OFG Bancorp (OFG) 2016 Q2 法說會逐字稿

Good morning. My name is Paula and I'll 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 in the Investor Relations website on the homepage in the What's New box, 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.

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.

Good morning. Thank you for joining us this morning. If you'd please turn to slide 3. We had another strong quarterly performance as we continued to focus on building our franchise and constantly adapting to our economic environment. We generated net income available to shareholders of $10.7 million; earnings-per-share were $0.25 fully diluted. Our results were comparable to the first quarter, as we had expected.

Turning to Puerto Rico, the economy continues to fare reasonably well despite some headlines to the contrary. PROMESA, as you know, was enacted into law. In addition, PREPA continued to make progress toward final implementation of its restructuring support agreement by the end of 2016. We view both of these developments as very encouraging.

Please turn to slide 4. Here is our dashboard of key business trends. New loan generation remained robust, up more than 5% from the first quarter, underscoring our growing retail franchise. Originated loan balances continue to grow, up 2.7% from March 31, and average originated loan yields increased 9 basis points.

Deposits, excluding broker CDs, were up about 2%. Banking and wealth management fee revenue increased close to 7%, with increases in all major operations, but primarily in Wealth Management. And expenses are being well-contained, with the efficiency ratio improving to the best level in the last five quarters.

Now here is Ganesh Kumar to review the quarter in a little more detail; after which I will make some closing remarks.

Thank you, Jose. Good morning, everyone. I'll start from slide 5. This quarter, we closed $238 million in new loans. While higher than the first quarter, production was generally in the range of the last five quarters. Retail business teams had a stellar performance with commercial doing well too.

In terms of fee revenues, mortgage banking activities saw higher volumes, corresponding to the loan generation levels in the prior quarters. Wealth Management also benefited from higher annuity sales and from cyclical insurance revenues.

Moving on to slide 6, this quarter's results were very similar to last quarter's, as we had mentioned it would be so in our last call. Interest income from loans declined $1.5 million from the last quarter. This was due to lower balances from acquired loans as they continue to run off and they were less [cost trajectories].

Interest and income from securities declined $2 million, and interest expense fell $1.7 million. This was a result of previously disclosed first-quarter sales of mortgage-backed securities done in conjunction with a partial unwinding of [higher] rate funding in form of repurchase agreements.

NIM remained fairly level at 4.65%. There was a slight increase in provision, mainly due to one acquired loan. Total noninterest expenses were down more than $1 million with decreases in compensation and G&A, partially offset by increase in credit cost as compared to the first quarter. In first-quarter, we had a gain on repo sales that explains partially the results. FDIC lost share expense was down a little bit as well.

Moving on to slide 7, there are two things I would like to point out. The second quarter was the first in a while in which the quarter end loan balances exceeded the prior quarter. Loan growth was strong, as Jose pointed out, and outflows were normal.

The second thing is that the [cost trajectories] constituted only 6 basis points of the NIM this quarter versus 12 in the first quarter, and as much as 21 basis points in the year-ago quarter. The NIM is close to our core NIM and we expect to continue so in the shorter run.

This slide, on slide 8, shows the continuing reduction of government-related exposure. Balances fell approximately 1% from the end of the first quarter, primarily due to the PREPA payments being applied towards the principal as the credit is still on nonaccrual status. Combined with the specific reserve, PREPA is at 65% of its face value.

Please turn to slide 9. As you can see from our metrics, credit equality continued to improve over the last five quarters. We are particularly pleased to see net charge-off rates continue to decline. At 1.21%, it is 9 basis points down from the first quarter. This was due to declines in auto, commercial, mortgage lending categories, partially offset by increase from consumer lending.

The nonperforming loan rate is also down, both with and without PREPA, and both the early and total bankruptcy rates are down. This is the result of our prudent lending standards combined with proactive servicing programs we have put in place, consistent with the realities of the economic environment.

Starting in first-quarter, we adopted a different methodology to report the early delinquency for auto and consumer to be in line with rest of the retail categories and with the industry practice to facilitate comparisons. Without this adjustment, early delinquency for auto was down $1.3 million and consumer down by $600,000 as well.

On slide 10, this is an update of our credit exposure 90 days or more delinquent. Note that these are ledger balances, and as such, they exclude all allowances, purchase accounting and FDIC lost share amounts.

There are three key points -- one, our overall outflows have continued to exceed inflows while we have kept the charge-off levels under control. Two, we have actively reduced the delinquent loan inflows; and three, we have acted specifically to reduce the OREO repo balances in the last two quarters. From our balance sheet, you can see this was at $55 million compared to $61.1 million last quarter and $134.4 million last year.

Moving on to slide 11, you can see our capital ratios continue to exceed the requirements for a well-capitalized institution. In addition, compared to 2012-end after our BBVA acquisition, leverage ratio, TC-ETA, and our capital ratio are all significantly up. Why? We have derisked the balance sheet to the extent possible.

On slide 12, we ended the quarter with tangible book value of 14.96 per quarter per-share, up from last quarter. These metrics are up from the preceding quarters as well. We expect further steady growth of capital levels in the coming quarters.

Please turn to slide 13. To conclude my part of the presentation, the table on the slide shows some quantitative trends over the last five quarters. The main points here is that even that in our core earnings capability, in 2015, there were some nonrecurring steps to -- we had taken to derisk our credit exposure.

Now I would like to turn the call back to Jose.

Thank you, Ganesh. Please turn to slide 14. We believe our first and second quarters this year demonstrate our plan is working, producing the expected results. To be clear, the operating environment is still challenging, but we continue to successfully adapt to it.

Conditions are not favorable to aggressively build the balance sheet, but our retail marketing and our technology initiatives are enabling us to expand our customer base, increase deposits, and maintain loan production levels. As we mentioned in our news release today, in the second quarter of 2016, we introduced the Oriental Biz mobile app, adding mobile check capture for small business customers.

We were the first to introduce this feature for retail customers in Puerto Rico in 2013. Now, we're the first to introduce this feature to small commercial clients.

During the second quarter of 2016, we also introduced Cardless Cash, another first for Puerto Rico, for making ATM withdrawals quickly without using an ATM debit card. In addition, cost control efforts focused on interest, noninterest, and credit costs, are enabling us to maintain good profitability levels and build capital.

With regards to the macro situation in Puerto Rico, our priority is to continue to closely monitor developments regarding PREPA. As I mentioned earlier, we are encouraged by the additional progress we made, and look forward to executing on the new jointly-approved timetable.

While still very early, the business community is also encouraged PROMESA will create some certainty, lead to a government fiscal solution, and create a path toward economic growth -- something we'd all like to see.

So, please, with this, I end my formal presentation. Operator, please open the call for questions.

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

So what's interesting with all the headline risk, and everything you hear and read in the news, that's a good job working through a pretty tough environment and the results you guys have put up so far this year. And you've also put out some pretty innovative products to your customers and kept running the business. So, congratulations on that.

With -- I guess with maybe the positives we've finally got in the last couple of weeks is we finally got some pretty important things done from the fiscal situation with PERMESA, as you've talked about. So obviously. maybe you can say, well, is there anything that -- you guys put up the organic growth that was pretty solid in the quarter -- so is there anything that you are starting to see, maybe from the retail side or even commercial side, that the businesses and consumers are starting to feel better about what's going on, now that there's some progress towards some ultimate fiscal resolutions that may be translating into that good loan growth?

So Brian, let me kind of repeat a little bit of what I've said in the last several calls. The problem in Puerto Rico is not really the economy; it's the government. It's the fiscal situation.

So, what's happened in the last several weeks is encouraging because it's -- for the first time in several years, there is at least a mechanism to address the fiscal situation in Puerto Rico, which is mostly the fiscal imbalances that we have. So, I think it's too early to tell, but certainly the PROMESA law prevented -- first and foremost, prevented a government shutdown, because it allowed for a stay on lawsuits and it allowed also for Puerto Rico's government to put a moratorium, basically, on its debt.

So, from that perspective, kind of the government lives to another day. From a business perspective, though, I think the business sector looks at PROMESA as a way to first bring stability. It kind of has the -- we understand what the rules of the game will be, but there's still some paths that we need to follow, which are going to be executed within the next several months, which is naming the Board and stuff like that.

So, from a business perspective, I think it's too early to tell that the business sector is gung ho with everything that is going on, although they recognize that it's positive. And it's certainly constructive for a solution on the fiscal side.

Also, Brian, we cannot definitely ignore the fact that over the last year and a half or so, the market has come down. So, if you look at the loan generation for activity for all the banks over here in several retail sectors, it's down. But we have, so far, sort of rallied the troops and responded to increase our market share. And therefore, you see at least even performance levels, which would indicate a little bit of a market share growth on our part.

That's great. Thank you. Thank you for that color. That's very helpful. And I guess just one follow-up. So, Jose Rafael, there's been a lot of progress made on PREPA, and I think as we are getting closer to getting the ball over the goal line, I think you referred to the most recently generally-approved timetable.

So, I think we're -- the only thing we're waiting right now on is the investment-grade rating from the ratings agencies, right? And I guess maybe you can just tell us what you think? You know, the timetable is going forward since getting that last piece of the puzzle.

Yes. That's part of -- one of the kind of toll gates that we need to go through -- getting an investment-grade rating for the restructure bonds. And that is something that should happen in the next several months, or at least be submitted to consideration by the credit agencies.

Also we are waiting for the Energy Commission to conclude on the permanent rate increase. We -- they have approved two rate increases. One is temporary. And now they are in the analysis stage on the permanent rate increase for PREPA, which will come later. It will come in the first quarter of 2017.

So those things -- the last part I mentioned, the rate approval is not going to impede the closing of the transaction by the end of this year. We feel comfortable that, with PROMESA being enacted, all the players -- creditors, PREPA, and government alike -- have -- the incentives are being put in place for getting this thing done. And I think the investment-grade rating objective is something that needs to be pursued, but it's -- I don't think, at this point in time, it's going to derail the conclusion of these almost three-year restructure process that we have constructively worked on.

Okay. Okay, that's helpful. So I mean it's still -- those are the two last -- like you said, milestones that have to be done here. And so there's still time for that to happen before anything. There's no expiration to the RSA -- it's been extended to the end of the year, is that right?

Correct. Correct. December of 2016. And again, we feel -- on our position with PREPA, we feel that not only have we taken the appropriate allowance, if you look at what happened with the PREPA bonds -- which is, let's say, a proxy to our loan -- that bond is trading around $0.66, $0.67 on the dollar.

We have it on the books -- the loan, which is going to amortize in less than six years and it won't have a haircut -- we have it on the books at around $0.65 on the dollar. So, we feel very comfortable with the level of provisioning that we've taken and how we continue to reduce the exposure on PREPA. And I -- if you look at it right now from a government credit perspective, probably PREPA is the best credit the government of Puerto Rico has today.

Yes. I would agree with that. And it would seem that I'm sure, with the cash flows you've got in your PREPA line versus the bond, that you guys should have a valuation above what the bonds are trading at, right? So -- and I only wanted to ask one follow-up and I'll throw this in and get back into queue.

So, how soon could you then think about the reserve you have? It has to be a final PREPA agreement, that all RSA and getting the investment-grade and the final, before you'd say, well, let's reevaluate this reserves again?

I'll let Ganesh go to that one.

Well, we do have (technical difficulty) technically speaking every quarter. I think we have our assumptions in our model in terms of document default and probabilities. I think we will continue valuating. But conceptually speaking, I think one would at least assume that if things don't deteriorate -- or even improve -- the reserve could be released potentially with the principal payments that's coming in. Because this loan, unlike the other bond, which has got the principal's holiday, it has a built-in amortization schedule for the principal.

Got it. That's very helpful. Thanks for your time, guys.

Yes, you're welcome.

Brett Rabatin, Piper Jaffray.

I wanted to, I guess, first, just talk about the funding mix and the changes in the deposits linked quarter. Can you guys maybe talk a little bit more about the averages versus in the period? And just kind of -- you are obviously trying to grow the core deposits, but there was a linked quarter increase in the now cost. Can you maybe just walk through that and kind of what your expectations might be for your --?

Yes. I have to tell you the averages are not very far away from the quarter-end balance -- the stock balances. The increase in the NOW accounts are primarily because of one account that we had opened towards the end of the first quarter, and we had to adjust the interest payment schedule during the quarter.

So, most of the increase could be explained, although I think it will be a little bit higher but not as high as it indicates in our cost to fund a Board and table. So I think the two things over there -- what I'm saying is the averages are very close to the balances that we do, and increases primarily because of a nonrecurring item that's there.

Okay. And then just with what's going on in Puerto Rico, and thinking about your loan generation, which is a little bit better linked quarter, and you saw some C&I growth -- although the originations were a little lower in that category -- are you any more optimistic on maybe net loan growth? Going forward, obviously, the runoff of acquired loans is a headwind, but any thoughts on your optimism level on the organic portfolio growth?

Ganesh mentioned earlier a retail, and we certainly are encouraged with the momentum we are having with retail on the retail lending side. And that is something that we continue to focus on.

On the commercial side is -- I see it more steady. It's more larger-ticket items. And we -- from our perspective, we feel we need to see a little bit more clarity in terms of the economy going forward, to kind of be more aggressive. But we're very encouraged with the retail performance and how we're generating good yields there too.

As you noticed on our numbers, our yields are up 9 basis points on the loan side. And it's primarily because of the retail originations.

Okay. And then just lastly, this is the first quarter I think you guys got the reserve actually lower on a dollar basis linked quarter. Can you talk about reserve levels going forward? And should we be hoping for provisioning to decline on the originated portfolio?

Well, the dollar basis is down because the portfolio is down a little bit in terms of the asset quality I'm talking about. So, the reserve levels that you see is what we are planning to maintain in the short and for the next two, three quarters. And I don't see any change in the general reserve levels.

Okay. Great. Nice results. Thanks, guys.

From a coverage ratio perspective, it's -- you can see that on the table we reported. And the dollar amounts -- obviously, as the new book goes up, it will grow as well.

Alex Twerdahl, Sandler O'Neill.

A couple of questions for me. First off, you changed the strategy last year, I believe, a little bit to instead of selling mortgage production to turn them into the mortgage-backed securities and keep them on the balance sheet. And then it looks like this quarter, you did actually wind up selling some. So, has the strategy shifted back towards doing mortgage banking and selling them to a secondary market or --?

No, Alex, it's just a -- we did not entirely ship what we had in the previous quarters, or we are retaining the Ginnie securitizations -- Ginnie Mae securitizations and creating the Fannie Mae. And as the volumes go up, the activity goes up as well. And that's what you see in this quarter.

Okay. So you retain the Ginnie's, you sell the Fannie's --?

Exactly.

Yes.

You have some of each -- okay. And then, Ganesh, in the past, you've given sort of a range and expectations for the margin going forward. And I know that you are getting closer to a core margin. Those are all the moving parts that happen intra-quarter. Can you just maybe update that guidance? I think in the past, you said it's between sort of 4.4% and 4.6% was sort of an expected range. Is there any update to that?

So, if you want an average between the 4.4% and 4.6%, I would say 4.5% right now. (laughter) But we hope to beat that thing. And I'm not being fictitious over here about the margin, but I think it depends on the loan mix that we generate. So, that's -- basically I would say it's a range between 4.5% to 4.6% is what you would see.

Okay. And then you talk a little in your prepared remarks and in an answer to a previous question, you are saying business -- the business sector is optimistic following PROMESA, but not yet gung ho. I mean, as you look out at sort of the things that have to happen, creating a control Board, actually resolving some debt, et cetera, like what's the headline, in your opinion, that we see come across, or all of a sudden business leaders go from taking this capital that's on the sideline, optimistic, to actually making investments in the Island?

I think it will take -- first and foremost, you need to restructure the debt. And that's going to take a while. And first, you need to get the Board, then you get to get the team that reports to that Board, and then you've got to work on restructuring the debts.

And once that gets done, and once there is clarity there, then I think the business sector will feel more comfortable. Because then the equilibrium is achieved between expenses and income, hopefully. And then -- and certainly too -- as I said on the call earlier, it's about economic development. It's about economic growth.

And if the Fiscal Board comes here just to reach a fiscal equilibrium without a focus on economic development, I don't think they are working for the long-term. So, I'm encouraged to see that there's a Congressional Committee that has been appointed already, that has a deadline by December of this year to provide recommendations.

I hope that they take this very seriously. Because for the long-term sustainability of the economy of Puerto Rico, and having a stable growth rate -- economic growth rate, we need to make sure that there is an economic development plan, at the same time that the fiscal situation gets resolved.

So, from my perspective, I think it's going to be sometime next year that the restructure will hopefully get significantly done. I'm very encouraged to see that PREPA will get done before the end of this year and we can move forward. And that's one of the largest, if not the largest, credits in the government operating right now. It's ex-GO's and Gofina.

So, from what we are seeing -- all the trends and what we're seeing on all the momentum that has been built, I think I'm encouraged to see that we're moving in the right direction. But again, as you guys do to us, a result is what matters. And so we'll be very, very focused on how things turn out with the Fiscal Board.

Okay. And do you think the same sort of commentary on -- as you look out at your capital position, and you've got the dividend but just in terms of other capital return, perhaps being able to buy back shares at some point in time, is that pretty much also dependent on the sort of the same time-frame that you just laid out for increased optimism on the Island?

So, from our perspective, capital is king, and -- because of what as I said in the past. It's important for us to build our capital levels, continue to build them, because of the uncertainties that still remain. But as the uncertainties start to recede, we will feel more comfortable and we will feel more confident. And we will evaluate at that point in time.

But we can't predict the future at this time in terms of how everything is going to play out here in Puerto Rico. There is still a few innings to go in terms of getting the fiscal house in order.

Okay. And then just final question for me. In the past, you said that derisking activity was pretty much done at this point. Has anything changed in your outlook that would change whether or not there's any further derisking as 2016 progresses?

No, the only derisking remaining is PREPA, if you ask me. The rest is just blocking and tackling. We have done a very good job, as Ganesh mentioned, on reducing our repo lot on autos. We've done a good job at reducing our OREOs. And we've done a great job on reducing our nonperforming loans.

I mean, the charts are all moving in the right direction at the right speed. So it's about blocking and tackling on that end. And we need to deal with the remaining six months on how to finalize the PREPA deal. So that's kind of our game plan while we watch the fiscal situation in Puerto Rico, and hopefully, the beginning of a discussion on economic development for the Island.

Great. Thank you for taking my questions.

Yes. You're welcome. Thank you.

(Operator Instructions) Joe Gladue, Merion Capital Group.

I think I've hit most of the points I was going to ask, but would like a little -- dive a little deeper into the loan yields and what's driving the increase in the originated loan yields. Is that just loan mix? Or are you finding a better competitive environment? Or what?

It's primary loan mix, Joe.

Yes.

Retail loan mix yields?

As the retail and auto loans are higher in proportion than the commercial loan yields, the yields will go up -- [the commercial yield].

Okay. I guess that was the last one I had left. Thanks.

Thank you, Joe.

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

Thank you, operator. Thank you also to all our stakeholders who have listened in today. Looking ahead, we will be at the KBW Community Bank Conference on August 2nd in New York City. In September, we plan to host Piper Jaffray as part of their investor visit to Puerto Rico. And we preliminarily schedule our third-quarter conference call for October 21st.

Until then, thank you all. And have a great day and a great weekend.

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