Good morning. My name is Lori, and I'll be your conference operator today. Thank you for joining us for OFG Bancorp's conference call. Our speakers are José Rafael Fernández, President, Chief Executive Officer, and Vice Chairman, Ganesh Kumar, Senior Executive Vice President and Chief Operating Officer, 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, & 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 second quarter. This way, we can maximize the amount of time for Q&A. We still have all our traditional slides in the appendix. We want to try something different that is faster and more to the point, like we do every day with our customers and clients. Please turn to slide three. We at OFG are extremely proud to announce yet another quarter of superior results across all parts of our business. Earnings were $0.35 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 are now seeing the result in the form of higher earnings per share.
As you can see, it has moved from $0.25-$0.30 range to the mid-$0.30s range in the second quarter. We're 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 first quarter and has expanded from the 1% range to 1.23%. Efficiency ratio improved more than 200 basis points from the first quarter. 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 first quarter 2018 and year-over-year. As a result, total net revenues increased 4% while expenses remained flat.
Please turn to slide four for some of our key operational highlights. Loan growth has been a key to our performance for the third quarter in a row. As a result, net loans are up more than 4% from the first quarter 2018 and more than 6% higher than fourth quarter 2017. In addition, loan yield increased seven 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 first quarter and 10% from a year ago. There was more than a 6% increase in non-interest-bearing accounts to a record high of $1.1 billion.
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 million, it was up 40% from the first quarter. There were sequential increases across the board. Auto lending was a record $131 million. This continued to reflect pent-up demand, along with the market's effort to adjust to one less auto lender. Consumer lending increased close to 13% as customers moved 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 million.
During the second 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 million. Per our plan, that consisted of commercial and industrial-related loan participations diversified across an array of industries and geographies. One 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 SmallBiz, another banking first for Puerto Rico, where new and existing customers can apply for commercial loans online. In April, we launched Mis Pagos, or My Payments, another online service that allows our loan-only customers 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 five for our outlook. We think the title of this slide says 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. 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 recognize. Auto sales are up year-over-year. The Puerto Rico Economic Activity Index continues to improve sequentially. Net out-migration has fallen below expectations. Funds from insurers, FEMA, and other government and private sources are starting to flow. Altogether, there's been a general revival of business activity as reconstruction of homes, business, and public infrastructure has begun. 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 power is the single most important transformation effort Puerto Rico needs to accomplish. 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.
At this time, I would like to inform everyone if you would like to ask a question, please press star 1 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 1. 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. 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?
Yep. From a high-level perspective, we agree with you. We continue to see credit trends trending better than pre-Maria levels. You saw in the first quarter that we had a little bit of an increase in auto NPLs, and that's part of the remnants of a Maria effect on the auto business. That's a little bit of what you're seeing on the charge-offs in this quarter. We had already previously provisioned for that. That's kind of where we see the reasoning for the charge-offs on the auto side. Going forward, we continue to believe that credit trends will remain along these levels, and we don't see any evidence of deterioration.
When you say along these levels, does that mean modest migration downward in NPLs and net charge-offs from 2Q levels? 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. What we're seeing is a more stable NPLs also this quarter. What we see is a more business as usual type of asset quality going forward.
Okay. I guess I'm curious to hear, I believe the HUD money's showing up and there's definitely more money coming to the island and your cost of deposits was flat, you used borrowings to fund some of the growth. Is OFG in line to get any of the deposits or funds that are coming to the island? How should we think about how you're funding your growth here?
Yeah. 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 increase on the retail side. 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 is not something that is a big item for us. When you look at our numbers, you're looking really pretty much customer-related deposits. 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. 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?
Yeah. I'll let Ganesh go into that one.
Hi, Brett. Good morning. The sort of $100 million loan origination this quarter in participations primarily came from about 16 credits spread over manufacturing, specialized professional services to industries, healthcare, and other segments. The purpose varied from acquisition to refinance to dividend payouts in these loans. We typically look at those transactions to see from its ability to amortize the loan over the next five years, the extent of their ability to amortize the loans over the next five years, fixed charge coverages, and senior leverage. The advantage obviously, as you would know, the industry's data is very well reported under the LCD Comps S&P database. We compare ourselves, our opportunities to that to see we are staying in the mainstream.
Okay. Great. Nice quarter.
Thank you.
Thank you.
Your next question comes from the line of Alex Twerdahl of Sandler O'Neill.
Hey, good morning.
Good morning.
Good morning.
Just first off, a technical question. I saw in the release that expenses were a little bit higher due to lease cancellations in the second quarter. Can you quantify what that is and whether or not those are going to go away starting in the third quarter?
Yep. Maritza will go there.
Yes. We have a charge since we decided to cancel a lease that we have, long-term lease in another facility, so we can concentrate our people in our own building here in Hato Rey. That's a $1.5 million cancellation penalty that we will be having savings going forward next year, starting next year.
Starting next year.
Yes.
You'll still have that $1.5 million for the next two quarters, and then that's going to go away starting in the first quarter of 2019?
No, this quarter was $1.5 million charge to expenses.
Yeah, it's a one-time penalty.
Great
next year we get the
The savings
the rental savings.
Okay, great. That's great. 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 pretty good. Would you characterize the pipeline still that way?
Yeah. As I said on my remarks, this time as opposed to the first quarter, 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 first quarter, if you recall. Going forward to the second half of the year, I would expect levels better than the first quarter for sure, but not necessarily at the same level as this quarter of $127 million. 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.
Keep in mind, the summer is typically a cyclically low quarter in terms of commercial productions for us.
Okay. Then just to talk a bit about credit and going back to the hurricane-related reserve and now that we're four quarters out, can you just remind us, in the third and the fourth quarter of last year, I think it was something like $30 million 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, in the assessment that we do every quarter, we assess every risk related to the hurricanes. So far, we have been evaluating the charge-off related to the hurricane, and we have applied some of this charge-off to the allowance. In the allowance that we still have around $94 million in the new book, we still have some reserve there. You can have more detail in the 10-Q.
Okay. 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-
Yeah
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 Non-Performing.
Yes.
Okay. 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 of the non-performing status?
Six months.
The non-accruing status.
Six months.
Six months from the end of the moratorium?
From the day we put them on.
Back to current status.
Yeah.
Okay, great. Thanks for taking my questions. I'll get back in the queue for now.
Yeah, thank you.
Our next question comes from the line of Glen Manna of Keefe, Bruyette & Woods.
Hi, good morning.
Hi, Glen. 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&I loans and kind of parse out what you had 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.
Is that about right? 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?
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 one quarter or two quarter situation. If you look at the last 14 years that we have led OFG, we have successfully navigated a very complicated and challenging economic environment. Through it, we have successfully positioned OFG to what you see today. A growing franchise with a culture of proactive, simple, easy, straightforward approach to banking. That is what makes us different. That is why OFG results today demonstrate 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. When you look at our commercial growth, 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. 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 three or four quarters in a row.
We're really encouraged with what we're seeing going forward. 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. Our retail franchise is also doing very well, and it's growing customers in a steady fashion. 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, Glen, 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 is closer more to a 50/50. There's certainly construction services and professional services that we are lending to that are part of the rebuilding. We're also seeing 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. Oriental is stepping up and participating in that opportunity.
Okay, great. Thank you. When you look at the NCOs in the quarter, particularly in the auto 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? Could you say at any point, possible charge-offs in that book would be 60% cleaned up of the Hurricane or 70% or kind of what your 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. Going forward, it's going to become more normalized, like Maritza mentioned earlier.
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. How do you balance that now against growth, and what's your thinking on return of capital?
Return of capital continues. 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. That's one thing. Number two, we see an opportunity here to grow and to generate good quality earnings going forward. 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. That's how we view capital return, Glen.
Great. Thank you. Thank you for taking my questions. Great quarter.
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? 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?
I think what's happening at PREPA is just a disaster. I think what we've seen in the last two years, and particularly in the last six 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. I am hopeful that the fiscal board and Judge Swain, who is the bankruptcy judge, who 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 put transformation in the hands of politicians that have no experience in transformation. That's my take.
Okay. 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? Is there anything going on? 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 coloring.
Yep, 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. 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. 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. If I'm not mistaken, they've been trading at least for a couple of days above the conversion price. 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 the shares into common, et cetera.
That will probably take an hour and a half for me to explain. 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 communicate to the market accordingly, and when and if we do something.
Okay. The option to do something is purely in your court, depending on, obviously, the stock price has to be above, I think.
That is correct.
$15.04?
That is correct.
Okay. You could either convert them into common, or you could just redeem them completely, or you could do some combination of that.
All of the above. Yep.
Fantastic. Thank you for taking my follow-up.
Yep, you're welcome.
Once again, if you'd like to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from the line of Glen Manna of Keefe, Bruyette & 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 letters that you mentioned mean? I'm not aware of those letters.
Because my Spanish is not as good as yours.
No.
That's the automotive industry of Puerto Rico.
Oh, got it. GUIA.
GUIA. Okay.
GUIA. Yeah. You got to come down to Puerto Rico, visit us, and learn a little bit more of our accent. GUIA. Yeah. Sales are up. New auto sales are up, for sure. That's what we're benefiting from. There's pent-up demand from consumers, and certainly, there's one less player in the making. That also gives us an opportunity, or at least we think.
Okay, great. Thank you for that. I'm sure somewhere my high school Spanish teacher is hiding in shame right now.
Take care.
Once again, if you'd like to ask a question, please press star, then the number one on your telephone keypad. Thank you. I'll now return the call to José Rafael Fernández 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. We look forward for the third quarter results sometime in October. Have a great day, a great Friday, and a wonderful weekend.
Thank you. That does conclude today's OFG Bancorp call.