OFG - OFG Bancorp: Earnings Outlook Remains Positive While Risks Remain Manageable

2023-03-22 04:36:59 ET

Summary

• Thanks to the persistently high level of non-interest-bearing deposits, the deposit costs will continue to remain sticky this year.
• Puerto Rico's unemployment rate is near record lows. As a result, loan growth is likely to remain positive this year.
• The December 2023 target price suggests a moderately-high upside from the current market price. Further, OFG is offering a decent dividend yield.
• OFG's risk level is at a normal level despite the ongoing banking sector crisis.

Earnings of OFG Bancorp ( OFG ) will most probably continue to surge this year on the back of continued margin expansion. Further, the strengthening Puerto Rican economy will continue to support loan growth this year, which will boost earnings. As a result, I'm expecting OFG Bancorp to report earnings of $3.60 per share for 2023, up 5% year-over-year. Compared to my last report on the company, I've barely changed my earnings estimate for this year. The year-end target price suggests a moderately-high upside from the current market price. Therefore, I'm maintaining a buy rating on OFG Bancorp.

Further Margin Expansion is Likely as the Deposit Mix Remains Remarkable

OFG Bancorp's net interest margin continued to surge in the last quarter thanks to sticky deposit costs and responsive loan yields.

Even though the high-rate environment has given customers the incentive to chase yields and shift their funds to higher-rate accounts, the management was successful in maintaining its non-interest-bearing deposits at an elevated level throughout last year. These non-interest-bearing deposits made up a whopping 60.4% of total deposits at the end of December 2022. They will restrain total deposit costs this year even as interest rates rise.

The results of the management's rate-sensitivity analysis given in the 10-K filing showed that a 200-basis points hike in interest rates could boost the net interest income by 2.9% over twelve months, which isn't too bad.

Considering the factors mentioned above, I'm expecting the net interest margin to expand by ten basis points in 2023.

Puerto Rico's Outstanding Economic Condition to Keep Loan Growth from Falling Too Low

OFG Bancorp's loan portfolio grew strongly once again in the last quarter. The portfolio grew by 2.0% during the quarter, taking the full-year growth to 6.2%. The management is expecting loan growth to slow down to 3% - 4% this year due to high-interest rates, as mentioned in the conference call .

In my opinion, loan growth is unlikely to drop too low because Puerto Rico's economy is currently better than it has been in decades. The region's unemployment rate is near record lows, as shown below. However, the IMF in its World Economic Outlook report expects the unemployment rate to bottom out this year and then rise to 9% over the next two years, as shown in the chart below.

Considering the high-rate environment and Puerto Rico's economy, I'm expecting the loan portfolio to grow by 3.0% in 2022. Meanwhile, I'm expecting deposits to grow in line with loans. The following table shows my balance sheet estimates.

In my last report on OFG Bancorp, I estimated earnings of $3.64 per share for 2023. My updated earnings estimate is barely changed from my previous estimate even though I've tweaked almost all income statement line items following the fourth quarter's results. My tweaks mostly cancel each other out; therefore, my new estimate hasn't changed much.

Risks Remain Subdued

Despite the ongoing banking sector crisis, OFG's risk is at a normal level due to the following factors.

1. OFG is Safe from regional spillover effects. OFG Bancorp operates mostly in Puerto Rico, so it is safe from the regional spillover effects of the recent bank failures. A common link between all three banks, Signature Bank ( SBNY ), SVB Financial ( SIVB ), and Silvergate Capital ( SI ), is that they had operations in California; whereas, OFG doesn't have material exposure to that state.
2. Unrealized losses are limited . Even though OFG Bancorp has a very large securities portfolio, the unrealized mark-to-market losses on it are only moderately high. The company reported unrealized losses of around $94 million on available-for-sale securities, which is around 9% of total equity. In the unlikely case that there is a deposit run and OFG Bancorp needs to sell its securities to satisfy its deposit customers, it can do so without incurring too much of a loss. In my opinion, 9% equity erosion is not a very big deal.
3. Capital is more than adequate . OFG Bancorp reported a total risk-based capital ratio of 14.89% at the end of December 2022, which is much higher than the minimum regulatory requirement of 10.50%.

Moderate Total Expected Return Calls for a Buy Rating

OFG Bancorp is offering a dividend yield of 3.3% at the current quarterly dividend rate of $0.22 per share. The earnings and dividend estimates suggest a payout ratio of 25% for 2023, which is in line with the five-year average of 22%. Therefore, I'm not expecting another increase in the dividend level this year.

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 1.22 in the past, as shown below.

The stock has traded at an average P/E ratio of around 8.8x in the past, excluding the anomaly in 2019, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $29.2 , which implies a 9.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 13.2%. Hence, I'm maintaining a buy rating on OFG Bancorp.

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