Good morning. Thank you for joining OFG Bancorp's conference call. My name is Lori, and I will be your operator today. Our speakers are José Rafael Fernández, President, Chief Executive Officer, and Vice Chairman, and Maritza Arizmendi, Executive Vice President and Chief Financial Officer. A presentation accompanies today's remarks. It can be found on the investor relations website on the homepage in the What's New box or on the Webcasts, Presentations, and Other Files page. 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 any background noise.
After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Fernández.
Good morning. Thank you for joining us. Please turn to page three. First, I would like to thank all our team members for their dedication and commitment during these very challenging times. Like other banks, we faced a number of COVID-19 related challenges during the second quarter. For us at OFG, the pandemic also followed the earthquakes we experienced in January and occurred while we were in the process of integrating the Scotiabank acquisition. Certainly no small challenge. By acting quickly and with foresight, we produced excellent results for our customers, communities, and people, and continue to help them build better financial futures. In March, governments in Puerto Rico and U.S. Virgin Islands shut down businesses and personal activities. Restrictions were eased in late May, but recent spikes in new cases have forced Puerto Rico to reduce some of the flexibility.
The Federal Reserve Bank cut rates 150 basis points in March following the 75 basis points reduction in the second half of 2019. Our commitment and preparation enable us to successfully manage these challenges [Non-English content] easy, fast, done, as we say at OFG. All our branches operated safely throughout the quarter, enhanced by our technology platform. Our full-service ATMs and ITMs, mobile app, and online bill paying tools facilitated routine transactions in a contactless manner. Online and mobile appointment scheduling helped make COVID-safe customer meetings possible at branches. We deployed 100% digital client-friendly application and funds disbursement process for PPP loans. About half of our team members are still working remote.
We also implemented extensive new safety protocols for our customers and people on-site, and we continue to offer new benefits for our people, such as free COVID on-site testing and daily online health check-ins, as well as incentives. The results speak for themselves. We provided high levels of customer service, safety, and knowledge throughout all channels. Loan production in the second quarter totaled more than $500 million. Customer deposits increased $760 million. Our online loan deferral tool and call centers processed relief for more than 44,000 retail customers. We reduced higher cost wholesale funding, maintained a strong level of net interest margin, and continued to build liquidity and capital. We secured $100,000 in Federal Home Loan Bank of New York grants to support local, nonprofit, and small businesses in Puerto Rico and the U.S. Virgin Islands. Please turn to page four.
We have continued to see strong technology utilization trends among both our retail and business customers since the beginning of the year, and in particular since March. Online bill pay enrollment were up 12% as of March and 24% as of June. Mobile banking users jumped 17% by the end of the second quarter from the beginning of the first. The number of remote deposit capture users are up 68% from the end of March. In another area of success for us, during the second quarter, we scheduled more than 18,000 COVID-safe appointments with our customers through our online and mobile tool. We are very pleased to see these trends. Technology is a core part of our overall corporate strategy. We continue to look into new ways and innovative ways to use it to help our customers. Please turn to page five.
Looking at our SBA PPP Program, we continue to exceed our market share in Puerto Rico. We generated a total of $286 million in new loans. This enabled us to help more than 4,000 small businesses save more than 50,000 jobs. It also enabled us to attract new accounts in this strategically important customer base. We were able to distribute these funds electronically within five days of application approval. This is a great example of our ability to act quickly in response to changing conditions to the benefit of both existing and new customers, and the communities we serve. Let's talk about our results on page six. We reported EPS of $0.39 and $0.37 on a non-GAAP basis. Total core revenues were $128 million. Most of that was due to a large increase in interest-earning assets, chiefly loans and cash.
This was partially offset by a decline in yield due to significantly lower rates on cash and lower yields on variable rate commercial loans. In addition, we have lower investment security balances. As a result, we generated net interest income of $105 million, with a net interest margin of 4.78%. Banking and wealth management revenues totaled $23 million. Non-interest expenses were $86 million, primarily due to the addition of the Scotiabank acquisition. Second quarter results included several items: $9.5 million in revenues from Scotiabank interest recoveries and bargain purchase gain, we added $5 million in provision for the pandemic, and within non-interest expenses, we had a $5 million in merchant and restructuring charges and COVID-related operating costs. Please turn to page seven.
The effects of these results is that we're building tangible book value, and our return on assets and return on equity continue to improve sequentially from the fourth quarter. Please turn to page eight for operational highlights. Average loan balances increased 52% year-over-year and 2% quarter-over-quarter. Average core deposits, excluding brokered, increased 76% year-over-year and 5% quarter-over-quarter. Loan generation was strong. Increased production from PPP and other commercial loans was partially offset by reduced production in our retail categories, primarily due to the economic shutdown. We ended the quarter with good momentum and good pipelines in the mortgages and auto businesses. Loan yield at 6.97% continued to hold up well despite the recent Federal Reserve cuts. The cost of core deposits declined four basis points year-over-year. Net interest margin declined to 4.78%.
Please turn to page nine to review credit quality. The net charge-off and non-performing loan rates declined year-over-year and quarter-over-quarter, reflecting loan pay downs and the effects of deferrals. Provision for credit losses of $18 million was level with last year. I'd like to note the year-ago provision included an extra $9 million related to loans transferred to held for sale. Please turn to page 10 to review our loan deferrals. After disruptions in economic conditions caused by COVID-19, we offered several loan payment deferral programs ranging for one to four months. As I've mentioned, we've enhanced this effort by quickly developing unique and first-to-market digital tools to help consumers apply for forbearance on an individual basis. Our online loan deferral tool and call centers processed relief for more than 44,000 retail customers.
In total, we have about $1.4 billion or 32% of our retail loans on deferral. The pace of retail requests is significantly slowing. In addition, we have about $685 million or 26% of our commercial loans on deferral. Please turn to page 11. The allowance for loan and lease losses of $233 million increased $17 million year-over-year, and we have almost double the level of reserves from December 31st, 2019. Compared to March 31st, 2020, the allowance increased $2 million. Excluding SBA-guaranteed PPP loans, second quarter 2020 allowance was 3.49% of loans, eight basis points higher than the first quarter. Please turn to page 12. We are in a strong capital position. Our CET capital ratio, as you see on that slide, at 12.03%, is up 112 basis points since last year. Please turn to page 13.
While we still face much uncertainty regarding COVID and the economy, we are in a strong financial position, ready to help our customers during these trying times. Once we get through this, Puerto Rico stands to benefit significantly from COVID stimulus and still unspent and undistributed Maria and earthquake-related stimulus programs. At OFG, we believe our results and our history demonstrate our ability to quickly respond and adapt to changing economic environments. During the second quarter, we continued to build momentum in our core businesses and develop a good pipeline of new loans. From a liquidity, capital, and balance sheet point of view, we are well-positioned both financially and strategically. Our agenda going forward is clear. We plan to continue integrating the former Scotiabank operations and finish by the end of this year.
At the same time, we must achieve the full benefits of the acquisition by the end of 2021. We also plan to continue to invest in the future to further simplify our operations and enhance our ability to serve customers. Ultimately, we intend to continue to play a significant role in the recovery in Puerto Rico and the U.S. Virgin Islands. Again, I want to thank all our team members for our excellent results and for their dedication and commitment throughout these trying months. Crisis bring out the best in people to help others. Our people demonstrate that with purpose every single day. With this, we end our formal presentation. Thank you for listening. Operator, please open the call for the Q&A session.
Thank you. At this time, I would like to inform everyone, if you would like to ask a question, please press star, then the number one on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue, press the pound key. Once again, to ask a question, please press star one. Your first question comes from the line of Alex Twerdahl of Piper Sandler.
Good morning.
Good morning, Alex. How are you?
I'm well, thanks. Just to start off on the reserve and the provision, maybe you could help us kind of just break down the provision for this quarter and the $5 million that you put aside for COVID. Was that related mostly to a change in the Moody's S3 scenario, or was it related to internal downgrades of credits related to COVID? How should we be thinking about that?
I'll give you a high level. I'll let Maritza answer you in more detail. We actually have the S3 Moody's scenario. We have kept that S3 Moody's scenario, and we feel that the COVID-19 has proven to be extremely uncertain across the globe, and we feel that here in Puerto Rico is no exception. We decided to keep the S3 Moody's as the scenario where we drive our provisioning. That's the big side of it, the big picture of it. I'll let Maritza give you the details on the rest.
Hi, Alex. Regarding the additional $5 million, as José mentioned, we keep the Moody's S3 scenario. We also evaluate the old qualitative adjustment that we did during the last quarter. We update them, as a result of that, we added $5 million in the retail portfolio mostly, based on most recent information, that's the $5 million adjustment for the COVID-related provision.
Okay, it was retail-oriented mostly. I'm just kind of curious if there was a specific factor in retail that you're looking at, just kind of thinking about the amount of stimulus money that's flowing down to the island and seeing the deposits really balloon at you and some of your peers.
Yep.
It seems like the retail might be in better shape today than they normally would without that stimulus. Kind of how should we think about how you're expecting the retail portfolios to perform?
Yeah. I think the assumptions that you pose are correct. There's certainly a stimulus flowing down from COVID and still from Hurricane Maria and the earthquakes, and that's going to play out. I think there's a portion of it that will play out on the short-term. We would like to see the deferred program end, as it ended in June 30th. See how the retail portfolios behave forward to feel more comfortable on the scenarios. I agree with you. Longer term, we just think that it's hard for us to pinpoint how the economy is going to be doing in the next six months. We do agree that the economy, with the stimulus and all the items that you mentioned, should have a good momentum on a more longer-term scenario.
We will update as we see and feel more comfortable with the data on the credit side.
Great. You guys have done the full reviews at this point on all your commercial customers and gone through and, of course, if there's something that you saw, you would have added to the reserve this quarter.
Yeah. On the commercial side, I can tell you that we are keeping a close eye on different industries, but particularly on the hospitality. That's the industry that we are most focused on in terms of the effects of the COVID-19 pandemic. Right now, most all of the deferrals on the large and middle market commercial portfolios ended on June 30th. We just have 12 loans on the hospitality that asked for three additional months. We feel positive about our commercial portfolio on the middle and large commercial portfolio. We also feel good about our efforts on the small business side and how we're monitoring those. Again, we're okay on that side, and we're happy to see commercial clients coming back as they are.
Again, when we look at the provisioning, we felt that on the retail side, the effects of the pandemic are still quite uncertain, and we don't know how the government is going to react to the recent spikes.
Understood. Just to switch gears a little bit and looking at expenses, if you kind of back out the COVID adjustment as well as some merger expenses, you get to kind of like an $80.5 million run rate for expenses. Is that the right run rate to use going into the third quarter? I guess, where's the starting point, and then as you near the end of the integration of Scotia, where do you expect expenses to end the year and start 2021?
On the expense side, remember, the second quarter has lower activity. We're showing lower cost of transactionality, of the lower transactionality that we're seeing from the customer. As the economy picks up, we expect those expenses to come back up. On the other hand, we started the efforts on extracting the savings from the Scotia acquisition in this third quarter. We're very cautious simply because of the environment in terms of the COVID. We are going to see some benefits from those efforts. We feel more comfortable giving you comfort on us extracting the 25% cost saves from the acquisition by the end of 2021, because again, we're operating in a different environment than normal. That's kind of the best I can give you, Alex, on the expenses.
I really think that we are in good shape there as we are executing on our efficiencies, albeit at a slower pace than we anticipated given the COVID-19.
Okay. Thanks for taking my questions.
You're welcome, Alex. Thank you for your questions.
Your next question comes from the line of Glen Manna of KBW.
Hi, good morning.
Good morning, Glen.
I just wanted to discuss the NIM for a minute. Maybe if we could talk about what portion of the quarter-over-quarter decline came from excess liquidity and what portion came from rates and PPP. If you could discuss it in the context excluding the interest rate recovery, that would be helpful.
Including the interest rate recovery, you said, Glen?
Right.
Oh, yeah.
Excluding. Right. Excluding.
Okay. Now I understand. All right. I'll let Maritza answer that one.
Hey, Glen. Thanks for your question. In general, the 44 basis points reduction, excluding the recovery, we have done several assumptions regarding how much cash we will keep going forward. In general, our assessment is about one-third, about 15 basis points relates to the cash balances that we hold within the quarter, and the balances that we added in the PPP loan program. It's about 15 basis points.
That would be one-third from excess liquidity and two-thirds of the drop was on rates?
Because cash balances, as you know, were impacted because of the Fed rate cuts and also the portion of the commercial portfolio that is indexed variable rates that we have around 52% of the commercial portfolio is variable. We are expecting that this quarter already have the full effect of the Fed cuts. Going forward, we are expecting a more stable type of NIM as we will see during the third quarter the full effect of the PPP loan program in the loan yields, but also we will experience lower cost on borrowings as they continue to mature during the third quarter.
Right. I was looking at the repo balances, and it looked like on an average basis, they were still in there, but on a spot basis, you've taken off all the repos?
Yes.
Mm-hmm. And on the-
Glen, we still have some maturities coming in the next several quarters and into 2021, but we'll use the excess liquidity to cancel them.
Okay. On the PPP loans, what was the average yield you used in the quarter, and what's your expectation on forgiveness for those loans going forward?
I'll talk to you about the expectations on forgiveness, and I'll let Maritza talk about the yield. On the forgiveness, we're still expecting the federal government to give more guidelines on the forgiveness. We feel that there is a large proportion, more than 80% of those loans that will be forgiven. It's hard for us to pinpoint when that will occur, but we are more of the opinion that there's going to be a larger percentage of our PPP loans that will be forgiven. On the rate, I'll let Maritza.
Yes. The all-inclusive yield, including the amortization of the fees, we are expecting to be around 2.95%- 3% considering the life of the loans. Also remember that, as José mentioned, if they are repaid before maturity, we will be able to recognize the unamortized portion of that fees.
Okay. You're using the level yield method?
Yes.
Okay. On the deferrals, with some of them beginning to roll off, have you got an idea of what re-deferral rates are or re-deferral request rates?
It's too early to tell. We're not seeing that much activity on, as I mentioned, on the large and middle commercial so far. Where we're focusing are more on the hospitality industries. On the retail side, it's too early. It's been three weeks into the third quarter. We'll be able to update later in the next quarter's call. The first indications are positive for sure, but at the end of the day, it depends on how it plays out at the end of the third quarter, when you have the full effect of the end of the deferrals. How many ask for an additional deferral program or process, or how many come back to pay.
Okay. Thank you for taking my questions.
Yep. You're welcome, Glen.
Once again, if you would like to ask a question, please press star then the number one on your telephone keypad. Your next question comes from the line of Joe Gladue of Alden Securities.
Yeah. Good morning.
Hi, Joe. Good morning.
Morning. Just one quick question. Just wondering if you could give us, since the economy started opening up a little bit more late in the quarter, just wondering if you could sort of walk us through some of the trends you're seeing in the different lending markets, mortgage, and auto, and whatever.
Sure.
As...
Yep. We're seeing good momentum on the mortgage lending business. We have good pipelines there. Same with auto. We're also seeing good pipelines there. Obviously, that's a reflection on the one side. We're doing around 50% on the mortgage side, we're doing 50% is refi. There's 50% that it's purchase in terms of buying a home. That's actually encouraging for us. We're seeing some more residential activity, and that's extracting the benefits of the Scotia acquisition, which they had an important servicing portfolio as well as a more significant residential mortgage operation. We're happy with that. We're seeing that pipeline coming through. On the auto side, we are seeing higher new car sales, and that's translating into more volume for us also as I'm sure for the rest of the market. Those are the two main ones.
We're not seeing much yet on the consumer lending side, meaning on the installment lending side. On the commercial side, we're building a pipeline, but it's still below the trends that we've had before the pandemic. There's still some cautiousness from business people, and the uncertainty still can be felt across the different industries. We're seeing that in our commercial side, on commercial lending side.
All right. Well, thank you. That's it for me.
Thank you, Joe. Have a good weekend.
Once again, if you would like to ask a question, please press star one. I'm showing no further questions at this time. I will now return the call to management for any closing. I'm sorry, you now have a follow-up question from Alex Twerdahl of Piper Sandler.
Hey, you almost couldn't make it, Alex.
Yeah. I pressed the star one. I don't know, it didn't register the first time.
That's okay.
I was just looking at slide five here on the PPP, and just specifically the bullet where it talks about attracting new clients and strategically important small business segment.
If you can maybe expand a little bit on that, obviously it's meaningful enough to put it as a bullet here, but kind of what the opportunity could be, how big that is, that kind of stuff.
Yeah. For us, that's always been a focus on the small business side. We've been, for the last three or four years, incrementally doing more business in that segment. PPP gave us a great opportunity to act quickly, to be agile, and to deploy our technology and deploy our processes to be there for our customers. We got great reviews from our customers throughout the PPP process, and the fast and agile way that we disbursed the funds, particularly in the middle of the lockdown that we were operating in, which no other state or any other jurisdiction in the United States had a situation like that. I have to tell you, the results from that program have given us quite good momentum in that segment and excellent credibility by being close to our customers, but also reputationally. We're benefiting from that slowly but surely.
It's not gonna move the needle from your perspective in terms of the results at the end of the day. For us, it's important, be close to the communities and our team on the retail channel, Put their heart out, and they demonstrated what living a life with purpose at Oriental means. I'm really proud of that, and that's why I wanted to highlight that effort.
Great. Thanks for taking my follow-up.
You're welcome, Alex. Have a good weekend.
Once again, if you'd like to ask a question, please press star one. You have a follow-up from Glen Manna of KBW.
Hi. I just wanted to ask a question on the ACL. I think when we look at your competitor that reported yesterday and you guys, we've seen some stability in ACL to loans versus last quarter. Could you talk about what's kind of giving you comfort with that level? Some of the banks on the mainland have talked about whether or not they expect continued reserve building in forward quarters, and maybe if you could just discuss that a little bit too.
Again, Glen, what I can tell you is that we're looking at this from a longer term perspective. We're not trying to figure out what's going to happen next quarter or next half of the year. It's very hard to predict. We're living in different times. It requires a lot of adaptation. It requires a lot of flexibility. From our operation, we are ready to tackle those uncertainties and those challenges. Going and trying to predict how is life going to be in the next three months, it's really difficult. I say this in terms of your question because when we look at the different scenarios that we review to determine the provisioning, we want to be cautious, and that's kind of why we feel more comfortable with maintaining the Moody's S3.
The good thing is that we have a resilient bank, a fortress balance sheet that gives us the opportunity to build for the long term in a market that is a three-bank market. We have a great opportunity here to do the right thing longer term. We're not interested in trying to figure out how close am I, or are we to pinpointing the next quarter or the following quarter. We're here to do the longer term and to make sure that we win this long road. Sorry for my long-winded answer, but I can't give you specific on any of the numbers that you're inclining to get.
I appreciate what you did give. Just I wanted to follow up on Alex Twerdahl's question a little bit. You guys have been considered a challenger bank on the island, high digital. When you look at some of the numbers of your customers that are moving into using more digital platforms, I mean, it's no secret that Puerto Rico has lagged the mainland in some of the adoption of digital. Is COVID kind of pushing down that wall? There's a feeling that once customers start depositing a check online, they don't go back. Is this really an opportunity for Puerto Rico to push past that kind of resistance that may have been there before?
You're hitting on the nail. We've been in for the last 10 years, actually more than that. We've always said technology. Now the pandemic is forcing the speed of adoption at a higher speed. I think that plays completely into the strategy that we have deployed in the last several years. Again, we are showing you those charts, particularly because of what you mentioned, which is, yes, the pandemic is accelerating adoption here in Puerto Rico.
Having said that, though, we do have a great opportunity, but we also have to do what we need to do in terms of continuing to invest in technology, continuing to finding ways to do things more fast, agile, and proactively for our customers, because at the end of the day, we have great competitors here in the island with great resources and we need to do what we need to do. It's exciting for us. Again, our teams are all focused on how to achieve that and pull out the benefits of having a strong balance sheet, resilient bank with a culture that is proactive, that is agile, and is looking to do more simple things for customers. Again, the journey continues and that's what gets us up every morning to come to the bank or to stay at home remotely, but work for the bank.
I can't repeat how exciting times we have ahead of us in spite of the short-term pandemic we're operating in. I can't underestimate the tremendous amount of work and dedication our teammates are putting during this pandemic and all throughout the last three or four years, but particularly in the last three or four months. Again, I'm optimistic of the future and cognizant of the uncertainties of the short term and looking forward to continuing that path.
Okay. Thank you.
Thank you, Glen.
At this time, there are no further questions. Mr. Fernández, are there any closing remarks?
Thank you, operator. Thank you also to all our stakeholders who have listened in. Our concern goes out to those who have suffered from this pandemic. Our hope is that it ends as soon as possible and that everybody stays safe and healthy. Thank you again, and have a nice day and a great weekend.
Thank you. That does conclude the OFG Bancorp second quarter 2020 earnings conference call. You may now disconnect your lines and have a wonderful day.