents 2.3% of the Company's total assets at June 30, 2017, which is a level more in line with the Company's size. The composition of this balance is $90.0 million originated municipal loans with an allowance for loan losses of $7.1 million, and $50.8 million acquired municipal loans accounted for under ASC 310-30 with an allowance for loan losses of $557 thousand.
The increase in provision for commercial loans also reflected an $1.7 million increase in provision for loan losses from the growth of the originated loan portfolio.
Total charge-offs on originated and other loans increased 43.2% to $18.8 million, as compared to $13.1 million as a result of increases in commercial, consumer and mortgage charge-offs of $4.0 million, $1.2 million and $788 thousand, respectively. Increase in commercial charge-offs includes the $4.3 million loss on the aforementioned sale of the municipal loan. These increases in charge-offs were offset by a decrease in auto loan charge-offs of $325 thousand. Total recoveries on originated and other loans increased from $3.6 million to $5.2 million. Recoveries for 2017 included $1.1 million and $612 thousand from the sale of auto and consumer loans, respectively, previously fully charged-off. The net charge-off rate increased 58 basis points to 1.79%.
Provision for acquired loan and lease losses decreased 31.1%, or $1.7 million, to $3.7 million from $5.4 million. Provision for acquired BBVAPR loan and lease losses decreased $1.1 million to $3.3 million from $4.4 million. Provision for acquired Eurobank loan and lease losses decreased $619 thousand, as these loans continue to repay and mature.
Provision for loan and lease losses increased 56.5%, or $16.0 million, to $44.2 million. Based on an analysis of the credit quality and the composition of the Company’s loan portfolio, management determined that the provision for the quarter was adequate to maintain the allowance for loan and lease losses at an appropriate level to provide for probable losses based upon an evaluation of known and inherent risks.
Provision for originated and other loan and lease losses increased 75.3%, or $14.8 million, to $34.6 million from $19.7 million, mainly from the increase in the provision for commercial loans. This increase reflects the provision for commercial loans of $13.8 million, compared to a recapture of $119 thousand for the same period in 2016. Such provision includes $4.3 million recorded to charge-off the loss on sale of a municipal loan and another provision of $5.9 million recorded for the general allowance on the municipal loan portfolio. The increase in provision for commercial loans also reflected a $1.7 million increase in provision for loan losses from the growth of the originated loan portfolio. Also, provisions for consumer and mortgage loans increased $2.9 million and $2.7 million, respectively. Increases in provision for originated and other loan and lease losses were partially offset by a decrease in provision for auto loans of $4.1 million.
Total charge-offs on originated and other loans increased 24.8% to $32.9 million, as compared to $26.5 million as a result of increases in commercial, consumer and mortgage charge-offs of $3.9 million, $2.2 million and $1.5 million, respectively. The increase in commercial charge-offs includes the $4.3 million recorded to charge-off the loss on the aforementioned sale of the municipal loan. Increases in charge-offs were offset by a decrease in auto loan charge-offs of $1.1 million. Total recoveries on originated and other loans increased from $7.0 million to $8.8 million. Recoveries for 2017 included $1.1 million and $612 thousand from the sale of auto and consumer loans, respectively, previously fully charged-off. The net charge-off rate increased 34 basis points to 1.59%.
Provision for acquired loan and lease losses increased 13.1%, or $1.1 million, to $9.6 million from $8.5 million. Provision for acquired BBVAPR loan and lease losses increased $917 thousand to $7.6 million from $6.7 million. Provision for acquired Eurobank loan and lease losses increased $196 thousand, as these loans continue to repay and mature.
Income Taxes
Income tax expense was $4.0 million, compared to $5.9 million. The effective income tax rate decreased to 29.15% as a result of higher proportion of exempt income and income subject to preferential rates, mainly from to the gain on sale of investment securities available for sale during 2017.
108
Income tax expense was $13.2 million, compared to $11.5 million for the same period in 2016. Income tax expense reflects the net income before income taxes of $45.5 million for the six-month period ended June 30, 2017, compared to a net income before income taxes of $40.0 million for the same period of 2016.
Business Segments
The Company segregates its businesses into the following major reportable segments: Banking, Wealth Management, and Treasury. Management established the reportable segments based on the internal reporting used to evaluate performance and to assess where to allocate resources. Other factors such as the Company’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. The Company measures the performance of these reportable segments based on pre-established goals of different financial parameters such as net income, net interest income, loan production, and fees generated. The Company’s methodology for allocating non-interest expenses among segments is based on several factors such as revenue, employee headcount, occupied space, dedicated services or time, among others. Following are the results of operations and the selected financial information by operating segment for the quarters and six-month periods ended June 30, 2017 and 2016.
109
Provision for
loan and lease losses
Non-interest income (loss)
Net interest income of the Company’s Banking segment decreased $2.2 million, or 3.0%, reflecting a decrease of 3.1% in interest income from loans. Interest income from loans decreased to $77.0 million, reflecting a decrease of $7.6 million due to lower volume, partially offset by an increase of $4.9 million in from higher interest rates. Our loan portfolio is transitioning as originated loans with normal yields grow at a slower pace than higher-yielding acquired loans decline due to repayments and maturities.
Originated loans interest income increased 8.8% to $53.4 million, as average balances dropped 2.5% and yields increased to 7.03%, mainly from higher yields in commercial and retail categories. Acquired BBVAPR loans interest income declined 24.9% to $17.8 million as average balances declined 22.8% and yields decreased 21 basis points to 7.50%. Acquired Eurobank loans interest income fell 12.8% to $6.0 million as average balances declined 10.7% and yields decreased 45 basis points to 18.84%. The decline in acquired loans reflects continued pay downs, and periodic yield recasting.
Provision for loan and lease losses increased 83.7%, or $12.1 million, to $26.5 million, reflecting the increase in provision of commercial loans. Such provision includes $4.3 million recorded to charge-off the loss on sale of a municipal loan and another provision of $5.9 million recorded for the general allowance on municipal loan portfolio. The increase in provision for commercial loans also reflected an $1.7 million increase in provision for loan losses from the growth of the originated loan portfolio.
Non-interest income increased to $11.8 million, $3.6 million up from the same quarter in 2016. The increase was driven by the FDIC shared-loss agreement termination during the first quarter of 2017, compared to an expense of $3.4 million in the year ago quarter recorded for such agreement.
Non-interest expense of $47.4 million slightly increased 0.6%, primarily reflecting an increase in electronic banking charges of $503 thousand, as a result of an increase of $538 thousand in credit cards processing services.
Wealth Management
Wealth management segment revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, decreased $581 thousand to $6.3 million, compared to $6.9 million, mainly from changes in volume and market rates.
Non-interest expense of $4.1 million decreased $808 thousand, primarily reflecting a decrease in compensation expense from lower broker commissions.
Treasury's income before taxes, which consists of the Company's asset/liability management activities, such as purchase and sale of investment securities, interest rate risk management, derivatives, and borrowings, increased to $10.8 million, compared to a loss of $922 thousand.
Net interest income increased $4.4 million to $5.3 million, mainly from an increase in interest income and a reduction in interest expenses. Interest income from investments increased 5.7%, to $8.7 million, mainly attributable to higher interest rates on cash balances. Interest expense decreased $3.7 million to $3.6 million because of the drop in repurchase agreements from the payment at maturity of a $232.0 million repurchase agreement at 4.78% in March 2017. In addition, other borrowings balances decreased from the repayment at maturity of $227.0 million of short term FHLB advances during the second quarter of 2016. Total cost of borrowings decreased 99 basis points to 1.78% from 2.77%.
During the second quarter of 2017, the Company took advantage of the market conditions and sold $166.0 million of its mortgage-backed securities, generating a gain of $6.9 million. As a result of this sale, the Company repaid before maturity $100 million repurchase agreements at a cost of $80 thousand.
Net interest income of the Company’s Banking segment decreased $5.8 million, or 3.9%, reflecting a decrease of 3.9% in interest income from loans. Interest income from loans decreased $6.2 million to $154.6 million, reflecting a decrease of $11.7 million due to lower volume, partially offset by an increase of $5.5 million from higher interest rates.
Originated loans interest income increased 8.6% to $105.4 million, as average balances dropped 2.6% and yields increased to 7.01%, mainly from higher yields in commercial and retail categories. Acquired BBVAPR loans interest income declined 25.3% to $36.8 million as average balances declined 19.3% and yields decreased 57 basis points to 7.63%. Acquired Eurobank loans interest income fell 12.7% to $12.6 million as average balances declined 7.5% and yields decreased 107 basis points to 19.84%.
Provision for loan and lease losses increased 56.4%, or $15.9 million, to $44.2 million,reflecting the increase in provision of commercial loans. Such provision includes $4.3 million recorded to charge-off the loss on sale of a municipal loan and another provision of $5.9 million recorded for the general allowance on municipal loan portfolio. The increase in provision for commercial loans also reflected an $1.7 million increase in provision for loan losses from the growth of the originated loan portfolio.
Non-interest income increased to $25.0 million, $9.0 million up from the same period in 2016. The increase was mainly driven by the FDIC shared-loss agreement termination during the first quarter of 2017, in which the Company recorded a benefit of $1.4 million, compared to an expense of $7.4 million in the year ago quarter recorded for such agreement.
Non-interest expense of $93.5 million decreased 4.4%, primarily reflecting a decrease in loss on sale of foreclosed real estate and other repossessed assets, which decreased 48.9% to $3.1 million, as compared to $6.1 million in the same period for the previous year due to lower markdowns, $2.2 million in savings resulting from the loss-share termination, and to fewer losses on the sale of foreclosed real estate.
Wealth management segment revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, decreased $673 thousand to $12.3 million, compared to $12.9 million, mainly from changes in volume and market rates.
Non-interest expense of $8.3 million increased $467 thousand, primarily reflecting an increase in broker-dealer legal contingencies.
Treasury's income before taxes, which consists of the Company's asset/liability management activities, such as purchase and sale of investment securities, interest rate risk management, derivatives, and borrowings, increased to $13.0 million, compared to a loss of $1.9 million.
Net interest income increased $7.7 million to $9.2 million, mainly from a reduction in interest expenses. Interest income from investments decreased 6.3% to $17.2 million, reflecting a decrease from lower volume and interest rate of $1.3 million and $144 thousand, respectively. Interest expense reflects a decrease in repurchase agreements volume and rate of $2.8 million and of $2.6 million, respectively, and the decrease in other borrowings volume and rate of $4.1 million and $48 thousand, respectively. Decrease in repurchase agreements reflects the partial unwinding of $268.0 million repurchase agreement at 4.78% in February 2016 and the repayment at maturity of the remaining $232.0 million balance in March 2017. The decrease in other borrowings balances resulted from the repayment at maturity of $227.0 million of short term FHLB advances during the second quarter of 2016. Total cost of borrowings decreased 78 basis points to 2.10% from 2.88%.
During 2017, the Company took advantage of the market conditions and sold $166.0 million of its mortgage-backed securities, generating a gain of $6.9 million. As a result of this sale, the Company unwound $100 million of repurchase agreements at a cost of $80 thousand.
ANALYSIS OF FINANCIAL CONDITION
Assets Owned
At June 30, 2017, the Company’s total assets amounted to $6.236 billion representing a decrease of 4.1% when compared to $6.502 billion at December 31, 2016. This reduction is mainly due to a decrease in the investment portfolio of $140.9 million, a decrease in the loan portfolio of $55.8 million and a decrease in cash and cash equivalents of $33.1 million.
The Company's investment portfolio decreased $140.9 million from $1.363 billion at December 31, 2016 to $1.222 billion at June 30, 2017, reflecting decreases in investment securities available-for-sale portfolio by $102.0 million, mainly attributed to the sale of $166.0 million mortgage-backed securities during the six-month period ended June 30, 2017. There was also a decrease in investment securities held-to-maturity portfolio by $44.5 million primarily due to paydowns and premium amortizations of $41.9 million and $2.6 million, respectively.
The Company’s loan portfolio is comprised of residential mortgage loans, commercial loans collateralized by mortgages on real estate located in Puerto Rico, other commercial and industrial loans, consumer loans, and auto loans. At June 30, 2017, the Company’s loan portfolio decreased $55.8 million from $4.148 billion at December 31, 2016 to $4.092 billion. Our loan portfolio is transitioning as originated loans grow at a slower pace than acquired loans decrease, due to repayments and maturities. At June 30, 2017, loans held for sale, at fair value increased $35.2 million. The acquired BBVAPR loan portfolio decreased $108.9 million from December 31, 2016 to $899.0 million. The Eurobank acquired loan portfolio decreased $17.9 million from December 31, 2016 to $116.7 million at June 30, 2017. Mortgage loans held for sale increased to $14.0 million from $12.5 million on December 31, 2016. Other loans held for sale at June 30, 2017 included $33.6 million corresponding to a municipal loan which sale settled on July 5, 2017.
At June 30, 2017, loans represented 77% of total interest-earning assets while investments represented 23%, compared to December in which loans represented 75% of total interest-earning assets and investments represented 25%.
Financial Assets Managed
The Company’s financial assets include those managed by the Company’s trust division, retirement plan administration subsidiary, and assets gathered by its broker-dealer and insurance subsidiaries. The Company’s trust division offers various types of individual retirement accounts ("IRA"s) and manages 401(k) and Keogh retirement plans and custodian and corporate trust accounts, while the retirement plan administration subsidiary, OPC, manages private retirement plans. At June 30, 2017, total assets managed by the Company’s trust division and OPC amounted to $2.944 billion, compared to $2.850 billion at December 31, 2016. Oriental Financial Services offers a wide array of investment alternatives to its client base, such as tax-advantaged fixed income securities, mutual funds, stocks, bonds and money management wrap-fee programs. At June 30, 2017, total assets gathered by Oriental Financial Services and Oriental Insurance from its customer investment accounts amounted to $2.276 billion, compared to $2.351 billion at December 31, 2016. Changes in trust and broker-dealer related assets primarily reflect changes in portfolio balances and differences in market values.
Goodwill recorded in connection with the BBVAPR Acquisition and the FDIC-assisted Eurobank acquisition is not amortized to expense, but is tested at least annually for impairment. A quantitative annual impairment test is not required if, based on a qualitative analysis, the Company determines that the existence of events and circumstances indicate that it is more likely than not that goodwill is not impaired. The Company completes its annual goodwill impairment test as of October 31 of each year. The Company tests for impairment by first allocating its goodwill and other assets and liabilities, as necessary, to defined reporting units. A fair value is then determined for each reporting unit. If the fair values of the reporting units exceed their book values, no write-down of the recorded goodwill is necessary. If the fair values are less than the book values, an additional valuation procedure is necessary to assess the proper carrying value of the goodwill.
Reporting unit valuation is inherently subjective, with a number of factors based on assumptions and management judgments or estimates. Actual values may differ significantly from such estimates. Among these are future growth rates for the reporting units, selection of comparable market transactions, discount rates and earnings capitalization rates. Changes in assumptions and results due to economic conditions, industry factors, and reporting unit performance and cash flow projections could result in different assessments of the fair values of reporting units and could result in impairment charges. If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount, an interim impairment test is required.
Relevant events and circumstances for evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount may include macroeconomic conditions (such as a further deterioration of the Puerto Rico economy or the liquidity for Puerto Rico securities or loans secured by assets in Puerto Rico), adverse changes in legal factors or in the business climate, adverse actions by a regulator, unanticipated competition, the loss of key employees, or similar events. The Company’s loan portfolio, which is the largest component of its interest-earning assets, is concentrated in Puerto Rico and is directly affected by adverse local economic and fiscal conditions. Such conditions have generally affected the market demand for non-conforming loans secured by assets in Puerto Rico and, therefore, affect the valuation of the Company’s assets.
As of June 30, 2017, the Company had $86.1 million of goodwill allocated as follows: $84.1 million to the Banking unit and $2.0 million to the Wealth Management unit. During the last quarter of 2016, based on its annual goodwill impairment test, the Company determined that the Banking unit failed step one of the two-step impairment test and that the Wealth Management unit passed such step. As a result of step one; the Banking unit’s adjusted net book value exceeded its fair value by approximately $145.0 million, or 15%. Accordingly, the Company proceeded to perform step two of the analysis. Based on the results of step two, the Company determined that the carrying value of the goodwill allocated to the Banking unit was not impaired as of the valuation date. During the six-month period ended June 30, 2017, the Company performed an assessment of events or circumstances that could trigger reductions in the book value of the goodwill. Based on this assessment, no events were identified that triggered changes in the book value of goodwill at June 30, 2017.
115
TABLE 4 - ASSETS SUMMARY AND COMPOSITION
902,101
1,025,370
-12.0%
3,327
-14.3%
91,553
-10.1%
146,683
-11.2%
Puerto Rico government and public instrumentalities
6.6%
54.0%
-9.5%
297
-15.1%
Cash and due from banks (including restricted cash)
473,871
507,863
-6.7%
15.4%
5.7%
-2.1%
-6.4%
-0.8%
-28.0%
Other assets and customers' liability on acceptances
89,027
104,130
-14.5%
Total other assets
922,313
991,621
-7.0%
-4.1%
Investment portfolio composition:
73.7%
75.2%
3.6%
7.5%
12.0%
0.4%
1.4%
Other debt securities and other investments
0.2%
116
TABLE 5 — LOANS RECEIVABLE COMPOSITION
-3.1%
-0.5%
8.2%
6.7%
1.5%
-17.5%
1.2%
14.0%
-8.0%
-36.5%
-24.3%
22.1%
-24.4%
-4.4%
-9.1%
-49.7%
-32.2%
-8.5%
-20.7%
-10.8%
-3.7%
-17.9%
-11.1%
-2.4%
-13.3%
Mortgage loans held for sale
12.4%
Other loans held for sale
117
As shown in Table 5 above, total loans, net, amounted to $4.092 billion at June 30, 2017 and $4.148 billion at December 31, 2016. The Company’s originated and other loans held-for-investment portfolio composition and trends were as follows:
· Mortgage loan portfolio amounted to $699.3 million (22.6% of the gross originated loan portfolio) compared to $721.5 million (23.7% of the gross originated loan portfolio) at December 31, 2016. Mortgage loan production totaled $45.9 million and $89.4 million for the quarter and six-month period ended June 30, 2017, which represents a decrease of 20.4% and 15.7%, from $57.6 million and $106.0 million, respectively, for the same periods in 2016. Mortgage loans included delinquent loans in the GNMA buy-back option program amounting to $9.2 million and $9.7 million at June 30, 2017 and December 31, 2016, respectively. Servicers of loans underlying GNMA mortgage-backed securities must report as their own assets the defaulted loans that they have the option (but not the obligation) to repurchase, even when they elect not to exercise that option.
· Commercial loan portfolio amounted to $1.271 billion (41.1% of the gross originated loan portfolio) compared to $1.278 billion (42.0% of the gross originated loan portfolio) at December 31, 2016. Commercial loan production increased 21.3% to $80.4 million for the quarter ended June 30, 2017, from $66.3 million for the same period in 2016. However, for the six-month period ended June 30, 2017, the production decreased 12.9% to $126.8 million from $145.5 million for the same period in 2016.
· Consumer loan portfolio amounted to $314.3 million (10.2% of the gross originated loan portfolio) compared to $290.5 million (9.5% of the gross originated loan portfolio) at December 31, 2016. Consumer loan production increased 25.5% and 24.4% to $49.7 million and $91.8 million for the quarter and six-month period ended June 30, 2017, respectively, from $39.6 million and $73.8 million for the same periods in 2016.
· Auto and leasing portfolio amounted to $807.2 million (26.1% of the gross originated loan portfolio) compared to $756.4 million (24.8% of the gross originated loan portfolio) at December 31, 2016. Auto and leasing production increased by 5.6% and 19.3% to $78.6 million and $165.4 million for the quarter and six-month period ended June 30, 2017, respectively, compared to $74.4 million and $138.7 million for the same periods in 2016.
TABLE 6 — HIGHER RISK RESIDENTIAL MORTGAGE LOANS
Higher-Risk Residential Mortgage Loans*
High Loan-to-Value Ratio Mortgages
Junior Lien Mortgages
Interest Only Loans
LTV 90% and over
Delinquency:
0 - 89 days
2.61%
10,041
7.84%
74,909
1,525
90 - 119 days
217
3.69%
8.22%
120 - 179 days
10.95%
180 - 364 days
4.04%
456
25.57%
157
6.16%
15.75%
2,653
678
8,291
9.48%
10,742
3.09%
13,150
1,582
12.03%
86,654
2,551
2.94%
Percentage of total loans excluding
acquired loans accounted for under ASC 310-30
0.34%
0.42%
2.74%
Refinanced or Modified Loans:
9.71%
546
9.26%
16,718
6.87%
Percentage of Higher-Risk Loan
Category
19.50%
4.15%
Loan-to-Value Ratio:
Under 70%
195
2.80%
778
7.75%
70% - 79%
5.25%
2,886
268
9.29%
80% - 89%
11.37%
3,325
13.21%
90% and over
1,864
1.41%
6,161
815
13.22%
331
* Loans may be included in more than one higher-risk loan category and excludes acquired residential mortgage loans.
The following table includes the Company's lending and investment exposure to the Puerto Rico government, including its agencies, instrumentalities, municipalities and public corporations:
TABLE 7 - PUERTO RICO GOVERNMENT RELATED LOANS AND SECURITIES
Loans and Securities:
Carrying Value
Less than 1 Year
1 to 3 Years
More than 3 Years
Comments
Central government
10,613
The remaining balance is a loan to the Puerto Rico Housing Finance Authority ("PRHFA"). At June 30, 2017 the allowance for loan losses was $8.0 million. In July, PRHFA paid the Company $5.8 million to cancel the loan.
Municipalities
188,225
42,900
31,440
113,885
Secured by ad valorem taxation, without limitation as to rate or amount, on all taxable property within the issuing municipalities. The good faith, credit and unlimited taxing power of each issuing
municipality are pledged for the payment of its general obligations.
2,035
2,645
The remaining position is a PRHTA security maturing July 1, 2018 issued for P3 Project Teodoro Moscoso Bridge operated by private companies that have the payment obligation. A scheduled principal payment of $2.0 million was received on July 1, 2017
203,518
44,935
34,085
124,498
Some highlights follow regarding the data included above:
· At June 30, 2017, loans to municipalities included a $38.0 million loan classified as held for sale. The proceeds of the sale were received on July 5, 2017, and $13.8 million of scheduled principal payments were received in July.
· Deposits from the Puerto Rico government totaled $123.3 million at June 30, 2017.
Credit Risk Management
Allowance for Loan and Lease Losses
The Company maintains an allowance for loan and lease losses at a level that management considers adequate to provide for probable losses based upon an evaluation of known and inherent risks. The Company’s allowance for loan and lease losses policy provides for a detailed quarterly analysis of probable losses. At June 30, 2017, the Company’s allowance for loan and lease losses amounted to $132.3 million, a $16.4 million increase from $115.9 million at December 31, 2016.
Tables 8 through 12 set forth an analysis of activity in the allowance for loan and lease losses and present selected loan loss statistics. In addition, Table 5 sets forth the composition of the loan portfolio.
At June 30, 2017, $69.7 million of the allowance corresponded to originated and other loans held for investment, or 2.25% of total originated and other loans held for investment, compared to $59.3 million, or 1.95% of total originated and other loans held for investment at December 31, 2016. Provision for loan and lease losses of $34.6 million and recoveries of $8.8 million, were offset by charge-offs of $32.9 million during the six-month period ended June 30, 2017. The allowance for residential mortgage loans increased by 7.6% (or $1.3 million), when compared with the balances recorded at December 31, 2016. The allowance for commercial and consumer loans increased by 92.1% (or $8.3 million) and 14.6% (or $1.9 million), respectively, when compared with the balances recorded at December 31, 2016. The allowance for auto and leasing loans decreased 3.7% (or $721 thousand), when compared with the balances recorded at December 31, 2016.
Allowance for loan and lease losses recorded for acquired BBVAPR loans accounted for under the provisions of ASC 310-20 at June 30, 2017 was $3.3 million compared to $4.3 million at December 31, 2016, a 22.1% decrease. The allowance decreased as a result of $2.3 million in charge-offs and $92 thousand in recapture for loan and lease losses, which were partially offset by a $1.4 million of recoveries during the six-month period ended June 30, 2017. The allowance for commercial loans decreased by 75.7% (or $128 thousand), when compared with the balance recorded at December 31, 2016. The allowance for auto loans decreased by 38.0% (or $419 thousand) and consumer loans decreased by 13.4% (or $405 thousand) respectively, when compared with the balances recorded at December 31, 2016, due to the normal amortization of credit discount of these acquired loans.
Allowance for loan and lease losses recorded for acquired BBVAPR loans accounted for under ASC-310-30 at June 30, 2017 was $37.5 million as compared to $31.1 million at December 31, 2016. The allowance increased mainly as a result of a $7.7 million provision for loan and lease losses, slightly offset by $1.3 million in allowance de-recognition during the six-month period ended June 30, 2017.
Allowance for loan and lease losses recorded for acquired Eurobank loans at June 30, 2017 was $21.8 million as compared to $21.3 million at December 31, 2016. The allowance increased as a result of $2.0 million in provision for loan and lease losses, partially offset by $1.5 million in allowance de-recognition. The allowance for loan and lease losses on acquired Eurobank loans is accounted for under the provisions of ASC 310-30.
Please refer to the “Provision for Loan and Lease Losses” section in this MD&A for a more detailed analysis of provisions for loan and lease losses.
Non-performing Assets
The Company’s non-performing assets include non-performing loans and foreclosed real estate (see Tables 11 and 12). At June 30, 2017 and December 31, 2016, the Company had $95.2 million and $104.1 million, respectively, of non-accrual loans, including acquired BBVAPR loans accounted for under ASC 310-20 (loans with revolving feature and/or acquired at a premium).
At June 30, 2017 and December 31, 2016, loans whose terms have been extended and which are classified as troubled-debt restructuring that are not included in non-performing assets amounted to $98.7 million and $98.1 million, respectively.
Delinquent residential mortgage loans insured or guaranteed under applicable FHA and VA programs are classified as non-performing loans when they become 90 days or more past due, but are not placed in non-accrual status until they become 18 months or more past due, since they are insured loans. Therefore, these loans are included as non-performing loans but excluded from non-accrual loans.
Acquired loans with credit deterioration are considered to be performing due to the application of the accretion method under ASC 310-30, in which these loans will accrete interest income over the remaining life of the loans using estimated cash flow analyses. Credit related decreases in expected cash flows, compared to those previously forecasted are recognized by recording a provision for credit losses on these loans when it is probable that all cash flows expected at acquisition will not be collected.
At June 30, 2017, the Company’s non-performing assets decreased by 2.5% to $153.0 million (2.83% of total assets, excluding acquired loans with deteriorated credit quality) from $156.9 million (2.88% of total assets, excluding acquired loans with deteriorated credit quality) at December 31, 2016. The Company does not expect non-performing loans to result in significantly higher losses. At June 30, 2017, the allowance for originated loan and lease losses to non-performing loans coverage ratio was 71.4% (56.30% at December 31, 2016).
The Company follows a conservative residential mortgage lending policy, with more than 90% of its residential mortgage portfolio consisting of fixed-rate, fully amortizing, fully documented loans that do not have the level of risk associated with subprime loans offered by certain major U.S. mortgage loan originators. Furthermore, the Company has never been active in negative amortization loans or adjustable rate mortgage loans, including those with teaser rates.
The following items comprise non-performing assets:
· Originated and other loans held for investment:
Residential mortgage loans — are placed on non-accrual status when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the collateral underlying the loan, except for FHA and VA insured mortgage loans which are placed in non-accrual when they become 18 months or more past due. At June 30, 2017, the Company’s originated non-performing mortgage loans totaled $63.1 million (63.5% of the Company’s non-performing loans), a 15.3% decrease from $74.5 million (68.9% of the Company’s non-performing loans) at December 31, 2016.
Commercial loans — are placed on non-accrual status when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At June 30, 2017, the Company’s originated non-performing commercial loans amounted to $23.5 million (23.6% of the Company’s non-performing loans), an 18.9% increase from $19.8 million at December 31, 2016 (18.3% of the Company’s non-performing loans).
Consumer loans— are placed on non-accrual status when they become 90 days past due and written-off when payments are delinquent 120 days in personal loans and 180 days in credit cards and personal lines of credit. At June 30, 2017, the Company’s originated non-performing consumer loans amounted to $2.7 million (2.7% of the Company’s non-performing loans), a 35.3% increase from $2.0 million at December 31, 2016 (1.8% of the Company’s non-performing loans).
Auto loans and leases — are placed on non-accrual status when they become 90 days past due, partially written-off to collateral value when payments are delinquent 120 days, and fully written-off when payments are delinquent 180 days. At June 30, 2017, the Company’s originated non-performing auto loans and leases amounted to $8.3 million (8.3% of the Company’s total non-performing loans), a decrease of 8.4% from $9.1 million at December 31, 2016 (8.4% of the Company’s total non-performing loans).
· Acquired BBVAPR loans accounted for under ASC 310-20 (loans with revolving features and/or acquired at premium):
Commercial revolving lines of credit and credit cards — are placed on non-accrual status when they become 90 days or more past due and are written-down, if necessary, based on the specific evaluation of the underlying collateral, if any. At June 30, 2017, the Company’s acquired non-performing commercial lines of credit accounted for under ASC 310-20 amounted to $1.1 million (1.1% of the Company’s non-performing loans), a 19.9% decrease from $1.4 million at December 31, 2016 (1.3% of the Company’s non-performing loans).
Consumer revolving lines of credit and credit cards — are placed on non-accrual status when they become 90 days past due and written-off when payments are delinquent 180 days. At June 30, 2017, the Company’s acquired non-performing consumer lines of credit and credit cards accounted for under ASC 310-20 totaled $536 thousand (0.5% of the Company’s non-performing loans), a 35.3% decrease from $828 thousand at December 31, 2016 (0.8% of the Company’s non-performing loans).
Auto loans acquired at premium - are placed on non-accrual status when they become 90 days past due, partially written-off to collateral value when payments are delinquent 120 days, and fully written-off when payments are delinquent 180 days. At June 30, 2017, the Company’s acquired non-performing auto loans accounted for under ASC 310-20 totaled $325 thousand (0.3% of the Company’s non-performing loans), a 41.1% decrease from $552 thousand at December 31, 2016 (0.5% of the Company’s non-performing loans).
The Company has two mortgage loan modification programs. These are the Loss Mitigation Program and the Non-traditional Mortgage Loan Program. Both programs are intended to help responsible homeowners to remain in their homes and avoid foreclosure, while also reducing the Company’s losses on non-performing mortgage loans.
The Loss Mitigation Program helps mortgage borrowers who are or will become financially unable to meet the current or scheduled mortgage payments. Loans that qualify under this program are those guaranteed by FHA, VA, PRHFA, conventional loans guaranteed by Mortgage Guaranty Insurance Corporation (MGIC), conventional loans sold to FNMA and FHLMC, and conventional loans retained by the Company. The program offers diversified alternatives such as regular or reduced payment plans, payment moratorium, mortgage loan modification, partial claims (only FHA), short sale, and payment in lieu of foreclosure.
The Non-traditional Mortgage Loan Program is for non-traditional mortgages, including balloon payment, interest only/interests first, variable interest rate, adjustable interest rate and other qualified loans. Non-traditional mortgage loan portfolios are segregated into the following categories: performing loans that meet secondary market requirement and are refinanced under the credit underwriting guidelines of FHA/VA/FNMA/ FHLMC, and performing loans not meeting secondary market guidelines processed by the Company’s current credit and underwriting guidelines. The Company achieved an affordable and sustainable monthly payment by taking specific, sequential, and necessary steps such as reducing the interest rate, extending the loan term, capitalizing arrearages, deferring the payment of principal or, if the borrower qualifies, refinancing the loan.
In order to apply for any of the loan modification programs, if the borrower is active in Chapter 13 bankruptcy, they must request an authorization from the bankruptcy trustee to allow for the loan modification. Borrowers with discharged Chapter 7 bankruptcies may also apply. Loans in these programs are evaluated by designated underwriters for troubled-debt restructuring classification if the Company grants a concession for legal or economic reasons due to the debtor’s financial difficulties.
TABLE 8 — ALLOWANCE FOR LOAN AND LEASE LOSSES BREAKDOWN
Originated and other loans held for investment
Allowance balance:
92.1%
Unallocated allowance
Total allowance balance
17.5%
Allowance composition:
26.80%
29.24%
-8.3%
24.80%
15.17%
63.5%
21.50%
22.04%
-2.5%
26.90%
32.82%
-18.0%
0.73%
100.00%
Allowance coverage ratio at end of period applicable to:
2.67%
2.40%
11.3%
1.36%
0.70%
94.3%
4.77%
6.0%
2.32%
-9.7%
Total allowance to total originated loans
2.25%
Allowance coverage ratio to non-performing loans:
29.59%
23.28%
27.1%
73.47%
45.46%
61.6%
557.54%
657.96%
-15.3%
225.94%
215.01%
5.1%
71.40%
56.30%
26.8%
-75.7%
-13.4%
-38.0%
-22.1%
1.22%
3.93%
-69.0%
78.35%
70.42%
20.43%
25.65%
-20.4%
3.04%
-74.7%
8.68%
9.21%
-5.8%
2.08%
Total allowance to total acquired loans
4.84%
4.70%
3.0%
3.62%
11.94%
-69.7%
489.37%
365.70%
33.8%
210.46%
199.82%
5.3%
167.90%
153.85%
9.1%
TABLE 8 — ALLOWANCE FOR LOAN AND LEASE LOSSES BREAKDOWN (CONTINUED)
Acquired BBVAPR loans accounted for under ASC 310-30
54.4%
9.2%
57.2%
20.7%
11.04%
8.64%
27.8%
68.32%
75.51%
20.64%
15.85%
30.2%
Acquired Eurobank loans accounted for under ASC 310-30
14.3%
-12.8%
62.66%
56.14%
11.6%
37.31%
43.83%
-14.9%
0.02%
0.03%
-33.3%
TABLE 9 — ALLOWANCE FOR LOAN AND LEASE LOSSES SUMMARY
Originated and other loans:
-46.6%
-47.3%
152.1%
75.3%
43.2%
24.4%
41.6%
26.0%
-38.2%
BBVAPR loans
Acquired loans accounted for
under ASC 310-20:
-27.6%
-22.4%
-110.8%
-110.9%
-31.0%
64.9%
12.6%
-25.4%
under ASC 310-30:
25.9%
20.4%
-11.8%
31.7%
Loan pools fully charged off
-90.6%
-85.3%
64.4%
Eurobank loans
-76.2%
-76.4%
-60.0%
10.7%
FDIC shared-loss portion on
recapture of loan
-99.1%
-97.9%
-1.5%
Allowance for loans and lease losses on
originated and other loans to:
Total originated loans
3.53%
-36.3%
Non-performing originated loans
38.85%
83.8%
acquired loans accounted for under
ASC 310-20 to:
Total acquired loans accounted
for under ASC 310-20
3.84%
Non-performing acquired loans
accounted for under ASC 310-20
214.07%
-21.6%
TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30
(Dollar in thousands)
Originated and other loans and leases:
57.4%
49.6%
75.0%
-34.3%
(2,099)
(1,338)
56.9%
(4,422)
(2,855)
54.9%
481.2%
208.9%
-40.4%
-28.5%
(4,705)
(605)
677.7%
(5,471)
(1,528)
258.0%
42.7%
43.4%
486.5%
302.1%
(3,232)
(2,678)
(6,423)
(4,903)
-6.8%
20.1%
(3,599)
(4,857)
-25.9%
(7,869)
(10,240)
-23.2%
Net credit losses
Total charge-offs
Total recoveries
(13,635)
(9,478)
43.9%
(24,185)
(19,526)
23.9%
Net credit losses to average
loans outstanding:
66.7%
64.5%
0.17%
782.4%
0.87%
0.21%
314.3%
4.42%
4.35%
1.6%
4.49%
4.08%
10.0%
1.79%
2.75%
-34.9%
1.99%
-32.5%
1.21%
47.9%
1.59%
27.2%
Recoveries to charge-offs
27.43%
27.75%
-1.1%
26.59%
26.26%
Average originated loans:
-6.0%
-12.4%
-12.5%
19.0%
19.1%
13.8%
-2.6%
TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30 (CONTINUED)
950.0%
594.7%
-75.0%
-92.5%
(124)
(4)
3000.0%
(129)
-714.3%
-23.9%
-9.3%
235.2%
112.4%
(925)
-48.5%
(1,297)
-21.7%
-64.1%
-63.1%
33.9%
0.5%
392
-413.6%
566
(264)
-314.4%
(208)
-80.3%
(860)
(1,899)
-54.7%
126.52%
4467.5%
64.18%
-7.13%
-1000.1%
3.29%
6.19%
-46.8%
4.46%
5.51%
-19.2%
-3.78%
-702.2%
-2.50%
-506.2%
3.01%
-72.1%
1.66%
-35.9%
81.13%
33.96%
138.9%
62.13%
39.75%
56.3%
Average loans accounted for under ASC 310-20:
577
-32.1%
589
-31.7%
57,813
59,785
-3.3%
58,214
60,087
41,447
79,603
-47.9%
45,281
85,815
-47.2%
99,652
139,965
-28.8%
103,897
146,491
131
TABLE 11 — NON-PERFORMING ASSETS
(%)
Non-performing assets:
Non-accruing loans
Troubled-Debt Restructuring loans
27,315
32,408
-15.7%
Other loans
67,848
71,941
-5.7%
Accruing loans
3,395
25.5%
1,008
1,067
-5.5%
Total non-performing loans
99,566
108,122
-7.9%
Foreclosed real estate not covered under the
shared-loss agreements with the FDIC
45,587
153,014
156,933
Non-performing assets to total assets, excluding covered assets and acquired loans with deteriorated credit quality (including those by analogy)
2.83%
Non-performing assets to total capital
16.30%
17.05%
Interest that would have been recorded in the period if the
loans had not been classified as non-accruing loans
909
984
1,644
1,821
132
TABLE 12 — NON-PERFORMING LOANS
Non-performing loans:
63,071
74,503
19,786
18.9%
1,986
35.3%
-8.4%
97,572
105,327
-7.4%
Acquired loans accounted for under ASC 310-20 (Loans with
revolving feature and/or acquired at a premium)
-19.9%
-35.3%
-41.1%
-28.7%
Non-performing loans composition percentages:
Originated loans
68.9%
23.6%
18.3%
1.8%
8.3%
8.4%
1.1%
Non-performing loans to:
Total loans, excluding loans accounted for
under ASC 310-30 (including those by analogy)
3.15%
3.45%
-8.7%
Total assets, excluding loans accounted for
1.84%
Total capital
10.60%
11.75%
-9.8%
Non-performing loans with partial charge-offs to:
2.56%
Non-performing loans
38.13%
34.09%
11.9%
Other non-performing loans ratios:
Charge-off rate on non-performing loans to non-performing loans
on which charge-offs have been taken
57.72%
63.58%
-9.2%
Allowance for loan and lease losses to non-performing
loans on which no charge-offs have been taken
118.53%
89.25%
32.8%
FDIC Indemnification Asset
The Company recorded the FDIC indemnification asset, measured separately from the covered loans, as part of the Eurobank FDIC-assisted transaction. On February 6, 2017, the Bank and the FDIC agreed to terminate the single family and commercial shared-loss agreements related to the FDIC assisted acquisition.
TABLE 13 - ACTIVITY OF FDIC INDEMNIFICATION ASSET
TABLE 14 - LIABILITIES SUMMARY AND COMPOSITION
-0.4%
NOW accounts
999,595
1,091,237
Savings and money market accounts
1,196,231
-2.3%
1,566,746
1,526,805
2.6%
4,580,718
4,662,775
Accrued interest payable
1,968
1,712
15.0%
Total deposits and accrued interest payable
30.4%
Other term notes
190.2%
-21.1%
Other Liabilities:
-22.8%
Acceptances outstanding
Other liabilities
62,260
-34.7%
5,296,858
-5.1%
Deposits portfolio composition percentages:
18.5%
18.2%
21.8%
23.4%
25.7%
34.2%
32.7%
Borrowings portfolio composition percentages:
72.3%
82.2%
21.9%
13.3%
5.8%
Securities sold under agreements to repurchase (excluding accrued interest)
Amount outstanding at period-end
Daily average outstanding balance
523,448
663,845
Maximum outstanding balance at any month-end
655,790
902,500
135
Liabilities and Funding Sources
As shown in Table 14 above, at June 30, 2017, the Company’s total liabilities were $5.297 billion, 5.1% less than the $5.581 billion reported at December 31, 2016. Deposits and borrowings, the Company’s funding sources, amounted to $5.210 billion at June 30, 2017 versus $5.460 billion at December 31, 2016, a 4.6% decrease.
Borrowings consist mainly of repurchase agreements, FHLB-NY advances and subordinated capital notes. At June 30, 2017, borrowings amounted to $627.3 million, representing a decrease of 21.1% when compared with the $795.4 million reported at December 31, 2016. The decrease in borrowings is attributed to decreases in repurchases agreements and to decrease in FHLB-NY advances. Repurchase agreements at June 30, 2017 decreased $200.3 million to $453.5 million from $653.8 million at December 31, 2016, reflecting the maturity of a repurchase agreement amounting to $232.0 million with a rate of 4.78% on March 2, 2017 and an unwinding of $100.0 million in repurchase agreements during the second quarter of 2017, at a cost of $80 thousand. These decreases were partially offset by new repurchase agreements of $110.0 million with the FHLB, $37.0 million with Nomura and $66.0 million with Credit Suisse. As a member of the FHLB-NY, the Bank can obtain advances from the FHLB-NY secured by the FHLB-NY stock owned by the Bank as well as by certain mortgage loans and investment securities of the Bank. Additional FHLB short-term borrowings of $33.0 million were received during the second quarter of 2017, which matured on July 3, 2017 and were renewed as one month short term advances.
At June 30, 2017, deposits represented 88% and borrowings represented 12% of interest-bearing liabilities. At June 30, 2017, deposits, the largest category of the Company’s interest-bearing liabilities, were $4.583 billion, a decrease of 1.8% from $4.664 billion at December 31, 2016. During the six-month period ended June 30, 2017, demand and savings deposits decreased 3.5% to $2.961 billion, brokered deposits decreased 1.3%, or $7.5 million, to $568.9 million, and time deposits, excluding brokered deposits, increased 3.2% to $1.053 billion.
Stockholders’ Equity
At June 30, 2017, the Company’s total stockholders’ equity was $939.0 million, a 2.0% increase when compared to $920.4 million at December 31, 2016. This increase in stockholders’ equity reflects increases in retained earnings of $16.9 million, in legal surplus of $3.2 million, and in treasury stock of $358 thousand, partially offset by a decrease in accumulated comprehensive income of $1.9 million. Book value per share was $17.59 at June 30, 2017 compared to $17.18 at December 31, 2016.
From December 31, 2016 to June 30, 2017, tangible common equity to total assets increased to 10.93% from 10.19%, Tier 1 Leverage capital ratio increased to 13.69% from 12.99%, Common Equity Tier 1 capital ratio increased to 14.66% from 14.05%, Tier 1 Risk-Based capital ratio increased to 19.14% from 18.35%, and Total Risk-Based capital ratio increased to 20.42% from 19.62%.
New Capital Rules to Implement Basel III Capital Requirements
In July 2013, the Board of Governors of the Federal Reserve System (the “Board”), the Office of the Comptroller of the Currency (the “OCC”) and the FDIC (together with the Board and the OCC, the “Agencies”) approved new rules (“New Capital Rules”) to establish a revised comprehensive regulatory capital framework for all U.S. banking organizations. The New Capital Rules generally implement the Basel Committee on Banking Supervision’s (the “Basel Committee”) December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The New Capital Rules substantially revise the risk-based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and the Bank, as compared to the previous U.S. general risk-based capital rules. The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratios. The New Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratios and replace the existing general risk-weighting approach, which was derived from the Basel Committee’s 1988 “Basel I” capital accords, with a more risk-sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 “Basel II” capital accords. In addition, the New Capital Rules implement certain provisions of Dodd-Frank Act, including the requirements of Section 939A to remove references to credit ratings from the federal agencies’ rules. The New Capital Rules became effective for the Company and the Bank on January 1, 2015, subject to phase-in periods for certain of their components and other provisions. Among other matters, the New Capital Rules: (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”) and related regulatory capital ratio of CET1 to risk-weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and
adjustments to capital as compared to existing regulations. Under the New Capital Rules, for most banking organizations, including the Company, the most common form of Additional Tier 1 capital is noncumulative perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allocation for loan and lease losses, in each case, subject to the New Capital Rules’ specific requirements.
Pursuant to the New Capital Rules, the minimum capital ratios as of January 1, 2015 are as follows:
• 4.5% CET1 to risk-weighted assets;
• 6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk-weighted assets;
• 8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk-weighted assets; and
• 4% Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).
The New Capital Rules also introduce a new 2.5% “capital conservation buffer” composed entirely of CET1 on top of the three minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. Thus, when fully phased-in on January 1, 2019, the Company and the Bank will be required to maintain an additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7%, (ii) Tier 1 capital to risk-weighted assets of at least 8.5%, and (iii) Total capital to risk-weighted assets of at least 10.5%.
The New Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.
In addition (as noted above), under the previous general risk-based capital rules, the effects of AOCI items included in shareholders’ equity (for example, mark-to-market adjustments to the value of securities held in the available for sale portfolio) under U.S. GAAP are reversed for the purposes of determining regulatory capital ratios. Pursuant to the New Capital Rules, the effects of certain AOCI items are not excluded; however, non-advanced approach banking organizations may make a one-time permanent election to continue to exclude these items. The Company and the Bank made the election to continue to exclude these items in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of their securities portfolio, concurrently with the first filing of the Company’s and the Bank’s periodic regulatory reports in the beginning of 2015. The New Capital Rules also preclude certain hybrid securities, such as trust preferred securities, from inclusion in bank holding companies’ Tier 1 capital, subject to phase-out, in the case of bank holding companies that had $15 billion or more in total consolidated assets as of December 31, 2009. Therefore, the Company is permitted to continue to include its existing trust preferred securities as Tier 1 capital.
Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a 4-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer will begin on January 1, 2016 at the 0.625% level and increase by 0.625% on each subsequent January 1, until it reaches 2.5% on January 1, 2019.
With respect to the Bank, the New Capital Rules revise the “prompt corrective action” (“PCA”) regulations adopted pursuant to Section 38 of the Federal Deposit Insurance Act by: (i) introducing a CET1 ratio requirement at each PCA category (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized. The New Capital Rules do not change the total risk-based capital requirement for any PCA category.
The New Capital Rules prescribe a new standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a larger and more risk-sensitive number of categories, depending on the nature of the assets, and resulting in higher risk weights for a variety of asset classes.
137
The following are the consolidated capital ratios of the Company under the New Capital Rules at June 30, 2017 and December 31, 2016:
TABLE 15 — CAPITAL, DIVIDENDS AND STOCK DATA
(Dollars in thousands, except per share data)
Capital data:
Regulatory Capital Ratios data:
Common equity tier 1 capital ratio
Minimum common equity tier 1 capital ratio required
Actual common equity tier 1 capital
Minimum common equity tier 1 capital required
Minimum capital conservation buffer required
54,892
27,922
96.6%
Excess over regulatory requirement
391,106
398,770
Risk-weighted assets
4,391,321
4,467,556
Tier 1 risk-based capital ratio
Minimum tier 1 risk-based capital ratio required
Actual tier 1 risk-based capital
Minimum tier 1 risk-based capital required
577,225
551,608
4.6%
Total risk-based capital ratio
Minimum total risk-based capital ratio required
Actual total risk-based capital
Minimum total risk-based capital required
545,621
519,252
Leverage capital ratio
Minimum leverage capital ratio required
Actual tier 1 capital
Minimum tier 1 capital required
-2.7%
595,127
567,318
4.9%
Tangible common equity to total assets
10.93%
10.19%
7.3%
Tangible common equity to risk-weighted assets
15.52%
14.82%
4.7%
Total equity to total assets
14.16%
6.4%
Total equity to risk-weighted assets
21.38%
20.60%
3.8%
Stock data:
Outstanding common shares
43,947,442
43,914,844
Market capitalization at end of period
439,474
575,284
-23.6%
138
The following table presents a reconciliation of the Company’s total stockholders’ equity to tangible common equity and total assets to tangible assets at June 30, 2017, and December 31, 2016:
(In thousands, except share or per
share information)
(176,000)
Preferred stock issuance costs
10,130
(86,069)
Core deposit intangible
(3,799)
(4,260)
Customer relationship intangible
(1,625)
(1,900)
Total tangible common equity
681,606
662,312
Total tangible assets
6,144,333
6,409,595
Tangible common equity to tangible assets
11.09%
10.33%
Common shares outstanding at end of period
The tangible common equity ratio and tangible book value per common share are non-GAAP measures and, unlike Tier 1 capital and Common Equity Tier 1 capital, are not codified in the federal banking regulations. Management and many stock analysts use the tangible common equity ratio and tangible book value per common share in conjunction with more traditional bank capital ratios to compare the capital adequacy of banking organizations. Neither tangible common equity nor tangible assets or related measures should be considered in isolation or as a substitute for stockholders’ equity, total assets or any other measure calculated in accordance with GAAP. Moreover, the manner in which the Company calculates its tangible common equity, tangible assets and any other related measures may differ from that of other companies reporting measures with similar names.
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. To mitigate these limitations, the Company has procedures in place to calculate these measures using the appropriate GAAP or regulatory components. Although these non-GAAP financial measures are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
The following table presents the Company’s capital adequacy information under the New Capital Rules:
Risk-based capital:
Common equity tier 1 capital
Additional tier 1 capital
197,097
191,929
Tier 1 capital
Additional Tier 2 capital
56,223
56,995
-1.4%
Risk-weighted assets:
Balance sheet items
4,242,573
4,307,817
Off-balance sheet items
148,748
159,739
-6.9%
Total risk-weighted assets
Ratios:
Common equity tier 1 capital (minimum required - 4.5%)
Tier 1 capital (minimum required - 6%)
Total capital (minimum required - 8%)
Leverage ratio
Equity to assets
Tangible common equity to assets
140
The Bank is considered “well capitalized” under the regulatory framework for prompt corrective action. The table below shows the Bank’s regulatory capital ratios at June 30, 2017 and December 31, 2016:
Oriental Bank Regulatory Capital Ratios:
Common Equity Tier 1 Capital to Risk-Weighted Assets
Minimum capital requirement (4.5%)
Minimum capital conservation buffer requirement (1.25% at June 30, 2017 - 0.625% at December 31, 2016)
54,882
27,859
97.0%
Minimum to be well capitalized (6.5%)
Tier 1 Capital to Risk-Weighted Assets
Minimum capital requirement (6%)
Minimum to be well capitalized (8%)
Total Capital to Risk-Weighted Assets
5.0%
3.5%
Minimum capital requirement (8%)
Minimum to be well capitalized (10%)
Total Tier 1 Capital to Average Total Assets
0.14%
-98.9%
Minimum capital requirement (4%)
Minimum to be well capitalized (5%)
The Company’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “OFG.” At June 30, 2017 and December 31, 2016, the Company’s market capitalization for its outstanding common stock was $439.5 million ($10.00 per share) and $575.3 million ($13.10 per share), respectively.
The following table provides the high and low prices and dividends per share of the Company’s common stock for each quarter of the last two calendar years:
Price
Dividend
High
Low
Per share
12.03
9.19
March 31, 2017
13.80
10.90
14.30
9.56
September 30, 2016
11.09
8.07
June 30, 2016
9.14
6.32
March 31, 2016
7.32
4.77
2015
December 31, 2015
10.52
6.39
September 30, 2015
10.20
6.63
0.10
June 30, 2015
17.04
10.67
March 31, 2015
17.70
14.88
Under the Company’s current stock repurchase program, it is authorized to purchase in the open market up to $7.7 million of its outstanding shares of common stock. The shares of common stock repurchased are to be held by the Company as treasury shares. There were no repurchases during the quarter ended June 30, 2017.
At June 30, 2017, the number of shares that may yet be purchased under such program is estimated at 773,085 and was calculated by dividing the remaining balance of $7.7 million by $10.00 (closing price of the Company common stock at June 30, 2017).
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Background
The Company’s risk management policies are established by its Board of Directors (the “Board”) and implemented by management through the adoption of a risk management program, which is overseen and monitored by the Chief Risk Officer and the Risk Management and Compliance Committee. The Company has continued to refine and enhance its risk management program by strengthening policies, processes and procedures necessary to maintain effective risk management.
All aspects of the Company’s business activities are susceptible to risk. Consequently, risk identification and monitoring are essential to risk management. As more fully discussed below, the Company’s primary risk exposures include, market, interest rate, credit, liquidity, operational and concentration risks.
Market Risk
Market risk is the risk to earnings or capital arising from adverse movements in market rates or prices, such as interest rates or prices. The Company evaluates market risk together with interest rate risk. The Company’s financial results and capital levels are constantly exposed to market risk. The Board and management are primarily responsible for ensuring that the market risk assumed by the Company complies with the guidelines established by policies approved by the Board. The Board has delegated the management of this risk to the Asset/Liability Management Committee (“ALCO”) which is composed of certain executive officers from the business, treasury and finance areas. One of ALCO’s primary goals is to ensure that the market risk assumed by the Company is within the parameters established in such policies.
Interest Rate Risk
Interest rate risk is the exposure of the Company’s earnings or capital to adverse movements in interest rates. It is a predominant market risk in terms of its potential impact on earnings. The Company manages its asset/liability position in order to limit the effects of changes in interest rates on net interest income. ALCO oversees interest rate risk, liquidity management and other related matters.
In executing its responsibilities, ALCO examines current and expected conditions in global financial markets, competition and prevailing rates in the local deposit market, liquidity, unrealized gains and losses in securities, recent or proposed changes to the investment portfolio, alternative funding sources and their costs, hedging and the possible purchase of derivatives such as swaps, and any tax or regulatory issues which may be pertinent to these areas.
On a quarterly basis, the Company performs a net interest income simulation analysis on a consolidated basis to estimate the potential change in future earnings from projected changes in interest rates. These simulations are carried out over a five-year time horizon, assuming certain gradual upward and downward interest rate movements, achieved during a twelve-month period. Instantaneous interest rate movements are also modeled. Simulations are carried out in two ways:
(i) using a static balance sheet as the Company had on the simulation date, and
(ii) using a dynamic balance sheet based on recent growth patterns and business strategies.
The balance sheet is divided into groups of assets and liabilities detailed by maturity or re-pricing and their corresponding interest yields and costs. As interest rates rise or fall, these simulations incorporate expected future lending rates, current and expected future funding sources and costs, the possible exercise of options, changes in prepayment rates, deposits decay and other factors which may be important in projecting the future growth of net interest income.
The Company uses a software application to project future movements in the Company’s balance sheet and income statement. The starting point of the projections generally corresponds to the actual values of the balance sheet on the date of the simulations.
These simulations are complex, and use many assumptions that are intended to reflect the general behavior of the Company over the period in question. There can be no assurance that actual events will match these assumptions in all cases. For this reason, the results of these simulations are only approximations of the true sensitivity of net interest income to changes in market interest rates. The following table presents the results of the simulations at June 30, 2017 for the most likely scenario, assuming a one-year time horizon:
Net Interest Income Risk (one year projection)
Static Balance Sheet
Growing Simulation
Percent
Change
Change in interest rate
+ 200 Basis points
10,811
8,802
3.13%
+ 100 Basis points
5,339
1.97%
4,392
- 50 Basis points
(2,537)
-0.92%
(2,014)
-0.72%
The impact of -100 and -200 basis point reductions in interest rates is not presented in view of current level of the federal funds rate and other short-term interest rates.
Future net interest income could be affected by the Company’s investments in callable securities, prepayment risk related to mortgage loans and mortgage-backed securities, and any structured repurchase agreements and advances from the FHLB-NY in which it may enter into from time to time. As part of the strategy to limit the interest rate risk and reduce the re-pricing gaps of the Company’s assets and liabilities, the Company has executed certain transactions which include extending the maturity and the re-pricing frequency of the liabilities to longer terms reducing the amounts of its structured repurchase agreements and entering into hedge-designated swaps to hedge the variability of future interest cash flows of forecasted wholesale borrowings that only consist of advances from the FHLB-NY as of June 30, 2017.
The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The Company’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. As a result of interest rate fluctuations, hedged fixed-rate assets and liabilities will appreciate or depreciate in market value. Also, for some fixed-rate assets or liabilities, the effect of this variability in earnings is expected to be substantially offset by the Company’s gains and losses on the derivative instruments that are linked to the forecasted cash flows of these hedged assets and liabilities. The Company considers its strategic use of derivatives to be a prudent method of managing interest-rate sensitivity as it reduces the exposure of earnings and the market value of its equity to undue risk posed by changes in interest rates. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by the Company’s gains or losses on the derivative instruments that are linked to these hedged assets and liabilities. Another result of interest rate fluctuations is that the contractual interest income and interest expense of hedged variable-rate assets and liabilities, respectively, will increase or decrease.
Derivative instruments that are used as part of the Company’s interest risk management strategy include interest rate swaps, forward-settlement swaps, futures contracts, and option contracts that have indices related to the pricing of specific balance sheet assets and liabilities. Interest rate swaps generally involve the exchange of fixed and variable-rate interest payments between two parties based on a common notional principal amount and maturity date. Interest rate futures generally involve exchanged-traded contracts to buy or sell U.S. Treasury bonds and notes in the future at specified prices. Interest rate options represent contracts that allow the holder of the option to (i) receive cash or (ii) purchase, sell, or enter into a financial instrument at a specified price within a specified period. Some purchased option contracts give the Company the right to enter into interest rate swaps and cap and floor agreements with the writer of the option. In addition, the Company enters into certain transactions that contain embedded derivatives. When the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, it is bifurcated and carried at fair value. Please refer to Note 7 to the accompanying consolidated financial statements for further information concerning the Company’s derivative activities.
Following is a summary of certain strategies, including derivative activities, currently used by the Company to manage interest rate risk:
Interest rate swaps — The Company entered into hedge-designated swaps to hedge the variability of future interest cash flows of forecasted wholesale borrowings attributable to changes in the one-month LIBOR rate. Once the forecasted wholesale borrowings transactions occurred, the interest rate swap effectively fixes the Company’s interest payments on an amount of forecasted interest expense attributable to the one-month LIBOR rate corresponding to the swap notional stated rate. A derivative liability of $923 thousand (notional amount of $35.9 million) was recognized at June 30, 2017 related to the valuation of these swaps.
In addition, the Company has certain derivative contracts, including interest rate swaps not designated as hedging instruments, which are utilized to convert certain variable rate loans to fixed-rate loans, and the mirror-images of these interest rate swaps in which the Company enters into to minimize its interest rate risk exposure that results from offering the derivatives to clients. These interest rate swaps are marked to market through earnings. At June 30, 2017, interest rate swaps offered to clients not designated as hedging instruments represented a derivative asset of $893 thousand (notional amounts of $12.5 million), and the mirror-image interest rate swaps in which the Company entered into represented a derivative liability of $893 thousand (notional amounts of $12.5 million).
Wholesale borrowings — The Company uses interest rate swaps to hedge the variability of interest cash flows of certain advances from the FHLB-NY that are tied to a variable rate index. The interest rate swaps effectively fix the Company’s interest payments on these borrowings. As of June 30, 2017, the Company had $35.9 million in interest rate swaps at an average rate of 2.4% designated as cash flow hedges for $35.9 million in advances from the FHLB-NY that reprice or are being rolled over on a monthly basis.
Credit Risk
Credit risk is the possibility of loss arising from a borrower or counterparty in a credit-related contract failing to perform in accordance with its terms. The principal source of credit risk for the Company is its lending activities. In Puerto Rico, the Company’s principal market, economic conditions are challenging, as they have been for the last ten years, due to a shrinking population, a protracted economic recession, a housing sector that remains under pressure, the Puerto Rico government’s fiscal and liquidity crisis, and the payment defaults on various Puerto Rico government bonds, with severe austerity measures expected for the Puerto Rico government to be able to restructure its debts under the supervision of a federally created Fiscal Oversight Board.
The Company manages its credit risk through a comprehensive credit policy which establishes sound underwriting standards by monitoring and evaluating loan portfolio quality, and by the constant assessment of reserves and loan concentrations. The Company also employs proactive collection and loss mitigation practices.
The Company may also encounter risk of default in relation to its securities portfolio. The securities held by the Company are principally agency mortgage-backed securities. Thus, a substantial portion of these instruments are guaranteed by mortgages, a U.S. government-sponsored entity, or the full faith and credit of the U.S. government.
The Company’s executive Credit Risk Committee, composed of its Chief Executive Officer, Chief Operating Officer, Chief Credit Officer, Chief Risk Officer, and other senior executives, has primary responsibility for setting strategies to achieve the Company’s credit risk goals and objectives. Those goals and objectives are set forth in the Company’s Credit Policy as approved by the Board.
Liquidity Risk
Liquidity risk is the risk of the Company not being able to generate sufficient cash from either assets or liabilities to meet obligations as they become due without incurring substantial losses. The Board has established a policy to manage this risk. The Company’s cash requirements principally consist of deposit withdrawals, contractual loan funding, repayment of borrowings as these mature, and funding of new and existing investments as required.
The Company’s business requires continuous access to various funding sources. While the Company is able to fund its operations through deposits as well as through advances from the FHLB-NY and other alternative sources, the Company’s business is dependent upon other external wholesale funding sources. The Company has selectively reduced its use of certain wholesale funding sources, such as repurchase agreements and brokered deposits. As of June 30, 2017, the Company had $452.9 million in repurchase agreements, excluding accrued interest, and $568.9 million in brokered deposits.
Brokered deposits are typically offered through an intermediary to small retail investors. The Company’s ability to continue to attract brokered deposits is subject to variability based upon a number of factors, including volume and volatility in the global securities markets, the Company’s credit rating, and the relative interest rates that it is prepared to pay for these liabilities. Brokered deposits are generally considered a less stable source of funding than core deposits obtained through retail bank branches. Investors in brokered deposits are generally more sensitive to interest rates and will generally move funds from one depository institution to another based on small differences in interest rates offered on deposits.
Although the Company expects to have continued access to credit from the foregoing sources of funds, there can be no assurance that such financing sources will continue to be available or will be available on favorable terms. In a period of financial disruption or if negative developments occur with respect to the Company, the availability and cost of the Company’s funding sources could be adversely affected. In that event, the Company’s cost of funds may increase, thereby reducing its net interest income, or the Company may need to dispose of a portion of its investment portfolio, which depending upon market conditions, could result in realizing a loss or experiencing other adverse accounting consequences upon any such dispositions. The Company’s efforts to monitor and manage liquidity risk may not be successful to deal with dramatic or unanticipated changes in the global securities markets or other reductions in liquidity driven by the Company or market-related events. In the event that such sources of funds are reduced or eliminated and the Company is not able to replace these on a cost-effective basis, the Company may be forced to curtail or cease its loan origination business and treasury activities, which would have a material adverse effect on its operations and financial condition.
As of June 30, 2017, the Company had approximately $477.3 million in unrestricted cash and cash equivalents, $667.8 million in investment securities that are not pledged as collateral, $935.5 million in borrowing capacity at the FHLB-NY.
Operational Risk
Operational risk is the risk of loss from inadequate or failed internal processes, personnel and systems or from external events. All functions, products and services of the Company are susceptible to operational risk.
The Company faces ongoing and emerging risk and regulatory pressure related to the activities that surround the delivery of banking and financial products and services. Coupled with external influences such as market conditions, security risks, and legal risks, the potential for operational and reputational loss has increased. In order to mitigate and control operational risk, the Company has developed, and continues to enhance, specific internal controls, policies and procedures that are designed to identify and manage operational risk at appropriate levels throughout the organization. The purpose of these policies and procedures is to provide reasonable assurance that the Company’s business operations are functioning within established limits.
The Company classifies operational risk into two major categories: business specific and corporate-wide affecting all business lines. For business specific risks, a risk assessment group works with the various business units to ensure consistency in policies, processes and assessments. With respect to corporate-wide risks, such as information security, business recovery, legal and compliance, the Company has specialized groups, such as Information Security, Enterprise Risk Management, Corporate Compliance, Information Technology, Legal and Operations. These groups assist the lines of business in the development and implementation of risk management practices specific to the needs of the business groups. All these matters are reviewed and discussed in the Executive Risk and Compliance Committee.
The Company is subject to extensive United States federal and Puerto Rico regulations, and this regulatory scrutiny has been significantly increasing over the last several years. The Company has established and continues to enhance procedures based on legal and regulatory requirements that are reasonably designed to ensure compliance with all applicable statutory and regulatory requirements. The Company has a corporate compliance function headed by a Chief Compliance Officer who reports to the Chief Executive Officer and supervises the BSA Officer and Regulatory Compliance Officer. The Chief Compliance Officer is responsible for the oversight of regulatory compliance and implementation of a company-wide compliance program, including the Bank Secrecy Act/Anti-Money Laundering compliance program.
146
Concentration Risk
Substantially all of the Company’s business activities and a significant portion of its credit exposure are concentrated in Puerto Rico. As a consequence, the Company’s profitability and financial condition may be adversely affected by an extended economic slowdown, adverse political, fiscal or economic developments in Puerto Rico or the effects of a natural disaster, all of which could result in a reduction in loan originations, an increase in non-performing assets, an increase in foreclosure losses on mortgage loans, and a reduction in the value of its loans and loan servicing portfolio.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this quarterly report on Form 10-Q, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon such evaluation, the CEO and the CFO have concluded that, as of the end of such period, the Company’s disclosure controls and procedures provided reasonable assurance of effectiveness in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act. Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s periodic reports.
Internal Control over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended June 30, 2017, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART - II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company and its subsidiaries are defendants in a number of legal proceedings incidental to their business. The Company is vigorously contesting such claims. Based upon a review by legal counsel and the development of these matters to date, management is of the opinion that the ultimate aggregate liability, if any, resulting from these claims will not have a material adverse effect on the Company’s financial condition or results of operations.
ITEM 1A. RISK FACTORS
There have been no material changes to the risk factors previously disclosed in the Company's annual report on Form 10-K for the year ended December 31, 2016. In addition to other information set forth in this report, you should carefully consider the risk factors included in the Company’s annual report on Form 10-K, as updated by this report or other filings the Company makes with the SEC under the Exchange Act. Additional risks and uncertainties not presently known to the Company at this time or that the Company currently deems immaterial may also adversely affect the Company’s business, financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
Exhibit No. Description of Document:
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101 The following materials from OFG Bancorp’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Statements of Financial Condition, (ii) Unaudited Consolidated Statements of Operations, (iii) Unaudited Consolidated Statements of Comprehensive Income, (iv) Unaudited Consolidated Statements of Changes in Stockholders’ Equity, (v) Unaudited Consolidated Statements of Cash Flows, and (vi) Notes to Unaudited Consolidated Financial Statements.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
(Registrant)
By:
/s/ José Rafael Fernández
Date: August 4, 2017
José Rafael Fernández
President and Chief Executive Officer
/s/ Maritza Arizmendi
Maritza Arizmendi
Executive Vice President and Chief Financial Officer
/s/ Vanessa de Armas
Vanessa de Armas
Controller