OFG Bancorp (OFG) 2016 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 homepage in the what's new box or on the webcast, presentations, and other files page.

Please note this call made 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 conference call over to Mr. Fernandez.

Thank you for joining us this morning and please turn to slide 3. We had another quarter of strong steady performance. Earnings per share of $0.26 was slightly better than the prior two quarters.

Our Oriental franchise continue to do well. New loan origination totaled $227 million in the third quarter, in line with our target of about $1 billion a year. We saw a nice expansion of net interest margin, excluding recoveries. And retail and commercial deposits grew more than 2% due in part to continued growth of net new customer accounts at an annualized rate of 4%.

Most credit quality metrics remain stable, but there was a major decline in net charges, excluding PREPA. There was also a substantial drop in OREO and repo balances. This reflects our effective servicing and workout efforts.

As a result, return on average assets and return on average tangible common equity hit the highest levels they have been in the last five quarters. As a further consequence, capital continued to build, with tangible book value per share now at $15.18 and TCE ratio at 10.25%.

Please turn to slide 4. Oriental is now a proven innovator and challenger brand in Puerto Rico. Our goal is to be consistently the best-performing bank on the island. To date, we have been very successful differentiating our brand in a commoditized market, focusing on customer service, targeted marketing, and innovative retail and commercial mobile banking technology. This has been the real force behind our ability to grow our customer base, expand deposits, and generate steady loan volume as always with prudent credit underwriting and pricing discipline.

At the same time, we have proactively managed credit quality and balance sheet risks. As you will see later in the presentation, we now have less than one-fourth of the Puerto Rico government-related exposure we had three years ago when we acquired the operations of BBVA in Puerto Rico.

We have also been optimizing operating efficiencies while continuing to invest in the retail channel and customer-facing technology. As a result, our game plan going forward is to keep the strategic momentum going. We will continue to grow our originated loan portfolios and enhance operating efficiencies when strategically advantageous. Assuming the economy continues to move along at its present pace, we anticipate similar results for OFG for the next few quarters.

Please turn to slide 5. This is our dashboard of key business trends. I have already mentioned a number of them, but let me point out a few others. Originated loan balances showed a slight sequential dip due to the PREPA transaction. Otherwise, they would have been level. Originated loan yields are all primarily due to continued growth in higher-yielding retail categories. We grew retail and commercial deposits while holding costs steady at 53 basis points.

As a result of our strong liquidity, we were able to pay down a significant amount of borrowings contributing to net interest margin expansion. Fee revenues remain level, and the operating efficiency ratio continued to improve for the fifth consecutive quarter.

Before handing over the call to Ganesh, I would like to take this opportunity to discuss the sale of our participation in the PREPA loan. As you know, we acquired it in our purchase of BBVA Puerto Rico operations in December of 2012.

While we were hopeful PREPA's agreement with creditors would restructure the credit into a viable and profitable term loan, our thinking evolved over time. Continued uncertainties regarding the economy of Puerto Rico forced us to take a fork closer look into execution risks as well as how the credit will fare over the next six years.

Ultimately, we decided the better option was to take advantage of an opportunity to exit the position, eliminate the distraction, and immediately improve our overall credit quality and capital positions. In the final analysis, we are pleased with the decision, as clearly reflected in the improved statistics in today's presentation. With PREPA behind us, we look forward to continuing to pursue our strategic goal of becoming the best bank in Puerto Rico with no additional distractions.

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

Thank you, Jose. I will start from slide 6, covering the loan generation volumes for the quarter. We closed $227 million in new loans in addition to renewals. While lower than the last quarter, it is within the range we have seen over the past few periods.

Mortgage production was lower. The overall market is down 18% year to date and our loan originations are in line with this trend as well. Commercial originations were within the range. Nothing unusual to mention here.

Consumer lending was robust. We continue to refine our direct marketing techniques and the origination to disbursement processes. Auto lending was a little off. Considering car buying activity is highly sensitive to events like the September blackout, it did not have a meaningful impact.

Moving on to noninterest revenues, banking fees were up a little caused by usual fluctuations in the transactional volumes. Wealth management fees were down. In second quarter, we recognized certain annual broker-dealer and insurance fees. Excluding this, third-quarter results were similar.

Mortgage banking revenues were up strongly, reflecting better margins on secondary market sales and from higher MSR valuations. We continue to be an originate-to-sell operation, focusing on high-cycle conforming loans. This quarter, we successfully completed our efforts to bring mortgage servicing in-house. Previously, we had used another bank locally to service these loans.

Please turn to slide 7. Trends in this quarter's income statement are somewhat similar to last quarter's. Interest income from loans increased approximately $3 million. It included a $2.2 million cost recovery on an acquired former Eurobank loan. Originated loan balances and yields grew, and the acquired portfolio run offs were as expected.

Excluding the cost recovery, loan income increased slightly over the prior period. Securities income fell slightly due to variations in premium amortization in our MBS portfolio. Interest expense fell close to $1 million. This reflected paydowns and maturity of borrowings, such as Federal Home Loan Bank advances and the subordinated capital notes.

Total provision for loan losses was up $9 million. Increase in provisions for nonacquired loans due to $2.9 million towards the sale of PREPA loan and another $2.9 million on a commercial loan. In the acquired loan category, we added $4.4 million for the Puerto Rico Housing Finance Authority loan. This loan under purchase accounting has now a carrying amount of $3.5 million or 31% of its ledger balance. These increases were partially offset by lower provisions on all other loans as net charge-offs for the quarter reduced overall.

Total noninterest expenses increased approximately $1 million due to a mix of items. G&A alone included $900,000 in expenses associated with the efforts to bring mortgage servicing in-house. On the plus side, we received an unexpected $5 million recovery from a claim against Bear Stearns. This was related to write-offs on a private label CMO we took back in 2009. In addition, taxes benefited from a $300,000 reversal of a contingent tax position. Also, our effective income tax rate reduced to 26%.

Please turn to slide 8. As I just explained, we had a few quarter-specific items both positive and negative. The net effect is not significant, clearly demonstrating that our core performance is in line with the prior-period Result. Rather than go through it by line by line, I will be happy to answer any questions during the Q&A.

Please turn to slide 9. There are two things that I would like to point out. As a clarification here, we show loan balances held for investment and net of allowances. Therefore, the second-quarter balances include PREPA, while the current quarter does not. If you adjust for this, originated loan balances have increased.

The other point is that our core NIM at 4.70% expanded slightly by 6 basis points. While the loan yields without recoveries is similar to the prior quarters, the improvement primarily comes from the lower interest expenses.

Please turn to slide 10. Here we show the [deficit] steps we have taken to reduce our direct exposure to Puerto Rico government credits over the last few quarters. From the prior quarter, balances fell 50% to $206 million as a result of the PREPA sale.

Moving on to slide 11, you can see our credit quality remains stable. If you exclude PREPA, we see a gain in meaningful reduction in net charge-offs in sequential quarters. At 1.15% in the third quarter, it is down 6 basis points due to declines in auto and commercial loan charge-offs.

Nonperforming loan rate is also down, declining 541 basis points, reflecting the PREPA sale. Excluding PREPA, it remained level versus the last quarter. Both the early and total delinquency rates are below year-ago levels. This is a result of our proactive loan servicing capabilities we have developed that commensurate with the realities of our operating [end run].

Please turn to slide 12 to see an update on the loan delinquencies that are due 90 days or more. Please note that these are ledger balances, excluding allowances, purchase accounting discounts, and any FDIC loss share obligations. At $276 million, exiting PREPA enabled us to reduce such delinquencies by 40% from the prior quarter.

I want to highlight that $156 million or 57% of these loans are in our acquired book with purchase accounting discounts and some FDIC loss share obligations. The other $120 million dollars is in our originated loan portfolio. To add further color to this, we have a [recent] coverage ratio of 11.5% for these loans.

By shortening asset disposal time frames, we have reused OREO repo balances significantly from last year, along with the associated losses. Putting it all together, you can see that we are in vastly improved position in terms of our asset quality.

Please turn to slide 13. Our capital ratios continue to substantially exceed the requirements of a well-capitalized institution. From these ratios, you can see our capital position has increased dramatically since the end of 2012. I would ask you to consider this in the context of negative economic trends in the same period.

Please turn to slide 14. We have ended the quarter with a TCE of $666 million or $15.18 per share and a TCE ratio of 10.25%. All the three metrics are up from the preceding quarter. This positive trend should continue as we show continuous quarterly results.

On slide 15, we show some quantitative trends over the last five quarters. The main point here is the stability in our core earnings, which we stated as our main goal as the beginning of the year.

With these remarks, I conclude my portion and turn the call back to Jose.

Thank you, Ganesh. Please turn to slide 16. With regards to the macro situation in Puerto Rico, we are pleased to see that the PROMESA board has started its activities. We look forward to seeing them gaining more momentum in exercising their legal mandate, of instilling fiscal discipline while providing a path towards a consensual resolution among all stakeholders.

As to the state of Puerto Rico's economy, it remains under pressure because of significant levels of political and fiscal uncertainty. The reality is that a clear path toward sustainable economic growth is imperative and cannot be further delayed. For that to occur, we need strong leadership and we are confident that the fiscal board will provide it.

Having said that, we are convinced that OFG will continue to demonstrate solid and consistent financial results based on our experienced and proven management team, strong capital position, and an accelerated momentum in building a differentiated banking franchise.

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

(Operator Instructions) Brian Klock, KBW.

It is interesting, Jose Rafael, when you say -- again, we read the headlines and all the negative things going on, but there has obviously been a lot of positive things in the past quarter that you highlighted.

When I think about your capital ratios, you did derisk the balance sheet this quarter. You have got a nice 13%-plus CET 1 ratio and you are above 10 in the TCE ratio. So maybe talk about what you think about a buyback and what would get you more comfortable about thinking about buying back your stock with it below tangible book?

Yes. You know, Brian, we don't fail to recognize the environment we operate in. And that is something that we are very cognizant of. We have been living in it and operating in it for the last 10 or 11 years.

So when you look at us from a management perspective, we have consistently and prudently deployed capital, either for acquisitions, strategic moves, like we have done. And we have also return capital to shareholders when we feel that the level of capital that we have and the environment we operate in is one where it allows us to return that capital to shareholders. And that is kind of the way we have operated in for the last 12 years that I have been CEO, and we have [run the bank and H&I] here in Puerto Rico.

That has not changed. We still see some uncertainties in Puerto Rico's economy. We also are a regulated institution, like any other bank in the United States. And we continue to have a very fluid dialogue with our shareholders, with our Board, with our regulators. And when we all feel that this is the right moment to do some capital deployment, we will certainly execute on it. But at this point, we have not reached that point.

Okay. And just a quick follow-up on the capital deployment side. I know you talked about some of the origination data and trends that you have seen.

With everything kind of, like I said, with PROMESA in place and maybe there is some -- maybe you can talk about what you are seeing down on the ground with the commercial customer. You did see some good consumer growth. So maybe just talk about what you are seeing now in real time down on the ground.

What we are seeing on the commercial side, Brian, is a business community that is hoping for some stability and some level of certainty in terms of the prospects -- the economic prospects. I think that they are encouraged, as I am and we are, with the recent enactment of PROMESA and the board being put in place and all that stuff.

But the business community also recognizes that there are a few more innings to go. And those innings are going to be challenging. It is going to take quite a bit of effort to make sure that Puerto Rico gets back on track from a fiscal perspective and from a budget -- a balanced budget perspective. So I think everyone here in Puerto Rico that runs a business is tiptoeing into slightly more optimistic, a little bit more certainty, but not necessarily a completely liberated in terms of what the prospects are.

Then we also add that we are in the middle of an election here in Puerto Rico. And gubernatorial, legislative, and municipal elections. It should take place in three weeks or so, like the one in the States for president. And that adds another level of uncertainty, Brian. It really does. You have politicians in Puerto Rico still going out and being a populist and making promises that are clearly unattainable.

So that also for prudent business managers creates another layer of uncertainty. We are hopeful that once the elections are over and once the board gets more traction on the issues at hand in Puerto Rico, that we will have more clarity. And we are hopeful that next year we will see a clear path towards economic growth.

I appreciate that. And so it just sounds like we have got some uncertainties and maybe there are some positives here to get past the election and get the fiscal situation down further down the road. Just there is some uncertainties right now, but maybe that could just be pent-up demand and we will see how that shakes out.

Yes. I think that is accurate.

All right. Thanks for your time, guys.

Brett Rabatin, Piper Jaffray.

Wanted to first to say congrats on getting the PREPA situation taken care of. I was curious on a little bit of slippage, maybe, in the early-stage delinquencies. Is there anything to read into that or can you give us any color on? I know it is tough when you have one-off items happen. But is there any hope for charge-offs maybe continuing to abate over the next few quarters, despite the environment?

Well, Brett, early-stage delinquencies, as you see, yes, it is up little bit this quarter, but one quarter does not make a trend. So we don't see anything concerning at this point in time. Obviously, we do have data and like what we have shown for what has happened in that particular quarter. So we don't see any foreseeable trend over here yet.

And keep in mind, we also had a September blackout. And even though it was only for couple of days for us, personally, over here, the whole island sort of suffered through that for around week. And there was some disruptions in our business activities concerning collections and other such activities. So let's watch and see next quarter, and hopefully we will be able to give you a better color on that one.

Also, Brett, as Ganesh mentioned in his remarks, we had a mortgage servicing conversion during the quarter. And as you can imagine, it always has a little bit of a disruption in terms of the conversion. It was seamless. It was a great job that our team data, and we are pretty -- very happy and proud of what we accomplished, but still it had a little bit of a noise. We are seeing already into the fourth quarter and we are confident that this is not a trend. It is just a (multiple speakers).

Something that we can catch up.

Yes.

Okay. And then can you remind us on FHLB and other borrowings what you might be able to have roll off here in the next few quarters if your deposit trends continue to be favorable. And does the margin outlook look a little better net net with the deposit flows you are having?

We continue to be opportunistic, Brian, as the maturities come and we assess the liquidity position. And remember: we don't do FHLB primarily for funding purposes. It is purely for asset liability management purposes. So at this point in time, we need to kind of look into the cash position and all those kind of things.

But to give you an idea of what comes tangibly for -- it gives us an opportunity for reducing the interest expenses. We do have a repo borrowing that is maturing in March and I think that is a significant item at this point in time because it does carry 4.2% cost. And we don't plan to look at it from that time perspective. We might get shorter-term funding, which will be much cheaper than that.

Okay. And then just last question. And sort of [brought it] back on the capital levels. Is a roundabout way of deploying capital perhaps using liquidity to increase the size of the balance sheet and maybe buy more securities? Or are there other ways that you might think about using some of this capital besides strictly buying back stock?

Brett, we are looking at everything from an organic perspective. We are looking at different opportunities. From an investment portfolio, we are not keen on that. We feel that it adds too much duration risk and not -- really not much of a spread there for the risk that we are taking.

So we are looking organically how we can deploy some of the capital that we have in high ROA type of activities. And we are in the ending part of our planning for 2017, so more to come when we speak next time in 2017.

Okay. Fair enough. Thanks for all the color.

(Operator Instructions) Joe Gladue, Merion Capital Group.

Congratulations on a good quarter. My question was regards to the average loan yield. They have been rising in recent quarters. Just [was it due] to mix or what is driving that and can we expect any of that to continue going?

So from a loan kind of distribution, we are having good success on our consumer lending part and lending business on the auto side as well as on the installment loan side, which has higher yields. So there is a little bit of a shift there in terms of how the production is coming in. So that is one.

And I think that is something that you should see into the future where we are trying to cater to the retail market in Puerto Rico at the right price for the risk that we are taking. And that is what you are seeing this year so far.

I don't know if you want to add anything additional, Ganesh, regarding the loan mix?

No. You covered it, I think. Jose is right in saying if you look at the originated book, he mentioned that we are focusing and we are being successful on the retail side. And the commercial side has been a little difficult because of the environment and the uncertainties still.

So at this point in time, the mix is favorably shifting towards a higher-yielding retail portfolio and because, quite frankly, there is no opportunities to originate commercial loans at a right pricing that we expect. And credit quality we expect. So that is why you are seeing yield higher than normal at this point in time. I cannot say it will continue, but right now that is what we are looking into for next two quarters.

And just to expand on that a little bit, just in terms of the competitive environment and the consumer side, is anybody backing out of that market a little bit? Or just as competitive as always?

No, on the contrary. I think after I said that this is higher-yielding and this is where we are making money, I'm sure everybody wants to get into that. But it is the reality of the market, that I think primarily Puerto Rico, what it offers is a retail market. And the commercial businesses are -- as Jose Rafael said, the market, we hope it will come back once the cloud lifts over the Puerto Rico economic uncertainties that we have.

All right. Thank you.

(Operator Instructions) Alex Twerdahl, Sandler O'Neill.

Couple questions. First off, Ganesh, why did the tax rate decline in the third quarter? Or the effective tax rate.

We had a higher proportion of the nonexempt income, Alex, and that is quite simply that. So keep in mind, the tax rates are an estimate for the whole year. So every quarter, we take a look at the [component] of our income -- taxable income versus the tax exempt income and we tweak it. And that is what we are expecting at this point in time to close. So it will be closer to this, if not exactly this.

So we had a higher exempt.

Tax exempt income.

Okay. So 26% is what we should be modeling for 2017?

Thereabouts. This quarter it is 26%. And next quarter, probably would be close to that. Depends on what happens next quarter.

Okay. Good. And then the $900 million of G&A expenses related to the mortgage servicing, that is an ongoing G&A expense, correct? That wasn't a one-time thing?

Correct.

Okay. And then did you say the sale of PREPA, that closed early in the fourth quarter. So even though it closed in the fourth quarter, all the capital numbers and everything tangible, book value, all those things, are reflective of PREPA because the provision, et cetera, was taken in the third quarter. So there was no -- other than that held for sale loan moving off balance sheet in the fourth quarter, there should be really no other impact. Is that right?

Correct.

Correct.

Okay. And then did you say the $124 million of cash that you are getting in exchange for the PREPA note, have you decided what the use of proceeds for that will be? Is it repaying borrowings or what?

We don't know. We will look at it from -- again, as I said, this is same answer as when I replied to Brett regarding the opportunity to reduce in borrowing. There is going to be an opportunity in a couple of quarters to shed some repos that are coming to maturity.

So we are -- as we said during the call, first announcement of the PREPA, at this point in time, the proceeds we are purely looking for optimizing are making the liability side of the balance sheet better than anything else.

Okay. And then could you just clarify when you said, I think on page 4, the anticipated results similar to 2015's quarterly performances, what that means? I mean, are we looking to extrapolate forward the third-quarter results? And if so, are you excluding the additional provision from PREPA and the $5 million Bear Stearns claim and the tax rate? Or are you just saying $0.26 is the right number for the next couple quarters?

The latter. $0.26 is the right [thing]. Whatever happens between the line items, that is what we are saying that's [fund].

And that is roughly $0.26. And is that good for all of 2017 the way you are looking at it right now or is that just the next --

I would say the next quarter and the following quarter, and then probably we can add a little bit more color as we go.

Remember, Alex, that looking forward is hard to do, given the uncertainties in the economy. So we are really trying to help you guys look at our situation, but also from a perspective of a reality in Puerto Rico. So that is what we are doing.

I think to add a little bit more to Jose Rafael, we would feel a lot more comfortable if we know what the Puerto Rico budget is going to be and where the impact is going to be and those kind of things.

So at this point in time, we are operating -- don't take it that we just know what is going to happen in two quarters in front of us. We always look at six-quarter horizon, but the operating assumptions that we have for projecting for the next few quarters, we believe that is going to change.

And really what we are seeing on the ground here from our operations is that we are gaining market share. We are growing our client base and deposit flows are coming in nicely. So all of the operating levers are moving in the right direction for us. It is us, ourselves as managers, that are looking into the short-term future and there is too much uncertainty.

But we are very happy with the operating results. We are very happy with the trends that we have in terms of the businesses. And we are very happy on how strategically we have been able in the last three years after the acquisition with BBVA we have been able to position the Bank as a challenging -- challenger brand and a challenging bank with innovation and changes in how service is provided for bank clients.

So we have great momentum and we look forward to lead the Bank forward with additional transformation in that area. So I mean, we just wish that the economy would come to stronger footing and be able to add another level of speed to what we are doing.

Yes. I hear you on all that. Is there anything on the P&L going forward in the next couple quarters that we as analysts may not be fully thinking about? For example, the mortgage servicing thing that you moved on this quarter. I don't think it is something that -- I did certainly did not expect that or had it in my model. I don't know if anybody else did.

But is there anything else that could be like that? Anything that's strategic in that nature that would impact the P&L or the balance sheet in the next several quarters or through 2017?

No. We are basically blocking and tackling, as we have done this year. If you look at our performance for this year, Alex, it is pretty consistent and recurring. And that is what we expect to do in the next several quarters.

Great. Thank you for taking my questions.

Nick Adams, Wellington Management.

You have significantly derisked the balance sheet with the PREPA sale. Assets are shrinking here. And all your capital ratios are significantly higher than your peers. For what it is worth, it just seems like it is a shame not to be buying back stock here. Notwithstanding the uncertainties, if there were not uncertainties, then your stock wouldn't be at 65% of book value.

That's correct.

So you can't really have it both ways. You either have to believe that your balance sheet is far better than your peers, which by the numbers it is, that you've just created a significant amount of liquidity, that $120 million, that also had a nice yield attached to it. It just seems like it is a really opportunistic time now to take that excess liquidity and that excess capital and put it back into the shares of the stock here. Because again, you are not going to have this opportunity if Puerto Rico stabilizes.

And even if it doesn't, again, your capital ratios and your risk profile is so much lower than your peers that the buyback is just really, I think, screaming out for most shareholders. And the fact that you don't even have one in place and have that opportunity makes everybody scratching their heads and wonder, well, what is it that we are missing. There must be something horrific that the management sees that they are not telling us about because at the very least they did have that buyback as an alternative use of capital and liquidity.

Nick, we agree with you 100%. And that is how we view it, too. Unfortunately, we are in the island, as our peers are, too. Well above-capital levels; we have higher capital levels from historical perspective that have never been seen.

Having said that, too, we also have additional constituents, meaning the regulators. And we keep a dialogue with them, but their perspective is one of even more concern than ours. And we just want to make sure that that dialogue continues with them as well as it continues with you guys. And that we reach a moment where everybody feels comfortable that this is the right thing to do. But we hear you, we sympathize with you, and we just need to continue to move with how to achieve that optimal level of capital management.

Great. Understood. Thank you for the great job.

Brett Rabatin, Piper Jaffray.

Just a follow-up on thinking about the discount accretion going forward. Can you guys maybe give us any color on what you might expect the run rate to be at least in the fourth quarter on that? Obviously, given a little higher number in 3Q.

I think one of the -- I am assuming you are excluding the cost recoveries and looking at. We tried to call out the cost recoveries and there are major cost recoveries, but there are small loans. And this quarter, we did have a pickup in accretable earnings. And the rate at which the cash flows are accreting or we are receiving on the acquired loan, we think it is going to be at the same flat level for the next quarter. As (multiple speakers) at yield-level wise.

Okay. Yield-level wise. Okay. Thank you.

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

Thank you, operator. Thank you to all our stakeholders for listening in today. Looking ahead, we will be in -- November 7, the week of November 7, we will be visiting investors in Pennsylvania with Merion Capital. December 12, we will be hosting the annual KBW Puerto Rico bank tour in our corporate headquarters.

And we have preliminarily scheduled our fourth-quarter conference call for January 31. So until then, I wish you a great weekend and thank you again for listening to us today.

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