First BanCorp. New

Good morning and welcome to the first Bancorp third quarter earnings conference call and webcast. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to John Pelling, IRO. Please go ahead.

Thank you, Debbie. Good morning, everyone, and thank you for joining First Bank Corp's conference call and webcast to discuss the company's financial results for the third quarter 2020. Joining you today from First Bank Corp are Willie Wallman, President and Chief Executive Officer of and Orlando Berges, Executive Vice President and Chief Financial Officer. Before we begin today's call, it is my responsibility to inform you that this call may involve certain forward-looking statements, such as projections of revenue, earnings, and capital structure, as well as statements on the plans and objectives of the company's business. The company's actual results could differ materially from the forward-looking statements made due to important factors described in the company's latest SEC filings. The company assumes no obligation to update any forward-looking statements made during the call. If anyone does not already have a copy of the webcast presentation or press release, you can access them at our website, onefirstbank.com. At this time, I'd like to turn the call over to our CEO.

Brilliant. Thank you, John. Good morning, everyone, and thanks for joining our call today. Please, let's move to slide four of the presentation. It was a very important quarter for our corporation, and I would like to go over some key highlights and then expand in certain matters. First of all, we're extremely pleased that we completed our strategic acquisition by closing the Santander transaction on September 1st. This transaction not only solidifies our position in the island, but strengthens our competitiveness in commercial, retail, as well as residential. Very pleased to welcome our 150,000 new customers, and we look forward to support them, to support their plans with an expanded branch network, expanded service channels, and enhanced technological offerings. On the economic front, definitely the relief funds from the pandemic, combined with 2017 hurricane funds being deployed, have bolstered liquidity in our market and will continue to drive economic activity. We'll touch on that. On the balance sheet side, even following the completion of the acquisition, we truly sustain a fortress balance sheet. Our liquidity, reserve, capital levels are among the highest in the banking sector. Core performance was strong for the quarter. We generated $28.6 million of net income Pre-tax pre-provision was $77 million with only one month of earnings from the acquired operations, and loan originations were strong at $971 million for the quarter. We basically increased originations in all categories through the quarter. Total deposits, including broker and government, increased to $12.5 million. And finally, our capital ratios remain among the highest in the banking sectors, and capital actions remain a priority as we see the economic environment stabilizing. Now let's cover more closely a few of these items on slide six. Start with slide six. Let's talk about the transaction. Definitely was a long time in the making, and as you see, we really improved our market position in all key areas. As you recall, the transaction was announced back in October 2019, and closing and completing was impacted by the COVID pandemic, definitely. But since then, some of the deal metrics have improved from announcement. We still expect 35% EPS accretion to consensus estimates. The revised TBB at closing is estimated at 4%, lower than our original estimate. and we expect less than two years of earn back now. This improvement is driven by, you know, slightly smaller loan portfolio, additional reserves delivered at closing, and the rate marks due to the rate environment. While cost savings are estimated at $48 million, we definitely work harder to see if there are areas that we can achieve more, but we're also focused on growing the franchise, so it's a balancing act as we move forward and achieve our goals of being more efficient and increase market share. I think together we have an excellent team, and we're working diligently to integrate and to turn on the growth engines as opportunities come in the economy. I want to touch on the integration. You know, we made a lot of progress on the first 45 days. Integration is underway. In those 45 days, we completed the conversion and integration of the mortgage business. the insurance agency, and several administrative functions. The plan is to complete the integration process by the end of the second quarter 2021. And this do consider, remember that we continue to operate under COVID limitation and distancing, and obviously a process of this magnitude, you know, takes times. We also announced this month as part of the The program, as part of the synergies and integration, we announced a voluntary separation program that provides an opportunity for early retirement to approximately 160 employees of the combined institution. This program will be executed over the next three quarters, starting in the fourth quarter. Other potential synergies identified include the opportunity of consolidating 8 to 10 branches, definitely the incremental utilization of digital channels could drive other efficiencies. But again, we don't want to hamper our potential to grow our market share with the now expanded market distribution that we have. So we will continue to move and report on this effort. Now let's move to slide seven. The new combined balance sheet is solid and well diversified. You know, the $2.6 billion acquired loan portfolio definitely complements ours nicely. And the deposit books improve our funding. Now the loan-to-deposit ratio stands at 78%, and obviously we have an expanded customer base to cross-sell and move to other products. Let's move to slide eight to talk about the economy. I think the quarter, we clearly saw the correlation of the reopening in our markets and the trends of economic recovery. It was clearly reflected in the third quarter. Remember that in the case of Puerto Rico, we have some severe tightening in the second quarter, and some of those rules were relaxed later. We're still operating under certain lockdowns, But I think the market has reacted very well to the situation and getting used to operate under that scenario. Importantly, you know, to support this economy, there are still over, you know, 60 billion of pandemic and hurricane relief. So those are numbers that are big for this economy. And there's a lot going on regarding reconstruction. Those funds are being deployed and they're definitely showing the liquidity and activity. Employment figures continue to turn positive. Recent numbers of August are 92% of August 2019. So definitely there's a recovery on the employment side. From the perspective of our client base, 100% of our corporate clients are operating and close to 99% of the business banking clients have reopened well. There are sectors that are more sensitive. The hospitality industry continues to reflect lower occupancy, but improving trends. Our hotel portfolio is below typical occupancy level, and San Juan Airport traffic is low, closer to 50%. And as we are all aware, These are the segments that are more sensitive and will require longer recovery periods. So we continue to closely monitor. On the other hand, from the business activity perspective, lending activity for the quarter was near pre-pandemic levels and digital activity sub-significantly. Retail lending for the quarters was very strong for both auto and mortgage lending activities. And actually, it came above pre-pandemic levels. So we are optimistic with the recovery and the possibilities of additional stimulus, but we are also vigilant to the fact that, you know, potential economic hurdles could come if there is a need to implement additional restrictions for COVID in the future. So we have to be watchful. Please now let's move to slide nine. We wanted to give you an update on the relief programs trends. The relief trends are actually positive. The graph show, you know, the peaks and lows over the last six months, actually since March, of the different regions and products. I think, you know, we see a positive trend during the quarter, actually after the quarter closes, our active moratoriums were reduced to only 0.8% of the portfolio, less than 1%. This is as of October 21st. I think so far the post-moratorium payments performance is positive with, you know, 98% of commercial clients scoring and 94% of retail as of October 21st. It's important to note that this data reflects only the due dates prior to October 21st regarding the payment patterns. So we have to wait until the end of the month to see the final trend. We do have a segment of the commercial portfolio that belongs to the industries that I mentioned, the more sensitive ones, such as hospitality, retail, and entertainment, that could need additional support through a longer stabilization period Those are being evaluated under the potential modification of terms provided by the section 14 of the CARES Act. So, please let's move to slide eight. You know, here we have how the trend of the balance sheet, you know, how we compare to peers and definitely, you know, acquisition, you know, our liquidity level, reserve coverage and capital position. they really give us opportunity with their position well to take advantage of any growth opportunity. Definitely will be good stewards of our capital position. And again, capital deployment opportunities remain a priority once our economic environment stabilizes. Let's move to slide nine for a moment. I wanted to talk about and show you the trends of core metrics. Obviously, you know, this graph shows you know, the trends and the positive impact of the acquired operation. We generate the incremental PPNR net income with only one month of earnings contribution for the acquired operations. And again, the enhanced funding profile should help us driving, you know, additional revenues. Loan origination, as I mentioned, were solid for the quarter. You look at the level and digital adoption rates continue to improve during this pandemic. We will continue to work harder now with more clients and more distribution points to improve our level of service to all our customers. I have to say that I'm really proud of my team and what I've been able to accomplish so far, managing the pandemic challenges. And we're definitely excited for the future growth prospect of our institution. And we're also excited to show our patient investors what we are able to accomplish. With that, I will turn the call to Orlando to cover the details of some of the financial metrics. Thanks to all.

Good morning, everyone. As Aurelio made reference to, net income for the quarter was $28.6 million, $0.13 a share compared to $21 million last quarter. We break down the components. You can see that corporations, legacy core business, achieved a net income of $44.3 million which mostly is a result of reductions in the required provision for credit losses. Last quarter, we had a provision of $39 million as compared to $8 million this quarter. During the quarter, the improvements on macroeconomic projected variables in most portfolios, except for the commercial real estate, as well as some changes in portfolio balances led to this reduction. The acquired Santander operation contributed $3.5 million of after-tax net income. That excludes day one CECL adjustments, which I'll touch upon. These results include the impact of the amortization of the fair value marks on all the assets and liabilities and the amortization of the resulting intangibles. For example, a few of the things that had impact, if we look at the investment portfolio, Santander had a large U.S. treasuries portfolio that, after marks, resulted in a portfolio which yields only 15 basis points. Since then, we decided to improve margin to sell this portfolio and reinvest it in other securities according to our policies. which yield around 94 basis points, which will improve going forward some of the yield. On the other hand, amortization of some of the other discounts and intangibles resulted in about a $1 million improvement in net interest income from the combination of loan and deposit, preliminary fair value adjustments that have been booked. If we look at the other components of transactions, some large ones that were in the quarters, The first one would be the CECL I made reference to. CECL requires that in a case of a business combination, we set up an allowance for credit losses on non-purchased credit deteriorated loans on top of or in addition to any kind of fair value measurements. This resulted in a recognition of an allowance of almost $39 million for the quarter in addition to those fair value marks. The non-purchase credit deteriorated portfolio, it's about 1.7 billion after marks. During the quarter, we also decided to sell around 160 million of MBS that were experiencing significant prepayments. And that resulted in a gain of about 5.1 million from the transaction. And it's being reinvested, again, in other instruments. Merger and restructuring costs, Aurelio mentioned some of it. During the quarter, we had $10.4 million, which compares to $2.9 million in the last quarter, which was mostly legal, financial, and financial consulting fees, as well as some conversion-related costs as we prepare for the conversion. So far, we have incurred about $25 million in expenses related to the transaction over the last few quarters. And during the fourth quarter, we expect to have some amounts associated with the voluntary separation program that Aurelio mentioned, as well as costs associated with branch and other consolidations as we finalize the sessions on those processes. Finally, the other large items is that we did have an analysis, completed an analysis of the DTA now, including the Santander operation. and that resulted in the reversal of approximately $8 million of deferred tax asset valuation allowance we had on the books. Net interest income for the quarter was $148.7 million, which is $13.5 million higher than last quarter. $14 million of that was the Santander operation. On the other hand, the legacy by a first bank operation had a reduction of $500,000 in interest income as compared to last quarter. In here, reduction in rates, obviously accelerated prepayments on the investment portfolio has been large. Higher proportion of cash and investment securities to total earning assets have resulted in a reduction in the NIEM on First Bank. Last quarter, we had a 422 name that you saw in our prior release. That number is down to about 394 this quarter. Breaking down some of the components, the commercial loan repricing was our four basis points of the reduction, but the much higher proportion of Cash and investment securities as well as the large prepayments and the alternatives for reinvestment affected by 18 basis points more of that margin. Santander on a standalone margin was about 389, considering the purchase accounting adjustments. And that combined with First Bank ended up with a 393 margin that you see on the release. Not interest income improved to $29.9 million. This $9 million increase includes $5 million in the gains on sales that I made reference to before, of securities that I made reference to. We had $3.4 million increase in revenue for mortgage banking activities. Mostly, or all of it, it's related to sales of residential mortgage. This quarter, We had a much more active quarter on originations than what we had in the second quarter, and ended up selling 98 million more inconforming paper than we did last quarter, resulting in that revenue increase. Also, the reopening of businesses, as we have seen on the quarter, seen a much higher level of credit and debit card activity, which improved That includes ATM merchant fees and some of the other components that improve our fee income by over $2.8 million in the quarter. And then the improvement we had in deposit service fees associated with the Santander transaction that brought in $1.1 million of additional deposit fees to the operation. On the expense side, expenses were $107 million That includes $10.7 million in expenses for the acquired Santander operation and $96.8 million for the First Bank legacy operation. This $96 million is $7 million higher than the almost $90 million we had last quarter. As I mentioned, the merger and restructuring costs for the quarter were $10.4 million. which is $7.5 million higher than last quarter, basically created most of the increase. But in the quarter, if we exclude this, First Bank was $86.4 million of expenses. COVID-related expenses were about $1 million this quarter, which is down about $2 million from last quarter. But other expenses, obviously, as we saw improvements in volume of transactions and improvement in fee, we also have some higher expenses associated with that volume of business in those debit and credit card transactions. The allowance for credit losses has increased significantly. As of September 30, the allowance for loans and leases only was up $65 million to $385 million as compared to June. Mostly it's due to the initial allowance of credit losses required to the Santander operation. If we look at total allowance for credit losses, including on funded commitments and debt securities, that's up to $403 million. This quarter, as I mentioned before, we recorded $38.1 million in allowance for credit losses in total, $37.5 million of that is related to loans. That built up that allowance associated with the portfolio. And in addition, for BCD loans or purchase credit deteriorated specifically, we established almost $29 million allowance, which represents the fair value marks on this loan, which also requires what is commonly referred to as a cross-up. that the loans represented gross and the discount represented in the allowance. Those two combined were about $65 million. The ratio of the allowance for credit losses on loans to total loans was 3.25% at September, slightly down from 3.40% we had at June, but a very significant coverage if we consider that we added a large amount of portfolios. that a large part of it is also mark-to-market and fair value mark-to-market and has been discounted. On a non-GAAP basis, if we exclude the PPP loans, which don't carry much reserve, the ratio of the allowance to total loans was 338 as compared to 355 last quarter. Asset quality remained good in the quarter. Non-performings are down 10.5 million to 293 million. Most of the reduction happened on the Oreo portfolio, which decreased 7.3 million. Mostly sales were completely in the quarter. Migrations to non-performing were higher this quarter. As moratoriums expire, we start getting back to levels of more to the normal levels that we were seeing before, and we are in a position to continue to pursue some of the foreclosure processes that were put on hold for a couple of quarters, you know, as we provided those moratoriums to customers. The inflows were 18.4 million this quarter, which is 10 million higher than that quarter. Capital ratios remain Really strong. As you can see, even with the impact of the acquisition, we still have tier one ratios of 17%. The leverage ratio, I think that's important to mention. You see it's about 13% for the quarter, but we only had Santander operation for one month in the quarter, so average assets were less. If we were to normalize and assume the full quarter of average assets, that ratio would be closer to 11% just over that. And that was, you know, what we expected. It's still very significant with the acquisition of, you know, 5 plus billion in assets in the quarter. With that, I will open the call for questions.

We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you were using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Abram Poonwala with Bank of America. Please go ahead. Good morning, guys.

Good morning, everyone.

So in your prepared remarks earlier, you mentioned a bunch of times around the focus on capital return and optimism about things getting better, barring any sort of negative developments on COVID. Like by my math, like when you look at your largest competitor, their tier one leverage ratio is about 8%. You're at 11, there's about 300 basis points of excess capital return. very conservatively. As a shareholder, you would want the bank to act now, given where the stock is. Just talk to us around level of urgency with the deal being done. Do you think regulators are on board? I know you can't talk about your regulatory discussions, but there should be a sense of urgency, I would imagine, in executing this, given where the stock is. So just if you could talk about that.

Yeah, I think, I think, Ibrahim, thank you for the question. Yeah, you know, we have a sense of urgency. You understand the importance of more. On the other hand, you know, it's really about the environment. You know, you have to see what's happening around the world, and we have to see what's happening in the U.S., and we have the elections. You know, commenting on that, I think, you know, Puerto Rico is also positioned with Congress, you know, to benefit either case, so things will continue independently of who wins, we believe. But the COVID, you know, Risk is still out there. You know, hopefully we don't have to go back to more lockdowns or closing. We have seen the impact. Yes, there's another stimulus that, you know, the high probability that will come. But I think we have a lot more visibility first quarter on this, okay? There's also some regulatory guidelines regarding these matters that are being issued through the end of the year. So, So it is a priority for the management team. Yes, we recognize the excess capital. I think we need to get through the end of the year, close of the year, see where the economic trends are in the next round. We have a couple of quarters that we increase with provision incrementally in a material amount. We are well-covered. But all that depends on the economic forecast. So I think that's the, you know, we need an additional step of time in this matter to be prudent and make sure that, you know, that, yes, the economy is stabilizing. And, you know, as we are learning to work on the COVID environment, we know that you can operate, you know, that you can be, you can achieve your business. You know, you have to spend some money for that to happen. But in some environments, you know, we're watchful of additional restrictions. So that is a caveat here, okay?

No, understood. Thanks for that. And I guess just moving on, Orlando, on slide 11, looking at pre-provision earnings, if you give the full quarter impact to Santander, implies about $87 million in quarterly pre-provision earnings. outside of the $48 million in cost saves that you expect. Talk to us in terms of your outlook on PPNR or revenue relative to third quarter levels as it pertains to fee income and the margin outlook.

I think there's obviously, what are the levers here? Obviously, long growth. We will look to achieve some long growth, but again, it's driven by the economy and the opportunities. We have seen good numbers in the mortgage business. I think commercially solid, auto, it continues to sustain. On the other hand, you have still some margin compression risk that is still out there. We're still repricing. We have excess liquidity. Liquidity continues to grow. And we have other components in the investment portfolio. I think Orlando covered some levers that we're pulling there. But on the other hand, we continue to have higher prepayments. And then, obviously, the expense, their synergies and expense will move to a positive. But all those levers regarding PPNR, without getting into the provision, we have a lot more levers that we had before closing the deal. And we're very focused on how we pull this lever. Some of them we control, some of them we don't control, like the RAID environment. But that's really the – now it's about execution, you know, and achieving what we have in the plan on integration, the estimates that we provided to you on how long it takes and how much it will cost to get those synergies. It's sustained. So that is our plan. We continue to execute. recognizing that, yes, the right environment is still a challenge.

Keep in mind that the savings is in part related also to the integration process. They don't happen immediately. It's going to take two or three quarters before we achieve full benefit of all savings that we could get. We're still running systems independently. We're still covering costs related to running the Santander systems. So there is a number of things that will happen as we go through the integration over the next three quarters, as Aurelio mentioned. And that's going to push it. The margin is a challenge. And, you know, at this point, the expectation, it's not necessarily interest rate reduction, but it's more of a mix. And the impact it has... And, you know, we don't mind having a lot of deposits and we don't have a lot of liquidity, but it does have an impact. And the prepayment that we are seeing in the portfolios is pretty large, you know, much higher than we would have anticipated a couple of quarters ago.

And I appreciate the challenge with the margin, Orlando. Do you think NII, which was about 177 on a full quarter basis for the combined bank can at least hang in flat to higher from here, or do you feel this pressure on NII as well?

We're hoping that it's going to stay flat to higher, you know, a little bit based on also what Aurelio said, that, you know, that now as we integrate, we can pursue additional business. You know, we do see some things that have to be taken into account, like, Mortgage originations are good, but we're doing a lot of conforming paper. So that's been sold. We're generating fee income, but it's resulting in some reductions on the portfolio side on one hand. So the mix is going to be the pressure component here more than the rates going forward. We still have a little bit on the repricing side of the liabilities. As time deposits come due, the renewal rates are lower than some of these cities that were issued, you know, a couple of years ago. So there is a little bit in there, but it's going to be more of a mixed kind of thing.

Got it.

Thanks for taking all my questions.

Thank you.

Again, if you have a question, please press star then one. Our next question comes from Alec Twirdle with Piper Sandler. Please go ahead.

Hey, good morning, guys. Good morning, Alec. First off, just wanted to circle back to what you're talking about with capital return and obviously understand that there's a lot of moving parts in the economy and we're not out of the woods yet on COVID, etc. But when we are out of the woods, is there a formal process that you guys need to go through in order to turn on a buyback at some point in time? Maybe you can sort of elaborate on what that might look like.

You know, all capital actions have a formal process. That is delineated, you know, either by regulation or by our capital plans. So, you know, after you complete your analysis and your recommendations, you have to go to a process and, you know, engage in the different flavors that we can execute. If it's a buyback, you know, obviously, you know, I think it's a common process that people know. Obviously, I don't think it's a process what is holding us today. I think we have to make sure that we do it at the right time as things move forward. We have priorities that are the integration, and we have priorities that are sustaining our quality. And again, those are challenged by the current COVID situation. I think we have to take that in mind. So that's really, we need to see more evidence of stabilization before concluding on that decision, Alex.

Okay, understood. And then just as I look at the pro forma balance sheet, it seems like, you know, you guys do have a lot of liquidity and then you have some higher costing brokered CDs and you got some FHLB advances that are a little bit higher costing today. I mean, are there some opportunities to do some deleveraging to get rid of some inefficient leverage out there?

Clearly, and you can see that the level of broker deposits has been coming down. In reality, we have not been renewing any of the broker deposits. We do have some, they're not as expensive, but we do have some broker money market accounts in here that move a little bit up and down every quarter. But on the broker city side, we're not renewing it and letting it go. It's much cheaper using the cash that you have on hand than even with the lower cost broker deposits out there. But obviously, you have to go through the process of the maturity of those. But we have not been renewing any broker deposits or FHLB advances that mature. So those are some of the opportunities, as well as what I mentioned on the repricing of the time deposits that come due, that were priced at much higher rates, you know, one or two years ago when they were issued.

Are there big tranches of either broker CDs or advances that will be coming or maturing in the near term?

The way we structure the broker CDs that we were issuing was fairly spread to try to not have precisely that, a big chunk coming in and facing putting time in the market that was, you know, at some points market becomes complex for some of these issuance. So it's not a bunch. It's a bit every quarter. That's what we have, a bit every quarter.

Okay. And then can you help us sort of figure out the loan mark inclusive of the credit adjustment that would be coming back through NII over the life of the loan and sort of how to project that purchase accounting accretion over the next couple quarters?

The... Obviously, the marks on the PCD portfolio are part of the reserves, and those marks don't accrete back. It's a matter of just up or down. It depends on the C-cell analysis that you do going forward. In the case of the non-PCD portfolios, there is about 35, 36 million of marks that would be both credit and rates that would come back through the life of the loans. And obviously, you know, the mortgage ones will take longer. The commercial ones are typically, you know, happening faster because of the maturity terms. So more or less, those are the components. It's, you know, we'll see a chunk between three months And two years, which is related to commercial and the consumer portfolios. And then the mortgage ones will be more in the five to seven-year term.

Great. And then just a final question for me is, just as I think about expenses and sort of the phase-in on cost-saves, can you kind of help us get a sense for sort of the cadence of the cost saves coming in over 2021? I know you got the guidance in the slide deck. And then also the voluntary retirement program, is that part of the $48 million of cost saves or is that additional to that?

That's part. The cost save will come from rationalizing operations, technology side, you know, the cent under cost as compared to adding that size of operation to our technology structure, it's higher. So the voluntary separation has an immediate cost, but then you start saving from that point on. Those are positions that in general, if not all, basically all would not be replaced. So those are immediate savings, and that was part of the assumptions we did from the start. that we would do something like this. So, you know, CHUNK will start with those voluntary operations in January. Technology ones, which is another large one, will start happening at the end of the year, but, you know, most of it in the first half of 2021. The other one would be facilities. That's going to take a little bit of time because, again, Aurelio mentioned there is related to branch consolidations. When we decide to do that, we don't want to affect customer. But that's why I mentioned that we'll see the full benefits starting really in the second half of 2021.

Yeah, some of them have been achieved already, and you're going to see some of them through this quarter as we integrate more operations and systems. We completed two significant businesses this quarter, early in October, so some of the benefit comes into the quarter. Obviously, that's our focus of priority. It's a lot of little things also when you add marketing costs, legal, and the different consultants and professional services. That's why we come up with the potential SAFEs. Perfect. Thank you for taking my questions. Thank you, Alex.

If you have a question, please press star then one. At this time, there are no further questions, so this concludes our question and answer session. I would like to turn the conference back over to John Pelling for any closing remarks.

Thank you, Debbie. On the IR front, we have a couple of virtual conferences coming up here in November. November 9th, the Piper Sandler Conference, and on the 10th, the BAML Conference. So we look forward to chatting with you then. We appreciate your continued support, and this will conclude the conference call. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.