First BanCorp: Flattish Earnings Outlook

Summary

• Although Puerto Rico's unemployment rate is still stubbornly high, there is hope for credit demand partly due to the region’s good handling of the pandemic.
• Further provision reversals are unlikely. However, the provisioning will likely remain below normal because of the substantial improvement in credit metrics.
• The December 2022 target price suggests a small downside from the current market price. Further, FBP is offering a low dividend yield.

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Earnings of First BanCorp. (NYSE: NYSE:FBP) will likely remain flattish next year as subdued loan growth will likely counter an increase in the provision expense. After declining for the last four consecutive quarters, there is hope that the loan portfolio will likely turn around next year because of Puerto Rico’s superior handling of the pandemic and signs of a pick-up in credit demand. Overall, I'm expecting First BanCorp to report earnings of $1.29 per share in 2022, almost unchanged from expected earnings of $1.30 per share for 2021. Next year's target price is close to the current market price. Therefore, I'm adopting a neutral rating on First BanCorp.

Loans Likely to Bottom-out in 4Q’21

First BanCorp's loan portfolio has declined for the last four consecutive quarters. The loan portfolio is likely to experience further pressure in the fourth quarter of 2021 due to the forgiveness of Paycheck Protection Program (“PPP”) loans. According to details given in the third quarter’s 10-Q filing, PPP loans made up around 2% of total loans at the end of September 2021. Moreover, Puerto Rico’s unemployment rate has remained stubbornly high this year (see below), which bodes ill for credit demand.

Data by YCharts

Despite the recent trend of the unemployment rate, there's some good macroeconomic news. Puerto Rico has so far handled the COVID-19 pandemic much better than the rest of the country, which gives hope for a brighter future. According to CDC, the territory reported a daily average of only 25.4 cases per 100,000 people in the last seven days. In comparison, the United States reported 198.8 cases per 100,000 people. Moreover, a whopping 82.3% of eligible individuals (12 years or older) in Puerto Rico are vaccinated, according to official sources. In comparison, 69.1% of the country's 12 years or older population is fully vaccinated, according to CDC. The emergence of the new, seemingly vaccine-resistant COVID-19 variant called Omicron does pose some risks. However, I'm not too worried about it right now. Hopefully, the last two years have taught the world how to better deal with such threats.

Further, the management mentioned in the third quarter’s conference call that credit demand is picking-up among their customers. The management expects this pick-up to continue. Considering the factors mentioned above and management's guidance, I'm expecting the loan portfolio to decline further in the fourth quarter because of PPP, and then turn around next year.

Due to the recent loan decline trend, excess cash has built up on First BanCorp’s books. Cash and Due from Banks has almost doubled in the first nine months of 2021, as shown below.

The release of relief funds for the pandemic and other natural disasters has been quite slow in Puerto Rico in the last few months. The website of Puerto Rico’s Central Office for Recovery, Reconstruction, and Resiliency shows that $22.09 billion worth of relief funds have been disbursed as of November 22, 2021 (see screenshot below). By June 2022, when I wrote on First BanCorp, funds worth around $20.58 billion had been disbursed. This means the government has released only $1.5 billion worth of funds in the last five months.

Considering the pace of relief fund disbursement, I'm expecting deposits to grow more or less in line with loans in the coming quarters. This means that the excess liquidity will likely remain unchanged through the end of 2022. The following table shows my balance sheet estimates.

The recent pile-up of cash has dragged the net interest margin. Going forward, an interest rate hike will likely counter the impact of the cash drag. Overall, I'm expecting the net interest margin to decline by 2 basis points in the fourth quarter of 2021 and increase by four basis points in 2022.

Revising the Provision Expense Estimate Due to Better than Expected Credit Performance

First BanCorp’s third-quarter earnings surprised me because of large loan loss reserve releases. The company has now posted net reversals of provisions for the last three consecutive quarters. I'm expecting no further significant reserve releases because the allowance for loan losses is uncomfortably close to the actual loan losses in the third quarter. According to details given in the 10-Q filing, allowances made up 2.59% of total loans at the end of September 2021, while net charge-offs made up 0.99% of average loans in the third quarter. This means that the allowance was just 2.6 times the actual loan losses. I consider a multiple higher than 7x to be comfortable for a bank.

Nevertheless, the provisioning next year will likely remain below normal because the portfolio’s credit risk has substantially subsided. Non-performing assets made up 0.81% of total assets at the end of September 2021, down from 1.57% of assets at the end of September 2020. Additionally, non-accrual loans made up 1.1% of total loans at the end of September 2021, as opposed to 1.7% of total loans at the end of September 2020. As the existing allowance is almost double the non-accrual loans, I believe the provisioning will likely remain below the historical average.

As the credit performance has exceeded my expectations, I'm now revising down my provision expense estimate for 2021 and 2022. In my previous report on First Bancorp, I had expected the company to report a net provision reversal of $21 million in 2021, which I'm now changing to $48 million. Further, I had previously expected a provision expense of $40 million in 2022, which I'm now reducing to $20 million.

Expecting 2022 Earnings of $1.29 per Share

Earnings will likely be flat next year as the benefit of subdued loan growth will cancel out a higher provisions expense. Overall, I'm expecting First BanCorp to report earnings of $1.29 per share in 2022.

For the last quarter of 2021, I'm expecting the company to report earnings of $0.31 per share, which will take full-year earnings to $1.30 per share. The following table shows my income statement estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic, especially the Omicron variant.

Current Market Price Close to the Year-Ahead Target Price

First BanCorp is offering a dividend yield of 2.9% at the current quarterly dividend rate of $0.10 per share. The earnings and dividend estimates suggest a payout ratio of 31% for 2022, which is in line with the 2019-2021 average of 29%. Therefore, I’m not assuming any change in the dividend level for next year.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value First BanCorp. The stock has traded at an average P/TB ratio of 0.86 in the past, as shown below. Due to natural disasters, I have ignored the P/TB ratios before 2019.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $11.3 gives a target price of $9.8 for the end of 2022. This price target implies a 29.2% downside from the November 26 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

The stock has traded at an average P/E ratio of around 14.2x in the past, as shown below.

Multiplying the average P/E multiple with the forecast earnings per share of $1.29 gives a target price of $18.4 for the end of 2022. This price target implies a 33.1% upside from the November 26 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $14.1, which implies a 2.0% upside from the current market price. Adding the forward dividend yield gives a total expected return of 4.9%. Hence, I’m adopting a neutral rating on First BanCorp. I wouldn’t consider investing in the stock unless its market price dipped by more than 10% from the current level.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.