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 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 Webcast 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.
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 speaker's 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 slide three. We are extremely pleased with our second 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 on more than a 3% increase in net revenue. 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 four to review our financial highlights. Net revenues increased 3.3% year-over-year to $99 million. The key driver was a 7.1% increase in net interest income. The efficiency ratio was 51.89%, a 260 basis points improvement year-over-year. We are increasing productivity, and this is enabling us to continue to invest in our operations without affecting our overall non-interest 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%, and return on average tangible common equity expanded 112 basis points to 10.32%. Please turn to slide five.
There were three other items that affected second quarter results. First, we sold $350 million in low-yielding mortgage-backed securities in May, reducing $191 million and $63 million of high-cost repurchase agreements and broker CDs, respectively. The sale also resulted in a $4.8 million gain. Second, we're selling $54 million of unpaid principal balance acquired distressed residential mortgage loans. The sale is expected to occur in the third quarter, taking advantage of improving market conditions in Puerto Rico. The decision to do so resulted in an $8.8 million net increase in the acquired loan provision. Third, we incurred $1 million in expenses related to our previously announced Scotiabank Puerto Rico and U.S. Virgin Islands acquisition. Please turn to slide six to review our operational highlights. Total net loans increased 3.7% to $4.47 billion, with the growth of originated loans at 8.5%, more than offsetting the continued paydown of acquired loans.
Compared to the preceding quarter, originated loans increased 2.5%. Loan production has been picking up. Second quarter production totaled $327 million. Auto and consumer lending remain high at $136 million and $48 million, respectively. While residential mortgage lending totaled $22 million. Commercial lending at $64 million reflected continued growth of small business customers in Puerto Rico. OFG USA added another $56 million in primarily mainland small business commercial loans. Core deposit average balances increased 2% to $4.47 billion. 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 stemmed in part from the effect of Federal Reserve rate hikes last year, also a larger proportion of higher-yielding commercial and auto loans in the originated portfolio.
Core deposit costs continued to remain relatively low, up only 16 basis points year-over-year. The end result was a net interest margin of 5.37%, 14 basis points higher year-over-year. Please turn to Slide seven to review credit and capital. Credit quality continued to improve year-over-year and from the first quarter. We're seeing a clear, favorable improving trend with customers showing increased liquidity and stronger finances. The net charge-off rate at 1.32% was the lowest in seven quarters. Non-performing loan and delinquency rates showed steady and core declining trends. Excluding the $8.8 million related to the transfer to held-for-sale of distressed acquired mortgages mentioned earlier, provisioning fell $5.8 million 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 recognized 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 Islands acquisition.
Upon closing, Oriental Bank will become the second-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 talented 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. If you wish to ask a question at this time, simply press star then the number 1 on your telephone keypad. Again, that is star 1. If at any point your question has been answered and you wish to remove yourself from the queue, press the pound key. Our first question comes from line of Brett Rabatin of Piper Jaffray.
Hey, good morning, everyone.
Good morning, Brett.
Good morning.
wanted to first ask José Rafael, I saw that the CIO Portela resigned. The governor's 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. 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 not running for re-election and resigning to his own party presidency. Right now, it's too early to tell what the economic impact is. We are not seeing any impact so far. 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 minds 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. 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. 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. Talking about economic activity, and you talk about market conditions continuing to improve, and 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?
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. They're growing and improving significantly. We're seeing more liquidity on the consumer side, and therefore spending is steady and slightly growing. 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 tailwind of insurance funds, federal funds, as well as the rebuilding efforts that are being put in place.
Okay. 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?
Brett, may I clarify your question? Are you referring to growth, Oriental growth or economic growth?
Oriental growth. The loan-
Yeah, 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. 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. We're seeing good opportunities with good credits. We're encouraged by that.
Okay, great. Appreciate all the color.
Thank you, Brett.
Our next question comes from the line of Alex Twerdahl of Sandler O'Neill.
Hey, good morning.
Good morning.
Hi, Alex.
First wanted to drill into the provision a little bit. If you exclude that $8.8 million that was specific to the loan sale, provision came down quite a bit, down to $8.9 million, 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, while NPLs declined, wasn't that huge of a decline. I mean, can you talk a little bit about sort of the, as it relates to some of the improved economic conditions that you've cited in the past, specific metrics, et cetera.
Is this new level of provisioning, or is this a new level of provisioning at kind of $8.9 million 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?
Yeah. 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 will continue to see improving trends. 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. We don't give a guidance in terms of provisioning going forward.
Okay. 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.
Yeah
should be more similar to what we saw in the second quarter, than the first quarter or prior.
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. As to the provision going forward, we don't give a guidance, but it will reflect whatever the environment and our credit portfolio performs. We don't want to give a guidance on the provision.
Okay. Understood. 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?
Remember, we sold residential mortgage loans. These are distressed that we acquired from BBVA. The way we monitor it has a couple of variables, but let's just share with you a couple of them, two of them. One of them is demand. There is a higher demand for these type of assets in the recent months. Certainly, residential home prices have stabilized and started to show some upticks. That's what kind of gave us a good moment to sell those or to put them for sale, and we should be closing in the third quarter.
Okay. 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. 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. If there is an opportunity that it's opportunistic and we feel it makes sense for us, we'll do it. If there's 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. It has nothing to do with anything related to the previously announced acquisition.
Great. Just final question from 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 first quarter 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 second quarter?
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 one, two-year, three-year term. We also saw a great opportunity for us to reduce our institutional funding. 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. 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 increase our core retail funding base through the CD market.
Okay, great. Thanks for taking my questions.
Yeah, you're welcome.
Again, ladies and gentlemen, if you wish to ask a question, simply press star then the number one on your telephone keypad. Our next question comes from one of Glen Manna of Keefe, Bruyette & Woods.
Hi, good morning.
Good morning, Glen.
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 third quarter about 10 basis points higher than the average NIM for the second quarter. I guess, Maritza, am I thinking about that right?
We don't try to forecast here or guidance in terms of NIM. Again, we look at the NIM relatively stable as we're seeing it in this quarter. It's not too far from what you're saying, Glen. Let's just put it that way.
Okay. When you think about the sales and kind of the buildup in excess cash that happened in the quarter, 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 on or our reliance on wholesale funding, broker CDs, purchase agreement, and just use our core deposit, our main source of funds.
Okay. On the tax rate, looks like a couple percentage points lower than we were maybe expecting over here. What could 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 next two quarters.
Okay, super. Thanks for taking my questions.
You're welcome.
Our next question comes from one of Joe Gladue of Alden Securities.
Hey, good morning.
Good morning.
I'll just ask, at the end of the first quarter, you had mentioned that there were some.
Hello?
Hello? Joe?
Yeah.
Joe?
Yeah. Can you hear me?
No, we could not hear your question.
Okay. I guess at the end of first quarter, you mentioned that there were opportunities for growth in Puerto Rico, clearly we've seen that come to fruition. 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.
Yep, you're welcome.
Again, ladies and gentlemen, if you wish to ask a question, simply press star, then the number one on your telephone keypad. Our next question comes from the line of Brett Rabatin of Piper Jaffray.
Hey, just two follow-up items. One, wanted to follow up on that on the OFG USA strategy and the loans that you booked this quarter, $56 million. Can you give us some color on that? What industries, how many loans? Any color on the OFG USA strategy is part one.
Yeah. These are small commercial business loans. These are mostly SBA loans that we're lending also over there in the U.S., and they are from a variety of industries, and they're smaller in the range of $2 million-$3 million or less. That's kind of the description of the loans that we've done over in the U.S. in this quarter.
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 million related in 2Q. What does that look like for the back half? Just thinking about expenses, 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 million 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. As we see going forward, we will see the expenses being level 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. As we go by, we will see that 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. Just following up on that from Scotia. Since that deal's 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?
Everything that we have modeled so far, it's been, as we speak, being validated. We're really excited about bringing in the team from Scotia later in the year. 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.
Yep, thank you.
Again, ladies and gentlemen, if you wish to ask a question, simply press star then the number 1 on your telephone keypad. 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. Well, we'll be looking forward to hearing that. Thank you for taking my follow-up.
Thanks.
Yep.
Yep.
Again, ladies and gentlemen, if you wish to ask a question, simply press star then the number one on your telephone keypad. There appears to be no further questions at this time. I would like to turn the floor back over to Mr. Fernández for any additional or closing remarks.
Thank you, operator. Thank you everyone for listening in today. We'll be at the KBW conference on July 30th in New York. We'll be coming back to you on a conference call for earnings late in October when we report our third quarter 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.