First BanCorp: A Call Option On Puerto Rico (NYSE:FBP)

Introduction

First BanCorp (NYSE:FBP) is the holding company for FirstBank in Puerto Rico. The bank has 58 branches in Puerto Rico and eight branches on the (US and British) Virgin Islands. Additionally, there are another eight branches in Florida. As First BanCorp is heavily exposed to Puerto Rico, you could say the bank is a call option on Puerto Rico.

While the bank’s earnings remain strong – notwithstanding recording in excess of $12M in net loan loss provisions in the first quarter of the year, I’m not a big fan of the bank’s focus on buying back stock at a premium of in excess of 100% to the tangible book value per share.

The net interest income remained relatively stable

Puerto Rico has been a troubled region for a while, so I am mainly interested in seeing the bank’s financial performance and its balance sheet strength to make sure it can withstand economic shocks.

Fortunately, the bank’s net interest income remained very strong. As you can see below, its interest income increased by approximately $26M to $268.5M, while the interest expenses increased by $30.5M. While this indeed results in a slightly smaller net interest income ($196.5M versus $200.9M), the ‘damage’ remains pretty limited.

The bank also reported approximately $34M in non-interest income and almost $121M in net non-interest expenses. This resulted in a pre-tax and pre loan loss provision income of approximately $109M. The bank has put $12.2M aside in loan loss provisions resulting in a pre-tax profit of $97.4M while the net profit was $73.5M for an EPS of $0.44.

The bank currently pays a quarterly dividend of $0.16, which means the majority of its earnings are retained on the balance sheet.

Keeping a close eye on the Puerto Rico heavy loan book

Looking at that balance sheet, there are a few interesting elements worth highlighting. As you can see below, the bank had approximately $18.9B in total assets. The balance sheet is pretty liquid as the bank has almost $700M in cash and $5.05B in debt securities available for sale. There also is a position of $348M in securities held to maturity (with a fair value of $338M, so there isn’t a massive valuation discrepancy).

I’m obviously more interested in the $12.05B loan book.

As you can see below, the vast majority of the loans are focusing on Puerto Rico and the Virgin Islands, where $10.2B of the loan book has been invested. A large portion is related to mortgages, but the bank has an even higher exposure to consumer loans, especially in Puerto Rico. And although it has barely issued any consumer loans in Florida, the position in Puerto Rico alone is high enough to make the consumer loans the most important exposure of the entire loan book.

The image above also shows the bank has already recorded a total loan loss provision in excess of $260M, and it’s obviously important to have a look at what percentage of the loan book is classified as ‘past due’.

The footnotes to the financial statements provide a very useful look under the hood. As you can see below, there is a total of $93M in loans that are classified as non-accrual loans, while an additional $57.5M in loans are more than 90 days past due.

Additionally, approximately $133M of loans are more than 30 but less than 90 days past due.

It’s interesting to see that not the consumer loans, but the residential mortgage loans are the problem child. Of the $92.7M in non-accruing loans, $32.7M was related to residential mortgages, representing approximately 35% of the total amount of non-accruing loans. And when you look at the loans that are more than 90 days past due but still accruing, almost 70% of the $57.5M is related to residential mortgages. The bank is currently in the process of foreclosing on $37.7M of the residential real estate loans.

While the ratio of consumer loans versus the total amount of loans past due is substantially higher in the 60-89 day segment and definitely the ‘worst’ category in the 30-59 day segment, it still appears to be manageable. The majority of the consumer loans (and the majority of the consumer loans past due) are related to car loans, which means there is collateral that could be seized and monetized. And with a total net loan loss provision of just over $12M in the first quarter, the bank should be able to increase its loan loss provisions should the need arise.

Investment thesis

While the bank is relatively attractive from an earnings profile (as it appears to be trading at just 10 times earnings and 9 times forward earnings), the book value as of the end of the first quarter was just $8.88 per share. And one would deduct the $50M in goodwill and other intangible assets, the net tangible book value would be approximately $1.43B. Divided over the net share count of 166.7M shares, this represents a tangible book value of approximately $8.56/share.

While I wouldn’t mind ‘betting on the future of Puerto Rico’ and having exposure to a large bank with a core focus on the area would be a good move, I’m not sure I’m willing to pay a 104% premium over the tangible book value. While the bank retains the majority of its earnings on the balance sheet, the net retained amount is just over $1/share (excluding the impact from the items on the comprehensive income statement), which means the book value per share will be positively impacted by the earnings retention, but the bank’s share buyback plan isn’t really helping, considering the stock is being repurchased at a substantial premium to the TBVPS. In the first quarter of this year, for instance, First BanCorp spent in excess of $52M on buying back 3.1 million shares.

Taking all these elements into consideration, I think First BanCorp is a ‘hold’ at its current valuation. While attractive from an earnings multiple, I’m not keen on paying the current premium to the TBVPS and the current capital allocation priority to repurchase stock is also something I’m not entirely in favor of.