UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☑QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2019
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 ☑ 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 ☑ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☐
Accelerated Filer ☑
Non-Accelerated Filer ☐
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 ☑
Number of shares outstanding of the registrant’s common stock, as of the latest practicable date:
51,329,431 common shares ($1.00 par value per share) outstanding as of April 30, 2019
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 – Restricted Cash
11
Note 3 – Investment Securities
12
Note 4 – Loans
17
Note 5 – Allowance for Loan and Lease Losses
41
Note 6 – Foreclosed Real Estate
47
Note 7 – Derivatives
48
Note 8 – Accrued Interest Receivable and Other Assets
49
Note 9 – Deposits and Related Interest
50
Note 10 – Borrowings and Related Interest
52
Note 11 – Offsetting of Financial Assets and Liabilities
54
Note 12 – Income Taxes
56
Note 13 – Regulatory Capital Requirements
57
Note 14 – Stockholders’ Equity
59
Note 15 – Accumulated Other Comprehensive Income
60
Note 16 – Earnings per Common Share
62
Note 17 – Guarantees
Note 18 – Commitments and Contingencies
64
Note 19 – Operating Leases
65
Note 20 – Fair Value of Financial Instruments
68
Note 21 – Banking and Financial Service Revenues
74
Note 22 – Business Segments
76
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
78
Critical Accounting Policies and Estimates
79
Overview of Financial Performance
80
Selected Financial Data
Financial Highlights of the First Quarter of 2019
82
Analysis of Results of Operations
Analysis of Financial Condition
94
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
119
Item 4.
Controls and Procedures
123
PART II – OTHER INFORMATION
Legal Proceedings
124
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
125
Signatures
126
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;
· a credit default by municipalities of the government of Puerto Rico;
· amendments to the fiscal plan approved by the Financial Oversight and Management Board for 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, earthquakes and other natural disasters;
· 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 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, 2019 AND DECEMBER 31, 2018
March 31,
December 31,
2019
2018
(In thousands)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
498,328
442,103
Money market investments
7,665
4,930
Total cash and cash equivalents
505,993
447,033
Restricted cash
3,030
Investments:
Trading securities, at fair value, with amortized cost of $647 (December 31, 2018 - $647)
381
360
Investment securities available-for-sale, at fair value, with amortized cost of $1,248,749 (December 31, 2018 - $854,511)
1,239,469
841,857
Investment securities held-to-maturity, at amortized cost, with fair value of $410,353 at December 31, 2018
-
424,740
Federal Home Loan Bank (FHLB) stock, at cost
12,800
12,644
Other investments
Total investments
1,252,653
1,279,604
Loans:
Loans held-for-sale, at lower of cost or fair value
7,682
10,368
Loans held for investment, net of allowance for loan losses of $162,488 (December 31, 2018 - $164,231)
4,393,719
4,421,226
Total loans
4,401,401
4,431,594
Other assets:
Foreclosed real estate
30,865
33,768
Accrued interest receivable
33,152
34,254
Deferred tax asset, net
112,744
113,763
Premises and equipment, net
69,017
68,892
Customers' liability on acceptances
25,791
16,937
Servicing assets
10,623
10,716
Derivative assets
110
347
Goodwill
86,069
Operating lease right-of-use assets
20,860
Other assets
50,883
57,345
Total assets
6,603,191
6,583,352
See notes to unaudited consolidated financial statements
AS OF MARCH 31, 2019 AND DECEMBER 31, 2018 (CONTINUED)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Demand deposits
2,218,186
2,191,802
Savings accounts
1,252,157
1,212,259
Time deposits
1,426,758
1,504,054
Total deposits
4,897,101
4,908,115
Borrowings:
Securities sold under agreements to repurchase
431,566
455,508
Advances from FHLB
81,111
77,620
Subordinated capital notes
36,083
Other borrowings
286
1,214
Total borrowings
549,046
570,425
Other liabilities:
Derivative liabilities
439
333
Acceptances executed and outstanding
Operating lease liabilities
22,618
Accrued expenses and other liabilities
87,004
87,665
Total liabilities
5,581,999
5,583,475
Commitments and contingencies (See Note 18)
Stockholders’ equity:
Preferred stock; 10,000,000 shares authorized;
1,340,000 shares of Series A, 1,380,000 shares of Series B, and 960,000
shares of Series D issued and outstanding
(December 31, 2018 - 1,340,000 shares; 1,380,000 shares; and 960,000
shares) $25 liquidation value
92,000
Common stock, $1 par value; 100,000,000 shares authorized; 59,885,234 shares
issued: 51,328,431 shares outstanding (December 31, 2018 - 59,885,234;
51,293,924)
59,885
Additional paid-in capital
619,828
619,381
Legal surplus
92,621
90,167
Retained earnings
268,101
253,040
Treasury stock, at cost, 8,556,803 shares (December 31, 2018 - 8,591,310 shares)
(103,196)
(103,633)
Accumulated other comprehensive loss, net of tax of $1,562 (December 31, 2018 - $1,677)
(8,047)
(10,963)
Total stockholders’ equity
1,021,192
999,877
Total liabilities and stockholders’ equity
2
UNADUTIED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS ENDED MARCH 31, 2019 AND 2018
Quarter Ended March 31,
(In thousands, except per share data)
Interest income:
Loans
84,119
74,612
Mortgage-backed securities
7,925
7,051
Investment securities and other
2,666
1,507
Total interest income
94,710
83,170
Interest expense:
Deposits
9,049
7,298
2,785
1,076
Advances from FHLB and other borrowings
563
374
524
428
Total interest expense
12,921
9,176
Net interest income
81,789
73,994
Provision for loan losses, net
12,249
15,460
Net interest income after provision for loan and lease losses
69,540
58,534
Non-interest income:
Banking service revenue
10,465
10,463
Wealth management revenue
5,882
6,019
Mortgage banking activities
1,206
1,757
Total banking and financial service revenues
17,553
18,239
Other non-interest income
103
275
Total non-interest income, net
17,656
18,514
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS ENDED MARCH 31, 2019 AND 2018 (CONTINUED)
Non-interest expense:
Compensation and employee benefits
20,341
20,608
Occupancy, equipment and infrastructure costs
7,746
7,768
Electronic banking charges
5,065
4,966
Loss on sale of foreclosed real estate, other repossessed assets and credit related expenses
3,366
3,645
Professional and service fees
3,208
2,694
Taxes, other than payroll and income taxes
2,154
2,260
Information technology expenses
2,507
2,009
Insurance
1,146
1,478
Advertising, business promotion, and strategic initiatives
1,211
1,347
Loan servicing and clearing expenses
1,209
1,161
Communication
741
885
Printing, postage, stationary and supplies
578
644
Director and investor relations
230
240
Other
2,650
2,416
Total non-interest expense
52,152
52,121
Income before income taxes
35,044
24,927
Income tax expense
11,574
8,010
Net income
23,470
16,917
Less: dividends on preferred stock
(1,628)
(3,465)
Income available to common shareholders
21,842
13,452
Earnings per common share:
Basic
0.43
0.31
Diluted
0.42
0.30
Average common shares outstanding and equivalents
51,626
51,121
Cash dividends per share of common stock
0.07
0.06
4
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Other comprehensive income (loss) before tax:
Unrealized gain (loss) on securities available-for-sale
3,374
(11,326)
Unrealized (loss) gain on cash flow hedges
(343)
656
Other comprehensive gain (loss) before taxes
3,031
(10,670)
Income tax effect
(115)
1,434
Other comprehensive income (loss) after taxes
2,916
(9,236)
Comprehensive income
26,386
7,681
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES
IN STOCKHOLDERS’ EQUITY
Preferred stock:
Balance at beginning of period
176,000
Balance at end of period
Common stock:
52,626
Additional paid-in capital:
541,600
Stock-based compensation expense
447
291
Stock-based compensation excess tax benefit recognized in income
(127)
Lapsed restricted stock units
(360)
541,404
Legal surplus:
81,454
Transfer from retained earnings
2,454
1,684
83,138
Retained earnings:
200,878
Lease standard initial adoption
(736)
Cash dividends declared on common stock
(3,591)
(2,638)
Cash dividends declared on preferred stock
Transfer to legal surplus
(2,454)
(1,684)
210,008
Treasury stock:
(104,502)
Lapsed restricted stock units and options
437
(104,142)
Accumulated other comprehensive loss, net of tax:
(2,949)
Other comprehensive (loss), net of tax:
(12,185)
946,849
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
809
1,118
Amortization of investment securities premiums, net of accretion of discounts
1,113
1,614
Amortization of core deposit and customer relationship intangibles
292
330
Net change in operating leases
10
Depreciation and amortization of premises and equipment
2,095
2,277
Deferred income tax expense, net
1,344
586
Stock-based compensation
(Gain) loss on:
Sale of loans
(167)
(87)
Foreclosed real estate and other repossessed assets
1,137
1,284
Sale of other repossessed assets
39
217
Originations of loans held-for-sale
(18,282)
(23,292)
Proceeds from sale of loans held-for-sale
5,923
5,945
Net (increase) decrease in:
Trading securities
(21)
(102)
1,102
14,828
93
(712)
6,703
10,448
Net (decrease) in:
Accrued interest on deposits and borrowings
(991)
(359)
(16,687)
(11,235)
Net cash provided by operating activities
20,678
35,401
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash flows from investing activities:
Purchases of:
Investment securities available-for-sale
(207)
(173,162)
FHLB stock
(1,101)
(35,775)
Maturities and redemptions of:
44,758
23,408
Investment securities held-to-maturity
19,844
945
38,271
Proceeds from sales of:
Foreclosed real estate and other repossessed assets, including write-offs
11,948
(619)
Origination and purchase of loans, excluding loans held-for-sale
(258,082)
(286,129)
Principal repayment of loans
254,992
197,622
Additions to premises and equipment
(2,220)
(1,580)
Net cash provided by (used in) investing activities
51,033
(218,120)
Cash flows from financing activities:
Net increase (decrease) in:
12,850
40,198
(23,766)
81,000
FHLB advances, federal funds purchased, and other borrowings
2,547
(55,221)
Restricted units lapsed
Dividends paid on preferred stock
(1,229)
Dividends paid on common stock
(3,590)
Net cash (used in) provided by financing activities
(12,751)
59,874
Net change in cash, cash equivalents and restricted cash
58,960
(122,845)
Cash, cash equivalents and restricted cash at beginning of period
450,063
488,233
Cash, cash equivalents and restricted cash at end of period
509,023
365,388
Supplemental Cash Flow Disclosure and Schedule of Non-cash Activities:
Reconciliation of the Consolidated Statements of Cash Flows to the Consolidated Balance Sheets:
354,930
7,428
Total cash, cash equivalents, restricted cash and restricted cash equivalents at end of period
Interest paid
13,513
9,103
Operating lease liabilities paid
1,519
Mortgage loans securitized into mortgage-backed securities
15,163
17,954
Transfer from held-to-maturity securities to available-for-sale securities
Transfer from loans to foreclosed real estate and other repossessed assets
10,995
11,179
Reclassification of loans held-for-sale portfolio to held-for-investment portfolio
1,247
Financed sales of foreclosed real estate
186
369
Loans booked under the GNMA buy-back option
12,942
12,515
Initial recognition of operating lease right-of-use assets
21,930
Initial recognition of operating lease liabilities
23,689
8
NOTES TO UNAUDITED 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. (“OIB”). 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 Adopted in 2019
Leases. In February 2016, the FASB issued ASU No. 2016-02 (Topic 842), the FASB issued ASU No. 2016-02, under the new guidance, lessees are required to recognize the following for all leases (with the exception of short-term leases): 1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, and 2) a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lessor accounting under the new guidance remains largely unchanged as it is substantially equivalent to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limited changes were made to align lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures are required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities. All entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. As Oriental elected the transition option provided in ASU No. 2018-11 (see below), the modified retrospective approach was applied on January 1, 2019 (as opposed to January 1, 2017). Oriental also elected certain relief options offered in ASU 2016-02 including the package of practical expedients and the option not to recognize right-of-use assets and lease liabilities that arise from short-term leases (i.e., leases with terms of twelve months or less). Oriental also elected the hindsight practical expedient, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets. Oriental has several lease agreements, mainly branch locations, which are considered operating leases, and therefore, were not previously recognized on Oriental’s consolidated statements of financial condition. The new guidance requires these lease agreements to be recognized on the consolidated statements of financial condition as a right-of-use asset and a corresponding lease liability. The new guidance did not have a material impact on the consolidated statements of operations or the consolidated statements of cash flows. See Note 19 Leases for more information.
Leases - Targeted Improvements. In July 2018, the FASB issued ASU No. 2018-11 to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU No. 2016-02. Specifically, under the amendments in ASU 2018-11: (1) entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and (2) lessors may elect not to separate lease and non-lease components when certain conditions are met. The amendments have the same effective date as ASU 2016-02 (January 1, 2019 for Oriental). Oriental adopted ASU 2018-11 on its required effective date of January 1, 2019 and elected both transition options mentioned above. ASU 2018-11 did not have a material impact on Oriental’s consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Narrow-Scope Improvements for Lessors. In December 2018, the FASB issued ASU No. 2018-20 which allows lessors to make an accounting policy election of presenting sales taxes and other similar taxes collected from lessees on a net basis, (2) requires a lessor to exclude lessor costs paid directly by a lessee to third parties on the lessor’s behalf and include lessor costs that are paid by the lessor and reimbursed by the lessee in the measurement of variable lease revenue and the associated expense, and (3) clarifies that when lessors allocate variable payments to lease and non-lease components they are required to follow the recognition guidance in the new leases standard for the lease component and other applicable guidance, such as the new revenue standard, for the non-lease component. Oriental adopted ASU 2018-20 on its required effective date of January 1, 2019 and elected to present sales taxes and other similar taxes collected from lessees on a net basis as described in (1) above. ASU 2018-20 did not have a material impact on Oriental’s consolidated financial statements.
Leases: Codification Improvements. In March 2019, the FASB issued ASU No. 2019-01 which states that for lessors that are not manufacturers or dealers, the fair value of the underlying asset is its cost, less any volume or trade discounts, as long as there isn’t a significant amount of time between acquisition of the asset and lease commencement; (2) clarifies that lessors in the scope of ASC 942 (such as Oriental) must classify principal payments received from sales-type and direct financing leases in investing activities in the statement of cash flows; and (3) clarifies the transition guidance related to certain interim disclosures provided in the year of adoption. To coincide with the adoption of ASU No. 2016-02, Oriental elected to early adopt ASU 2019-01 on January 1, 2019. The adoption of this ASU did not have a material impact on Oriental’s consolidated financial statements.
Targeted Improvements to Accounting for Hedging Activities. In August 2017, the FASB issued ASU No. 2017-12 with the objectives to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities; and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. This guideline allows the entity to elect whether to perform quantitative or qualitative assessments for their hedge accounting transactions. In addition, the guideline provides that “an entity may reclassify a debt security from held-to-maturity (HTM) to available-for-sale (AFS) if the debt security is eligible to be hedged under the last-of-layer method in accordance with paragraph 815-20-25-12A. Any unrealized gain or loss at the date of the transfer shall be recorded in accumulated other comprehensive income in accordance with paragraph 320-10-35-10(c).” Transition elections must be adopted within the timeframe outlined in paragraphs 815-20-65-3(f) to 65-3(g). This includes the transition election available for the transfer of eligible securities from the HTM to the AFS category. ASU No. 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018. Oriental elected to maintain its current quantitative assessment for the existing hedge accounting transaction. In addition, Oriental elected to reclassify all of the securities in its held-to-maturity portfolio amounting to $424.7 million to its available-for-sale portfolio, as they were debt securities that qualified as eligible to be hedged under the last-of-layer method. The new guidance did not have a material impact on the consolidated statements of operations or the consolidated statement of cash flows.
New Accounting Updates Not Yet Adopted
Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force). In August 2018, the FASB issued Accounting Standards Update (“ASU”) 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Accordingly, ASU 2018-15 requires an entity (customer) in a hosting arrangement that is a service contract to follow the guidance in Subtopic 350-40 to determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. The ASU also requires the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes reasonably certain renewals. This ASU is the final version of Proposed Accounting Standards Update 2018–230—Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which has been deleted.This ASU will be applied prospectively for annual and interim periods in fiscal years beginning after December 15, 2019. Early adoption is permitted. The effects of this standard on our consolidated statement of financial position, results of operations or cash flows are not expected to be material.
Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. In August 2018, the FASB issued ASU 2018-13, which modifies disclosure requirements related to fair value measurement. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2019. Implementation on a prospective or retrospective basis varies by specific disclosure requirement. Early adoption is permitted. The standard also allows for early adoption of any removed or modified disclosures upon issuance of this ASU while delaying adoption of the additional disclosures until their effective date.
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. The effects of this standard on our consolidated statement of financial position, results of operations or cash flows are not expected to be material.
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 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 keep disclosing relevant information of concerning implementation process and impact of ASU No. 2016-13, as well as the updating of policies, procedures and internal controls, in preparation for performing a full parallel run. Oriental’s preliminary evaluation indicates the provisions of ASU No. 2016-13 are expected to impact Oriental’s consolidated financial statements, in particular the level of the reserve for credit losses. Oriental is continuing to evaluate the extent of the potential impact and expects that portfolio composition and economic conditions at the time of adoption will be a factor.
NOTE 2 – RESTRICTED CASH
The following table includes the composition of Oriental’s restricted cash:
Cash pledged as collateral to other financial institutions to secure:
Derivatives
1,980
Obligations under agreement of loans sold with recourse
1,050
At March 31, 2019 and December 31, 2018, the Bank’s international banking entities, OIB and Oriental Overseas, a division of the Bank, held short-term highly liquid securities in the amount of $305 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, 2019 and December 31, 2018, 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, 2019 and December 31, 2018, 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, 2019 was $212.2 million (December 31, 2018 - $211.6 million). At March 31, 2019 and December 31, 2018, the Bank complied with this requirement. Cash and due from bank as well as other short-term, highly liquid securities, are used to cover the required average reserve balances.
NOTE 3 – INVESTMENT SECURITIES
Money Market Investments
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, 2019 and December 31, 2018, money market instruments included as part of cash and cash equivalents amounted to $7.7 million and $4.9 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, 2019 and December 31, 2018 were as follows:
March 31, 2019
Gross
Weighted
Amortized
Unrealized
Fair
Average
Cost
Gains
Losses
Value
Yield
Available-for-sale
FNMA and FHLMC certificates
947,332
2,504
12,558
937,278
2.37%
GNMA certificates
224,157
3,072
671
226,558
3.15%
CMOs issued by US government-sponsored agencies
62,927
1,538
61,389
1.90%
Total mortgage-backed securities
1,234,416
5,576
14,767
1,225,225
2.49%
Investment securities
US Treasury securities
10,933
10,859
1.37%
Obligations of US government-sponsored agencies
2,238
42
2,196
1.38%
Other debt securities
1,162
27
1,189
2.99%
Total investment securities
14,333
116
14,244
1.50%
Total securities available for sale
1,248,749
5,603
14,883
2.47%
December 31, 2018
561,878
404
8,951
553,331
2.59%
211,947
2,827
210,170
3.10%
66,230
2,166
64,064
840,055
1,454
13,944
827,565
2.66%
10,924
10,805
1.36%
2,325
2,265
1,207
15
1,222
14,456
179
14,292
Total securities available-for-sale
854,511
1,469
14,123
2.64%
Held-to-maturity
14,387
410,353
2.07%
On January 1, 2019, Oriental adopted the Accounting Standard Update ("ASU") No. 2017-12 and reclassified all of its mortgage backed securities with a carrying value of $424.7 million and an unrealized losses of $14.4 million from the held-to-maturity portfolio into the available-for-sale portfolio.
The amortized cost and fair value of Oriental’s investment securities at March 31, 2019, by contractual maturity, are shown in the next table. Securities not due on a single contractual maturity date, such as collateralized mortgage obligations, are classified in the period of final contractual maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Cost
Fair Value
Due from 1 to 5 years
3,056
3,054
Total due from 1 to 5 years
Due after 5 to 10 years
55,367
53,936
267,310
266,195
98
Total due after 5 to 10 years
322,771
320,229
Due after 10 years
676,966
668,029
224,063
226,460
7,560
7,453
Total due after 10 years
908,589
901,942
Due less than one year
Total due in less than one year
100
2,338
2,296
Due from 5 to 10 years
1,062
1,089
Total
During the quarter ended March 31, 2019, Oriental retained securitized GNMA pools totaling $15.1 million amortized cost, at a yield of 3.84% from its own originations while during the year ended March 31, 2018 that amount totaled $18.0 million amortized cost, at a yield of 3.26%.
During the quarters ended March 31, 2019 and 2018, Oriental did not sell 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 at March 31, 2019 and held-to-maturity at March 31, 2019 and December 31, 2018, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position:
12 months or more
Loss
Securities available-for-sale
CMOs issued by US Government-sponsored agencies
686,773
674,215
Obligations of US Government and sponsored agencies
73,290
670
72,620
US Treasury Securities
9,983
9,909
835,211
14,882
820,329
Less than 12 months
20
19
Obligations of US government and sponsored agencies
73,310
72,639
835,231
820,348
357,955
8,603
349,352
131,044
2,739
128,305
9,977
9,858
567,531
13,687
553,844
Securities held-to-maturity
109,772
348
109,424
17,126
88
17,038
323
127,221
436
126,785
467,727
458,776
148,170
145,343
10,300
10,181
694,752
680,629
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.
All of the investments ($835.2 million, amortized cost) with an unrealized loss position at March 31, 2019 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.
NOTE 4 - 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, 2019 and December 31, 2018 was as follows:
Originated and other loans and leases held for investment:
Mortgage
651,423
668,809
Commercial
1,569,551
1,597,588
Consumer
350,543
348,980
Auto and leasing
1,167,482
1,129,695
3,738,999
3,745,072
Allowance for loan and lease losses on originated and other loans and leases
(94,035)
(95,188)
3,644,964
3,649,884
Deferred loan costs, net
8,254
7,740
Total originated and other loans held for investment, net
3,653,218
3,657,624
Acquired loans:
Acquired BBVAPR loans:
Accounted for under ASC 310-20 (Loans with revolving feature and/or
acquired at a premium)
2,405
2,546
22,768
23,988
Auto
2,336
4,435
27,509
30,969
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-20
(1,968)
(2,062)
25,541
28,907
Accounted for under ASC 310-30 (Loans acquired with deteriorated
credit quality, including those by analogy)
484,578
492,890
176,908
182,319
9,866
14,403
671,352
689,612
Allowance for loan and lease losses on acquired BBVAPR loans accounted for under ASC 310-30
(42,133)
(42,010)
629,219
647,602
Total acquired BBVAPR loans, net
654,760
676,509
Acquired Eurobank loans:
Loans secured by 1-4 family residential properties
62,649
63,392
46,588
47,826
856
846
Total acquired Eurobank loans
110,093
112,064
Allowance for loan and lease losses on Eurobank loans
(24,352)
(24,971)
Total acquired Eurobank loans, net
85,741
87,093
Total acquired loans, net
740,501
763,602
Total held for investment, net
Mortgage loans held-for-sale
Total loans, net
18
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 tables below present the aging of the recorded investment in gross originated and other loans held for investment at March 31, 2019 and December 31, 2018, by class of loans. Mortgage loans past due include delinquent loans in the GNMA buy-back option program. Servicers of loans underlying GNMA mortgage-backed securities must report as their own assets the defaulted loans that they have the option (but not the obligation) to repurchase, even when they elect not to exercise that option.
Loans 90+
Days Past
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
243
972
2,695
3,910
35,619
39,529
164
Years 2003 and 2004
144
2,715
4,934
7,793
66,079
73,872
Year 2005
86
1,668
3,098
4,852
33,355
38,207
Year 2006
228
1,658
4,729
6,615
47,844
54,459
Years 2007, 2008
and 2009
810
5,832
6,642
51,783
58,425
55
Years 2010, 2011, 2012, 2013
722
7,001
8,009
103,092
111,101
307
Years 2014, 2015, 2016, 2017 and 2018
707
1,844
2,551
139,629
142,180
987
9,252
30,133
40,372
477,401
517,773
526
Non-traditional
364
2,617
2,981
10,225
13,206
Loss mitigation program
11,639
4,533
19,026
35,198
72,059
107,257
1,645
12,626
14,149
51,776
78,551
559,685
638,236
2,171
Home equity secured personal loans
236
245
GNMA's buy-back option program
64,727
91,502
559,921
Commercial secured by real estate:
Corporate
272,698
Institutional
1,167
67,759
68,926
Middle market
9,966
6,510
16,476
189,673
206,149
Retail
593
522
8,036
9,151
221,814
230,965
Floor plan
4,098
Real estate
18,664
10,559
15,713
26,794
774,706
801,500
Other commercial and industrial:
150
148,258
148,408
146,380
464
298
5,982
6,744
85,771
92,515
743
89
1,200
2,032
330,094
332,126
48,605
48,622
1,357
387
7,199
8,943
759,108
768,051
11,916
909
22,912
35,737
1,533,814
Credit cards
803
281
732
1,816
26,110
27,926
Overdrafts
35
137
172
Personal lines of credit
29
121
1,808
1,929
Personal loans
4,566
1,746
1,025
7,337
297,271
304,608
Cash collateral personal loans
261
564
15,344
15,908
5,754
2,041
2,078
9,873
340,670
65,490
22,010
12,163
99,663
1,067,819
95,786
39,109
101,880
236,775
3,502,224
21
77
1,516
2,707
4,300
36,344
40,644
168
91
2,412
5,632
8,135
67,707
75,842
552
3,531
4,083
35,004
39,087
255
1,693
5,074
7,022
49,213
56,235
1,059
6,677
7,991
52,781
60,772
253
328
8,697
9,278
104,429
113,707
270
Years 2014, 2015, 2016 and 2017
483
1,462
1,945
139,500
141,445
931
8,043
33,780
42,754
484,978
527,732
494
3,085
3,201
11,072
14,273
10,793
6,258
19,389
36,440
70,393
106,833
2,223
11,724
14,417
56,254
82,395
566,443
648,838
2,717
241
250
19,721
11,733
75,975
102,125
566,684
289,052
68,413
69,613
1,430
5,202
6,632
200,831
207,463
1,641
463
8,570
10,674
213,440
224,114
4,184
19,009
1,893
14,972
18,506
794,929
813,435
179,885
156,410
917
6,020
6,937
81,030
87,967
571
546
817
1,934
308,278
310,212
46
49,633
49,679
1,488
6,883
8,917
775,236
784,153
3,129
2,439
21,855
27,423
1,570,165
22
725
363
411
1,499
26,535
28,034
204
214
90
1,827
1,917
3,966
1,740
1,262
6,968
296,151
303,119
339
416
15,280
15,696
4,832
2,453
1,698
8,983
339,997
58,094
27,945
13,494
99,533
1,030,162
77,788
47,254
113,022
238,064
3,507,008
At both March 31, 2019, and December 31, 2018, Oriental had a carrying balance of $91.4 million in current status, respectively, in originated and other loans held for investment granted to the Puerto Rico government, including its instrumentalities, public corporations and municipalities as part of the institutional commercial loan segment. All originated and other loans granted to the Puerto Rico government are general obligations of municipalities secured by ad valorem taxation, without limitation as to rate or amount, on all taxable property within the issuing municipalities. The good faith, credit and unlimited taxing power of each issuing municipality are pledged for the payment of its general obligations.
Acquired Loans
Acquired loans were initially measured at fair value and subsequently accounted for under either ASC 310-30 or ASC 310-20. 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, 2019 and December 31, 2018, by class of loans:
Commercial secured by real estate
878
955
932
1,009
Other commercial and industrial
67
1,329
1,396
999
1,406
486
391
1,014
19,608
20,622
111
2,035
2,146
541
158
426
1,125
21,643
210
460
1,876
768
358
1,458
2,584
24,925
24
888
982
942
1,036
30
1,461
1,510
950
991
1,555
499
147
380
1,026
20,796
21,822
32
114
2,052
398
1,140
22,848
405
200
3,589
998
431
1,548
2,977
27,992
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, 2019 and December 31, 2018 is as follows:
Contractual required payments receivable:
1,279,147
1,304,545
Less: Non-accretable discount
342,902
345,423
Cash expected to be collected
936,245
959,122
Less: Accretable yield
264,893
269,510
Carrying amount, gross
Less: allowance for loan and lease losses
42,133
42,010
Carrying amount, net
25
At March 31, 2019 and December 31, 2018, Oriental had $44.1 million and $44.5 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, 2019 and 2018:
Quarter Ended March 31, 2019
Accretable Yield Activity:
232,199
36,508
560
Accretion
(6,350)
(2,656)
(216)
(298)
(9,520)
Change in expected cash flows
3,265
3,566
Transfer from (to) non-accretable discount
1,058
262
(133)
1,337
226,907
37,379
180
427
Non-Accretable Discount Activity:
291,887
10,346
24,245
18,945
Change in actual and expected losses
(729)
(173)
(39)
(243)
(1,184)
Transfer from accretable yield
(1,058)
(262)
(150)
133
(1,337)
290,100
9,911
24,056
18,835
Quarter Ended March 31, 2018
258,498
46,764
2,766
308,913
(7,073)
(3,685)
(869)
(256)
(11,883)
3,156
58
3,640
Transfer (to) from non-accretable discount
(3,046)
(524)
(597)
(38)
(4,205)
248,379
45,711
1,726
649
296,465
299,501
10,596
23,050
19,284
352,431
(1,440)
(389)
(204)
(13)
(2,046)
3,046
597
38
4,205
301,107
10,731
23,443
19,309
354,590
26
Acquired Eurobank Loans
The carrying amount of acquired Eurobank loans at March 31, 2019 and December 31, 2018 is as follows:
March 31
Contractual required payments receivable
151,917
156,722
2,542
2,959
149,375
153,763
39,282
41,699
Less: Allowance for loan and lease losses
24,352
24,971
The following tables describe the accretable yield and non-accretable discount activity of acquired Eurobank loans for the quarters ended March 31, 2019 and 2018:
Loans Secured by 1-4 Family Residential Properties
Construction & Development Secured by 1-4 Family Residential Properties
Leasing
37,734
3,310
655
(1,351)
(1,165)
(12)
(46)
(2,574)
(423)
(44)
(31)
87
(411)
408
159
(1)
43
(41)
568
36,368
654
1,276
1,550
(58)
151
Transfer from (to) accretable yield
(408)
(159)
(43)
(568)
875
1,551
41,474
6,751
1,447
49,672
(1,605)
(1,606)
(34)
(96)
(3,341)
(144)
898
(63)
178
869
(103)
(427)
(91)
97
(82)
(606)
39,622
5,616
1,356
46,594
4,576
276
758
235
5,845
(200)
(703)
(98)
(904)
Transfer (to) from accretable yield
(97)
606
4,479
849
219
5,547
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, 2019 and December 31, 2018:
December 31
Originated and other loans and leases held for investment
2,529
2,538
5,217
5,818
3,600
5,140
Years 2007, 2008 and 2009
5,850
6,697
6,694
8,427
29,961
33,682
22,170
22,107
54,748
58,874
Home equity loans, secured personal loans
54,757
9,760
7,114
7,266
15,950
16,123
32,824
33,300
6,401
6,481
2,251
2,629
8,669
9,156
41,493
42,456
31
2,907
2,909
294
3,971
3,354
Total non-accrual originated loans
112,384
118,178
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
113,842
119,726
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, 2019 and December 31, 2018, loans whose terms have been extended and which are classified as troubled-debt restructurings that are not included in non-accrual loans amounted to $113.1 million and $112.9 million, respectively, as they are performing under their new terms.
At March 31, 2019 and December 31, 2018, loans that are current in their monthly payments, but placed in non-accrual due to credit deterioration amounted to $30.6 million and $21.2 million, respectively.
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 $89.4 million and $82.0 million at March 31, 2019 and December 31, 2018, 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 $10.9 million and $8.4 million at March 31, 2019 and December 31, 2018, respectively. The total investment in impaired mortgage loans that were individually evaluated for impairment was $83.4 million and $84.2 million at March 31, 2019 and December 31, 2018, 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 $11.1 million and $10.2 million at March 31, 2019 and December 31, 2018, 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, 2019 and December 31, 2018 are as follows:
Unpaid
Recorded
Related
Principal
Investment
Allowance
Coverage
Impaired loans with specific allowance:
61,854
56,408
10,828
19%
Residential impaired and troubled-debt restructuring
94,964
83,406
11,135
13%
Impaired loans with no specific allowance:
38,512
32,207
N/A
0%
Total investment in impaired loans
195,330
172,021
21,963
54,636
49,092
8,434
17%
95,659
84,174
10,186
12%
Impaired loans with no specific allowance
38,241
32,137
188,536
165,403
18,620
11%
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, 2019 and December 31, 2018 are as follows:
Impaired loans with specific allowance
926
747
3%
Specific
2%
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, 2019 and December 31, 2018 are as follows:
to Recorded
Impaired loan pools with specific allowance:
489,638
484,577
17,901
4%
162,612
156,682
20,733
10,336
3,499
35%
Total investment in impaired loan pools
662,586
651,125
6%
December 31 , 2018
498,537
15,225
188,413
180,790
20,641
14,551
6,144
43%
701,501
688,083
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, 2019 and December 31, 2018 are as follows:
66,713
60,642
15,110
25%
38,447
39,319
9,242
24%
105,160
99,961
Impaired loan pools with specific allowance
70,153
63,406
15,382
47,342
47,820
9,585
20%
100%
117,510
111,230
22%
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.
33
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, 2019 and 2018:
Interest Income Recognized
Average Recorded Investment
Originated and other loans held for investment:
399
50,890
263
51,331
Residential troubled-debt restructuring
667
83,657
720
84,754
305
32,246
176
17,764
1,371
166,793
1,159
153,849
Acquired loans accounted for under ASC 310-20:
Total interest income from impaired loans
167,540
154,596
Modifications
The following tables present the troubled-debt restructurings in all loan portfolios during the quarters ended March 31, 2019 and 2018.
34
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)
4,494
5.52%
4,242
4.60%
353
11.50%
36
71
963
15.20%
967
11.86%
73
5,747
5.69%
397
5,339
5.08%
1,559
4.75%
72
354
15.75%
355
11.60%
69
The following table presents troubled-debt restructurings for which there was a payment default during the twelve month periods ended March 31, 2019 and 2018:
Twelve month Period Ended March 31,
Number of Contracts
Recorded Investment
3,011
1,981
587
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, 2019 and December 31, 2018, 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
230,648
17,502
24,548
58,976
9,950
149,873
33,394
22,882
205,603
3,902
21,460
2,817
1,281
666,581
54,798
80,121
123,288
25,120
81,395
3,711
7,409
322,540
304
9,282
45,463
719,066
32,094
16,891
1,385,647
86,892
97,012
Commercial - acquired loans
(under ASC 310-20)
1,473
37
Retail - originated and other loans held for investment
Mortgage:
Traditional
487,640
10,589
88,231
586,696
Consumer:
27,194
Unsecured personal lines of credit
1,900
Unsecured personal loans
303,582
15,616
348,429
2,114
Auto and Leasing
1,155,319
2,169,448
2,090,444
79,004
Retail - acquired loans (accounted for under ASC 310-20)
20,232
390
2,111
22,343
425
2,236
25,104
24,579
525
3,766,508
3,502,143
177,473
246,711
26,544
15,797
59,509
10,104
151,638
32,638
23,187
198,402
3,996
21,716
2,890
1,294
678,159
63,178
72,098
154,629
25,256
63,876
13,737
10,354
307,160
318
2,734
47,092
2,541
729,167
41,852
13,134
1,407,326
105,030
85,232
1,604
493,952
11,188
87,444
592,834
27,623
1,895
301,857
15,693
347,272
1,708
1,116,201
2,147,484
2,056,307
91,177
Retail - acquired loans
21,442
2,148
23,590
4,235
28,423
27,825
598
3,776,041
3,493,062
177,949
40
NOTE 5 – ALLOWANCE FOR LOAN AND LEASE LOSSES
The composition of Oriental’s allowance for loan and lease losses at March 31, 2019 and December 31, 2018 was as follows:
Allowance for loans and lease losses:
16,689
19,783
32,154
30,326
16,085
15,571
29,107
29,508
Total allowance for originated and other loans and lease losses
94,035
95,188
1,869
1,905
135
1,968
2,062
Total allowance for acquired BBVAPR loans and lease losses
44,101
44,072
Total allowance for acquired Eurobank loan and lease losses
Total allowance for loan and lease losses
162,488
164,231
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.
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
(587)
(1,086)
(4,121)
(11,371)
(17,165)
Recoveries
287
3,982
4,679
(Recapture) provision for loan and lease losses
(2,794)
2,767
4,372
6,988
11,333
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
5,554
21,326
72,072
Total ending allowance balance
88,615
568,017
1,480,936
3,566,978
Total ending loan balance
20,439
30,258
16,454
25,567
92,718
(968)
(1,149)
(4,258)
(8,982)
(15,357)
314
182
3,777
4,513
(Recapture) provision for originated and other loan and lease losses
(802)
3,883
5,587
6,290
14,958
18,983
33,174
18,023
26,652
96,832
9,597
21,892
76,568
81,229
584,635
1,516,359
3,579,669
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:
(440)
(85)
(525)
Provision (recapture) for acquired BBVAPR
loan and lease losses accounted for
under ASC 310-20
(73)
1,944
26,762
3,225
595
3,862
(1,022)
(125)
(1,147)
285
Provision (recapture) for acquired
(8)
402
(210)
184
2,659
488
3,184
44
2,048
1,799
30,222
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:
loans and lease losses accounted for under
ASC 310-30
2,733
850
(2,314)
1,269
Allowance de-recognition
(57)
(758)
(331)
(1,146)
45
14,085
23,691
7,961
45,755
Provision (recapture) for acquired BBVAPR loans and
lease losses accounted for under ASC 310-30
752
(887)
(68)
(2,396)
(304)
(2,768)
14,331
22,047
6,770
43,166
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, 2019 and 2018 were as follows:
Allowance for loan and lease losses for acquired Eurobank loans:
(Recapture) for loan and lease losses, net
(202)
(449)
(651)
(70)
106
(4)
Loans secured by 1-4 Family Residential Properties
15,187
25,174
Provision (recapture) for acquired Eurobank loan and lease losses, net
(40)
139
15,414
9,992
25,410
NOTE 6 — FORECLOSED REAL ESTATE
The following tables present the activity related to foreclosed real estate for the quarters ended March 31, 2019 and 2018:
Acquired BBVAPR loans
Acquired Eurobank loans
9,571
14,617
9,580
Decline in value
(168)
(1,157)
(421)
(1,746)
Additions
2,354
1,055
495
3,904
Sales
(1,673)
(1,718)
(1,567)
(4,958)
Other adjustments
(72)
10,012
12,766
8,087
14,283
18,347
11,544
44,174
(488)
(1,036)
(462)
(1,986)
1,487
1,649
113
3,249
(1,917)
(2,465)
(741)
(5,123)
13,365
16,495
10,454
40,314
NOTE 7 — DERIVATIVES
The following table presents Oriental’s derivative assets and liabilities at March 31, 2019 and December 31, 2018:
Derivative assets:
Interest rate swaps designated as cash flow hedges
Interest rate swaps not designated as hedges
Interest rate caps
207
Derivative liabilities:
329
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 and are properly documented as such; 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, 2019:
Notional
Fixed
Variable
Trade
Settlement
Maturity
Type
Amount
Rate
Rate Index
Date
33,175
2.4210%
1-Month LIBOR
07/03/13
08/01/23
An accumulated unrealized loss of $329 thousand and a gain of $14thousand were recognized in accumulated other comprehensive income related to the valuation of these swaps at March 31, 2019 and December 31, 2018, respectively, and the related asset or liability is being reflected in the consolidated statements of financial condition.
At March 31, 2019 and December 31, 2018, interest rate swaps not designated as hedging instruments that were offered to clients represented an asset of $33 thousand and $126 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, 2019 and December 31, 2018, interest rate swaps not designated as hedging instruments that are the mirror-images of the derivatives offered to clients represented a liability of $33 thousand and $126 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, 2019:
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, 2019 and December 31, 2018, the outstanding total notional amount of interest rate caps was $42.4 million and $150.9 million, respectively. At March 31, 2019 and December 31, 2018, the interest rate caps sold to clients represented a liability of $77 thousand and $207 thousand, respectively, and were included as part of derivative liabilities in the consolidated statements of financial condition. At March 31, 2019 and December 31, 2018, the interest rate caps purchased as mirror-images represented an asset of $77 thousand and $207 thousand, respectively, and were included as part of derivative assets in the consolidated statements of financial condition.
NOTE 8 — ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS
Accrued interest receivable at March 31, 2019 and December 31, 2018 consists of the following:
Loans, excluding acquired loans
29,373
30,409
Investments
3,779
3,845
Other assets at March 31, 2019 and December 31, 2018 consist of the following:
Prepaid expenses
7,391
9,788
Other repossessed assets
3,574
2,986
Core deposit and customer relationship intangibles
3,076
3,369
Tax credits
277
Investment in Statutory Trust
1,083
Accounts receivable and other assets
35,482
37,842
Prepaid expenses amounting to $7.4 million and $9.8 million at March 31, 2019 and December 31, 2018, respectively, include prepaid municipal, property and income taxes aggregating to $4.0 million and $5.5 million, respectively.
Other repossessed assets totaled $3.6 million and $3.0 million at March 31, 2019 and December 31, 2018, respectively, that consist mainly of repossessed automobiles, which are recorded at their net realizable value.
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, 2019 and December 31, 2018 this core deposit intangible amounted to $2.3 million and $2.5 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, 2019 and December 31, 2018, this customer relationship intangible amounted to $796 thousand and $888 thousand, respectively.
At March 31, 2019 and December 31, 2018, tax credits for Oriental totaled $277 thousand and $2.3 million, respectively. These tax credits do not have an expiration date.
NOTE 9— DEPOSITS AND RELATED INTEREST
Total deposits, including related accrued interest payable, as of March 31, 2019 and December 31, 2018 consist of the following:
Non-interest bearing demand deposits
1,092,488
1,105,324
Interest-bearing savings and demand deposits
2,356,868
2,274,423
Retail certificates of deposit
810,670
805,712
Institutional certificates of deposit
185,849
197,559
Total core deposits
4,445,875
4,383,018
Brokered deposits
451,226
525,097
Brokered deposits include $430.2 million in certificates of deposits and $21.0 million in money market accounts at March 31, 2019, and $500.8million in certificates of deposits and $24.3 million in money market accounts at December 31, 2018.
The weighted average interest rate of Oriental’s deposits was 0.74% and 0.67%, respectively, at March 31, 2019 and December 31, 2018. Interest expense for the quarters ended March 31, 2019 and 2018 was as follows:
Demand and savings deposits
3,411
2,812
Certificates of deposit
5,638
4,486
At March 31, 2019 and December 31, 2018, time deposits in denominations of $250 thousand or higher, excluding accrued interest and unamortized discounts, amounted to $338.5 million and $346.0 million, respectively. Such amounts include public funds time deposits from various Puerto Rico government municipalities, agencies and corporations of $14.1 million and $19.6 million at a weighted average rate of 127.0% and 116.4% at March 31, 2019 and December 31, 2018, respectively.
At March 31, 2019 and December 31, 2018, total public fund deposits from various Puerto Rico government municipalities, agencies and corporations amounted to $228.8 million and $207.4 million, respectively. These public funds were collateralized with commercial loans and securities amounting to $278.2 million and $281.2 million at March 31, 2019 and December 31, 2018, respectively.
Excluding accrued interest of approximately $2.2 million, the scheduled maturities of certificates of deposit at March 31, 2019 and December 31, 2018 are as follows:
Within one year:
Three (3) months or less
275,976
305,088
Over 3 months through 1 year
469,477
545,363
745,453
850,451
Over 1 through 2 years
508,568
484,197
Over 2 through 3 years
94,306
89,340
Over 3 through 4 years
33,099
34,018
Over 4 through 5 years
43,117
42,998
1,424,543
1,501,004
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 $578 thousand and $1.1 million as of March 31, 2019 and December 31, 2018, respectively.
51
NOTE 10— BORROWINGS AND RELATED INTEREST
Securities Sold under Agreements to Repurchase
AtMarch 31, 2019, 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.
The following table shows Oriental’s repurchase agreements, excluding accrued interest in the amount of $609 thousand and $785 thousand at March 31, 2019 and December 31, 2018, respectively:
Short-term fixed-rate repurchase agreements, interest ranging from 2.45% to 2.95% (December 31, 2018 2.45% to 2.95%)
190,957
214,723
Long-term fixed-rate repurchase agreements, interest ranging from 1.72% to 2.86% (December 31, 2018; 1.72% to 2.86%)
240,000
Total assets sold under agreements to repurchase
430,957
454,723
Repurchase agreements mature as follows:
Less than 90 days
Over 90-days
The following securities were sold under agreements to repurchase:
Approximate
Cost of
Underlying
Balance of
of Underlying
Interest Rate
Underlying Securities
Securities
Borrowing
of Security
FNMA and FHLMC Certificates
464,669
461,092
3.03%
496,814
487,181
3.01%
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, 2019 and December 31, 2018, these advances were secured by mortgage and commercial loans amounting to $871.2 million and $847.3 million, respectively. Also, at March 31, 2019 and December 31, 2018, Oriental had an additional borrowing capacity with the FHLB-NY of $790.3 million and $762.0 million, respectively. At March 31, 2019 and December 31, 2018, the weighted average remaining maturity of FHLB’s advances was 28.0 months and 26.6 months, respectively. The original terms of these advances range between one day and seven years, and the FHLB-NY does not have the right to exercise put options at par on any advances outstanding as of March 31, 2019.
The following table shows a summary of the advances and their terms, excluding accrued interest in the amount of $192 thousand and $176 thousand, at March 31, 2019 and December 31, 2018, respectively:
Short-term fixed-rate advances from FHLB, with a weighted average interest rate of 2.67% (December 31, 2018 - 2.61%)
33,572
Long-term fixed-rate advances from FHLB, with a weighted average interest rate of 2.90% (December 31, 2018 - 2.89%)
47,744
43,872
80,919
77,444
Advances from FHLB mature as follows:
Under 90 days
Over one to three years
8,780
Over three to five years
34,514
Over five years
4,450
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, 2019 and December 31, 2018.
53
NOTE 11 – 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, 2019 and December 31, 2018:
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
Collateral
Net
Assets
Condition
Instruments
Received
2,076
(1,966)
Net amount of
2,037
(1,690)
Liabilities
Presented
Provided
(1,541)
(30,135)
431,396
(31,676)
(1,647)
(32,458)
455,056
(34,105)
NOTE 12 — INCOME TAXES
Oriental is subject to the provisions of the Puerto Rico Internal Revenue Code of 2011, as amended (the “Code”), which imposes a maximum statutory corporate tax rate of 37.5% on a corporation’s net taxable income. Under the Code, all corporations are treated as separate taxable entities and are not entitled to file consolidated tax returns. Such entities are subject to Puerto Rico regular income tax or the alternative minimum tax (“AMT”) on income earned from all sources pursuant to the Code. The AMT is payable if it exceeds regular income tax. The excess of AMT over regular income tax paid in any one year may be used to offset regular income tax in future years, subject to certain limitations.
Oriental also has operations in the United States mainland through its wholly owned subsidiary, OPC, a retirement plan administrator based in Florida. In October 2017, Oriental expanded its operations in the United States through the Bank’s wholly owned subsidiary, OFG USA. Both subsidiaries are subject to federal income taxes at the corporate level. In addition, OPC is subject to Florida state taxes and OFG USA is subject to North Carolina state taxes.
At March 31, 2019 and December 31, 2018, Oriental’s net deferred tax asset amounted to $112.7 million and $113.8 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 mainly 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 is 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, 2019 and December 31, 2018. The amount of the deferred tax asset that is considered realizable could be reduced in the near term if there are changes in estimates of future taxable income.
Oriental maintained an effective tax rate lower than statutory rate for the quarters ended March 31, 2019 and 2018 of 33.0% and 32.0%, respectively, mainly by investing in tax-exempt obligations, doing business through its international banking entity, and by expanding its operations in the U.S, which are taxed at a lower rate.
Oriental classifies unrecognized tax benefits in other liabilities. These gross unrecognized tax benefits would affect the effective tax rate if realized. At March 31, 2019 and December 31, 2018, unrecognized tax benefits amounted at $891 thousand and $875 thousand, respectively. Oriental had accrued $17 thousand at March 31, 2019 (December 31, 2018 - $81 thousand) for the payment of interest and penalties relating to unrecognized tax benefits.
Income tax expense for the quarters ended March 31, 2019 and 2018, was $11.6 million and $8.0 million, respectively
NOTE 13 — 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 based on the framework of the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”), which 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 Basel III 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 Basel III 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 Basel III 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, 2019 and December 31, 2018, OFG Bancorp and the Bank met all capital adequacy requirements to which they are subject. As of March 31, 2019 and December 31, 2018, 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, 2019 and December 31, 2018 are as follows:
Minimum Capital
Minimum to be Well
Actual
Requirement
Capitalized
Ratio
OFG Bancorp Ratios
As of March 31, 2019
Total capital to risk-weighted assets
1,012,112
20.77%
389,824
8.00%
487,281
10.00%
Tier 1 capital to risk-weighted assets
949,794
19.49%
292,368
6.00%
Common equity tier 1 capital to risk-weighted assets
832,924
17.09%
219,276
4.50%
316,732
6.50%
Tier 1 capital to average total assets
14.64%
259,456
4.00%
324,320
5.00%
As of December 31, 2018
990,499
20.48%
386,977
483,721
928,577
19.20%
290,233
811,707
16.78%
217,675
314,419
14.22%
261,125
326,406
Bank Ratios
966,848
19.91%
388,573
485,716
904,813
18.63%
291,429
218,572
315,715
14.02%
258,183
322,728
949,596
19.68%
385,992
482,490
887,918
18.40%
289,494
217,120
313,618
13.68%
259,547
324,434
NOTE 14 – STOCKHOLDERS’ EQUITY
Preferred Stock and Common Stock
On October 22, 2018, Oriental completed the conversion of all of its 84,000 shares of Series C preferred stock into common stock. Each share of Series C preferred stock was converted into 86.4225 shares of common stock. Upon conversion, the Series C preferred stock is no longer outstanding and all rights with respect to the Series C preferred stock have ceased and terminated, except the right to receive the number of whole shares of common stock issuable upon conversion of the Series C preferred stock and any required cash-in-lieu of fractional shares. At both March 31, 2019 and December 31, 2018, preferred and common stock paid-in capital amounted $92.0 million and $59.9 million, respectively.
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, 2019 and December 31, 2018, accumulated issuance costs charged against additional paid-in capital amounted to $13.6 million and $10.1 million for common and preferred stock, respectively.
Legal Surplus
The Puerto Rico Banking Act requires that a minimum of 10% of the Bank’s net income 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, 2019 and December 31, 2018, the Bank’s legal surplus amounted to $92.6 million and $90.2 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, 2019 and 2018, Oriental did not repurchase any shares under the program.
At March 31, 2019 the number of shares that may yet be purchased under the $70 million program is estimated at 390,644 and was calculated by dividing the remaining balance of $7.7 million by $19.79 (closing price of Oriental's common stock at March 31, 2019).
The activity in connection with common shares held in treasury by Oriental for the quarters ended March 31, 2019 and 2018 is set forth below:
Dollar
Shares
(In thousands, except shares data)
Beginning of period
8,591,310
103,633
8,678,427
104,502
Common shares used upon lapse of restricted stock units and options
(34,507)
(437)
(20,900)
End of period
8,556,803
103,196
8,657,527
104,142
NOTE 15 - ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income, net of income taxes, as of March 31, 2019 and December 31, 2018 consisted of:
Unrealized loss on securities available-for-sale which are not
other-than-temporarily impaired
(9,280)
(12,654)
Income tax effect of unrealized loss on securities available-for-sale
1,439
1,682
Net unrealized gain on securities available-for-sale which are not
(7,841)
(10,972)
(329)
Income tax effect of unrealized (loss) gain on cash flow hedges
(5)
Net unrealized (loss) gain on cash flow hedges
(206)
Accumulated other comprehensive (loss), net of income taxes
Unrealized losses on available-for-sale securities includes $14.4 million as effect of the adoption of ASU No. 2017-12 and reclassification of all of its mortgage backed securities with carrying value of $424.7 million, from the held-to-maturity portfolio into the available-for-sale portfolio.
The following table presents changes in accumulated other comprehensive income by component, net of taxes, for the quarters ended March 31, 2019 and 2018:
Net unrealized
Accumulated
gains on
loss on
other
securities
cash flow
comprehensive
available-for-sale
hedges
(loss) income
Beginning balance
Other comprehensive income (loss)
Transfer of securities held-to-maturity to available-for-sale
(12,041)
Other comprehensive income (loss) before reclassifications
15,189
(432)
14,757
Amounts reclassified out of accumulated other comprehensive (loss) income
(17)
3,131
(215)
Ending balance
(311)
Other comprehensive (loss) income before reclassifications
(9,576)
(9,550)
(60)
Other comprehensive (loss) income
(9,636)
400
(12,274)
The following table presents reclassifications out of accumulated other comprehensive income for the quarters ended March 31, 2019 and 2018:
Amount reclassified out of accumulated other comprehensive income
Affected Line Item in Consolidated Statement of Operations
Cash flow hedges:
Interest-rate contracts
Available-for-sale securities:
Net interest expense
Residual tax effect from OIB's change in applicable tax rate
Net impairment losses recognized in earnings
Tax effect from changes in tax rates
(65)
61
NOTE 16 – EARNINGS PER COMMON SHARE
The calculation of earnings per common share for the quarters ended March 31, 2019 and 2018 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
Weighted average common shares and share equivalents:
Average common shares outstanding
51,305
43,955
Effect of dilutive securities:
Average potential common shares-options
321
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
During the last quarter of 2018, Oriental converted all of its 84,000 outstanding shares of Series C Preferred Stock into common stock. Each Series C Preferred Stock share was converted into 86.4225 shares of common stock. In computing diluted earnings per common share during the first nine months of 2018, the 84,000 shares of Series C Preferred Stock that remained outstanding, 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 quarter ended March 31, 2018 on the convertible preferred stock were added back as income available to common shareholders.
For the quarters ended March 31, 2019 and 2018, weighted-average stock options with an anti-dilutive effect on earnings per share not included in the calculation amounted to 28,414 and 859,322, respectively.
NOTE 17 – GUARANTEES
At March 31, 2019 and December 31, 2018, the unamortized balance of the obligations undertaken in issuing the guarantees under standby letters of credit represented a liability of $12.6 million and $23.9 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, 2019 and December 31, 2018, the unpaid principal balance of residential mortgage loans sold subject to credit recourse was $5.3 million and $5.4 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, 2019 and 2018.
346
Net (charge-offs/terminations) recoveries
(132)
(94)
264
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 quarters ended March 31, 2019 and 2018, Oriental did not repurchase any mortgage loans subject to credit recourse provision. 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, 2019, Oriental’s liability for estimated credit losses related to loans sold with credit recourse amounted to $214 thousand (December 31, 2018– $346 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 31,2019, Oriental repurchased $1.9 million (March 31, 2018 – $2.3 million) of unpaid principal balance in mortgage loans, excluding mortgage loans subject to credit recourse provision referred above.
During the quarters ended March 31, 2019 and 2018, Oriental recognized $116 thousand and $100 thousand, respectively, in losses from the repurchase of residential mortgage loans sold subject to credit recourse, and $16 thousand and $1 thousand, respectively, in losses from the repurchase of residential mortgage loans as a result of breaches of 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, 2019, Oriental serviced $900.0 million (December 31, 2018 - $895.6 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, 2019, the outstanding balance of funds advanced by Oriental under such mortgage loan servicing agreements was approximately $647 thousand (December 31, 2018 - $706 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.
63
NOTE 18— 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 at March 31, 2019 and December 31, 2018 were as follows:
Commitments to extend credit
588,159
541,423
Commercial letters of credit
340
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, 2019 and December 31, 2018, 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 $650 thousand and $627 thousand, at March 31, 2019 and December 31, 2018, respectively.
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, 2019 and December 31, 2018, is as follows:
Standby letters of credit and financial guarantees
12,595
23,889
Loans sold with recourse
5,341
5,414
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 non-performance 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.
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 arbitration, 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 arbitration, 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 19— OPERATING LEASES
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, Oriental adopted ASU No. 2016-02 “Leases” (Topic 842) and all subsequent ASUs that modified Topic 842. For Oriental, Topic 842 primarily affected the accounting treatment for operating lease agreements in which Oriental is the lessee. Oriental elected the hindsight practical expedient, which allows entities to use hindsight when determining lease term and impairment of right-of-use assets. As a result of the changes to the lease terms, Oriental reduced its retained earnings by $736 thousand on the effective date, January 1, 2019.
Lessee Accounting
Right of use assets and lease liabilities are recognized at the commencement of an arrangement where it is determined at inception that a lease exists. Lease assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. These assets and liabilities are initially recognized based on the present value of lease payments over the lease term calculated using our incremental borrowing rate. Lease terms include options to extend or terminate the lease when it is reasonably certain that those options will be exercised. The right-of-use asset is measured at the amount of the lease liability adjusted for the remaining balance of any lease incentives received, any cumulative prepaid or accrued rent if the lease payments are uneven throughout the lease term, any unamortized initial direct costs, and any impairment of the right-of-use-asset.
Operating lease expense consists of a single lease cost calculated so that the remaining cost of the lease is allocated over the remaining lease term on a straight-line basis, and any impairment of the right-of-use asset. Variable lease payments are generally expensed as incurred and include certain nonlease components, such as maintenance and other services provided by the lessor, and other charges included in the lease. Leases with an initial term of 12 months or less are not recorded on the balance sheet, and the expense for these short-term leases and for operating leases is recognized on a straight-line basis over the lease term.
Oriental’s leases do not contain residual value guarantees or material variable lease payments. All leases were classified as operating leases.
Substantially all of the leases in which Oriental is the lessee are comprised of real estate property for branches, ATM locations, and office space with terms extending through 2032. All of our leases are classified as operating leases, and therefore, were previously not recognized on Oriental’s consolidated statements of financial condition. With the adoption of Topic 842, operating lease agreements are required to be recognized on the consolidated statements of financial condition as a right-of-use asset and a corresponding lease liability. Oriental leases to others certain space in its principal offices for terms extending through 2023; all are operating leases.
Operating Lease Cost
Quarter Ended
Statement of Operations Classification
Lease costs
1,529
Occupancy and equipment
Variable lease costs
684
Short-term lease cost
156
Lease income
(155)
Total lease cost
2,214
Rent expenses for the quarter ended March 31, 2018, prior to adoption of ASU 2016-02 (Topic 842), were $2.2 million.
Operating Lease Assets and Liabilities
Statement of Financial Condition Classification
Right-of-use assets
Lease Liabilities
Operating leases liabilities
Weighted-average remaining lease term
4.4 years
Weighted-average discount rate
8.0%
Future minimum payments for operating leases with initial or remaining terms of one year or more as of March 31, 2019 were as follows:
66
Minimum Rent
Year Ending December 31,
4,653
2020
5,636
2021
4,678
2022
3,824
2023
2,961
Thereafter
8,929
Total lease payments
30,681
Less imputed interest
8,063
Present value of lease liabilities
Future minimum payments for operating leases with initial or remaining terms of one year or more as of December 31, 2018 were as follows:
5,618
4,293
3,360
2,494
6,679
Total future minimum lease payments
24,412
NOTE 20 - 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 valuations obtained from an independent pricing provider, ICE Data Pricing (formerly known as IDC). ICE is a well-recognized pricing company and an established leader in financial information. 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, 2019 and December 31, 2018, Oriental did not have investment securities classified as Level 3.
Derivative instruments
The fair value of the interest rate swaps is largely a function of the financial market’s expectations regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future impact of derivative instruments on earnings. This will depend, for the most part, on the shape of the yield curve, the level of interest rates, as well as the expectations for rates in the future. The fair value of most of these derivative instruments is based on observable market parameters, which include discounting the instruments’ cash flows using the U.S. dollar LIBOR-based discount rates, and also applying yield curves that account for the industry sector and the credit rating of the counterparty and/or 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:
(439)
1,239,521
1,257,809
Non-recurring fair value measurements:
Impaired commercial loans
89,362
123,801
(333)
842,231
857,877
81,976
118,730
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, 2019 and 2018:
Level 3 Instruments Only
Servicing Assets
9,821
New instruments acquired
302
352
Principal repayments
(201)
(199)
Changes in fair value of servicing assets
(194)
559
10,533
During the quarters ended March 31, 2019, and 2018, there were purchases and sales of assets and liabilities measured at fair value on a recurring basis. There were no transfers into and out of Level 1 and Level 2 fair value measurements during such periods.
The table below presents quantitative information for all assets and liabilities measured at fair value on a recurring and non-recurring basis using significant unobservable inputs (Level 3) at March 31, 2019:
Valuation Technique
Unobservable Input
Range
Cash flow valuation
Constant prepayment rate
4.38% -8.96%
Discount rate
10.00% - 12.00%
Collateral dependent
impaired loans
44,717
Fair value of property
or collateral
Appraised value less disposition costs
16.20% - 36.20%
Other non-collateral dependent impaired loans
44,645
4.25% - 12.25%
Estimated net realizable value less disposition costs
40.00% - 60.00%
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
70
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, 2019 and December 31, 2018 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)
4,074,348
4,106,628
4,868,473
4,881,903
429,250
453,135
81,366
78,503
35,458
36,184
87,664
The following methods and assumptions were used to estimate the fair values of significant financial instruments at March 31, 2019 and December 31, 2018:
• Cash and cash equivalents (including money market investments and time deposits with other banks), restricted cash, accrued interest receivable, accounts receivable and other assets, accrued expenses and other liabilities, and other borrowings 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 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 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, 2019 and 2018:
Banking service revenues:
Checking accounts fees
Savings accounts fees
155
154
Electronic banking fees
7,892
7,571
Credit life commissions
117
Branch service commissions
373
327
Servicing and other loan fees
316
601
International fees
169
Miscellaneous income
Total banking service revenues
Wealth management revenue:
Insurance income
1,238
Broker fees
1,789
Trust fees
2,604
2,696
Retirement plan and administration fees
Investment banking fees
Total wealth management revenue
Mortgage banking activities:
Net servicing fees
944
1,754
Net gains on sale of mortgage loans and valuation
162
Total mortgage banking activities
In May 2014 FASB issued ASU No. 2014-09 - Revenue from Contracts with Customers (ASC 606) to clarify the principles for recognizing revenue and to develop a common revenue standard that would remove inconsistencies in revenue requirements, provide a more robust framework for addressing the revenue issues, improve comparability in revenue recognition and to simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The standard defines revenue (ASC-606-10-20) as inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.
Revenue is recognized when (or as) the performance obligation is satisfied by transferring control of a promised good or service to a customer, either at a point in time or over time. Where a performance obligation is satisfied over time, the related revenue is also recognized over time.
Oriental recognizes the revenue from banking services, wealth management and mortgage banking based on the nature and timing of revenue streams from contracts with customer:
Banking Services Revenue
Electronic banking fees are credit and debit card processing services, use of the Bank’s ATMs by non-customers, debit card interchange income and service charges on deposit accounts. Revenue is recorded once the contracted service has been provided.
Service charges on checking and saving accounts as consumer periodic maintenance revenue is recognized once the service is rendered, while overdraft and late charges revenue are recorded after the contracted service has been provided.
Other income as credit life commissions, servicing and other loan fees, international fees, and miscellaneous fees recognized as banking services revenue are out of the scope of the 606 guideline.
Wealth Management Revenue
Insurance income from commissions and sale of annuities are recorded once the sale has been completed.
Brokers fees consist of two categories:
· Sales commissions generated by advisors for their clients’ purchases and sales of securities and other investment products, which are collected once the stand-alone transactions are completed at trade date or as earned, and managed account fees which are fees charged to advisors’ clients’ accounts on the Company corporate advisory platform. These revenues do not cover future services, as a result there is no need to allocate the amount received to any other service.
· Fees for providing distribution services related to mutual funds, net of compensation paid to a service provider who provides such services, as well as trailer fees (also known as 12-b1 fess). These fees are considered variable and are recognized over time, as the uncertainty of the fees to be received is resolved as the net asset value of the mutual fund is determined and investor activity occurs. Fees do not cover future services, as a result there is no need to allocate the amount received to any other service.
Retirement plan and administration fees are revenues related to the payment received from the clients of OPC for assistance with the planning, design and administration of retirement plans, acting as third party administrator for such plans, and daily record keeping services of retirement plans. Fees are collected once the stand-alone transaction was completed at trade date. Fees do not cover future services, as a result there is no need to allocate the amount received to any other service.
Trust fees are revenues related to fiduciary services provided to 401K retirement plans, a unit investment trust, and retirement plans, which include investment management, payment of distributions, if any, safekeeping, custodial services of plan assets, servicing of Trust officers, on-going due diligence of the Trust, and recordkeeping of transactions. Fees are billed based on services contracted. Negotiated fees are detailed in the contract. Fees collected in advance, are amortized over the term of the contract. Fees are collected on a monthly basis once the administrative service has been completed. Monthly fee does not include future services.
Investment banking fees as compensation fees are out of the scope of the 606 guideline.
Mortgage Banking Activities
Mortgage banking activities as servicing fees, gain on sale of mortgage loans valuation and other are out of the scope of the 606 guideline.
75
NOTE 22 – 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, 2019 and 2018:
Wealth
Total Major
Consolidated
Banking
Management
Treasury
Segments
Eliminations
Interest income
83,516
11,176
Interest expense
(8,636)
(4,285)
(12,921)
74,880
6,891
Provision for loan and lease losses, net
(12,207)
(42)
(12,249)
Non-interest income
11,656
5,984
Non-interest expenses
(46,483)
(4,327)
(1,342)
(52,152)
Intersegment revenue
554
(554)
Intersegment expenses
(174)
(380)
28,400
1,501
5,143
10,650
361
17,750
938
4,782
5,862,487
25,425
1,742,557
7,630,469
(1,027,278)
74,374
8,784
(6,290)
(2,886)
(9,176)
68,084
5,898
(15,455)
(15,460)
12,193
6,308
13
(48,081)
(3,286)
(754)
(52,121)
(361)
(179)
(182)
17,102
2,855
4,970
Income tax expense (benefit)
6,670
227
10,432
1,742
4,743
5,661,759
28,377
1,529,912
7,220,048
(972,927)
6,247,121
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, 2018 (the “2018 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 2018 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 2018 Form 10-K, we identified several accounting policies as critical, including the following, 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 and lease losses
· Accounting for purchased credit-impaired loans
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 2018 Form 10-K.
OVERVIEW OF FINANCIAL PERFORMANCE
SELECTED FINANCIAL DATA
Variance
%
EARNINGS DATA:
13.9%
40.8%
10.5%
-20.8%
Net interest income after provision for loan
and lease losses
18.8%
-4.6%
0.1%
Income before taxes
40.6%
44.5%
38.7%
53.0%
62.4%
PER SHARE DATA:
40.0%
16.7%
1.0%
Cash dividends declared per common share
Cash dividends declared on common shares
3,591
2,638
36.1%
PERFORMANCE RATIOS:
Return on average assets (ROA)
1.42%
1.09%
30.3%
Return on average tangible common equity
10.32%
7.73%
33.5%
Return on average common equity (ROE)
9.34%
6.84%
36.5%
Efficiency ratio
52.50%
56.51%
-7.1%
Interest rate spread
5.26%
5.14%
2.3%
Interest rate margin
5.37%
5.22%
2.9%
SELECTED FINANCIAL DATA - (Continued)
PERIOD END BALANCES AND CAPITAL RATIOS:
Investments and loans
-2.1%
Loans and leases, net
-0.7%
Total investments and loans
5,654,054
5,711,198
-1.0%
Deposits and borrowings
-0.2%
-5.3%
117,480
114,917
2.2%
Total deposits and borrowings
5,446,147
5,478,540
-0.6%
Stockholders’ equity
Preferred stock
0.0%
Common stock
2.7%
6.0%
Treasury stock, at cost
0.4%
Accumulated other comprehensive (loss)
26.6%
Total stockholders' equity
2.1%
Per share data
Book value per common share
18.30
17.90
Tangible book value per common share
16.56
16.15
2.5%
Market price at end of period
19.79
16.46
20.2%
Capital ratios
Leverage capital
3.0%
Common equity Tier 1 capital ratio
1.8%
Tier 1 risk-based capital
1.5%
Total risk-based capital
1.4%
Equity to assets ratio
15.47%
15.19%
Financial assets managed
Trust assets managed
2,925,982
2,771,462
5.6%
Broker-dealer assets
2,302,834
2,116,035
8.8%
81
FINANCIAL HIGHLIGHTS
Summary for the first quarter of 2019 versus first quarter of 2018
· Net interest income and total banking and financial revenues increased 7.7% to $99.3 million from $92.2 million. Increased interest income from originated loans and investment securities and cash more than offset pay downs of acquired loans.
· Net income available to shareholders increased 62.4% to $21.8 million from $13.5 million. Results reflect increased operating leverage, reduced provision and elimination of dividends on Series C preferred stock following its conversion.
· Earnings per share diluted of $0.42 compared to $0.30, a 40% increase.
· Book value per common share increased 3.0% to $18.30. Tangible book value per common share expanded 5.4% to $16.56.
· Loans increased 6.5% to $4.40 billion, while deposits grew 1.3% to $4.90 billion.
· New loan origination of $276.4 million included a 41.4% increase in commercial loans due to the success of Oriental’s strategic targeting of small business customers.
· Net interest margin of 5.37%, a 15 basis points increase, while both credit quality and the efficiency ratio improved.
· Return on average assets increased 33 basis points to 1.42%, return on average tangible common equity expanded 259 basis points to 10.32%, and capital metrics continued at new multi-year highs.
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, 2019 and 2018:
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
83,169
6.22%
5.86%
6,171,448
5,751,444
Tax equivalent adjustment
0.15%
0.08%
Interest-earning assets - tax equivalent
97,048
84,331
6.37%
5.94%
Interest-bearing liabilities
12,922
9,174
0.96%
0.72%
5,452,860
5,134,452
Tax equivalent net interest income / spread
84,126
75,157
5.41%
718,588
616,992
Tax equivalent interest rate margin
5.56%
5.31%
B - NORMAL SPREAD
Interest-earning assets:
8,223
7,350
2.65%
2.40%
1,258,899
1,239,794
Interest bearing cash and money market investments
2,368
1.51%
388,578
323,695
10,591
8,557
2.61%
2.22%
1,647,477
1,563,489
Non-acquired loans
8,887
9,012
5.39%
5.28%
668,654
692,532
25,202
18,322
6.42%
5.65%
1,591,415
1,315,993
10,977
9,952
12.36%
360,093
348,029
26,232
21,019
9.15%
9.12%
1,162,153
934,501
Total non-acquired loans
71,298
58,305
7.64%
7.18%
3,782,315
3,291,055
Acquired BBVAPR
6,351
7,071
5.44%
5.57%
473,517
515,226
3,746
6.90%
6.96%
159,049
218,199
760
25.30%
21.12%
12,969
14,596
1,389
11.00%
9,962
51,211
Total acquired BBVAPR loans
10,247
12,966
6.34%
6.58%
655,497
799,232
Acquired Eurobank
2,574
3,341
12.12%
13.87%
86,159
97,668
7.54%
7.23%
4,523,971
4,187,955
Total interest-earning assets
83
Interest-bearing liabilities:
NOW Accounts
899
0.53%
0.34%
1,119,612
1,059,129
Savings and money market
1,615
1,497
0.55%
0.50%
1,181,024
1,211,364
2,944
2,800
1.20%
1.11%
992,331
1,024,740
6,013
5,196
0.74%
0.64%
3,292,967
3,295,233
2,835
1,887
2.31%
1.64%
498,116
466,638
8,848
7,083
0.95%
0.76%
3,791,083
3,761,871
Non-interest bearing deposits
0.00%
1,099,624
1,020,730
Core deposit intangible amortization
201
215
0.75%
0.62%
4,890,707
4,782,601
2.54%
1.73%
444,843
251,582
2.81%
2.36%
81,226
64,186
5.89%
4.80%
3,872
1,877
2.79%
2.16%
562,152
351,851
Total interest bearing liabilities
9,175
5,452,859
Net interest income / spread
Excess of average interest-earning assets
over average interest-bearing liabilities
718,587
Average interest-earning assets to average
interest-bearing liabilities ratio
113.18%
112.02%
C - CHANGES IN NET INTEREST INCOME DUE TO:
Volume
Interest Income:
1,574
2,034
5,977
3,530
9,507
6,437
5,104
11,541
Interest Expense:
165
1,586
1,751
Repurchase agreements
827
882
1,709
136
1,128
2,618
Net Interest Income
5,309
2,486
7,795
84
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 of the quarters ended March 2019 and 2018
Net interest income of $81.8 million increased $7.8 million from $74.0 million. Interest rate spread increased 12 basis points to 5.26% from 5.14% and net interest margin increased 15 basis points to 5.37% from 5.22%. These increases are mainly due to the net effect of an increase of 36 basis points in the average yield of total interest-earning assets and an increase of 24 basis point in average cost of interest-bearing liabilities.
Net interest income increased as a result of:
· Higher interest income from investments of $2.0 million, reflecting an increase in interest rates and volume of $1.6 million and $460 thousand, respectively. Cash and money market investments increased 98 basis points and investments securities increased 25 basis points, both mainly due to an increase in Federal Reserve Bank interest rates; and
· Higher interest income from originated loans of $13.0 million, reflecting higher balances in the commercial, auto and consumer portfolios. This increase also reflects higher interest rates in the originated loan portfolio by 46 basis points.
Such increases in net interest income were adversely impacted by:
· An increase in interest expense of $3.7 million mainly from an increase in volume of repurchase agreements by $827 thousand and an increase in cost of deposits and repurchase agreements of $1.6 million and $882 thousand, respectively, and;
· A decrease of $3.5 million in the interest income from acquired loans as such loans continue to be repaid.
Comparison of 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.
85
TABLE 2 - NON-INTEREST INCOME SUMMARY
-2.3%
-31.4%
Total banking and financial service revenue
-3.8%
-62.5%
Non-Interest Income
Non-interest income is affected by the amount of the trust department 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, fees generated from loans and deposit accounts, and gains on sales of assets.
Comparison of quarters ended March 31, 2019 and 2018
Oriental recorded non-interest income, net, in the amount of $17.7 million, compared to $18.5 million, a decrease of 4.6%, or $858 thousand. The net decrease in non-interest income was mainly due to:
· A decrease of $551 thousand in mortgage banking activities, mainly from lower valuation of the servicing asset by $804 thousand, partially offset by higher gains on loans sold by $77 thousand due to higher volume;
· A decrease of $137 thousand in wealth management revenue mainly from lower fee income from the trust division, commissions revenues and consulting revenues.
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.
TABLE 3 - NON-INTEREST EXPENSES SUMMARY
Variance %
-1.3%
-0.3%
2.0%
-7.7%
19.1%
24.8%
-4.7%
-10.1%
4.1%
-22.5%
-16.3%
Printing, postage, stationery and supplies
-10.2%
-4.2%
9.7%
Total non-interest expenses
Relevant ratios and data:
Compensation and benefits to
non-interest expense
39.00%
39.54%
Compensation to average total assets owned
1.23%
1.32%
Average number of employees
1,394
1,367
Average compensation per employee
14.59
15.08
Average loans per average employee
3,245
3,061
Non-Interest Expenses
Non-interest expense was $52.2 million, representing an increase of 0.1% compared to $52.1 million.
The slight increase in non-interest expenses was driven by:
· Higher professional and service fees by $514 thousand, mainly attributed to higher consulting and advisory expenses; and
· Higher information technology expenses by $498 thousand mainly attributed to higher data processing charges.
The increases in the foregoing non-interest expenses were offset by:
· Lower insurance expenses by $332 thousand mainly related to a decrease in the FDIC Deposit Insurance Assessment (SAIF); and
· Lower compensation and employee benefits by $267 thousand, mainly due to a decrease in variable compensation.
The efficiency ratio improved from 56.51% to 52.50%. 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, 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 the efficiency ratio computation for the quarters ended March 31, 2019 and 2018 amounted to $103 thousand and $275 thousand, respectively.
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; and
· 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%. 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. Oriental received a $1.0 million partial payment from the insurance company in December 2017, a $0.7 million payment during the first quarter of 2018, and the final payment of $0.5 million during the fourth quarter of 2018.
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 quarters 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 20.8%, or $3.2 million, to $12.2 million. The decrease in the provision was mostly due to:
· A decrease in the provision of originated loan and lease losses for the amount of $2.4 million is attributable to the change in environmental factors; and
· A decrease in the provision of acquired Eurobank loan and lease losses of $790 thousand mainly due to better cash flows than expected.
The decreases in the provision for loan and lease losses were partially offset by:
· An increase of $1.2 million in the provision of acquired BBVA loan and lease losses due to impairments in the residential portfolio.
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.
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.
Income Taxes
Income tax expense was $11.6 million, compared to $8.0 million, reflecting the effective income tax rate of 33.0% and the net income before income taxes of $35.0 million for the first quarter of 2019.
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.
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 its services 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, 2019 and 2018.
Provision for loan and lease losses
Oriental's banking segment net income before taxes increased $11.3 million from $17.1 million to $28.4 million, mainly reflecting:
· Higher interest income from originated loans of $13.0 million due to higher balances and interest rates, offset by a decrease of $3.5 million in interest income from acquired loans as such loans continue to be repaid;
· A decrease in the provision of originated loan and lease losses for the amount of $2.4 million is attributable to the change in environmental factors;
· Increase in interest expense of $2.3 million mainly from increase in cost of deposits.
Wealth Management
Wealth management segment revenue, which consists of commissions and fees from fiduciary activities, and securities brokerage and insurance activities, decreased $1.4 million to $1.5 million mainly from the increase in the reasonable estimate accrual of claims and settlements in the broker-dealer subsidiary by $547 thousand and higher compensation expense by $285 thousand.
Treasury segment net income before taxes decreased $173 thousand from $5.0 million to $5.1 million, reflecting:
· Higher interest income from investment of $2.4 million due to increases in interest rates and volume of investments;
· Higher interest expense of $1.4 million due to increase in volume and cost of repurchase agreements by $827 thousand and $882 thousand, respectively.
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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; and
· 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.
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:
ANALYSIS OF FINANCIAL CONDITION
Assets Owned
At March 31, 2019, Oriental’s total assets amounted to $6.603 billion representing an increase of 0.3% when compared to $6.583 billion at December 31, 2018. This increase is mainly attributable to the adoption of the Accounting Standard Update (“ASU”) No. 2016-02, under the effective date method, which requires lessees to recognize a right-of-use asset and related lease liability for lease classified as operating leases, prospectively. At March 31, 2019, the right of use assets amounts $20.9 million. Cash and cash equivalents increased $59.0 million. Increases were offset by decreases in the loans and investments portfolios of $30.2 million and $27.0 million, respectively.
Cash and cash equivalents increased 13.2% to $506.0 million, mainly from higher core demand and savings deposits, offset by a decrease in brokered deposits and repayments of repurchase agreements.
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, 2019, Oriental’s loan portfolio decreased 0.7%. Loan production during the first quarter of 2019, reached $276.4 million compared to $309.4 million in the year ago quarter, a 10.7% decrease, mainly from lower originations in the US loan program. The non-acquired loan portfolio decreased $6.1 million from December 31, 2018 to $3.739 billion at March 31, 2019. From December 31, 2018, the BBVAPR acquired loan portfolio decreased $21.7 million to $654.5 million and the Eurobank acquired loan portfolio decreased $1.4 million to $85.7 million at March 31, 2019.
Investment securities available for sale increased 47.23% to $1.239 billion at March 31, 2019, mainly attributed to the reclassification of held-to-maturity securities into available-for-sale securities during the quarter amounting to $410.4 million (fair value at December 31, 2018), as a result of the adoption of ASU 2017-12.
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, 2019, total assets managed by Oriental’s trust division and OPC amounted to $2.926 billion, compared to $2.771 billion at December 31, 2018. 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, 2019, total assets gathered by Oriental Financial Services and Oriental Insurance from its customer investment accounts amounted to $2.303 billion, compared to $2.116 billion at December 31, 2018. 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, 2019, 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 2018, based on its annual goodwill impairment test, Oriental determined that both units passed step one of the two-step impairment test. As a result of step one, the fair value of both units exceeded its adjusted net book value. Accordingly, Oriental determined that the carrying value of the goodwill allocated to the Banking unit and Wealth Management was not impaired as of the valuation date. There were no events that caused Oriental to perform interim testing in Q1 2019.
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TABLE 4 - ASSETS SUMMARY AND COMPOSITION
978,071
2,197
-3.0%
0.5%
226,557
210,169
7.8%
1.2%
-2.7%
384
5.5%
Cash and due from banks (including restricted cash)
501,357
445,133
12.6%
55.5%
-8.6%
-3.2%
-0.9%
0.2%
-68.3%
Right of use assets
100.0%
Other assets and customers' liability on acceptances
76,675
74,282
3.2%
Total other assets
949,137
872,154
0.3%
Investment portfolio composition:
74.8%
76.5%
0.9%
0.8%
4.9%
5.0%
18.1%
16.4%
Other debt securities and other investments
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TABLE 5 — LOANS RECEIVABLE COMPOSITION
-2.6%
-1.8%
3.3%
-1.2%
-0.1%
6.6%
-5.5%
-5.1%
-47.3%
-11.2%
-11.6%
-1.7%
-31.5%
-2.8%
-2.5%
-1.6%
Mortgage loans held for sale
-25.9%
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 $4.401 billion at March 31, 2019 and $4.432 billion at December 31, 2018. Oriental’s originated and other loans held-for-investment portfolio composition and trends were as follows:
· Mortgage loan portfolio amounted to $651.4 million (17.4% of the gross originated loan portfolio) compared to $668.8 million (17.9% of the gross originated loan portfolio) at December 31, 2018. Mortgage loan production totaled $23.1 million for March 31, 2019, which represents a decrease of 13.3% from $26.6 million for the same periods in 2018. Mortgage loans included delinquent loans in the GNMA buy-back option program amounting to $12.9 million and $19.7 million at March 31, 2019 and December 31, 2018, 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 $1.570 billion (42.0% of the gross originated loan portfolio) compared to $1.598 billion (42.7% of the gross originated loan portfolio) at December 31, 2018. Commercial loan production, including the U.S. loan program production of $31.7 million, decreased 21.3% to $92.2 million for 2019, from $117.1 million for the same period in 2018.
· Consumer loan portfolio amounted to $350.5 million (9.4% of the gross originated loan portfolio) compared to $349.0 million (9.3% of the gross originated loan portfolio) at December 31, 2018. Consumer loan production increased 9.0% to $40.9 million for 2019 from $37.5 million when compared to the same period in 2018.
· Auto and leasing portfolio amounted to $1.167 billion (31.2% of the gross originated loan portfolio) compared to $1.130 million (30.1 of the gross originated loan portfolio) at December 31, 2018. Auto production decreased by 6.2% to $120.2 million for 2019, compared to $128.1 million for the same period in 2018.
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
8,620
3.54%
7,545
52,176
897
1.72%
90 - 119 days
222
12.61%
1,104
4.17%
120 - 179 days
12.31%
296
9.46%
180 - 364 days
25.00%
814
10.81%
365+ days
13.74%
1,377
202
14.67%
6,428
8.12%
9,157
383
4.18%
9,086
309
3.40%
60,818
1,581
2.60%
Percentage of total loans excluding
acquired loans accounted for under ASC 310-30
0.24%
1.61%
Refinanced or Modified Loans:
2,226
293
13.16%
533
13.32%
15,507
1,179
7.60%
Percentage of Higher-Risk Loan
Category
24.31%
5.87%
25.50%
Loan-to-Value Ratio:
Under 70%
6,068
4.04%
1,215
0.49%
70% - 79%
1,304
5.60%
1,914
1.78%
80% - 89%
994
0.10%
3,533
3.28%
90% and over
791
8.09%
2,424
153
6.31%
* Loans may be included in more than one higher-risk loan category and excludes acquired residential mortgage loans.
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Deposits from the Puerto Rico government totaled $228.8 million at March 31, 2019. The following table includes the maturities of Oriental's lending and investment exposure to the Puerto Rico government, which is limited solely to loans to 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.
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
Municipalities
135,471
23,704
68,220
43,547
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.
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 the 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.
At March 31, 2019, Oriental’s allowance for loan and lease losses amounted to $162.5 million, a $1.7 million decrease from $164.2 million at December 31, 2018.
Tables 8 through 10 set forth an analysis of activity in the allowance for loan and lease losses and present selected loan loss statistics. In addition, Table 5 sets forth the composition of the loan portfolio.
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, 2019 and December 31, 2018, Oriental had $122.7 million and $119.7 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, 2019 and December 31, 2018, loans whose terms have been extended and which are classified as troubled-debt restructurings that are not included in non-performing assets amounted to $113.1 million and $112.9 million, respectively.
At March 31, 2019 and December 31, 2018, loans that are current in their monthly payments, but placed in non-accrual amounted to $30.6 million and $21.2 million, respectively. During the quarter ended March 31, 2019, a $8.6 million loan that is current in its monthly payments was placed in non-accrual due to credit deterioration.
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 their remaining life using estimated cash flow analyses. Credit related decreases in expected cash flows, compared to those previously forecasted are recognized by recording a provision for credit losses on these loans when it is probable that all cash flows expected at acquisition will not be collected.
At March 31, 2019, Oriental’s non-performing assets increased by 0.5% to $162.1 million (2.50% of total assets, excluding acquired loans with deteriorated credit quality) from $161.3 million (2.76% of total assets, excluding acquired loans with deteriorated credit quality) at December 31, 2018. Foreclosed real estate and other repossessed assets amounting to $30.9 million and $3.6 million, respectively, at March 31, 2019, and $33.8 million and $3.0 million, respectively, at December 31, 2018, were recorded at fair value. Oriental does not expect non-performing loans to result in significantly higher losses. At March 31, 2019, the allowance coverage ratio for originated loan and lease losses to non-performing loans was 74.53% (77.38% at December 31, 2018).
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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, 2019, Oriental’s originated non-performing mortgage loans totaled $59.7 million (46.7% of Oriental’s non-performing loans), a 6.4% decrease from $63.7 million (51.1% of Oriental’s non-performing loans) at December 31, 2018.
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, 2019, Oriental’s originated non-performing commercial loans amounted to $50.4 million (39.5% of Oriental’s non-performing loans), a 18.7% increase from $42.5 million at December 31, 2018 (34.1% of Oriental’s non-performing loans). This increase is mainly from a $8.6 million loan that is current in its monthly payments but was placed in non-accrual during the quarter ended March 31, 2019 due to credit deterioration.
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, 2019, Oriental’s originated non-performing consumer loans amounted to $4.0 million (3.1% of Oriental’s non-performing loans), a 18.4% increase from $3.4 million at December 31, 2018 (2.7% 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, 2019, Oriental’s originated non-performing auto loans and leases amounted to $12.2 million (9.5% of Oriental’s total non-performing loans), a decrease of 9.9% from $13.5 million at December 31, 2018 (10.8% of Oriental’s total non-performing loans), mainly due to higher balance in the portfolio.
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:
-15.6%
-1.4%
Total allowance balance
Allowance composition:
17.8%
20.8%
-14.6%
34.2%
31.9%
7.3%
17.1%
4.6%
31.0%
Allowance coverage ratio at end of period applicable to:
2.56%
2.96%
-13.5%
2.05%
7.9%
4.59%
4.46%
Total allowance to total originated loans
2.51%
Allowance coverage ratio to non-performing loans:
27.97%
31.05%
-9.9%
63.83%
71.43%
-10.6%
405.06%
464.25%
-12.7%
239.31%
218.67%
9.4%
74.53%
77.38%
-3.7%
TABLE 8 — ALLOWANCE FOR LOAN AND LEASE LOSSES BREAKDOWN (CONTINUED)
45.5%
-1.9%
-50.4%
1.6%
1.1%
52.3%
95.0%
92.4%
2.8%
3.4%
-48.1%
100.00%
1.33%
0.86%
54.7%
8.21%
7.94%
2.87%
3.04%
-5.6%
Total allowance to total acquired loans
7.15%
6.66%
7.4%
3.43%
2.32%
47.8%
438.73%
478.64%
-8.3%
67.00%
67.50%
134.98%
133.20%
1.3%
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Acquired BBVAPR loans accounted for under ASC 310-30
17.6%
-43.1%
42.5%
36.2%
17.2%
49.2%
49.1%
8.3%
14.6%
-43.3%
Acquired Eurobank loans accounted for under ASC 310-30
-3.6%
-100.0%
62.1%
61.6%
0.7%
37.9%
38.4%
-1.1%
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TABLE 9 — ALLOWANCE FOR LOAN AND LEASE LOSSES SUMMARY
Originated and other loans:
-24.2%
11.8%
3.7%
-2.9%
BBVAPR loans
Acquired loans accounted for
under ASC 310-20:
-46.6%
Provision (recapture) for loan and lease losses
62.0%
-54.2%
-53.3%
-38.2%
under ASC 310-30:
-8.2%
608.9%
-58.6%
-2.4%
Eurobank loans
-0.8%
-568.3%
-67.0%
TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30
Originated and other loans and leases:
-39.4%
(300)
(654)
-54.1%
-19.2%
(939)
(967)
9.6%
(3,858)
(4,018)
-4.0%
5.4%
(7,389)
(5,205)
42.0%
Net credit losses
Total charge-offs
Total recoveries
(12,486)
(10,844)
15.1%
Net credit losses to average
loans outstanding:
0.18%
0.38%
-52.6%
0.30%
-20.0%
4.29%
5.07%
-15.4%
2.23%
1.34%
-1.5%
Recoveries to charge-offs
27.26%
29.39%
-7.2%
Average originated loans:
683,398
-2.2%
1,310,444
21.4%
317,295
13.5%
933,456
24.5%
3,244,593
16.6%
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TABLE 10 — NET CREDIT LOSSES STATISTICS ON LOAN AND LEASES, EXCLUDING LOANS ACCOUNTED FOR UNDER ASC 310-30 (CONTINUED)
-56.9%
(400)
-58.7%
-32.0%
-60.5%
-95.1%
(392)
(862)
-54.5%
-0.48%
-0.38%
26.3%
12.29%
28.82%
-57.3%
-0.56%
-2.14%
-74.0%
8.20%
9.60%
-14.5%
25.33%
24.85%
Average loans accounted for under ASC 310-20:
3,194
-21.9%
13,015
13,436
-3.1%
3,602
19,292
-81.3%
19,111
35,922
-46.8%
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TABLE 11 — NON-PERFORMING ASSETS
(%)
Non-performing assets:
Non-accruing loans
Troubled-Debt Restructuring loans
40,815
41,679
Other loans
81,910
78,047
Accruing loans
4,302
536
Total non-performing loans
127,633
124,569
19.7%
162,072
161,323
Non-performing assets to total assets, excluding acquired loans with deteriorated credit quality (including those by analogy)
2.50%
2.76%
-9.4%
Non-performing assets to total capital
15.87%
16.13%
Interest that would have been recorded in the period if the
loans had not been classified as non-accruing loans
1,107
996
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TABLE 12 — NON-PERFORMING LOANS
Non-performing loans:
59,665
63,717
-6.4%
50,376
18.7%
18.4%
126,175
123,021
2.6%
Acquired loans accounted for under ASC 310-20 (Loans with
revolving feature and/or acquired at a premium)
7.0%
-50.0%
-5.8%
Non-performing loans composition percentages:
Originated loans
46.8%
51.1%
39.5%
34.1%
3.1%
9.5%
10.8%
Non-performing loans to:
Total loans, excluding loans accounted for
under ASC 310-30 (including those by analogy)
3.39%
3.30%
Total assets, excluding loans accounted for
1.97%
2.13%
-7.5%
Total capital
12.50%
12.46%
Non-performing loans with partial charge-offs to:
1.16%
-6.03%
Non-performing loans
32.23%
35.30%
-8.7%
Other non-performing loans ratios:
Charge-off rate on non-performing loans to non-performing loans
on which charge-offs have been taken
60.10%
59.20%
Allowance for loan and lease losses to non-performing
loans on which no charge-offs have been taken
110.99%
120.67%
-8.0%
TABLE 13 - LIABILITIES SUMMARY AND COMPOSITION
NOW accounts
1,125,658
1,086,447
3.6%
Savings and money market accounts
1,252,158
1,212,260
1,501,002
4,894,847
4,905,033
Accrued interest payable
2,254
3,082
-26.9%
Total deposits and accrued interest payable
4.5%
Other term notes
-76.4%
Other Liabilities:
31.8%
Acceptances outstanding
Lease liability
Other liabilities
Deposits portfolio composition percentages:
22.3%
22.5%
23.0%
22.1%
25.6%
24.7%
29.1%
30.7%
Borrowings portfolio composition percentages:
78.5%
79.9%
14.8%
13.6%
6.3%
Securities sold under agreements to repurchase (excluding accrued interest)
Amount outstanding at period-end
Daily average outstanding balance
357,086
Maximum outstanding balance at any month-end
457,053
Liabilities and Funding Sources
As shown in Table 15 above, at March 31, 2019, Oriental’s total liabilities were $5.582 billion, 0.03% less than the $5.583 billion reported at December 31, 2018. Deposits and borrowings, Oriental’s funding sources, amounted to $5.446 billion at March 31, 2019versus $5.479 billion at December 31, 2018, a 0.6% decrease.
Borrowings consist mainly of repurchase agreements, FHLB-NY advances and subordinated capital notes. At March 31, 2019, borrowings amounted to $549.0 million, representing a decrease of 3.8% when compared with the $570.4 million reported at December 31, 2018. The decrease in borrowings reflects:
· A decrease of $23.9 million attributable to $23.7 million decrease in short-term repurchase agreements that matured during the quarter ended March 31, 2019 and were not renewed, partially offset by;
· An increase of $3.5 million in advances from the FHLB-NY attributable to $4.5 million of new advances from a special program from the FHLB called Disaster Relief Funding (DRF) and it was created to offer advances with special rates to those areas declared as disaster areas.
On January 1, 2019, Oriental adopted the Accounting Standard Update (“ASU”) No. 2016-02, under the effective date method, which requires lessees to recognize a right-of-use asset and related lease liability for lease classified as operating leases, prospectively. At March 31, 2019, the lease liability amounted to $22.6 million.
At March 31, 2019, deposits represented 89% and borrowings represented 11% of interest-bearing liabilities. At March 31, 2019, deposits, the largest category of Oriental’s interest-bearing liabilities, were $4.897 billion, a decrease of 0.2% from $4.908 billion at December 31, 2018.
Stockholders’ Equity
At March 31, 2019, Oriental’s total stockholders’ equity was $1.021 billion, a 2.13% increase when compared to $999.9 million at December 31, 2018. This increase in stockholders’ equity reflects increases in retained earnings of $15.1 million, a decrease in accumulated other comprehensive loss, net of tax of $2.9 million, an increase in the legal surplus of $2.5 million and reduction in treasury stock, at cost, of $437 thousand. Book value per share was $18.30 at March 31, 2019 compared to $17.90 at December 31, 2018.
FromDecember 31, 2018 to March 31, 2019, tangible common equity to total assets increased from 12.59% to 12.88%, leverage capital ratio increased from 14.22% to 14.64%, common equity tier 1 capital ratio increased from 16.78% to 17.09%, tier 1 risk-based capital ratio increased from 19.20% to 19.49%, and total risk-based capital ratio increased from 20.48% to 20.77%. The increase in these ratios reflect an increase of $21.3 million in total capital.
On October 22, 2018, Oriental completed the conversion of all 84,000 shares of its Series C Preferred Stock into common stock. Each share of Series C Preferred Stock was converted into 86.4225 shares of common stock. Upon conversion, the Series C Preferred Stock is no longer outstanding and all rights with respect to the Series C Preferred Stock have ceased and terminated, except the right to receive the number of whole shares of common stock issuable upon conversion of the Series C Preferred Stock and any required cash-in-lieu of fractional shares.
Capital Rules to Implement Basel III Capital Requirements
Oriental 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 Oriental 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, 2019, the capital ratios of Oriental and the Bank continue to exceed the minimum requirements for being “well-capitalized” under the Basel III capital rules.
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The risk-based capital ratios presented in Table 14, which include common equity tier 1, tier 1 capital, total capital and leverage capital as of March 31, 2019 and December 31, 2018, 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, 2019 and December 31, 2018:
TABLE 14 — 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
91,365
90,698
Excess over regulatory requirement
522,283
503,334
3.8%
Risk-weighted assets
4,872,806
4,837,214
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
657,427
638,344
Total risk-based capital ratio
Minimum total risk-based capital ratio required
Actual total risk-based capital
Minimum total risk-based capital required
622,288
603,522
Leverage capital ratio
Minimum leverage capital ratio required
Actual tier 1 capital
Minimum tier 1 capital required
690,339
667,452
Tangible common equity to total assets
12.88%
12.59%
Tangible common equity to risk-weighted assets
17.45%
17.13%
1.9%
Total equity to total assets
Total equity to risk-weighted assets
20.96%
20.67%
Stock data:
Outstanding common shares
51,328,431
51,293,924
Market capitalization at end of period
1,015,790
844,298
20.3%
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, 2019 and December 31, 2018:
(In thousands, except share or per
share information)
(92,000)
Preferred stock issuance costs
10,130
(86,069)
Core deposit intangible
(2,280)
(2,480)
Customer relationship intangible
(796)
(888)
Total tangible common equity (non-GAAP)
850,177
828,570
Total tangible assets
6,514,046
6,493,915
Tangible common equity to tangible assets
13.05%
12.76%
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.
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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
116,870
Tier 1 capital
Additional Tier 2 capital
62,318
61,922
0.6%
Risk-weighted assets:
Balance sheet items
4,640,278
4,641,998
Off-balance sheet items
232,528
195,216
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
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, 2019 and December 31, 2018:
Oriental Bank Regulatory Capital Ratios:
Common Equity Tier 1 Capital to Risk-Weighted Assets
Minimum capital requirement (4.5%)
Minimum capital conservation buffer requirement (1.875% at March 31, 2019 - 1.875% at December 31, 2018)
91,072
90,467
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%)
-0.5%
Minimum to be well capitalized (5%)
Oriental’s common stock is traded on the New York Stock Exchange (“NYSE”) under the symbol “OFG.” At March 31, 2019 and December 31, 2018, Oriental’s market capitalization for its outstanding common stock was $1.016 billion ($19.79 per share) and $844.3 million ($16.46 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 three calendar years:
Price
Dividend
High
Low
Per share
21.24
16.37
18.56
14.93
September 30, 2018
17.60
14.45
June 30, 2018
14.75
10.60
March 31, 2018
12.05
8.60
2017
December 31, 2017
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
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, 2019.
At March 31, 2019, the number of shares that may yet be purchased under such program is estimated at 390,644 and was calculated by dividing the remaining balance of $7.7 million by $19.79 (closing price of Oriental's common stock at March 31, 2019).
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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’s 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, 2019 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
11,451
3.63%
12,716
3.76%
+ 100 Basis points
5,790
1.84%
6,421
- 100 Basis points
(5,726)
-1.82%
(6,339)
-1.88%
- 200 Basis points
(11,449)
-3.63%
(12,675)
-3.75%
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, 2019.
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 fluctuation 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 7 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:
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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 borrowing 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 liability of $329 thousand (notional amount of $33.2 million) was recognized at March 31, 2019 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, 2019, interest rate swaps offered to clients not designated as hedging instruments represented a derivative asset of $33 thousand (notional amounts of $12.5 million), and the mirror-image interest rate swaps in which Oriental entered into represented a derivative liability of $33 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, 2019, Oriental had $33.2 million in interest rate swaps at an average rate of 2.42% designated as cash flow hedges for $33.2 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 for 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 mainland. 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 all agency mortgage-backed securities. Thus, 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, 2019, Oriental had $431.0 million in repurchase agreements, excluding accrued interest, and $451.2 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, 2019, Oriental had approximately $506.0 million in unrestricted cash and cash equivalents, $638.3 million in investment securities that are not pledged as collateral, and $790.3 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.
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.
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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 Oriental’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, 2019, that has materially affected, or is reasonably likely to materially affect, Oriental’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, 2018. 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 2007 Omnibus Performance Incentive Plan Performance Shares Award and Agreement.
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, 2019, 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 3, 2019
José Rafael Fernández
President and Chief Executive Officer
/s/ Maritza Arizmendi
Maritza Arizmendi
Executive Vice President, Chief Financial Officer and
Chief Accounting Officer
/s/ Krisen Aguirre Torres
Krisen Aguirre Torres
Vice President Financial Reporting and Accounting Control