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First BanCorp. deploys capital stockpile in $1.1B deal

First BanCorp. took a big step toward fulfilling widespread investor expectations that it would use its strong capital position in a transaction to boost shareholder returns.

Its $1.1 billion, all-cash deal for Santander BanCorp. would lower First BanCorp.'s Tier 1 common equity ratio from 21.6% in the third quarter to a pro forma 15.3%. The bank also estimated that the transaction would be 35% accretive to its 2020 EPS relative to the consensus forecast, and dilute tangible book value per share by just 7%, reflecting a modest 105.1% price-to-book multiple, according to data from S&P Global Market Intelligence.

First BanCorp.'s shares were up by almost 5% in early afternoon trading on Oct. 22, the day after the merger was announced.

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Nevertheless, the bank's target of cutting Santander's expenses by 35% was less than some analysts had modeled, and executives said they are making conservative assumptions because they are focused on growth.

"We want to get bigger," President and CEO Aurelio Alemán-Bermudez said during an Oct. 22 call to discuss the deal. The bank's assumptions, "which you could view as conservative, are driven by the fact that we would like to have more presence, retain more clients, grow more clients and expand our branch network," he said.

Combined, the two banks would have 76 branches in Puerto Rico, according to S&P Global Market Intelligence data, ranking second behind Popular Inc. First BanCorp. estimated that it would have a 20% share of deposits on the island, also ranking second behind Popular, after adjusting Citigroup Inc.'s presence for brokered deposits.

First BanCorp.'s emphasis on growth echoes the message that fellow Puerto Rican bank OFG Bancorp sent when it announced its $550 million acquisition of Scotiabank de Puerto Rico in June, and said that it had no plans to close any of the branches it would acquire.

Together, the two deals reshape the competitive landscape in Puerto Rico, and deliver on longstanding speculation that consolidation was imminent as the island stabilizes after Hurricane Maria and banks seek to pull back from high capital levels that regulators encouraged as protection against economic instability.

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Alemán-Bermudez said discussions with regulators "have been very helpful in preparing us to address the key points that most likely arise in the formal application process." He noted that the capital ratios estimated for the combined company "are still well in excess of the well-capitalized regulatory guidelines."

Still, the CEO said there may be room to increase First BanCorp.'s dividend if Puerto Rico's economy stays on track and "asset quality trends continue at the pace we've been achieving."

First BanCorp.'s nonperforming assets decreased by $52 million in the third quarter to $332.1 million, reflecting the repayment of a $31.5 million nonaccrual commercial mortgage in Florida. The bank also said that two criticized commercial mortgages totaling $120.4 million had been refinanced with other lenders and paid off. Alemán-Bermudez said that the bank's conservative assumptions for the deal also reflect caution about economic conditions in Puerto Rico.

Alemán-Bermudez declined to give a specific number for potential branch closures, saying the bank is still performing a review. He said there are opportunities to consolidate back-office facilities, but that "if you want to grow, you have to do less reduction in expenses."

"This is a very strategic transaction," CFO Orlando Berges-González added. "We want to be able to maximize the capacities of the combined entities."

In a note, analysts at Sandler O'Neill said this is "the deal we have been waiting for," and applauded it as "one of the only ways that [First BanCorp.] could conceivably leverage its massive excess capital cushion, thus helping to translate a 1.4% [return on assets] to a double digit [return on tangible common equity]."