Electronic income

OFG Bancorp stock: strong growth in net interest income (NYSE: OFG)

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Earnings of OFG Bancorp (NYSE: NYSE: OFG) will most likely increase this year thanks to the strength of the Puerto Rican economy, which will increase loan balances. In addition, net interest income, which is moderately sensitive to interest rates changes, will benefit from rising interest rates. On the other hand, a normalization of loan loss reserve releases will limit year-over-year earnings growth.

Overall, I expect OFG Bancorp to report earnings of $3.07 per share for 2022, up 9% year-over-year. Compared to my last report on the company, I have revised my earnings estimate upwards due to upward revisions to loan and margin estimates. The year-end target price suggests a strong upside from the current market price. Therefore, I maintain a buy rating on OFG Bancorp.

Puerto Rico’s economy to drive loan growth

OFG Bancorp’s portfolio grew 1.9% in the first quarter of 2022, or 7.6% annualized, which exceeded my expectations. The outlook for loan growth remains rosy, primarily because the Puerto Rican economy continues to strengthen. The region’s economic activity index rose 3.5% year-over-year in April 2022, according to the Economic Development Bank of Puerto Rico.

Annual Growth of Puerto Rico's Economic Activity Index

Economic Development Bank of Puerto Rico

Additionally, Puerto Rico’s labor market continued to improve. The jobless rate fell to just 6.2%, which is near multi-decade lows.

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Data by YCharts

Management also expressed optimism about loan pipelines and utilization of the credit line during the latest conference call. Given the economic outlook and the apparent strength on the ground, I expect the loan portfolio to grow by 5.0% by the end of 2022 compared to the end of 2021. In my last report on OFG Bancorp, I estimated loan growth at just 2.0% for 2022. I have revised my loan growth estimate upwards due to the surprising performance in the first quarter as well as an improvement in economic outlook for Puerto Rico. The following table shows my balance sheet estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
Financial situation
Net loans 4,056 4,432 6,642 6,501 6,329 6,645
Net loan growth (2.2)% 9.3% 49.9% (2.1)% (2.6)% 5.0%
Other productive assets 1,173 1,285 1,095 459 896 1,303
Deposits 4,799 4,908 7,699 8,416 8,603 9,250
Total responsibilities 5,244 5,583 8,252 8,740 8,831 9,423
Common Equity 853 908 953 994 1,069 1,132
Book value per share ($) 16.7 17.7 18.4 19.3 20.8 22.9
Tangible BVPS ($) 15.0 15.9 15.7 16.7 18.4 20.5

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

Net interest income appears moderately sensitive to rates

OFG Bancorp’s net interest income is only moderately sensitive to rate changes. Management’s interest rate sensitivity analysis presented in the latest 10-Q filing shows that a 200 basis point increase in interest rates could increase net interest income by 7.02% on twelve months.

OFG Bancorp Interest Rate Sensitivity

Filing 1Q 2022 10-Q

This interest rate sensitivity is largely explained by the rigidity of deposit costs. An overwhelming majority of 61% of the total deposit portfolio consists of non-interest bearing deposits, which will not be revalued if interest rates rise.

The Federal Reserve expects the upper limit of the target federal funds rate to reach around 3.5% later this year, up from 1.75% currently. Given the Fed’s projection and management’s interest rate sensitivity analysis, I expect the net interest margin to increase 23 basis points over the last nine months of 2022, compared to 4.47% in the first quarter of the year.

In my last report on OFG Bancorp, I estimated the margin would only increase by four basis points this year. I have revised my margin estimate upwards due to the recent faster and larger than expected Fed Funds rate hike. Also, the Fed now expects the fed funds rate to hit a higher level than I had previously forecasted.

Improve asset quality to keep provisioning low

After last year’s large provision releases, loan loss reserve releases will likely decline this year to a more normal level. This is because increased provision reversals cannot be sustained for an extended period.

Nonetheless, provisioning for this year is likely to remain below the historical average. The outlook for the credit quality of the loan portfolio remains positive despite the rising rate environment. The optimistic outlook is attributable to the strength of Puerto Rico’s economy. The number of bankruptcies in the region continues to remain near multi-year lows, as shown below.

Puerto Rico Bankruptcy

Economic Development Bank of Puerto Rico

In addition, the level of provision is now quite high compared to the credit risk of the portfolio; therefore, the need for additional provisioning will remain moderate. The allocations-to-non-performing loans ratio jumped to 232.77% at the end of March 2022, from 191.5% at the end of March 2021 and 126.6% at the end of March 2020.

Given these factors, I expect the provision charge, net of reversals, to remain below the historical average this year. I expect net provisioning expense to be approximately 0.25% of total loans in 2022. In comparison, provisioning expense has averaged 1.39% of total loans over the past five years .

Expect revenue to increase by 9%

OFG Bancorp’s earnings will most likely rise this year on the back of decent loan growth and moderate spread expansion. On the other hand, a decline in provision reversals will likely limit earnings growth. Overall, I expect OFG Bancorp to report earnings of $3.07 per share for 2022, up 9% year-over-year. The following table shows my income statement estimates.

EX17 EX18 FY19 FY20 FY21 FY22E
income statement
Net interest income 304 316 323 408 407 447
Net allowance for loan losses 113 56 97 93 0 17
Non-interest income 79 80 82 124 133 127
Non-interest charges 202 207 233 345 326 338
Net income – Common Sh. 46 78 47 68 145 152
BPA – Diluted ($) 0.88 1.52 0.92 1.32 2.81 3.07

Source: SEC Filings, Author’s Estimates

(In millions of dollars, unless otherwise indicated)

In my last report on OFG Bancorp, I estimated earnings of $2.84 per share for 2022. I have now increased my earnings estimate as I have revised my loan and margin estimates upwards.

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, the threat of a recession may increase the provisioning of expected loan losses beyond my expectations.

A high expected total return warrants a buy rating

OFG Bancorp offers a dividend yield of 2.3% at the current quarterly dividend rate of $0.15 per share. Earnings and dividend estimates suggest a payout ratio of 19.5% for 2022, which is close to the five-year average of 22%. Based on the payout ratio, I believe OFG Bancorp will no longer increase its dividend this year.

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 1.13 in the past, as shown below.

Chart
Data by YCharts

Multiplying the average P/TB multiple by the expected tangible book value per share of $20.5 yields a target price of $23.2 for the end of 2022. This price target implies a decline of 10.0% compared to the closing price on July 1. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB 0.93x 1.03x 1.13x 1.23x 1.33x
TBVPS – Dec 2022 ($) 20.5 20.5 20.5 20.5 20.5
Target price ($) 19.1 21.1 23.2 25.2 27.3
Market price ($) 25.7 25.7 25.7 25.7 25.7
Up/(down) (25.9)% (17.9)% (10.0)% (2.0)% 5.9%
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
Data by YCharts

Multiplying the average P/E multiple with the expected earnings per share of $3.07 yields a price target of $44.1 for the end of 2022. This price target implies a 71.1% upside from at the July 1 closing price. 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 ($) 3.07 3.07 3.07 3.07 3.07
Target price ($) 37.9 41.0 44.1 47.1 50.2
Market price ($) 25.7 25.7 25.7 25.7 25.7
Up/(down) 47.3% 59.2% 71.1% 83.1% 95.0%
Source: Author’s estimates

An equal weighting of the target prices from the two valuation methods gives a target price of $33.6, implying a 30.6% upside from the current market price. Adding the forward dividend yield gives an expected total return of 32.9%. Therefore, I maintain a buy rating on OFG Bancorp.