Five posts of building tools. Now we take those tools into the real world — and see what the model actually tells us about a bank in our investment universe.
Parts 1 through 5 of this series built the framework piece by piece. You learned why the standard free cash flow formula breaks for banks. You learned how to use Return on Equity and the retention ratio as a growth engine. You learned how to normalize insurance earnings to smooth out catastrophe years. You learned how to estimate a discount rate using the Cost of Equity formula. And in Part 5, you watched the whole machine run on a fictional bank called First River.
Now it’s time to do this for real.
The company in this post is OFG Bancorp, a regional bank based in San Juan, Puerto Rico. OFG is a bank we’ve been evaluating — one that sits in our investment screening universe. We run the same model on it that we run on every financial firm we track — every week, automatically, using live data from SEC filings.
This post walks through what that model finds. We’ll use the same five steps from Part 5. The inputs are real. The outputs are real. The conclusion is whatever the math says — even when the market disagrees.
Introducing OFG Bancorp
If you haven’t heard of OFG, that’s the point.
OFG Bancorp is a bank holding company headquartered in San Juan, Puerto Rico. Through its primary banking subsidiary — Oriental Bank — it operates roughly 50 branches across Puerto Rico, providing personal banking, commercial lending, and mortgage services to individuals and businesses on the island.
It is not a headline bank. It doesn’t have branches in Chicago or Los Angeles. It isn’t discussed in the financial press. It is exactly the kind of company Lynch’s framework was built to find — a well-run, profitable, regionally dominant business that most investors haven’t looked at because it doesn’t show up in their daily news feed.
Puerto Rico’s banking market has its own story. Hurricane Maria in 2017 devastated the island’s economy, and several large banks reduced their Puerto Rico exposure in the years that followed. The banks that stayed — and stayed disciplined — found themselves in a stronger competitive position by the early 2020s, as the island’s economy recovered, federal disaster relief funds flowed in, and fewer competitors were fighting for the same customer base.
OFG has navigated that environment with strong underwriting discipline and consistent profitability. Over the past five years, it has grown its loan book, maintained low credit losses, and increased its dividend.
That’s the story. Now let’s see what the model says.
Step 1 — Can We Explain the Business in Two Minutes?
Before we run a single number, we ask the question Lynch always asked first: can we explain why we own this in two minutes?
For OFG, the story goes like this.
OFG is a regional bank in Puerto Rico operating in a market where the competition thinned out after Hurricane Maria, regulatory reform created a more predictable environment, and the island’s economic recovery generated steadily growing loan demand. The bank earns its income the way all banks do — it takes in deposits, lends that money to individuals and businesses, and pockets the spread between what it earns on loans and what it pays depositors. It has been consistently profitable, carries modest credit risk, and is well-capitalized relative to the regulatory minimums.
The risk: Puerto Rico’s economy is heavily dependent on federal transfers, tax incentives for companies relocating to the island, and pharmaceutical manufacturing. A reversal of those tailwinds — federal policy changes, tax reform that removes the incentive for businesses to locate in Puerto Rico, or a major weather event — would put pressure on loan demand and credit quality.
Two minutes. Clear story. Named risks. We understand what we’re evaluating.
Step 2 — The Growth Engine (ROE × Retention Ratio)
For a bank, growth doesn’t come from factories or inventory buildup. It comes from one thing: the ability to earn returns on equity and reinvest a portion of those returns back into the business.
The formula is simple:
Growth Rate = Return on Equity × Retention Ratio
Two inputs. Return on Equity (ROE) — think of it as how efficiently OFG converts shareholder capital into profit. If OFG holds $1,400 in equity and earns $220 in annual net income, its ROE is $220 / $1,400 = 15.7%.
The retention ratio is the fraction of that net income OFG keeps inside the business rather than paying out as dividends. A bank that pays out $46 in dividends on $220 in net income has a payout ratio of 21% and a retention ratio of 79%.
The model computes OFG’s growth rate using multi-year averages of both inputs — smoothing out any one year’s noise. Across recent years, OFG’s ROE has averaged approximately 15.0%, and the bank has retained roughly 78.5% of earnings. Multiplying:
Growth Rate = 15.0% × 78.5% ≈ 11.77%
The model’s precise output, using OFG’s actual SEC filing data averaged across multiple years: 11.77% per year.
What does 11.77% mean? It means OFG is expected to grow its earnings — and therefore its free cash flow to equity holders — at 11.77% per year over the next five years. That’s the “engine” we plug into the projection.
Step 3 — The Cost of Equity
To discount OFG’s future cash flows back to today, we need a discount rate — the minimum annual return we’d require for taking on the risk of owning OFG stock. For a bank, this is the Cost of Equity — not WACC, because deposits (debt) are the raw material of the business, not financial leverage.
We use the CAPM formula — the Capital Asset Pricing Model:
Cost of Equity = Risk-Free Rate + Beta × Equity Risk Premium
Three inputs:
The risk-free rate is the yield on the 10-year US Treasury — the baseline return available with essentially no risk. At the time of our analysis: 4.68%.
Beta measures how much OFG’s stock moves relative to the overall market. We don’t use OFG’s own historical beta — that number is noisy and gets distorted by single events. Instead, we use the industry beta for regional banks from Professor Damodaran’s database at NYU, which averages across all regional banks to smooth out the noise. For OFG, the industry beta puts its market sensitivity at approximately 0.44 — lower than the average stock (which is 1.0) because regional banks with stable, interest-rate-driven earnings tend to move less dramatically than the broad market.
The equity risk premium (ERP) is the extra return investors demand for owning stocks instead of risk-free Treasuries. Our model pulls this from Damodaran’s monthly implied ERP estimates: 4.14% at the time of this analysis.
Plugging in:
Cost of Equity = 4.68% + (0.44 × 4.14%)
= 4.68% + 1.82%
= 6.52%
OFG shareholders require approximately a 6.52% annual return. Every dollar of future free cash flow to equity will be discounted back to today at that rate.
Step 4 — Five Years of Free Cash Flow to Equity
With the growth rate (11.77%) and discount rate (6.52%), we project OFG’s Free Cash Flow to Equity — the cash available to shareholders each year after the bank funds the regulatory capital needed to support its growth.
For a bank, FCFE in any year equals net income multiplied by the payout ratio. The payout ratio is the share of earnings paid out to shareholders as dividends. This number matters more than it might seem — we’ll come back to why in a moment.
The model uses OFG’s most recent year’s payout ratio from actual SEC filings. In the most recent filing period, OFG’s dividend payout was approximately 10.5% of earnings. This is lower than a simple multi-year average of around 21% would suggest — because OFG’s earnings grew significantly in the recent period while the annual dividend level held near its historical amount. The model uses the single corrected figure from that most recent year for consistency.
Starting from OFG’s most recent annual net income of approximately $220 million, growing at 11.77% per year, with a 10.5% payout ratio:
| Year | Net Income | FCFE (10.5% payout) | PV at 6.52% |
|---|---|---|---|
| 1 | $245.7M | $25.8M | $24.2M |
| 2 | $274.6M | $28.8M | $25.4M |
| 3 | $306.9M | $32.2M | $26.6M |
| 4 | $342.9M | $36.0M | $28.0M |
| 5 | $383.2M | $40.2M | $29.3M |
Total present value of 5-year FCFEs: approximately $133.5 million
Step 5 — Terminal Value and Intrinsic Value
OFG won’t stop operating in year five. It will keep earning and paying cash to shareholders indefinitely. We capture that value in a terminal value — a single number representing everything beyond the five-year projection.
In the stable phase, OFG’s growth slows to the long-run rate of the overall economy (3.0%, our model’s fixed stable growth rate). The bank’s beta also converges toward 1.0 as it becomes a more mature firm — so the stable cost of equity rises slightly to approximately 7.82%.
The terminal value calculation:
Stable FCFE = Year 5 FCFE × (1 + Terminal Growth)
≈ $40.2M × 1.03 ≈ $41.4M
Terminal Value = Stable FCFE ÷ (Stable Cost of Equity − Terminal Growth)
= $41.4M ÷ (7.82% − 3.0%)
= $41.4M ÷ 4.82%
≈ $859M
Terminal Value PV = $859M ÷ 1.0652⁵
≈ $626M
Adding the two pieces together:
Equity Value = PV of 5-Year FCFEs + PV of Terminal Value
= $133.5M + $626M
= $759.5M
Divide by shares outstanding (~28 million shares):
Intrinsic Value per Share ≈ $759.5M ÷ 28M shares
≈ $27.13 per share
The model’s precise output for OFG, using exact multi-decimal inputs: $27.23 per share. (Minor rounding differences between the by-hand walkthrough above and the model’s exact computation are normal — the model uses full precision throughout.)
The Payout Ratio Limitation
Why 10.5%? A reader might expect the payout ratio to be higher, given that OFG has paid out around 21% of earnings as dividends over a multi-year period. The answer matters for how you interpret the intrinsic value.
The model uses a corrected single-year figure: the actual dividends paid in the most recent fiscal year divided by that year’s earnings. When OFG posts a particularly strong earnings year — and earnings were strong in the most recent period — a dividend maintained near historical levels produces a lower single-year payout ratio. This isn’t OFG cutting its dividend. It’s the model capturing the most current, precise measurement.
This is the honest limitation of FCFE models for banks. The model sees dividends as the measure of cash returned to shareholders. Total returns including buybacks would be higher. OFG has been an active share repurchaser. Buybacks don’t show up in the dividend line, but they are just as real as dividends for shareholders. If you include share repurchases in the effective payout, OFG’s capital return to shareholders is meaningfully higher — and the model would produce a higher IV.
With those caveats stated, our model’s IV for OFG is $27.23 per share.
At the time of our September 2026 analysis, OFG’s market price was $52.16 — approximately 192% of our modeled intrinsic value.
What the Model Is Telling Us
Let’s be precise about what the model is and isn’t saying.
It is saying: At its current single-year dividend payout rate, OFG’s FCFE-based DCF produces an intrinsic value of $27.23 per share. The market is pricing the stock at nearly twice that level.
It is not necessarily saying: OFG is a bad company. Our model’s methodology — which focuses on cash dividends as the measure of cash returned to equity holders — almost certainly understates OFG’s true total capital return. OFG has been an active share repurchaser. Buybacks don’t show up in the dividend line, but they are just as real as dividends for shareholders. If we added buybacks into the effective payout, the IV would be higher.
What it is saying with more confidence: At the current market price of $52.16, the margin of safety is negative. There is no cushion. If our assumptions about OFG’s growth, earnings, and cost of equity are approximately right, the market is pricing in a level of optimism that the model doesn’t support — even accounting for the buyback undercount.
This is exactly what the framework is for. It doesn’t just find cheap stocks. It also tells you when the market has priced something ahead of where the model can justify it.
What Lynch Would Have Said
Lynch would have applied his own lens to OFG before trusting any model output.
He’d have wanted to understand the Puerto Rico market — not just the current environment, but whether the tailwinds that made OFG attractive (post-Maria recovery, reduced competition, federal funding flows) are durable. Markets don’t usually pay twice book value for a regional bank unless they’re pricing in continued growth. Is that growth baked into the current price fairly, or is it overly optimistic?
He’d have asked about credit quality. In a rising interest rate environment, how does OFG’s loan book hold up? Are loan losses starting to tick up? Is the spread between what the bank earns on loans and what it pays depositors compressing?
And he’d have revisited the Two-Minute Story. Can I still explain why I’m evaluating this? Is the original thesis — disciplined regional bank, reduced competition, Puerto Rico recovery story — still intact? Or has the story changed?
The Lynch framework doesn’t give you the buy or sell decision. It gives you the questions to ask before you make one.
What This Post Is Actually Teaching
Part 6 isn’t a simple case of “look how undervalued this stock is.” OFG gives us something more valuable: a model that shows a negative margin of safety on a real company we’ve been evaluating, and a chance to think carefully about what that means.
The model is a tool. Like any tool, it has limitations. The payout-ratio methodology underweights total capital return for buyback-heavy banks. The terminal value assumptions drive most of the intrinsic value. Small changes in the growth rate or cost of equity produce large changes in the output.
What the model does well: it forces discipline. It makes your assumptions explicit. It gives you a number you can compare to the market price — and a framework to decide whether the gap between those two numbers reflects a genuine opportunity, a model limitation, or a market correctly pricing in something you haven’t.
For OFG, the gap reflects some of all three. The model may be underestimating true capital return. The market may be pricing in faster growth than the model assumes. And there may be factors — regulatory changes, rate environment, Puerto Rico’s fiscal trajectory — that the model doesn’t capture.
What does the investor do with all of that?
They make a judgment. The model informs the judgment. It doesn’t replace it.
That is what every tool in this series — FCFE, normalization, cost of equity, the full DCF — is designed to give you. Not certainty. Clarity.
A Note to Luca and Lili
I want you to notice something about this series.
In Part 5, I used a fictional company. The numbers were clean. The model produced an intrinsic value that was very close to the market price, and we could talk about it precisely and neatly.
This post is messier. The real world usually is.
OFG’s model has a known limitation (payout ratio understates buybacks). The conclusion (negative margin of safety) isn’t a clean “buy this” story. The model gives us a range of outputs depending on how we handle total capital return. That’s not the model failing — that’s the model being honest about what it knows and doesn’t know.
The goal isn’t to find models that always give you clean answers. The goal is to develop the habit of asking: what does the model say, why does it say that, and what might it be missing?
That kind of thinking — iterative, honest, always looking for the gap between the model and reality — is what separates investing from guessing.
— Papa
The One-Sentence Summary
Applying the full Financial Firms framework to OFG Bancorp — a Puerto Rico regional bank in our investment screening universe — produces an intrinsic value of $27.23 per share against a market price of $52.16, a gap explained partly by the model’s dividend-only view of payout (which understates buyback capital returns) and partly by the market pricing in optimism that the FCFE model doesn’t support, illustrating that the framework is just as useful for identifying when the market has moved ahead of value as it is for finding undervalued opportunities.
← Part 5: Putting It All Together | Part 7: When to Sell and Why →
The Financial Firms series continues. Explore all published parts on the Valuing Financial Firms series page.
— Jim