Earnings Call: Q2 2019

Jul 22, 2019

Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Maria, and I'll be your conference operator today. Our speakers are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman and Maritza Arismendi, 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 OFC'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. We also direct you to the explanation of non GAAP measurements that are included in our presentation and news release. All lines have been placed on mute to prevent 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. Fernandez. Good morning. Thank you for joining us. Please turn to Slide 3. We are extremely pleased with our 2nd quarter results. OFG has continued to deliver on all fronts. Our levels of small business, auto and consumer loan production, core deposit growth, credit quality and capital and the number of net new customer growth all confirm the effectiveness of our differentiation strategies. As a result, we generated a 23% increase in earnings per share or more than a 3% increase in net revenue. And our return on assets, net interest margin and efficiency ratios are continuing at levels similar to the top performing peer Mainland Banks. Looking ahead, Oriental will further consolidate its position as the premier retail bank on the island with the recently announced acquisition of Scotiabank's Puerto Rico and U. S. Virgin Islands operations. Thanks to our entire OFG team for their commitment and dedication and to all our retail and commercial customers for their support and loyalty. Let's turn to Slide 4 to review our financial highlights. Net revenues increased 3.3 percent year over year to $99,000,000 The key driver was a 7.1% increase in net interest income. The efficiency ratio was 51.89%, a 260 basis point improvement year over year. We are increasing productivity, and this is enabling us to continue to invest in our operations without affecting our overall noninterest expense levels. As a result, earnings per share came in at $0.43 fully diluted, 23% ahead of a year ago. Tangible book value per share increased 6.7% to more than $17 return on average assets increased 25 basis points to 1.48 percent and return on average tangible common equity expanded 112 basis points to 10.32%. Please turn to Slide 5. There were 3 other items that affected 2nd quarter results. First, we sold $350,000,000 in low yielding mortgage securities in May, reducing $191,000,000 $63,000,000 of high cost repurchase agreements and broker CDs, respectively. The sale also resulted in a $4,800,000 gain. 2nd, we're selling $54,000,000 of unpaid principal balance acquired distressed residential mortgage loans. The sale is expected to occur in the Q3, taking advantage of improving market conditions in Puerto Rico. The decision to do so resulted in an $8,800,000 net increase in the acquired loan provision. 3rd, we incurred $1,000,000 in expenses related to our previously announced Scotiabank Puerto Rico and U. S. Virgin Islands acquisition. Please turn to Slide 6 to review our operational highlights. Total net loans increased 3.7 percent to $4,470,000,000 with the growth of originated loans at 8 point 5%, more than offsetting the continued pay down of acquired loans. Compared to the preceding quarter, originated loans increased 2.5%. Loan production has been picking up. 2nd quarter production totaled $327,000,000 Auto and consumer lending remained high at $136,000,000 $48,000,000 respectively, while residential mortgage lending totaled $22,000,000 Commercial lending at $64,000,000 reflected continued growth of small business customers in Puerto Rico. OFG USA added another $56,000,000 in primarily mainland small business commercial loans. Core deposit average balances increased 2% to $4,470,000,000 That reflects growth in commercial loans and customers as well as the success of our efforts to build a larger core retail funding base. The loan yield increased 25 basis points reflecting higher returns on originated commercial loans. This stem in part from the effect of Federal Reserve rate hikes last year, but also a larger proportion of higher yielding commercial and auto loans in the originated portfolio. Core deposit cost continued to remain relatively low, up only 16 basis points year over year. The end result was a net interest margin of point 37%, 14 basis points higher year over year. Please turn to Slide 7 to review credit and capital. Credit quality continued to improve year over year and from the Q1. We're seeing a clear, favorable improving trend with customers showing increased liquidity and stronger finances. The net charge off rate at 1.32 percent was the lowest in 7 quarters. Nonperforming loan and delinquency rates showed steady and or declining trends. Excluding the $8,800,000 related to the transfer to held for sale of distressed acquired mortgages Mentioned earlier, provisioning fell $5,800,000 year over year due to better credit trends and improving economic conditions in Puerto Rico. Capital continued to build. Our ratios increased across the board to new multiyear highs, remaining significantly above regulatory requirements for a well capitalized institution. Please turn to Slide 8 for our outlook. We are very excited about our current market position and how we view our strategic path taking shape in the future. Our strategies are clearly proving effective in growing loans, deposits and customers and improving productivity. With our strong team of bankers and the ongoing deployment of technology that benefits both customers and operations, our performance continues to demonstrate excellent momentum. As the economy began to show signs of recovery after hurricanes Irma and Maria and with our strong capital position building fast, we recognize the importance of effectively deploying our excess capital for the benefit of our investors. We believe we have done just that with our recently announced Scotiabank Puerto Rico and U. S. Virgin Island acquisition. Upon closing, Oriental Bank will become the 2nd largest bank in several important categories in Puerto Rico: core deposits, branches, ATMs and interactive teller machines, insurance and mortgage servicing, in addition to expanding to our neighboring U. S. Virgin Islands. This will strengthen our businesses by providing enhanced scale, the addition of Scotiabank's Talenta team and an improved competitive position as Puerto Rico's premier retail bank. As we have said before, the acquisition is expected to be significantly accretive, generating strong capital, thus increasing further our return on average tangible common equity. To sum it up, we're capturing the positive economic shift that we're seeing in Puerto Rico, building excellent momentum for growth now and more so in the future. With this, we end our formal presentation. Thank you for listening. Operator, please open the call for questions. Thank you. The floor is now open for questions. Our first question comes from the line of Brett Rabatin of Piper Jaffray. Hey, good morning everyone. Good morning, Brett. Good morning. I wanted to first ask Jose Rafael, what I saw that the CIO Portela resigned and the governor is not going to run for reelection. Can we talk about just the macro and how this is impacting Puerto Rico and what's going on with the recovery funds and maybe just some thoughts on the broader implications of the current events? Sure. So it's been a week and a half since the latest events have been developing. It's a fluid process as we speak. You heard last night the governor is now running for reelection and resigning to his own party presidency. So right now, it's too early to tell what the economic impact is. We are not seeing any impact so far. So from that perspective, that's what we're seeing. Longer term, if this situation is not addressed proactively by the leadership of the legislature in Puerto Rico, it could have economic consequences on the longer term. I am confident that level headed mines will prevail and confident that the legislature will assume their role and make the right decisions to stabilize the situation here in Puerto Rico in terms of political situation and let's get on with business. That's kind of how I see it. Certainly, it provides opportunities going forward to continue to achieve higher levels of governance, higher levels of transparency and focus on what's really important for the people of Puerto Rico, which is economic growth. And I view this, albeit uncertain on the short term, I see this as an opportunity also to execute on the right path for the future of Puerto Rico. And again, focusing on having a true governance and having total transparency and focusing on economic development, which is at the end what's going to bring credibility from Washington and from investors alike. Okay. That's a good summary. And talking about economic activity and you talk about market conditions continuing to improve. I see that June auto sales are actually up year over year. A lot of the other data is kind of mixed. Can you maybe elaborate a little further on market conditions? Is that purely on the credit side? Or are there other things that you would point to that are notable in terms of improvement? [SPEAKER JOSE RAFAEL FERNANDEZ:] So you mentioned auto. That's one aspect. Consumer strength continues to build. Certainly, our commercial client finances are stronger and that is clearly been seen in the last year or so, either growing and improving significantly. We're seeing more liquidity on the consumer side. And therefore, spending is seeing is steady and slightly growing. So, from our perspective and what we're seeing from our client base and what we see here on the ground is that the economy continues to benefit from the backwind of insurance funds, federal funds, as well as the rebuilding efforts that are being put in place. Okay. And maybe if I can just sneak one last one in. Just thinking about growth, is it fair to assume that the recent improvement continues? Or can you give us any color on what you see from the pipeline and just how you expect the back half of the year to unfold from a growth perspective? So Brett, may I clarify your question? Are you referring to growth, oriental growth or economic growth? Oriental growth, the loan portfolio. Yes, yes, yes. We're encouraged with what we're seeing, honestly. We see good pipelines on the commercial side. We continue to take advantage of the disruption going on in the auto portfolio or the auto market with the consolidation that occurred last year and we're seeing good opportunities there. We're very focused on the retail side and particularly on the small commercial businesses. What we're seeing is a good pipeline and we're seeing good opportunities with good credits. So we're encouraged by that. Our next question comes from the line of Alex Firdoll of Sandler O'Neill. Hey, good morning. Good morning. Hi, Alex. I just first wanted to drill into the provision a little bit. If you exclude that $8,800,000 that was specific to the loan sale, provision came down quite a bit down to $8,900,000 which is kind of much lower than the sort of the run rate you guys have been running at. You had charge offs were pretty much in line. Loan growth was pretty solid during the quarter and while NPLs declined, wasn't that huge of a decline. So I mean, can you talk a little bit about sort of the as it relates to some of the economic conditions that you've cited in the past, specific metrics etcetera, is this new level of provisioning or is this a new level of provisioning kind of $8,900,000 per quarter? Or is there something else kind of that we're not seeing that might be working underneath the surface that we should be considering? Yes. So Alex, from our perspective, a little bit of adding to what I already have mentioned regarding the economic conditions and the strength of the commercial clients finances, that is the reflection that you're seeing on the reduced provisioning. It is a reflection of a stronger economy and stronger balance sheets and certainly stronger consumers. As we go forward, we feel that as the economy continues to grow and we continue to we will continue to see improving trends. And that's what we will be looking at in terms of provisioning. We will look at the environment, we will look at the current credit performance and we'll provision accordingly. But we don't give a guidance in terms of provisioning going forward. Okay. So I mean kind of probably putting some words into your mouth. If everything kind of continues along the path as it has been, provisioning levels should be more similar to what we saw in the Q2 than the Q1 or prior? So, well, let me just repeat a little bit. We're very encouraged with what's going on. We're really excited about the growth prospects that we're seeing and that is directly related to how the economy is behaving as opposed to the last 10 years and how the strength of the commercial clients continue to build. And as to the provision going forward, we don't give a guidance, but it will reflect whatever the environment and our portfolio credit portfolio performs, we don't want to give a guidance on the provision. Okay. Understood. And then just talking a little bit about you said it improved market conditions prompting the loan sale. What metrics specifically do you look at for that? Is that just purely appetite for distressed loan purchases on the island? So remember, we sold residential mortgage loans. These are distressed that we acquired from BBVA. The way we monitor it, it has a couple of variables, but let's just share with you a couple of them 2 of them, which is one of them is demand. There is a higher demand for these type of assets in the recent months. And certainly, residential home prices have stabilized and started to show some upticks. So that's what kind of gave us a good moment to sell those or put them for sale and we should be closing in the Q3. Okay. So was the loan sale or any sort of reduction of NPLs, was that required by regulators or internally before you were able to announce the Scotiabank deal? No, no, no. This is something of our business plan and this is something that we are on the lookout every day if you think of it. We don't want to have non performing assets in our balance sheet. So if there is an opportunity that it's opportunistic and we feel it makes sense for us, we'll do it. If there is no opportunity for us and it makes more sense for us to work those loans out, we will work them out. It's an NPV analysis that we do. So it has nothing to do with anything related to the previously announced acquisition. Great. And then just final question for me. It looks like deposit costs kind of in several of the categories increased in the second quarter, higher than we've seen some of the increases at least in the Q1 and maybe kind of average over the last couple of quarters. Is that reflective of the whole market moving higher in Puerto Rico for deposit costs? Or is it more specific to OFG related to some deposit promotions that potentially were offered in the Q2? A couple of I think all of the above. I think on the term CD kind of market, there's a little bit more competition. Some of our competitors have in the past been somewhat more aggressive on the 1, 2 year, 3 year term. And we also saw a great opportunity for us to reduce our institutional funding. So when you see us growing CDs, it is because the cost of those CDs is lower than the broker CDs or the other type of institutional funding that we might use. So that's kind of the spirit behind it, Alex. It's a little bit of the market kind of addressing the market price, but also it makes sense to us to become to increase our core retail funding base through the CD market. Okay, great. Thanks for taking my questions. Yes, you're welcome. Our next question comes from the line of Glenn Manna of Keith, Bruyette Woods. Hi, good morning. Good morning, Mike. Good morning. I just wanted to get a little bit better handle on the NIM, obviously, with the average balance sheet and the timing of the security sales and kind of pay downs of the broker deposits. When I pencil it out, I would get an end of quarter NIM that was probably heading into the 3rd quarter about 10 basis points higher than the average NIM for the Q2. I guess, Mauritsa, am I thinking about that right? We don't try to forecast here our guidance in terms of NIM. We again, we look at the NIM relatively stable as we're seeing it in this quarter. But it's not too far from what you're saying, Glenn. Let's just put it that way. Okay. And when you think about the sales and kind of the buildup in excess cash that happened in the quarter, it looks like you're going to be holding some cash. Is that kind of getting ready ahead of the acquisition? Or could we see the possibility that you could sell down or pay down some more brokered deposits or repos? Glenn, we will be using that excess cash to continue reducing our dependency or our reliance on wholesale funding, broker CDs, repurchase agreement and just use our deposit, our main source of fund. Okay. And on the tax rate, it looks like a couple percentage points lower than we were maybe expecting over here. What can we expect in the second half of the year? Well, at the end, the effective tax rate came at 32 point something and we will see that as the effective tax rate for the effective tax rate for the next two quarters. Okay, super. Thanks for taking my questions. You're welcome. Our next question comes from the line of Joe Gladue of Alden Securities. Hey, good morning. Good morning. I'll just ask, at the end of the Q1, you had mentioned that there were some Hello? Hello, Joe? Yes. Yes. Joe, can you hear me? No. We could not hear your question. Okay. I guess on the at the end of Q1, you mentioned that there were opportunities for growth in Puerto Rico. And clearly we've seen that come to fruition. But you also talked about there being some potential opportunities on the mainland. Just wondering if any of those things are on hold or if you're still looking at some potential there? On the U. S, what we're seeing is continuing to deliver on our U. S. Loan strategies. As we mentioned earlier, I think in the previous investor call. We are at this point focused on getting regulatory approval for the Scotiabank acquisition and regulatory approval for the USVI side of it too. And then moving to the conversion and merger process. At this point in time, the U. S. Strategy remains the same, which is originating or lending into the small business and doing a few participations on a quarterly basis. All right. Thank you. Yes. You're welcome. Our next question comes from the line of Brett Rabatin of Piper Jaffray. Hey, just 2 follow-up items. 1, I wanted to follow-up on that on the OFG USA strategy and the loans that you booked this quarter, dollars 56,000,000 Can you give us some color on that? What industries? How many loans? Any color on the OFG USA strategies part 1? Yes. I mean, these are small commercial business loans. These are some mostly SBA loans that we are lending also over there in the States. And they are from a variety of industries. And they're smaller in the range of $2,000,000 to $3,000,000 or less. So that's kind of the description of the loans that we've done over in the U. S. In this quarter. Okay. And then secondly on expenses, can you give us some color on the back half of the year expenses that will continue related to the deal? I know you had $1,000,000 related in 2Q. What did that look like for the back half? And then thinking about expenses, I mean, you've held them flattish even down a little bit year over year. How are you being able to do that? And where are you investing versus being able to pull back on terms of expenses? Well, in general, Brett, we have only $1,000,000 this quarter related to the acquisition. If we exclude that, the performance in the expenses was better than expected in the sense that it keeps going down. We have been able to deploy a new technology while keeping our cost well controlled. And as we see going forward, we will keep we will see the expenses being leveled with this quarter. We cannot anticipate what will be the additional cost regarding the acquisition quarter by quarter, but we do know that there will come some expenses. So as we go by, we will see those expenses coming into the efficiency ratio. However, we don't see big ticket item at least in the ongoing basis. Also recall that most of the transactions expenses will also become part of the modeling that we did with the Scotiabank acquisition and the related merger one time expenses. Okay. And then just following up on that from Scotia. Just since that deal has been announced, what's been your experience in terms of thinking about the expenses, the franchise you're acquiring the opportunities to grow their book? So everything that we have modeled so far it's been as we speak being validated. And we're really excited about bringing in the team from Scotia later in the year. But Brett, we're right now focusing on what's really important, which is the regulatory approval process. And that's what our focus is. Certainly, we've had extensive discussions with the Scotia team already and we're collaborating as we speak as much as we can before regulatory approval. Okay, great. Appreciate the additional color. Yes. Thank you. Our next question comes from the line of Alex Twerdahl of Sandler O'Neill. Hey, just wanted to see if you guys wanted to get on the record with any preliminary expectations for CECL? Well, at this point, Alex, we are very advanced in the process. And what we're seeing is that probably for next quarter, we will be able to provide you some specific or more specific regarding the possible impact of CECL next year. Fantastic. We'll be looking forward to hearing that. Thank you for taking my follow-up. There appears to be no further questions at this time. I would like to turn the floor back over to Mr. Fernandez for any additional or closing remarks. Thank you, operator, and thank you, everyone, for listening in today. We'll be at the KBW conference on July 30 in New York. We'll be coming back to you on a conference call for earnings late in October when we report our Q3 results. Until then, thank you again and have a great day. Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.