OFG Bancorp: Puerto Rico's Rapid Economic Recovery To Drive Earnings

Sep. 18, 2022 1:52 PM ETOFG Bancorp (OFG)1 Comment
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Sheen Bay Research
2.71K Followers

Summary

  • The strong regional economy will drive loan balances in the next year and a half.
  • Thanks to the large balance of non-interest-bearing deposits, the margin will surge as interest rates rise.
  • The December 2022 target price suggests a high upside from the current market price. Further, OFG is offering a decent dividend yield.

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Earnings of OFG Bancorp (NYSE:OFG) will likely continue to surge in the next year and a half due to Puerto Rico’s strong economy which will boost the loan portfolio size. Moreover, the margin will expand amid the rising interest-rate environment, which will further support earnings. Overall, I'm expecting OFG Bancorp to report earnings of $3.33 per share for 2022, up 18% year-over-year. Compared to my last report on the company, I've increased my earnings estimate mostly because I've raised my loan growth estimate. For 2023, I'm expecting the company to report earnings of $3.64 per share, up 9% year-over-year. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on OFG Bancorp.

Regional Economy Bodes Well for Loan Growth

OFG Bancorp's loan portfolio beat my expectations by growing by 2.1% in the second quarter of 2022. This led to first-half loan growth of 8% annualized. The management appeared optimistic about loan growth during the conference call and mentioned that it expects auto finance, consumer, and commercial segments to contribute to the growth.

The rapidly strengthening Puerto Rican economy will likely be the chief driver of OFG Bancorp’s loan growth. Puerto Rico's unemployment rate has fallen sharply this year, and it continues to break records every month. Such a rapidly improving job market is bound to whet local credit appetite, especially that of consumer loans.

Chart
Puerto Rico Unemployment Rate data by YCharts

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

Economic Activity Index of Puerto Rico

Economic Development Bank Puerto Rico

Considering these factors, I'm expecting the loan portfolio to increase by 6% annualized every quarter till the end of 2023. In my last report on OFG Bancorp, I estimated loan growth of 5.0% for 2022. I have now revised upwards my loan growth estimate to 7.2% due to the second quarter’s performance as well as the greater-than-expected speed of economic improvement.

I'm expecting growth of other balance sheet items to trail loan growth. Growth of equity book value, in particular, will be much lower because of pressures from unrealized losses on available-for-sale securities. As interest rates have increased, the market value of these securities has fallen, leading to large unrealized losses that have flowed directly into the equity account without affecting the income statement. The tangible book value per share has already dropped from $19.1 at the end of December 2021 to $18.86 at the end of June 2022.

The 75 basis points hike in the Fed funds rate in July will further pressurize equity book value. Additionally, I'm expecting a further 75 basis point hike in the Fed funds rate in the remainder of the year. On the other hand, retained earnings will lift the equity book value. The following table shows my balance sheet estimates.

FY18 FY19 FY20 FY21 FY22E FY23E
Financial Position
Net Loans 4,432 6,642 6,501 6,329 6,784 7,201
Growth of Net Loans 9.3% 49.9% (2.1)% (2.6)% 7.2% 6.1%
Other Earning 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 Liabilities 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 USD million unless otherwise specified)

Sticky Deposit Costs to Enable Margin Expansion

OFG Bancorp’s net interest margin has rapidly expanded this year mostly due to the rising interest-rate environment.

Net Interest Margin OFG Bancorp

2Q 2022 Earnings Presentation

The margin shot up this year despite a two-to-three-month lag between a rate hike and its consequences, as mentioned in the conference call. The margin’s high rate sensitivity is attributable to not only variable-rate loans but also a deposit mix that is heavy on non-interest-bearing deposits. These deposits made up a hefty 60.5% of total deposits at the end of June 2022. The non-interest-bearing deposits will keep the average deposit cost upwards sticky amid a rising rate environment.

The results of the management's interest rate sensitivity analysis showed that a 200-basis point hike in interest rates can boost the net interest income by 5.14% over twelve months.

Interest Rate Sensitivity Analysis OFG Bancorp

2Q 2022 10-Q Filing

Considering these factors, I'm expecting the margin to increase by 15 basis points in the second half of 2022 and then remain unchanged in 2023.

Raising the Provision Expense Estimate

Non-performing loans made up 1.81% of total loans, while allowances made up 2.36% of total loans at the end of June 2022. This allowance coverage appears satisfactory, especially because Puerto Rico's rapidly improving economy signals future improvement in credit quality. As a result, I'm not expecting much pressure on provisioning from the existing loan portfolio. However, the loan additions mentioned above will require incremental provisioning for expected loan losses.

Overall, I'm expecting the net provision expense to make up around 0.4% of total loans (annualized) in every quarter till the end of 2023. In comparison, the net provision expense averaged 1.4% of total loans in the last five years. In my last report on OFG Bancorp, I estimated a net provision expense of $17 million for 2022. I have now increased my provision expense estimate to $22 million for this year mostly because I've increased my loan growth estimate.

Expecting Earnings to Grow by 18%

The anticipated loan additions and margin expansion will likely be the biggest drivers of earnings growth in the next year and a half. On the other hand, higher provision expenses will likely restrict earnings growth. Overall, I am expecting OFG Bancorp to report earnings of $3.33 per share for 2022, up 18% year-over-year. For 2023, I'm expecting earnings to grow by a further 9% to $3.64 per share. The following table shows my income statement estimates.

FY18 FY19 FY20 FY21 FY22E FY23E
Income Statement
Net interest income 316 323 408 407 468 518
Provision for loan losses 56 97 93 0 22 28
Non-interest income 80 82 124 133 133 133
Non-interest expense 207 233 345 326 345 367
Net income - Common Sh. 78 47 68 145 161 176
EPS - Diluted ($) 1.52 0.92 1.32 2.81 3.33 3.64

Source: SEC Filings, Author's Estimates

(In USD million unless otherwise specified)

In my last report on OFG Bancorp, I estimated earnings of $3.07 per share for 2022. I've now revised upwards my earnings estimate mostly because I've increased my loan growth estimate.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Maintaining a Buy Rating

OFG Bancorp is offering a dividend yield of 2.9% at the current quarterly dividend rate of $0.20 per share. The earnings and dividend estimates suggest a payout ratio of 22% for 2023, which is the same as the last five-year average. Therefore, I’m not expecting an increase in the dividend level.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-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.

Chart
OFG Price to Tangible Book Value data by YCharts

Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.9 gives a target price of $23.2 for the end of 2022. This price target implies a 15.0% downside from the September 16 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

P/TB Multiple 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
Upside/(Downside) (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.

Chart
OFG PE Ratio data by YCharts

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

P/E Multiple 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
Upside/(Downside) 50.4% 62.6% 74.8% 86.9% 99.1%
Source: Author's Estimates

Equally weighting the target prices from the two valuation methods gives a combined target price of $35.5, which implies a 29.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 32.4%. Hence, I’m maintaining a buy rating on OFG Bancorp.

This article was written by

Sheen Bay Research profile picture
2.71K Followers
Around 10 years of experience covering Banks and Macroeconomics. Passionate about discovering lucrative investments and generating alpha.

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.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.

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