OFG Bancorp (OFG) 2014 Q1 法說會逐字稿

Good morning. My name is Brandi and I will be your conference operator today. At this time, I would thank you for joining us for the conference call for OFG Bancorp. Our speakers are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman; and Ganesh Kumar, Executive Vice President and Chief Financial Officer.

There is a presentation that accompanies today's remarks. It can be found on the Investor Relations website under the webcasts, presentations, and other files page.

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 OFG'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. (Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Fernandez to begin.

Thank you and good morning to all. I'll cover the general overview and Ganesh will discuss key aspects of our financials. If you could please turn to slide 4, this is the fifth consecutive quarter since the BBVA Puerto Rico acquisition that we have produced solid core performance which has been in line with our expectations.

Our business has become more predictable and recurring. This is in contrast to when our results were heavily subject to the ups and downs of the bond market. Yes, the Puerto Rico economy is under pressure, but we're dealing with the situation and are confident in our ability to sustain our business model.

Now, let me review key highlights for the quarter. We earned $0.42 per share diluted. That included a $4.4 million gain on the sale of securities. NIM continued strong. Puerto Rico government-related balances, excluding municipalities, declined 14%. This is on top of the 17% reduction in the fourth quarter of 2013.

Our strong credit quality continues to improve. Excluding acquired loans, nonperforming loans rate declined for the fourth quarter in a row and net charge-off rate fell for the third straight quarter.

Cost of deposits declined 7 basis points as we were very successful in growing demand and savings account deposits in both dollars and as a proportion of total deposits. This is good evidence, early evidence, of how our clients and prospects are embracing our banking business model: focus on agility of execution, excellence in customer service, and technology differentiation.

Tangible book value increased 3.5% sequentially to $14.07. Book value per share increased 3.1% to $16.23. Late in the first quarter, when OFG shares traded close to tangible book value, we opportunistically repurchased approximately 707,000 common shares in the open market.

If you please turn to slide 5, as a result of our performance metrics -- our performance metrics came in near or above our targets. Return average assets was 1.18% versus our target of 1.25% and 96 basis points year ago. Return on average tangible common equity came in at 12.86%, exceeding our 12% target.

Our efficiency ratio in at 50.03%, in line with our low 50%s target. It also is a significant improvement to the more than 57% level a year ago.

And net interest margin came in at 5.90%. That compares to our target of approximately 5% and it compares to 6.01% in the fourth quarter, which benefited from some nonrecurring items.

So now I'd like to turn the call over to Ganesh, so he can discuss in more detail the financial results.

Thank you, Jose. And a very good morning to everyone on the call. Let me start with the slide 6 and walk you through the results of the first quarter of 2014.

In this quarter, we continue to demonstrate the success of our strategy. We want to highlight that this is a first quarter after a very successful integration -- our second in four years. Specific to the loan production this quarter, which is a seasonally soft one, we closed $212 million in new loans.

Auto production was $94 million, up $9 million from the last quarter, while the production levels were lower in commercial category, as it was expected to be. Our midmarket C&I pipeline is building up and we have no concerns here.

In our residential mortgage business, the revenues at $2 million were slightly ahead of the fourth quarter. However, we are seeing shrinking mortgage market and consequently, our production was also down. Consumer loan production was up nicely -- 18% -- compared to the fourth quarter.

Our new marketing approach and automated streamline origination processes were the primary underlying factors for this increase. At close to $11 million, we maintained a high level of banking services revenues, in part due to our commercial transaction services business.

In terms of free business, broker-dealer revenues were slightly higher than the fourth quarter, despite client trading activity continuing to drop. We infer this is because of what has happened to investor wealth in general in wake of sell-off in Puerto Rico bonds. While we are seeing some softness in few areas, we do see opportunities in cross-selling further optimization of deposit costs and some more expense opportunities in the quarters ahead.

A big bright spot has been in the growth in demand and saving deposit balances. I will cover more on these topics on the next slide.

If you turn to slide 7, you can see that we have grown our core deposit nicely. We are especially proud of this accomplishment in light of the composition of the deposits. As you can see, there is a steady growth in our non-maturity deposits. They increased $126 million from the end of the last year.

In addition to the serving as evidence of customer confidence in our abilities to provide innovative products and high levels of customer service, this has shifted our funding profile very favorably.

Such year-over-year increase in DDA and saving balances, when combined with corresponding reductions in CDs, retail, and brokered, drove a 27 basis point decrease in cost of deposits. You may recall that in our acquisition model presentation pre-capital raise, we had assumed a deposit runoff of $250 million and no reduction in cost of deposit as part of our integration approach.

One slide 8, regarding the net interest margin, we have added a linked quarter comparison of the components, isolating certain items, to provide a view of the adjusted NIM. You can see that our adjusted NIM was 5.73% in the first quarter versus the 5.26% in the fourth quarter. There are four factors that affected positively the adjusted NIM, first quarter versus fourth quarter.

Yield on the loan portfolio was higher due to repricing of certain commercial loans. The yield on investment securities was also higher due to lower premium amortization of our portfolio.

Taking advantage of growth in DDA and savings deposit balances, we shifted away from costly institutional and brokered CDs, achieving a seven basis point reduction in deposit quarter over quarter. All this was partially offset by higher borrowing costs due to reduction of short-term lower-cost funding.

Please turn to slide 9. To facilitate easier comparison of the linked quarter results, we also removed the effect of certain items from reported GAAP income numbers in this table. Most of the adjusted items occurred in the fourth quarter and they were discussed in the last conference call.

As you can see, the first quarter had minimal impact from such items. The first item is the additional recoveries in our covered portfolio over the normal levels to the tune of $1.6 million and its corresponding impact on the FDIC loss share receivable. The second item is the $4.4 million gain from the sale of securities.

In such a comparison, key highlights of the quarter are as follows. Non-covered loan income increased 2.5% to $85.2 million from $83.1 million due to better loan yields mentioned earlier. Provision for loan and lease losses, excluding acquired loans, fell to $5.6 million from $6.9 million, while provision for acquired loans increased. The reasons for this increase vary from replenishment of day one discounts to account for the charge-offs, to revisions in cash flow estimates.

We already talked about the noninterest income line items, so let me skip down to the FDIC indemnification asset amortization. That remained high, as expected, at $17.2 million compared to $18.1 million. However, we have reduced the FDIC shared-loss indemnification asset to $166 million, with just five quarters to go for a commercial loss-share period to end. We have always managed this receivable conservatively to avoid any major write-offs at the expiry of the loss-share agreement.

Noninterest expenses were slightly higher at $61.5 million compared to $61.3 million. This was due to slightly higher losses related to valuation and disposition of the repossessed assets. As a final point, during the first quarter, we sold approximately $111 million of mortgage-backed securities at a gain of $4.4 million.

We took advantage of an opportunity to realize these gains while lowering interest rate sensitivity a bit. The securities were held in our IBE subsidiary, which has tax advantages on its earnings and as well on its gains.

Please turn to slide 10 on balance sheet highlights. With respect to the balance sheet evolution, the average interest earning assets declined to $7.1 billion from $7.3 billion a quarter ago. This reflects the reduction of approximately $240 million in credits to Puerto Rico government starting late in the fourth quarter and continuing in the first.

In addition, this quarter, we also had the previously mentioned sale of MBS and as well as normal prepayment of MBS of about $55 million.

Stockholders' equity increased to $896.5 million. The movement includes increase in retained earnings from the first quarter and OCI during the quarter, partially offset by their share repurchases.

As already mentioned, we repurchased 707,400 shares in the open market late in the first quarter. We used $10.4 million of existing Board authority. We still have about $23.1 million remaining in this Board-approved repurchase program. Due to the timing of the repurchases, first quarter weighted average diluted shares declined only by approximately 389,000 shares.

On slide 11, as we have done in the past, we have included an updated disclosure on Puerto Rico government-related holdings. These numbers are contractual balances, excluding the 2.2% valuation allowance we carry. In line with what we discussed in our earlier phone calls, and calls with many of you on an individual basis, you can see that we can -- you can see we continue to manage this exposure prudently.

The credit exposure declined this quarter as $99 million of debt, which we accounted for as a security in our balance sheet, was repaid at par.

As it stands now, 42% of our loan and security balances mature in 12 months or less. We are comfortable with the loan exposure at this level, particularly the way we are managing this portfolio. As we have mentioned in the past, the loans represent an attractive proposition on a risk/reward basis due to their high tax-free income.

Furthermore, the defined sources of repayment are something we can monitor continuously as well as the associated debt service ratio levels. The recent data coming out of GDB shows some level of stabilization in the economy. While we believe there are further challenges, there are encouraging signs of development on various fronts.

We will continue to include this disclosure, but hope not to dwell so much on the topic in the coming quarters as the reason for us holding this portfolio is self-evident.

On credit quality, we have included detailed information on several aspects in table 6.1 and 6.2 of our financial supplement. There are a few aspects that I would like to highlight here. Year-over-year nonperforming loan rates have fallen 9% to 3.25% as we disposed the bulk of the residential nonperforming loans last year. The net charge-offs have reduced 20 basis points in the similar period as well.

On a linked quarter basis, we are seeing stabilization in the nonperforming levels in our auto portfolio as the loans originated post acquisition begin to season to its normal levels. This is something that we have mentioned in our calls and you can see it now.

We are making progress towards streamlining the collection efforts post information technology systems replacement that we undertook in the fourth quarter of 2013.

The tables and the financial supplement highlight the strong credit quality OFG has always maintained. All in all, the allowance for loan losses and leases increased slightly to $49.5 million from the last quarter. We continue to hold a coverage ratio of 1.95%.

Please turn to slide 13. Our plan for 2014 remains unchanged from what we had outlined in the last call. Excluding any strategic balance sheet moves, we are assuming a small decline in interest-earning assets. We see opportunities to further optimize deposit costs and expense levels. As we mentioned earlier, we expect to see some pressure in mortgage originations and broker-dealer businesses.

On the other hand, we are anticipating continued favorable trends in our deposit product relationships. We also see cross-selling opportunities across the full spectrum of nearly all of our products and services. We will, of course, continue to expense a high level of non-cash FDIC indemnification asset amortization, but that should reduce precipitously after the second quarter of 2015.

This concludes my part of the presentation. Let me turn it over to Jose for a wrap up.

Thank you, Ganesh. Please turn to slide 14 and let me close with our general outlook on Puerto Rico and OFG Bancorp. As everybody knows, the Puerto Rico fiscal and liquidity situation has been temporarily addressed with the recent Puerto Rico GO bond issuance. We commend government officials for addressing the situation diligently, but more needs to be accomplished in order to fully restore market and investor confidence in Puerto Rico.

We believe that additional government expense reduction measures need to be implemented, design and execute a long-term economic development plan, and approve a credible energy reform plan that regulates and monitors Puerto Rico energy authority, while improving Puerto Rico's competitiveness. We expect that tonight, the governor of Puerto Rico will fully address these issues in his scheduled national broadcast.

Turning now to the local banking market, in which we don't see a strong loan growth, we expect significantly increased price based competition. As always, however, we will be steadfast in our pricing discipline and in our customer-focused value-added business approach that emphasizes profitability and risk management above indiscriminate market share growth. And we will continue to rely on our excellent execution capabilities, which we have demonstrated in two very successful acquisitions.

Regarding our very strong capital position, we continue to have a wide degree of flexibility and we demonstrated that with our first quarter share repurchases mentioned earlier. We continue to believe that we are uniquely positioned to exploit further long-term opportunities for growth.

With this, we end our formal presentation. With us is Norberto Gonzales, our Executive Vice President and Chief Risk Officer. The three of us will be available for the question-and-answer session.

So operator, would you please open the call for questions?

(Operator Instructions) Brian Klock, Keefe, Bruyette & Woods.

So the margin was actually a lot stronger than we thought and that over time, you guys say that it should trend down to 5%. It just feels like with a higher level of the accretable yield and some stability and some of the commercial margins -- maybe Jose or Ganesh, you can kind of give us the thought process of does that sort of glide path down to 5% just a little bit longer than we thought before, because this first quarter was so much stronger?

Let me ask Ganesh to address that issue more specifically.

Yes, Brian, you are correct in assuming in to get to the 5%, it's going to take longer than what we originally had discussed in the prior calls, primarily because of the repricing affect and the age of the weighted average life of those loans.

So I think at this point in time, it could be -- the short-term forecast that for us could be around another 30 basis points higher than the 5% that I mentioned. So over a period of time, it should, in the next few quarters, trend towards the 5.35%, 5.40% range rather than the 5% range.

Okay, thank you for that color. And I guess with the outlook for average earning assets -- so it feels like there will be a little bit more pressure on the loan portfolio. You'll have the runoff in the covered portfolio like normal. But I guess maybe talk to us about the overall thought process with the level of the government loan portfolio.

Are you expecting that to be stable from here on out or maybe talk about the mix in the loan portfolio -- government, mortgage, and auto -- about where you think directionally those three products are going.

So let me start with the government exposure. As we discussed in the call, we brought it down, basically, from the December number of 14%. We still have some opportunities to continue to reduce the exposure. I think the biggest exposures have been eliminated completely from the balance sheets, which were a short-term GO-type of exposures. The rest of the exposures that we have are very much short-term and with direct cash flows or sources of repayment.

So we feel relatively more comfortable with the exposure that we have. Having said that, there are certain opportunities in the rest of the year for us to reduce further the exposure to the government and we will take advantage of those opportunities as they present.

Regarding the rest of the loan portfolio, I'd like to start with the mortgage portfolio, and as you know, and you probably have seen from the rest of the competitors in the market here, the residential mortgage market origination -- mortgage origination -- has been under significant pressure.

And so they are lower originations. We have an originate to sell model, so we have the normal repayment of that portfolio going down. So we expect the mortgage portfolio to continue to move down throughout the year pretty much at the same rate as it did last year, except for the NPL loan sales that we executed.

Regarding the auto portfolio, we remain to be the leading or one of the leading auto financing banks in the island. And we have good market penetration and we feel very comfortable with the level of profitability and yield that we earn from that portfolio. And at the same time, we feel very comfortable also with the risk that we are engaging in at the price that we're engaging in.

So we expect that portfolio to remain stable to slightly higher, depending on the -- here it's more depending on the Puerto Rico economy and how demand for auto purchases shows up. So far, it's relatively flat versus last year. So the auto sales -- new auto sales. So we expect the portfolio to remain around these levels and maybe slightly higher.

And then on the commercial side, more the small business and the middle market and the corporate, excluding government, I think there are opportunities for us in the small business, primarily. Certainly competition is becoming quite irrational in some segments of the commercial market, specifically on the middle market and being very aggressive on the pricing side. And we choose to look at those loans, but not necessarily be as aggressive.

So again, we might have some pressure there on the commercial side. But having said that, when you've seen the growth in our commercial and retail deposits, demand and savings, we're getting very good traction from our clients and we expect to continue to have good traction on the lending side for the small and midsize companies as well as corporate.

So we would expect the portfolio to remain also relatively flat to slightly higher. So that's kind of the summary that I can give you, Brian, regarding the loan portfolio segment by segment.

Thanks for that. That's actually great color. I just wanted to segue -- I'll ask just one quick follow up on that and I'll get back into queue. So the economic activity index talked about the Puerto Rico economy -- seems like it's kind of stabilizing and finding some footing near the positive results of the GO issuance earlier in the quarter.

So it does feel like maybe there's some positive outlook in the loan pipelines for the second quarter from your comments. So is that true? Is that a right way to think about your pipeline going to the second quarter?

On the commercial side, we have a good pipeline, as you noted and Ganesh mentioned also in his remarks on the consumer side. We've seen an increase, also. So yes, we see opportunities for us to look for the best clients and good relationships on the commercial side and be very competitive there. And we have a pipeline for building up nicely for the second and third quarter. Same thing with the consumer side.

So that's kind of how I feel what's going to happen in the second quarter and beyond regarding the economy. I don't know if you want me to comment on the index that you mentioned, but yes, the economy in Puerto Rico is not falling off a cliff. It?s certainly stagnant and contracting slightly, showing some improvement on those indexes, but certainly we do not drive our business model and our strategy based on that index from the GDB.

It's quite volatile and pretty -- not necessarily a good driver for economic performance in our view. So again, we go by what our private economists discuss with us and how we see the market and we feel that Puerto Rico needs quite a bit more of economic development and increases in productivity.

That's great color. Thanks, Jose, appreciate it.

(Operator Instructions) Taylor Brodarick, Guggenheim Securities.

I think Brian touched on most of my loan yield questions, but on brokerage, I guess kind of going back to your comments about the issues with customer asset bases, is there opportunity to acquire customers from other competitors? Could you give us some kind of color on your business development efforts there?

Yes, I think that there is good opportunity for us to acquire or bring in clients from some other competitors that have been engaged with local bond funds and having significant market losses, so we can bring the clients, but not necessarily the corresponding immediate commission-generating activity, because these are assets that are somewhat liquid. I'm referring to the bond funds.

But in general, I think what we are seeing is significantly better recognition of Oriental's wealth management approach, and by the same token, clients bringing in more relationships and more of their assets to Oriental. And I think that bodes well for the future.

But in the short term -- in the next two, three, four quarters, as Ganesh mentioned in his remarks, it's going to be challenging because there's still an adjustment to be made by investors in terms of the way we approach the business, where it's more diversified, less concentrated in Puerto Rico assets, and more diversified to the US and international as our portfolio of assets from our clients shows.

Great. Back to the FDIC amortization, I guess there was a note about sort of looking at 1Q and kind of forecasting it out. I know it's hard to project that out, but that would be four of the next five quarters, just for modeling purposes, to kind of look at 1Q and sort of even it out, correct, Ganesh?

Correct. That's correct, Taylor.

Okay, great. And then last question -- tax rate. With changes over the tax laws, could you give us some guidance on that? I might have missed it. I was a little late to the call.

We used the 33% for the provision for the taxes. As with every year, at the end of the year, we need to do a tax written filing until that point in time -- until the -- we are well into the fourth quarter, we won't know exactly what the tax we need to pay. So at this point in time, we are assuming that 33% is what we would end up to be. That is our assumption at this point time.

Okay, thank you, gentlemen.

Emlen Harmon, Jefferies.

When you guys look at share repurchases, are those the best use of capital when shares approach tangible book value, or do they make sense for you at higher levels as well? Just trying to get a sense of kind of where the repurchases stand in your capital deployment options.

We certainly can buy shares below tangible book value, but also it makes sense to buy them below book value. So it's really -- as we feel there's an opportunity and there's the volume for us to execute in a more significant way, we will look at that. As well as looking at where best to deploy our capital, not only on the repurchase, but other opportunities.

So again, as I said on the call, we have great flexibility from our capital perspective, as we not only have the capital that we show, but also the protection from the purchase accounting levels that we have marked already in our portfolios. So we feel very confident on how we see things for us, for Oriental, in the foreseeable future. And if the market is not recognizing that, as we feel they are not, we will certainly be proactive on exercising that repurchase plan.

Got it, thank you. And then just on the loan production disclosure you gave us this quarter, just kind of on an overall basis, how did the production this quarter kind of compare to a typical quarter? Does the first-quarter tend to be seasonally weak? Could you maybe just give us a sense of, directionally, where you expect overall production to go?

Yes. First quarter for commercial lending typically is slower, because everybody's getting their financials and there are some delays and there?s quite a few holidays in the process. So we typically see -- at least for Oriental, we see first-quarter levels for remissions lower. Then it starts picking up later in the first quarter and then you start seeing the results in the second and third quarter and beyond.

That's how we see it. But it's more on the commercial side. This quarter, particularly, we saw some pressure there on the mortgage side compared to the first quarter of last year, but the market has gone significantly down in originations in Puerto Rico, 35% to 40% across the board. So that's also a driver there.

We look from a strategic point of view -- we feel that we have a very good opportunity on the consumer side, too, Emlen. And that is something that we are continuing to focus on.

Got it. And I assume that production levels include any renewals of existing relationships --

No, they do not.

They are new loans, Emlen.

They do not. Okay.

These are brand-new loans. These are no renewals or -- there are no refinancings or anything. This is just new loans (multiple speakers)

Okay. So if a five-year commercial note matures and you originate a new loan for the customer, that's not included in your new production numbers?

No, that's not included in our new production. That's important because some of our competitors do that and we don't.

Got it. That's helpful. I'll step back now. Thanks, guys.

(Operator Instructions) Brett Rabatin, Sterne Agee.

Most of my questions have been asked, but wanted just to ask maybe a question around expenses and efficiency ratio going forward. I'm just curious -- just thinking about -- as you look at the next year, or two -- if any improvement in efficiency would be mostly related to topline revenue growth as opposed to any of your expense reduction or can you talk maybe about any opportunities to improve the efficiency ratio otherwise?

Hi, Brett. Yes, definitely. I think, in terms of the efficiency ratio, as you know, there was a gain this quarter and therefore the efficiency ratio had the benefit of it and we've always said, though, in the prior calls, we shoot for a sort of low 50%s as our efficiency ratio. So our target primarily is -- at this point in time, it's 52%, 52.5%, which it was at last quarter and if you remove the 4.4% in gains, the efficiency ratio would have been that level.

You are correct in assuming that going forward from the run rate of what we have for the quarter -- basically further improvements can only begun through the increase in revenues as opposed to the expenses.

Okay. Great, thanks for the color.

There are no further questions at this time. I would now like to turn the call back over to Mr. Jose Fernandez for any closing comments.

Thank you, operator, and thank you all for listening in today. We would like to also thank our depositors -- our retail and business customers, our investors, our staff, and ultimately the communities that we serve. We're very happy with our results and we look forward to talking to you next quarter when we hold our second quarter conference call. Have a great day.

Thank you. That concludes today's conference call. You may now disconnect.