OFG Bancorp (OFG) 2014 Q2 法說會逐字稿

Presentation

Good morning. Thank you for joining us for this conference call for the 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 IR website under the Webcast Presentations and Other Files page.

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 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.) I would now like to turn the call over to Mr. Fernandez.

Thank you, and good morning to all. I'll cover the general overview, and Ganesh will discuss key aspects of our financials.

So, if you please turn to slide three, this is the sixth consecutive quarter since the BBVA Puerto Rico acquisition that we have produced solid core performance, which we are pleased to note has been in line with our expectations. While as everybody knows the Puerto Rico economy is in transition, we at OFG have been dealing with this situation for some time now, and are confident of our ability to continue to sustain and enhance our business model.

Now, let me review key highlights for the quarter. We earned $0.38 per share diluted. This compares well to the preceding and year-ago quarters, taking into consideration that both contained substantial and beneficial nonrecurring items. Net interest margin continued strong. Puerto Rico government related balances, excluding municipalities, declined close to 16%. This is on top of the 14% reduction in the fourth quarter. All of our government exposures have either collateralized or defined income sources for their repayment.

Compared to the first quarter, net charge-offs and total delinquencies were higher but within the ranges we've seen over the last 12 months. Cost of deposits continued to decline as demand and savings account balances increased as a proportion of total deposits, and we continued to purposely reduce the level of high-priced retail time deposits.

Tangible book value increased 4.6% sequentially to $14.71. Book value per share increased 3.9% to $16.87. Average common shares declined 0.7% due to share repurchases late in the first quarter.

As a result, if you please turn to slide four, our performance metrics for the quarter were in line with or above our target ranges. Return on average assets was 1.10% versus our target of 1.25%. Return on average tangible common equity came in at 10.96% versus our 12% targets. Our efficiency ratio came in at a solid 47.89%, better than our low 50s target, and it is also significantly improved over the more than 52% level of a year ago. And net interest margin came in at 6.10%. That compares to our target of approximately 5% and 5.90% in the first quarter.

Now, I will turn the call over to Ganesh.

Thank you, Jose, and a very good morning to everyone on the call. Let me start with slide five and walk you through the second quarter of 2014. Our operational outlook remains intact. We are focused on managing our businesses in a prudent manner while carefully controlling the costs and credit exposures in order to grow core profits. At the same time, we have continued -- we are continuing our focus on building our franchise and the brand to differentiate Oriental in the local market space.

Specific to loan generation, we were able to close more than $221 million this quarter. Auto production of $90 million was down a little as demand softened from the first quarter. Commercial production of $45 million was up 14%. This reflects our first quarter buildup of our midmarket C&I pipeline.

In our residential mortgage business, production of $52 million was up 2% as we maintained originations in a challenging regulatory environment. This helped to offset lower pricing in the secondary market. As a result, revenues were approximately level with the first quarter. As you know, we sell most of our production to the GSEs.

Consumer loan production had yet another strong quarter. This was up 24% after an 18% increase in the first quarter. This reflects our new marketing approach and automated streamlined origination processes. At close to $10 million, banking services revenue continued at a high level in part due to our commercial and institutional transaction business services.

In terms of [three] business, broker-dealer revenues were up 7%. This was due to increased annual resales more than offsetting softer client trading activity levels. As we mentioned last quarter, we anticipated trading activity would be lower because of what happened to investor balances in general in wake of the sell-off in Puerto Rico bonds recently. Please turn to slide six.

We would like to point out two significant transitions in our business. The first is that what is happening with our loan portfolio. This slide shows how we have been increasing originated loan volumes, offsetting a good portion of outflows or paydowns from the acquired portfolios. We believe this demonstrates the success of our integration efforts and our combined loan generation capabilities. Credit metrics have been embedded in the carrying amount of the acquired loans, but they are reported separately as the new loans are originated. Please turn to slide seven.

The other transition which we mentioned last quarter is with our core deposit portfolio. Due to innovative products and high customer service levels, we have increased our proportional DDA and savings balance. This proportion rose to 64% of the total deposits in the second quarter of 2014 from 63% last quarter and 57% in the year-ago quarter. This increase, when combined with corresponding reduction in CDs, high-cost retail and as well as brokered, has resulted in a 20 basis point decline year-over-year in the cost of deposits.

On slide eight, we talk about the income statement. With no nonrecurring items of note in the second quarter and only one in the first quarter, we are comparing our income statement highlights quarter-to-quarter on a GAAP basis. Non-covered loan income increased 3.3% to $88 million. Growth reflects certain acquired loans rolling over to the originated loan category and higher cost recoveries from the acquired loans due to our workout activities. Covered loan income rose 6.4% to $25 million. This also reflects continued higher cost recoveries due to successful workout efforts. Investment securities income declined $1.5 million to $13 million. This was primarily due to lower balances, the result of prepayments and previously reported first quarter sale of securities and repayment of a PR government related security.

Total provision for loan and lease losses increased $3.1 million to $14.8 million. This primarily reflects higher originated loan balances and increase in charge-off levels. The provision for loan losses, excluding acquired, was higher by $1.8 million quarter-over-quarter. Besides the volume factor, the increase was primarily due to replenishing the net charge-offs and its effect on the allowance estimation. In addition, it has the impact of reclassification of the certain loans, government-related loans, in accordance with our credit risk management policies and practices.

We already talked about non-interest income line items. Let me skip down a few lines. Non-cash FDIC asset amortization continued as expected at $18.4 million. Non-interest expenses declined 2.5% to $59.8 million from $61.4 million a quarter ago. This primarily reflects reaching deduction limits for payroll benefits and reduced costs associated with the foreclosed real estate.

Lastly, there were no sales of securities in the second quarter. This is as opposed to the first quarter, which had a gain of $4.4 million. Please turn to slide nine.

With respect to the balance sheet evolution, average interest-earning assets declined to $7 billion from $7.1 billion during the first quarter. This reflects a reduction of $120 million in Puerto Rico government-related debt and securities, and the previously reported first quarter 2014 sale of MBS and repayment of PR government-related securities.

Total stockholders' equity increased 3.2% to $925.2 million. The improvement was primarily due to increases in retained earnings and OCI.

On slide 10, we present the updated Puerto Rico government-related balances. As we have done in the past quarters, we are including an updated disclosure of our government-related holdings. These numbers are contractual balances, excluding a gross valuation allowance. In line with what we discussed in our earlier conference calls, you can see we continued to manage this exposure prudently. The credit exposure declined $85 million this quarter. The main drivers for the decrease was the contractual maturity at par of $100 million of central government TRANs debt, $20 million in principal amount for our privately-based securities.

As it stands now, 33% of our loan and security balances mature in 12 months or less. With regard to (inaudible), Oriental is part of a four-bank syndicate providing $550 million revolving line of credit to Puerto Rico Electric Power Authority to finance the repurchase -- the purchase of fuel for PREPA�s day-to-day power generation activity. The revolving line of credit, which expires on August 14, 2014, is currently accruing, and all loan covenants are substantially being complied with.

The bank syndicate has a short-term agreement in place to facilitate dialogue with PREPA and the Government Development Bank of Puerto Rico regarding the future of the revolving line of credit. This dialogue is actively ongoing. Because of the ongoing discussions, we are limited as to further comment. Any developments will be promptly disclosed and included in our regulatory filings as appropriate.

On slide 11, we present you the credit metrics which are detailed on our credit quality tables, in table 6.1 and 6.2 of our financial supplement. Overall credit metrics, net charge-offs and nonperforming loans are within the range of 12 months. The total delinquency rate rose to 8.61% from 8.1% in the first quarter. The net charge-off rate went to 96 basis points from 86 basis points, and the nonperforming rate rose slightly to 3.39% from 3.25%. These metrics are related to loan portfolio that was not acquired, and consequently under purchase accounting. We are continuing to refine the effectiveness of underwriting and recovery processes, but we believe that this impact, or the increase in credit quality metric, can only be managed by adhering to a risk-adjusted pricing discipline.

Please turn to slide 12 for an update of a -- for a mid-year update for 2014. We thought it would be a good -- we thought it would be good in this call to take a look at where we are midway through the 2014 plan. Interest-earning assets have declined $331 million from the end of the last year. This has been primarily due to reduction in Puerto Rico government loans and securities in the covered portfolio and other routine outflows. This demonstrates a high degree of structural flexibility. While the balance sheet has shrunk a little, we have managed a high level of core earnings.

Looking at the non-interest fee revenues, despite the market pressure, they are holding up, and we are continuing to manage the non-interest expenses very aggressively. And due to Puerto Rico's current economic conditions, credit remains an area of focus for us. The bottom line is we reported diluted EPS today � to date, year-to-date $0.80, in line with our expectations, and we have continued to grow capital and book value.

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

Thank you, Ganesh, and please turn to slide 13. We wanted to close with our general outlook regarding Puerto Rico. Recent actions by the rating agencies have put additional fiscal pressure on the government and its agencies. GDB, the Government Development Bank, has stated that it is government's intent to use the recently enacted Puerto Rico Public Corporation Debt Enforcement and Recovery Act as a last resort in an emergency, and GDB has also stated that the government has a strong preference for consensual negotiated solutions. Based on these recent statements, we believe that the Puerto Rico government will constructively approach the situation in a manner so as to avoid further strain on the banking sector.

As for the local banking industry, overall we continue to see intense price-based competition for loan originations. In consumer credit in particular, we're beginning to see some weakening of the credit which can only be overcome by better pricing. Looking at OFG, as always, we will be steadfast in our pricing discipline and our business approach. We will be rational in our risk management, and we will continue to rely on our excellent execution capabilities.

Regarding capital, which remains substantial, we continue to have a wide degree of flexibility. We continue to believe we are uniquely positioned to exploit further long-term opportunities for growth.

That ends our formal presentations. Operator, please open up the call to questions.

(Operator instructions.) Brian Klock of Keefe, Bruyette & Woods.

Good morning, gentlemen.

Good morning.

Good morning, Brian.

I guess I just have two quick questions. I mean, first on the net interest margin, continued to be very strong and actually came in quite higher than I thought. And from my interpretation, doesn't look like it has anything to do with accretable yield. Looks like it was actually core non-acquired loan yields actually were up eight basis points sequentially. You brought the cost of funding down. So, I guess maybe -- can maybe highlight us, or update us on what you see for the margin outlook, going forward?

And I guess [sort of remind us] to a second part of the question on is it December, or is it the fourth quarter, when you would re-evaluate again all the purchase accounting marks, and maybe there'd be adjustments on accretable yield?

Let me just give an overall, and I'll pass this to Ganesh. But certainly we're happy with our stronger than expected net interest margin, and has a lot to do with our focus on bringing down cost of funds and working with our loan portfolios and managing the environment in a very -- from a pricing perspective on a risk-adjusted basis. So, that's part of what's going on, as you pointed out.

But, I'd like to ask Ganesh to give you more color to the NIM.

Okay. Hi, Brian, good morning. I think you are right. The increase in NIM quarter-over-quarter has -- it builds in two different effects, right? So, one is what we've been trying to do at the yield levels, and as well as the cost of deposit. On table five, you see in our earnings supplement the lines which says non-acquired loans and as well as the deposit pricing. Those are the ongoing recurring work that we have done to increase the margin.

Whereas the acquired loans, that's where there will be a effect of if -- as we continue to work out our acquired loans, we would continue to have some additional cash flow other than what we have expected. So, if you ask me where the NIM would fall the next quarter, or this should have been this quarter without those workout efforts, it would have been close to the last quarter. And if you remove any recovery at all, it should be closer to 5.6, around that range.

So, I would -- all I can say at this point in time is we expect the NIM to be around 5.5 to 5.6 in the second half of the year, but as usual the cost recoveries would still be there.

Oh, so Ganesh, so I guess when you say cost recoveries, so included in -- so on that page, table five, so on the acquired loans accounted under both 310-30 and 20, so included in that interest income of $39.7 million and $5.3 million, how much was I guess the cost recovery portion of that, or the accelerated piece?

Totally I think between those two lines, there were about 1.6, 1.7 in that line, and as well as if you look at the covered loans, there's another $1.5 million, $1.6 million.

Okay, so, all-in, about $3.1 million.

Yes.

Okay. And just a follow-up question on the credit trends, I know you have been talking about the focus you guys have on the consumer. We did see some NPA formations increase in this quarter on the consumer side, consumer and in auto. So, maybe you can kind of help us -- give us an update on what you're seeing there. And, I guess, guidance as far as the provision outlook versus this quarter, and does that -- do we see an upward trend in that provision level, then?

Yes, clearly we are starting to see some strain on the consumers, and that's primarily due to the economy kind of continuing to struggle. So, we see that. We obviously see us provisioning higher for that portion, but remember that these are higher yielding type of loans, and so you just can't -- we need to separate the consumer portfolios from the commercial portfolio simply because of the risk profile that each one has.

So, going back to consumer, we're seeing some strain on the consumers. We're starting to see a pickup on inflows and delinquencies and charge-offs, and we're certainly looking into pricing to adjust for that pickup, as we've done in the past.

Okay, so fair point I guess, there's definitely an increased credit risk there, but you're getting paid for it on the yield side.

Correct, correct.

Correct.

And our main portfolio on the consumer side is the auto portfolio, which we continue to look into and adjust as we see trends evolving on the credit side.

Okay. Hey, thanks for your time, guys. I'll go back in the queue.

Thank you, Brian.

Emlen Harmon of Jefferies.

Hey, good morning, guys.

Morning, Emlen.

Quick question on capital. We saw a pretty meaningful jump in the other comprehensive income this quarter. I guess, one, I'd just be curious as to which part of the securities portfolio was generating that improvement. And then, two, we did see a government debt downgrade after the end of the quarter. Just curious if that affects your AFS valuation at all, as well.

Most of the increase in the OCI comes from the MBSs that we have, Fannies and Freddies that we have on the portfolio. The downgrade on the government really did not have a meaningful effect on our investment portfolio because we don't have much. We have, I think, a total of $20 million or so in the investment portfolio regarding Puerto Rico securities, and these are small balances. So, it didn't have that much of an effect. And those investments are really not necessarily affected directly by the downgrades.

Got it. And then, so the majority of that gain coming in the MBS portfolio, with kind of the 10-year getting down to lower levels today. I mean, is that gain something that you guys would consider locking in?

It's something that we always struggle with, Emlen, what do you do when you sell those, yielding right now around 3% because you've got a lower prepayments piece. So, then you sell those securities, and what you reinvest in, it's a little bit of a give-and-take. So, in the past, we -- as you saw in the first quarter, we took some gains. If we see there's an opportunity for us to sell, get the gains and reinvest those assets in a higher yielding situation, we will consider it. But, otherwise, it's a tricky one because you're taking a gain today that you're foregoing in the future in terms of interest income. So, it's something that we discuss on a monthly basis when we meet (inaudible) there.

Got it. And then, just a quick one. In terms of government exposure, the one area you guys are increasing exposure there a little bit is the public corporations book. I'm just kind of curious as to kind of which entities you're adding to there.

We're really not adding to any entities. These are lines of credit that it depends on how you compare quarter to quarter what's -- how much they have drawn on those lines. So, that's why you see an increase versus the first quarter because, in the second quarter, there were some draws that they had available to draw on and that�s the difference.

As they rotate, which they continue to rotate, the balance would go down and up depending on the last day of the reporting.

Got you. Okay, thanks for taking those, appreciate it.

Just, I mean, as a reminder to everyone, our focus continues to reduce our exposure, as we have said in the past.

And we have not made any new commitments in last three quarters.

Brett Rabatin of Sterne, Agee.

Hi, good morning.

Hi, how are you doing?

I'm well, thanks. Wanted to ask on the loan portfolio, just thinking about the commercial loan pipeline, maybe some comments around just what you're seeing there, and then maybe just kind of an outlook thinking about the loan portfolio on a net basis, going forward, if you would consider it to have modest shrinkage, going forward, as covered loan payoffs continue but you're still generating a solid amount of internal production.

Yes. Our forecast going forward, based on the pipelines that we have, we feel that it's going to be around the same levels that we've had in this quarter, maybe slightly better. But, really, competition is fierce here, and, I mean, in our view, pricing is too aggressive for the economic environment that we're operating in.

So, from our perspective, we're going to be very rational in this approach, and that's something that we will continue to do. Certainly there are some great clients that we are going after, and there's opportunities for us to gain some of those relationships from some of our competitors, and we will continue to pursue them. So, in general, I think we continue to abide by the trends of reducing our loan portfolio 1% or 2% on a yearly basis given the environment we're operating in, especially on the commercial side, which is very aggressive on the pricing side.

And has that increased any in the past quarter or so in terms of the pricing relative to credit spreads?

I'm sorry, can you repeat the question?

Pricing regarding the commercial loans. We have not seen that much of an increase, primarily because, as Jose Rafael (inaudible), the competition is fierce over here. Though we don't resort to price-based competition, there is pressure on pricing those loans.

Too many banks looking up to the same [buck].

Okay. And then, I guess the other thing I was just curious about was you were talking about the delinquency trends and obviously getting pretty solid yields on the loans. Is there any plan to do anything from a restructuring perspective, give some potentially or maybe do TDRs on a larger scale, or any thoughts on kind of changing the delinquency pattern by giving some concessions?

We do that actively on the mortgage portfolio, and we work on that on a loss mitigation program that we have. And when you look at our numbers, especially on the mortgage side, you're seeing the whole picture, but you haven't seen within the picture there are some Ginnie Mae repurchases that we are mitigating, and those are guaranteed. So, we are just showing it as a whole delinquency, but it has a different profile.

So, when you look at our -- specifically on the mortgage side, we will continue to work on loss mitigation strategies and trying to bring them into a current status after they perform for several months. So, that's part of something that we do ongoing, and we need to do it more aggressively.

Okay, great. Thanks for all the color.

You're welcome.

(Operator instructions.) Taylor Brodarick of Guggenheim Securities.

Great. Hey, thanks. I think everybody else has hit on most of my questions, but I just wanted clarity. On the public corporation exposure, how much of that is that PREPA LLC participation, and is the rest of it -- is it in some of the other -- is it in PRASA, or could you give any more (inaudible)?

--Yes. Yes. The PREPA line is $200 million, and the other line of credit that we have with public corporations is PRASA, which is the water authority. And it's a $100 million bond anticipation note that we have that matures on March of 2015, if I'm not mistaken. Those are the two main agencies that we have.

Okay. You guys hit on everything else for me, so thanks very much, appreciate it.

Welcome. You're welcome.

Ken Puglisi of Sandler O'Neill.

Good morning.

Morning.

Ganesh, I didn't quite catch what you said earlier about the public corporation debt that's going to be maturing in August. I didn't quite catch exactly what you said there.

I think the same question that Taylor just asked. The public corporation debt that's due to mature in August is PREPA, and it's on our presentation. It's on slide 10. We show that less than six months that we have $200 million in that bucket.

Right. And did you say that's in the process of being renewed or renegotiated?

Basically in my script, I read that the bank syndicate has a short-term agreement in place to facilitate the dialogue with PREPA. And because of the ongoing discussions at this point in time, we are limited to further comment on that one.

Okay. And the comment that you made earlier, actually you've made several times, that most of your government exposure is backed either by collateral (inaudible) of revenue. Does that apply to PREPA as well?

Exactly. PREPA's line is purely -- as Jose Rafael just pointed out, the balances increases because it's a rotating line, and it is used for purchase of oil and gas for their power generations.

Okay, so that's income.

So, we have gross revenues that are assigned to--.

They are identified, exactly. It is treated as the line that would get rotated as they have the cash flow.

I see. Okay, thank you very much.

You're welcome.

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

Thank you, Operator. Thank you, all of our stakeholders who have listen in, our depositors, our retail and business customers, our investors, our staff, and ultimately the communities we serve. We will be participating at the KBW Community Bank Conference in New York next Wednesday, and also we will be participating at the Deutsche Bank 2014 Bank Conference in Boston on August 6. So, I look forward to meeting some of you guys there. And until next quarter, thank you for participating in this call. Have a great day.

Thank you, gentlemen.

Thank you for participating in today's conference. This does conclude your call. You may now disconnect.