OFG Bancorp (OFG) 2009 Q2 法說會逐字稿

Thank you for joining us for this conference call to discuss quarterly financial results for Oriental Financial Group. Our participants today are Jose R. Hernandez, President, Chief Executive Officer and Vice Chairman; Julio R. Micheo, Senior Executive Vice President, Chief Investment Officer and Treasurer; and Norberto Gonzalez, Executive Vice President and Chief Financial Officer.

Please note that this call may feature certain forward-looking statements about management's goals, plans and expectations which are subject to various risks and uncertainties outlined in the risk factors section of Oriental's Securities and Exchange Commission 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 which occur afterwards.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will question-and-answer session. During the question-and-answer session we ask questioners to not use cell phones or BlackBerries, as they might cause loud static on the line. I would now like to turn the call over to Mr. Fernandez.

Thank you. Good morning. Good morning, everyone. I will review the highlights of the quarter, and then Julio, Norberto and I will be available to answer questions.

From a big picture point of view our income continues to move forward with our strategic direction focusing on the mid-net-worth and the high-net-worth clients. As we noted in our press release, operating earnings of approximately $17.3 million increased when compared to the $13 million to $15 million range that we have been generating since the first quarter of 2008.

On the banking side of our franchise, core deposits, interest-bearing demand deposits, money accounts, which is our flagship checking account, savings accounts and non-interest-bearing accounts continued to grow. As these trends suggest, we are capturing more market share in Puerto Rico as we take advantage of our solid financial position.

Customers are utilizing our services and generating banking service revenue in a more consistent way. As a result, we earned $1.6 million in banking service revenue for the quarter. That's about 14% higher than the $1.4 million run rate we've had in the preceding four quarters. Compared to the year-ago quarter, 20% more of our clients are using value-added account features such as ATM, debit cards, checking, online services and telephone banking. This is as opposed to clients just parking their money on a temporary short-term basis.

That should provide you, as it does us, with an idea of how clients in the mid-net-worth and high-net-worth categories are embracing our service offerings.

On the financial services sides of our franchise, assets under management [which] generate recurring fees, increased 5.23% from March to more than $2.8 billion. Assets benefited from a record or a second quarter rebound in equity markets, although that was somewhat offset by the fact that at Oriental, clients' accounts contain a high proportion of fixed-income investments. This growth plus the group's participation in the underwriting of Puerto Rico's COFINA 2 Bond sale, which [resulted] recently, resulting in a sequential increase in financial services revenues.

We saw good client growth in the trust business. Oriental was also awarded the business of tuning large trust accounts during the quarter that will add approximately $75 million in assets under management. When we all start realizing fees, it will be in the third quarter of these accounts. One of the accounts is an endowment account. The other is a retirement plan.

We still believe it is going to be a challenging year for financial services at the brokerage level, but we believe that our diversified strategy of insurance and trust, together with the financial services, will play out very well in the second half.

On the mortgage banking side of our franchise, we also posted another good quarter. Approximately 80% of our production is conforming. We typically package and sell these mortgages in the secondary markets. However, we keep the servicing rights of this production. So when you are seeing $2.8 million we made in mortgage banking segment, an important component is from servicing. As we package and sell more mortgages, those fees create a growing source of recurring fee (inaudible) revenue while also taking some credit risk off the balance sheet.

Mortgage production was good even though it was a little lower than in the first quarter. Production slowed mainly because of the spike that we had in interest rates during the second quarter. However, we continued to gain market share in this line of business.

Credit quality was excellent on residential mortgage loans originating in the quarter. The average FICO score was 722, and the average loan-to-value ratio was 81%.

There are three more major highlights that I would like to discuss. One is net interest income. Net interest income of about $35.5 million was primarily due to the continuing reduction in the cost of funds. That's mainly coming from the repo side. The steepener repos are still at $1 billion at zero basis points and $250 million at 25 basis points. But it is also coming from the deposit side, where we are growing deposits without having to offer higher rates.

The second thing I want to highlight is that, during the second quarter, benefiting from the strategic positioning of our investment securities portfolio, we took advantage of market conditions to realize gains on, one, sale of securities of $10.5 million; two, derivative activities of $19.4 million; and, three, trading activities of $30 million. Consistent with the theme that we have been sharing with you throughout the last several quarters, we continued to remain attentive to market opportunities in the management of our portfolio. These gains more than offset credit-related other-than-temporary impairment charges of approximately $4.4 million on securities and highlight our opportunistic approach to market developments in a very challenging environment.

The relatively small [OTPI] charges are related to projected credit losses of less than 1% on our two largest prime collateral private-label CMO's, the Countrywide's. There were no OTPI charges on our Alt-A (inaudible) private-label CMO or on our structured credit investments. Our experience with implementation of the new FASB statement of position shows that the magnitude of OTPI charges in the future, if any, will be for amounts even smaller than we had originally expected when this statement of position was issued.

In addition, subsequent to June 30, 2009 and as part of our general banking and asset and liability management strategies, we executed a $200 million deleverage of our balance sheet at the holding company level by terminating certain repurchase agreements at a cost of approximately $17.5 million before income taxes. This transaction increases the group's financial flexibility at the holding company, creating additional liquidity, and helps to offset the group's income tax liability.

Now I will address a few other items with regards to the income statement and balance sheet. We have a higher level of expenses, primarily due to the FDIC special industry-wide insurance assessment. That cost us approximately $2.9 million. Otherwise, our run rate on non-interest expenses would have been closer to the prior quarter's $19.3 million.

We will continue to invest in marketing. We believe we continue to have opportunities to gain market share in Puerto Rico. Electronic banking charges are up. That's a direct response to the higher number of clients utilizing our services, as I mentioned earlier. Occupancy is higher by 12% versus last year. That reflects the two new branches we acquired from Banco Popular last year in that go popular last year in (inaudible), and the rest is pretty much stable, including compensation and employee benefits, which remained virtually flat versus last year.

Our yield on interest-earning assets during the second quarter decreased to 5.30% from 5.43% in the first quarter. That is primarily due to the investment portfolio, where the yield for the quarter fell to 5.07% from 5.27% the previous quarter. The yield on investments declined mainly due to higher prepayments in mortgage-backed securities during the second quarter and the temporary investment of $300 million in discounts notes at 0% yield.

Yield on loans increased to 6.27% from 6.09%. We usually retain mortgages paying 6% or higher. Due to the high proportion of our conforming mortgages, as I noted earlier, we are not replenishing our own mortgage loan portfolio as fast as we have done in the past. That explains why our loan balances are down a little. We also experienced lower yields on our commercial portfolio due to changing rate of our variable rate loans.

Regarding our cost of funds with deposits, there was a slight decrease to 3.25% from 3.27%. With borrowings, there was a significant reduction to 3.08% from 3.79%, and that is due to the full quarter effect of lower rates from the 0% and 25 basis points repo, which also helped us improve the spread for the quarter to 2.17% from 1.79% and the margin from 2.29% from 1.98%.

Looking at interest-earning assets, we had an average balance of $6.2 billion, very similar to the previous quarter. Regarding our level 3 securities, we continued to have the same investments. The aggregate amortized cost of our portfolio of private-label CMO's decreased from $619 million as of March 31, 2009, to $595 million as of June 30, 2009, mainly as a result of approximately $34 million of principal repayments during the quarter. There were no major changes in the fair value of the principal label CMO's during the quarter. The aggregate fair value of this portfolio stood at $476 million as of June 30, 2009, compared to $501 million as of March 31, 2009, the reduction being primarily the principal repayment during the quarter that I mentioned earlier.

Our structured credit investments, consisting of CDOs and NCLs continued to have the same amortize cost of approximately $176 million since these instruments only pay interest up to maturity, but the fair value increased approximately $10 million during the quarter.

Deposits, as noted earlier, were up strongly. They increased 24% from last year to $1.85 billion versus $1.5 billion. We increased core retail balances and reduced brokered deposits. We are possibly the bank in Puerto Rico having the least reliance on brokered deposits. Demand deposits are now at a record $620 million, up from $496 million in March of '09 and $400 million in December of '08. Savings accounts also have seen good movement, although not as significant.

The IRA season ended, and we had a good increase, considering the commissions in our economy. We kept our discipline of paying no higher than 3% on those IRA CDs, and we are very satisfied with the results.

Our capital position also ended the quarter in excellent shape. Book value per share increased to $12.04 per share or $360 million of total stockholders equity and $292 million of common equity. That was mostly due to increased earnings. Our total stockholders equity increased $41.3 million during the quarter and $98.3 million since December 31, 2008, representing an increase of 37.6% on a year-to-date basis.

We had around $2.1 million in total [recorded] losses for the second quarter. [That is] 70 basis points of average loans outstanding versus the 78 that we had in the first quarter, 70 versus 78. For the first six months we were growing at a rate of 74 basis points, or $4.4 million. We continued to increase our allowance for loan losses. Our second-quarter provision was $3.7 million, a little higher than our prior quarter. The allowance is now at $16.7 million, up from $15.1 million from the last quarter and $11.9 million in June of '08. The ratio of our allowance for loan losses to total loans has increased during the last 12 months from 0.97% as of June 30, 2008, to 1.39% as of June 30, 2009.

Non-performing assets continued to increase but at a much slower pace. They were $86.5 million in March and now are $89.9 million. We continued to work on our foreclosed properties. We do not expect non-performing loans to result in significantly higher losses, as most are well collateralized with adequate loan to valuation.

I also wanted to give you some little color on some new banking products that we have come out with during the first half of the year. Our new commercial cash management and point of sale products and services are working well. We began with them at the beginning of '09. We're going to end the year with more than $1 million in POS business and about $350,000 of cash management fees for the rest of the year, for the whole year. So we have two products that are going to have more than $1.3 million by the end of the year in fees, and that is going to be recurring. So next year, we expect to have additional growth on top of that.

We also during the quarter introduced at the end of this quarter a new credit card, which is called Visa Infinite, and we are very cautious with how we are doing it. But we believe it will catch on. We believe that these are the kind of things that we want to continue to use, introducing to the mid-net-worth and high-net-worth markets to build and complement our current core offerings.

There are two challenges we faced the second half of the year apart from the local economy and the credit markets in general. One is that we need to generate bank assets at a faster pace. I'm talking about good quality assets, residential mortgages, commercial loans secured by existing commercial real estate properties and, to some minor extent, credit cards and other consumer credits. However, this is not the time to be aggressive lenders, as there are still issues in Puerto Rico with the economy and the banking space is still up in the air. But we continue to work to identify potential clients in our segment and try to bring them in.

And number two challenge, we need to convert our new banking depositors into full financial services customers. We have $680 million in core deposits that have an average balance of around $45,000 to $50,000 per account. We are working on using our proven skills in investment management with these clients and moved part of that money to our financial services business. We believe that, long-term, that's the best financial planning strategy for our customers, for them not to leave it in a checking account with high balances.

As for the outlook, we continue to expect good banking and financial services revenue, considering the state of the Puerto Rican economy. NPLs are likely to continue to increase, but we do not envision any major increases in net charge-offs. We should continue to have an adequate net interest margin. While income taxes have gone up on the local level, that should not have a major impact on our results. And altogether, we should continue to see a strong increase in capital. All of that puts us in a good position, should the long-awaited shake out in the Puerto Rico banking industry occur.

To sum up, our results are showing traction on our retail and deposit strategies. We are doing this with 23 branches, of which six are situated in the east coast but does not necessarily fit our target core market. Despite that, we are growing $120 million a quarter in core deposits. That tells us two things. One, customers are starting to identify Oriental as a desirable place to bank; and, two, our strategies and the training that we have put into place in our branches are starting to work.

We have already implemented more than 3000 MVPs, which is our client profiling tool. It stands for most valuable practice. As a result, new clients are coming back to use other products and services.

Now, we will open the phone lines to any questions you may have, and operator, will you please begin the question and answer session.

(Operator instructions) Joe Gladue, B. Riley.

Congratulations on a good quarter. I wanted to ask about the securities sales and everything, the impact it's going to have on the net interest margin going forward. In other words, what did you replace those securities with and how do the yields on those compare to what you sold?

Thank you for the question, Joe, and thank you for your comments. I think Julio Micheo can give you a very precise answer to that question.

Yes, very good. Thanks for the call. When you look at the significant, say, revenues or gains we are able to achieve in the markets, we always are very, very sensitive to not do them at the expense of prospective net interest margin [or] interest income. We have had certain fee income we continue to execute. One of the things that we have executed in the markets -- and are performing [to] 83% agency, right, so it's $5 billion or -- [it's] (inaudible) $5 billion investment performing at 83% in agencies.

The weighted average coupon of the portfolio is still around 5.5 with an average cost of the portfolio is low par. So when we look at the current yields of the portfolio, it's 5.48, around there. So we still have the raw material to have a higher-yielding portfolio where rate eventually rise and prepayments decrease. So we continue to have -- and also, we have significant unrealized gains in the agency portfolio. So we have not -- the gains -- we would not like to give the impression that we are pruning the portfolio to take gains, but set up like adversely selecting it because we look at the composition of the portfolio (inaudible) weighted average coupon, in terms of price. When we look at our agency portfolio, which is $3 billion of agency mortgage-backed, the weighted average coupon there is almost [580] and the cost is [low 1 or 2].

So we continue to execute to that high coupon sector because we have (inaudible) and it has delivered, the strategy has delivered for us that, given much lower infrastructure in the home mortgage arena, given much tighter credit standards, the payment is going to be relatively lower than normal. And that continues to pay for us.

So the final [sell-in] clearly reflects that there were some prepayment increases, given our higher coupon composition, but were [raised] to increase the period, and that reverse we could easily have pickup potential in terms of net interest income from the investment portfolio.

Joe, I would like to add also, on the question that you asked regarding the gains, and as Julio mentioned, there are to me macro issues or macro themes that are very present in our management execution. One of them is capital, and the second one is liquidity. Those are the two main ones. For us it's very important to have a [fortress] balance sheet. And as we executed in this quarter, we looked at some opportunities to take gains; but, as Julio mentioned, not trying to prune the balance sheet. It was more towards generating immediate liquidity in these difficult times, and we have a very strong liquidity position. And we also have developed a very strong balance sheet in terms of the capital.

And the third reason or the third focus that we have for the times that we are working is basically we need to do this at the same time we grow organically and position Oriental for the future growth and try to become more bank-like. And those are the steps that we're working, those are the three-pronged approach that we have, and currently, in that same order.

I did want to ask about the overall plans for balance sheet growth. You had good, I guess, 7.2% sequential growth in total assets in the quarter, although, again, most of that is on the security side. What is your outlook for growing just the balance sheet for the remainder of the year?

My view or our view on the balance sheet, Joe, is to remain relatively stable unless there are opportunities for us to grow in more organic assets, loan type of assets. And that's -- we need to wait for that to happen, but we do not expect to grow the investment portfolio much further from here.

I just wanted to add, Joe, that the average interest-earning assets during the quarter were basically the same. Maybe, if you look at the total assets as of the end of the quarter, there are still some of those transactions, which, in (inaudible) [increased] the total assets temporarily as of June 3. And you will see the [decrease] a few weeks, when these transactions are finally scheduled. But, the average interest-earning assets really did not change that much in the quarter.

Bain Slack, KBW.

Good quarter -- wanted to ask a quick question on -- I guess, quick question on the taxes with regard to all these gains. Is it safe to assume that all these are in the [IBE] and put a 10% tax rate, just to figure out the income tax rate?

We will give Norberto a chance to answer that issue regarding the taxes. I think you will explain it very clearly to you.

Not all the taxes -- not all the gains are on the [IBE]. In fact, I would say that $16 million, $17 million of gains at the holding company level, which -- that's part of the reason when, in the release we talk about the leverage that we did, subsequent to June 30. In part, that deleveraged, since we are, and [in terms of] setting, that termination cost again, the short-term gains that we had at the holding company, that is saving us approximately $6 million to $7 million in taxes on the year.

And, if I can add to Norbert's statement on the subsequent event, I think not only from a tax point of view, which is one of the reasons, the other one is, it provides us at the holding company level more flexibility, less restrictions regarding a holding company that has no -- I mean, it's already no access to deposits, and we have a more liquid holding company.

At its peak, the holding company -- they had $300 million of repos, which meant that the liquidity of the holding company had to be somewhat reserved versus perspective margin calls to interest rate movement. By canceling 200 of those repos and just leaving 100 means that the liquidity of the holding company -- and one of the things, one of the features, I think, and the themes of the quarter is that we have significantly added to the liquidity of both the bank and the holding company. And now the (technical difficulty) liquidity at the holding company is much more, because it doesn't need to be reserved versus potential margin calls.

So it's truly -- not only we have through the gains, because those gains to us were part of that [necessary] mantra or, let's say, objective of attentiveness to market opportunities. We still are in the context of the portfolio, but also in the context of asset liability management because, again, they are not designed -- because simply proving gains for the portfolio, as we still have significant gains in the portfolio, but more to take opportunities. And if we feel we can capitalize and liquefy the Company, then the liquidity of the holding company now is not only categorically much higher, but qualitatively better because it's [free]; it's basically, it doesn't need to be reserved versus potential margin calls.

And I was wondering also if you could give us some color on the OCI loss, which looked like it increased on a link quarter basis?

I think Norberto can give you the explanation on that one, Bain.

Basically, the increase in the OCI during the quarter was approximately $23 million. And of those $23 million, approximately $14 million is related to the implementation of the new statement of position in which the community (inaudible), also changing the accounting for (inaudible) is basically a rejustification that does not affect (inaudible) [integrity]. It basically increases the OCIs and increases the retained earnings. So you also have to look at the increase in retained earnings during the quarter.

So, in summary, of the $23 million increase in the OCI loss, $14 million is related to that [BALTA] (inaudible) and the other $9 million is basically an (inaudible) credit of some increase (inaudible) in the fair value of the structured credits and some of the minor decreases in the fair value of the agency securities.

And the OTTI, if I understood correctly, you all said in the opening statement, was -- it seemed like this quarter was based on predicted credit losses. Is this a result of the hiring, I think, of a third-party that you all had talked about previously when valuing this portfolio? And then how do we interpret predicted losses versus actual losses?

We run the analysis internally, and we have external consultants that help us out. And we also use the credit agencies for our analysis and conclusion of OTTI, and it's all on projected losses. So we are not changing the methodology or anything this quarter; it's just that the accounting of the OTTI is different.

It's only the credit-related impairment, it's basically what it -- it's the net effect that goes into earnings. But you know (inaudible) you continue to do a present value calculation of the expected future cash flows, and you compare with the principal balance of the security. And I think the conclusion is that you are not going to recover 100% of the principal balance, then you have a loss that goes to the P&L.

Okay, great. And just last question, you noted that -- and we saw that you were able to grow core deposits while, at the same time, bringing the cost on those down. But they [are] still relatively expensive at 3.25%. I'm assuming that's due to just what is going on in the industry as a whole, I guess. Could you give some color as to what competitors are doing to try to acquire deposits?

They are paying a lot higher than that, and we are starting to see benefits from -- even though we recognize that those are higher rates than outside of Puerto Rico, we feel that we have some traction here to continue to lower our rates and continue to grow, maybe not at the same rate as in the first half of the year, our core deposits. But we have the opportunity to continue to move forward, even bringing down the cost of funds there, even though knowing that they are higher than in the marketing [states].

Amanda Larson, Raymond James & Associates.

The cost associated with the termination of the repo agreements, $17.5 million -- where is that going to show up on the income statement?

Could you repeat your question, Amanda, the beginning of your question?

Yes. The costs associated with the termination of the repo agreement of $17.5 million -- where is that going to show up on the income statement?

Yes, it's going to show in the income statement in the third quarter.

Is that an expense?

It's -- no; as a loss on an early extinguishment of debt.

Okay, so non-interest income?

Yes, right, yes.

Okay, cool. And what tax rate are you hoping to secure as a result, like a net effective tax rate? Is that going to lower? Because it came out to like 8.55% this quarter, if I got it right. What's going to be a net effective tax rate with that?

Well, the answer -- I have to answer that question from two aspects. One is related to the question Bain asked before. We did this because of the financial possibility that (inaudible) and so on, but we had this year some short-term capital gains at the holding company level, and, not from an accounting, from a tax point of view, these termination costs or this loss is basically offset, I mean, those short-term capital gains, which would save us over $6 million in taxes. That's one thing.

The other thing is, from an accounting point of view, since the transactions technically occurred in the third quarter, then we have to do a calculation of the effective tax yield for us during the year, which is close to 8%; 7%, 8%. And then, to that 17.5%, since it is done in the third quarter, and (inaudible) like that effective tax yield and gives you approximately $1.5 million of, let's say, income tax benefit related to it that is accounted for in the third quarter.

But the 17.5%, since it was at the holding company, the effective tax rate there was like 35%, 40%. (multiple speakers)

Yes, but that's what I said, --

(multiple speakers) a significant savings that --

The 40%, which is more or less the $6 million to $7 million I said.

Which is one of the reasons that made the termination appealing, the fact that it was, on a standalone, such a higher tax rate.

Okay. Since you are expanding your franchise to provide to more mid- and high-net-worth clients, would you be interested in purchasing more branches to facilitate the increased business?

Amanda, I think Puerto Rico is over-banked, and there is more than 500 branches in the island. I think that we are showing quarter after quarter that with the number of branches that we have and to train people that we have, we have been able to grow $230 million in half a year, in core deposits. That's bringing in new clients and more deposits from existing clients and more services.

I don't see a need for us to expand our branch network from a new branches point of view. But if, in the future, there are opportunities for us to look at the process and look at businesses in Puerto Rico, we will look at them. But we, again, continue to feel that we are in the middle innings of a very difficult economic situation in Puerto Rico.

Okay. I guess I want to know what are the majority of the increases in the NPA's and what was charged off also.

Okay, on the [NPL's] the majority is residential (inaudible). That's -- mostly, the increase comes from there. And the charge-offs -- there is a -- on the quarter, there is $1.3 million in commercial. But those are -- there are a couple of loans there that are kind of legacy loans from the commercial book. That amounts to like, I'd say, $500,000 of the $1.3 million. But we are, as everybody else, we are seeing some pressure on the commercial loans. But we feel that, going forward, we are well-positioned. We don't expect to have more than $10 million in total charges for the rest of -- for the entire year.

Okay. What's the outlook for the net interest margin, now that the full effects of the repo agreement -- obviously, it went up a lot this quarter. But do you expect that it will be able to continue to go up from here?

I'll let Julio Micheo answer that question.

When you look at margin going forward, there's some potential positives. We'll continue to reprice our deposit liabilities. The repos are pretty much set, but simply -- and part of the beauty of taking down the $200 million is that those repos were at 4.47%, almost 4.5%, actually -- one 4.47%, and the other 4.25%. So that continues to bring lower our overall wholesale cost of funds. But in the retail side we continue to see possibilities to capture lower pricings, which are accretive to margin.

If rates increase, and like I said, with a 5.5% weighted average coupon in the portfolio and a cost of a very low par, it's a [core] (inaudible) [yield] of 5.48%, just potential with -- if rates go up and prepayments come down a bit, there might be 20, 30 basis points pickup there in the whole portfolio, so that -- which is significant, on $5 million. So those would be, I think, the potential positives towards margin.

On the negative side would be whatever hedges we do, we decide to do. If we use interest rate swaps, that could be decretive to margin. But the positives are still there, and perhaps none of the same magnitude that we saw going from 185, 190 to 229. But we feel that there's still some potential positives with regards to margin.

What exactly were the derivative gains this quarter?

Interest rate swaps.

Yes; we positioned, as part of our ALM, asset liability management, so it's -- the hedging and the derivatives and the trading [goals] is associated to the portfolio in the sense that at moments we can book, we can pull in to protect the OCI of the portfolio, like we did. We had a -- we started that -- [rates] for the -- there was a pressure in rates, and we were able to put five-year swaps in the low 245 area. And with a significant spike in rates that we saw until the first week in June, we were able to take them out at a significant gain.

So, in terms of the markets, we feel there's very contradictory forces which have added volatility which has played in our favor because there is, we feel, a very clear trading range now in terms of 10-year notes, 4% versus 3%, if you look at it. And we feel, if there is opportunities within that range, we can execute. We have to be observant of perhaps eventual pressures towards higher rates as the threat unwinds [quantitative easing].

But, on the other side, we are also observant of what could be a trend towards lower inflation numbers. So we feel there's a trading range in rates, and there's still opportunities to transact around that trading range.

And my final question is, is there any change in the outlook for the 0% repo and the 25-basis-point repo? Any outlook on --

Not at this time. We feel that it's going to remain there at least until the end of the year and -- at 0% and 25 basis points.

Concomitant to our position of higher coupons versus [multi] payments, which has paid off, we have taken a position that, even in this time around, if rates do go up, the massive unwinding of term paper would still have the yield curve steep, significantly steep. So we feel that that's a 0% and 25 basis points percent repo for the foreseeable future.

Thanks very much, guys. Good quarter.

Scott Roth, Severn River Capital.

Just another question on these repos, I guess two questions on it. I don't understand how you guys could borrow money so cheap from your counterparties. It looks like they can put these to you guys. Is there any cost associated that -- like if it resets and they don't put it back, that you have to make a payment? The reason I ask is, you took off it looks like $200 million of repos, and I think you said they're at 4.47%. But the payment of $17.5 million is almost 10% of that notional amount. So could we expect any other charges associated with these repos if they get unwound?

First of all, it's net of taxes. We need to understand that -- we explained during the call a couple of times that we looked at it from an after-tax basis. So the $17 million that -- the $7 million of taxes is equivalent to $10 million on that $200 million of unwind on repos.

Which makes it accretive. If our capital ratio is 7% and we pay 5%, it's actually accretive to capital.

From a delever point of view, it's accretive to capital because you have to look at net of taxes.

I understand that, but I guess -- obviously, your counterparty on that trade, if they looked at a trade, made $17.5 million on a fairly small notional part of your book. And then, if I'm your counterparty and I'm lending you money at 0% on $1 billion, what exactly are they getting in return for that?

That's another repo, and that's the steepener. And we have $1.250 billion in repos with, we call it the steepener. And I'm not sure if we have enough time here to explain in detail to you the structure, but we would be very much willing to entertain and explain to you that in a telephone call, because we -- I think we have some limited time in this call.

Is that fair with you, Scott?

Sure, that's fine. I'll call you guys afterwards.

The bottom line, Scott, is that there is an option value associated with the steepener, and there's a theoretical value that the [dealer] still associates with the option.

Avi Barak, Sandler O'Neill.

Firstly, I'm just looking at the $143 million in structured credit investments. I was wondering if you could give us just a little flavor or sense for the underlying reference credit to the collateral behind most of that.

In terms of the performance?

Just, what's the collateral behind those investments? Is it credit card receivables? Is it --

No, no, no.

Julio will give you an explanation on that one.

The 145 -- 143 to 145 is 23 -- 21 to 23 in collateralized loan obligations, which are backed by middle-market loans, which are, in turn, fully securitized by real estate or (inaudible). They are senior secured loans from middle-market corporate names.

Is that across the globe, or just Puerto Rico?

The US, across the US. Across the US, and there's three CLOs. Each one of them has the money manager, a fund manager which has expertise in that area, and there are significant, Avi, significant subordination means we own the single-A tranche, so there's bond holders under us. So -- and that's an asset class that has been significantly documented, and we have between 15% to 20% subordination below us. So that -- we feel very strongly about the asset quality of that particular portion.

Then 120 are synthetic CDOs in which the reference portfolio is a portfolio of investment grade corporate names diversified by industry and by geography, US and international, about 100 names.

Is there any focus on, say, financials or telecom or any specific industry? What would be the biggest industry in terms of (multiple speakers) --?

It would be financials.

It would be financials, about 20%. 20%, 22% would be financials. And those we conduct significant strenuous internal stress levels. As also, we have a firm that does significant perspective looking at stress analysis as well.

Fair enough, thank you. Next question -- when you look at what the loan loss estimates the Fed has proposed under the S-CAP, how do you think that would compare to what we are going to see or what you're seeing in Puerto Rico, and then within your own loan portfolio?

Hard to say, Avi. I think what's happening in the economy of Puerto Rico is a slower, a protracted economic slowdown versus a sharp slowdown or a sharp shutdown like the US economy had recently. So values here in real estate are continuing to go down, but they are not going at the same fast pace that it did in the states. We expect the economy of Puerto Rico to continue to contract slowly. The Obama plan money are coming in slower than we thought, and obviously the government is contracting the workforce.

So I think, as I said earlier, we are in the middle innings in Puerto Rico, and I think we still need to be very cautious and prudent. And we have seen some of our competitors already showing some credit numbers. We really don't have anything, that [compares in] our books to them, since we don't have any exposure to construction or any aggressive, let's call it, irrational type of commercial loan prices.

Can you give us a sense for what you are seeing in the 30-to-89 past-due bucket?

In the 30, in the residential mortgage? I can tell you our total delinquency on the residential mortgage portfolio, and you'll see it on the FDIC report. But it's in the 14% to 15% of the total delinquent, 30 days plus. That compares like 300 to 500 basis points less than the competitors here in Puerto Rico.

I don't know if you're allowed to say, but when the last time you had your annual regulatory exam.

(multiple speakers) I'm not sure if I'm allowed to say this or not, but we do have it every year; let's just put it that way. So we are -- I think everybody in Puerto Rico is having an examination by the FDIC this year.

Earlier in the quarter I noticed a couple of senior management had sold a little bit of stock. Was that just estate planning, or could you give us some color on what was going there?

Sure. It was primarily myself, and I have an 18-year-old daughter. She's going to college, and there's college planning to be done, and I am very much invested in Oriental stock. In total, I have close to 300,000 shares. And that's the reason why I executed some sales. That's basically the [lean] portion there.

There were some other sales, but they were less significant in terms of size.

Okay, thank you very much.

And remember, I have three kids, and they are all going to college.

William Griffin, Sterne Agee.

Good, very good quarter. Actually, most of my questions have been answered, but I had one little clarification. When you were talking about the OCI loss, did you mention $9 million of that was from the private CMOs and the structured credits?

Norberto was the one who answered that question, so let him explain.

What I meant to say -- the question I think Bain asked was in terms of the change in the OCI, the balance of the OCI, the loss as of June 30, and the change from March to June was approximately $23 million.

So basically what I said, that of those $23 million, $14 million belongs to the reclassification of the [delta], because of the implementation of the recently issued statement of position, which is basically increases retained earnings and increases OCI. It does not affect the whole [executive]. And the difference is $9 million. The $9 million is basically the net effect of some increases and decreases. The structured credits, really the fair value, increased during the quarter, and there were some decreases in general in the fair value of the agency securities.

William, I also think, and I'd like Julio to expand a little bit regarding our OCI position and what does it mean a little bit regarding our future.

Just a while ago, we spoke with Amanda regarding what could be the margin drivers. And it's important that we also mention what could be the OCI drivers because, when we look at our private-label CMO and also our structured credit portfolio, the private-label CMO is almost a three-year-old portfolio. So by now, there's actual severity that you have, there's actual loss data. These are reviewed by the rating agencies. We have also two private consultant entities that do shock analysis and perspective. So it's much less of an unknown than it was before.

Regardless, even that is the case, we still see a market, when we look at our fair value pricing, that is still broken. So when you look at the unrealized loss or the fair value for our private-label CMO, it's still $120 million less than a value that you would derive based on projected losses, the present value based on projected losses. That's almost $5 a share which you say is -- our book value at [12/04] has already discounted about $5 of (technical difficulty) OCI, which perhaps is based on a very, very depressed market, much more above forecasted losses. And we argue that over time, let's say that maybe not all the (inaudible) [points] are recouped, but a portion of that should be recouped over time.

We would all say that it's part of what we call the hidden value. And when we look at OCI, certainly the other side is that we have $3.5 million or $4 million of fixed-rate securities which have significant unrealized gains that, if rates move up, we have to hedge and protect. That's why we are so attentive all the time to hedging and positioning. But the counter of that is that we already have about $5 of unrealized loss, and about $1 of unrealized losses in our structured credit, over and above projected present value, projected loss present value. That's a significant amount of book value that has been associated (inaudible) that is hidden that could potentially be recovered.

Okay. And, can you give a little color at all on what drove the markup of the structured credit from last quarter?

What was the markup?

(multiple speakers) marked up the carrying values a little bit.

They were up $10 million for the quarter.

Right, and was there any color you can give us around what drove that change?

Well, the spreads are tighter, the market is a lot more liquid, less liquidity premium is being required. And, based on the analysis of ourselves and our third parties, we assign those prices.

It goes in tandem with what we've said. If, over time, green shoots turns into better economics, China growing at 8%, volatility coming down significantly in the base -- I mean, if risk aversion is something that eventually will fade, so will these prices improve. So that's what I said in the context of hidden value. Over time, you should be able to see -- if this trend continues, you should see the market being less punitive in the market price of the securities.

Well, thank you very much, and congratulations on a good quarter.

At this time there are no further questions. I will now turn the call back over to Mr. Fernandez for closing remarks.

Thank you very much to all for participating on our second-quarter 2009 conference call. We hope to see some of you as we travel to meet investors this quarter. Next week on Wednesday I will be at the KBW Community Bank Conference in New York City. We look forward to chatting with you again, when we report our third quarter results in October. On behalf of the Oriental team in Puerto Rico, myself, Julio and Norberto would like to wish all of you a very good day and thank you for your interest and support of Oriental. Have a great day.

Thank you very much.

This concludes today's conference call. You may now disconnect.