OFG Bancorp (OFG) 2014 Q4 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 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 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 our 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. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would now like to turn the call over to Mr. Fernandez.

Thank you and good morning to all. I will cover the general overview and Ganesh will discuss key aspects of our financials. Please turn to slide 3. We are pleased to report our eighth consecutive quarter of strong core performance since the acquisition of BBVA's Puerto Rico operations.

We earned $0.36 per share for the fourth quarter and $1.50 per share for the year. Our results reflect what we believe is our sound strategy in a tough operating environment. We are prudently growing new loans and optimizing both loan yields and credit costs. Concurrently, we are focused on managing our expense footprint and in further refining our loan servicing capabilities.

Looking at the fourth quarter, we saw higher originated loan balances and interest income, higher noninterest fee income and lower credit expenses, FDIC amortization and recurring noninterest expenses. All of this more than offset lower interest income and lack of significant cost recoveries from acquired loans.

Fourth quarter 2014 also included a nonrecurring accrual of $3.8 million for a cost-savings initiative planned for 2015 and a lower effective tax rate. In other areas, loan production was good, demand and savings deposit costs continued to fall and performance metrics remained high. All of this had a beneficial effect on capital. The tangible common equity ratio rose to 9.25% and tangible book value increased to $15.25. As a result, as we previously announced in the fourth quarter, we repurchased $6.5 million in shares below tangible book. In addition, the Board increased the quarterly dividend per common share by 25% to $0.10 per quarter.

If you please turn to slide 4, 2014 capped off another year of accomplishments for OFG and our Oriental Banking wealth management and insurance subsidiaries. Looking at our balance sheet, over the course of the year, acquired loans have declined to 42% of balances versus 52% a year ago. We improved our funding portfolio as demand and savings balances grew to 67% of deposits from 60% and we reduced our loan and security balances to the Puerto Rico government sector by 24%, which accounted for a good portion of the decline in acquired loans in 2014.

As for our income statement, provisions were higher excluding the effect of last year's NPL sales. This primarily reflected increased balances of originated loans versus acquired as opposed to any major deterioration in credit quality. In fee income, we saw some pressure in banking and mortgage, but wealth management held up well and mortgage banking rebounded in the second half of the year. Including the fourth-quarter accrual, noninterest expense came down nicely.

However, the real story is on the progress we have made on the business front. We have been able to leverage our acquisitions to acquire great strides evidenced from the results above. Our new branding message, Vive la Diferencia, Live the Difference, banking with a difference, is starting to pay off in terms of new customer acquisitions. One good example of this is our new checking account, Cuenta Libre, that added 10,000 plus net new customers in 2014.

In addition, we have led the market in product and technology innovations such as surcharge-free ATM access, photo depositor, People Pay and others, all exhibiting greater acceptance and growth in our market. I will have some additional observations later, but for now I will turn the call over to Ganesh to get into the financial details.

Thank you, Jose. Good morning to everyone on the call. As usual, we have a few slides on the fourth quarter and then I will go through a series of slides on key trends shaping our business going forward. Please turn to slide 5. During the fourth quarter, you can see that we continued to perform close to target ranges that we set ourselves for various metrics. ROAA was up at 1.09% compared to the third quarter. ROTCE was up at 10.16% and the efficiency ratio improved to 49.2%, eliminating the effect of $3.8 million accrual that Jose mentioned.

NIM came in at more than normalized around 5.65%. The key differences from the third quarter were lower interest income, in particular due to lack of any significant cost recoveries in our acquired pools and the absence of premium amortization on acquired higher cost time deposits, which we benefited from in the prior quarter.

Please turn to slide 6. We continued to experience positive and stable trends in most of our businesses during the fourth quarter. Compared to the preceding quarter, total loan production at $239 million was slightly lower. The decrease in the commercial category was partially offset by increases in retail categories. Auto loan production increased slightly as the overall market showed some stability this quarter.

Mortgage production continued to grow although associated fee revenues were approximately level due to pricing pressures we faced in the secondary market. Consumer loan production held steady. For the year, we originated $919 million in loans, which compares to $1.5 billion last year. The difference besides market trends can be attributed to our strategy of continual lower reliance on [garment] sector.

On the fee income side, in the fourth quarter, banking services revenue increased 7%. This was primarily due to seasonal increases, as well as higher electronic banking volume. Wealth management was also up nicely. This was due to $1 million in the year-end recognition of our insurance commission revenues. 2014 was a good year for our insurance business.

On slide 7, we show you some of the changing dynamics in our income statement. As compared to the third quarter, interest income from originated loans increased as we continued to carefully expand volumes. Interest income from acquired loans declined due to normal paydowns, as well as no significant cost recoveries as I had mentioned previously. Interest income from securities also declined a little more than $1 million primarily due to higher premium amortization as the interest rates fell. In turn, the following rates had a beneficial effect on other than comprehensive income and the shareholders' equity.

Quarterly interest expenses increased slightly as compared to the third quarter, which benefited from some premium amortization on higher cost CDs. Provision for non-acquired loans increased about $1 million. While the net charge-offs decreased quarter-over-quarter, this increase in provision was driven primarily by higher volumes in the originated segment.

Meanwhile, provision for acquired loans declined even more as there were no significant deviations in cash flows from current forecasts. We already discussed the increase in banking and wealth management revenue, so let me skip to the next point regarding the FDIC indemnification asset amortization. This was down close to $5 million quarter-over-quarter. This is primarily due to lack of cost recoveries as mentioned earlier, but also because of higher inflows from lost share claims this quarter. Recurring noninterest expenses declined primarily due to reduced general and administrative expenses.

On slide 8, you can see Puerto Rico-related loan and security balances continued to decline in the fourth quarter. Contractual balances of these garment loans dropped about $9 million largely due to a full repayment of a loan in the central government category.

Regarding PREPA, we continue to maintain our PREPA credit in the same status as last quarter. The decision to leave the status unchanged is based on our latest iteration of associated cash flow and credit analysis.

Now on slide 9, for you to better understand all of these income generation capabilities, it is important to recognize the underlying trends. On this slide, we are using average loan balances as we have reported on table 4 of our financial supplement. The top half of this slide shows our non-acquired loan portfolio. This is around 13% or $369 million year-over-year. Now it represents 57% of our total loans as compared to 47% a year ago. The yield has generally been increasing. It was 6.6% in the fourth quarter and 6.2% in the year-ago quarter. The growth rate of the portfolio reflects our prudent approach to the prevailing Puerto Rico economy while overcoming the normal paydowns in our mortgage portfolio. For several years now, we have not been replenishing our originated residential mortgage portfolio as we have shifted to an originate to sell model.

On the bottom half of the slide, we show our acquired loan portfolio. This portfolio consists of acquisitions of BBVA Puerto Rico operations in 2012, namely the noncovered loans and from the euro bank FDIC deal in 2010 as covered loans as we refer to it. This portfolio as a total has declined 23% or $631 million year-over-year. It represents 43% of our loans compared to 53% as a year ago. But because of the purchase accounting, the blended yield is in the 11% range, much higher than in our originated portfolio. This portfolio has been declining due to normal paydowns. In terms of accretable yield, the noncovered loans have $446 million of accretable yield while the covered loans still have $110 million with a weighted average life of 4 to 5 years on the noncovered side and 2 to 2.5 years on the covered side.

In terms of interest income trends, I want to highlight that as the higher yielding acquired loans are paying down, we are replacing them with lesser amount of loans with a more normalized rate. This is the reason that you are seeing NIM trending down. As we have already harvested the cost recovery opportunities in 2013 and 2014, we don't expect major windfalls in 2015.

Please turn to slide 10. There are several trends that we believe will result in generally reduced costs to offset some of the decline in the interest income from the acquired loans. The first is that credit quality showed some encouraging signs of stabilization. With the refinement of our servicing capability, we continue to keep an eye on (inaudible) levels in our portfolio while monitoring the delinquency levels in our residential mortgage loans associated with certain vintages. As a result of improvement in our collection effort, we saw a decline in the net charge-offs this quarter. With NPLs, although there were remnants of last quarter issues with mortgage delinquencies, we saw improvement in auto and (inaudible) commercial loan categories. The total delinquency overall was lower as well.

On slide 11, you can see the next trend, which we have previously discussed, is the more favorable deposit funding mix. Our proportion of demand and savings account loans as a share of total deposits continued to grow. Due to ongoing product enhancements and leadership locally in our mobile banking offerings, favorable market perceptions as already mentioned are evident from the balances that we have reported. Such changes have enabled us to reduce our alliance on higher cost CDs over the last two years and reduce our deposit costs continuously. We continue to harness our franchise strength for further opportunities in this area.

Please turn to slide 12. We have always operated in a cost-efficient manner. Although we see the need for investment in branding, customer-facing capabilities and service innovation further, we are aggressive in managing other categories. For 2015, therefore, we expect a modest improvement only in our non-interest expenses. We are evaluating further branch consolidation opportunities, but at the same time we would like to grow our deposit base. However, we see the necessity to continue investing in our capabilities in order to lead the market in terms of service delivery while continuing our strong financial performance.

Now let us move to slide 13. As many of you know, in the second quarter of 2015, most of the FDIC indemnification assets would have been amortized. The amortization charge totaled $66 million in 2014 and should be approximately $25 million in the first half of 2015. After that, it should continue at approximately $3 million per quarter in the second half.

The reduction in FDIC amortization will help offset the reduction in interest income from acquired loans as well contribute less to the bottom line growth. As you can see in slide 14, we continue to build our tangible common equity. While we believe it is prudent to hold higher than normal levels of PCE, because of the economy in Puerto Rico, our strong capital levels afford us with considerable capital management flexibility. As we have demonstrated in the past, I believe we are unique in employing dividend increases, share buybacks and timely acquisition strategies to maximize longer-term shareholder returns.

That concludes my part of the presentation; let me turn it over to Jose for a wrapup.

Thank you, Ganesh. Please turn to slide 15 for a current outlook. With regard to Puerto Rico, it is a mixed picture. On the one hand, the GDP economic activity index has seen consistent declines in the last few months. Treasury inflows for the first half of the current fiscal year, that is July through December, are behind the year-ago period and the current fiscal year estimates. GDB is planning to raise debt again to solve some challenging liquidity conditions.

On the other hand, a sustained drop in oil prices could provide an additional lever in managing current conditions as many servers have noted. We have seen some beneficial effects in certain industries such as tourism and some local manufacturing and consumers are very happy about the significant drop in the price of gas, but we have not yet seen any impact in the official statistics.

With regard to the local banking industry, balance sheets continue to shrink, FDIC acquirers face expiration of commercial loss share agreements next quarter and credit quality continues to be a concern. However, consolidation opportunities can play a meaningful role in boosting bank performances in these environments.

Within this challenging environment, we have continued to adapt while adhering to our time-tested approach all during this eight-year recession. This has enabled us to generate performance metrics that compare us favorably to top tier peers in the mainland. We plan to continue managing the situation prudently and build capital further as Ganesh just outlined and we plan to be flexible in our capital management approach, increasing dividends and share buybacks or exploring strategic growth opportunities.

As we look ahead, we are confident that our growing market position, strong capital and liquidity levels, along with the momentum we have built in our franchise, should enable us to deliver best-in-market financial results. We strongly feel Puerto Rico deserves financially strong players like us to deliver unparalleled levels of service catering to the needs of the market. It has always been our goal to be that institution in Puerto Rico.

That ends our formal presentation. Operator, let's open the call for questions.

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

Good morning, gentlemen. So just a quick question on the expense side. You guys have had some success with the promotions you talked to about with growing solid growth in your net new deposit customers and the quarter was pretty good on core expenses. So I guess can you talk about the impact going forward I guess maybe on the personnel side, if the early retirement program might actually lead to downward momentum on the personnel expenses? And I guess is there any thought of maybe you would reinvest that into other programs for growth? So maybe just kind of talk about the expense outlook.

Brian, I will let Ganesh get into the details. Let me just take the opportunity to show you a little bit of a big picture on what we are doing with our franchise and the success we have had because I think that is what is making the difference all along. We mentioned that we have grown our Cuenta Libre 10,000 new customers in the whole year and that is a great success for us, but bringing to market new technologies like the photo depositor, People Pay, which nobody else has it on the island, has put Oriental in a different position where we have had significant growth on mobile banking. We have grown it in the year like 254%. We have grown penetration on bill pay significantly. We have done all kinds of great news regarding our banking franchise.

So when you look at OFG and our banking franchise here in Puerto Rico, we aspire to be the best bank, not necessarily the largest, but the best and we are on our way to get to that level. We will continue to invest on our infrastructure just to make sure that we are leading the market in bringing innovation, but also focusing on our people and making sure that service is the differentiation at every touch point that we have.

So given that overall kind of look at where we are from our strategy and how we are being very methodical on executing on our strategy from a banking perspective, I think we also need to be very efficient and that balances what has made the difference for us throughout many, many years. So the early retirement plan is something that we announced late last year and I think it is going to allow us to be more efficient in 2015 from the payroll side.

Sure, well, I think he covered everything. I just wanted to add that unfortunately it is not so static for me to say that we will definitely see a $3.8 million reduction in compensation expenses, but what we are trying to do is also bring in some of the servicing aspects inside. Some of the expenses might shift from other categories into personal category as we enhance our own capability in addition to expanded volume that Jose was talking about. So at the end of the day, Brian, I would still ask you to look at the efficiency ratio. That is what we shoot for and we have said what the targets are and we want to operate close to that.

Okay, perfect. That is good color. Thank you for that and maybe just a follow-up question. The strong ROA, strong ROTC, internal capital generation keeps growing. I know you've talked about the flexibility. With the buyback, you had a nice increase in the dividend in December. So maybe you can talk about the capital deployment thought process for 2015. It seems like you still have I think $16 million or $17 million in the authorization on the buyback. So maybe talk about the priority on the buyback and then the potential for -- are there assets or other things that you can buy in Puerto Rico that could help deploy some of that capital?

The short answer to all those questions is yes to all. So we will continue to look at the dividend and the repurchase. We discuss this on a monthly basis at the Board of Directors and we are all on the same page on where we stand. They are also, as I mentioned on my remarks earlier, there is some potential consolidation opportunities in Puerto Rico and those things will continue to exist for the next couple of years as Puerto Rico I believe continues to be overbanked for the shrinking economy that we have.

So when we look at capital, Brian, we recognize that we have a very strong capital position and dividends and repurchase are part of the equation and it is primarily part of the decision-making process and if there is any potential opportunity for us to look at some assets, we will certainly take a look at them.

We will also look at those assets in a very efficient way. Meaning we have some ROE and ROA targets that we want to continue to meet, so we are very disciplined on all three approaches.

Great. I will get back in the queue, but I think you guys have done a good job positioning yourself for opportunities in 2015. Thank you for your time.

Emlen Harmon, Jefferies.

Good morning, guys. Just wanted to hit on the PREPA credits quickly. Seeing just a couple of things in the market lately. A competitor moved their PREPA exposure to nonaccrual this quarter and then we've seen some articles the past couple days about the restructuring getting pushed out another three months or so. Could you give us a little bit of color just on your PREPA exposure maybe relative to peers and why you feel a little bit more comfortable there? But also just be interested to know if there is any additional, any provision got shifted to that or any reserve got shifted to that this quarter?

Well, I can't speak for our competitors; I can only speak for us and we have our methodology. We have our analysis, great analysis on how we evaluate the cash flows from PREPA. I think when you compare the September quarter to the December quarter in terms of the PREPA exposure, we feel slightly more optimistic at the end of the fourth quarter than the third quarter and it is primarily because there are additional levers that have come to the table, meaning reduction in the cost of fuels for PREPA and that gives them the ability to act in a way that our credit is in a better position.

So we, as of today, the information that we have is information that things continue as planned and there is a forbearance agreement that has some timelines and has some toll gates that need to go through and we are waiting for PREPA to meet those timelines and those toll gates. As I said, we feel slightly more optimistic about the credit than we were in the September quarter simply because the analysis shows a better debt service and everything. So that is where we are with regards to PREPA. Regarding what others have done, I can't speak for.

Got it. Thanks. And then just yield on originated loans kind of topping out here the last couple of quarters. I know at one point auto had been additive. I don't know if maybe that is kind of reaching a point where the mix is such that you don't see the loan yields increase anymore, but could you talk just a little bit about what you are expecting in terms of the direction there and just kind of what is happening with market rates more broadly?

There has been no deterioration in auto pricing so far. We do face some pricing pressure, but look at the volume has come down 20%. So the upside that it adds to the overall yield is not that much perceptible or tangible. Having said that, I think the conversation stays the same for quarter-over-quarter. It is just that the upside as you point out from the auto is not that much.

In addition to that, certainly, there is a lot of competition on the commercial side and on the pricing side. There is pressure there too. That is also what plays out a little bit on the interest income.

Got it. Okay, I will step back now. Thanks.

(Operator Instructions). Brett Rabatin, Sterne, Agee.

Wanted to I guess go back to the commentary around consumer and you mentioned that you weren't really seeing the benefit yet of lower energy prices, a la gas prices in consumer and I guess we kind of continue to hear of consumer activity being weak or consumer trends being weak. Do you guys think it is a timing issue that the benefit of lower gas prices will eventually move through consumer trends and improve both credit and their spending power in a material way or can you give us any color on what you guys are specifically seeing with some of those trends?

When I mentioned that we haven't seen the effects of the lower fuel cost on the statistics, it is on the statistics. Certainly the consumers are seeing the reduction in fuel prices when they go to the gas pump. So I am sure there is an underlying positive effect, an additional disposable income for individuals and also for businesses. Energy prices have also trended down these last couple of months and they have been passing some of the benefits to consumers. So there has been some positive trends there and again, as I said, there is additional disposable income for consumers.

But the truth of the matter is that there is still a lot of measures coming on into Puerto Rico by the government that are also contractive and that is -- a net effect of that is what is going to happen. In my estimation, economists in Puerto Rico are basically saying that the lower fuel prices should push on 1% of GDP growth. So if they were expecting 2% contraction, now they are expecting 1% contraction, so that is the expectation.

Also remember the estimation is around 25% to 30% of underground economy in Puerto Rico and that is something that does not translate into the statistics. It is something that is very challenging for us to measure. So when we don't see those benefits or those numbers trickling into the statistics, it is also due to that affect that it is inherent in our economy.

Okay. And then you touched on it some, but just thinking about the capital ratios and you are hoping to see potential opportunities over time in Puerto Rico, can you guys give us a refresh on maybe your optimism on doing something specifically in the US in terms of potential deployment of capital either via de novo branching or actually buying a bank in the US?

Part of our discussions at the Board has to do with realizing that the Puerto Rico economy is a challenging operating environment, so one of the strategies we need to look at as prudent managers is diversification of businesses. So it is in the table to look outside of Puerto Rico to look for opportunities to diversify.

Having said that, we are not looking at it from a de novo perspective. We are more looking at it from striking some level of partnership and evaluating. We are in that process right now and it is something that we do as part of other strategies that we operate with during the year and throughout the year. So that is kind of how we are looking at a diversification strategy. But it is prudent for us to look to see if we can diversify some of our assets outside of Puerto Rico and we are seeing potential opportunities outside and we want to explore them.

Okay. And then just lastly, there was some noise in the quarter on the tax rate and the securities portfolio yields. Can you give us a little color on some of those differences linked quarter?

Okay. The securities portfolio, the primary difference, even though the yield levels are almost the same, we had a higher premium amortization because of the interest rate movement. So if you eliminate the effect of $1 million and that, it is very much flat quarter-over-quarter and it has been so for the last few quarters.

In terms of taxes, so we ended the tax with close to 32% and basically being the end of the year quarter, we had to do our tax exercise and we came to the calculation of what the effective tax rate would be based on that and that is what gave us a little bit of a lower tax accrual for the last quarter. It is not noise per se, but it is part of what we do last quarter of every year to find out what exactly the tax rate would be for the year.

Okay. Would it be fair to assume the full-year tax rate for 2014 might be similar in 2015?

So I would ask you to take a look at the 32% as the entire year effective tax rate and 32%, 33%, in that range.

Okay. Thanks for all the color.

(Operator Instructions). At this time, there are no further questions. I will now turn the call back over to Mr. Jose Fernandez for any closing remarks.

Thank you, operator. Thank you all for joining us today and listening in. We will be at some investor conferences in February and March. February 12, we will be at Sterne, Agee in Boca Raton for a conference. On March 12, we will be at the Deutsche Bank Mid-Cap Bank Summit in New York and of course, we look forward to talking to you in April when we hold our first-quarter call for 2015. Have a great day and a great weekend.

Thank you. This concludes your conference call. You may now disconnect your lines and have a wonderful day.