Good morning. Thank you for joining OFG Bancorp's conference call. My name is James. I will be your operator today. Our speakers are José Rafael Fernández, Chief Executive Officer and Vice Chair of the Board of Directors, and Maritza Arizmendi, Chief Financial Officer. A presentation accompanies today's remarks. It can be found on the homepage of the OFG website under the third quarter 2023 section. This call may feature certain forward-looking statements about management's goals, plans, and expectations. These statements are subject to risks and uncertainties outlined in the Risk Factors section of OFG's SEC filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. All lines have been placed on mute to prevent background noise. After the speaker's remarks, there will be a question-and-answer session.
Instructions will be given at that time. I'd now like to turn the call over to Mr. Fernández.
Good morning, and thank you for joining us. We are very pleased to report our third quarter results. All our businesses performed well, and we continue to generate steady year-over-year revenue and earnings growth. Highlights include increased loan balances, stable core deposits with low cumulative beta, increased operating leverage, and strong credit and performance metrics. Our digital-first strategy continues to attract customers and speed the transition of routine transactions from in-branch to digital platforms. This makes it easier for customers to do their banking and for us to increase efficiency and engage in more business development activities. In Puerto Rico, consumer liquidity is sound, and the economy is doing well. As always, thanks to our team for helping our customers and the communities we serve achieve their financial goals. Please turn to page three for a summary of our third quarter results.
First, looking at the income statement, earnings per share diluted was $0.95, an increase of 9% year-over-year. Total core revenues were $172.2 million, up 10% compared to last year. Net interest margin was 5.8%, provision was $16.4 million, and non-interest expenses were $90.2 million. Pre-provision net revenues totaled $82.3 million, up 18% year-over-year. Now, turning to the balance sheet, total assets increased to $10.3 billion from last quarter. Based on our growth and outlook for next year, we will remain above $10 billion. Customer deposits were stable at approximately $8.5 billion. Loans held for investment totaled $7.3 billion, up 2% from the second quarter.
New loan production was approximately $563 million, in line with the last five quarters. Investments increased to $2.1 billion, and cash declined to $533 million. Moving to capital, the CET1 Ratio was 14.03%, level with the second quarter. We bought back about 74,000 OFG shares in the third quarter. Please turn to page four for an update on our digital-first strategy. Looking at data year-over-year to date, September, compared to the same period a year ago, 87% of all routine retail customer transactions and 92% of all retail deposit transactions are now being made through digital and self-service channels.
This has been driven by 11% growth in digital enrollment, 14% growth in digital loan payments, 5% growth in kiosk usage, and the success of our recently deployed Oriental Servicing Portal. The portal is a cornerstone of our self-service strategy. Customers can manage all loan and deposit accounts in one place. The portal now enables digital account opening for checking, savings, and CDs, applying for and accessing loans, managing automatic loan payments, and downloading a wide variety of bank letters and tax documents that customers in Puerto Rico frequently request in our branches or by phone. New features to the portal will continue to be added on a regular basis. All this continues to validate our strategy and investments in technology. As I have mentioned before, they help us provide more value-added service, increase our efficiency, and assign more staff for new business development activities.
Having said that, branches continue to be an important component of our island-wide sales and service network. During the third quarter, we opened a new branch in Dorado, an area with good commercial and retail opportunities. As you probably already know, Dorado is a growing, high-net-worth suburb of San Juan that has attracted many new residents from the mainland. We already have a 9% market share there, and we think we can grow further. These developments, both digital and physical, continue to better position us to serve our customers and communities and grow our businesses. Now, here is Maritza to go over the financials in more detail.
Thank you, José. Please turn to page five to review our financial highlights. Let me start with total core revenues. Net interest income totaled $142 million, an increase of 1.5% from the second quarter. This reflected the full effect of the Fed's 25 basis point increase in the second quarter, the partial effect of the 25 basis point increase in the third quarter, higher yields on higher loan balances, in particular, variable rates and new loans, higher balances and yield on investment securities, and one extra day, which added around $1 million. Banking and wealth management revenues were $30.4 million, approximately level with the second and year-ago quarters. Other non-interest income totaled about $300,000.
This compared to a loss of about $800,000 in the second quarter, due to the early sale of a $200 million treasury note. The efficiency ratio was 52.36%, reflected continued growth, strong operating leverage. Non-interest expense totaled $90 million, $1 million higher than the second quarter. This reflected lower gains on the sale of forec losed real estate, partially offset by lower G&A expenses. We expect non-interest expenses to continue to average about $90 million-$92 million next quarter and next year. The efficiency ratio should continue in the low to mid-50% range. Other performance metrics remained high. Return on average assets was 1.76%. Return on average tangible common equity was 70.59%, and tangible book value per share was $21.01.
Please turn to page five to review our operational highlights. Average loan balances increased $188 million from the second quarter. The end-of-period balance increased $144 million. Growth continued to reflect increases in Puerto Rico and U.S. commercial loans and retail auto and consumer loans. This was partially offset by the continued regular paydowns on the residential mortgages. Loan yield was 7.84%, up eight basis points from the second quarter. This reflected increases from variable rate commercial loans and higher yields on new auto, consumer, and commercial loans. Average core deposits increased $90 million from the second quarter, while the end-of-period balance was approximately level with the June 30th year. Retail deposits declined $102 million, commercial increased $73 million, and government increased $30 million.
We continue to see a shift to time deposit and wealth management. Core deposit cost was 90 basis points, compared to 69 in the second quarter. This increase of 21 basis points mainly relates to six basis points due to higher rates on government deposits, six basis points in time deposits, four basis points in commercial NOW and savings accounts, and four basis points in retail NOW and savings accounts. As of the third quarter, our cumulative deposit beta has been 19%. Excluding government deposits, it was 14%. Through this cycle, we continue to expect a cumulative deposit beta of about 25% by the end of this year. Average borrowings were $264 million, while the end-of-period balance was $452 million. The increase reflected our asset liability management strategies during the quarter.
Net Interest Margin was 5.80%. That compares to 5.90 in the second quarter. Our effective tax rate was 32%, which will be our rate for the year. Please turn to page 7 to review our credit quality and capital strength. Net charge-offs totaled $18.8 million. That compares to $6.6 million in the second quarter. The third quarter included about $7 million for two U.S. loans previously and substantially reserved. This compares to the second quarter, which included a $4 million recovery from the sale of older, fully charged-off auto and consumer loans. Provision for credit losses totaled $16.4 million.
This included more than $11 million due to increased loan volume, $4 million in quantitative adjustment, mainly related to the auto loan portfolio, and $700,000 for a specific reserve for the sale of a small portfolio of non-performing Puerto Rico small business commercial loans. Overall, credit continued to be strong. Early and total delinquency rates were 2.75% and 30.78%, respectively. The non-performing loan rate at 1.33% was in the lower ranges seen over the last five quarters. Looking at some of our other capital metrics, total stockholder equity was $1.1 billion, and the TCE ratio was 9.74%. To sum up, during the third quarter, we saw a steady revenue growth from higher yields on higher loans and security balances.
Good loan originations, driven by auto, commercial, and consumer lending. Deposit costs increased from higher average balances during the quarter and higher rates, but betas remain well below peers. End-of-period core deposit balances were approximately level with the second quarter. Credit conditions remained benign. Net charge-offs were higher due to two U.S. commercial loans, and expenses were in line with our expected range. Now, here is José.
Thank you, Maritza. Please turn to page 8. Our outlook has not changed from the second quarter call. The economy continues to do well, supported by the flow of federal funds to rebuild the island's infrastructure, as well as additional federal funding from the Inflation Reduction and the CHIPS Act. With this as a backdrop, consumers continue to deploy their liquidity, and U.S. private capital and local businesses are investing to acquire, expand, and grow their operations on the island. Having said that, we continue to keep our eye on the potential impact of interest rate changes, inflation, and a possible mainland recession. Also, and while it's unlikely to affect Puerto Rico directly, the recent incursions in Israel and the mounting events in the Middle East region leave us with a heavy heart, and our wishes for an early end to the fighting and for peace.
We can't help but be concerned about the possible global economic ramifications as well. All in all, we remain optimistic about Puerto Rico's strength and its continued decoupling from mainland economic uncertainties. Now, turning to OFG, and to sum up on my end, we had another excellent quarter confirming our operational and financial strategies. Results benefited first and foremost from our efforts over the years to grow our commercial and consumer business capabilities, which are helping us gain market share and increase capital. Second, from our stable, low-cost core deposit base, and third, from our new Oriental Servicing Portal and other technology investments, which have increased the use of customer self-service channels, allowing our teams to spend more time on new business development activities. Externally, we benefited from the positive and more resilient economic environment in Puerto Rico.
All this translates into a strong commercial lending pipeline for us into the fourth quarter and into 2024, and our ability to continue to deploy innovations to better service the banking and financial needs of our customers. Against a higher base, this should result in continued growth across most of our businesses next year. In closing, I want to reemphasize that our performance could not have been possible with the hard work and purposeful commitment of all our team members. We are thankful to them for executing our corporate vision. This ends our formal presentation. Operator, let's start the Q&A.
Thank you. If you have a question at this time, please press star one on your telephone keypad. If you wish to remove yourself from the queue, press star two. Our first question today will come from Timur Braziler with Wells Fargo Securities.
Hi, good morning.
Good morning.
Maybe starting on maybe Maritza's comment around deposit beta expectation and still calling for a 25% beta by year-end. I mean, that sounds pretty conservative, but then maybe thinking in a longer term, just starting at such a low base and a higher for longer environment, is the expectation that deposit betas and deposit costs continue to migrate higher, just given such a low starting base? Or do you still see some abatement there as we get a quarter or two past the final rate hike?
Yep, I am. Thank you for your question, Timur. You know, the way we look at this is in terms of deposit costs and the corresponding data. First, let's look at our market, and the market we're operating in certainly is very different from the U.S. market, and that gives us a different, a very positive landscape to operate in. That's number one. Number two, we also look at it from our business strategy perspective and our customer kind of relationship perspective. We also wanna have some wiggle room to be able to attract additional customers and also to retain some good relationship customers, particularly on the commercial side.
We're sticking with the 25% beta for the end of the year, and we'll take a look at it at the end of the year and see how do we see it as interest rates would probably remain higher for longer and what impact would that have in our market. As of now, we feel that with the 19% cumulative beta, including government deposits, keeping the 25% beta for the end of the year is the prudent way to go.
Okay. What is the balance of government deposits at quarter end?
The balance of government deposits is in the $350 million range.
Okay. I guess as we're thinking about, you know, next quarter, next year, if deposit betas do lag, if they do go up to that 25%, maybe it's not in 4Q, maybe it's 1Q or 2Q next year, the growth profile still seems pretty strong. Is the expectation that you're able to offset this NIM compression with growth and NII continues to go higher? Or is that.
Yep.
Gonna be more challenging in the current environment?
Mm-hmm. Yeah, so as you saw this quarter, and you've seen so far this year, we have pretty good loan growth, and we expect that to continue to build throughout the next year. Our way of looking at this is, if the scenario plays out next year where we need to think about higher cost of deposits, we will mitigate that with our loan growth from a net interest income perspective. Yeah, we might have right now a lower trending NIM, but that does not necessarily mean it will be a lower trending net interest income, because we expect loan growth to compensate for that.
Okay, great. Just lastly for me, on the credit front, we saw a bump up in net charge-offs. Maritza explained that and kind of the corresponding decline in allowance ratio. I know it's a hard question to really get a good answer for, but as you think about this normalizing credit environment, how should we be thinking about net charge-offs? With the allowance ratio still well over 2% of loans, is that pretty flat and kind of goes hand-in-hand with charge-offs, or is there maybe an ability to release some of those reserves as the broader Puerto Rico story continues to improve?
Well, thank you, Timur, for your question. You know, this quarter included about $7 million in the charge-off of two loans that were previously reserved, and we discussed during our last call in the second quarter. We talk about these loans that were put in nonaccrual. We completed the restructuring of one of them during the quarter, and it requires about $4.2 million in charge-off. The other one was transferred to held for sale at the end of the quarter, and it requires about $3.7 million in charge-off. That loan was already sold on October 18th, so that reserve were already established in prior quarters.
If you exclude that two loans, our net charge-off is about 0.62% for the quarter, which compares really good with the prior quarters. As we look forward, I think we are starting to see a more normalized level of charge-off compared to 2021, 2022. We need to keep monitoring that trend to see what would be the normal trend. We think the credit condition continues to be benign in Puerto Rico compared to pre-pandemic levels, and that's how we see it.
Great. Thank you for the color on the questions.
Yep, you're welcome.
Our next question will come from Alex Twerdahl with Piper Sandler.
Hey, good morning.
Good morning, Alex.
First off, just, you know, it sounds to me, José, now like you're fairly committed to being above $10 billion. I'm just curious how you're thinking about the overall strategy, the overall growth strategy, if that's no longer sort of an upper level on assets, you know, how you think about, you know, how the balance sheet might transition over the next couple of quarters as you continue to deploy the excess capital you have?
Yep. Yeah, look, the way we look at the $10 billion mark this year is very different from the prior two years, where we managed below the $10 billion mark. It has everything to do with where interest rates are and how the kind of how the balance sheet from the loan side of in terms of loan growth and also the deposit side, how it's playing out. We feel that it makes sense for us to cross it right now and just make sure that we take advantage of the opportunities to grow the balance sheet from a loan side, particularly here in Puerto Rico. That's what we're committed to do.
We see good opportunities on the commercial side as well as on the retail side. Managing it into next year, you know, I'm not sure what exactly you mean by the question on how to manage it into next year, but I can tell you that our balance sheet will be north of the $10 billion, and it will be impacted by the expected loan growth that I've guided to in my original remarks. If there is a follow-up, please feel free, because I'm not sure if I understood fully your question.
Yeah, I mean, it looks like, you know, sort of just high level on the balance sheet that you guys added some borrowings, added some securities. You know, I don't know if leverage is the right term there, or maybe it's just.
Okay
Sort of a mismatch in timing. I guess as you look to grow loans, you know, how are you thinking about funding it? You know, the complexion.
Yeah, yeah. I get it. I get it. I get it. Now I get it. That's a very valid and good question, Alex. The way we look at this is the scenario of interest rates that we are using, and we expect our interest rate forecast is for interest rates on the Fed Funds side to remain, you know, kind of plateauing at these levels, 5.25, 5.5. We also expect into 2024, interest rates to start ticking down the second half of the year.
When we look at that scenario and us being an asset-sensitive bank, we felt that it was prudent to put in some now with MBS yielding 5.60% and north of that, with short duration, 4, 5, 4 or 4.5, 5 years duration, it will be prudent for us to protect ourselves in an environment where interest rates start moving down. Just recall, 1.5 years ago, we kept dollars, cash, and we did not go long on duration. That was the prudent, right thing to do. I think that in our scenario and the way we look at interest rates today, the right and prudent thing to do is to go longer on duration, take advantage of the higher yields.
It might not be optimal because life is not perfect, right? It certainly helps us mitigate a potential recessionary environment in the States and the resulting lower interest rates on the Fed. We are financing that also with short-term Federal Home advances and repos. Today, the spread is not that significant. Again, based on our forecast and our expectations of second half of next year, interest rates starting to trickle down, we will have our cost of borrowings will be declining in that scenario. That's kind of the picture, and that's how we looked at this.
We will continue to manage the balance sheet in that fashion, because our capital is clearly being deployed first and foremost for loan growth and the opportunities that we're having. That's kind of how we're looking at this. Again, I answered a question earlier on deposits. We're very much focused on also retaining good banking relationships on the deposit side.
Okay, that's good. You know, just expanding on your comments on loan growth and the strong pipeline into the fourth quarter in 2024, you know, I think some of us have been talking about the Metropistas deal that was announced earlier this week, and you guys are listed as a bank that would be potentially participating in some of the financing. Can you talk a bit about your appetite for something like that and sort of how big of a piece you might be willing to take on?
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Okay. I guess, as we think about the loan mix going into next year, you know, this year and in past years, auto has been a very big component of that. Do you expect that to continue, or do you think we'll see a little bit of a mix shift over the next couple of to more commercial?
Yeah, yeah. That's a question you guys ask me every quarter, and every quarter I say: Well, I'm happily surprised that loan, auto loan growth continued to remain, right? I think we're starting to see that plateauing. In terms of the latter parts of the third quarter, we started to see a little bit of a slowdown. I think it's more from competitive forces than anything else. But we're monitoring it, and we're probably gonna see not a significant drop, but it's starting to plateau at this levels and trickle down into 2024. That's kind of the way we look at the auto lending business right now.
Great. Thanks for taking my questions.
Yeah, you're welcome, Alex.
Again, if you'd like to ask a question, press star, then the number one on your telephone keypad. We'll now hear from Kelly Motta with KBW.
Hey, all. Good morning.
Hi, Kelly. How are you?
I'm great. I love all the detail on slide 4. It seems like this digital-first strategy is really nice penetration here. Just wondering, with the success you're having there, is there opportunities to gain greater efficiencies and with potentially, you know, reallocating branch personnel, and how you're thinking about that relative to some other investments you may be making?
Yeah. Thank you, Kelly. You know, we've been going at this for the last four or five years, right? We've been investing in the technology. We're deploying dollars into kind of adding capabilities towards commercial lending and consumer lending, and certainly, it's starting to pay off. You're starting to see not only the adoption levels going up and not only the consolidation of the portal as a vehicle to serve our retail customers. We're also providing similar type of innovations on the commercial side and working on them and more to come. Those are the dollars that we're investing. As you saw today, Maritza mentioned our guidance for expenses next year, we're keeping it at the same level. This is the beginning.
In our minds, it's the beginning of us starting to extract some efficiencies from the investments we've made in technology. Not all of them will trickle down to a reduction in non-interest expenses, because we also wanna utilize some of those efficiencies to continue to innovate and continue to bring technology that will help the market that we operate in here, which is significantly different than the way customers behave than in the States. You know, some of what you're seeing already into 2024 includes some of the efficiencies that we're seeing, and us, the team in general, is working into 2024 to add additional efficiencies.
Again, we're very happy and excited about the innovations that we're bringing in and how our customers are adopting them, and we're gonna continue to do so because that's the way we can differentiate from our competitors in the island.
Thanks for all the color, José Rafael. Switching to capital, levels remain very strong. You're seeing really nice loan growth, and I think you picked away a little bit at the buyback this quarter. Can you just, with the stock we're trading here, remind us your comfort and appetite with buybacks and how you're looking towards capital return towards the back half of the year and beyond?
Yeah. Kelly, capital for us has, number one, it's gonna be used for loan growth and the opportunities that present ourselves, and we're gonna deploy that capital there. I alluded earlier to Alex's question on the investment that we made on MBSs. It's part of, you know, how we're managing capital. But also we are very much focused on our dividend growth and our buybacks. We're gonna be having that discussion in the January Board, and we will update.
Our expectation is for us to capital manage as we've done in the past, where if there are opportunities here in the market in Puerto Rico which we are seeing, we will deploy that capital for loan growth and then at the same time look at dividend growth and buybacks. The script and the plan has not changed from prior quarters on the capital management front.
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Yeah. The way we look at this on the short term, and we'll update you in the fourth quarter call in terms of 2024, but the way we're looking at this is that on the short term, NIM might be trending slightly lower from these levels, but as I mentioned, not necessarily a net interest income, just simply because we're expecting additional loan growth. In the near term, we are seeing the plateau and slight downturn on the NIM. 2024, it's still out there, so we'll see in the fourth quarter call how we look at NIM for 2024. Early indicators are that we're gonna be in a pretty good shape with regards to NIM in 2024.
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Thank you.
Once again, if you would like to ask a question, press star one on your telephone keypad. We'll pause for a moment. At this time, there are no further questions. I'll now turn the call back over to Mr. Fernández for closing remarks.
Thank you, operator. Thanks again to all our team members and to all our stakeholders who have listened in. Looking forward to update you in January. Have a great weekend.
This does conclude today's conference call. Thank you for your participation. You may now disconnect.