About First BanCorp

First BanCorp (NYSE: FBP) (the “Bank”, “Company”, or the “Corporation”) is a diversified financial holding company headquartered in San Juan, Puerto Rico, offering a full range of financial products to consumers and commercial customers through various subsidiaries. First BanCorp is the holding company of FirstBank Puerto Rico and FirstBank Insurance Agency. Through its wholly owned subsidiaries, the Corporation operates in Puerto Rico, the United States Virgin Islands and the British Virgin Islands, and the State of Florida, concentrating on commercial banking, residential mortgage loans, finance leases, credit cards, personal loans, small loans, auto loans, and insurance agency activities.

FBP’s results of operations depend primarily on its net interest income (difference between interest income earned on interest-earning assets, including investment securities and loans, and the interest expense incurred on interest-bearing liabilities, including deposits and borrowings). Net interest income is affected by the interest rate environment; the composition of interest-earning assets and interest-bearing liabilities; and the re-pricing characteristics of these assets and liabilities. FBP’s results of operations also depend on the provision for credit losses, non-interest expenses and income, gains (losses) on sales of investments and mortgage banking activities, and income taxes. (Source: FBP Q3 report)

First BanCorp operates one of the top three banks in Puerto Rico – the others being Banco Popular (the largest) and OFG (Oriental Bank). Effective September 1, 2020 First BanCorp acquired Banco Santander de Puerto Rico (BSPR) for nearly $1.3 billion ($394.8 million for 117.5% of BSPR’s tangible book value plus $882.8 million for its excess capital) – getting $5.5 billion in total assets from the company, $2.6 billion in gross loans, and $4.2 billion in total deposits. BSPR operated 27 banking branches in Puerto Rico.

Our View

We believe FBP is modestly undervalued at $8/share. Despite a low interest rate environment, the current market price does not factor in the bank’s earnings potential, strong market position in Puerto Rico, growth potential from the acquisition of BSPR, and prospects for economic recovery following COVID-19.

ChartData by YCharts

Although we have seen some price improvement in the last few weeks, it is still early days. Shares of FBP offer an attractive yield (over 5% earnings yield, 2.5% dividend yield) relative to the S&P 500 and should trade in the vicinity of $11/share given our current analysis and expectations for future economic recovery.

At $8/share, investors can effectively buy FBP at tangible book value and get a free call option on future earnings.

Valuation

Given the relatively strong position and stable revenue base of FBP in Puerto Rico (and the U.S. Virgin Islands), it seems fairly reasonable to use earnings in terms of the company’s valuation.

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Average earnings for the last 8 years were just under $0.5/share ($0.465/share) and the trailing twelve months earnings (NYSE:TTM) were $0.39/share, which includes unusual expenses due to the acquisition of BSPR and practically no earnings for the first half of 2020. While earnings may come in on the lower end for the next few quarters, due to low interest rates and economic challenges, it is not unreasonable to approximate long-term future earnings to be at least around $0.5/share, especially since FBP has gained market share with the BSPR acquisition and will achieve cost efficiencies and possible loan growth going forward. With the current market price of FBP at $8/share, this would result in 6.25% earnings yield (5.6% if we assume 10% set aside for legal surplus reserve).

In the current economic and low interest rate environment, we might prefer to take a more conservative approach and simply assume no future earnings, in which case, adjusted tangible book value would be the proper valuation metric.

($ thousands) September 30, 2020

Total equity

2,225,282

(Preferred equity)

(36,104)

(Goodwill)

(34,401)

(Purchased credit card relationship intangible)

(5,789)

(Core deposit intangible)

(37,749)

(Insurance customer relationship intangible)

(355)

(Deferred tax assets)

(347,543)

Tangible common equity

1,763,341

Common shares outstanding

218,229

Tangible common equity per share

8.08

(Source: FBP Q3 Report)

As the above table shows, FBP has tangible book value of $8.08/share, which equals the current market price.

Considering the strong market position, growth potential and capitalization of FBP (its total capital-to-risk assets ratio is 20.32%, well above the 10% threshold), along with the fact that economic growth is likely to start picking up in the next few quarters – with possibility of further stimulus and rising yields (steeper yield curve) – we believe that $8/share is too conservative.

As an example, using 4% discount rate FBP fair value would be roughly $11/share. With the S&P 500 currently yielding under 3%, FBP looks quite attractive with over 5% earnings yield and a 2.5% dividend yield.

Downside Risks

Economic downturn / Further delay in recovery from COVID-19

According to FBP’s Q3 report:

“Financial results for the nine-month period ended September 30, 2020 were adversely affected by, among other things, a $163.3 provision for credit losses. The charges were largely related to the effect of the COVID-19 pandemic on forecasted economic and market conditions. In addition, the various stay-at-home/lockdown orders have resulted in reductions in the Corporation’s transaction fee income (credit and debit cards, ATMs, and point-of-sale transactions) and an increase in deposit balances from stimulus benefits received by customers, requiring FBP to maintain higher liquidity levels. Further, the situation required the Corporation to implement payment deferral programs to alleviate the hardships being experienced by FBP’s borrowers during the COVID-19 pandemic.”

Overall, the bank may face rising loan delinquencies and credit losses if the pandemic continues to drag on (e.g., due to delay of vaccine or continued economic weakness). This would negatively impact earnings and harm FPB’s balance sheet. Still, the bank has made considerable allowances for credit losses on loans and finance leases already – amounting to $384.7 million (3.25% of total loans) as of Q3 ’20, compared to $155.1 million (1.72% of total loans) as of December 31, 2019. It is very well-capitalized (see earlier) and has a relatively well-balanced loan portfolio comprised of commercial and construction loans (47%), residential real estate loans (31%), and consumer and finance leases (22%). To date, FBP has not experienced rising charge-offs or draws on credit (“draws from unfunded loan commitments”).

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Additionally, with lower economic growth yields may stay lower for longer, that, in turn, would further negatively impact net interest income (and margin) and investment income (FBP’s investments are mainly in US treasuries), and thereby earnings. However, the acquisition of BSPR might compensate for that to some extent.

Exposure to Puerto Rico Government

As of Q3 2020, FBP had credit risk concentration of approximately 79% in the Puerto Rico region, 17% in the United States region (mainly in the state of Florida), and 4% in the Virgin Islands region.

According to the Q3 report:

“As of September 30, 2020, the Corporation had $400.5 million of direct exposure to the Puerto Rico government, its municipalities and public corporations. Approximately $201.7 million of the exposure consisted of loans and obligations of municipalities in Puerto Rico that are supported by assigned property tax revenues and for which, in most cases, the good faith, credit and unlimited taxing power of the applicable municipality have been pledged to their repayment, and $133.8 million consisted of municipal revenue and special obligation bonds.

Approximately 70% of the Corporation’s exposure to Puerto Rico municipalities consisted primarily of senior priority obligations concentrated in four of the largest municipalities in Puerto Rico. The municipalities are required by law to levy special property taxes in such amounts as are required for the payment of all of their respective general obligation bonds and notes.”

While this exposure is moderately significant, it is still not a very large portion of FBP’s total loans and assets, which amount to approximately $11.9 billion and $18.7 billion, respectively. The Puerto Rico bonds also mostly consist of long-term bonds maturing in 5-10 years and over 10 years. However, problems in public sector finances may roll over into other areas of the economy if the state enacts significant austerity measures. At the moment, that seems unlikely, since the worst of the debt crisis is mostly over and the state is actively engaged in debt restructuring (Source).

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Exposure to U.S. Virgin Islands

FBP has operations in the U.S. Virgin Islands (USVI) and has some credit exposure to the local government entities, albeit relatively small:

“For many years, the USVI has been experiencing a number of fiscal and economic challenges that have deteriorated the overall financial and economic conditions in the area.

As of September 30, 2020, the Corporation had $64.0 million in loans to USVI government instrumentalities and public corporations. Of the amount outstanding as of September 30, 2020, public corporations of the USVI owed approximately $40.8 million and an independent instrumentality of the USVI government owed approximately $23.2 million. As of September 30, 2020, all loans were currently performing and up to date on principal and interest payments.”

Summary

Overall, FBP currently trades at $8/share (tangible book value), which excludes future earnings power, soon-to-be cost savings, strong capitalization, and growth potential. Given our analysis and expectations for near-term economic recovery, FBP is an attractive investment choice delivering at least 5% in earnings yield (2.5% dividend yield), and should trade near $11/share (assuming 4% discount rate) as the economic recovery takes hold in the coming quarters.

Recommendation: Buy.

Target Price: $11/share.

Catalysts: Economic growth (stimulus, COVID vaccine), steeper yield curve.

Time Frame: Q1-Q2 ’21.

Risks: Delayed economic recovery (main risk), Puerto Rico public fiscal problems (moderate), USVI (small).

Hedge: E.g. Long 10-year treasuries (or 3M-10Y, 2Y-10Y spread).

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in FBP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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