OFG Bancorp (OFG) 2015 Q3 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 on the home page or on the webcast presentations and other files page.

Please note this call may feature 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.

Good morning. Thank you for joining us. We received good feedback to the shorter-format presentation we did last quarter, so we will continue with that, and I will address the big picture here in Puerto Rico as it affects OFG. Then we will open it up for questions and answers.

We have all our usual quarterly slides in the appendix of today's presentation. Ganesh and I will be happy to answer any questions on them.

To start, please turn to slide 3. There are four major points that we would like to communicate today.

One, Puerto Rico's economy remains flat. It is not falling off the cliff, as many people outside the island fear. The GDP activity index has been mostly stable since early 2014. The Puerto Rico manufacturers purchasing index indicates relatively flat trends. And September unemployment reached a seven-year low with the private sector adding new jobs.

However, there is still a great uncertainty about the future. Puerto Rico's government liquidity is declining and the threat of a government shutdown and/or default still looms. We believe a comprehensive solution is needed and we are encouraged by the attention Puerto Rico has received from the federal government in recent weeks. But more needs to be done out of Washington and from the local government officials.

Second, we have continued to make important progress working out our PREPA loan. As everybody knows from news reports, PREPA has reached agreements with the ad hoc bondholders and the fuel line banks of which we are part. The government is about to introduce the PREPA Revitalization Act to facilitate needed reforms. Based on what we have seen in the media, there appears to be increased confidence on the part of PREPA to reach an agreement soon with the monolines, and it will be our desire to conclude all this by the end of this year or at least, at the latest, the first quarter of 2016.

Three, our core business is strong and stable. We are growing originated loan balances and income. Credit metrics are solid. Loan production was strong in the quarter. We are seeing net new retail customer growth. Fee income performs well and capital levels are strong.

Four, we significantly reduced risk in the third quarter. We reduced our Puerto Rico government and agency balances by 28% from the second quarter. The recent bulk sale of the former Eurobank and BBVA Puerto Rico nonperforming assets will reduce credit costs going forward. And our originated loan credit metrics were relatively stable.

Please turn to slide 4, for a summary of third-quarter results. We reported a profit of $1.1 million or $0.03 per share. That, of course, included $20 million in pretax costs associated with the bulk sale. It also included $3 million in net benefit from other nonrecurring items.

Excluding these factors, core profitability was $12.2 million or $0.28 per share. This compares favorably to second quarter's adjusted result of an $11.5 million profit, equal to $0.26 per share.

Highlights of the quarter included sequential growth intangible book value and book value per share and an expansion of the tangible common equity ratio. We continue to grow the [Oriental] franchise. We gained market share in conventional mortgage originations. Consumer and auto volumes are up this quarter. And we launched MyStatus, an industry first mobile app for clients to track the status of their residential mortgage application. That is part of our strategy to continue to win business through service and best-in-class customer experience versus relying solely on price competition.

During this quarter, we decided to retain some of our Ginnie Mae mortgage pool production for its recurring income rather than selling it into the secondary market. In addition, noninterest expenses came down as a result of lower OREO and auto repo cost. We expect our core business to continue to do well in spite of the challenging economy and assuming that there is no additional economic contraction due to a government shutdown.

However, this will be somewhat affected by lower interest income from former Eurobank loans and from the reduction in Puerto Rico government and agency loans. Ultimately, we will look forward to put our Puerto Rico government exposure behind and highlight our core business successes.

Please turn to slide 5. Now I would like to address our Puerto Rico central government and public corporation line exposure in more detail. As of September 30, it totaled $216 million, down 28% from June 30. PREPA -- even though we placed this loan on nonaccrual status in first quarter of 2015, we continue to receive interest payments. During the second and third quarters the principal balance has come down to $194 million. This does not include the $24 million provision we took in the first quarter.

As I mentioned earlier, the ad hoc bondholders and banks have reached an agreement to work out PREPA's bond and bank debt. As a result of this progress, there was no need for an additional provision. We had a $78 million loan with a Puerto Rico state insurance fund. This was completely paid off in the third quarter. This resulted in a $3.2 million cost recovery in interest income and prepayment penalty totaling $800,000 that added to bank service revenue.

We also have a $21 million in long-term credit facility to the Puerto Rico Housing Finance Authority. It is repaid from inactive and unclaimed customer deposits from local financial institutions. This loan balance declined 17% due to the repayment in the third quarter.

To sum up, two years ago our Puerto Rico central government and public corporation exposure was $772 million. That has been reduced by $556 million or 72% without a loss.

Please turn to slide 6. The other local government exposure we have is $203 million in loans to five of the largest municipalities. This balance is also down by about 5% from June 30. These municipalities, as we have said in the past, are autonomous from the central government and its agencies, and these loans do not share the same credit characteristics as the central government.

These municipalities have the most in terms of population and property values. They are also the most important centers of economic activity and have the highest potential to generate property tax revenue among municipalities in Puerto Rico.

These loans also are collateralized and guaranteed by our first lien on property taxes and secured by money set aside in special accounts held by GDB. We continue to be comfortable with the municipalities' debt service capabilities. The weighted average aggregate debt service coverage ratio is around 2.3 times. Our shock scenarios assuming drops in property tax revenues indicate north of 100% coverage. Recently there has been a legal dispute between CRIM, the agency that collects these taxes, some of the municipalities and the GDB over where these tax deposits should be held. We expect this will be satisfactorily settled soon.

Please turn to slide 7. Our capital ratios continue to exceed requirements for well-capitalized institutions. And as you can see, we continue to have a strong capital position.

Please turn to slide 8. Our tangible common equity remains very strong. Tangible value per share increased to $14.76 in the third quarter from $14.67 in the second quarter.

The TCE ratio expanded to 9.11% from 8.91%.

Before we conclude, we noted in our release today that Oriental Bank has entered into a consent order with the FDIC. The purpose is to address certain matters related to our Bank Secrecy Act anti-money laundering compliance program. I would like to know that it did not involve any single penalties.

Please turn to slide 9. To sum up, we will continue to focus on aspects of the business that we can control. Going forward, NIM should be in the 4.5% range. This is due to reductions in higher yielding Puerto Rico government and Eurobank loans. However, our level of success in retail loan production might be able to counteract some of this.

We will continue to reduce credit risk when possible. Currently nothing is pending but we have a track record of acting when opportunities present themselves. We sold off all residential NPLs in 2014. We sold problem MSRs earlier this year, and they will all sell in the third quarter. We will continue to maintain pricing discipline and prudent underwriting standards. This has served us well. Originated loans have an averaging 6.4% yield over the past year and net charge-off rate has averaged only 1.2%.

We will continue focusing on creating best-in-class customer experience. Over the last two years, we have introduced four major consumer technology innovations. This has made it easier than ever for customers to do their banking with us.

In turn, this has enhanced our efforts to grow the franchise organically. Over the last five quarters, we have averaged more than $250 million in new loans. We have also been averaging about 5,000 net new retail deposit customers in the last couple of quarters.

Clearly, we cannot control what the Puerto Rico central government will negotiate with bondholders. So we have to stay vigilant, closely monitor our direct exposures and continue to approach next few quarters cautiously.

However, with our solid capital levels, favorable balance sheet and good expense control, as we have shown you in our credit shop scenarios, we are well-positioned to navigate the challenging environment we face.

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

(Operator Instructions) Brian Klock of Keith, Bruyette and Woods.

Rafael, a question for you -- the other matter that you discussed was the consent order around the BSA AML. I know it's early in the process, but what are you thinking about as far as -- it's the good news that there is no civil monetary penalties. Is there a thought process about expenses going forward, about having to either comply with or enhance some of your internal controls?

The way I can easily answer that question for you is that we have been working with this for the last year or so. It's something that we have already built into our expense, the results we are seeing with our expense levels. So we don't -- even though we have increased our expenses due to BSA, they have already been baked 10, into the results that you have seen. We do not expect any significant incremental expenses from that part right now. They have already been included in the results.

Okay, thanks for that. Appreciate that. And I think the quarter -- and I'll say thanks again -- like on page 4 of the release there was a lot of noise with the bulk sale and some moving parts. So thanks for that reconciliation. It helps show a clearer form of your recurring earnings power.

So given how challenging it has been, in the economy or at least the headlines, I'll say that -- I know it's a challenging economy that you are dealing with and challenging times. But maybe just talk about there is some stability on the ground, it seems. As you mentioned, the economic activity index seems to be somewhat stable and you are seeing some good origination trends. So maybe talk about that dichotomy of what you are reading in the papers, if you are not in Puerto Rico, and what you are seeing on the ground and how you guys are operating through that.

So we see the numbers. And certainly, the consumer continues to be resilient to the economic situation in Puerto Rico and the levels of consumption remain relatively stable also. You are seeing -- again, we have been at this for nine years. And the businesses that we visit, and I visit clients quite often -- they continue to tell me a couple things.

One, we have been able to streamline our operations and certainly are preparing ourselves to a difficult economic environment. Two, energy prices are down significantly. And therefore that has given them some cushion in terms of being able to navigate the environment also.

So, that's one side of what you're seeing. And I also think that it has to do a lot with two different types of industries. Certainly, industries related to professionals and manufacturing that does not depend on government as a client -- they remain strong. And it's a zero-sum economy, so that the weak are being bought by the stronger. And we tend to look towards those type of clients to do business with them.

Okay. Thank you for that.

We are also seeing, Brian, lower levels of cash on the different businesses that we do business with. And that's because they are trying not to leverage themselves to invest in their different operations. So they are using their excess cash to invest in their operations rather than going out and borrowing. We are seeing that on several different industries.

But in general, I think that the economy is not falling off a cliff, as I said. And it's going to be very much dependent on how the next couple of quarters or months, the central government liquidity shortfall plays out. And that's what concerns us.

Sure, sure. And so, I guess maybe my last question and I'll get back in the queue -- so when you think about that, so you spent the time to try to go through your exposure. Obviously, you've done a great job working through the direct government exposure.

But as far as the indirect, how do you think about the potential issues, if there is a government shutdown? Is that something that -- I guess how worried are you in the near-term on that?

We have been proactively analyzing the direct exposure in all our portfolios. We feel comfortable that the exposures that we have -- not only are they manageable but they are also focused from our part to make sure that we reduce them or proactively manage and interact with those clients to make sure that they reduce their government exposure. I think we have been very successful, and really it does not have much of an effect. It's around $82 million in total that we have an indirect exposure to the Puerto Rican government on the commercial loans.

Okay, great. Thank you for your time. Appreciate it.

(Operator Instructions) Emlen Harmon of Jefferies.

Just another -- a quick follow-up on the DSA consent order. Were there any capital provisions related to that order?

No.

Okay, so no restrictions on capital levels or capital allocation decisions? Got it. Okay. And then -- again, I would second Brian's thanks on the reconciliation tables. I think those are going to be pretty helpful.

When we think about just the interest income effect from those bulk sales, you broke it down into two components. There's a $7 million component and $3 million component. That $7 million -- is that a full quarter's run rate from the sale, or is there an incremental effect that we should be thinking about as we get into the fourth quarter?

The $7 million -- what we said was because of the accounting effect of this sale, going forward, we do believe the Eurobank portfolio will not have such a high yield. And it should drop. And we are in the process of working on our forecast, and we need to work on it to exactly size what it's going to be.

Okay.

It's going to be much lower than the 22%, 32% that we have. We are (multiple speakers) yes, yield-wise.

Right, got you. Okay. And then last one for me -- you mentioned you added more mortgage to the portfolio as to the selling this quarter. Is that something you think you would continue to do?

Yes. It's something that it makes sense to us from a yield perspective rather than going out and buying mortgage-backed securities at 2.25%, we are holding onto our FHA originations and securitizing at a 3% and change. So make sense for us and it's also tax-exempt so -- .

All right, that was it for me. Thanks.

(Operator Instructions) Taylor Brodarick of Guggenheim Securities.

Really, two questions for me -- just looking at the charge-off and delinquency slide, how much of the decline is from the bulk sale and [derisking]? I'm just trying to get a sense of on the core trends --

Can you repeat the question? It got a little bit cut off.

Sorry; I think I'm having some telephony issues. I was just wondering -- so just looking at the improvement in the delinquency rate, how much of that is a function of the derisking through the bulk sales? And is the core -- is there core improvement tracking that as well?

Well, Taylor, if you look at table 6 we show over there excluding acquired loans. And so if you look at that, that should give you the idea of what is the decrease in our non-acquired book. And we show a decrease in early delinquency and also at the [NPA levels EBIT].

Okay, got it. Okay, great. And then have you updated the credit shock scenario that you released at the last earnings call?

We do that -- yes, we are in the process of starting that process. The last one was what we presented last quarter. And we will be continuing to update that, starting right now.

Okay. All right, great. All right, thank you very much.

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

Thank you, operator. Thank you also to all our stakeholders who listened in today.

In November, we will be visiting investors in Dallas and at the Sandler O'Neill East Coast financial services conference in Palm Beach. So we look forward to seeing some of you there. And our preliminary date for reporting fourth-quarter results is Friday, January 29, 2016. So thank you again and have a great weekend.

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