Earnings Call: Q3 2021

Oct 20, 2021

Good morning. Thank you for joining OSG Bancorp's Conference Call. My name is Ashley, and I will be your operator today. Our speakers today are Jose Rafael Fernandez, Chief Executive Officer and Vice Chair of the Board of Directors and Maritza Aracendi, Chief Financial Officer. A presentation accompanies today's remarks. You can be found on our Investor Relations website, on the homepage in the website to be box or on the Quarterly Results page. This call may contain 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 speakers' remarks, there will be a question and answer session. Instructions will be given at that time. I would now like to turn the call over to Mr. Fernandez. Good morning and thank you for joining us. Please turn to Page 3 for our conference call presentation. We had another outstanding performance in the 3rd quarter earning $0.81 per share. This reflects several factors. Our consistently growing recurring net income, our larger scale, our focus on increasing digital utilization and customer service differentiation and Puerto Rico's nascent economic and post pandemic recovery. All this continues to validate our optimism on Puerto Rico's economy and OFG's future. Our 3rd quarter results confirm this across all businesses. Total core revenues were $135,000,000 a 4% annualized increase compared to the 2nd quarter. Net interest income increased to $103,000,000 in part that benefited from a 17% decline in cost of funds. Banking and Financial Services revenues rose 3%. Provision for credit losses was a $5,000,000 net benefit as asset quality continues to trend to levels closer to U. S. Peer banks. Non interest expenses fell 5%, reflecting in part reduced credit related expenses. And pre provision net revenues increased to $56,000,000 from $52,000,000 in the Q2. Looking at the September 30 balance sheet, customer deposits increased 154,000,000 dollars to $9,200,000,000 reflecting even greater liquidity on the part of both commercial and customer and consumer customers. As a result, both cash and assets grew. Loans held for investment declined $87,000,000 Excluding PPP loan forgiven, they increased $5,000,000 New loan origination remained strong at 5 $56,000,000 Ex equity originations now total more than $1,600,000,000 as of the 9 months. That is up 69% compared to the same period last year and 79% compared to the same period in 2019 pre COVID. During the Q3, we also successfully executed on our capital actions. We acquired $40,200,000 of shares as part of our current $60,000,000 buyback program. We increased our common stock dividend to $0.12 per share and $0.08 in the first and second quarters and $0.07 in the year ago quarter. And we completed our $92,000,000 redemption of all preferred stock. Please turn to Page 4. On OSG, we believe better banking is focused on fulfilling our purpose, mainly helping our customers, our people and our communities achieve their financial well-being. During the Q3, our customers will continue to demonstrate our agility by launching the 1st digital residential mortgage process in Puerto Rico. With one click and in just minutes, a customer can get a prequalification letter, access valuable information about the mortgage process and apply online all in one place. We also quickly processed our business for our PPP customers. We have now processed our business for 91% of first and 25% of second round PPP loans using our proprietary all digital system. We believe faster, better solutions like these show our retail and commercial customers the value of doing business with Oriental. Online and mobile banking 30 and 90 day utilization levels continue well above the pandemic levels. This continues to validate our long standing digital strategy and its growing acceptance by our customers and the market in general. For our people, we have decided on a mandatory COVID vaccination policy to keep our customers and people safe. We have also implemented a hybrid work model to increase flexibility for our people. And as we mentioned on the previous slide, we have increased the hourly base pay rate for non salaried staff. For our communities, Cash Global and Oriental closed on a $15,000,000 financing for a joint venture between cash and Puma Energy. This is enabling 200 Puma gas stations in Puerto Rico to install solar panels to produce and consume solar energy. This project is the first of its time and scale on the island. We have also been working on several new corporate social responsibility programs. One program launched in the Q3 is a farming developing program with the Puerto Rico Conservation Trust to help several communities achieve economic sustainability. We are extremely proud of these achievements. At the end of the day, there is nothing more rewarding than being part of a team that delivers on its purpose. This quarter's overall performance energizes us at OSG to work harder and to aspire for more. Now here is Maritza to go over the financials in more detail. Thank you, Jose. Please turn to Page 5 to review our financial highlights. Total core revenues were $135,000,000 That is an increase of about $1,400,000 or about 4% annualized in the 2nd quarter. This is a result of consisting of $1,800,000 decline in cost of funds, a $1,000,000 increase in core non interest income and $800,000 increase from cash and investment securities and $730,000 as a result of one additional debt. This more than offset a $2,000,000 decline from TCG loans and a $700,000 loan repayment that benefited fee income in the 2nd call. The TCV decline was due to a combination of lower volume, mainly from modest takedowns and lower rates. Non interest expenses totaled $79,000,000 based on decrease of $8,800,000 from the 2nd quarter. The 3rd quarter included a $2,200,000 benefit in credit related expenses. This was mainly driven by gains from some capital expenditures. The 2nd quarter included a $2,200,000 cumulative project write down. The Q3 also included a combination of increased compensation from our lease costs and our previously announced cost savings. Overall, we continue to see recurring operating expenses in line with our previously announced plans for the year. Higher revenues and lower net interest expenses resulted in increased operating leverage. Efficiency ratio improved to 58.6%. 2% in the 2nd quarter. Our goal is to continue to improve our efficiency ratio to the mid to lower 50% range. Recenter on average assets was 1.6%. Return on average tangible common equity was 70.7%. We continue to build capital. And your book value per share was $18.59 This is an increase of 3% from the 2nd quarter. Please turn to page 6 to review our operational highlights. Average loan balances totaled $6,500,000,000 That is a decline of $133,000,000 from the 2nd quarter. This was due primarily to residential mortgage pay downs and PCC loan conditions. In turn, this was partially offset by new commercial and auto loans. The change in mix resulted in a 7 basis point decline in loan yields. Higher levels of residential mortgage breakdown reflected increased liquidity on the part of consumers. Our residential mortgage portfolio consists of legacy for the entire mortgage loans and mortgage loans from BBVA and Scotiabank acquisition. Total new origination was $556,000,000 that is down $85,000,000 from the 2nd quarter, but it is up $109,000,000 year over year. We believe we are continuing to see generally expense trends in mortgage, commercial and out. We continue to see increasing demand from commercial launches and business operations with the new stores and warehouses buying inventory or making acquisitions. Commercial portfolio annual period balance activity has increased 2 consecutive quarters. Average for the $9,100,000,000 a return increase of 1.6 percent and $103,000,000 from the 2nd quarter. Increases in non interest bearing accounts, savings accounts and now accounts were partially offset by the declines in customer savings. Core deposits continued to fall. They were 30 basis points in the first quarter, that is a reduction of 8 basis points from the Q2. This reflects general rate reductions and the continued maturity of other higher priced CDs. As a result of the increase in deposits, average expenses totaled $2,700,000,000 that is an increase of 7% or $180,000,000 from the second quarter. The average investment per quarter was $715,000,000 that that increased $106,000,000 or 70% from the 2nd quarter. That includes the partial impact of $250,000,000 of MBA purchases at the end of the quarter, taking advantage of market conditions. Net interest margin was 4.12%, a decline of 10 basis points from the 2nd quarter. The increased amount of cash reduced NIM by 6 basis points. Our current strategy is to continue to look for opportunities to deploy excess liquidity to lending, capital actions and investments. Please turn to Page 7 to give you our credit quality and capital strength. Asset quality metrics continued to be positive. Our net charge offs were 37 basis points. 3rd quarter net charge offs of $6,000,000,000 included $6,500,000 for a previously reserved amount on a commercial loan. The early and full delinquency rates were 2.06% and 1582 percent to 63%, some of the lowest levels in the last 5 quarters. The non performing loan rate of the non PCD loan portfolio was 1.93%, lower level in the last 5 quarters. As a result of all of these, provision for trade losses was a net benefit of $5,000,000,000 That reflects $4,300,000 of net fixed liabilities. Our allowance coverage was 2.82 percent on a reported basis and 2.88% excluding CPP loans. The CET1 ratio remains high compared to our U. S. Peers at 13.58%. Stockholders' equity was $1,050,000,000 a decline of $26,000,000 from the Q2. This reflected the horizon of the shares to First Stock Series B and the common stock price. A good portion of this was offset by the increase in pretrained earnings. Intangible common equity ratio was 8.86%. Now here is Jose. Thank you, Marisa. Please turn to Page 8 for our conclusion. As I mentioned earlier, we had a strong performance this quarter at all levels. Our performance and credit metrics continue to be equal to or better than Mainland peers. We executed most of our stock buyback program in addition to increasing our common share dividend and redeeming our preferred stock. Looking at the big picture, Puerto Rico continues to benefit from federal reconstruction and COVID stimulus. So the relative economic impact here is more meaningful than in other U. S. Jurisdictions given the size of our economy and average income. As a result, we're continuing to see incremental business sector optimism confirming Puerto Rico's economic revival. Our plan is to continue to take advantage of our momentum in this improved economic environment. We intend to deploy excess liquidity for loan growth and or capital return initiatives. We also intend to accelerate the speed of our transformation, further simplify operations and improve efficiencies, all part of our effort to serve customers faster and better while helping them achieve their financial well-being. We at ORG are more than ready. Thanks to all our resilient team members for their continued dedication and commitment. This ends our formal presentation. Thank you for listening. Operation, please begin the question and answer session. And we'll take our first question from Alex Twerdahl with Piper Sandler. Please go ahead. First off, Jose, I was hoping you could give us a little bit more color on what you're seeing in terms of loan growth, So what happened and I guess really I'm most interested in commercial, but also would be interested in some of the other categories. What happened during this quarter in terms of things like line utilizations? Is there any construction component in there? And what sort of pipelines look like heading into the last 3 months of the year? So first of all, Alex, I think when you look at on the commercial side particularly, we need to think about loan growth looking at several components. You have alluded to some of them. Number 1 is certainly production and our production levels continue to remain strong. So we feel optimistic with what we have accomplished so far, certainly in terms of our commercial portfolio and how we've grown that vis a vis last year and vis a vis 2019. So clearly, our scale and the acquisition that we did at the end of 2019 is adding additional capabilities for us to have higher production. In terms of pay downs, we certainly are seeing excess liquidity in the market and we are still seeing higher levels of pay downs than we've seen in years past and we expect that to maybe remain at this level for the rest of the year and hopefully we'll see some changes and progress on that next year. In terms of line utilization, it remains very low, again, due to the high liquidity levels that are right now in the market. So right now, we're probably close to 25% of the normal utilization on the lines. That's what we're seeing. And then lastly, the pipelines. I think when you look at our pipeline on the commercial side, we see strong pipelines. We see businesses getting ready for continued economic growth. And when you look at it all, I went through 4 components, right, production, pay downs, utilization and pipeline. Right now what I see today, positive on production, positive on pipeline, line utilization and pay downs are putting pressure on loan growth. I expect sometime in the 2022 to continue to see positive production and positive trends on pay downs and utilization so that with a strong pipeline, we can see loan growth. So I'm optimistic. I think what we're building today is going to pay off in the next several years as the economy becomes more sustainable in its growth. Great. Has anything changed in terms of your thought process around the mortgage portfolio? You had some pretty strong P and M sale on mortgage this quarter, but is there any change in the appetite to keeping on the balance sheet? So what we saw this quarter was a slower level of refis. So our production came in lower than prior quarters in this year, particularly because of a slower refinancing activity. But that also plays positively on the book, right? So instead of having $100,000,000 or so in repayments from the mortgage portfolio, we only had around 62, so give and take. And then on the fee side, on the mortgage expansion activities, we're also seeing that our servicing portfolio remains steady and we're getting good valuation on the servicing asset as well as the sales of our originations where we're generating good deals there. So I don't see a change going forward on that side. Okay. I'm switching gears a little bit to Doug Rex Capital. You guys announced the $50,000,000 share repurchase since the last conference call, which is great, maybe a little bit lower than some investors would have expected. But when you combine it with the $92,000,000 payoff in preferreds earlier this year and the dividend, does your total capital return for this year above what or potentially a total of 100% of earnings. Can you talk a little bit about sort of what the target capital levels are in terms of ComNet with Tier 1, you're still pretty elevated at the 2.5% and sort of what the appetite is for buybacks from here? And then considering that you've made pretty good headway through the $50,000,000 when we should expect or when we can expect that to be readjusted by the Board? So first off, you are correct. So we returned capital across the board this year above 100% of our earnings. So we're executing pretty aggressively on that side in 2021. When you look at 2022, we'll take a look at our capital activity and capital actions, potential capital actions in the January Board. So that's kind of the beginning of the year and we finished through the budget process, which we're in the middle of it right now and have a clearer picture on what the size of what we should be executing during 2022. Longer term, and again, we feel that we should not be going above 100% of our earnings, given the levels of CET1 that we have right now in the high 30s. But longer term, as strength in credit continue to inch closer to the peers in the state or peers in state, then our capital levels should not have much different from the operating capital levels that our peers in the U. S. Are operating on. So CET level closer to 11% or so, that's kind of a good target to have going forward. So I think we have good momentum on our capital actions. And the optimism that we're seeing in the Island, we want to continue to be confirmed. We want to feel more and more incrementally comfortable with that economic revival that we are each quarter seeing improve. And based on that, we'll execute on capital actions. But we are clear that, like we did before, we're buying our stock back at between 8x and 9x earnings. So that significant discounts from some not smaller peers in this case. And I think it gives very good returns for for shareholders to be buying that stock. Totally agree. Switching gears to the ACL. How should we think about it from here? You guys are still above your CECL day 1. By my calculation, net charge offs are now running well below where they were prior to that T Slim implementation. So kind of what's holding the reserve up at this point and what are the milestones to expect that ACL to drop lower? So let me take a big picture. And if I miss anything, Marisa will correct me and get into the details. The big picture is how we look at ACL is based on a methodology. And our methodology has several components, charges, so ground and the macroeconomic kind of scenarios and projections. Those macros still have risk embedded in it and for Puerto Rico, it's just a bit. It's got COVID and it's got all the issues referring the coming out of the bankruptcy on So from our side, the macroeconomic scenarios still have some embedded risk in it that are preventing us from releasing some of that coverage that we have, that we serve that we have. Also, I think we do also have a higher proportion of co loans, and I mentioned charge offs. We're having right now net recoveries. And I don't we don't think that we should be looking at our ACL from the current state where we're seeing a net recovery and that we project going forward. That's not sustainable longer term. So we will have certainly a level of charges at some point in time on our consumer portfolios. Will they be back to what they were prior to COVID? We don't expect that. We expect the trends to be completely consistently more positive or better than what we saw in 2019 before COVID. We also think that those portfolios will stabilize and start showing some levels of charges at some point in 2022. So that's kind of our big picture. Anything, Maritza? I think the essence of what we're doing right now. So it sounds like from what you said on the macro side that if we keep the bankruptcy resolution by the end of this year, and it seems like you're getting pretty close to that, correct me if I'm wrong, then we can see that at least the piece of the equation change favorably in the next quarter. Yes. I mean, that's one of the components. It's pretty noisy. I mean, if you're here on the ground, there's a lot of noise regarding that. And the political processes are also uncertain. So that's kind of how we see it, Alex. But at the end of the day, I think it's a good problem to have. Agreed. So then talking about the NIMs a little bit, I was hoping Mauritza, I'm not sure if you said in your prepared remarks if you had the impact of PPP fees in the Q3 and then also what remains of PPP fees that is yet to be recognized? Well, yes. For this quarter, I will talk about the net impact of this year because at the end, we did have higher fees for the quarter. It was about $1,300,000 but it was offset because of volume factor. We have lower balances there and that VGA and the net impact of VGA within the NII will be about 4 $100,000 So volume factor mitigates a little bit increase in the fees. And I don't have the on amortized portion here with me. But as Jose mentioned, a big portion of the previous year's round program was 95% has already been paid off. So it should not be significant amount that is remaining on the books because mostly it's a second round That was lower than the first one. Okay. And then, I missed what you said about the mortgage backed security purchases you just mentioned in the quarter. Do you say it's $250,000,000 of mortgage backed securities. And if you can talk a little bit more about that? Yes. By the end of it was mostly during September that we did the acquisition. We take advantage of higher rates in the market, and we acquired 250 NBL. Okay. And then in terms of the when I look at the balance sheet, I still see over 20% cash. What's your appetite there? And just how willing like how much of that are you willing to ladder out in the next, probably, 6 to 12 months? It's all being opportunistic about how interest rates fluctuate from here and throughout the next several quarters. We recognize that we have excess cash, but at the same time, we don't want to kind of go long on mortgage backed securities with low rates. So when we see an inching up of rates, we go in into the market and buy some. As we see interest rates trending upwards, we will be more consistent in our purchases of MBSs going forward. We also want to make sure that we think deposits will stabilize. We had a good increase in deposits again this quarter, which is good for us, but we need to kind of feel more comfortable also on how is that going to play out next year as COVID seems to start to flow out and what is the need on businesses to use that cash. So we just want to be careful there too. But I agree with you, we have a significant portion of our balance sheet in cash and we need to kind of put it to work sooner rather than later. And then on the same sort of lines and deposits, time deposits, you saw some, I guess, some flow out. Can you just remind us what's maturing in the Q4 and into next year in terms of time deposits to see if you reprice lower? Yes. For this half quarter, it's about $100,000,000 that will mature. Next year, it's about $400,000,000 So that's the runoff of the portfolio. So the biggest thing, do you have the rates of reserve? Sorry, Alex. I was speaking when you started. Sorry, I need you to repeat the question. I was just asked what the rates were on that $100,000,000 in the 4th quarter and the $400,000,000 next year? Well, for the Q4, it's about 80 basis points. Maturity. Next year, it's lower. It's about 75 basis points in average for the year. And we see those CV much being replaced at 30, 35 basis points. That is the average cost that we have for now. Okay. Just a couple more questions that I had just in terms of modeling. Fee revenues, it looks like the banking service revenues have stabilized a little bit over $18,000,000 since we don't really have a clean quarter post Scotia. So is that $18,000,000 is that the right level to use? Yes. We certainly see businesses and consumers having more activity and after COVID and Puerto Rico's COVID situation has turned extremely positive after the vaccination. So what we're seeing is opening up of the economy, we're seeing more activity and therefore banking fees are kind of leveling at the $18,000,000 a quarter. We do have some seasonality in some of the quarters throughout the year, but in terms of activity, but we feel that $18,000,000 is a good number. And then finally on expenses, Maritza, you talked about sort of the recurring expense being in line with previous expected expense levels. Can you just remind us what the when you talked about that guidance, exactly what it says? I think in your prepared remarks, you said that expense levels were consistent with previous expected interest levels or something along those lines. And I was hoping you could just remind us in terms of the run rate for expenses, how you guys are thinking about the run rate from here? Yes. Well, the recurring operating expenses, we see them between $79,000,000 to $80,000,000 worth a quarter. But keep in mind that we will continue to invest in technology and developing the digital transformation. But we still think that we will be able to absorb those incremental. So run rate right now is almost $80,000,000 to be in the baseline. Most of my questions have been answered, but let me give you 3 and they're somewhat related. You talked a little about your transformation and accelerating the speed. Can you talk about that? And the customer facing technology, which I know is very important to you, what and some of the changes, what is working well and what isn't. And related to that, you've mentioned acquisitions before. How would it play in given that you have excess capital and 20 exec? Well, thank you for the question. Regarding our transformation that I mentioned in my remarks in terms of what we're trying to achieve is basically trying to make sure that we focus on the customer experience, trying to be more agile and faster on how we serve our customers and certainly bring them added value to help them achieve their goals, right? So that's very general. But at the end of the day, everything that we're doing in terms of our people, in terms of our digital strategy and in terms of our how do we analyze the data that we have to actually make a difference and be able to serve our customers better and differentiate ourselves against the local competitors. That's kind of the transformation and that transformation requires that not only the front end of the equation is agile fast and C, it requires also that the back end too. And as you probably can understand, it's harder to push the track to the speed of the front. So to me that's the biggest challenge we have and we're pushing hard. And again, we see that also in terms of our business model and how do we continue to transform our business model to be different and add value to our customers and the customer experience on the commercial side as well as on the individual side. So that's what I'm referring to. And in the process, we will also be kind of changing and transforming our distribution. And it's not a the approach is not a traditional branch model. So we've got several other components that include technology as the integral part of that distribution model. And that's kind of how we're seeing that. So that's what I'm referring to and that's why Marissa mentioned about the investments that we're making. So what we're trying to achieve here in terms of efficiency too is how do we kind of make the right investments in the transformation that we're trying to achieve as well as keeping expenses under control and trending lower. So that's the answer for the first question. The second question, I don't recall exactly what you're asking. So if you can repeat, I'd appreciate it. Then the third question, you asked something about acquisitions and looking into future acquisitions. Well, the market here in Puerto Rico is already being consolidated. And as you know, we were an important part of that. We finished the acquisition of Scotia and the integration of Scotia already. And the scale that we have now is showing on the production side of the loan book and as well as on the deposit side. So we do understand that our growth coming in Puerto Rico is going to be coming from our larger scale and the positive economic momentum and our ability to differentiate from our competitors. So I forgot, forgive me for the second question because I don't recall. No, I think you got the second question, the first and second together because it was transformation and technology and I think you answered them both at the same time. And it does appear that there are no further questions at this time. I will turn the call back over to May for any closing remarks. Thank you, operator. Thanks again to all our team members who have helped our customers through the pandemic and worked so hard. Thanks to our stakeholders who have looped in. Looking forward to our next call. Have a great day. And that concludes today's program. Thank you for your participation. You may disconnect at any