OFG Bancorp (OFG) 2010 Q1 法說會逐字稿

Good morning. My name is Melissa, and I will be your conference operator today. Thank you for joining us for this conference call to discuss quarterly results for Oriental Financial Group.

Our participants today are Jose R. Fernandez, President, Chief Executive Officer and Vice Chairman; Julio Micheo, Senior Vice -- sorry, Senior Executive Vice President, Chief Investment Officer and Treasurer; and Norberto Gonzalez, Executive Vice President and Chief Financial Officer.

Please note 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 be a question-and-answer session. (Operator Instructions) I would now like to turn the call over to Mr. Fernandez.

Thank you for calling in this morning. I'll review the highlights of the first quarter and then Julio, Norberto, and I will answer questions.

First, capital. This quarter shows a significant increase in capital from our mid-March share offering, an improvement in the valuation of our investment securities portfolio and our growing amount of retained earnings.

Total stockholders' equity was $464 million, an increase of $134 million, or more than 40% from the December 31, 2009, quarter end. Book value per share of $11.97 is up nearly 11%, and tangible common equity to total assets improved 209 basis points to 6.06%.

All of this reflects net proceeds of almost $95 million from our stock offering, the net income for the quarter, and an improvement of approximately $33 million in the fair value of our investment securities portfolio.

Second, preparing for a rising rate environment, this quarter results shows steps that we have taken to prepare for such environment. As most of you know, in December 2009 and in January of this year, we sold certain non-agency securities.

Rather than reinvesting all of the proceeds in the purchase of new long-term securities, we have been building up our cash position. At March 31, 2010, we had $468 million in cash versus $277 million in December 31, 2009.

As a result of these two factors, yields on the interest -- on interest-earning assets declined to 4.50% for the first quarter from 4.94% in the previous quarter. And at the same time, our increased level of deposits enabled us to reduce total cost of funds to 2.88% from 2.98% in December. The net effect of our net interest income was a reduction of only 4% compared to the year-ago quarter.

Third, our franchise continues to perform. During the quarter, our banking and financial services franchise performed well in an environment that continues to be, in most people's opinion, one of the most challenging in the history of the banking industry in Puerto Rico.

We continue to grow core retail deposits. These increased nearly 6% or $81 million sequentially and 25% or $294 million year-over-year while reducing the cost of funds. This reflects a flight to safety and the success of our relationship banking team. We did not have to resort to rate increases as other banks did.

We have seen a nice increase in commercial deposits as well, $58 million in savings and checking account deposits sequentially, and $215 million year-over-year. We're not just waiting for depositors to walk through the door. We have built a highly motivated and incentivized group of relationship bankers. They're doing a great job attracting clients to Oriental and we really appreciate their effort.

With the significant increase in core retail deposits, we have significantly reduced our brokered deposits. These are now less than $145 million, representing declines of $58 million sequentially and $307 million year-over-year.

With regards to client activity, that remains strong on the retail level. Our commercial POS cash management business continues to do well. And we maintain a steady level of loan originations.

We produced a total of $75 million including $52 million in residential mortgage origination and 20% (sic -- see press release) in commercial originations. While residential mortgage production was soft in January and February, it rebounded in March. And in commercial banking, we continued to see quality loans at better pricing.

Total loans at $1.13 billion declined marginally from the preceding quarter. This reflected the breakdown of residential mortgages and increasing commercial loans. As we've mentioned in previous calls, we're selling most of our conforming mortgages, which represented 90% of the first quarter production into the secondary market while retaining the servicing rights.

Now, turning to brokerage, we had another good quarter. Broker-dealer assets increased 2.5% or $32 million to $1.3 billion. We also had a good quarter in trust, but it is hard to see from the numbers, which show a decline in -- of $130 million in assets. Virtually all of that can be accounted for a strategic decision we made to let go of custody assets that generated very little fees. Altogether, we achieved a healthy level of core non-interest income; revenues increased nearly 12% year-over-year to $7.4 million, reflected -- reflecting increases in both financial and banking service revenues.

Fourth, credit quality remains strong, net credit losses remain low. At $1.3 million these fell 44% year-over-year and dropped to 0.46% of average loans outstanding. We continue to increase our allowances for loan losses. At $26 million, it is now up 72% year-over-year and our coverage ratio has expanded to 2.24% of total loans. We have pretty much doubled from a year ago.

Non-performing loans increased $4.9 million from the preceding quarter, a relatively small amount. We don't expect non-performing loans to result in significantly higher losses as most of them are well-collateralized with adequate loan-to-value ratios. And we feel very comfortable with our coverage ratio given the low credit risk we have on our mortgage loan portfolio.

Our portfolio has an average balance of approximately $150,000. What we are seeing from delinquent loans when we reappraise the property is a 15% to 20% reduction in market value. With an estimated actual loan-to-value ratio of less than 80%, we have a nice cushion that can protect us against any further reduction in fair values of the residences held as collateral.

Our latest stress test shows losses in our mortgage loan portfolio should not be higher than last year. Just a few other items before we go into questions and answers. Approximately 96% of our Group's portfolio of fixed rate mortgage-backed securities or notes are guaranteed or issued by Fannie, Freddie and Ginny, and our US agency senior debt obligations are also backed by the US government, most of them. Reflecting our mid-March offering, common shares outstanding at March 31, 2010, was 33.1 million shares, up 8.9 million shares from December 31, 2009.

With our capital raise and strong performance, regulatory capital ratios continue to be well above the requirement for well-capitalized institutions. Our leverage capital ratio is 7.82%, tier 1 at 23.55% and total risk-based at 24.73%.

Looking at our growth opportunities, we feel that the economy continues to contract here in Puerto Rico. We've seen some better news recently with the announcement by Moody's, and we feel that those are positive data points, but we continue to feel that the economy will contract further.

It will contract at a slower pace than in 2009. Perhaps we're getting to a bottom on the economy, not necessarily now, but further along in the year. And within this environment, we continue to believe we're well-positioned to grow this year and in the years ahead.

Our focus is on both organic and inorganic growth opportunities. Our goal is to achieve a strategic shift on our balance sheet to become more of a traditional bank. In doing so, we don't want to become the biggest bank on the island, but we want to be the most profitable. We see opportunities in three areas.

One, there are many unsatisfied commercial clients in Puerto Rico who have good credit quality and fit in well with our professional market, middle market type of clients. To capture that business, we're expanding our commercial lending unit and our credit team.

Two, we continue to see a flight to safety in retail banking. While it is unlikely that we're going to replicate our 2009 deposit growth, we are encouraged by the 6% sequential growth we saw this quarter. Subsequent to the quarter, we believe we did very well in our IRA season this year.

Three, we see a great opportunity in trust, retirement and financial services. Everyday we're helping our customers make better decisions on how to invest and protect their money, to buy a home, finance their business, create cost savings or plan for retirement, and that attracts assets and generates recurring financial revenues going forward.

Now, I know many of you have questions regarding what is happening with the FDIC and the banking scenario in Puerto Rico. I hope you understand that it would be inappropriate for us to answer any such questions in this call. Now, having said that, let's open the phone lines to questions. Operator, would you please begin the Q-and-A session?

Thank you. (Operator Instructions) Your first question comes from Joe Gladue of B. Riley.

Yes, hi, good morning.

Good morning.

Let me start out with the growth in non-interest-bearing deposits. That was, I guess, pretty impressive growth in the first quarter. Can you give us a little more detail on what was driving that?

On the non-interest income?

Non-interest-bearing deposits.

Non-interest-bearing --

Oh, non-interest-bearing, okay. On the -- well, non-interest-bearing deposits is driven primarily by commercial, and that's part of what we're starting to see this year. The commercial unit is attracting better clients with better pricing and with it -- on the long side -- and with it is coming good deposit relationships. So that's one of the catalysts for that non-interest-bearing increase, Joe.

Okay. Was there any particular -- you know, I'm not interested in a particular client, but was there one or two particular clients that brought in a big chunk of that, or was that --?

It's across the board. We had a good quarter in commercial. And we saw the $20 million increase in loans. You have to add to that the flight to safety type of scenario. We mentioned last year that when we launched the POS and the cash management business, we said that we were seeing good momentum, and we continue to see it this year. And that has -- that is what is primarily driving the growth in non-interest-bearing deposits in commercial, Joe.

And the [positive] relationship with commercial clients is often necessarily -- you see it on day one when you grant the loan. You have to continue establishing that relationship, and maybe a loan that was granted several quarters ago, then increased the deposit relationship with Oriental this quarter.

All right. Just want to talk a little bit about the net interest margin, I guess, reduction in -- you mentioned a reduction in yields on securities and the excess liquidity you'd built up. Just wonder -- trying to get some idea how long we expect to maintain that -- those cash holdings and what we can look forward to in that regard.

Well, I think, Joe, that given the scenario how it's playing out here in Puerto Rico and also how interest rates are also playing out, we feel that we should have a higher level of cash at this time. And that's going to sacrifice a little NIM, but really it's more of a tactical decision.

And we are cognizant of that, our normal level of cash should be closer to $200 million, $150 million to $200 million. So we feel that with potential interest rates going up, on the longer end, we need to be careful with how we deploy that cash. So going forward, if you look at Oriental, we should be looking at a margin of north of 1.80%.

Okay. All right. And just one last thing for now. Just wondering if you could just touch on the housing market in Puerto Rico and do you still expect further price declines? I guess maybe tell us a little bit about the inventory of unsold homes or what you're seeing just in the housing market in general.

I don't have hardcore statistics on that that are more recent. But from anecdotal evidence, we feel the -- at least I feel, and Norberto and Julio can add -- but I feel that the housing market is still bound to drop even more in value. I think there's -- especially the higher end segment, the above $400,000 or above $350,000.

I also think that apartments and condominiums in the metropolitan area, there is an excess supply there too. And there's going to be quite a few years of absorption to deal with. So my view of this is that I think we're going to still see some more pressure on real estate values in Puerto Rico.

Okay. All right, thank you. I'll step back now.

Thank you, Joe.

Your next question comes from Bain Slack of KBW.

Hey, good morning.

Good morning, Bain.

Hey. I wonder if I can get a little color on the $10 million derivative loss during the quarter.

Sure.

What that was driven by and what's the impact of that.

Those are the -- the $900 million forward-settled swaps. We -- recall in December we had a gain there of $9.1 million more or less. So interest rates were higher in December than what they were in March. And that's why you see a valuation there. That's the reason for that negative valuation.

Okay.

Because the interest rates were lower as of March 31st than as of December 31st.

Okay.

Which is consistent with the drive in -- that you mentioned, Jose, $33 million increase in the fair value of securities.

Correct.

Correct. Yes, and I guess actually that that's -- could lead to my last question. I wanted to know, the $33 million swing in OCI, was that only agencies or was there any impact with [BALTA] within that move?

The impact with BALTA was not that much. You -- the only thing -- and I will not say significant, but with BALTA, you see there's an other than temporary impairment of $632,000 which was basically on the BALTA. But the deferred value of the non-agency securities remains similar to December 31st.

Did it improve a little bit, the non-agencies, or did it remain pretty much the same, just in -- on a BALTA [scale]?

Remained more or less the same.

Okay.

Improved, but not much. Nothing significant.

Nothing significant.

So the rest of the agency book is the one that drives the increase in book value.

Okay.

Not only, Bain, we saw improvement because if you look at, as we have mentioned, a proxy for a -- about $3.5 billion agency mortgage-backed securities, if you look at Fannie Mae's 5%, 30 years, they only are like about, I don't know, a quarter to three-eighths of a point higher, in absolute price, December to March. But we also saw -- the type of security we'll be buying, we also saw a pick-up in price, relative price to the underlying instrument.

And Bain, just to give some -- be more granular, let's say the non-agencies, the structured credits, the fair value during the quarter increased from -- basically, it is less than $2 million, but there was an increase -- let's say, a reduction in the unrealized loss. And in the case of the non-agencies that had an unrealized loss of 41.4 as of December. It is 34.9 now, net of the --

38.9.

38.9 now, net of the OTTI of $600,000. So there was some slight improvement in the non-agencies.

Yes.

Okay. Okay, great. And with the portfolio in general, where does the duration stand today and what does the annual cash flow look like going -- over, say, the next 12 months?

Well, as you know, in terms of duration we have two measurements. One is effective duration, which includes optionality, and the other one is modified duration, which is static with the current cash flows. Effective duration is in the area of the 3 year and change, while the modified duration is in the area of slightly under 6 years, 6% or 6 years.

Okay. And --

And that's including the cash position.

That's including -- that's all-in, that's including that -- that's the total portfolio including the $400 odd million, yes, the -- around 5.75 of modified duration, which would probably be the more meaningful number at this juncture.

Okay. And -- yes, I guess just the last question. We've got the cap raise, and it looks as if you guys are pretty effectively getting more bank-like-type products, both on the deposit side and with regard to commercial loan generation.

What are the plans going forward, should there not be an FDIC-assisted transaction at Oriental? What's -- is there -- maybe I'll call it plan B, to still get to the 50-50 mix, and does it -- and how does it change the outlook in terms of how long it may take to get there?

Yes, well, we've said it all along, Bain, we -- we're building or -- and recruiting commercial bankers and we're actively moving there. I also think that the dynamics of the local banking market in Puerto Rico are going to change dramatically in the upcoming weeks. So that's going to be a very good opportunity for us to attract more clients and better clients at a better price too.

So it's going to take us longer certainly, but I think we can work in an environment with less banks. And with all the remaining banks except ourselves dealing with all kinds of dislocations and disruptions, Oriental can work aggressively with our sales force and bring in a good relationship for growth.

So there are different scenarios that can be played out on there, but organically I think certainly it's going to take longer, but it's still a very good opportunity for us to work toward our goal.

Yes, as well as if it were to be inorganic as repo mature -- we have a repo maturity of $100 million in August -- there should be also selling securities and deleveraging opportunities, so the mix improves in terms of loans to total assets.

That's a very good point, Julio.

Okay, great, thanks, you guys.

All right, thank you, Bain.

Thank you.

Your next question comes from Adam Barkstrom of Sterne Agee.

Hey, guys, good morning.

Hi, Adam.

Good morning, Adam.

I was wondering if you could maybe take a couple of more seconds -- and I know the question's already been asked, but maybe if you could put a little bit more color around the margin issue and the accumulation of cash issue and why this quarter -- what's your rate outlook from here.

And I know you gave us a loose guidance of north of 1.80%. Any way we could tighten that up and -- I mean, are we stuck at these levels margin-wise for a while or a couple of quarters down the road, should we look for a rebound back toward where we were for fourth quarter?

I think the best way to answer your question is to start by talking a little bit about what we feel the interest rate scenarios are going to look like from our point of view, recognizing that we don't have a crystal ball.

So -- but we feel the trend for interest rates on the short end and the long end is to go up. Not necessarily there is a strong momentum for that, but it's moving there. And that's one reason why we have a high cash position.

Having said that, we don't think -- we don't think that the short end of the curve is going to go to 4% or 5% on the [FEFCON] side. We feel that it might go at best at the end of next year at 2.5%.

So that's how we see the scenario playing out. So given that, we feel that we will certainly have the ability to reinvest if we reinvest on securities, we reinvest at a higher yield -- higher-yielding securities, and that's going to be positive for margins.

I also think that even though we will have some pressure on the funding side, if interest rates continue to go up on the -- or start to go up on the FEFCON side, as Julio mentioned we do have the ability to cancel some of these repos or -- some of those repos become mature. So that's also another scenario that plays out that might help us to some degree.

And lastly, I think we have good momentum on continuing to reduce the cost of our core deposits. We've done it throughout the last three or four quarters, and we plan on continuing doing that as the market in Puerto Rico becomes more rational on the deposit side.

And then also on the asset side, we feel that we will be bringing in higher levels of loans at a higher price. So that should help. So that's the long strategic answer.

The short tactical response to your question is on the short end, things are too fluid in Puerto Rico to commit ourselves to long term. So that's why we're keeping the cash at a higher level.

Yes, were we to -- just to give you also a quantitative measurement, were we to deploy around $300 million of cash at roughly 4% or slightly north of 4%, that would be another 20 basis points of NIM just right there. So clearly, there is opportunity value to cash being potentially deployed.

The other comment I would add to Jose Rafael's interest rate outlook is something similar to what is happening today, which we're seeing, finally, a meaningful flattening of the yield curve, and insofar as the yield curve flattens, that is positive to our portfolio, [that's good] with our portfolio.

As we just answered before, it's more skewed towards intermediate to longer term duration assets. And that could be a combination of improving things in the US, which means a lower budget deficit, less Treasury supply, and I guess [watching] things in Europe that could bring a stronger dollar and a flattening of the yield curve, which we feel could be positive to the mix here.

So that's kind of why we have to be careful when we -- in matters regarding hedging, because you see a day like today, the short end's not doing anything but the long end is up between three-eighths of a point to three quarters of a point.

Okay, thank you. And hey, I was wondering if you could give us an update on -- over the last couple of quarters, one of the focal points has been the $1.25 billion repo contract and where we are with that and what's the latest.

It's stayed the same. It's the same. No change from the last several quarters and we are not expecting to see any change in the foreseeable future.

And just remind me, I'm sure those -- remind me, that's puttable only -- that's puttable every quarter, but only on a particular date, right?

Correct.

That is correct, right.

So that would be -- what -- March 31 is puttable, or was puttable?

It's something close to that, early June --

It's the earlier part of the calendar, so the next day will be June 2 and June 7th.

Okay.

Would be the next dates, for the beginning of that quarter. There's one June 2 and the other one is June 7th. So it's early June and then early September, early December and early March, that's how it goes.

Got you, okay.

They can only -- they can only put it in those days. If they don't put it, then it's locked in for the quarter.

And then remind me, effectively, that's a 0% cost for you guys right now, correct?

Pretty much, pretty much.

Effectively. It's $1 billion at 0 and $250 million at the quarter. So effectively it's 0%, that's correct, Adam.

Okay. Okay, great. Thank you.

Thank you.

Thank you.

Have a good day.

(Operator Instructions) Your next question comes from Amanda Larsen of Raymond James.

Hi guys.

Hi, Amanda, how are you?

Hi, Amanda.

The repo agreement that you guys have now was from kind of a bet that you made a couple of years ago. I guess this question is directed at Julio. Do you have anything up your sleeve for where you think rates are going to go now, or are you staying ultraconservative in anticipation of just growing the bank organically or through FDIC deals?

It's a mix of both. Certainly, we have to be keenly aware of that -- of those possibilities and remain conservative. And insofar as the repo, there's so much cushion in it that the -- it seems like a binary sort of possibility. Either it gets put back to us, or simply we will have a cost of 0% effectively for the considerable future.

Okay. If you didn't do an FDIC deal, would you consider, possibly, a financial technology company, or even expanding outside of Puerto Rico, maybe outside of -- to the Caribbean?

I think the greatest opportunity is local here, organically, Amanda, and -- but we don't exclude anything. We certainly think that there are going to be opportunities here in Puerto Rico on financial services and other businesses. So yeah, we'll look at everything but our focus right now is Puerto Rico.

Okay. And lastly I know there's not that many economic indicators out there for Puerto Rico. And since we're not there, can you give us any type of indication of how you feel about the economy to make us more comfortable with it?

My view of it is that it's still kind of the same. We are contracting around 3% for this year, or a little bit more than 3%. They're starting to show some positive indications in terms of cement sales and in terms of energy utilization, but unemployment continues to go up, and I think that's the most important variable that we need to look at.

We saw some positive news yesterday from Moody's even though that's kind of modest, since it's kind of a rearrangement of their own credit parameters. So again, I think there are some positive data points on the economy of Puerto Rico. I still don't see the actual feeling of it and I think it's going to take a while, for the rest of the year, given the financial sector being in such distress, it's going to take a while. So that's how I see it now.

I also think that sooner -- in the next six months or 10 months, the economy should hit bottom, and going forward it's not going to go up 3% or 4%, but it's going to range from 0% to 2% a year. It's going to depend on the US economy, how it impacts Puerto Rico, and what other things we can do here in the island to create a catalyst for growth.

Okay, to add on to that, do you see any specific deterioration, like are any of your commercial customers coming to you and they're worse off today than they were a couple of months ago or so?

I'm sure there are some -- I can say a couple of examples certainly, because the economy is in contraction, but nothing to -- in our case at least, it's nothing to alarm us. It's something it's part of a cycle and we are well-reserved for that. So we are not seeing that. But we have been very conservative in the past and that's probably a reflection of that too.

Okay, great, thanks so much.

Okay, Amanda, thank you.

Thank you.

Thank you. Your next question comes from Avi Barak of Sandler O'Neill.

Good morning, guys.

Hi, Avi, how are you?

Hi, Avi.

A couple of quick questions for you. First, could you just remind us again the book value of the CDOs and the private-level CMOs? Did you say $62 million for the CDOs and $130 million for the CMOs?

Norberto will give you the information.

Well, the non-agency CMO as of March 31st has an amortized cost of $110 million and a fair value of $71.2 million. It's available for sale, so that's what we have in the books.

Okay.

The structured credits that we have, which are the CLOs and one CDO, the amortized cost is 61. -- is -- yes, $61.7 million, and the fair value is $40 million.

Okay, perfect. Thank you. Secondly as far as the agency portfolio is concerned, could you quantify for us the potential impact to capital ratios and book value as a result of a premium amortization on delinquent paper with Fannie and Freddie buying the delinquent stuff?

Well, Avi, we have cleaned -- and Freddie Mac already did that, but we cleaned our exposure to low FICO and high LTV underlying pools. So the type of pools we have are much more credit-quality-oriented pools, high credit quality, high FICO, lower LTV. So we really would not expect much.

Fannie Mae has announced to be doing it in a ladder of coupons, starting with the higher coupons and moving down to the lower coupons. But we really do not expect any major disruption or distortion to our portfolio, given the high underlying credit composition.

Okay, fair enough. Third, obviously difficult to quantify with so many moving parts in the economy, but the $70 million of fair value Puerto Rico obligations, how should we think about that with so many question marks in the economy?

What do you mean --?

You mean in terms of (multiple speakers)?

Potential losses.

Well, in terms of the unrealized losses in the portfolio or in terms of potential losses on the investments?

Both please.

Well, in terms of potential, we don't expect to have any losses right now on that portfolio, realized losses, right. We don't feel the economy in Puerto Rico is going to go -- and -- we're going to default -- the government is going to default on their debt. So --

Okay.

So that's our feeling there.

Okay.

And then in terms of valuation, Norberto will --

Yes, Avi, basically, the -- what we have is $71.6 million in costs and the fair value is $66.5 million, so there is like $5 million realized loss on that portfolio.

Okay.

Yes, these are mostly debtor obligations, so like Jose Rafael said, it would be very difficult to envision a scenario in which the government would default on its own debtor obligations.

And especially with what happened yesterday on Moody's increasing the rating of the GOs precisely, to A level, I think it was, makes it even less [probable].

Okay. Okay, thank you. And then lastly, in light of the recent capital raise and the corresponding commentary in that press release about potential FDIC transactions, just as a general statement, would the $100 million be sufficient for what you had in mind or is it more just having some dry powder in case something else came along?

As I mentioned, Avi, I'm staying away from answering any of those questions at this point.

Okay, thank you.

Thank you. You do have a follow-up from Amanda Larsen with Raymond James.

Hi again, guys. I just have a maintenance question -- if you have the earning assets number for the end of the quarter, not the average.

The actual earning assets?

Yes.

We cannot provide it you right now --

I will send it to you by e-mail. I don't have it here in front of me. Okay?

All right, thanks, guys.

Thank you.

At this time there are no further questions. I'll now hand the floor back to Jose Fernandez (technical difficulty.)

Okay, thank you guys for the questions and your participation today. We appreciate your time and are looking forward to continuing our conversation on Oriental's performance in the future. Have a great day.

Thank you very much.

Thank you for participating in (technical difficulty.) You may now disconnect.