Earnings Call: Q2 2018

Jul 20, 2018

Good morning. My name is Laurie, and I'll be your conference operator today. Thank you for joining us for OFG Bancorp's Conference Call. Our speakers are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman Ganesh Kumar, Senior Executive Vice President and Chief Operating Officer and Maritza Arasmindy, 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 the 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 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. I will focus today my prepared remarks only on the most significant highlights for the Q2. This way we can maximize the amount of time for Q and A. We still have all our traditional slides in the appendix. Want to try something different that is faster and more to the point like we do with every day with our customers and clients. Please turn to Slide 3. We at OFG are extremely proud to announce yet another quarter of superior results across all parts of our business. Earnings were 0 point 3 $5 per share, an increase of more than 17% sequentially and more than 16% year over year. This confirms the success of our strategies, our technology and most of all our people. We're now seeing the result in the form of higher earnings per share. As you can see, it has moved from $0.25 to $0.30 range to the mid-30s range in the second quarter. Are particularly encouraged at how we continue to build our capital base. Tangible book value per common share was $15.96 up sequentially more than 6% on an annualized basis. Our performance metrics are also improving. Return on average assets increased 14 basis points from the Q1 and has expanded from the 1% range to 1.23%. Efficiency ratio improved more than 200 basis points from the Q1. This was a function of revenue growth rather than cost control per se, although we always keep a very close watch over expenses. Net interest income, net interest margin and fee income are all up from the Q1 2018 year over year. As a result, total net revenues increased 4% while expenses remained flat. Please turn to Slide 4 for some of our key operational highlights. Loan growth has been a key to our performance for the Q3 in a row. As a result, net loans are up more than 4% from the Q1 2018 and more than 6% higher than 4th quarter 2017. In addition, loan yield increased 7 basis points sequentially. That was primarily due to a higher proportion of higher rate originated loans more than offsetting the decline in higher yielding acquired loans. Average core deposit balances rose 1.6% from the Q1 and 10% from a year ago. There was more than a 6% increase in non interest bearing accounts to a record high of $1,100,000,000 At the same time, the cost of deposits remained flat at 51 basis points, reflecting a combination of our increase in non interest bearing deposits and the lack of deposit beta in the Puerto Rico market. This quarter, new loan production was outstanding. At more than $430,000,000 it was up 40% from the Q1. There were sequential increases across the board. Auto lending was a record $131,000,000 This continued to reflect pent up demand along with the market's effort to adjust to 1 less auto lender. Consumer lending increased close to 13% as customers move to replace needed items and prepare for the 2018 hurricane season. Residential mortgage lending continued to rebound with production up nearly 20%. We saw a strong rebound in commercial lending. Production was up 70% year over year to $127,000,000 During the 2nd quarter, we saw a general recovery in lending activities over all sectors and industries. Our recently established OFG USA loan program added close to $100,000,000 per our plan that consisted of commercial and industrial related loan participations diversified across an array of industries and geographies. 1 of the drivers to both loan and deposit growth as well as fee revenues has been our customer count. It continued to climb increasing 3% year over year in the second quarter. Credit quality remained stable. The non performing loan rate declined 19 basis points, while delinquency rates fell below pre hurricane levels. Altogether, we believe these strong core operating results reflect the continued success of our strategic differentiation. We are keenly focused on delivering superior customer convenience and service with innovative product and technology solutions to our customers. In June, we launched Oriental Small Biz, another banking first for Puerto Rico, where new and existing customers can apply for commercial loans online. In April, we launched mispagos or My Payments, another online service that allows our loan only customers to ease the ease of paying online. Services like this enable us to step up our ability to reach out to customers and clients as we say at Oriental. Please turn to Slide 5 for our outlook. We think the title of this slide sets it all. After years of talking about the challenge ahead and 10 months since Maria struck, we're now looking at the opportunity ahead. Our results demonstrate strong momentum in our businesses. We are developing new commercial relationships in Puerto Rico and on the mainland. We have an institutional effort to develop new ways to optimize our internal processes and implement technology that service customers better and faster. And as a result, we're increasingly confident in our ability to grow and expand. Certainly, the local economy has played a role in our growth. Puerto Rico is coming back, as statistics and a growing number of analysts already recognized. Auto sales are up year over year. The Puerto Rico Economic Activity Index continues to improve sequentially. Net migration has fallen below expectations. Funds from insurers, FEMA and other government and private sources are starting to flow. Altogether, there has been a general revival of business activity and as reconstruction of homes, business and public infrastructure has begun. But once again, I'm going to have to repeat some of what I have said previously. Puerto Rico is far from being out of the woods. We must develop a lasting solution to PREPA. Lower cost, reliable, resilient and depoliticized electric electric power is the single most important transformation effort Puerto Rico needs to accomplish. And we must permanently resolve the island's fiscal problems, while instilling a culture of fiscal discipline in government affairs and political culture. Our government officials need to roll up their sleeves and collaborate with federal authorities to successfully implement the approved fiscal plan and execute its long term economic revival strategy. On our end, we at OFG and Oriental will continue our relentless pursuit of differentiation while proactively providing credit and other financial services to clients and in that way contribute to Puerto Rico's economic revival and reconstruction. This ends our formal presentation. Operator, please open the call for questions. Your first question comes from the line of Brett Rabatin of Piper Jaffray. Hi, good morning everyone. Good morning, Brett. Wanted to first ask, it's great to see the delinquencies below pre hurricane levels. I was curious if you could give us some additional color around auto and obviously that impacted charge offs in 2Q. What's the outlook for that in the back half of the year? [SPEAKER JOSE RAFAEL FERNANDEZ:] Yes. I'll give you from a high level perspective, we agree with you. We continue to see credit trends trending better than pre Maria levels. We you saw in the Q1 that we had a little bit of an increase in auto NPLs and that's part of the remnants of the Maria effect on the auto business. And that's a little bit of what you're seeing on the charge offs in this quarter. We had already previously provisioned for that. So that's kind of where we see the reasoning for the charges on the auto side. But going forward, we continue to believe that credit trends will remain along these levels and we don't see any evidence of deterioration. And when you say along these levels, does that mean modest migration downward in NPLs and net charge offs from 2Q levels or what does that mean exactly? I'll let Maritza go into a little bit more detail. What we're seeing is that we're getting back to pre Maria level type of early delinquencies. And what we're seeing is a more stable NPLs also this quarter. So what we see is a more business as usual type of asset quality going forward. Okay. And then I guess I'm curious to hear, I know the HUD I think I believe the HUD money is showing up and there's definitely more money coming to the island and your cost of deposits was flat, but you used borrowings to fund some of the growth. Are you or is OFG in line to get any of the deposits or funds that are coming to the island? And how should we think about how you're funding your growth here? Yes. From a deposit perspective, Brett, we're really happy with the growth that we've had year over year growing 10%. We continue to see increasing on the retail side. And on the commercial side, I have to be honest, we are not going to be receiving or participating in receiving government funding. Local government deposits, it's not something that it's a big item for us. So when you look at our numbers, you're looking really pretty much customer related deposits. And we feel that going forward, we will continue to see the same trends that you're seeing, a slight increase going forward in deposits and being core. Okay. And then maybe last one, the growth that you had this quarter in OFG USA, can you maybe give us a little more granularity on that piece and how many loans it was and what kind of industries? Yes. I'll let Ganesh go into that one. Hi, Brett. Good morning. The sort of $100,000,000 loan origination this quarter in participations primarily came from about 16 credits spread over manufacturing specialized services to industries, healthcare and other segments. The purpose varied from acquisition to refinance to dividend payouts in these loans. And we typically look at those transactions to see from its ability to amortize the loan over the next 5 years, the extent of their ability to amortize the loans over the next 5 years, fixed charge coverages and senior leverage. And the advantage obviously as you would know, the industry's data is very well reported under the LCD Coms SMP database and we compare ourselves, our opportunities to that to say we are staying in the mainstream. Okay, great. Nice quarter. Thank you. Your next question comes from the line of Alex Twerdahl of Sandler O'Neill. Hey, good morning. Good morning. Just first off a technical question. I saw in the release that Q2. Can you quantify what that is and whether or not those are going to go away starting in the Q3? Yes. I think I will go there. Yes. We have a charge since we decided to cancel lease that we have long term lease in another facility, so we can concentrate our people in our own building here at Antares. That's a 1.5 $1,000,000,000 cancellation penalty that we will be having savings going forward next year starting next year. Starting next year. So you still have that $1,500,000 for the next two quarters and then that's going to go away starting in the Q1 of 2019? No, this quarter was $1,500,000 charged to expenses. Yes, it's a one time penalty. And then next year we get the rental savings. Okay, great. That's great. And then maybe just a bit more color on the commercial growth that you saw during the quarter. I know last quarter you said the pipelines were Q1, we're seeing a little bit this time as opposed to the Q1, we're seeing a little bit broader industries with appetite for commercial lending. I have to admit that the second quarter was an outstanding quarter in production for us, coming from a relatively low level in the Q1, if you recall. So going forward to the second half of the year, I would expect levels better than the Q1 for sure, but not necessarily at the same level as this quarter of $127,000,000 But we do have good pipeline and we have to be very, I would say, cautious and at the same time discern well the credits just to make sure that we participate appropriately in the growth of the different industries. And keep in mind, the summer is typically cyclically a low quarter in terms of commercial productions for us. Okay. And then just to talk a bit about credit and going back to the hurricane related reserve and now that we're 4 quarters out, can you just remind us in the 3rd Q4 of last year, I think it was something like $30,000,000 that you put aside as hurricane related. Can you remind us how much is still in that category? And at what point in time can we see that start to come down more meaningfully? Well, the assessment that we do every quarter, we every risk related to the hurricanes. So far, we have been evaluating the charge offs related to the hurricane and we have applied some of these charge offs to the allowance. And in the allowance that we still have around $96,000,000 in the $94,000,000 in the new book, we still have some reserve there. You can have more detail in the thank you. Okay. And then as I think about NPL levels right now, were there some NPLs that you have on the books that maybe are classified as NPLs just because of a specific industry that was particularly hard hit during the hurricane even though the loan might be paying to terms? Could you repeat the question? You got cut off. I'm sorry. In terms of the color of the NPLs, are there some NPLs that you have on your books that are classified as non performing just because of the particular industry that perhaps that loan is in, that maybe got hit harder during the hurricane, but the loan itself is actually paying to terms. And so maybe they're not actually non performing loans? That's correct. You hit it right on the nail. That's what it is. We have them as non performing, but they're accruing. We have them as non accrual, but they're not necessarily nonperforming. Okay. And so how long following the hurricane for those types of loans that are still accruing, would you have to see good performance before it could fall off the nonperforming status or the non accruing status? 6 months. 6 months from the end of the moratorium? From the day we put them on Back to current status. Okay, great. Thanks for taking my questions. I'll get back in the queue for now. Yes. Thank you. Your next question comes from the line of Glenn Manna of Keith, Bruyette Woods. Hi, good morning. Hi, Glenn. How are you? Some really spectacular loan growth. I think it's the best that I've ever seen. If we look at the C and I loans and kind of parse out what you had in out of OFG USA last quarter and then this quarter, it looks like by my math, growth on the island end of period was about 4.5% quarter over quarter, which I think is the best we've ever seen. So is that about right? And could you kind of quantify what you think might be coming from hurricane related borrowing and just kind of normal business or taking market share out of that? So, Glenn, since KBW has been following us for several decades now, allow me to indulge a little bit here for a second in our history, because I think you bring up a good point here that it's not a 1 quarter or 2 quarter situation. I mean, if you look at the last 14 years that we have led OFG, we have successfully navigated a very complicated and challenging economic environment. And through it, we have successfully positioned OFG to what you see today, a growing franchise with a culture tremendous potential and that is why we are so proud of our achievements today. Having said all that, nothing that we have accomplished in the past 14 years matters if we do not continue showing results like this quarter's. So when you look at our commercial growth and when you see our auto lending growth and you see our overall loan growth, what you're seeing is certainly an impact from the economy in Puerto Rico that is turning the corner at least in the next several years with the funds coming from the states. But what you're also seeing is a methodical approach to our vision, executing our vision and that is playing out as it is today. These results are really core. We have no purchase accounting. We don't have acquisitions in the middle. This is real core and this is not one quarter. We've been seeing this for 3 or 4 quarters in a row and we're really encouraged with what we're seeing going forward. So the commercial side of it is important and it's key to our success and we're working hard to continue to simplify and be closer to our customers with some of the technology and the services that we have provided. But our retail franchise is also doing very well and it's growing customers in a steady fashion. And we are transforming as fast as we can to differentiate ourselves and become a unique banking institution here in Puerto Rico. Going to your specific question, Glenn, about the different where are the lending opportunities coming from and how much of it is construction and rebuilding the island and how much is general industries that are not necessarily related to the economy or to the recovery. It's very hard to tell, but anecdotally, I can tell you that this quarter it's closer more to a fifty-fifty. There's certainly construction services and professional services that we are lending to that are part of the rebuilding. But we're also seeing businesses, core businesses that are more enthusiastic about the future in Puerto Rico and the economy and they're starting to invest in their businesses in a more consistent way. And Oriental is stepping up and participating in that opportunity. Okay, great. Thank you. And when you look at the NCOs in the quarter, particularly in the order book where it ticked up and I know in your text you kind of cited that some of it was hurricane related cleanup. Do those losses related to the hurricane move fairly quickly through the auto book? And could you say at any point like possible charge offs in that book would be 60% cleans up of the hurricane or 70% or kind of what you're feeling would be left in it? I think they're I wouldn't say 100% clean, but let's say ballpark figure 75%, 80% clean. And going forward, it's going to become more normalized like Maritza mentioned earlier. And just a question on capital, the CET1 ratio was down. This looks like it's strictly risk weighted asset movement given you're kind of adding the commercial loans in the U. S. Could you kind of tell us the balance between I know in the past you've said that you've been cautious on returning capital given the environment, but how do you balance that now against growth and what your thinking on return of capital? [SPEAKER JOSE RAFAEL FERNANDEZ:] Yes. Return on capital continues to remember, even though what we're seeing in the ground is what we're communicating to you guys today. From a regulatory perspective, we still have to have dialogues and we still have to have conversations with them. So that's one thing. Number 2, we see an opportunity here to grow and to generate good quality earnings going forward. So from a capital return perspective, we continue to dialogue with regulators, we continue to assess what the environment looks like and how our business opportunities present. And that's how we view capital return, Glenn. Great. Thank you. Thank you for taking my questions. Great quarter. Yes. You're welcome. Your next question is a follow-up from Brett Rabatin of Piper Jaffray. Hi. I just wanted to follow-up on maybe some of the things that are going on in Puerto Rico. It seems like PREPA has been a soap opera lately with just kind of the news going on there. Can you give us maybe a little bit of color on how you think that plays out in the next few quarters? And I know it's going to be a long process for Puerto Rico to have more stable power, but what's your view on what's transpired at PREPA here recently? [SPEAKER JOSE RAFAEL FERNANDEZ:] I think what's happening at PREPA is just a disaster. I think what we've seen from in the last 2 years and particularly in the last 6 months with PREPA after Maria has been just a complete mismanagement and a confirmation that while political forces insert themselves in running clean, clearly important essential services for the island like energy, there's not going to be any transformation. So I am hopeful that the fiscal board and Judge Swain, who is the bankruptcy judge, who is more daily, she becomes more and more relevant in the decision making process here in Puerto Rico, step up to the plate too and exercise the executive powers that PROMESA has been given to the board. If we want transformation, we can't give transformation put that transformation in the hands of politicians that have no experience in transformation. So that's my take. Okay. And then wanted to follow-up on the banking service income that usually is a little bit softer in the back half of the year. Is that sort of the expectation this year? Or is there anything going on with you obviously had a lot of accounts added here in the past couple of quarters. Does that change that usual trend? We continue to see the second half of the year on the fees trending slightly higher than what you have seen in the first half of the year, but not that meaningful. Okay. That goes across all fee income categories. Okay, great. Thanks for the color. Yes, you're welcome. Your next question is a follow-up from Alex Twerdahl of Sandler O'Neill. Hey. Just a follow-up question on the capital return. So maybe talk a little bit about the capital stack today and beyond just straight share buybacks, the opportunities that exist to clean up the capital stack boost earnings. And it seems to me like you got these converts out there that could be a particularly juicy piece of the capital stack to clean up. And if I'm not mistaken, they've been trading at least for a couple of days above the conversion price. So maybe you can remind us what the terms are of the converts, who has the option of the redemption, the likelihood of you guys either redeeming it or converting into shares, the shares into common, etcetera? [SPEAKER JOSE RAFAEL FERNANDEZ:] So that will probably take an hour and a half for me to explain. So I'll sum it up in this way. We're very cognizant of the opportunities that we have in terms of our capital stack and how we can address some of the opportunities we have. We monitor it, we continue to evaluate them and we'll your court, depending on obviously the stock price has to be your court depending on obviously the stock price has to be above I think $50.04 That is correct. Okay. And you have and you could either convert them into common or you could just redeem them completely or you could do some combination of that? All the above, yes. Fantastic. Thank you for taking my follow-up. Yes, you're welcome. Your next question comes from the line of Glenn Manna of Keith Ruett Woods. Hi. I just wanted to follow-up on the loan production. I think when you look at the GUIA numbers for sales, they've just been kind of off the charts for the last couple of months. Do you expect that to continue? Or has demand kind of been pulled through on that line? Can you remind me what the G the letters that you mentioned mean? I'm not aware of those letters. So because my Spanish is not as good as yours, but that's the automotive industry of Puerto Rico. Oh, got it, got it, got it, got it. Gia. Gia, okay. Gia, yes. You got to come down to Puerto Rico, visit us and learn a little bit more of our accent. Yes, sales are up. Sales autos new auto sales are up for sure. And that's what we're benefiting from. There's pent up demand from consumers and certainly there's one less player in the making. So that also gives us an opportunity or at least we think. Okay, great. Thank you for that. And I'm sure somewhere my high school Spanish teacher is hiding in shame right now. Take care. Thank you. I'll now return the call to Jose Rafael Fernandez for any additional or closing remarks. Thank you all for joining us today. Again, we had a very successful quarter. We look forward to successful quarters in the future and we'll be participating at the KBW conference in the next week or so. So we look forward for the Q3 results sometime in October. Have a great day, a great Friday and a wonderful weekend. Thank you. That does conclude today's OFG Bancorp conference