OFG Bancorp: Puerto Rico’s rapid economic recovery to boost earnings (NYSE: OFG)

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OFG Bancorp Earnings (NYSE: OFG) will likely continue to increase over the next year and a half due to the strength of Puerto Rico’s economy, which will increase the size of the loan portfolio. In addition, the margin will increase in the context of the increase interest rate environment, which will further support earnings. Overall, I expect OFG Bancorp to report earnings of $3.33 per share for 2022, up 18% year-over-year. Compared to my last company report, I increased my revenue estimate primarily because I increased my loan growth estimate. For 2023, I expect the company to report earnings of $3.64 per share, up 9% year-over-year. The year-end target price suggests a strong upside from the current market price. Therefore, I maintain a buy rating on OFG Bancorp.

Regional economy bodes well for loan growth

OFG Bancorp’s loan portfolio exceeded my expectations by growing 2.1% in the second quarter of 2022. This led to first-half loan growth of 8% annualized. Management was bullish on loan growth on the conference call and said it expects the auto finance, consumer and business segments to contribute to growth.

The rapidly strengthening Puerto Rican economy will likely be the main driver of OFG Bancorp’s loan growth. Puerto Rico’s unemployment rate has fallen sharply this year and continues to break records every month. Such a rapidly improving labor market can only whet the local appetite for credit, especially consumer loans.

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Unemployment rate in Puerto Rico given by Y-Charts

Additionally, the economic activity index shows that economic activity is currently robust in the region, which also bodes well for credit demand.

Puerto Rico Economic Activity Index

Puerto Rico Economic Development Bank

Given these factors, I expect the loan book to grow at an annualized rate of 6% each quarter through the end of 2023. In my last report on OFG Bancorp, I estimated loan growth to 5.0% for 2022. I have now revised my estimated growth loan up to 7.2% due to the second quarter performance as well as the faster than expected speed of economic improvement.

I expect growth in other balance sheet items to follow loan growth. Equity book value growth, in particular, will be much lower due to pressures from unrealized losses on available-for-sale securities. As interest rates rose, the market value of these securities fell, resulting in large unrealized losses that flowed directly to equity without affecting the income statement. The tangible book value per share has already fallen from $19.1 at the end of December 2021 to $18.86 at the end of June 2022.

The 75 basis point hike in the federal funds rate in July will put further pressure on the book value of equity. Additionally, I expect another 75 basis point hike in the fed funds rate for the rest of the year. On the other hand, retained earnings will increase the book value of equity. The following table shows my balance sheet estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
Financial situation
Net loans 4,432 6,642 6,501 6,329 6,784 7,201
Net loan growth 9.3% 49.9% (2.1)% (2.6)% 7.2% 6.1%
Other productive assets 1,285 1,095 459 896 1,767 1,774
Deposits 4,908 7,699 8,416 8,603 9,211 9,585
Total responsibilities 5,583 8,252 8,740 8,831 9,415 9,790
Common Equity 908 953 994 1,069 1,078 1,216
Book value per share ($) 17.7 18.4 19.3 21.3 22.3 25.1
Tangible BVPS ($) 15.9 15.7 16.7 19.1 19.9 22.7

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Sticky deposit costs to allow for margin expansion

OFG Bancorp’s net interest margin has grown rapidly this year, primarily due to rising interest rates.

Net interest margin OFG Bancorp

Presentation of 2nd quarter 2022 results

The margin has jumped this year despite a two to three month lag between a rate hike and its aftermath, as mentioned in the conference call. The high sensitivity of the margin to rates is explained not only by floating rate loans, but also by a deposit mix which is heavily composed of non-interest bearing deposits. These deposits represented 60.5% of total deposits at the end of June 2022. Non-interest bearing deposits will keep the average cost of deposits rising in a rising rate environment.

The results of management’s interest rate sensitivity analysis showed that a 200 basis point increase in interest rates can increase net interest income by 5.14% year-over-year.

OFG Bancorp Interest Rate Sensitivity Analysis

Filing 2Q 2022 10-Q

Given these factors, I expect the margin to increase by 15 basis points in the second half of 2022 and then remain unchanged in 2023.

Increase in provision expense estimate

Non-performing loans represented 1.81% of total loans, while provisions represented 2.36% of total loans at end-June 2022. Puerto Rico’s economy signals a future improvement in credit quality. Therefore, I do not expect much pressure on the provisioning of the existing loan portfolio. However, the loan additions mentioned above will require additional provisioning for expected loan losses.

Overall, I expect net provision expense to be approximately 0.4% of total loans (annualized) in each quarter through the end of 2023. In comparison, net provision expense was an average of 1.4% of total loans over the past five years. In my last report on OFG Bancorp, I estimated a net provision charge of $17 million for 2022. I have now increased my provision charge estimate to $22 million for this year, primarily because I increased my loan growth estimate.

Profits are expected to increase by 18%

Planned loan additions and margin expansion are likely to be the main drivers of earnings growth over the next year and a half. On the other hand, higher provision charges will likely limit earnings growth. Overall, I expect OFG Bancorp to report earnings of $3.33 per share for 2022, up 18% year-over-year. For 2023, I expect earnings to grow another 9% to $3.64 per share. The following table shows my income statement estimates.

EX18 FY19 FY20 FY21 FY22E FY23E
income statement
Net interest income 316 323 408 407 468 518
Allowance for loan losses 56 97 93 0 22 28
Non-interest income 80 82 124 133 133 133
Non-interest charges 207 233 345 326 345 367
Net income – Common Sh. 78 47 68 145 161 176
BPA – Diluted ($) 1.52 0.92 1.32 2.81 3.33 3.64

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

In my last report on OFG Bancorp, I estimated earnings at $3.07 per share for 2022. I have now revised my earnings estimate upwards, mainly because I increased the growth estimate of my loan.

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with inflation and, therefore, the timing and magnitude of interest rate increases. Also, a deeper or longer than expected recession may increase the expected loan loss provisioning beyond my estimates.

Maintain a buy rating

OFG Bancorp offers a dividend yield of 2.9% at the current quarterly dividend rate of $0.20 per share. Earnings and dividend estimates suggest a payout ratio of 22% for 2023, which is the same as the average for the past five years. Therefore, I do not expect an increase in the level of dividends.

I use historical price/tangible accounting (“P/TB”) and price/earnings (“P/E”) multiples to value OFG Bancorp. The stock has traded at an average P/TB ratio of 1.17 in the past, as shown below.

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OFG price at tangible book value given by Y-Charts

Multiplying the average P/TB multiple by the expected tangible book value per share of $19.9 yields a price target of $23.2 for the end of 2022. This price target implies a decline of 15.0% compared to the closing price on September 16. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 0.97x 1.07x 1.17x 1.27x 1.37x
TBVPS – Dec 2022 ($) 19.9 19.9 19.9 19.9 19.9
Target price ($) 19.3 21.2 23.2 25.2 27.2
Market price ($) 27.3 27.3 27.3 27.3 27.3
Up/(down) (29.5)% (22.2)% (15.0)% (7.7)% (0.4)%
Source: Author’s estimates

The stock has traded at an average P/E ratio of around 14.4x in the past, as shown below.

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OFG PE report given by Y-Charts

Multiplying the average P/E multiple by the expected earnings per share of $3.33 yields a target price of $47.7 for the end of 2022. This price target implies a 74.8% upside from at the closing price on September 16. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E 12.4x 13.4x 14.4x 15.4x 16.4x
EPS – 2022 ($) 3.33 3.33 3.33 3.33 3.33
Target price ($) 41.1 44.4 47.7 51.1 54.4
Market price ($) 27.3 27.3 27.3 27.3 27.3
Up/(down) 50.4% 62.6% 74.8% 86.9% 99.1%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $35.5, implying a 29.9% upside from the current market price. Adding the forward dividend yield gives an expected total return of 32.4%. Therefore, I maintain a buy rating on OFG Bancorp.

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