OFG Bancorp (OFG) 2011 Q1 法說會逐字稿

Good morning. My name is Paula, and I will be your conference operator today. Thank you for joining us for this conference call for Oriental Financial Group. Our participants today are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman; Norberto Gonzalez, Executive Vice President and Chief Financial Officer; and Julio Micheo, Senior Executive Vice President, Chief Investment Strategist.

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. 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, Paula. And thank you, everyone, for listening in today. We're continuing with increasing progress to transform Oriental through our three core strategies -- one, continue to grow our Oriental Bank and Trust and Oriental Financial Services franchise; two, preparing for a second wave of bank consolidation on the island; and three, returning capital to investors through increased dividends and share buybacks.

As a result, during the first quarter, we saw a major improvement in total pretax operating income. It totaled $13 million, up 126% from the fourth quarter and up 5% year over year.

About $30 million, or 64% of our net revenues, came from our banking and wealth management operations. This compares to less than $14 million or 37% in the year-ago quarter. And we bought back more than 1 million shares, reducing our share count approximately 2%.

During today's call, I'll go through the income statement, Norberto will cover some special items and the balance sheet, and then we'll open it up for questions and answers.

Jose Ramon Gonzalez, our Senior Executive Vice President of Banking and Corporate Development, is on a previously scheduled personal engagement outside of the island and will not be participating in this call.

Now, turning first to our fee businesses, we maintain a lot of momentum from the fourth quarter. Wealth management was up more than 17% year over year, led by brokerage, trust and a successful IRA campaign with our flagship fund, Diversified Growth IRA. Banking revenues were up more than 136%, reflecting organic growth and the benefits of the former Eurobank branches and customers. And mortgage banking activities and mortgage banking fees increased 9%. All together, banking and wealth management revenues totaled $10.5 million, up more than 40% year over year and on pace with the fourth quarter of 2010.

Assets under management, which generates recuring noninterest revenues, totaled a record $4 billion, up 35% year over year and more than 4% sequentially. This reflects increased market valuations as well as growth in new brokerage and trust assets.

On the deposit side, we continue to lower our costs while increasing our core retail deposits. Growth in deposits might be more moderate for a little while as might be expected. But we continue to anticipate better pricing ahead.

On the production side, commercial loans and leases, we generated nearly $22 million in production. Our small business and professional lending teams had a good quarter. In our corporate business, we have concentrated on developing a quality pipeline of accounts and expect this emphasis to pay off in the future quarters.

As for residential mortgage lending, production and purchases totaled $53 million. Now that rates have rebounded somewhat, we are seeing a reduction in the refinancing. And lastly, consumer lending remains strong at $3.6 million.

Looking at interest income, noncovered loans generated $17.8 million, which was up a little year over year and down slightly from the fourth quarter. For the most part, this reflects our loan balances. Residential mortgages continue to decline due to maturities and some prepayments. We are making up for this with increased balances of commercial, leasing and consumer loans.

As you know, our strategy has been to sell most of our residential mortgage originations in the secondary market and to grow our portfolio primarily through the generation of quality commercial loans.

Covered loans generated more than $14 million in interest income compared to about $15.9 million in the December quarter. The decline was largely due to normal maturities.

We also had a strong rebounding performance from mortgage-backed securities. These generated $43.7 million in interest income, up more than 21% from the fourth quarter. This was driven by a reduction in prepayments due to a rebound in mortgages -- in mortgage rates on the mainland. In turn, this reduced the amount of premium amortization we needed to take.

Total interest expense was $40.7 million, which was down both year over year and from the December quarter. Sequentially, this reflected, as we have noted, lower cost of funds in both deposit and borrowing on increased balances in core retail deposits and lower balances in institutional and broker deposits and short-term balance. The cost of deposits fell to 1.91% from 1.95%, while the cost of borrowing fell to 2.91% from 2.95%.

Consequently, we saw meaningful improvement in spread and margin. Spread increased to 2.31% from 1.95%, and margin improved to 2.30% from 1.90%. We expect NIM to be more stable, around 2.20% for the remaining part of the year.

Provision for covered loan and lease losses fell to $549,000 from $6.3 million in the fourth quarter. There was a minor increase in the provision for noncovered loans and leases. As a result, we saw major improvement in net interest income after provision for loan losses. It totaled $32.8 million which was up 59% sequentially and 29% year over year.

Noninterest expenses came in at $30.8 million, more than $800,000 less than the last quarter, due to our continuing emphasis on cost control. We would expect to maintain about the same level of spending in the second quarter. In the second half, however, we plan to invest more in marketing.

There are a variety of factors continuing to drive our growth. First is our expanded commercial team under the direction of Jose Ramon. Our strategy of focusing on quality clients disenfranchised by other banks is working. We are already benefiting with increased commercial deposits. Given our growing pipeline, we expect to see increased commercial lending.

Second, we are benefiting from our larger, more strategically located network of 30 branches, combined with our well-trained staffs. This is enabling us to attract both deposits and wealth management assets. We also believe the local economy, though still challenging, is beginning to show signs of at least stabilization after several weak years. Looking at the prime economic indicators, we are seeing some pockets of light at the end of the tunnel.

Puerto Rico is at this point in a tipping point where we can either start to grow or go down again. Petroleum prices will have a big influence on what happens.

Now I'd like to turn it to Norberto to continue with the balance sheet and nonoperating assets.

Thank you, Jose. The results for the quarter included a derivatives loss of about $4 million as a result of a strategic decision to sell the company's former forward sales swaps and purchase new swaps.

Oriental has elected to apply hedge accounting on the new swaps. As a result, any future fluctuations in evaluation of the swaps that meet the hedge effectiveness requirements will be recorded in other comprehensive income.

As we indicated in our 10-K, in the first quarter of 2011, we reduced by approximately $5.4 million the deferred tax asset as a result of the Puerto Rico government lowering, in January 2011, the statutory tax rate to 30% from 39%. On the other hand, the reduction in tax rates will have an ongoing positive effect for Oriental since taxes on all income will be calculated at a lower rate.

Regarding our balance sheet, the cash position of $317.4 million declined $131 million as excess liquidity was partially used to invest in mortgage-backed securities and to repay maturing broker certificates of deposits.

Our investment securities portfolio stands at $4.4 billion, and it increased 1.7%, or $73.6 million. This reflects the reduction in the available for-sale portfolio mainly due to principal repayments on Fannie Mae and Freddie Mac certificates and an increase of approximately $185 million in the held-to-maturity portfolio.

As you know, approximately 98% of Oriental investment securities portfolio, as of March 31, 2011, consists of mortgage-backed securities, guaranteed or issued by Fannie Mae, Freddie Mac or Ginnie Mae.

Looking at our credit quality, the allowance on noncovered loans increased 4.1%, rising to 2.78% after the loans and leases, versus 2.66% as of December 31, 2010.

Nonperforming loans fell $1.7 million to $121 million, primarily due to our effective loss mitigation program on residential mortgages.

Net credit losses on noncovered loans only increased by approximately $600,000.

With regards to covered loans, or loans covered by the FDIC loss-share agreements, [for on] their acquisition on April 30, 2010, through March 31, 2011, these have generated approximately 28 -- $22 million more in cash flows than originally expected. If these cash flows continue to outperform the original estimate, interest income for these loans may be increased.

Regarding our total number of shares, we had 45.4 million [sic - see press release] on March 31, 2011, versus 33.1 million a year ago. This increase reflects the capital raise in the June 2010 quarter related to the FDIC-assisted acquisition of Eurobank, less share repurchases during the March 2011 quarter.

During this first quarter, Oriental returned approximately $12.5 million to shareholders through its current $30 million share repurchase program, buying back over 1 million shares at an average cost of $12.18 per share. As of March 31, 2011, the total stockholder share equity stands at $713 million. Book value per common share is $14.22 compared to $11.97 on March 31, 2010, and $14.33 at December 31, 2010.

We continue to maintain regulatory capital ratios well above the requirements for a well-capitalized institution. At March 31, 2011, the leverage capital ratio was 9.52%, Tier 1 risk-based capital ratio was 30.29%, and total risk-based capital ratio was 31.57%. Reflecting share repurchases [to annual] common equity to total assets was 8.92% compared to 9.02% at December 31st.

Now I would like to turn the call back to Jose.

Thank you, Norberto. Before we conclude our initial remarks, I'd like to share some important and key indicators of future results for Oriental. First, improved margin, looks like we will be able to maintain margin around 2.20% for the rest of the year. And as we will have higher loan originations, we feel very encouraged with that.

Number two, credit quality continues to remain stable. We expect losses for the year around $10 million. So again, we feel very comfortable with that.

And number three, wealth management business continues to grow assets at a good rate. We are very encouraged with how we are playing in this market, and achieving $4 billion in total assets a [gather] has been an exceptional achievement for us in the recent months. So as we continue to hit higher level of assets, we expect higher fees.

Fourth, banking business, I think the momentum that we have might not be evident by the numbers. But internally, we are building a strong team of bankers that already are attracting a good commercial pipeline of banking relationships. And we expect to show the results into the future.

Fifth, cost of deposits, we continue to bring down the cost of our deposits, and we expect further reductions next quarter.

And lastly, I feel that the future of Oriental looks very bright. I think we have an excellent team that we have recruited and developed throughout the years. We have worked on the infrastructure to make sure that we take advantage of this once-in-a-lifetime opportunity.

So our game plan is straight forward. We continue to increase business through commercial loan production, our banking and wealth management activities. We will continue to reduce the cost of funds. We will carefully manage our investment securities portfolio. We remain open to opportunities that might result from further consolidation in the local banking market, and we return capital to investors when appropriate.

Our goal, as I have said often, is not to be the biggest, but continue to be the best and most profitable bank in Puerto Rico. We are pleased to report that we are making steady progress, even if it is a little uneven at times. The trends in our market are moving in the direction for us. We believe that we have strong momentum.

Now I'll be happy to take your questions.

(Operator Instructions) Your first question comes from Michael Sarcone of Sandler O'Neill.

Hey, good morning, guys. First question, on the NIM, you had said you expected to be stable around 2.2%. It's at 2.3% now. Can you just walk us through kind of the moving parts there?

First, we are taking into consideration the fact that interest rates moved up in the first quarter versus what we were seeing in the fourth quarter. So there is an increased -- actually a reduced prepayment speed that we don't think is going to continue to replicate throughout the year. So we see some stabilization there. You also have February having 28 days, so that also helps a little bit on the margin. And lastly, we do have the Eurobank covered loan book that continues to pay down. So we need to account for that also. So when we come up with a guidance of around 220 for the rest of the year, we're taking all those issues into consideration and giving us ourselves a little wiggle room in case interest rates go down further, which will put pressure on our investment risk.

And then on the commercial loan production that dropped pretty substantially from the prior quarter, do you expect it to kind of remain around those levels with a focus on building a higher quality pipeline? Or do you think that will rebound?

We do expect to continue to build a higher quality pipeline but at a higher rate. The volume that we originated this quarter is not what we expected. First quarter of the year is always complicated from a commercial lending perspective as first tax -- income tax work is being done, and financial statements are being provided and et cetera, et cetera. So we did have some lagging efforts there.

Also, this quarter, we recruited a new head of corporate banking, Elena Manrara. So there is a transition there that we need to account for. Going forward, we do not expect to have this level of origination. We expect to have higher levels of origination. The pipeline shows it.

And my last question, just on the noninterest expense, I know you said 2Q levels are likely to remain in line with the first quarter. Can you give us any guidance on expense increases in the second half of the year?

Well, I think the guidance for expenses for the year is around $124 million if I'm not mistaken. That doesn't change. So you can think of us as having noninterest expenses around $124 million, even though we're going at a rate lower than that into -- with the first quarter numbers.

Your next question comes from Brett Scheiner of FBR.

Can you talk about the difference in the new swaps? It looks like the rate on slide 12 is exactly the same as the prior disclosure. Did you push out the term?

On slide 12, what -- could you repeat your question, Brett?

It looks like the cost on the new swaps is 183.

The 206 that you are referring to there versus the 180-something that we had previously?

Right. I'm saying, did you push out the term, the maturity date of the --

We pretty much -- did we extend a little bit of time? No. It's kind of remained the same, right?

The average term is more or less the same.

It's more or less the same. The 206 takes into consideration the repo cost, which you don't buy repos at LIBOR. You buy them a little bit above LIBOR for us when we go out to borrow. So that difference shows the 206. When you look at the cost of the swaps, it remains around 183. So this number here takes into account the spread above LIBOR, three months LIBOR when we do the short-term borrowings.

A couple other quick things, are you going to continue to repay brokers fees with excess cash? And how much do you think that you could do in 2Q?

Yes. We do have some maturities, and I believe we will continue to repay them as they come due.

Can you comment on the size?

It's around $75 million.

That's very helpful. As far as the buyback, do you have a specific price in mind? Do you have a timeframe for the rest of the buyback authorized?

Brett, there are a couple of factors that you need to take into account with the buyback. One is the stock volume on a daily basis and the requirement. There is an SEC regulation where you need to have some rules -- you need to follow some rules in order to buy back the stock. So that's one thing. In terms of the target price, our book value is north of $14. And when you see stock around $12, 12 and change, it certainly makes it very difficult not to be a buyer of our stock. So we will continue to, on a weekly basis, look at our stock and continue to execute on our repurchase program. It's part of our strategy. As I said earlier, it's a three-pronged strategy. And the third strategy is repurchasing stock.

Can you talk about second quarter buybacks, quarter to date?

It will be disclosed on the 10-Q that will come up in the first week of May.

Thank you. And then one last question. I know a lot of the potential MBSD levering is being held off in the excess cash due to potential M&A opportunities. Can you talk about any progress? Are you seeing some more clarity on what you may be able to accomplish, or is that still sort of just a wait-and-see?

Brett, let me allow Norberto to talk to you about your previous question, which was the level of repurchase that we've done in the first -- in the second quarter, because we have the information that we can share.

Yes. So far in April, we have purchased approximately $1.3 million in additional share repurchases. So the total amount that we have repurchased till today is around $13.8 million.

That's very helpful. And then just on the M&A?

On the M&A, things are developing on the island. As I have said in prior quarters, we are on the lookout. And if there are opportunities for us to explore, we certainly will evaluate them. And that's as much as I can talk about that.

Your next question comes from Joe Gladue of B. Riley.

Good morning. Just wondering if you could give a little more color when you say you're trying to develop a more high-quality commercial pipeline. Just a little bit more color on what you mean by that.

Sure. I think there's a great opportunity for us to attract good clients from our competitors. And that's what I mean. I -- what I'm trying to say with my statement, Joe, is that we're not bringing in commercial loans at random. We are very selective. It's still a challenging economy, and there's still some fierce competitors out there who are trying to keep their business. So we need to look at rationality of the pricing and on the credit quality of those clients. So when I say high quality, I mean good relationships that can complement and benefit themselves from our expanded services in commercial lending as well as financial services. And from the pipeline that I'm seeing, I'm very encouraged with what we can accomplish here in the upcoming quarters and years. And again, the landscape here in Puerto Rico for us plays out perfectly because we're seeing everybody working on their own issues, and Oriental really has an opportunity to go and try to attract those types of high-quality commercial clients and commercial relations.

Can you share with us any numbers about the pipeline, or just the trend, where it stands now versus where it stood at year end?

I think some of the pipeline that stood at year end carries into the second quarter because of what I said earlier, Joe. It really -- we got a little delayed on the first quarter as we transition a new leadership at the department, but also as clients have to gather up their financial statements end of the year and kind of freshen up that pipeline. So I would say the pipeline has the work that was done in the fourth quarter that wasn't closed plus the work that has been done in the first quarter. But at this point, I really will not like to go out on a limb and say what the pipeline we have. We have competitors listening, as you would expect.

Just curious, any change in the environment on deposit pricing over the last three months or so?

Certainly, we have seen some improvement there, especially on the CD rates. We've seen some larger financial institutions in the island lowering their deposit cost on the CDs. So that's good for us as we continue to move it. And certainly, we have been leaders in that aspect throughout the last 11 quarters, reducing the cost of our funds. But the big impact is done by the larger or largest players. So once they start moving, I think the momentum will pick up. And I think at the end of the first quarter, we started to see that happening. So I'm encouraged with that also.

All right. Thank you. That's all I had.

Thank you, Joe. Have a great weekend.

Next question comes from James Ellman of Seacliff.

Thanks for taking my question. Could you give us some insight into what you believe your return on investment has been on the Eurobank transaction?

I can tell you that from the projections that we did and the work that we did back a year ago -- actually tomorrow is the first-year anniversary of our acquisition. Everything that we projected has kind of resulted to the cent. From a return on investment certainly, we did raise quite a bit of capital. So that in itself puts a little pressure on that. But in general terms, the acquisition of Eurobank has been very accretive to us. We projected income from their operations. What we projected has come to fruition so far. And the reduction in expenses that we also projected, we also executed on. So from a net income of that operation itself, we are very encouraged with what we have gotten. As I said earlier in answering your question, we still have quite a bit of capital, and that might put some pressure on the return.

All right. And when you calculate right now your return on investment of buying back your own stock at below book value, is that return on investment lower than the ROI of the Eurobank deal?

No. That is higher.

All right. And so in that case, when we're thinking about the potential second wave of consolidation on the island, if the return, the ROI of another potential acquisition is lower than buying back stock right now, assuming a similar price of a distressed property similar to Eurobank -- if the return on buying back your own stock is higher, why not buy back more stock now?

Well, as I said, we need to be able to evaluate things and be on the lookout. At this time, we are trying to first grow the operation organically, and secondly, deal with the market as it is today. And there's certainly going to be consolidation. And we want to be -- have enough capital to evaluate. And that doesn't mean we are going to evaluate and execute. It's just an evaluation that we want to do of the possibilities and opportunities.

Now, having said that, we are also here to grow a franchise longer term. And by that, I mean that if we have an opportunity that is similar in terms of return, and it provides to us a great strategic transformation above and beyond what we have done in the last year or year and a half, we certainly look at that. And we're here to run a bank and to maximize return for our shareholders, not only on the short term, but also the immediate and long term. And that's our focus, and that's how we're going to evaluate it.

Your next question comes from Chris Gamaitoni of Compass.

Thanks for taking my call. Can you give us any insight if you have discussions with regulators around the implementation of Basel 3 and how that will impact your business model given your nontypical security loan mix?

We have conversations with our regulators on an ongoing basis. Our primary regulator is the FDIC. The conversation specifically regarding Basel 3 issues and on our composition of our balance sheet has been -- has happened in a very general way. But certainly, they recognize that the balance sheet that we have is unique in itself, but it also has provided us the ability to be the only bank in the island who has not gone through all these credit issues. So there is a give-and-take there.

From their perspective, we are a very strong management team, and our balance sheet is very strong from a credit perspective. And they are helping us continue to develop our franchise here with the acquisition of Eurobank and with the continuous developing landscape here in the banking industry in Puerto Rico. So yes, we have addressed that issue in a general way, but it's nothing of imminence or concern for us or for them at this point from a regulatory perspective.

And can you discuss your cost operations base? When I look at the company, you have a 67% loan-to-deposit ratio. And without the leverage of using repo lines to make a margin on your securities book, you really don't come close to covering the expense base. I really don't see that anywhere else. So can you explain what the dynamics around there are?

Well, to be able to understand this, we need to understand where we come from. And frankly, you need to be a -- to do, as an analyst, a little bit of historical search, because we're not here today because we decided to do that a year ago. We have been a very conservative management team who has been very concerned about the economy in Puerto Rico for the last ten years. And we had decided strategically not to get aggressive on the lending side in the island, and instead, we invested in mortgage-backed securities, et cetera. So that's where we come from.

Now, we also, as management, recognize that there was going to be consolidation taking place in the island. And that came in a little later than what we expected, but it happened last year. And we participated in that process as part of our efforts to transform our balance sheet. And that's the stage we're in. We are, right now, in a process of transforming.

So to get to your question, certainly, our expense base is not covered by our operating businesses if you exclude these investments [increase] portfolio. Mind you that here in Puerto Rico, the international banking entity that we have allows us to invest tax free. So there is an incentive for us to have a high balance of investment securities on our balance sheet, so as all the other banks in the island of Puerto Rico have done.

So expect us to continue to move forward on growing our loans and growing our franchise from a fee perspective and from a commercial banking perspective as we try to move lower the reliance on short-term funding and institutional treasury-type of spread. And that is a job that doesn't happen and cannot be accomplished in a quarter or a year if we want to build a franchise and grow shareholder value long term.

Your final question comes from Derek Hewett of KBW.

Could you guys comment on your longer term goals in terms of ROA, ROE?

Maybe we should have emphasized that in this call, and we failed to do that. I'm sorry. But we remain targeting 1% ROA and 12% ROE. Again, we feel that we are really moving in that direction. 2012 is a year where we feel that that's going to be accomplished. And the job that we need to do is to remain providing, on a consistent and recurring basis, that type of performance on an ROA and ROE perspective.

And that 2012, is that going to be kind of towards the back half of 2012, or is it for the full year?

Well, no, for the full year. If you see what should happen at the end of this year in terms of the maturing repos that we have and the strategy that we have implemented with our swaps, we should have a significantly better net interest income. And if we execute on our commercial strategy and our banking, commercial banking, strategies, we should have also a more variable rate type of loan book. And all those things will play into 2012 and beyond, reaching our targets of ROA and ROE.

This concludes our question-and-answer session. I will now turn the call back over to management for any closing remarks.

Thank you, everyone, for listening in today. We look forward to talking to you again when we report our second quarter results. And as always, we appreciate your time and our trust on our team to continue to execute on our strategies. Have a good day, and have a great weekend.

Thank you. This concludes your conference. You may now disconnect.