OFG Bancorp (OFG) 2015 Q1 法說會逐字稿

Good morning. My name is Christine 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 the risk factor 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 three. After eight quarters of strong performance, the first quarter of 2015 was very challenging. We reported a loss of $0.14 per share. This includes the $0.35 per share PREPA provision we announced previously. Excluding that provision, we had a profit of $0.21 per share.

Three major factors adversely affected first-quarter results. First, obviously was a $24 million provision to place the PREPA line on nonaccrual. I will talk more about that in a moment. Also we generated $8 million less in loan interest income as compared to the fourth quarter. This was largely due to a transition in balances and yields in our three major loan portfolios, covered, acquired and originated.

This item was also affected by a fewer number of days in the period, lower cost recoveries and a cash flow re-forecast in our covered loan portfolio. Ganesh will go into more detail about that in his presentation.

Third, we had close to $5 million in provisions for covered loans. As most of you are aware, our commercial loss share agreement with the FDIC ends in the current second quarter.

On the plus side, net interest margin at 5.42% remains strong. Credit improved. Our efficiency ratio at 51.75% continues in our target range. We saw continued growth with our Oriental Bank franchise. We continue to have a growing influx of new customers that value Oriental for our service, innovation and commitment to make banking simple.

We also experienced a reduction in the cost of funds, cost of deposits. Core noninterest fee revenue remains strong and after the quarter ended, we significantly expanded our ATM network, becoming the second largest in Puerto Rico.

Most important, we experienced only a marginal decline in tangible book value and book value per common share. We are clearly disappointed at being forced to take the large provision against our PREPA credit. We also remain concerned about the challenges, businesses and the people of Puerto Rico face in our heavily taxed underperforming economy. Having said that, most of our FDIC indemnification asset amortization ends in the second half. This will help offset reduced interest income and increase our core profitability from the first quarter 2015 levels.

Please turn to slide four. Let me recap the PREPA situation. Our contractual obligation with PREPA is a 7.5% nontaxable $200 million fuel purchase line, part of a syndicated $550 million line. It is the most senior PREPA debt and has a payment priority. We acquired our participation as part of our late 2012 purchase of BBVA's Puerto Rico operations. Last week we announced we were placing it on nonaccrual status and taking the $24 million provision I mentioned earlier. Previously it had been classified as a TDR.

Our credit analysis showed PREPA has the financial capability to pay its creditors. We also saw that PREPA's cash flows were improving or are improving. However, after a more than eight months forbearance period previously granted by its creditors, PREPA clearly demonstrated an unwillingness to commit to pay as contracted.

With regard to interest payments, those are being paid monthly and were included in our first-quarter 2015 results. Going forward however, these payments will be applied to principal as per FASB regulation.

Our preference is to work constructively with PREPA. We would be happy to answer more questions about this in the question-and-answer session. I will have some additional observations later but for now, I will turn the call over to Ganesh.

Thank you, Jose. Good morning and thank you for joining us. I will start from slide five.

During the first quarter, our performance metrics were mixed against our stated targets. As Jose pointed out, on one hand, the core business continued to perform strongly. On the other hand, our exposure to Puerto Rico economy directly or indirectly continues to be the main concern. With this quarter's results, you can see the increased profitability we enjoyed from our acquired loan portfolio has abated as well. Despite these challenges, we are proud of our NIM and the efficiency ratio as they compare well with the rest of the industry.

On slide six, you will see our capital ratios continue to exceed requirements for a well-capitalized institution. All of the ratios grew stronger on a sequential quarterly basis. Please note that in this quarter we started reporting the common equity tier 1 capital ratio calculated using the Basel III methodology.

Please turn to slide seven. One of the major trends we have been talking about over the last year has been the shift in composition of our loan portfolio. Generally speaking, higher-yielding acquired portfolio outflows are occurring at a faster pace than the originated loan net inflows. As these trends continue, the yield normalizes over time. This is what I alluded to as reducing benefits from the acquired portfolio earlier.

Covered loan balances declined more than 9% quarter over quarter primarily due to pay offs. Yield fell 306 basis points due to a myriad of reasons including collateral value and duration adjustment accounted for $2.2 million drop and cost recovery reductions for another $400,000 shortfall. As a result, the interest income was off $4.3 million.

The acquired loan balances declined about 6% quarter over quarter. Yield compressed 23 basis points. The day factor of the quarter accounted for about $900,000 drop and cost recoveries for another $500,000 shortfall. As a result, interest income was off $4 million.

Continuing on slide eight in the top part you can see the originated loan balances grew more than 2% quarter over quarter reflecting our ability to generate loans with good credit quality even in this environment. Yield expanded 4 basis points. As a result, there was a small increase in interest income to more than $46 million.

On the bottom part of the slide, we show the total loans. This pulls everything together. Even though our loan balances declined only 1% and yield declined 36 basis points, the interest income however declined 8% or $7.9 million. This clearly illustrates the point that I made earlier about changing composition of our loan portfolio. As a result, it is important for you to analyze these portfolios separately.

Looking ahead, interest income from the originated portfolio should continue to grow based on the pace at which we add new loans. However, we plan to continue to be very prudent given the fiscal situation we have here in Puerto Rico. Interest income from the covered portfolio will likely continue to decline at a faster pace. Interest income from the acquired portfolio should continue to shrink as well albeit over the next two to three years.

Moving on to slide nine, business activity during the quarter was generally good considering the economy. Commercial loan production was up 3% and we have a good pipeline for the balance of the year. Mortgage loan production was up close to 8%. With one less player we have been expanding our market share. Auto loan production was down 5%. We are seeing increased competition from manufacturers captive finance arms. In addition, we raised our FICO score requirements to improve credit and loan quality. Consumer loan production was down 10% but we believe this is largely seasonal.

Core noninterest income declined but it was mostly due to the year-end insurance commissions that were recognized in the fourth quarter.

Finally, core retail deposit gathering did very well. For more on that, please turn to slide 10. Core deposits were up more than 2% to $3.36 billion. We opened more than 7600 net new checking accounts and savings accounts. This success can largely be attributed to our holistic retooling of our retail business ranging from brand positioning, product range and striving for differentiation in this commoditized market.

We continue to be the only Puerto Rico bank to offer all of the following services; mobile check deposit, People Pay and as well as online account opening. Oriental also expanded its ATM network 34% to 332 units on the island making it the second largest in Puerto Rico. In addition to that, we always had an arrangement with a surcharge free network to many more ATMs both in Puerto Rico and on the mainland as well. As a result, we were able to shave off another 7 basis points from the cost of deposits while further improving our funding profile. Overall the retail franchise continues its successes from the previous quarters.

Please turn to slide 11. We already talked about most of the big ticket items that affected our income statement in the first quarter 2015. Let me point out a few additional details. Interest income from investment securities declined $1.1 million. This primarily reflects higher premium amortization on those securities. Total interest expense declined $1.5 million. About two-thirds of it came from reduced cost of deposits as mentioned earlier. The balance reflects wholesale borrowing costs as we paid down maturing repurchase agreement funding. Provision for acquired loan and lease losses increased $1.2 million quarter over quarter. This was due to a $3.5 million increase for the covered loan. This quarter we increased the allowance for covered loans by $6.4 million.

FDIC indemnification amortization increased $1.1 million as well to $13.1 million and the total noninterest expenses fell $5.6 million to $56.3 million. Besides the decrease in all major categories and accruals, we also consolidated two branches as previously planned. At the end of the quarter, we had 53 financial centers.

On slide 12 you can see the detail on our covered loans and FDIC asset amortization. The indemnification asset yet to be amortized stood at $75 million at the end of the first quarter. I would also like to remind you that our commercial loss share agreement with FDIC comes to an end in this quarter while the residential loss share continues for another three more years.

Please turn to slide 13. Here is a full slide on noninterest operating expenses. We expect modest improvement in this year versus last year. We intend to continue to invest in branding, customer facing capabilities and service innovation as part of our franchise building effort. However, our primary goal is to maintain a healthy efficiency ratio on the longer run. This is an area where we have proven our depth in managing for so many years.

Now onto the next slide. Puerto Rico government related balances continued to decline in the first quarter. The reduction was about $27 million primarily due to a $25 million partial repayment by PRASA, the government water and sewer utility. The contractual due date for the remaining $75 million balance is June 1, 2015. Year-over-year our PR government loan balances are down close to 20%. They are also down more than 27% since the end of 2013.

Please turn to slide 15. Credit continued to show a tangible improvement largely due to stellar efforts on our credit servicing team. The charge-off rate dropped slightly as we adjusted collection efforts in response to evolving market conditions. The nonperforming loan rate inched up a little primarily due to inflows from repurchases from GSEs. The total delinquency fell due to improvements in mortgage and in auto portfolios. We are actively monitoring credit trends, continuously refining our collection approaches to mitigate the impact of the environment we operate in.

Now on slide 16 you can see despite our GAAP loss in this quarter, tangible common equity remains strong. Our TCE ratio inched up to 9.29%. While we believe it is prudent to hold higher levels of -- higher than normal levels of TCE as a cushion because of the economy in Puerto Rico, our strong capital levels afford us considerable capital management flexibility. As we have demonstrated in the past, we believe we are unique in the employing dividend increases, share buybacks and timely acquisition strategies to maximize longer-term shareholder returns.

We have still $16.7 million in buyback authorization. As we mentioned earlier, our target for repurchases is when stock is trading close to tangible book value for an extended period of time.

This concludes my part of the presentation. Let me turn this over to Jose.

Thank you, Ganesh. Please turn to slide 17 for our current Outlook.

Puerto Rico continues to be a mixed picture. The GDB Economic activity index is showing a erratic month to month performance. Treasury collections lag estimates yet the latest employment numbers show modest gains. Within this scenario, the central government is considering a high 16% VAT tax and the GDB needs the highway authority to raise close to $3 billion to solve the near-term liquidity issues.

With regards to the local banking industry, FDIC acquirers face expiration of commercial loss share agreements this quarter. Credit quality continues to be a concern. Doral's closing moves the island one step forward in rationalizing the banking landscape but with balance sheets continuing to shrink, there is still a need for greater consolidation.

Within this environment, we plan to continue managing the situation prudently and build capital further as Ganesh just outlined. We plan to be flexible in our capital management approach with regards to increasing dividends and share buybacks while exploring strategic growth opportunities. As we look ahead, we are confident in our growing market position, strong capital and liquidity levels along with the momentum we have built in our franchise.

We strongly believe Puerto Rico deserves financially strong players like us to deliver unparalleled levels of service and innovation, catering to the needs of the market. It has always been our goal to be that institution on the island.

With this, we end our formal presentation. Operator, please open the call to questions.

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

You know, I guess what is interesting is -- in my opinion you guys have done a good job managing through a pretty difficult and challenging environment in Puerto Rico for a long time and you look through the slides and you think about the growth in the franchise, growth in customer accounts and slide eight shows the originated loan growth and pricing is still pretty good.

So I guess with all of the things going on with some of the headwinds to the top line with the runoff in the accretable yield, the headwinds from the non-accruing and the PREPA loan and then all of the news we have seen lately about what is going on with the GDB warning of maybe a government shutdown, I guess how do you think about managing in this next level of the challenging Puerto Rico economy? I know you guys have levers so maybe talk about what the plan is to kind of operate in this new level of challenging times.

Sure, Brian, thank you for your question. I think it is very pertinent. First, I would like to say that we are focused on growing our franchise and the results that we have seen are very strong. We have very good traction in terms of our brand and how it is growing and we are seeing how we are opening a growing number of new accounts every month and we are tracking that on a very close basis.

We feel that retail customers in Puerto Rico, retail clients in Puerto Rico, are starting to gravitate to our offering of good service We differentiate with service, we differentiate with innovation and we have proven that in the last couple of years and we have led the market with such offerings. We feel very confident that from a retail side of the equation we are growing our franchise in a fast pace and the numbers you alluded to show that.

On the commercial side, we also feel very encouraged given the economic dynamics of our economic situation in Puerto Rico We still see how good, strong commercial clients that have managed their businesses for the last eight, nine years through these economic contractions are still strong and solid and we have been seeing an increased pipeline on the commercial loan side.

Lastly, we have grown our core deposits. We have grown our core deposits significantly while at the same time reducing the cost of those funds. So we not only see the growing of the customer base, we are also seeing the reduction in the cost of funds which equates to a very strong response from the market to our high service innovative approach to banking.

Having said that, I agree with you, it continues to be a very challenging environment. For the last nine years we have successfully navigated a tough economic environment in Puerto Rico where we had nine years of economic contraction. What is going on locally these days regarding the VAT and all these liquidity issues regarding GDB, I think has a lot to do with political posturing and that is certainly increasing the anxiety of the people of Puerto Rico, the businesses in Puerto Rico and certainly investors in general so it is unfortunate that that political posturing is occurring.

Clearly politicians are not accustomed to operating a liquidity strapped economy where higher government revenues and lower government expenses are required to stabilize the patients. So for them it is a very hard pill to swallow and that is why you are seeing all this screaming and yelling across different parts of the government.

So all of this I believe will end with a consensus on the tax bill. It will eventually be reached. GDB will eventually be able to have the markets and gain some liquidity and I think from Oriental's perspective, we will continue to be -- the landscape will continue to be an extremely challenging environment to operate in.

It is not fun to be a banker in Puerto Rico these days but we are confident that we will continue to perform to our standards as we have proven capable during the past nine years of economic contraction in Puerto Rico.

So we've got to move forward. We are disappointed with the provision that we took from a recently announcement on PREPA. We are disappointed on how the government and their consultants are treating banks and treating creditors in general. I think to a large extent, the government of Puerto Rico is managed by consultants and there has got to be some level of leadership at the government level to act when you have liquidity and timing issues to address.

So it is really frustrating but we have a very strong management team. Our Board is very committed and our employees are totally committed to continuing to grow our franchise as we have done for the last three years. We are very excited on what we see here on the ground from our customer side. It is just challenging on the things that we can control regarding the economy.

Finally, Brian, internally in terms of levers, we are acutely focused on the cost of transactions and per customer. So I think given the times that we have stated the efficiency ratio as a target as the revenue goes down, we are prepared to take the steps to maintain that efficiency ratio to weather the storm at least for a short period of time.

Okay. I appreciate that. Maybe just follow-up, so you still have a buyback, you do get the benefit from the loss share amortization and the commercial that goes away. And with the disruption you finally got a competitor, Doral out of the market. So I guess besides those other levers, I mean you guys will focus in on expenses it sounds like if you need to.

Yes, as Ganesh said, we looked at efficiency hard and very focused and as you mentioned, the Doral exit has been a catalyst for us, it has been obvious and noticeable. The influx of clients on the mortgage side and gaining some market share there and also on the retail side that Doral had a small franchise here and we are gaining that clientele. So we are encouraged by that too.

As I said earlier, I think we've got to be more focused on our business development strategies, our retail group and our commercial group need to focus harder on bringing in good quality clients and mitigating the effects of the environment we are living in.

Thanks for your time, guys. I will get back in the queue.

(Operator Instructions). Taylor Brodarick, Guggenheim Securities.

Just a few questions for me. I guess you highlighted the growth in retail relationships and I just wanted to get your sense how much of that was the elimination of another competitor and how much of it do you think is just the focus, just the marketing focus you have put into growing those relationships?

I think part of it has to do with the elimination of a competitor like Doral, but we have been seeing an increasing trend of growth in new customers for the last year and a half and that trend has accelerated in the last quarter. I can tell you what we are seeing already in April which is the month we are in, we are continuing to see that level of growth in our customer, retail customer, new retail customers coming in. So at the end of the day, it is hard to tell what is what but in general I think our brand is sticking and our creative marketing approach as well as our business development teams are doing an excellent job of attracting new customers and expanding existing relationships to grow our franchise.

Great. I read an article talking about just where the auto industry is forecasted to go. I think car sales were down 12% last year, maybe a smaller drop this year. I don't know if you had any numbers that you can add as far as what you are projecting that line of business to do this year?

New auto sales continue to trend down this year. It is down 12%, 13% as you mentioned. I think the end of the year range of new auto sales for the island will be between 75,000 to 85,000 cars. Those are new. Now remember that we also finance used cars and there is also a trend now to higher used car sales and we are benefiting a little bit on those but the market itself is certainly on the auto contracting on the new car sales.

Okay. Ganesh, so after the commercial loss share portion expires, just remind I think everybody what is the noncommercial portion left? Like what should we expect income statement-wise about after we get past June 30?

Basically we are expecting because the remaining is residential, we are expecting between $3 million and $5 million over there per quarter.

Sure. Okay, great. Thank you.

Brian Klock, Keefe, Bruyette, Woods.

Thank you, and Ganesh, on the margin from a perspective of again it is still one of the highest margins in your peer group, over time you guys have talked in the past that eventually this would -- when the accretable yield and the covered loan balances would declined that you would get down toward the 5% range. I guess what directionally should we be thinking about from the 540 level from this first quarter where we should be going for the rest of the year? I guess having thought about that, you had so much more of this non-accretable difference that has been reclassed into accretable in the last couple of quarters. Is there any expectation that it should keep going down from this level or do we get it stabilizing?

Brian, it will trend down a little bit because primarily cost recoveries in the leasing portfolio it used to be around $1 million. It has entirely sort of dried up so we don't have any possibilities for cost recovery anymore. If you look at the non-acquired originated book on our table 5, we are showing you a 6.63% yield but that is primarily because there is a huge portion of auto loans in that and the resulting normalized composition is not going to have that level of auto loan. So there will be more commercial loans into it. Therefore it will bring down the yield on the originated book and therefore the total yield overall will trend down towards the end of the year, at least 20, 25 basis points.

Okay. And then I guess thinking about on the cost side, the funding cost side of it, I guess obviously you will get some extra cash flow coming out of PREPA. I know it is small but with the covered loan cash flows coming in, is there an ability to reduce any of the debt and reduce the non-core deposit debt side of it?

We are running out of opportunities. We have some short-term repo agreements that we are rotation and if our liquidity position continues to strengthen, yes, there are some opportunities but it is not going to move the needle that much.

And on the core funding side so far the pricing reductions have proven to be someone inelastic. From this point onwards we have to be a little bit careful to not run off any of the deposits that we have mobilized due to our effort so far. The opportunities are limited over there but we are continuing to look into it.

We would love to have our competitors to focus on lowering the core cost of funds also and unfortunately there is no downward movement on that side. So when you have a large competitor that controls 50% of the market in Puerto Rico and they are not bringing down cost of funds, it is very hard to move from here. So that is a challenge for the market too.

Okay. Maybe if I can just follow-up generally, I think what is interesting is the commentary that has been any news about the government and the potential shutdown and I appreciate your comments on it earlier. I guess in 2006 I remember when the last time it happened in Puerto Rico, it didn't seem like there was -- I think it was two weeks if I remember correctly the government shut down but as far as a negative impact on your customers and delinquencies and those sort of things, it seemed like that didn't show up because of the shutdown, it was more the economy had its issues that came out of obviously post a year later.

But what would you guys think about if there is, if it gets to the point where the politicians continue to do this sort of brinksmanship type posturing and there is a shutdown? Is there anything that should be different this time or I guess how should we think about it if that news does hit the tape over the next couple of months?

I will say that I will be very disappointed, we will be very disappointed if this ends in a government shutdown. Because in 2006, there were two different parties running the government. There was an executive governor with a party and the legislature was run by another party. That is not the case now, it is the same party. So coming to a closure or a government closure will be extremely disappointing for us.

Now if that occurs which we feel that there is a low probability of that occurring but if that occurs, I think this time around the consequences would be more negative than in 2006 simply because Puerto Rico has liquidity challenges that needs to be addressed with the capital markets and raising revenues as I said earlier. So I think that is one reason why when Ganesh and I on our formal remarks made our comments regarding loan originations going forward, we continue to highlight the word prudency because we are in a difficult economic environment that psychologically it is starting to build up into the people of Puerto Rico, it is building up into the businesses and we are seeing it on the market as we see pricing of the Puerto Rico debt and the banks in the island.

So I just don't think it will be a good scenario. I just think that psychologically at least it will have its effect and therefore its effect on credit.

Okay. I guess from a timing perspective, I think the HTA issuance was supposed to come to market in May and you've got a June fiscal end so a lot of these issues have to be resolved, right, with the tax reform, the VAT and the issuance of this, it has to be done in the next month or two, right?

That is the expectation and unfortunately as I mentioned, it is hard to read into the minds of all these people speaking out against each other and not considering the state of the economy as the primary objective to solve and it is a challenge.

Again, thanks for your time and thanks for your insights. Thank you.

(Operator Instructions). With no further questions, I will now turn the call back over to management for closing remarks.

Thank you, operator. Thank you all for listening in today. Our depositors, clients, retail and business customers, our investors, our staff and ultimately all of the communities we serve here in Puerto Rico. Ganesh will be traveling with KBW the week of May 4, visiting investors in Florida, Atlanta and Charlotte so looking forward to meeting some of you guys. The last week of May, Ganesh will be attending an event in Boston so we are also glad to schedule some meetings there.

Our preliminary date for reporting second-quarter results will be somewhere in the first week of August so looking forward to sharing the news with you then.

I wish you a great day and a wonderful weekend.

Ladies and gentlemen, that does conclude today's conference call. You may now disconnect your lines.