OFG - OFG Bancorp: Puerto Rico's Rapid Economic Recovery To Drive Earnings

Summary

• The strong regional economy will drive loan balances in the next year and a half.
• Thanks to the large balance of non-interest-bearing deposits, the margin will surge as interest rates rise.
• The December 2022 target price suggests a high upside from the current market price. Further, OFG is offering a decent dividend yield.

Earnings of OFG Bancorp (OFG) will likely continue to surge in the next year and a half due to Puerto Rico’s strong economy which will boost the loan portfolio size. Moreover, the margin will expand amid the rising interest-rate environment, which will further support earnings. Overall, I'm expecting OFG Bancorp to report earnings of $3.33 per share for 2022, up 18% year-over-year. Compared to my last report on the company, I've increased my earnings estimate mostly because I've raised my loan growth estimate. For 2023, I'm expecting the company to report earnings of $3.64 per share, up 9% year-over-year. The year-end target price suggests a high upside from the current market price. Therefore, I'm maintaining a buy rating on OFG Bancorp.

Regional Economy Bodes Well for Loan Growth

OFG Bancorp's loan portfolio beat my expectations by growing by 2.1% in the second quarter of 2022. This led to first-half loan growth of 8% annualized. The management appeared optimistic about loan growth during the conference call and mentioned that it expects auto finance, consumer, and commercial segments to contribute to the growth.

The rapidly strengthening Puerto Rican economy will likely be the chief driver of OFG Bancorp’s loan growth. Puerto Rico's unemployment rate has fallen sharply this year, and it continues to break records every month. Such a rapidly improving job market is bound to whet local credit appetite, especially that of consumer loans.

Additionally, the economic activity index shows that economic activity is currently robust in the region, which also bodes well for credit demand.

Considering these factors, I'm expecting the loan portfolio to increase by 6% annualized every quarter till the end of 2023. In my last report on OFG Bancorp, I estimated loan growth of 5.0% for 2022. I have now revised upwards my loan growth estimate to 7.2% due to the second quarter’s performance as well as the greater-than-expected speed of economic improvement.

I'm expecting growth of other balance sheet items to trail loan growth. Growth of equity book value, in particular, will be much lower because of pressures from unrealized losses on available-for-sale securities. As interest rates have increased, the market value of these securities has fallen, leading to large unrealized losses that have flowed directly into the equity account without affecting the income statement. The tangible book value per share has already dropped from $19.1 at the end of December 2021 to $18.86 at the end of June 2022.

The 75 basis points hike in the Fed funds rate in July will further pressurize equity book value. Additionally, I'm expecting a further 75 basis point hike in the Fed funds rate in the remainder of the year. On the other hand, retained earnings will lift the equity book value. The following table shows my balance sheet estimates.

In my last report on OFG Bancorp, I estimated earnings of $3.07 per share for 2022. I've now revised upwards my earnings estimate mostly because I've increased my loan growth estimate.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, a stronger or longer-than-anticipated recession can increase the provisioning for expected loan losses beyond my estimates.

Maintaining a Buy Rating

OFG Bancorp is offering a dividend yield of 2.9% at the current quarterly dividend rate of $0.20 per share. The earnings and dividend estimates suggest a payout ratio of 22% for 2023, which is the same as the last five-year average. Therefore, I’m not expecting an increase in the dividend level.

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 1.17 in the past, as shown below.

Multiplying the average P/TB multiple with the forecast tangible book value per share of $19.9 gives a target price of $23.2 for the end of 2022. This price target implies a 15.0% downside from the September 16 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.

Equally weighting the target prices from the two valuation methods gives a combined target price of $35.5 , which implies a 29.9% upside from the current market price. Adding the forward dividend yield gives a total expected return of 32.4%. Hence, I’m maintaining a buy rating on OFG Bancorp.

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