BPOP - First BanCorp Leveraged To Sustained Improvement In Puerto Rico's Economy

Summary

• First BanCorp's fourth quarter results were basically in line with expectations, but there wasn't much to get excited about in terms of core growth.
• Loan originations are putting attractively-priced business on the books, but earning assets aren't likely to grow much in 2023 and expenses will weigh heavily.
• First BanCorp has solid share in commercial lending and is leveraged to programs meant to stimulate the PR economy, but pre-provision profits could fall double-digits in 2023.
• The longer-term outlook for First BanCorp isn't bad, and the valuation does offer some upside, but sentiment may be a lingering issue with PPOP declines looming over the business.

Puerto Rico’s economy has definitely improved in recent years, with unemployment falling from the high single-digits to low double-digits in years past to just 6% in December of 2022. While the island likely won’t escape the macro slowdown emerging in the U.S., stimulus projects targeting public works and progress toward a restructured economy do point to a better outlook than has been the case in some time.

As the second-largest bank by deposits in Puerto Rico, and one that punches above its weight in commercial lending, First BanCorp ( FBP ) should be well-placed to leverage the potential of this improved economic outlook. I don’t think FBP stock is necessarily expensive, but I do see tougher operating conditions through at least the second half of 2023 and I think Popular ( BPOP ) offers an incrementally better risk/reward trade-off.

Not A Lot To Excite In The Fourth Quarter

First BanCorp didn’t have a poor fourth quarter, but it’s hard to get excited about an in-line quarter in a reporting season where many banks beat expectations, including meaningful beats at the pre-provision earnings line.

Revenue rose about 10% year over year and fell 2% sequentially, missing expectations by modestly (about $0.015/share) and performing broadly in line with Popular (down 3% qoq), but underperforming small/mid-sized mainline banks.

Net interest income rose 12% yoy and fell 2% qoq, driving the top-line miss but outperforming the 4% sequential drop at Popular. Net interest margin rose 69bp yoy and 3bp to 4.52% on an adjusted basis, while core NIM rose about 6bp qoq to 4.37%. Earning assets declined more than 2% sequentially.

Fee income isn’t a particularly large part of First BanCorp’s mix (about 12% of revenue), and revenue declined about 3% yoy and 1% qoq.

Operating expenses rose 3% yoy and fell 2% qoq, coming in better than expected in both absolute terms (a roughly $0.01 beat) and in terms of efficiency ratio, with a 10bp sequential improvement to 46.5% that was 50bp better than expected.

At the pre-provision profit line, First BanCorp saw 17% yoy growth and almost 2% qoq contraction, better than Popular’s results, but still about half a cent shy of expectations. Items like provisioning and taxes drove an in-line quarter at the final core EPS line.

Funding Volatility And Weaker Macro Weigh On Near-Term Growth Prospects

First BanCorp didn’t do too badly in terms of loans this quarter. End-of-period loans rose more than 2% sequentially, modestly outgrowing Popular, but with weaker core business lending (up 1% versus up 2.4% at Popular) and more reliance on commercial real estate lending (up more than 4%). Yields look impressive next to mainland banks, with average loan yield of 7.19% versus 6.43% a year ago and 6.88% in the prior quarter, but the rate of change (loan beta) is a lackluster 21% due in part to a higher mix of fixed-rate loans.

Loan originations were very healthy in the quarter, up 16% qoq, with 28% growth in C&I loan originations, and this will help but more high-yielding loans on the balance sheet. Still, with a slower macro outlook, it looks like loan growth could be limited to just the mid-single-digits in FY’23, with some acceleration possible in 2024 depending upon how the macro outlook evolves.

Assuming that Puerto Rico can stay on this better economic path, I think the outlook for First BanCorp’s loan growth beyond a year or two is pretty good. There are multiple stimulus initiatives underway in Puerto Rico, and those should help drive greater demand for construction and C&I loans in the coming years. I’d also note that while FBP has about 15% share of Puerto Rico’s deposits, it has closer to 20% share of C&I lending. OFG Bancorp (OFG) has been executing well and gaining share in commercial lending (pulling even with First BanCorp), but I believe FBP has a large enough presence in the market to grow loans meaningfully with these stimulus efforts.

Other aspects of the balance sheet are more mixed. First BanCorp has enjoyed an exceptionally low deposit beta (single-digits), and total deposit costs were only 0.52% in the quarter. Likewise, non-interest-bearing deposits were only down 2% in the quarter. On the other hand, public funds are a meaningful part of the deposit base (around 15%) and tend to have betas close to 100%. With that, I expect higher funding costs, but I wouldn’t call the funding situation here “stressed”.

Credit is also a watch-item. Charge-offs are heading higher, led by consumer loans (including auto), and a more significant slowdown in the economy, particularly one that impacts employment numbers, could drive bigger losses in the next year or two. I’m not expecting tremendous stress, but I do think charge-offs are going to be elevated relative to the levels of the past couple of years.

The Outlook

The biggest issue with my outlook right now is that I see a real likelihood of double-digit pre-provision contraction in FY’23 and only a modest recovery in FY’24 such that three-year PPOP growth could be only in the low single-digits (possibly even flat). It’s true that the Street can and will look forward, and I expect core earnings growth of around 5% after this adjustment phase, but I think two years of lackluster pre-provision performance could create some challenges in driving a higher multiple.

As I said, while the adjustment from FY’22 to FY’23 earnings will be painful, I do see pretty solid growth going forward, and I can see opportunities for First BanCorp to outperform (share gains in commercial lending and a better macro performance for Puerto Rico). Those long-term growth expectation support a fair value around $16 today on a discounted core earnings approach, while a ROTCE-driven P/TBV and P/E approach average out to around $15 (including a 10.5x multiple on my ’23 estimate of $1.44). My estimate for FY’23 is a little below the Street, and using the Street-average number bumps the fair value to about $16.

The Bottom Line

If you’re more bullish on the Puerto Rican economy and believe that stimulus and other restructuring efforts will allow the island’s economy to outperform in 2023, these are shares you might want to consider. I do see a good runway for commercial lending growth extending over multiple years, good operating efficiency, and the scope for meaningful returns of capital, but I’m concerned that the shares won’t get ahead in the near term given concerns about that weaker near-term earnings outlook.

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