First BanCorp of San Juan, Puerto Rico, said Tuesday that pending accounting corrections could leave its main subsidiary, FirstBank, below regulators' definition of "well capitalized."
Though it downplayed the possibility, analysts called the revelation worrisome, and the company's shares took a pummeling, closing down 6.4%.
First BanCorp said it would restate financial results from January 2001 through March of this year to reclassify mortgage-related transactions with R&G Financial Corp. and Doral Financial Corp. as commercial loans secured by mortgages. It also said it expects a noncash unrealized loss of approximately $175 million related to an accounting change for hedges, but it did not say when it would take the charge.
All three companies have been embroiled in accounting problems for several months. Doral was the first to stumble; it changed the way it values its interest-only strips in the first quarter. R&G later acknowledged similar problems.
Each had sold fixed-rate mortgages to First BanCorp. All three must restate and are being investigated by the Securities and Exchange Commission.
First BanCorp said it told the Federal Deposit Insurance Corp. on Dec. 7 that the reclassification would probably lower FirstBank's capitalization to "slightly below the well-capitalized level." The company said it is working with regulators on the issue and hopes to remain well capitalized.
According to the FDIC, 93% of FDIC-insured institutions are well capitalized - that is, they have risk-based capital of 10% or Tier 1 capital of 6%. The next category in the five-step system - "adequately capitalized" - is 8% risk-based capital or Tier 1 capital of 4%.
"I was surprised by the bank not being well capitalized, by the FDIC making that determination," said Bain Slack of Keefe, Bruyette & Woods Inc.
Avi Barak of Sandler O'Neill & Partners LP said two of First BanCorp's funding sources are now in jeopardy.
First BanCorp said the accounting changes will probably constrain its Federal Home Loan bank borrowing and its access to brokered certificates of deposit. "If both issues swing against them, this is really going to limit their ability to grow," Mr. Barak said.
Mr. Barak said the company has two unappealing options to boost its capital level. "They will have to raise capital or shrink the balance sheet. If you do a capital raise you're diluting current shareholders, and if you shrink the balance sheet you're not growing earnings. Which is less bad?"
Thomas J. Monaco of Moors & Cabot Capital Markets said he expects Doral to take back and refinance the portfolio of loans it sold to First BanCorp. He said that the move would shrink First BanCorp's balance sheet, reducing its earnings but also leaving it well capitalized.
"The well-capitalized issue for First BanCorp is a temporary issue," Mr. Monaco said. "They will be well capitalized probably over the coming month or so."
Joseph Gladue of Cohen Brothers & Co. said that he had expected most of Tuesday's disclosures but that "there are still some unresolved issues."
He and other analysts said that the company still needs to clarify its accounting on interest rate swaps and on $263 million worth of transactions with R&G.
Tuesday's release also left First BanCorp's funding sources and the effectiveness of its internal controls on financial reporting in doubt. The company said it would likely acknowledge a material weakness in those controls.
"People would like to see all of the issues done with and out of the way," Mr. Gladue said. "There may be some disappointment that at least some of this is still going to drag on."
Investor disappointment showed up quickly in First BanCorp's stock, which opened down almost 4%. Doral fell 8.1% and R&G fell 10.3%.
"We've got an earnings situation which was uncertain to begin with and is more uncertain after reading this press release," said Mr. Slack of Keefe Bruyette. With so much about earnings in doubt, he said, investors may have tried to price the stock Tuesday on the basis of tangible book value, which he set at $7.40.
A First BanCorp spokesman, Alan Cohen, wrote in an e-mail that the company has asked the FDIC to reduce the risk weighting normally applied to loans to mortgage companies, "returning us to the well-capitalized level." The company has also obtained a waiver to accept and renew brokered CDs, he wrote.
First BanCorp's announcement fueled more of the consolidation speculation that has recently helped boost the stocks of Puerto Rican banking companies.
Audrey Snell of ThinkEquity Partners LLC has argued that consolidation is likely because Puerto Rico's population of 4 million cannot support all the banks there. "If you have weak banks or weakened banks … it makes sense that they may combine to form bigger institutions that are stronger," she said.
But Mr. Monaco said, "There's a lot going on here, and any speculation about Doral or anyone else being sold is just premature."
