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 March 31, 2018
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:
43,968,342 common shares ($1.00 par value per share) outstanding as of April 30, 2018
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
9
Note 2 – Significant Events
10
Note 3 – Restricted Cash
11
Note 4 – Investment Securities
12
Note 5 – Loans
17
Note 6 – Allowance for Loan and Lease Losses
41
Note 7 – FDIC Indemnification Asset and True-Up Payment Obligation
49
Note 8 – Foreclosed Real Estate
48
Note 9 – Derivatives
50
Note 10 – Accrued Interest Receivable and Other Assets
51
Note 11 – Deposits and Related Interest
52
Note 12 – Borrowings and Related Interest
54
Note 13 – Offsetting of Financial Assets and Liabilities
56
Note 14 – Income Taxes
58
Note 15 – Regulatory Capital Requirements
59
Note 16 – Stockholders’ Equity
60
Note 17 – Accumulated Other Comprehensive Income
61
Note 18 – Earnings per Common Share
63
Note 19 – Guarantees
64
Note 20 – Commitments and Contingencies
65
Note 21 – Banking and Financial Service Revenues
68
Note 22 – Fair Value of Financial Instruments
69
Note 23 – Business Segments
75
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
77
Critical Accounting Policies and Estimates
Overview of Financial Performance:
Selected Financial Data
78
Financial Highlights of the First Quarter of 2018
80
Analysis of Results of Operations
81
Analysis of Financial Condition
90
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
117
Item 4.
Controls and Procedures
121
PART II – OTHER INFORMATION
Legal Proceedings
122
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
123
Signatures
124
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 “Oriental”), 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 Oriental’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 Oriental’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:
· the rate of growth in the economy and employment levels, as well as general business and economic conditions;
· changes in interest rates, as well as the magnitude of such changes;
· the credit default by the government of Puerto Rico or its municipalities;
· amendments to the fiscal plan approved by the Financial Oversight and Management Board of Puerto Rico;
· determinations in the court-supervised debt-restructuring process under Title III of PROMESA for the Puerto Rico government and all of its agencies, including some of its public corporations;
· the impact of property, credit and other losses in Puerto Rico as a result of hurricanes Irma and Maria;
· the amount of government, private and philanthropic financial assistance for the reconstruction of Puerto Rico’s critical infrastructure, which suffered catastrophic damages caused by hurricane Maria;
· the pace and magnitude of Puerto Rico’s economic recovery;
· the potential impact of damages from future hurricanes and natural disasters in Puerto Rico;
· the fiscal and monetary policies of the federal government and its agencies;
· changes in federal bank regulatory and supervisory policies, including required levels of capital;
· the relative strength or weakness of the commercial and consumer credit sectors and the real estate market in Puerto Rico;
· the performance of the stock and bond markets;
· competition in the financial services industry; and
· possible legislative, tax or regulatory changes.
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; Oriental’s ability to grow its core businesses; decisions to downsize, sell or close units or otherwise change Oriental’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 Oriental as of the date of this report, and other than as required by law, including the requirements of applicable securities laws, Oriental 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.
OFG BANCORP
UNAUDITED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF MARCH 31, 2018 AND DECEMBER 31, 2017
March 31,
December 31,
2018
2017
(In thousands)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
354,930
478,182
Money market investments
7,428
7,021
Total cash and cash equivalents
362,358
485,203
Restricted cash
3,030
Investments:
Trading securities, at fair value, with amortized cost of $647 (December 31, 2017 - $647)
293
191
Investment securities available-for-sale, at fair value, with amortized cost of $815,970 (December 31, 2017 - $648,800)
801,641
645,797
Investment securities held-to-maturity, at amortized cost, with fair value of $467,980 (December 31, 2017 - $497,681)
485,143
506,064
Federal Home Loan Bank (FHLB) stock, at cost
11,499
13,995
Other investments
Total investments
1,298,579
1,166,050
Loans:
Loans held-for-sale, at lower of cost or fair value
10,505
12,272
Loans held for investment, net of allowance for loan and lease losses of $168,592 (December 31, 2017 - $167,509)
4,122,924
4,044,057
Total loans
4,133,429
4,056,329
Other assets:
Foreclosed real estate
40,314
44,174
Accrued interest receivable
35,141
49,969
Deferred tax asset, net
128,270
127,421
Premises and equipment, net
67,163
67,860
Customers' liability on acceptances
25,869
27,663
Servicing assets
10,533
9,821
Derivative assets
898
771
Goodwill
86,069
Other assets
55,468
64,693
Total assets
6,247,121
6,189,053
See notes to unaudited consolidated financial statements
AS OF MARCH 31, 2018 AND DECEMBER 31, 2017 (CONTINUED)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits
2,117,857
2,039,126
Savings accounts
1,274,414
1,251,398
Time deposits
1,441,157
1,508,958
Total deposits
4,833,428
4,799,482
Borrowings:
Securities sold under agreements to repurchase
273,926
192,869
Advances from FHLB
43,934
99,643
Subordinated capital notes
36,083
Other borrowings
394
153
Total borrowings
354,337
328,748
Other liabilities:
Derivative liabilities
752
1,281
Acceptances executed and outstanding
27,644
Accrued expenses and other liabilities
85,886
86,791
Total liabilities
5,300,272
5,243,946
Commitments and contingencies (See Note 20)
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, 2017 - 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, 2017 -
84,000 shares); $1,000 liquidation value
84,000
Common stock, $1 par value; 100,000,000 shares authorized; 52,625,869 shares
issued: 43,968,342 shares outstanding (December 31, 2017 - 52,625,869;
43,947,442)
52,626
Additional paid-in capital
541,404
541,600
Legal surplus
83,138
81,454
Retained earnings
210,008
200,878
Treasury stock, at cost, 8,657,527 shares (December 31, 2017 - 8,678,427
shares)
(104,142)
(104,502)
Accumulated other comprehensive (loss), net of tax of $1,999 (December 31, 2017 $564)
(12,185)
(2,949)
Total stockholders’ equity
946,849
945,107
Total liabilities and stockholders’ equity
2
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS ENDED MARCH 31, 2018 AND 2017
Quarter Ended March 31,
(In thousands, except per share data)
Interest income:
Loans
74,612
77,650
Mortgage-backed securities
7,051
7,206
Investment securities and other
1,507
1,322
Total interest income
83,170
86,178
Interest expense:
Deposits
7,298
7,353
1,076
3,245
Advances from FHLB and other borrowings
374
596
428
366
Total interest expense
9,176
11,560
Net interest income
73,994
74,618
Provision for loan and lease losses, net
15,460
17,654
Net interest income after provision for loan and lease losses
58,534
56,964
Non-interest income:
Banking service revenue
10,463
10,626
Wealth management revenue
6,019
6,215
Mortgage banking activities
1,757
587
Total banking and financial service revenues
18,239
17,428
FDIC shared-loss benefit, net
-
1,403
Net gain on:
Derivatives
Other non-interest income
275
162
Total non-interest income, net
18,514
19,074
FOR THE QUARTERS ENDED MARCH 31, 2018 AND 2017 (CONTINUED)
Non-interest expense:
Compensation and employee benefits
20,608
20,347
Professional and service fees
2,694
3,237
Occupancy and equipment
7,768
7,199
Insurance
1,478
1,600
Electronic banking charges
4,966
4,902
Information technology expenses
2,009
1,998
Advertising, business promotion, and strategic initiatives
1,347
1,395
Loss on sale of foreclosed real estate and other repossessed assets
1,226
1,326
Loan servicing and clearing expenses
1,161
1,189
Taxes, other than payroll and income taxes
2,260
2,372
Communication
885
914
Printing, postage, stationary and supplies
644
637
Director and investor relations
240
280
Credit related expenses
2,419
2,626
Other
2,416
1,662
Total non-interest expense
52,121
51,684
Income before income taxes
24,927
24,354
Income tax expense
8,010
9,204
Net income
16,917
15,150
Less: dividends on preferred stock
(3,465)
Income available to common shareholders
13,452
11,685
Earnings per common share:
Basic
0.31
0.27
Diluted
0.30
0.26
Average common shares outstanding and equivalents
51,121
51,131
Cash dividends per share of common stock
0.06
4
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive income before tax:
Unrealized (loss) gain on securities available-for-sale
(11,326)
1,866
Unrealized gain on cash flow hedges
656
182
Other comprehensive (loss) income before taxes
(10,670)
2,048
Income tax effect
1,434
(296)
Other comprehensive (loss) income after taxes
(9,236)
1,752
Comprehensive income
7,681
16,902
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:
540,948
Stock-based compensation expense
291
218
Stock-based compensation excess tax benefit recognized in income
(127)
Lapsed restricted stock units
(360)
(358)
540,808
Legal surplus:
76,293
Transfer from retained earnings
1,684
1,479
77,772
Retained earnings:
177,808
Cash dividends declared on common stock
(2,638)
(2,637)
Cash dividends declared on preferred stock
Transfer to legal surplus
(1,684)
(1,479)
185,377
Treasury stock:
(104,860)
360
358
Accumulated other comprehensive (loss) income, net of tax:
1,596
Other comprehensive (loss) income, net of tax
3,348
931,429
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of deferred loan origination fees and fair value premiums on acquired loans
1,118
618
Amortization of investment securities premiums, net of accretion of discounts
1,614
2,336
Amortization of core deposit and customer relationship intangibles
330
369
FDIC shared-loss benefit
(1,403)
Depreciation and amortization of premises and equipment
2,277
2,110
Deferred income tax expense, net
586
2,443
Stock-based compensation
(Gain) loss on:
Sale of mortgage loans held-for-sale
(87)
(207)
(81)
1,284
1,570
Sale of other repossessed assets
217
(160)
Originations of loans held-for-sale
(23,292)
(38,945)
Proceeds from sale of mortgage loans held-for-sale
5,945
10,893
Net (increase) decrease in:
Trading securities
(102)
33
14,828
1,672
(712)
170
10,448
11,615
Net (decrease) in:
Accrued interest on deposits and borrowings
(359)
(1,031)
(11,235)
(25)
Net cash provided by operating activities
35,401
24,999
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale
(173,162)
(51,430)
FHLB stock
(35,775)
(7,065)
Maturities and redemptions of:
23,408
28,659
Investment securities held-to-maturity
19,844
20,551
38,271
697
Proceeds from sales of:
Foreclosed real estate and other repossessed assets, including write-offs
(619)
Origination and purchase of loans, excluding loans held-for-sale
(286,129)
(171,153)
Principal repayment of loans, including covered loans
197,622
213,135
(Repayments to) reimbursements from the FDIC on shared-loss agreements, net
(10,125)
Additions to premises and equipment
(1,580)
(1,489)
Net cash (used in) provided by investing activities
(218,120)
21,653
Cash flows from financing activities:
Net increase (decrease) in:
40,198
51,853
81,000
(121,792)
FHLB advances, federal funds purchased, and other borrowings
(55,221)
(378)
Exercise of stock options and restricted units lapsed, net
(1)
Dividends paid on preferred stock
Dividends paid on common stock
(3,037)
Net cash used in financing activities
59,874
(76,820)
Net change in cash, cash equivalents and restricted cash
(122,845)
(30,168)
Cash, cash equivalents and restricted cash at beginning of period
488,233
513,469
Cash, cash equivalents and restricted at end of period
365,388
483,301
Supplemental Cash Flow Disclosure and Schedule of Non-cash Activities:
Interest paid
9,103
12,131
Mortgage loans securitized into mortgage-backed securities
17,954
24,921
Transfer from loans to foreclosed real estate and other repossessed assets
11,179
1,601
Reclassification of loans held-for-sale portfolio to held-for-investment portfolio
1,247
Financed sales of foreclosed real estate
242
Loans booked under the GNMA buy-back option
12,515
9,973
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – ORGANIZATION, CONSOLIDATION AND BASIS OF PRESENTATION
Nature of Operations
OFG Bancorp (“Oriental”) is a publicly-owned financial holding company incorporated under the laws of the Commonwealth of Puerto Rico. Oriental 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”), a retirement plan administrator, Oriental Pension Consultants, Inc. (“OPC”), and two operating subsidiaries of the Bank, OFG USA, LLC ("OFG USA") and Oriental International Bank, Inc. Through these subsidiaries and their respective divisions, Oriental 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, Oriental 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.” These acquired businesses have been integrated with Oriental’s existing business.
New Accounting Updates Not Yet Adopted
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 Oriental's consolidated financial position or results of operations. At March 31, 2018, Oriental 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 Oriental'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 will assess the impact that the adoption of ASU 2017-04 will have on our consolidated financial statements and related disclosures during this year.
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. Oriental will implement ASU No. 2016-13 on January 1, 2020. 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. Oriental's cross-functional implementation team has developed a project plan to ensure we comply with all updates from this ASU at the time of adoption. We recently have selected the software and are in the process of assessing the methodology to be used in order to develop an acceptable model to estimate the expected credit losses. After the model has been developed, reviewed and validated in accordance with our governance policies, Oriental will provide further disclosure regarding the estimated impact on our allowance for loan and lease losses. Also, we are assessing the additional disclosure requirements from this update. Although Oriental expects the allowance for credit losses to increase upon adoption with a corresponding adjustment to retained earnings, the ultimate amount of the increase will depend on the portfolio composition, credit quality, economic conditions and reasonable and supportable forecasts at that time.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Leases. In February 2016, the FASB issued ASU No. 2016-02, 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. Oriental plans to adopt this guidance effective January 1, 2019 using the required modified retrospective approach, which includes presenting the cumulative effect of initial application along with supplementary disclosures. As a lessor and lessee, we do not anticipate the classification of our leases to change, but we expect to recognize right-of-use assets and lease liabilities for substantially all of our operating lease commitments for which we are the lessee as a lease liability and corresponding right-of-use asset on our consolidated financial statements. Oriental has made substantial progress in reviewing contractual arrangements for embedded leases in an effort to identify Oriental’s full lease population and is presently evaluating all of its leases, as well as contracts that may contain embedded leases, for compliance with the new lease accounting rules. Oriental’s leases primarily consist of leased office space, and information technology equipment. At March 31, 2018, Oriental had $33.7 million of minimum lease commitments from these operating leases (refer to Note 20). Although Oriental is still evaluating the impact that the adoption of this accounting pronouncement will have on its consolidated financial statements, preliminarily it expects that the amounts to be recognized as right-of-use assets and lease liabilities will be less than 1% of its total assets and is not expected to have a material impact on its regulatory capital.
New Accounting Updates Adopted During the Current Quarter
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. The standard requires application using a retrospective transition method. The adoption of ASU No. 2016-18 on January 1, 2018, changed the presentation and classification of restricted cash and restricted cash equivalents in our consolidated statements of cash flows.
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. Oriental has adopted this ASU on January 1, 2018 using the modified retrospective method. Oriental’s implementation efforts included the identification of revenue streams that are within the scope of the new guidance and the review of related contracts with customers to determine their effect on certain non-interest income items presented in our consolidated statements of operations and the additional presentation disclosures required (refer to note 21). We concluded that substantially all of Oriental’s revenues are generated from activities that are outside the scope of this ASU, and the adoption did not have a material impact on our consolidated financial statements. Therefore, there was no cumulative effect adjustment recorded.
NOTE 2 –SIGNIFICANT EVENTS
Hurricanes Irma and Maria
During 2017, Oriental was impacted by hurricanes Irma and Maria, which struck the Island on September 7, 2017 and September 20, 2017, respectively. Hurricane Maria caused catastrophic damages throughout Puerto Rico, including homes, businesses, roads, bridges, power lines, commercial establishments, and public facilities. It caused an unprecedented crisis when it ravaged the Island’s electric power grid less than two weeks after hurricane Irma left over a million Puerto Rico residents without power. For several months after the hurricanes, a large part of Puerto Rico was and some areas still remain without electricity, many businesses were unable to operate, and government authorities struggled to deliver emergency supplies and clean drinking water to many communities outside the San Juan metropolitan area. Further, payment and delivery systems, including the U.S. Post Office, were unable to operate for weeks after hurricane Maria.
Almost all of Oriental’s operations and clients are located in Puerto Rico. Although Oriental’s business operations were disrupted by major damages to Puerto Rico’s critical infrastructure, including its electric power grid and telecommunications network, Oriental’s digital channels, core banking and electronic funds transfer systems continued to function uninterrupted during and after the hurricanes. Within days after hurricane Maria, and upon securing a continuing supply of diesel fuel for its electric power generators, Oriental was able to open its main offices and many of its branches and ATMs in addition to its digital and phone trade channels.
As a result of this event, and based on current assessments of information available for the impact of the hurricanes on our credit portfolio, 2017 third and fourth quarter results included an additional loan loss provision of $27.0 million and $5.4 million, respectively. During the quarter ended March 31, 2018, Oriental recorded a $8.6 million provision for loan losses to replenish the allowance for loan charge-offs of $8.2 million related to the hurricanes.
Oriental implemented its disaster response plan as these storms approached its service areas. To operate in disaster response mode, Oriental incurred expenses for, among other things, buying diesel and generators for electric power, debris removal, security matters, property damages, and emergency communication with customers regarding the status of Bank operations. The estimated total losses as of December 31, 2017 amounted to $6.6 million. No additional losses have been incurred at March 31, 2018.
Oriental maintains insurance for casualty losses as well as for disaster response costs and certain revenue lost through business interruption. Management believes that recovery of $2.2 million incurred costs as of December 31, 2017 is probable. Oriental received a $1.0 million partial payment from the insurance company during the quarter ended December 2017 and a $0.7 million payment during the quarter ended March 31, 2018. Accordingly, a receivable of $0.5 million and $1.2 million was included in other assets at March 31, 2018 and December 31, 2017, respectively, for the expected recovery.
NOTE 3 – RESTRICTED CASH
The following table includes the composition of Oriental’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 both March 31, 2018 and December 31, 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. These instruments cannot be withdrawn or transferred by OIB or Oriental Overseas without prior written approval of the Office of the Commissioner of Financial Institutions of Puerto Rico (the "OCFI").
As part of its derivative activities, Oriental has entered into collateral agreements with certain financial counterparties. At both March 31, 2018 and December 31, 2017, Oriental had delivered approximately $2.0 million of cash as collateral for such derivatives activities.
Oriental has a contract with FNMA which requires collateral to guarantee the repurchase, if necessary, of loans sold with recourse. At both March 31, 2018 and December 31, 2017, Oriental 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 March 31, 2018 was $208.5 million (December 31, 2017 - $189.2 million). At March 31, 2018 and December 31, 2017, 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 4 – INVESTMENT SECURITIES
Money Market Investments
Oriental 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 March 31, 2018 and December 31, 2017, money market instruments included as part of cash and cash equivalents amounted to $7.4 million and $7.0 million, respectively.
Investment Securities
The amortized cost, gross unrealized gains and losses, fair value, and weighted average yield of the securities owned by Oriental at March 31, 2018 and December 31, 2017 were as follows:
March 31, 2018
Gross
Weighted
Amortized
Unrealized
Fair
Average
Cost
Gains
Losses
Value
Yield
Available-for-sale
FNMA and FHLMC certificates
538,900
328
9,133
530,095
2.51%
GNMA certificates
182,055
317
2,870
179,502
2.97%
CMOs issued by US government-sponsored agencies
78,104
2,729
75,375
1.90%
Total mortgage-backed securities
799,059
645
14,732
784,972
2.56%
Investment securities
US Treasury securities
10,280
156
10,124
1.28%
Obligations of US government-sponsored agencies
2,773
72
2,701
1.38%
Obligations of Puerto Rico government and
public instrumentalities
2,455
43
2,412
5.55%
Other debt securities
29
1,432
2.98%
Total investment securities
16,911
271
16,669
2.06%
Total securities available for sale
815,970
674
15,003
2.55%
Held-to-maturity
17,163
467,980
2.07%
December 31, 2017
383,194
1,402
2,881
381,715
2.39%
166,436
1,486
584
167,338
2.94%
82,026
1,955
80,071
631,656
2,888
5,420
629,124
2.47%
10,276
113
10,163
1.25%
2,927
2,879
362
2,093
1,538
17,144
523
16,673
2.04%
Total securities available-for-sale
648,800
2,940
5,943
2.46%
8,383
497,681
The amortized cost and fair value of Oriental’s investment securities at March 31, 2018, 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.
13
Amortized Cost
Fair Value
Due from 1 to 5 years
5,651
5,598
Total due from 1 to 5 years
Due after 5 to 10 years
69,086
66,513
216,028
212,418
Total due after 5 to 10 years
285,114
278,931
Due after 10 years
317,221
312,079
9,018
8,862
Total due after 10 years
508,294
500,443
Due less than one year
322
Total due in less than one year
2,777
2,734
9,958
9,802
Obligations of US government and sponsored agencies
12,731
12,503
Due from 5 to 10 years
Total
During the quarter ended March 31, 2018, Oriental retained securitized GNMA pools totaling $18.0 million amortized cost, at a yield of 3.26% from its own originations while, during the quarter ended March 31, 2017, that amount totaled $25.0million, amortized cost, at a yield of 3.14%.
During the quarters ended March 31, 2018 and 2017, Oriental did not sell any mortgage-backed securities or investment securities.
14
The following tables show Oriental’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 March 31, 2018 and December 31, 2017:
12 months or more
Loss
Securities available-for-sale
CMOs issued by US Government-sponsored agencies
69,921
2,594
67,327
106,196
3,804
102,392
Obligations of US Government and sponsored agencies
Obligations of Puerto Rico government and public instrumentalities
20,678
906
19,772
US Treasury Securities
211,981
7,575
204,406
Securities held to maturity
338,260
13,311
324,949
Less than 12 months
8,183
135
8,048
367,587
5,329
362,258
131,685
1,964
129,721
US Treausury Securities
507,777
500,349
Securities held-to-maturity
FNMA and FHLMC Certificates
146,883
3,852
143,031
473,783
464,650
152,363
149,493
719,758
704,755
15
72,562
1,857
70,705
111,635
2,122
109,513
20,803
499
20,304
9,952
9,839
220,334
5,001
215,333
352,399
7,264
345,135
9,464
98
9,366
125,107
759
124,348
14,001
85
13,916
324
148,896
942
147,954
153,665
1,119
152,546
236,742
233,861
34,804
34,220
369,230
363,287
16
Oriental performs valuations of the investment securities on a monthly basis. Moreover, Oriental 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 Oriental believes that the methodology used to value these exposures is reasonable, the methodology is subject to continuing improvement, 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 ($1.2 billion, amortized cost, or 99.8%) with an unrealized loss position at March 31, 2018 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 a Puerto Rico government bond ($2.5 million, amortized cost, or 0.2%) with an unrealized loss position at March 31, 2018 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 the federally-created Fiscal Oversight and Management Board of Puerto Rico. The PRHTA bond had an aggregate fair value of $2.4 million at March 31, 2018 (98% 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 2.3%, thus reflecting that it is more likely than not that the bond will not default during its remaining term. Based on this analysis, Oriental 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 March 31, 2018. Also, Oriental’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. As a result of the aforementioned analysis, no other-than-temporary losses were recorded during the quarter ended March 31, 2018.
As of March 31, 2018, Oriental 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 PRHTA official statement for the investment. Such key terms include among others the interest rate, amortization schedule, if any, and the 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.
NOTE 5 - LOANS
Oriental’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.
The composition of Oriental’s loan portfolio at March 31, 2018 and December 31, 2017 was as follows:
Originated and other loans and leases held for investment:
Mortgage
682,564
683,607
Commercial
1,346,404
1,307,261
Consumer
334,865
330,039
Auto and leasing
957,197
883,985
3,321,030
3,204,892
Allowance for loan and lease losses on originated and other loans and leases
(96,832)
(92,718)
3,224,198
3,112,174
Deferred loan costs, net
7,125
6,695
Total originated and other loans loans held for investment, net
3,231,323
3,118,869
Acquired loans:
Acquired BBVAPR loans:
Accounted for under ASC 310-20 (Loans with revolving feature and/or
acquired at a premium)
4,222
4,380
27,235
28,915
Auto
16,171
21,969
47,628
55,264
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-20
(3,184)
(3,862)
44,444
51,402
Accounted for under ASC 310-30 (Loans acquired with deteriorated
credit quality, including those by analogy)
526,089
532,053
230,988
243,092
932
1,431
35,006
43,696
793,015
820,272
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-30
(43,166)
(45,755)
749,849
774,517
Total acquired BBVAPR loans, net
794,293
825,919
Acquired Eurobank loans:
Loans secured by 1-4 family residential properties
69,328
69,538
52,418
53,793
972
1,112
Total acquired Eurobank loans
122,718
124,443
Allowance for loan and lease losses on Eurobank loans
(25,410)
(25,174)
Total acquired Eurobank loans, net
97,308
99,269
Total acquired loans, net
891,601
925,188
Total held for investment, net
Mortgage loans held-for-sale
Total loans, net
18
As a result of the devastation caused by hurricanes Irma and Maria, Oriental offered an automatic three-month moratorium for the payment due on certain loans. At December 31, 2017, Oriental had $2.6 billion loans under the moratorium program. The level of delinquencies for mortgage and auto loans as of December 31, 2017 was impacted by the loan moratorium. Aging of current and early delinquent loans in moratorium were frozen at September 30, 2017, throughout the moratorium period. In addition, although the repayment schedule was modified as part of the moratorium, certain borrowers continued to make payments shortly after the moratorium, having an impact on the respective delinquency status at December 31, 2017. At March 31, 2018, most of the loan moratoriums have expired, and delinquency levels are returning to pre-hurricane levels.
Originated and Other Loans and Leases Held for Investment
Oriental’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 March 31, 2018 and December 31, 2017, 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.
19
Loans 90+
Days Past
Due and
30-59 Days
60-89 Days
90+ Days
Total Past
Still
Past Due
Due
Current
Total Loans
Accruing
Traditional (by origination year):
Up to the year 2002
168
1,697
3,696
5,561
39,752
45,313
197
Years 2003 and 2004
235
1,612
6,989
8,836
73,203
82,039
Year 2005
1,235
3,303
4,538
38,610
43,148
Year 2006
2,486
5,069
7,633
53,279
60,912
Years 2007, 2008
and 2009
2,075
7,683
9,758
57,173
66,931
336
Years 2010, 2011, 2012, 2013
205
1,422
8,346
112,977
122,950
459
Years 2014, 2015, 2016, 2017 and 2018
318
1,499
1,817
125,289
127,106
686
10,845
36,585
48,116
500,283
548,399
1,060
Non-traditional
3,415
3,458
13,498
16,956
Loss mitigation program
12,921
4,695
20,062
37,678
66,767
104,445
4,439
13,607
15,583
60,062
89,252
580,548
669,800
5,499
Home equity secured personal loans
249
GNMA's buy-back option program
72,577
101,767
580,797
Commercial secured by real estate:
Corporate
237,751
Institutional
46,955
Middle market
4,839
560
2,454
7,853
208,697
216,550
Retail
939
640
9,113
10,692
231,981
242,673
Floor plan
4,078
Real estate
17,666
5,778
1,200
11,567
18,545
747,128
765,673
Other commercial and industrial:
168,490
115,034
881
1,130
91,148
92,278
140
919
1,818
176,225
178,043
26,835
26,886
1,008
1,851
2,999
577,732
580,731
6,786
1,340
13,418
21,544
1,324,860
20
Credit cards
1,144
260
1,465
26,049
27,514
Overdrafts
22
42
246
Personal lines of credit
125
67
1,791
2,033
Personal loans
3,310
2,410
1,278
6,998
283,137
290,135
Cash collateral personal loans
238
87
21
346
14,591
14,937
2,639
1,651
9,129
325,736
45,003
16,555
13,594
75,152
882,045
70,235
36,117
101,240
207,592
3,113,438
86
938
3,537
4,561
41,579
46,140
467
92
1,077
6,304
7,473
75,758
83,231
101
383
3,832
40,669
44,501
604
5,971
6,817
55,966
62,783
66
1,258
8,561
10,177
58,505
68,682
577
233
978
7,393
8,604
116,674
125,278
1,202
Years 2014, 2015, 2016 and 2017
1,649
1,724
121,194
122,918
5,313
36,763
43,188
510,345
553,533
2,380
326
3,543
3,869
14,401
18,270
7,233
3,331
18,923
29,487
73,793
103,280
4,981
8,345
8,970
59,229
76,544
598,539
675,083
7,361
256
8,268
67,497
84,812
598,795
235,426
118
44,648
44,766
765
3,527
4,292
225,649
229,941
352
936
9,695
10,983
235,084
246,067
3,998
17,556
1,117
13,340
15,393
762,361
777,754
170,015
125,591
84,482
85,363
455
103
1,616
2,174
111,078
113,252
35,226
35,286
464
2,548
3,115
526,392
529,507
1,581
1,039
15,888
18,508
1,288,753
130
1,227
1,603
26,827
28,430
31
57
157
214
259
400
1,820
2,220
3,778
1,494
223
5,495
278,982
284,477
312
474
14,224
14,698
4,406
1,743
1,880
8,029
322,010
21,760
10,399
4,232
36,391
847,594
36,092
22,151
89,497
147,740
3,057,152
At both March 31, 2018 and December 31, 2017, Oriental had a carrying balance of $94.9 million 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.
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 the acquisitions of 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 Oriental’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 Oriental’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.
23
The following tables present the aging of the recorded investment in gross acquired BBVAPR loans accounted for under ASC 310-20 as of March 31, 2018 and December 31, 2017, by class of loans:
Commercial secured by real estate
119
921
363
1,040
Other commercial and industrial
161
46
2,817
225
2,819
1,088
1,265
2,957
767
105
270
1,142
23,719
24,861
84
152
2,222
2,374
851
112
331
1,294
25,941
798
402
154
1,354
14,817
1,810
530
1,573
3,913
43,715
24
928
393
1,321
1,047
1,440
36
221
257
2,681
2,938
1,270
1,306
3,074
208
127
1,310
1,645
24,822
26,467
139
45
245
2,203
2,448
347
188
1,355
1,890
27,025
602
248
179
1,029
20,940
985
436
2,804
4,225
51,039
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 Oriental 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 March 31, 2018 and December 31, 2017 is as follows:
Contractual required payments receivable:
1,444,070
1,481,616
Less: Non-accretable discount
354,590
352,431
Cash expected to be collected
1,089,480
1,129,185
Less: Accretable yield
296,465
308,913
Carrying amount, gross
Less: allowance for loan and lease losses
43,166
45,755
Carrying amount, net
25
At March 31, 2018 and December 31, 2017, Oriental had $50.2 million and $50.3 million, respectively, in loans granted to Puerto Rico municipalities as part of its acquired BBVAPR loans accounted for under ASC 310-30. These loans are primarily secured municipal general obligations.
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 ended March 31, 2018 and 2017:
Quarter Ended March 31, 2018
Accretable Yield Activity:
258,498
46,764
2,766
Accretion
(7,073)
(3,685)
(869)
(256)
(11,883)
Change in expected cash flows
3,156
426
3,640
Transfer (to) non-accretable discount
(3,046)
(524)
(597)
(38)
(4,205)
248,379
45,711
1,726
649
Non-Accretable Discount Activity:
299,501
10,596
23,050
19,284
Change in actual and expected losses
(1,440)
(389)
(204)
(13)
(2,046)
Transfer from accretable yield
3,046
524
597
38
4,205
301,107
10,731
23,443
19,309
Quarter Ended March 31, 2017
292,115
50,366
8,538
3,682
354,701
(7,890)
(4,981)
(2,147)
(602)
(15,620)
198
287
Transfer (to) from non-accretable discount
(7,409)
1,319
(58)
(6,008)
276,817
46,902
6,583
3,058
333,360
305,615
16,965
22,407
18,120
363,107
(3,031)
(843)
297
(19)
(3,596)
Transfer from (to) accretable yield
7,409
(1,319)
(140)
6,008
309,993
14,803
22,564
18,159
365,519
26
Acquired Eurobank Loans
The carrying amount of acquired Eurobank loans at March 31, 2018 and December 31, 2017 is as follows:
March 31
December 31
174,859
179,960
5,547
5,845
169,312
174,115
46,594
49,672
Less: Allowance for loan and lease losses
25,410
25,174
The following tables describe the accretable yield and non-accretable discount activity of acquired Eurobank loans for the quarters ended March 31, 2018 and 2017:
Loans Secured by 1-4 Family Residential Properties
Construction & Development Secured by 1-4 Family Residential Properties
Leasing
41,474
6,751
1,447
(1,605)
(1,606)
(34)
(96)
(3,341)
(144)
(63)
178
869
(103)
(427)
(91)
97
(82)
(606)
39,622
5,616
1,356
4,576
276
758
(200)
(703)
(98)
(904)
427
91
(97)
82
606
4,479
849
219
27
45,839
16,475
2,194
64,508
(1,904)
(4,510)
(158)
(6,610)
778
37
(143)
310
1,063
Transfer from (to) non-accretable discount
681
(322)
143
(152)
350
44,697
12,743
1,871
59,311
8,441
3,880
12,340
(334)
(1,409)
(154)
(1,754)
Transfer (to) from accretable yield
(681)
(350)
7,426
2,471
333
10,236
28
Non-accrual Loans
The following table presents the recorded investment in loans in non-accrual status by class of loans as of March 31, 2018 and December 31, 2017:
Originated and other loans and leases held for investment
3,394
3,070
6,852
6,380
3,235
3,280
5,905
Years 2007, 2008 and 2009
7,347
7,984
7,652
6,259
1,383
34,932
34,527
17,456
16,783
55,803
54,853
10,548
10,128
11,394
16,638
14,438
37,314
25,950
6,829
6,323
2,850
2,929
9,730
9,303
47,044
35,253
102
1,877
900
2,263
2,572
Total non-accrual originated loans
118,704
96,910
Acquired BBVAPR loans accounted for under ASC 310-20
Total non-accrual acquired BBVAPR loans accounted for under ASC 310-20
Total non-accrual loans
120,277
99,714
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 12 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 March 31, 2018 and December 31, 2017, loans whose terms have been extended and which are classified as troubled-debt restructurings that are not included in non-accrual loans amounted to $98.2 million and $109.2 million, respectively, as they are performing under their new terms.
At March 31, 2018 and December 31, 2017, loans that are current in their monthly payments, but placed in non-accrual due to credit deterioration amounted to $28.0 million and $20.1 million, respectively.
30
Impaired Loans
Oriental 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 $68.6 million and $72.3 million at March 31, 2018 and December 31, 2017, 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 $13.3 million and $10.6 million at March 31, 2018 and December 31, 2017, respectively. The total investment in impaired mortgage loans that were individually evaluated for impairment was $84.3 million and $85.4 million at March 31, 2018 and December 31, 2017, 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 $9.0 million and $9.1 million at March 31, 2018 and December 31, 2017, respectively.
Oriental’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 March 31, 2018 and 2017 are as follows:
Unpaid
Recorded
Related
Principal
Investment
Allowance
Coverage
Impaired loans with specific allowance:
57,169
52,049
13,274
26%
Residential impaired and troubled-debt restructuring
94,405
84,283
9,022
11%
Impaired loans with no specific allowance:
19,020
15,784
N/A
0%
Total investment in impaired loans
170,594
152,116
22,296
15%
57,922
52,585
10,573
20%
94,971
85,403
9,121
Impaired loans with no specific allowance
22,022
18,953
174,915
156,941
19,694
13%
Acquired BBVAPR Loans Accounted for under ASC 310-20 (Loans with revolving feature and/or acquired at a premium)
Oriental’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 March 31, 2018 and December 31, 2017 are as follows:
Impaired loans with specific allowance
926
747
3%
Specific
Oriental’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 March 31, 2018 and December 31, 2017 are as follows:
to Recorded
Impaired loan pools with specific allowance:
536,514
14,331
239,976
229,216
22,045
10%
1,892
2%
35,560
6,769
19%
Total investment in impaired loan pools
813,942
791,243
5%
32
December 31 , 2017
547,064
532,052
14,085
250,451
241,124
23,691
2,468
1%
43,440
7,961
18%
843,423
818,303
6%
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.
Oriental’s recorded investment in acquired Eurobank loan pools that have recorded impairments and their related allowance for loan and lease losses as of March 31, 2018 and December 31, 2017 are as follows:
79,633
15,414
22%
56,087
9,992
100%
135,734
121,750
21%
Impaired loan pools with specific allowance
81,132
15,187
58,099
9,982
125%
139,246
123,335
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.
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 ended March 31, 2018 and 2017:
Interest Income Recognized
Average Recorded Investment
Originated and other loans held for investment:
263
51,331
12,809
Residential troubled-debt restructuring
720
84,754
766
89,543
176
17,764
532
43,895
1,159
153,849
1,423
146,247
Acquired loans accounted for under ASC 310-20:
917
Total interest income from impaired loans
154,596
147,164
Modifications
The following tables present the troubled-debt restructurings in all loan portfolios during the quarters ended March 31, 2018 and 2017.
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)
5,747
5.69%
397
5,339
5.08%
1,559
4.75%
1,555
354
15.75%
47
355
11.60%
34
4,004
6.53%
391
4,015
4.86%
387
1,218
7.29%
55
1,219
5.93%
392
10.94%
430
10.33%
74
8.90%
11.88%
39
The following table presents troubled-debt restructurings for which there was a payment default during the twelve month periods ended March 31, 2018 and 2017:
Twelve Month Period Ended March 31,
Number of Contracts
Recorded Investment
2,051
398
243
35
Credit Quality Indicators
Oriental 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.
Oriental 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 March 31, 2018 and December 31, 2017, 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:
Risk Ratings
Balance
Special
Outstanding
Pass
Mention
Substandard
Doubtful
Commercial - originated and other loans held for investment
203,090
32,790
36,206
10,749
180,511
13,389
22,650
213,262
4,178
25,233
2,771
1,307
653,506
50,357
61,810
156,581
11,909
78,493
5,425
8,360
174,727
2,983
24,439
2,396
549,274
20,063
1,202,780
70,420
73,204
Commercial - acquired loans
(under ASC 310-20)
2,812
3,175
Retail - originated and other loans held for investment
Mortgage:
Traditional
511,814
13,541
84,383
609,987
Consumer:
27,254
Unsecured personal lines of credit
1,983
Unsecured personal loans
288,857
14,916
333,178
1,687
Auto and Leasing
943,603
1,974,626
1,886,768
87,858
Retail - acquired loans (accounted for under ASC 310-20)
24,591
2,313
26,904
16,017
43,406
42,921
485
3,368,658
3,135,644
162,594
200,395
33,094
1,937
33,856
10,910
196,058
4,749
29,134
215,121
8,058
22,888
2,678
1,320
665,664
47,221
64,869
157,683
12,332
71,222
6,386
7,755
109,477
562
3,213
32,165
496,138
22,350
11,019
1,161,802
69,571
75,888
2,933
3,326
1,054
516,770
14,727
84,357
616,110
27,203
158
2,133
284,255
222
14,386
328,135
1,904
879,753
1,897,631
1,823,998
73,633
Retail - acquired loans
25,156
1,311
2,402
27,558
1,357
21,790
50,884
49,348
1,536
3,260,156
3,038,474
152,111
40
NOTE 6 – ALLOWANCE FOR LOAN AND LEASE LOSSES
The composition of Oriental’s allowance for loan and lease losses at March 31, 2018 and December 31, 2017 was as follows:
Allowance for loans and lease losses:
18,983
20,439
33,174
30,258
18,023
16,454
26,652
25,567
Total allowance for originated and other loans and lease losses
96,832
92,718
2,659
3,225
488
595
3,184
3,862
22,047
6,770
Total allowance for acquired BBVAPR loans and lease losses
46,350
49,617
Total allowance for acquired Eurobank loan and lease losses
Total allowance for loan and lease losses
168,592
167,509
Oriental 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. Oriental’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 Oriental’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.
As discussed in Note 2, during 2017, hurricanes Irma and Maria caused catastrophic damages throughout Puerto Rico. Management performed an evaluation of the loan portfolios in order to assess the impact on repayment sources and underlying collateral that could result in additional losses.
For the commercial portfolio, the framework for the analysis was based on our current ALLL methodology with additional considerations according to the estimated impact categorized as low, medium or high. From this impact assessment, additional reserve levels were estimated by increasing default probabilities (“PD”) and loss given default expectations (“LGD”) of each allowance segment.
As part of the process, Oriental contacted its clients to evaluate the impact of the hurricanes on their business operations and collateral. The impact was then categorized as follows: (i) low risk, for clients that had no business impact or relatively insignificant impact; (ii) medium risk, for clients that had a business impact on their primary or secondary sources of repayment, but had adequate cash flow to cover operations and to satisfy their obligations; or (iii) high risk, for clients that had potentially significant problems that affected primary, secondary and tertiary (collateral) sources of repayment. This criterion was used to model adjusted PDs and LGDs considering internal and external sources of information available to support our estimation process and output.
During the fourth quarter, Oriental performed an update of the initial estimate, taking into consideration the most recent available information gathered through additional visits and interviews with clients and the economic environment in Puerto Rico.
For the retail portfolios, mortgage, consumer and auto, the assumptions established in the initial estimate were based on the historical losses of each ALLL segment and then further adjusted based on parameters used as key risk indicators, such as the industry of employment for all portfolios and the location of the collateral for mortgage loans. During the fourth quarter of 2017, Oriental performed additional procedures to evaluate the reasonability of the initial estimate based on the payment experience percentage of borrowers for which the deferral period expired. The analysis took into consideration historical payment behavior and loss experience of borrowers (PDs and LGDs) of each portfolio segment to develop a range of estimated potential losses. Management understands that this approach is reasonable given the lack of historical information related to the behavior of local borrowers in such an unprecedented event. The amount used in the analysis represents the average of potential outcomes of expected losses.
During the first quarter of 2018, Oriental updated the previous performed analysis to estimate probable losses related to the hurricanes. Analyses were based on the payment experience percentage of borrowers for which the deferral period expired in retail portfolios. For commercial portfolio, no changes in the level of impact assessed were identified based on communications with credit officers.
The documentation for the assessments considers all information available at the moment; gathered through visits or interviews with our clients, inspections of collaterals, identification of most affected areas and industries.
At March 31, 2018 and December 31, 2017, Oriental's allowance for loan and lease losses incorporated all risks associated to our loan portfolio, including the impact of hurricanes Irma and Maria.
Allowance for Originated and Other Loan and Lease Losses Held for Investment
The following tables present 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:
Charge-offs
(968)
(1,149)
(4,258)
(8,982)
(15,357)
Recoveries
314
3,777
4,513
(Recapture) provision for loan and lease losses
(802)
3,883
5,587
6,290
14,958
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
9,961
19,900
74,536
Total ending allowance balance
67,833
598,281
1,278,571
3,168,914
Total ending loan balance
Unallocated
17,344
8,995
13,067
19,463
431
59,300
(2,379)
(856)
(3,358)
(7,563)
(14,156)
89
165
3,294
3,604
Provision (recapture) for originated and other loan and lease losses
3,557
1,660
3,520
3,427
(429)
11,735
18,578
9,888
13,394
18,621
60,483
11,318
19,685
73,024
71,538
598,204
1,235,723
3,047,951
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:
(1,022)
(125)
(1,147)
228
285
(Recapture) provision for acquired BBVAPR
loan and lease losses accounted for
under ASC 310-20
(8)
(210)
184
44
3,163
3,475
46,881
169
3,028
1,103
4,300
(6)
(885)
(278)
(1,169)
452
517
Provision (recapture) for acquired
384
(436)
(33)
183
2,591
841
3,615
3,842
3,633
54,517
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, Oriental 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:
Provision (recapture) for acquired BBVAPR loans and lease losses accounted for under ASC 310-30
(887)
Allowance de-recognition
(68)
(2,396)
(304)
(2,768)
2,682
23,452
4,922
31,056
923
3,186
4,332
(32)
(147)
(279)
(458)
3,573
23,528
7,829
34,930
Allowance for Acquired Eurobank Loan Losses
The changes in the allowance for loan and lease losses on acquired Eurobank loans for the quarters ended March 31, 2018 and 2017 were as follows:
Allowance for loan and lease losses for acquired Eurobank loans:
Provision (recapture) for loan and lease losses, net
(40)
9,991
11,947
9,328
21,281
2,398
(778)
1,620
(177)
(717)
(895)
14,168
7,833
22,006
NOTE 7- FDIC INDEMNIFICATION ASSET AND TRUE-UP PAYMENT OBLIGATION
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 ended March 31, 2018 and 2017:
FDIC indemnification asset:
14,411
FDIC indemnification asset benefit
Shared-loss termination settlement
(15,814)
True-up payment obligation:
26,786
(26,786)
NOTE 8 — FORECLOSED REAL ESTATE
The following tables present the activity related to foreclosed real estate for the quarters ended March 31, 2018 and 2017:
Acquired BBVAPR loans
Acquired Eurobank loans
14,283
18,347
11,544
Decline in value
(488)
(1,036)
(462)
(1,986)
Additions
1,487
3,249
Sales
(1,917)
(2,465)
(741)
(5,123)
13,365
16,495
10,454
12,390
21,379
13,751
47,520
(237)
(693)
(748)
(1,678)
3,412
3,534
440
7,386
(2,011)
(2,687)
(894)
(5,592)
Other adjustments
(85)
13,469
21,533
12,549
47,551
After hurricanes Irma and Maria in September 2017, management evaluated the potential impact these events brought to Oriental’s foreclosed real estate, considering the related underlying insurance coverage. Oriental has performed property inspections and taking into consideration all available information, the fair value of these properties was not materially impacted.
NOTE 9 — DERIVATIVES
The following table presents Oriental’s derivative assets and liabilities at March 31, 2018 and December 31, 2017:
Derivative assets:
Interest rate swaps designated as cash flow hedges
146
Interest rate swaps not designated as hedges
Interest rate caps
Derivative liabilities:
510
Interest Rate Swaps
Oriental 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 Oriental’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, Oriental 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 March 31, 2018:
Notional
Fixed
Variable
Trade
Settlement
Maturity
Type
Amount
Rate
Rate Index
Date
34,735
2.4210%
1-Month LIBOR
07/03/13
08/01/23
An accumulated unrealized gain of $146 thousand and a loss of $510 thousand were recognized in accumulated other comprehensive income related to the valuation of these swaps at March 31, 2018 and December 31, 2017, respectively, and the related asset or liability is being reflected in the consolidated statements of financial condition.
At March 31, 2018 and December 31, 2017, interest rate swaps not designated as hedging instruments that were offered to clients represented an asset of $459 thousand and $618 thousand, 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 March 31, 2018 and December 31, 2017, interest rate swaps not designated as hedging instruments that are the mirror-images of the derivatives offered to clients represented a liability of $459 thousand and $618 thousand, 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 March 31, 2018:
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
Oriental 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, Oriental 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 March 31, 2018 and December 31, 2017, the outstanding total notional amount of interest rate caps was $152.2 million and $152.6 million, respectively. At March 31, 2018 and December 31, 2017, the interest rate caps sold to clients represented a liability of $293 thousand and $153 thousand, respectively, and were included as part of derivative liabilities in the consolidated statements of financial condition. At March 31, 2018 and December 31, 2017, the interest rate caps purchased as mirror-images represented an asset of $293 thousand and $153 thousand, respectively, and were included as part of derivative assets in the consolidated statements of financial condition.
NOTE 10— ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS
Accrued interest receivable at March 31, 2018 and December 31, 2017 consists of the following:
Loans, excluding acquired loans
31,756
46,936
Investments
3,385
3,033
Accrued interest receivable at December 31, 2017, included $39.7 million, resulting from the loan payment moratorium. Accrued interest receivable resulting from the loan payment moratorium has been decreasing, as most moratoriums have expired. Some of these accrued interests are payable at the end of the loan term.
Other assets at March 31, 2018 and December 31, 2017 consist of the following:
Prepaid expenses
7,154
9,200
Other repossessed assets
5,082
3,548
Core deposit and customer relationship intangibles
4,357
4,687
Mortgage tax credits
4,277
Investment in Statutory Trust
1,083
Accounts receivable and other assets
35,515
41,898
Prepaid expenses amounting to $7.2 million and $9.2 million at March 31, 2018 and December 31, 2017, respectively, include prepaid municipal, property and income taxes aggregating to $4.2 million and $5.7 million, respectively.
In connection with the FDIC-assisted acquisition and the BBVAPR Acquisition, Oriental recorded a core deposit intangible representing the value of checking and savings deposits acquired. At March 31, 2018 and December 31, 2017 this core deposit intangible amounted to $3.1 million and $3.3 million, respectively. In addition, Oriental 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 March 31, 2018 and December 31, 2017, this customer relationship intangible amounted to $1.2 million and $1.4 million, respectively.
Other repossessed assets totaled $5.1 million and $3.5 million at March 31, 2018 and December 31, 2017, respectively, that consist mainly of repossessed automobiles, which are recorded at their net realizable value.
At March 31, 2018 and December 31, 2017, tax credits for Oriental totaled $2.3 million and $4.3 million, respectively. These tax credits do not have an expiration date.
NOTE 11— DEPOSITS AND RELATED INTEREST
Total deposits, including related accrued interest payable, as of March 31, 2018 and December 31, 2017 consist of the following:
Non-interest bearing demand deposits
1,071,648
969,525
Interest-bearing savings and demand deposits
2,274,855
2,274,116
Individual retirement accounts
219,427
231,376
Retail certificates of deposit
592,307
595,983
Institutional certificates of deposit
200,595
209,951
Total core deposits
4,358,832
4,280,951
Brokered deposits
474,596
518,531
Brokered deposits include $428.8 million in certificates of deposits and $45.8 million in money market accounts at March 31, 2018, and $471.6million in certificates of deposits and $46.9 million in money market accounts at December 31, 2017.
The weighted average interest rate of Oriental’s deposits was 0.62% and 0.65% at March 31, 2018 and December 31, 2017, respectively. Interest expense for the quarters ended March 31, 2018 and 2017 was as follows:
Demand and savings deposits
2,909
Certificates of deposit
4,486
4,444
At March 31, 2018 and December 31, 2017, time deposits in denominations of $250 thousand or higher, excluding accrued interest and unamortized discounts, amounted to $352.5 million and $359.6 million, respectively. Such amounts include public funds time deposits from various Puerto Rico government municipalities, agencies, and corporations of $2.3 million and $3.5 million at a weighted average rate of 0.30% and 0.28% at March 31, 2018 and December 31, 2017, respectively.
At March 31, 2018 and December 31, 2017, total public fund deposits from various Puerto Rico government municipalities, agencies, and corporations amounted to $127.3 million and $153.1 million, respectively. These public funds were collateralized with commercial loans amounting to $172.0 million and $173.0 million at March 31, 2018 and December 31, 2017, respectively.
Excluding accrued interest of approximately $1.7 million, the scheduled maturities of certificates of deposit at March 31, 2018 and 2017 are as follows:
Within one year:
Three (3) months or less
318,599
316,382
Over 3 months through 1 year
462,655
508,285
781,254
824,667
Over 1 through 2 years
462,528
470,670
Over 2 through 3 years
121,506
137,016
Over 3 through 4 years
36,936
36,125
Over 4 through 5 years
37,247
38,623
1,439,471
1,507,101
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 $1.1 million and $2.2 million as of March 31, 2018 and December 31, 2017, respectively.
53
NOTE 12 — BORROWINGS AND RELATED INTEREST
Securities Sold under Agreements to Repurchase
At March 31, 2018, 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 Oriental the same or similar securities at the maturity of these agreements. The purpose of these transactions is to provide financing for Oriental’s securities portfolio.
At March 31, 2018 and December 31, 2017, securities sold under agreements to repurchase (classified by counterparty), excluding accrued interest in the amount of $426 thousand and $369 thousand, respectively, were as follows:
Fair Value of
Borrowing
Underlying
Collateral
JP Morgan Chase Bank NA
152,500
164,749
82,500
88,974
KGS Alpha
11,000
11,730
Federal Home Loan Bank
110,000
116,589
116,509
273,500
293,068
192,500
205,483
The following table shows a summary of Oriental’s repurchase agreements and their terms, excluding accrued interest in the amount of $426 thousand, at March 31, 2018:
Weighted-
Year of Maturity
Coupon
Settlement Date
72,500
1.52%
12/30/2015
4/29/2018
2.15%
3/28/2018
4/4/2018
2019
50,000
1.72%
3/2/2017
9/3/2019
2020
60,000
1.85%
3/2/2020
2.61%
3/15/2018
3/15/2020
30,000
2.70%
3/23/2018
3/23/2020
1.96%
All of the repurchase agreements referred to above with maturity dates up to the date of this report were renewed as short-term repurchase agreements.
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 March 31, 2018 and December 31, 2017. There was no cash collateral at March 31, 2018 and December 31, 2017.
Market Value of Underlying Collateral
FNMA and
Repurchase
FHLMC
Liability
Certificates
Less than 90 days
83,500
90,170
Over 90 days
190,000
202,898
1.63%
Advances from the Federal Home Loan Bank of New York
Advances are received from the FHLB-NY under an agreement whereby Oriental is required to maintain a minimum amount of qualifying collateral with a fair value of at least 110% of the outstanding advances. At March 31, 2018 and December 31, 2017, these advances were secured by mortgage and commercial loans amounting to $972.8 million and $1.3 billion, respectively. Also, at March 31, 2018 and December 31, 2017, Oriental had an additional borrowing capacity with the FHLB-NY of $925.2 million and $920.0 million, respectively. At March 31, 2018 and December 31, 2017, the weighted average remaining maturity of FHLB’s advances was 5.8 months and 3.2 months, respectively. The original terms of these advances range between one month and seven years, and the FHLB-NY does not have the right to exercise put options at par on any advances outstanding as of March 31, 2018.
The following table shows a summary of these advances and their terms, excluding accrued interest in the amount of $75 thousand, at March 31, 2018:
1.86%
3/1/2018
4/2/2018
9,124
2.59%
7/19/2013
7/20/2020
43,859
2.01%
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 March 31, 2018 and December 31, 2017, for both periods.
NOTE 13 – OFFSETTING OF FINANCIAL ASSETS AND LIABILITIES
Oriental’s derivatives are subject to agreements which allow a right of set-off with each respective counterparty. In addition, Oriental’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 an account control agreement.
The following table presents the potential effect of rights of set-off associated with Oriental’s recognized financial assets and liabilities at March 31, 2018 and December 31, 2017:
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
2,003
(1,105)
Net amount of
2,010
(1,239)
Liabilities
Presented
Provided
(1,228)
(19,568)
274,252
(20,796)
(699)
(12,983)
193,781
(13,682)
NOTE 14 — INCOME TAXES
At March 31, 2018 and December 31, 2017, Oriental’s net deferred tax asset amounted to $128.3 million and $127.4 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 Oriental will realize the deferred tax asset, net of the existing valuation allowances recorded at March 31, 2018 and December 31, 2017. 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.
Oriental classifies unrecognized tax benefits in other liabilities. These gross unrecognized tax benefits would affect the effective tax rate if realized. At March 31, 2018 the amount of unrecognized tax benefits remained at $1.3 million when compared to December 31, 2017. Oriental had accrued $24 thousand at March 31, 2018 (December 31, 2017 - $97 thousand) for the payment of interest and penalties relating to unrecognized tax benefits.
Oriental 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%. Oriental maintained a lower effective tax rate for the quarters ended March 31, 2018 and 2017 of 32.0% and 37.8%, respectively.
Oriental has operations in U.S. through its wholly owned subsidiary OPC, a retirement plan administration based in Florida. Also, in October 2017, Oriental expanded its operations in U.S. through the Bank's wholly owned subsidiary OFG USA. Both subsidiaries are subject to state and federal taxes. OPC is subject to Florida state taxes and OFG USA is subject to North Carolina state taxes. OFG USA elected to be classified as a corporation.
Income tax expense for the quarters ended March 31, 2018 and 2017 was $8.0 million and $9.2 million, respectively.
NOTE 15 — REGULATORY CAPITAL REQUIREMENTS
Regulatory Capital Requirements
OFG Bancorp (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 Oriental’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Oriental 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 Oriental 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 previous 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 March 31, 2018 and December 31, 2017, OFG Bancorp and the Bank met all capital adequacy requirements to which they are subject. As of March 31, 2018 and December 31, 2017, 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.
OFG Bancorp’s and the Bank’s actual capital amounts and ratios as of March 31, 2018 and December 31, 2017 are as follows:
Minimum Capital
Minimum to be Well
Actual
Requirement
Capitalized
Ratio
OFG Bancorp Ratios
As of March 31, 2018
Total capital to risk-weighted assets
910,828
20.29%
359,130
8.00%
448,913
10.00%
Tier 1 capital to risk-weighted assets
852,882
19.00%
269,348
6.00%
Common equity tier 1 capital to risk-weighted assets
652,012
14.52%
202,011
4.50%
291,793
6.50%
Tier 1 capital to average total assets
14.07%
242,395
4.00%
302,994
5.00%
As of December 31, 2017
899,258
20.34%
353,653
442,067
842,133
19.05%
265,240
644,804
14.59%
198,930
287,343
13.92%
242,057
302,571
Bank Ratios
888,557
19.81%
358,832
448,541
830,845
18.52%
269,124
201,843
291,551
13.76%
241,559
301,948
879,648
19.92%
353,265
441,581
822,776
18.63%
264,949
198,712
287,028
13.63%
241,417
301,771
NOTE 16 – 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 March 31, 2018 and December 31, 2017, 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 March 31, 2018 and December 31, 2017, the Bank’s legal surplus amounted to $83.1 million and $81.5 million, respectively. The amount transferred to the legal surplus account is not available for the payment of dividends to shareholders.
Treasury Stock
Under Oriental’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 Oriental as treasury shares. During the quarters ended March 31, 2018 and 2017, Oriental did not purchase any shares under the program.
At March 31, 2018 the number of shares that may yet be purchased under the $70 million program is estimated at 739,795 and was calculated by dividing the remaining balance of $7.7 million by $10.45 (closing price of Oriental's common stock at March 31, 2018).
The activity in connection with common shares held in treasury by Oriental for the quarters ended March 31, 2018 and 2017 is set forth below:
Dollar
Shares
(In thousands, except shares data)
Beginning of period
8,678,427
104,502
8,711,025
104,860
Common shares used upon lapse of restricted stock units
(20,900)
(32,598)
End of period
8,657,527
104,142
NOTE 17 - ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income, net of income taxes, as ofMarch 31, 2018 and December 31, 2017 consisted of:
Unrealized loss on securities available-for-sale which are not
other-than-temporarily impaired
(14,329)
(3,003)
Income tax effect of unrealized loss on securities available-for-sale
2,055
365
Net unrealized gain on securities available-for-sale which are not
(12,274)
Unrealized gain (loss) on cash flow hedges
(510)
Income tax effect of unrealized (gain) loss on cash flow hedges
(57)
199
Net unrealized gain (loss) on cash flow hedges
(311)
Accumulated other comprehensive (loss), net of income taxes
The following table presents changes in accumulated other comprehensive income by component, net of taxes, for the quarters ended March 31, 2018 and 2017:
Net unrealized
Accumulated
gains on
loss on
other
securities
cash flow
comprehensive
available-for-sale
hedges
(loss) income
Beginning balance
Other comprehensive loss before reclassifications
(9,576)
(9,550)
Amounts reclassified out of accumulated other comprehensive income (loss)
(60)
Other comprehensive income (loss)
(9,636)
Ending balance
2,209
(613)
1,707
1,669
(66)
149
83
1,641
111
3,850
(502)
62
The following table presents reclassifications out of accumulated other comprehensive income for the quarters ended March 31, 2018 and 2017:
Amount reclassified out of accumulated other comprehensive income
Affected Line Item in Consolidated Statement of Operations
Cash flow hedges:
Interest-rate contracts
Net interest expense
Available-for-sale securities:
Residual tax effect from OIB's change in applicable tax rate
Tax effect from changes in tax rates
(65)
(74)
NOTE 18 – EARNINGS PER COMMON SHARE
The calculation of earnings per common share for the quarters ended March 31, 2018 and 2017 is as follows:
Less: Dividends on preferred stock
Non-convertible preferred stock (Series A, B, and D)
(1,627)
Convertible preferred stock (Series C)
(1,838)
Effect of assumed conversion of the convertible preferred stock
1,838
Income available to common shareholders assuming conversion
15,290
13,523
Weighted average common shares and share equivalents:
Average common shares outstanding
43,955
43,916
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 March 31, 2018, 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 ended March 31, 2018 and 2017 on the convertible preferred stock were added back as income available to common shareholders.
For the quarters ended March 31, 2018 and 2017, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 859,322 and 507,786, respectively.
NOTE 19 – GUARANTEES
At March 31, 2018 and December 31, 2017 , the unamortized balance of the obligations undertaken in issuing the guarantees under standby letters of credit represented a liability of $18.6 million and $21.1 million, respectively.
Oriental has a liability for residential mortgage loans sold subject to credit recourse, pursuant to FNMA’s residential mortgage loan sales and securitization programs. At March 31, 2018 and December 31, 2017, the unpaid principal balance of residential mortgage loans sold subject to credit recourse was $6.3 million and $6.4 million, respectively.
The following table shows the changes in Oriental’s liability for estimated losses from these credit recourse agreements, included in the consolidated statements of financial condition during the quarters ended March 31, 2018 and 2017.
710
Net (charge-offs/terminations) recoveries
(94)
264
570
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 Oriental is obligated to repurchase the loan.
If a borrower defaults, pursuant to the credit recourse provided, Oriental is required to repurchase the loan or reimburse the third party investor for the incurred loss. The maximum potential amount of future payments that Oriental 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 quarter ended March 31, 2018, Oriental did not repurchase any mortgage loans subject to credit recourse provisions. During the quarter ended March 31, 2017, Oriental repurchased approximately $41 thousand of unpaid principal balance in mortgage loans subject to the credit recourse provisions. If a borrower defaults, Oriental has rights to the underlying collateral securing the mortgage loan. Oriental 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 March 31, 2018, Oriental’s liability for estimated credit losses related to loans sold with credit recourse amounted to $264 thousand (December 31, 2017– $358 thousand).
When Oriental sells or securitizes mortgage loans, it generally makes customary representations and warranties regarding the characteristics of the loans sold. Oriental'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 Oriental to ensure that asset guideline qualifications are met. To the extent the loans do not meet specified characteristics, Oriental may be required to repurchase such loans or indemnify for losses and bear any subsequent loss related to the loans. During the quarter ended March 31, 2018, Oriental repurchased $2.3 million (March 31, 2017 – $978 thousand) of unpaid principal balance in mortgage loans, excluding mortgage loans subject to credit recourse provision referred above.
During the quarters ended March 31, 2018 and 2017, Oriental recognized $100 thousand in losses from the repurchase of residential mortgage loans sold subject to credit recourse, at both periods. During the quarters ended March 31, 2018 and 2017, Oriental recognized $1 thousand and $308 thousand, respectively, in losses 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 Oriental to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. At March 31, 2018, Oriental serviced $872.2 million (December 31, 2017 - 864.9 million) in mortgage loans for third-parties. Oriental 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, Oriental must absorb the cost of the funds it advances during the time the advance is outstanding. Oriental 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 Oriental would not receive any future servicing income with respect to that loan. At March 31, 2018, the outstanding balance of funds advanced by Oriental under such mortgage loan servicing agreements was approximately $605 thousand (December 31, 2017 - $440 thousand). To the extent the mortgage loans underlying Oriental's servicing portfolio experience increased delinquencies, Oriental 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 20—COMMITMENTS AND CONTINGENCIES
Loan Commitments
In the normal course of business, Oriental 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 Oriental’s involvement in particular types of financial instruments.
Oriental’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. Oriental uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Credit-related financial instruments atMarch 31, 2018 and December 31, 2017 were as follows:
Commitments to extend credit
508,955
485,019
Commercial letters of credit
494
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. Oriental evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by Oriental upon the extension of credit, is based on management’s credit evaluation of the counterparty.
At March 31, 2018 and December 31, 2017, 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 $567 thousand at both March 31, 2018 and December 31, 2017.
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 March 31, 2018 and December 31, 2017, is as follows:
Standby letters of credit and financial guarantees
18,648
21,107
Loans sold with recourse
6,332
6,420
Standby letters of credit and financial guarantees are written conditional commitments issued by Oriental 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 Oriental upon extension of credit, is based on management’s credit evaluation of the customer.
Lease Commitments
Oriental has entered into various operating lease agreements for branch facilities and administrative offices. Rent expense for the quarters ended March 31, 2018 and 2017, amounted to $2.2 million and $2.0 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 March 31, 2018, exclusive of taxes, insurance, and maintenance expenses payable by Oriental, are summarized as follows:
Minimum Rent
Year Ending December 31,
6,593
6,345
5,679
2021
4,796
2022
3,379
Thereafter
6,869
33,661
Contingencies
Oriental and its subsidiaries are defendants in a number of legal proceedings incidental to their business. In the ordinary course of business, Oriental and its subsidiaries are also subject to governmental and regulatory examinations. Certain subsidiaries of Oriental, 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.
Oriental seeks to resolve all litigation and regulatory matters in the manner management believes is in the best interests of Oriental 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 Oriental’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 Oriental. 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 Oriental’s consolidated results of operations or cash flows in particular quarterly or annual periods. Oriental has evaluated all litigation and regulatory matters where the likelihood of a potential loss is deemed reasonably possible. Oriental has determined that the estimate of the reasonably possible loss is not significant.
NOTE 21 – BANKING AND FINANCIAL SERVICE REVENUES
The following table presents the major categories of banking and financial service revenues for the quarters ended March 31, 2018 and 2017:
Banking service revenues:
Checking accounts fees
1,519
1,852
Savings accounts fees
155
Electronic banking fees
7,571
Credit life commissions
Branch service commissions
327
147
Servicing and other loan fees
601
484
International fees
Miscellaneous income
Total banking service revenues
Wealth management revenue:
Insurance income
1,238
1,551
Broker fees
1,789
1,876
Trust fees
2,696
Retirement plan and administration fees
Investment banking fees
Total wealth management revenue
Mortgage banking activities:
Net servicing fees
1,754
820
Net gains (losses) on sale of mortgage loans and valuation
174
(407)
Total mortgage banking activities
NOTE 22 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Oriental 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"), an 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 March 31, 2018 and December 31, 2017, Oriental did not have investment securities classified as Level 3.
Securities purchased under agreements to resell
The fair value of securities purchased under agreements to resell 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 instruments.
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 Oriental. 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.
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:
(752)
802,080
820,041
Non-recurring fair value measurements:
Impaired commercial loans
68,580
113,976
70
(1,281)
645,478
662,320
72,285
120,007
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 ended March 31, 2018 and 2017:
Level 3 Instruments Only
9,858
New instruments acquired
534
Principal repayments
(199)
(162)
Changes in fair value of servicing assets
559
(542)
9,688
During the quarters ended March 31, 2018 and 2017, 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.
71
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 March 31, 2018:
Valuation Technique
Unobservable Input
Range
Cash flow valuation
Constant prepayment rate
4.08% -8.50%
Discount rate
10.00% - 12.00%
Collateral dependent
impaired loans
35,239
Fair value of property
or collateral
Appraised value less disposition costs
19.20% - 35.20%
Other non-collateral dependent impaired loans
33,341
4.15% - 10.50%
Estimated net realizable value less disposition costs
29.00% - 71.00%
Information about Sensitivity to Changes in Significant Unobservable Inputs
Servicing assets – The significant unobservable inputs used in the fair value measurement of Oriental’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 Oriental.
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.
The estimated fair value and carrying value of Oriental’s financial instruments at March 31, 2018 and December 31, 2017 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)
3,735,449
3,842,907
4,767,479
4,782,197
271,811
191,104
43,880
99,509
34,158
33,080
73
The following methods and assumptions were used to estimate the fair values of significant financial instruments at March 31, 2018 and 2017:
• 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 December 31, 2017, Oriental 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.
• 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 and non-performing loans) is based on the exit market price, which 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. The fair value 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.
• 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.
NOTE 23 – BUSINESS SEGMENTS
Oriental 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 Oriental’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. Oriental 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. Oriental’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 Oriental’s own portfolio. As part of its mortgage banking activities, Oriental 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 Oriental’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 ended March 31, 2018 and 2017:
Wealth
Total Major
Consolidated
Banking
Management
Treasury
Segments
Eliminations
Interest income
74,374
8,784
Interest expense
(6,290)
(2,886)
(9,176)
68,084
5,898
(15,455)
(5)
(15,460)
Non-interest income, net
12,193
6,308
Non-interest expenses
(48,081)
(3,286)
(754)
(52,121)
Intersegment revenue
361
(361)
Intersegment expenses
(179)
(182)
17,102
2,855
4,970
Income tax expense (benefit)
6,670
1,113
227
10,432
1,742
4,743
5,661,759
28,377
1,529,912
7,220,048
(972,927)
77,573
8,593
(6,814)
(4,746)
(11,560)
70,759
3,847
(17,642)
(12)
(17,654)
13,227
5,928
(46,054)
(4,220)
(1,410)
(51,684)
535
(535)
(71)
(153)
20,683
1,409
2,262
Income tax expenses (benefit)
8,066
550
588
12,617
859
1,674
5,485,678
24,866
1,861,616
7,372,160
(957,553)
6,414,607
76
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion of Oriental’s financial condition and results of operations should be read in conjunction with the “Selected Financial Data” and Oriental’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, 2017 (the “2017 Form 10-K”), for discussion of the uncertainties, risks and assumptions associated with these statements.
Oriental 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. Oriental operates through three major business segments: Banking, Wealth Management, and Treasury, and distinguishes itself based on quality service. Oriental has 39 branches in Puerto Rico and a subsidiary in Boca Raton, Florida, and a non-bank operating subsidiary in Cornelius, North Carolina. Oriental’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.
Oriental’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, Oriental’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 2017 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 2017 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:
· Fair value measurements of financial instruments
· Interest on loans and allowance for loan losses
· Acquisition accounting for loans
· Income taxes
· Goodwill
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 2017 Form 10-K.
OVERVIEW OF FINANCIAL PERFORMANCE
SELECTED FINANCIAL DATA
Variance
%
EARNINGS DATA:
-3.5%
-20.6%
-0.8%
-12.4%
Net interest income after provision for loan
and lease losses
2.8%
Non-interest income
-2.9%
0.8%
Income before taxes
2.4%
-13.0%
11.7%
0.0%
15.1%
PER SHARE DATA:
14.8%
15.4%
43,915
0.1%
Cash dividends declared per common share
Cash dividends declared on common shares
2,638
2,637
PERFORMANCE RATIOS:
Return on average assets (ROA)
1.09%
0.95%
14.7%
Return on average tangible common equity
7.73%
7.00%
10.4%
Return on average common equity (ROE)
6.84%
6.15%
11.2%
Equity-to-assets ratio
15.16%
4.4%
Efficiency ratio
56.51%
56.15%
0.6%
Interest rate spread
5.13%
5.02%
2.2%
Interest rate margin
5.22%
5.10%
SELECTED FINANCIAL DATA - (Continued)
PERIOD END BALANCES AND CAPITAL RATIOS:
Investments and loans
11.4%
Loans and leases, net
1.9%
Total investments and loans
5,432,008
5,222,379
4.0%
Deposits and borrowings
0.7%
42.0%
80,411
135,879
-40.8%
Total deposits and borrowings
5,187,765
5,128,230
1.2%
Stockholders’ equity
Preferred stock
Common stock
2.1%
4.5%
Treasury stock, at cost
0.3%
Accumulated other comprehensive (loss)
-313.2%
Total stockholders' equity
0.2%
Per share data
Book value per common share
17.76
17.73
Tangible book value per common share
15.71
15.67
Market price at end of period
10.45
9.40
Capital ratios
Leverage capital
1.1%
Common equity Tier 1 capital ratio
-0.5%
Tier 1 risk-based capital
-0.3%
Total risk-based capital
-0.2%
Financial assets managed
Trust assets managed
2,939,723
3,039,998
-3.3%
Broker-dealer assets gathered
2,200,176
2,250,460
-2.2%
79
Our first quarter results reflect the success of our strategies and Puerto Rico’s recovery. Oriental earned $0.30 per share fully diluted, 15% higher than a year ago. Our strong capital position continued to build.
The island benefited from loan payment moratoriums by Oriental and other banks, an increased availability of electric power, improvement in communications, and the return of day to day stability, as well as rebuild spending by FEMA, the start of payments of insurance claims, and the prospect of growing assignments of federal funds.
Nearly every metric in the quarter ended March 31, 2018 confirmed this progress. For the second quarter in a row, our originated loan growth outpaced the pay down of acquired loans, resulting in a net increase of $77.1 million from December 31, 2017.
Auto, consumer and mortgage lending production at $192.3 million increased 52% from the preceding quarter and more than 11% from the year ago quarter. In particular, auto lending was at a record level, up more than 46% from the preceding and year ago quarters. Commercial loan production in Puerto Rico, while lower than the prior quarter, rose more than 13% year over year. Meanwhile, our US commercial and industrial loan program added close to $74 million in participations.
With nearly all of our loan moratoriums expiring during this quarter, credit quality remained solid. Most metrics were better than, or returned to, pre-hurricanes levels.
Fee revenues rebounded with a 24% sequential increase in Banking Services and a 43% increase in mortgage banking. Core wealth management held steady at pre-hurricanes levels.
Customer deposits (excluding brokered-deposits) increased 2% from December 31, 2017 and 5% from a year ago. Our net interest margin expanded to 5.22%, and net new customer accounts grew at an annualized rate of 8%, significantly exceeding 2017’s hurricanes affected 2% rise.
Our effort to differentiate Oriental through superior service and digital banking technology is proving effective. Our team of dedicated bankers continually reaching out to our customers and clients is clearly working. During the quarter ended March 31, 2018, we introduced another new technology-based service—My Payments (Mis Pagos), which enables loan customers to pay online instead of standing in line.
· Net income available to shareholders was $13.5 million, or $0.30 per fully diluted share. This was in line with the $13.6 million, or $0.30 per share from the preceding quarter, and exceeded the year ago quarter’s $11.7 million, or $0.26 per share.
· Return on average assets and average tangible common equity was 1.09% and 7.73%, respectively.
· Tangible book value per common share was $15.71, and the tangible common equity ratio was 11.22%.
· Loan production of $309.4 million increased 22.0% from the preceding and 41.4% from the year ago quarter.
· Total provision for loan and lease losses, net, declined $2.2 million from the year ago quarter.
· Core non-interest income of $18.2 million increased 9.0% from the preceding quarter and 4.7% from the year ago quarter as banking service fees and mortgage banking revenues rebounded.
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 ended March 31, 2018 and 2017:
TABLE 1 - ANALYSIS OF NET INTEREST INCOME AND CHANGES DUE TO VOLUME/RATE
Interest
Average rate
Average balance
March
A - TAX EQUIVALENT SPREAD
Interest-earning assets
5.86%
5.89%
5,751,783
5,932,923
Tax equivalent adjustment
1,162
1,225
0.08%
Interest-earning assets - tax equivalent
84,332
87,403
5.94%
5.97%
Interest-bearing liabilities
9,174
0.72%
0.87%
5,127,188
5,399,122
Tax equivalent net interest income / spread
75,158
75,843
624,595
533,801
Tax equivalent interest rate margin
5.29%
5.18%
B - NORMAL SPREAD
Interest-earning assets:
7,351
7,682
2.40%
2.29%
1,239,794
1,360,186
Interest bearing cash and money market investments
1,207
846
1.49%
0.80%
328,214
431,110
8,558
8,528
2.21%
1.93%
1,568,008
1,791,296
Non-acquired loans
9,006
9,531
5.34%
5.43%
683,398
711,553
18,274
15,997
5.66%
5.21%
1,310,444
1,245,530
8,433
7,648
10.78%
11.09%
317,295
279,558
21,068
18,780
9.15%
9.78%
933,456
778,815
Total non-acquired loans
56,781
51,956
7.10%
6.99%
3,244,593
3,015,456
Acquired BBVAPR
7,073
7,890
5.54%
5.73%
517,839
558,864
3,690
4,985
7.08%
7.81%
211,319
258,755
2,388
2,932
16.82%
19.15%
57,568
62,097
1,339
3,278
9.89%
11.27%
54,912
117,933
Total acquired BBVAPR loans
14,490
19,085
6.98%
7.76%
841,638
997,649
Acquired Eurobank
3,341
6,610
13.89%
20.86%
97,544
128,522
77,651
7.23%
7.60%
4,183,775
4,141,627
Total interest-earning assets
86,179
Interest-bearing liabilities:
NOW Accounts
1,041
0.34%
0.39%
1,059,129
1,092,389
Savings and money market
1,497
1,481
0.50%
0.52%
1,206,100
1,164,040
0.61%
0.68%
224,299
253,626
Retail certificates of deposits
2,460
1,650
1.67%
1.24%
596,479
541,706
5,191
4,598
3,086,007
3,051,761
Institutional deposits
641
0.01%
1.16%
203,962
224,196
1,886
1,885
1.64%
1.33%
466,638
574,549
Total wholesale deposits
2,526
1.14%
670,600
798,745
7,083
7,124
0.76%
0.75%
3,756,607
3,850,506
Non-interest bearing deposits
0.00%
1,018,789
832,665
Core deposit intangible amortization
215
229
0.62%
0.64%
4,775,396
4,683,171
1.73%
251,582
574,771
2.37%
2.30%
64,127
105,097
4.79%
4.12%
1,878
4,207
2.16%
2.38%
351,792
715,951
Total interest bearing liabilities
0.73%
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
112.18%
109.89%
C - CHANGES IN NET INTEREST INCOME DUE TO:
Volume
Interest Income:
(1,063)
1,092
(630)
(2,408)
(3,038)
(1,693)
(1,316)
(3,009)
Interest Expense:
145
(55)
Repurchase agreements
(1,825)
(344)
(2,169)
(1,959)
(2,386)
Net Interest Income
266
(889)
(623)
Net interest income is a function of the difference between rates earned on Oriental’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). Oriental 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 March 31, 2018 and 2017
Net interest income of $74.0 million decreased $623 thousand from $74.6 million. Interest rate spread increased 11 basis points to 5.13% from 5.02% and net interest margin increased 12 basis points to 5.22% from 5.10%. These increases are mainly due to the net effect of a decrease of 3 basis points in the average yield of total interest earning assets and a decrease of 14 basis points in the total average of interest bearing liabilities.
Net interest income was positively impacted by:
· Higher interest income from originated loans of $4.8 million reflecting higher balances in the commercial and retail loan portfolios; and
· Lower interest expenses on securities sold under agreements to repurchase due to decreases in volume and interest rate of $1.8 million and $344 thousand, respectively, mainly as a result of (i) the repayment at maturity of a $232.0 million repurchase agreement at 4.78% in March 2017, and (ii) the unwinding of $100.0 million repurchase agreements in June 2017.
Net interest income was adversely impacted by:
· A decrease of $7.9 million in the interest income from the acquired BBVAPR and Eurobank loan portfolios as such loans continue to be repaid.
Comparison of quarters ended March 31, 2017 and 2016
Net interest income of $74.6 million slightly decreased 0.5% compared with $75.0 million, reflecting a decrease in interest income of 5.6%, partially offset by a decrease in interest expenses of 29.2%. Interest rate spread increase 43 basis points from 4.59% to 5.02%. This increase is mainly due to the net effect of 20 basis points increase in the average yield of interest-earning assets from 5.69% to 5.89% and to 23 basis points decrease in average costs of interest-bearing liabilities from 1.10% to 0.87%
· Higher interest income from originated loans of $4.0 million reflecting higher yields on commercial and retail loan portfolios; and
· Lower interest expenses on repurchase agreements and other borrowings of $5.0 million as a result of the repayment of high cost repurchase agreements and FHLB advances.
· A decrease of $7.5 million in the interest income from acquired loans as such loans continue to be repaid; and
· A decrease in interest income from investments by $1.6 million due to lower volume and yield.
TABLE 2 - NON-INTEREST INCOME SUMMARY
-1.5%
-3.2%
199.3%
Total banking and financial service revenue
4.7%
-100.0%
69.7%
1,646
-83.3%
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 March 31, 2018 and 2017
Oriental recorded non-interest income, net, in the amount of $18.5 million, compared to $19.1 million, a decrease of 2.9%, or $560 thousand. The decrease in non-interest income was mainly due to:
· The termination of the FDIC shared-loss agreement during the first quarter of 2017 resulting in the recognition of a $1.4 million gain during such period.
The decrease in non-interest income was partially offset by:
· An increase in mortgage banking activities of $1.2 million, reflecting $881 thousand from mortgage servicing and $407 thousand from decrease in repurchased loans.
Oriental recorded non-interest income, net, in the amount of $19.1 million, compared to $13.5 million, an increase of 41.3%, or $5.6 million. The increase in non-interest income was mainly due to the termination of the FDIC shared-loss agreement during the first quarter of 2017 resulting in the recognition of a $1.4 million gain during such period, compared to $4.0 million expenses related to the aforementioned agreement in the year ago period.
TABLE 3 - NON-INTEREST EXPENSES SUMMARY
Variance %
1.3%
-16.8%
7.9%
-7.6%
-3.4%
-7.5%
-2.4%
-4.7%
Printing, postage, stationery and supplies
-14.3%
-7.9%
1,661
45.5%
Total non-interest expenses
51,683
Relevant ratios and data:
Compensation and benefits to
non-interest expense
39.5%
39.4%
Compensation to average total assets owned
1.32%
1.27%
Average number of employees
1,367
1,429
Average compensation per employee
15.1
14.2
Average loans per average employee
3,061
2,898
Non-Interest Expenses
Non-interest expense was $52.1 million, representing a slight increase of 0.8% compared to $51.7 million.
The increase in non-interest expenses was driven by:
· Higher other operating expense by $754 thousand, particularly attributed to an increase in claims and settlements accruals and to minor repairs to physical assets related to the impact of the hurricanes.
· Higher occupancy and equipment expenses by $568 thousand, primarily due to an increase in rent expenses driven by less rent income and to an increase in internet services.
The increases in the foregoing non-interest expenses were partially offset by:
· Lower professional and service fees by $543 thousand as a result lower consulting and advisory expenses; and
· Lower credit related expenses by $207 thousand, mainly due to a decrease in legal expenses from foreclosures of $249 thousand.
The efficiency ratio increased to 56.51% from 56.15%. The efficiency ratio measures how much of Oriental’s revenues is used to pay operating expenses. Oriental 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 that are excluded from efficiency ratio computation for the quarters ended March 31, 2018 and 2017 amounted to $275 thousand and $1.6 million, respectively.
Oriental implemented its disaster response plan as hurricanes Irma and Maria approached its service areas. To operate in disaster response mode, Oriental incurred expenses for, among other things, buying diesel and generators for electric power, debris removal, security services, property damages, and emergency communication with customers regarding the status of Bank operations. Estimated losses at December 31, 2017 amounted to $6.6 million. No additional losses have been incurred at March 31, 2018.
Oriental maintains insurance for casualty losses as well as for disaster response costs and certain revenue lost through business interruption. Management believes that recovery of $2.2 million incurred costs as of December 31, 2017 is probable. Oriental received a $1.0 million partial payment from the insurance company in December 2017 and a $0.7 million payment during the first quarter of 2018. Accordingly, a receivable of $0.5 million and $1.2 million was included in other assets at March 31, 2018 and December 31, 2017, respectively, for the expected recovery.
Non-interest expense for 2017 was $51.7 million, representing a decrease of 5.8% compared to $54.9 million in the previous year. The decrease in non-interest expenses was driven by:
· Lower insurance expense by $1.6 million, primarily 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 June 30, 2016 invoice, which was received during the third quarter of 2016.
· Lower loan servicing and clearing expense by $941 thousand, mainly due to mortgage servicing migration expenses amounting to $900 thousand during the first quarter of 2016.
· Lower electronic banking charges by $687 thousand, primarily as a result of a decrease of $885 thousand in credit cards merchant fees, partially offset by an increase in debit card billing fees of $135 thousand.
The efficiency ratio improved to 56.15% from 59.56% for the same period in 2016. Amounts presented as part of non-interest income that are excluded from efficiency ratio computation for the quarters ended March 31, 2017 and 2016 amounted to $1.6 million and $3.6 million, respectively.
Provision for Loan and Lease Losses
Based on an analysis of the credit quality and the composition of Oriental’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 loan and lease losses decreased 12.4%, or $2.2 million, to $15.5 million. The decrease in the provision was mostly due to:
· A decrease in the provision for acquired BBVAPR loan and lease losses of $3.9 million, mainly due to an additional provision recognized during the year ago quarter from the periodic assessment of loans remaining in these portfolios.
The decrease in the provision for loan and lease losses was partially offset by:
· An increase of $8.6 million to replenish the allowance for loan charge-offs of $8.2 million related to the hurricanes. It also included an increase in the allowance related to auto loan portfolio growth and one commercial loan placed in non-accrual.
Please refer to the "Allowance for Loan and Lease Losses" in the "Credit Risk Management" section of this MD&A for a more detailed analysis of the allowance for loan and lease losses.
Provision for loan and lease losses increased 28.0%, or $3.9 million, to $17.7 million. The increase in the provision was mostly due to:
· An increase in the provision for acquired BBVAPR and Eurobank loan and lease losses of $3.2 million from the periodic assessment of loans remaining in these portfolios during the quarter ended March 31, 2017; and
· An increase in the provision for originated and other loan losses of $1.1 million due to continued growth of the portfolio.
Income Taxes
Income tax expense was $8.0 million, compared to $9.2 million, reflecting the effective income tax rate of 32.0% and the net income before income taxes of $24.9 million for 2018, due to a higher proportion of exempt income and income subject to preferential rates.
Income tax expense was $9.2 million, compared to $5.7 million. The effective tax rate for 2017 was 37.8% compared to 28.5% for 2016.
Business Segments
Oriental 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 Oriental’s organization, nature of its products, distribution channels and economic characteristics of the products were also considered in the determination of the reportable segments. Oriental 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. Oriental’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 ended March 31, 2018 and 2017.
Provision for
loan and lease losses
Provision for loan and lease losses
Non-interest income (loss)
88
Oriental's banking segment net income before taxes decreased $3.6 million to $17.1 million, reflecting:
· A decrease in net interest income by $2.7 million, mainly from the acquired BBVAPR and Eurobank loan portfolios as such loans continue to be repaid;
· Lower provision for loan and lease losses by $2.2 million, mainly from acquired loans due to an additional provision recognized during the year ago quarter from the periodic assessment of loans remaining in these portfolios.
· Lower non-interest income by $1.0 million, reflecting the termination of the FDIC shared-loss agreement in the first quarter of 2017.
· Higher non-interest expenses by $2.0 million mainly as a result of higher occupancy and equipment expenses, primarily due to an increase in rent expenses driven by less rent income and to an increase in internet services and other expenses; and
Wealth Management
Wealth management segment revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, increased $1.4 million to $2.9 million mainly due to higher income by $380 thousand, mainly from changes in volume and market rates, and lower expenses by $934 thousand from lower broker related expenses.
Treasury segment net income before taxes, which consists of Oriental's asset/liability management activities, such as purchase and sale of investment securities, interest rate risk management, derivatives, and borrowings, increased to $5.0 million, compared to $2.3 million, reflecting:
· Lower interest expenses on securities sold under agreements to repurchase due to decreases in volume and interest rate of $1.8 million and $344 thousand, respectively, mainly as a result of (i) the repayment at maturity of a $232.0 million repurchase agreement at 4.78% in March 2017, and (ii) theunwinding of $100.0 million repurchase agreements in June 2017.
Oriental's banking segment net income before taxes increased $283 thousand in 2017, reflecting:
· A decrease in net interest income by $3.6 million, mainly from the acquired loan portfolios as such loans continue to be repaid;
· An increase in provision for loan and lease losses of $3.9 million. Provision for acquired loan and lease losses increased $2.8 million due to the periodic assessment of loans remaining in these portfolios;
· Higher non-interest income from the FDIC shared-loss benefit of $1.4 million related to the termination of the FDIC shared-loss agreements during the first quarter of 2017 compared to a $4.0 million expense in the year ago quarter.
· Lower non-interest expense by $2.2 million, primarily reflecting a decrease in loan servicing and clearing expenses of $941 thousand, mainly due to mortgage servicing migration expenses during the first quarter of 2016, and a decrease in electronic banking charges of $687 thousand, as a result of a decrease of $885 thousand in credit cards merchant fees, partially offset by an increase in debit card billing fees of $135 thousand.
Wealth management revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, slightly increased $146 thousand to $1.4 million, mainly from changes in volume and market rates.
Treasury segment net income before taxes increased to $2.3 million, compared to a loss of $1.8 million, reflecting:
· Lower interest expenses on repurchases agreements and other borrowings by $5.0 million, mainly from the partial unwinding of a repurchase agreement amounting to $268.0 million, which carried a cost of 4.78%, and the repayment of $227.0 million in short term FHLB advances at maturity.
ANALYSIS OF FINANCIAL CONDITION
Assets Owned
At March 31, 2018, Oriental’s total assets amounted to $6.247 billion representing an increase of 0.9% when compared to $6.189 billion at December 31, 2017. This increase is attributable to an increase in the investment and loan portfolios of $132.5 million and $77.1 million, respectively, partially offset by a decrease in cash and cash equivalents of $122.8 million.
Oriental's investment portfolio increased 11.4% to $1.299 billion at March 31, 2018, mainly attributed to the purchase of $155.8 million mortgage-backed securities available-for-sale, partially offset by paydowns in the investment securities held-to-maturity portfolio of $20.9 million during the first quarter of 2018.
Oriental’s loan portfolio is comprised of residential mortgage loans, commercial loans collateralized by mortgages on real estate, other commercial and industrial loans, consumer loans, and auto loans. At March 31, 2018, Oriental’s loan portfolio increased 1.9%. Loan production during the first quarter of 2018 reached $309.4 million compared to $218.9 million in the year ago quarter, a 41.3% increase. The non-acquired loan portfolio increased $116.1 million from December 31, 2017 to $3.321 billion at March 31, 2018. The BBVAPR acquired loan portfolio decreased $31.6 million from December 31, 2017 to $794.3 million at March 31, 2018. The Eurobank acquired loan portfolio decreased $2.0 million from December 31, 2017 to $97.3 million at March 31, 2018.
Cash and cash equivalents decreased 25.3% to $362.4 million, mainly attributed to the funding of new loan growth.
Accrued interest receivable resulting from the loan payment moratorium has been decreasing from December 31, 2017, as most moratoriums have expired. Some of these accrued interests are payable at the end of the loan term.
Financial Assets Managed
Oriental’s financial assets include those managed by Oriental’s trust division, retirement plan administration subsidiary, and assets gathered by its broker-dealer and insurance subsidiaries. Oriental’s trust division offers various types of individual retirement accounts ("IRAs") 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 March 31, 2018, total assets managed by Oriental’s trust division and OPC amounted to $2.940 billion, compared to $3.040 billion at December 31, 2017. 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 March 31, 2018, total assets gathered by Oriental Financial Services and Oriental Insurance from its customer investment accounts amounted to $2.200 billion, compared to $2.250 billion at December 31, 2017. 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, Oriental determines that the existence of events and circumstances indicate that it is more likely than not that goodwill is not impaired. Oriental completes its annual goodwill impairment test as of October 31 of each year. Oriental 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. Oriental’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 Oriental’s assets.
As of March 31, 2018, Oriental 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 2017, based on its annual goodwill impairment test, Oriental 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 $236.4 million, or 26%. Accordingly, Oriental proceeded to perform step two of the analysis. Based on the results of step two, Oriental determined that the carrying value of the goodwill allocated to the Banking unit was not impaired as of the valuation date. During the quarter ended March 31, 2018, Oriental 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 March 31, 2018.
TABLE 4 - ASSETS SUMMARY AND COMPOSITION
1,015,238
887,779
14.4%
-6.2%
-0.4%
-5.9%
7.3%
Puerto Rico government and public instrumentalities
15.2%
-17.8%
-6.9%
296
194
52.6%
Cash and due from banks (including restricted cash)
357,960
481,212
-25.6%
5.8%
-8.7%
-29.7%
-1.0%
7.2%
16.5%
Other assets and customers' liability on acceptances
81,337
92,356
-11.9%
Total other assets
815,113
966,674
-15.7%
0.9%
Investment portfolio composition:
78.2%
76.1%
6.9%
13.8%
Other debt securities and other investments
100.0%
TABLE 5 — LOANS RECEIVABLE COMPOSITION
3.0%
1.5%
8.3%
3.6%
6.4%
-3.6%
-5.8%
-26.4%
-13.8%
-17.6%
-13.5%
-1.1%
-5.0%
-34.9%
-19.9%
-5.7%
-3.8%
-2.6%
-12.6%
-1.4%
-2.0%
2.0%
Mortgage loans held for sale
-14.4%
93
94
Oriental’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.
As shown in Table 5 above, total loans, net, amounted to $4.133 billion at March 31, 2018 and $4.056 billion at December 31, 2017. Oriental’s originated and other loans held-for-investment portfolio composition and trends were as follows:
· Mortgage loan portfolio amounted to $682.6 million (20.6% of the gross originated loan portfolio) compared to $683.6 million (21.3% of the gross originated loan portfolio) at December 31, 2017. Mortgage loan production totaled $26.6 million for the quarter ended March 31, 2018, which represents a decrease of 38.7% from $43.5 million for the same period in 2017. Mortgage loans included delinquent loans in the GNMA buy-back option program amounting to $12.5 million and $8.3 million at March 31, 2018 and December 31, 2017, 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 $1.346 billion (40.5% of the gross originated loan portfolio) compared to $1.307 billion (40.8% of the gross originated loan portfolio) at December 31, 2017. Commercial loan production, including the U.S. loan program production of $74.4 million, increased 152.2% to $117.1 million for the quarter ended March 31, 2018, from $46.5 million for the same period in 2017.
· Consumer loan portfolio amounted to $334.9 million (10.1% of the gross originated loan portfolio) compared to $330.0 million (10.3% of the gross originated loan portfolio) at December 31, 2017. Consumer loan production decreased 11.0% to $37.5 million for the quarter ended March 31, 2018 from $42.1 million for the same period in 2017.
· Auto and leasing portfolio amounted to $957.2 million (28.8% of the gross originated loan portfolio) compared to $884.0 million (27.6% of the gross originated loan portfolio) at December 31, 2017. Auto production increased by 47.6% to $128.1 million for the quarter ended March 31, 2018 compared to $86.8 million for the same period in 2017.
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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
9,448
2.92%
9,143
416
4.55%
66,873
2.22%
90 - 119 days
172
9.88%
128
3.91%
1,831
2.35%
120 - 179 days
7.69%
13.24%
1,689
3.73%
180 - 364 days
12.24%
14.05%
1,510
3.38%
365+ days
14.41%
1,725
269
15.59%
8,087
651
8.05%
9,953
338
3.40%
11,336
736
6.49%
79,990
2,295
2.87%
Percentage of total loans excluding
acquired loans accounted for under ASC 310-30
0.30%
Refinanced or Modified Loans:
1,941
213
10.97%
529
10.96%
16,321
1,249
7.65%
Percentage of Higher-Risk Loan
Category
19.50%
4.67%
20.40%
Loan-to-Value Ratio:
Under 70%
6,652
3.50%
1,163
4.13%
70% - 79%
1,396
5.01%
2,518
104
80% - 89%
860
3,022
201
6.65%
90% and over
1,045
1.53%
4,633
8.27%
* Loans may be included in more than one higher-risk loan category and excludes acquired residential mortgage loans.
96
Deposits from the Puerto Rico government totaled $127.3 million at March 31, 2018. The following table includes Oriental'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
Municipalities
145,028
5,264
95,626
44,138
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.
A PRHTA security maturing July 1, 2018 issued for P3 Project Teodoro Moscoso Bridge operated by private companies that have the payment obligation.
147,440
7,676
Credit Risk Management
Allowance for Loan and Lease Losses
Oriental 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. Oriental’s allowance for loan and lease losses ("ALLL") policy provides for a detailed quarterly analysis of probable losses. At March 31, 2018, Oriental’s allowance for loan and lease losses amounted to $168.6 million, a $1.1 million increase from $167.5 million at December 31, 2017.
For the retail portfolios, mortgage, consumer and auto, the assumptions established in the initial estimate were based on the historical losses of each ALLL segment and then further adjusted based on parameters used as key risk indicators, such as the industry of employment for all portfolios and the location of the collateral for mortgage loans. During the fourth quarter of 2017, Oriental performed additional procedures to evaluate the reasonability of the initial estimate based on the payment experience percentage of borrowers for which the deferral period expired. The analysis took into consideration historical payment behavior and loss experience of borrowers (PDs and LGDs) of each portfolio segment to develop a range of estimated potential losses. Management understands that this approach is reasonable given the lack of historical information related to the behavior of local borrowers in such an unprecedented event. The amount used in the analysis represents the average of potential outcomes of expected losses. During 2017, and in accordance with ASC 450-20-25-2, Oriental increased its allowance for loan and lease losses in relation to these events.
Tables 8 through 10 set forth an analysis of activity in the ALLL and present selected loan loss statistics. In addition, Table 5 sets forth the composition of the loan portfolio.
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
Oriental’s non-performing assets include non-performing loans and foreclosed real estate (see Tables 11 and 12). At March 31, 2018 and December 31, 2017, Oriental had $120.3 million and $99.7 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 March 31, 2018 and December 31, 2017, loans whose terms have been extended and which are classified as troubled-debt restructuring that are not included in non-performing assets amounted to $98.2 million and $109.2 million, respectively.
At March 31, 2018 and December 31, 2017, loans that are current in their monthly payments, but placed in non-accrual amounted to $28.0 million and $20.1 million, respectively. During the quarter ended March 31, 2018, a $10.5 million loan that is current in its monthly payments was placed in non-accrual due to credit deterioration after the hurricanes.
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 12 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.
Following hurricanes Irma and Maria, Oriental offered automatic payment deferrals and 90-day extensions for most loan categories. Most of these payment moratoriums ended during the quarter ended March 31, 2018 with most credit metrics better than, or returned to, pre-hurricanes levels.
At March 31, 2018, Oriental’s non-performing assets increased by 10.9% to $173.7 million (2.87% of total assets, excluding acquired loans with deteriorated credit quality) from $156.7 million (2.95% of total assets, excluding acquired loans with deteriorated credit quality) at December 31, 2017. Oriental does not expect non-performing loans to result in significantly higher losses. At March 31, 2018, the allowance for originated loan and lease losses to non-performing loans coverage ratio was 76.39% (87.35% at December 31, 2017).
Oriental 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, Oriental 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 12 months or more past due. At March 31, 2018, Oriental’s originated non-performing mortgage loans totaled $63.9 million (49.8% of Oriental’s non-performing loans), a 0.3% decrease from $64.1 million (58.9% of Oriental’s non-performing loans) at December 31, 2017.
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 March 31, 2018, Oriental’s originated non-performing commercial loans amounted to $47.0 million (36.7% of Oriental’s non-performing loans), a 33.4% increase from $35.3 million at December 31, 2017 (32.4% of Oriental’s non-performing loans). This increase is mainly from a $10.5 million loan that is current in its monthly payments but was placed in non-accrual during the quarter ended March 31, 2018 due to credit deterioration after the hurricanes.
99
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 March 31, 2018, Oriental’s originated non-performing consumer loans amounted to $2.3 million (1.8% of Oriental’s non-performing loans), a 12.0% decrease from $2.6 million at December 31, 2017 (2.4% of Oriental’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 March 31, 2018, Oriental’s originated non-performing auto loans and leases amounted to $13.6 million (10.6% of Oriental’s total non-performing loans), an increase of 221.2% from $4.2 million at December 31, 2017 (3.9% of Oriental’s total non-performing loans).
Oriental 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 Oriental’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, RURAL, PRHFA, conventional loans guaranteed by Mortgage Guaranty Insurance Corporation (MGIC), conventional loans sold to FNMA and FHLMC, and conventional loans retained by Oriental. 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/interest 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 pursuant Oriental’s current credit and underwriting guidelines. Oriental 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, it 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 Oriental grants a concession for legal or economic reasons due to the debtor’s financial difficulties.
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TABLE 8 — ALLOWANCE FOR LOAN AND LEASE LOSSES BREAKDOWN
Originated and other loans held for investment
Allowance balance:
-7.1%
9.6%
9.5%
4.2%
Total allowance balance
Allowance composition:
19.6%
22.0%
-11.1%
34.3%
32.6%
5.0%
18.6%
17.8%
4.8%
27.5%
27.6%
Allowance coverage ratio at end of period applicable to:
2.78%
2.99%
-7.0%
2.31%
6.5%
5.38%
4.99%
7.8%
2.89%
Total allowance to total originated loans
1.0%
Allowance coverage ratio to non-performing loans:
29.72%
31.89%
-6.8%
70.52%
85.83%
796.42%
639.74%
24.5%
196.06%
604.14%
-67.5%
76.39%
87.35%
-12.5%
TABLE 8 — ALLOWANCE FOR LOAN AND LEASE LOSSES BREAKDOWN (CONTINUED)
-18.0%
83.5%
83.50%
15.3%
15.41%
100.00%
0.88%
0.96%
-8.3%
9.76%
11.15%
3.02%
2.71%
Total allowance to total acquired loans
6.69%
-4.3%
3.31%
2.7%
803.32%
238.01%
237.5%
316.88%
332.40%
202.42%
137.73%
47.0%
Acquired BBVAPR loans accounted for under ASC 310-30
1.7%
-15.0%
33.2%
30.8%
51.1%
51.8%
15.7%
17.4%
-9.9%
Acquired Eurobank loans accounted for under ASC 310-30
-20.0%
60.7%
60.3%
0.5%
39.3%
39.6%
TABLE 9 — ALLOWANCE FOR LOAN AND LEASE LOSSES SUMMARY
Originated and other loans:
56.4%
8.5%
25.2%
60.1%
BBVAPR loans
Acquired loans accounted for
under ASC 310-20:
-10.2%
-657.6%
-1.9%
-44.9%
under ASC 310-30:
47.3%
-95.9%
504.4%
23.6%
Eurobank loans
18.3%
-91.4%
-110.8%
15.5%
TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30
Originated and other loans and leases:
-59.3%
460.7%
(654)
(2,323)
-71.8%
34.2%
104.5%
(967)
(767)
26.1%
26.8%
(4,018)
(3,193)
25.8%
18.8%
(5,205)
(4,269)
21.9%
Net credit losses
Total charge-offs
Total recoveries
(10,844)
(10,552)
Net credit losses to average
loans outstanding:
0.38%
1.31%
-71.0%
0.25%
20.0%
5.07%
4.57%
10.9%
2.23%
2.19%
1.8%
1.34%
1.40%
Recoveries to charge-offs
29.39%
25.46%
Average originated loans:
-4.0%
5.2%
13.5%
19.9%
7.6%
TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30 (CONTINUED)
200.0%
-160.0%
-15.6%
(821)
17.9%
-55.0%
-49.6%
(862)
(652)
32.2%
-3.17%
4.88%
-165.1%
5.60%
19.5%
-1.20%
-1.42%
-15.3%
2.41%
54.5%
24.85%
44.23%
-43.8%
Average loans accounted for under ASC 310-20:
378
411
-8.0%
57,839
58,614
-1.3%
34,334
49,115
-30.1%
92,551
108,140
106
TABLE 11 — NON-PERFORMING ASSETS
(%)
Non-performing assets:
Non-accruing loans
Troubled-Debt Restructuring loans
34,261
25,354
35.1%
Other loans
86,016
74,360
Accruing loans
6,577
6,704
2,528
-41.2%
Total non-performing loans
128,340
108,946
43.2%
173,736
156,668
Non-performing assets to total assets, excluding acquired loans with deteriorated credit quality (including those by analogy)
2.95%
-2.7%
Non-performing assets to total capital
18.38%
16.58%
Interest that would have been recorded in the period if the
loans had not been classified as non-accruing loans
996
934
107
TABLE 12 — NON-PERFORMING LOANS
Non-performing loans:
63,866
64,085
33.4%
-12.0%
221.2%
126,767
106,142
19.4%
Acquired loans accounted for under ASC 310-20 (Loans with
revolving feature and/or acquired at a premium)
-75.6%
-14.0%
-43.9%
Non-performing loans composition percentages:
Originated loans
49.7%
58.7%
36.7%
32.4%
10.6%
3.9%
Non-performing loans to:
Total loans, excluding loans accounted for
under ASC 310-30 (including those by analogy)
3.81%
3.34%
14.1%
Total assets, excluding loans accounted for
2.12%
2.05%
3.4%
Total capital
13.58%
11.53%
Non-performing loans with partial charge-offs to:
1.15%
-5.22%
Non-performing loans
28.62%
34.49%
-17.0%
Other non-performing loans ratios:
Charge-off rate on non-performing loans to non-performing loans
on which charge-offs have been taken
58.96%
57.69%
Allowance for loan and lease losses to non-performing
loans on which no charge-offs have been taken
109.17%
134.26%
-18.7%
108
FDIC Indemnification Asset
Oriental 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 shared-loss agreements related to the FDIC assisted acquisition.
TABLE 13 - ACTIVITY OF FDIC INDEMNIFICATION ASSET
FDIC indemnification asset benefit (expense)
109
TABLE 15 - LIABILITIES SUMMARY AND COMPOSITION
10.5%
NOW accounts
1,046,179
1,069,572
Savings and money market accounts
1,274,411
1,251,396
1,439,473
-4.5%
4,831,711
4,797,594
Accrued interest payable
1,717
1,888
-9.1%
Total deposits and accrued interest payable
-55.9%
Other term notes
157.5%
Other Liabilities:
-41.3%
Acceptances outstanding
-6.4%
Other liabilities
Deposits portfolio composition percentages:
22.2%
20.2%
21.7%
22.3%
26.3%
29.8%
31.4%
Borrowings portfolio composition percentages:
77.3%
12.4%
30.3%
10.2%
11.0%
Securities sold under agreements to repurchase (excluding accrued interest)
Amount outstanding at period-end
Daily average outstanding balance
393,133
Maximum outstanding balance at any month-end
606,210
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Liabilities and Funding Sources
As shown in Table 15 above, at March 31, 2018, Oriental’s total liabilities were $5.300 billion, 1.1% more than the $5.244 billion reported at December 31, 2017. Deposits and borrowings, Oriental’s funding sources, amounted to $5.188 billion at March 31, 2018versus $5.128 billion at December 31, 2017, a 1.2% increase.
Borrowings consist mainly of repurchase agreements, FHLB-NY advances and subordinated capital notes. At March 31, 2018, borrowings amounted to $354.3 million, representing an increase of 7.8% when compared with the $328.7 million reported at December 31, 2017. The increase in borrowings reflects:
· An increase of $81.1 million in repurchase agreements used for the purchase of investment securities during the quarter ended March 31, 2018; and
· A decrease of $55.7 million attributable to the maturing of $90.0 million FHLB advances which were not renewed, partially offset by $34.7 million in new advances.
At March 31, 2018, deposits represented 93% and borrowings represented 7% of interest-bearing liabilities. At March 31, 2018, deposits, the largest category of Oriental’s interest-bearing liabilities, were $4.833 billion, an increase of 0.7% from $4.799 billion at December 31, 2017.
Stockholders’ Equity
At March 31, 2018, Oriental’s total stockholders’ equity was $946.8 million, a 0.2% increase when compared to $945.1 million at December 31, 2017. This increase in stockholders’ equity reflects increases in retained earnings of $9.1 million, legal surplus of $1.7 million and a decrease in treasury stock, at cost, of $360 thousand, partially offset by a decrease in accumulated other comprehensive income, net of tax of $9.2 million and in additional paid in capital of $196 thousand, respectively. Book value per share was $17.76 at March 31, 2018 compared to $17.73 at December 31, 2017.
From December 31, 2017 to March 31, 2018, tangible common equity to total assets decreased to 11.05% from 11.12%, Leverage capital ratio increased to 14.07% from 13.92%, Common Equity Tier 1 capital ratio decreased to 14.52% from 14.59%, Tier 1 Risk-Based capital ratio decreased to 19.00% from 19.05%, and Total Risk-Based capital ratio decreased to 20.29% from 20.34%.
Capital Rules to Implement Basel III Capital Requirements
OFG Bancorp and the Bank are subject to regulatory capital requirements established by the Federal Reserve Board and the FDIC. The current risk-based capital standards applicable to OFG Bancorp and the Bank (“Basel III capital rules”), which have been effective since January 1, 2015, are based on the final capital framework for strengthening international capital standards, known as Basel III, of the Basel Committee on Banking Supervision. As of March 31, 2018, OFG Bancorp's and the Bank’s capital ratios continue to exceed the minimum requirements for being “well-capitalized” under the Basel III capital rules.
The risk-based capital ratios presented in Table 16, which include common equity tier 1, tier 1 capital, total capital and leverage capital as of March 31, 2018 and December 31, 2017, are calculated based on the Basel III capital rules related to the measurement of capital, risk-weighted assets and average assets.
The following are the consolidated capital ratios of Oriental under the Basel III capital rules at March 31, 2018 and December 31, 2017:
TABLE 16 — 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
84,189
55,258
52.4%
Excess over regulatory requirement
365,812
390,615
-6.3%
Risk-weighted assets
4,489,130
4,420,667
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
583,534
576,893
Total risk-based capital ratio
Minimum total risk-based capital ratio required
Actual total risk-based capital
Minimum total risk-based capital required
551,698
545,604
Leverage capital ratio
Minimum leverage capital ratio required
Actual tier 1 capital
Minimum tier 1 capital required
610,487
600,076
Tangible common equity to total assets
11.05%
11.12%
-0.6%
Tangible common equity to risk-weighted assets
15.38%
15.57%
-1.2%
Total equity to total assets
15.27%
-0.7%
Total equity to risk-weighted assets
21.09%
21.38%
Stock data:
Outstanding common shares
43,968,342
43,947,442
Market price at end of year
Market capitalization at end of year
459,469
413,106
The following table presents a reconciliation of Oriental’s total stockholders’ equity to tangible common equity and total assets to tangible assets at March 31, 2018, and December 31, 2017:
(In thousands, except share or per
share information)
(176,000)
Preferred stock issuance costs
10,130
(86,069)
Core deposit intangible
(3,124)
(3,339)
Customer relationship intangible
(1,233)
(1,348)
Total tangible common equity
690,553
688,481
Total tangible assets
6,156,695
6,098,297
Tangible common equity to tangible assets
11.22%
11.29%
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 Oriental 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, Oriental 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 Oriental’s capital adequacy information under the Basel III capital rules:
Risk-based capital:
Common equity tier 1 capital
Additional tier 1 capital
200,870
197,329
Tier 1 capital
Additional Tier 2 capital
57,946
57,125
1.4%
Risk-weighted assets:
Balance sheet items
4,308,428
4,249,042
Off-balance sheet items
180,702
171,625
5.3%
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 (minimum required - 4%)
Equity to assets
Tangible common equity to assets
114
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 March 31, 2018 and December 31, 2017:
Oriental Bank Regulatory Capital Ratios:
Common Equity Tier 1 Capital to Risk-Weighted Assets
Minimum capital requirement (4.5%)
1.6%
Minimum capital conservation buffer requirement (1.875% at March 31, 2018 - 1.25% at December 31, 2017)
55,198
52.5%
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
Minimum capital requirement (8%)
Minimum to be well capitalized (10%)
Total Tier 1 Capital to Average Total Assets
Minimum capital requirement (4%)
Minimum to be well capitalized (5%)
115
Oriental’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “OFG.” At March 31, 2018 and December 31, 2017, Oriental’s market capitalization for its outstanding common stock was $459.5 million ($10.45 per share) and $413.1 million ($9.40 per share), respectively.
The following table provides the high and low prices and dividends per share of Oriental’s common stock for each quarter of the last two calendar years:
Price
Dividend
High
Low
Per share
12.05
8.60
10.25
7.90
September 30, 2017
10.40
8.40
June 30, 2017
12.03
9.19
March 31, 2017
13.80
10.90
2016
December 31, 2016
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
Under Oriental’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 Oriental as treasury shares. There were no repurchases during the quarter ended March 31, 2018.
At March 31, 2018, the number of shares that may yet be purchased under such program is estimated at 739,795 and was calculated by dividing the remaining balance of $7.7 million by $10.45 (closing price of Oriental's common stock at March 31, 2018).
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Background
Oriental’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 and Compliance Officer, the Board Risk and Compliance Committee and the executive Risk and Compliance Team. Oriental 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 Oriental’s business activities are susceptible to risk. Consequently, risk identification and monitoring are essential to risk management. As more fully discussed below, Oriental’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. Oriental evaluates market risk together with interest rate risk. Oriental’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 Oriental 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 Oriental is within the parameters established in such policies.
Interest Rate Risk
Interest rate risk is the exposure of Oriental’s earnings or capital to adverse movements in interest rates. It is a predominant market risk in terms of its potential impact on earnings. Oriental 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, Oriental 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 Oriental 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.
Oriental uses a software application to project future movements in Oriental’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 Oriental 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 March 31, 2018 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
10,578
3.66%
11,514
3.83%
+ 100 Basis points
5,357
1.82%
5,735
1.91%
- 100 Basis points
(5,335)
-1.82%
(5,639)
-1.88%
The impact of -200 basis point reduction 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 Oriental’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 Oriental’s assets and liabilities, Oriental 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 March 31, 2018.
Oriental 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. Oriental’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 Oriental’s gains and losses on the derivative instruments that are linked to the forecasted cash flows of these hedged assets and liabilities. Oriental 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 Oriental’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 Oriental’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 Oriental the right to enter into interest rate swaps and cap and floor agreements with the writer of the option. In addition, Oriental 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 9 to the accompanying consolidated financial statements for further information concerning Oriental’s derivative activities.
Following is a summary of certain strategies, including derivative activities, currently used by Oriental to manage interest rate risk:
Interest rate swaps — Oriental 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 Oriental’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 asset of $146 thousand (notional amount of $34.7 million) was recognized at March 31, 2018 related to the valuation of these swaps.
In addition, Oriental 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 Oriental 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 March 31, 2018, interest rate swaps offered to clients not designated as hedging instruments represented a derivative asset of $459 thousand (notional amounts of $12.5 million), and the mirror-image interest rate swaps in which Oriental entered into represented a derivative liability of $459 thousand (notional amounts of $12.5 million).
Wholesale borrowings — Oriental 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 Oriental’s interest payments on these borrowings. As of March 31, 2018, Oriental had $34.7 million in interest rate swaps at an average rate of 2.4% designated as cash flow hedges for $34.7 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 Oriental is its lending activities. In Puerto Rico, Oriental’s principal market, economic conditions are very challenging, as they have been for the last twelve 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 the federally-created Fiscal Oversight and Management Board of Puerto Rico. In addition, as was demonstrated with hurricanes Irma and Maria during the month of September 2017, Puerto Rico is susceptible to natural disasters, such as hurricanes and earthquakes, which can have a disproportionate impact on Puerto Rico because of the logistical difficulties of bringing relief to an island far from the United States main land. Moreover, the Puerto Rico government's fiscal challenges and Puerto Rico's unique relationship with the United States also complicate any relief efforts after a natural disaster. These events increase credit risk as debtors may no longer be capable of operating their businesses and the collateral securing Oriental's loans may suffer significant damages.
Oriental 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. Oriental also employs proactive collection and loss mitigation practices.
Oriental may also encounter risk of default in relation to its securities portfolio. The securities held by Oriental 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.
Oriental’s executive Credit Risk Team, composed of its Chief Operating Officer, Chief Risk and Compliance Officer, and other senior executives, has primary responsibility for setting strategies to achieve Oriental’s credit risk goals and objectives. Those goals and objectives are set forth in Oriental’s Credit Policy as approved by the Board.
Liquidity Risk
Liquidity risk is the risk of Oriental 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. Oriental’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.
Oriental’s business requires continuous access to various funding sources. While Oriental is able to fund its operations through deposits as well as through advances from the FHLB-NY and other alternative sources, Oriental’s business is dependent upon other external wholesale funding sources. Oriental has selectively reduced its use of certain wholesale funding sources, such as repurchase agreements and brokered deposits. As of March 31, 2018, Oriental had $273.5 million in repurchase agreements, excluding accrued interest, and $474.6 million in brokered deposits.
Brokered deposits are typically offered through an intermediary to small retail investors. Oriental’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, Oriental’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 Oriental 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 Oriental, the availability and cost of Oriental’s funding sources could be adversely affected. In that event, Oriental’s cost of funds may increase, thereby reducing its net interest income, or Oriental 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. Oriental’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 Oriental or market-related events. In the event that such sources of funds are reduced or eliminated and Oriental is not able to replace these on a cost-effective basis, Oriental 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 March 31, 2018, Oriental had approximately $362.4 million in unrestricted cash and cash equivalents, $953.3 million in investment securities that are not pledged as collateral, $925.2 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 Oriental are susceptible to operational risk.
Oriental 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 the risk of natural disasters, market conditions, security risks, and legal risks, the potential for operational and reputational loss has increased. In order to mitigate and control operational risk, Oriental 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 Oriental’s business operations are functioning within established limits.
Oriental 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, Oriental 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 Team. Oriental also has a Business Continuity Plan to address situations where its capacity to perform critical functions is affected. Under such circumstances, a Crisis Management Team is activated to restore such critical functions within established timeframes.
120
Oriental is subject to extensive United States federal and Puerto Rico regulations, and this regulatory scrutiny has been significantly increasing over the last several years. Oriental 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. Oriental has a corporate compliance function headed by a Chief Risk and Compliance Officer who reports to the Chief Executive Officer and supervises the BSA Officer and Regulatory Compliance Officer. The Chief Risk and 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.
Concentration Risk
Substantially all of Oriental’s business activities and a significant portion of its credit exposure are concentrated in Puerto Rico. As a consequence, Oriental’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 Oriental’s management, including the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of Oriental’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, Oriental’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 Oriental 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 Oriental to disclose material information otherwise required to be set forth in Oriental’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 March 31, 2018, 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
Oriental and its subsidiaries are defendants in a number of legal proceedings incidental to their business. Oriental 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 Oriental’s financial condition or results of operations.
ITEM 1A. RISK FACTORS
There have been no material changes to the risk factors previously disclosed in Oriental’s annual report on Form 10-K for the year ended December 31, 2017. In addition to other information set forth in this report, you should carefully consider the risk factors included in Oriental’s annual report on Form 10-K, as updated by this report or other filings Oriental makes with the SEC under the Exchange Act. Additional risks and uncertainties not presently known to Oriental at this time or that Oriental currently deems immaterial may also adversely affect Oriental’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:
10.1 Employment Agreement between Oriental and José R. Fernández.
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 March 31, 2018, 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.
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: May 4, 2018
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