FBP: Merger Expenses Trim 4Q19 Results; Progress Made on Asset Quality, Loan Growth, Core Funding; Maintaining Price Target; Reiterating Outperform Rating.

        First BanCorp (FBP – NYSE – Recent Price: $9.42)

                       Rating: Outperform / Buy Price: $11.50  / Target (Sell) Price: $12.50

4Q19 Results: First BanCorp reported 4Q19 net income to common shareholders of $35.8 million, compared to the $45.7 million recorded in 3Q19. On a per share basis, 4Q19 results were $0.16 compared to $0.21 in the prior quarter. There were several special items in 4Q19 results, including a $0.7 million ($0.5 million after-tax) insurance benefit related to hurricane insurance recoveries in the US Virgin Islands, and merger & restructuring charges related to the Santander acquisition totaling $10.9 million ($6.8 million after-tax). In the prior quarter, special items included $3.0 million ($1.8 million after-tax) of accelerated discount accretion on the payoff of an acquired commercial mortgage loan, a $0.4 million ($0.2 million after-tax) insurance benefit related to hurricane insurance recoveries in the US Virgin Islands, and a $0.5 million OTTI charge on private label MBS. The 4Q19 special items had a $6.3 million negative after-tax impact on results compared to the $1.2 million positive after-tax impact in 3Q19. Excluding these items from both quarters, adjusted net income available to common shareholders for 4Q19 was roughly $42.1 million or $0.19 per share compared to $44.4 million or $0.20 per share in 3Q19. The adjusted 4Q19 earnings of $0.19 were in-line with our $0.19 estimate and the $0.19 median Street estimate. The quarter was characterized by a lower-than-expected loan loss provision, higher noninterest income (excluding the insurance recovery), and lower noninterest expense (excluding the merger & restructuring expenses), offset partially by lower-than-expected net interest income. Highlights of the quarter include:

· Net interest income fell $4.5 million or 3.1% sequentially to $139.9 million, as a 0.8% increase in average earning assets was offset by a 19 bps contraction in the NIM (on a tax equivalent basis, excluding valuations) to 4.87%. The NIM compression was driven by a 10 bps decline in average earning asset yields offset partially by a 1 bps decrease in the average cost of interest bearing liabilities. Earning asset yields were dragged down by a 14 bps decline in average loan yields, partly as a result 10 bps of accelerated accretion on an early loan payoff in the prior quarter, and a shift in the mix of assets toward lower yielding securities from higher-yielding loans. The small decline in the average cost of interest bearing liabilities was mainly driven by a 1 bps rise in the cost of non-brokered deposits.

· Noninterest income increased $3.0 million or 14.0% linked-quarter. If we exclude the special items from both quarter – insurance proceeds of $727k in 4Q18 and $379k in 3Q19 and $497k of OTTI charges in 3Q19 – “core” noninterest income rose $2.2 million or 10.0%, primarily due to higher “other” noninterest income from the $2.1 million gain recognized on the sale of a nonaccrual commercial mortgage loan during the quarter.

· Noninterest expenses jumped $9.5 million or 10.2% sequentially. This was driven by the $10.9 million of merger & restructuring expenses noted earlier. Absent this item, noninterest expenses declined $2.1 million or 2.3.

· The loan loss provision advanced $1.1 million or 14.5% from 3Q19 to $8.5 million in 4Q19. The current quarter included a reserve release of $8.9 million, up from $6.5 million in the previous quarter. The current period reserve release consisted of $6.0 million related to adjustments to qualitative factors for nonperforming loan resolution strategies and $2.2 million from improvements in risk classifications and lower historical loss rates.

· Net charge-offs of $18.9 million represented 0.84% of average loans, up from 0.61% in 3Q19. With net charge-offs exceeding the provision, the allowance for loan losses decreased $10.4 million or 6.3% to $155.1 million. The ALLL slipped to 1.72% of loans held-for-investment from 1.85% at the end of the prior quarter.

· Inflows to nonaccrual increased to $32.5 million in 4Q19 from $31.8 million in 3Q19. The increase was largely due to higher inflows of commercial and construction loans, and to a lesser extent, consumer loans. However, the sale of a $6.7 million nonaccrual commercial mortgage loan and additional collections of $2.8 million in the quarter helped drive a $5.6 million or 2.6% reduction in nonaccrual loans. In addition, there was a $1.4 million decline in OREO and other repossessed property and a $1.1 million or 0.3% drop in performing TDRs. Consequently, total NPAs decreased approximately $8.9 million or 1.2% LQ. NPAs/Assets fell to 2.52% at December 31, 2018 from 2.65% at September 30, 2019.

· First BanCorp’s direct exposure to Puerto Rico government debt dipped slightly from $204.8 million last quarter to $204.5 million. The bulk of this exposure – $182.5 million or 89.2% – is to municipalities, not the central government.

· Gross loans held-for-investment advanced $33.8 million or 0.4% linked-quarter. The Puerto Rico region saw a decrease of $13.6 million while Florida climbed $26.0 million and the Virgin Islands experienced a decline of $5.8 million. The portfolio continues to show growth in the consumer segment (up $59 million), while the residential mortgage segment declines (down $64 million). Commercial, CRE, and construction loans also increased in 4Q19.

· Loan originations, including renewals and draws from existing commitments, but excluding credit card utilization, increased from $1.1 billion in 3Q19 to $1.2 billion in 4Q19, an advance of roughly 7.6%. Origination increases were mainly in commercial and construction loans, which grew $18 million sequentially, with growth in the Florida and Virgin Islands regions offsetting a decline in originations in the Puerto Rico region. The growth in originations continues a steady climb in quarterly originations versus the prior year period in each quarter since the hurricanes disrupted originations in 3Q17 and 4Q17.

· Total deposits increased $215.5 million or 2.4% LQ to $9.35 billion. Interest bearing deposits advanced $117.9 million while noninterest bearing accounts grew $97.6 million. The increase was spread among the Puerto Rico, Florida, and US Virgin Islands regions. While noninterest bearing accounts rose, brokered CDs fell $48.0 million LQ. However, government deposits grew $2.3 million, as increases in Puerto Rico and Florida offset a decline in the USVI. The deposit mix improved modestly as noninterest bearing deposits rose from 24.9% of total deposits at September 30, 2019 to 25.3% at December 30, 2019 while brokered CDs fell from 5.3% to 4.7%.

· Tangible book value per share rose 1.3% from $9.79 at September 30, 2019 to $9.92 at December 31, 2019. The TCE ratio now stands at 17.14%, up from 17.03% at September 30, 2019.

· Regulatory capital ratios decreased slightly compared to September 30, 2019 and remain far in excess of the minimums to be considered well capitalized. The total capital to risk-weighted assets ratio stood at 25.22% at December 31, 2019, down from 25.27% as of September 30, 2019. FBP boosted its recently re-instated quarterly common stock dividend 67%, from $0.03 per share to $0.05 per share. Further capital actions are unlikely until after the pending acquisition of BSPR is completed sometime in the middle of 2020.

Earnings Estimates:

First BanCorp’s 4Q19 results, excluding the merger & restructuring expenses in the quarter, were largely in line with our expectations. Loan and deposit growth were solid, asset quality improved, and noninterest expenses were down absent the merger-related charges. Though the NIM contracted a bit more than we anticipated, with further Fed rate cuts apparently on hold for the time being, we believe the NIM should stabilize near current levels. We still expect organic loan growth to run in the 3%-4% annual range for the foreseeable future, and we believe deposit generation, aided by greater post-crisis liquidity in the Puerto Rico market, will be able to fully support the loan growth. With NPAs continuing to decline substantially, we have lowered our projections for the loan loss provision going forward.

The BSPR transaction is expected to be completed in mid-2020. Though we believe the deal closing may occur as early as May or June, we have assumed a July 1, 2020 closing in our model to be on the safe side. We have included additional merger & restructuring charges, similar to what occurred in 4Q19, for the next few quarters until the merger is complete.

After making these adjustments, we are reducing our 2020 estimate from $0.81 to $0.78 while raising our 2021 estimate from $1.04 to $1.14. If we exclude merger & restructuring charges from 2020 results, our “core” EPS estimate is $0.84.

Valuation:

Currently, FBP is trading at 97.3% of tangible book value, far below the 164.3% valuation for the median mainland peer bank. On an earnings multiple basis, FBP is trading at 12.7x LTM EPS and 11.0x current year estimates. This compares to 12.4x LTM EPS and 12.1x current year estimates for the peer group. We still believe that improving asset quality, low expense growth, and the economic stimulus provided by hurricane (and now earthquake) recovery efforts will drive solid organic EPS growth. The pending BSPR acquisition should enable more rapid earnings growth through improved efficiencies, lower cost core funding, and a better competitive position.

We believe the bank’s long-term earnings potential is best represented by our $1.14 EPS estimate for 2021, which includes a full year of the post-acquisition operations. Our $12.50 price target translates to an 11.0x forward year EPS multiple applied to this estimate. Our target suggests a potential 32.7% gain from the current price. Consequently, we are reiterating our Outperform rating on FBP stock.