OFG Bancorp (OFG) 2022 Q1 法說會逐字稿

Good morning. Thank you for joining OFG Bancorp's conference call. My name is Gretchen. I will be your operator today. Our speakers are José Rafael Fernández, Chief Executive Officer and Vice Chair of the Board of Directors; and Maritza Arizmendi, Chief Financial Officer. A presentation accompanies today's remarks. It can be found on our Investor Relations website on the home page in the What's New box or on the Quarterly Results page.

This call may feature certain forward-looking statements about management's goals, plans and expectations. These statements are subject to risks and uncertainties outlined in the Risk Factors section of OFG's SEC 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 that occur afterwards. (Operator Instructions)

I would now like to turn the call over to Mr. Fernández.

Good morning, and thank you for joining us. We had a great start to 2022, and we are extremely proud of our achievements, particularly our continuous focus on helping our customers and the communities we serve. This is due, in no small part, thanks to our team members and their excellent work, commitment and dedication.

So let's turn to Page 3 of our conference call presentation. Fourth quarter EPS diluted was $0.76 compared to $0.66 in the preceding quarter and $0.56 in the year-ago period. Core revenues totaled $136 million. That's an increase of 7% year-over-year. Asset quality continued to improve, resulting in a net provision of $1.6 million. Noninterest expenses were in line at $81 million. Pre-provision net revenues totaled $56 million. That's 9% greater than last year.

Looking at the March 31 balance sheet, total assets grew 2.9% from the end of the fourth quarter to $10.2 billion. Customer deposits increased 4% to $9 billion. We saw continued loan growth quarter-over-quarter in all 3 of our priority areas: 5% in commercial loans, consumer loans grew 11%, and auto loans grew 2%. New loan origination was seasonally strong at $623 million.

We also successfully executed on all our capital strategies. We completed $33.5 million of our $100 million share buyback program. We early terminated all our outstanding subordinated capital notes totaling $36 million. We increased our regular quarterly cash dividend by 25% to $0.15 per common share, and we ended the quarter with continued strong levels of capital.

Our results continue to reflect the 3 main drivers of our business: consistently growing recurring net income, driven by loan growth; our larger scale and investment on our people; and our focus on increasing digital utilization and customer service differentiation. As a result, we had a strong quarter on all fronts. We grew loans at a stronger pace than we anticipated. While this is likely to moderate in the second quarter, we continue to expect single-digit loan growth for the rest of the year.

Deposits increased from both our retail and commercial customers. As a result, our balance sheet now is over $10 billion. Our strong, highly liquid balance sheet enable us to deploy more cash into higher-yielding loans and investment securities, improving our asset mix. We also paid down higher cost borrowings. All of this helped to expand net interest margin. In addition, we performed well from an operating perspective, giving us good momentum going forward.

We continue to introduce new digital solutions. This quarter, we launched fully digital processes for personal loan originations and for opening and making contributions into our IRA fund. Liquidity and credit continue to show positive trends. This positions us well to benefit from the expected rate increases by the Fed.

Against this backdrop, the Puerto Rico economy continues to show strength. Recent figures show employment increased close to 5% last year. As of March, the number of people employed is the highest since 2014, and the unemployment rate has fallen to the lowest level in several decades. The manufacturing index is up year-over-year, above pre-pandemic levels. Residential home values continue to increase, and we're seeing incremental construction activity of single-family housing. Overall, many of our commercial clients are experiencing higher demand for their products and services. All this continues to validate our optimism regarding the future of Puerto Rico and OFG.

Now here's Maritza to go over the financials in more detail.

Thank you, José. Please turn to Page 4 to review our financial highlights. Total core revenues increased $8.7 million year-over-year and declined $4.5 million quarter-over-quarter. The sequential decline reflects the absence of annual insurance revenues that we received at the end of last year. Interest income totaled [$113] million. This was slightly higher than the fourth quarter. Interest income benefited from increased yields on higher balances of loans and investment securities. It also benefited from improved yields on cash. This was despite 2 fewer days in the first quarter. This day factor has the effect of reducing interest income by $1.7 million.

Interest expense totaled $7.8 million. This was $600,000 lower than the preceding quarter. Interest expense benefited from lower average balances and reduced cost of both deposits and borrowings. This was partially offset by $405,000 to write off unamortized issuance costs related to the early retirement of our subordinated notes. During the quarter, we paid down the $36 million balance of those notes. The notes carry a variable rate at a current cost of 3.23%. Banking and Wealth Management revenues were $31 million. On a year-over-year basis, revenues increased $1.7 million. This was due to higher revenues in all 3 lines of business: banking services, mortgage banking and Wealth Management.

Noninterest expenses totaled $81 million. That's $5.3 million lower than the fourth quarter. Most of that reduction is attributable to $2.4 million less in legal reserve provisions and a $2 million reduction from a combination of items, such as operational losses, technology-related expenses and training costs.

The efficiency ratio was 59.5%. That's an improvement from both the previous and year-ago quarters. As we mentioned in our prior call, we will continue investing in our people and technology to further deploy our strategies.

Return metrics also improved year-over-year and quarter-over-quarter. They also continue to be in our target range. Return on average assets was 1.48%.

Return on average tangible common equity was 15.88%. Tangible book value per share was $18.90. That is a decrease of $0.18 from the fourth quarter. This reflects the repurchase of 1.2 million shares of common stock and a reduction in other comprehensive income, partially offset by an increase in return earnings.

Please turn to Page 5 to review our operational highlights. Average loan balances totaled $5.52 billion (sic) [$6.52 billion]. That is an increase of $67 million from the fourth quarter. End-of-period loans held for investment increased $145.4 million. The increase reflects new Puerto Rico and U.S. commercial loans and auto and consumer loans, partially offset by a decline in mortgages and PPP loans. Loan yield was 6.69%, a 7-basis-point increase from the fourth quarter.

New loan originations were $623 million. This was mainly level with the fourth quarter. It was also $97 million higher year-over-year. We continue to see high levels of auto lending, commercial lending in Puerto Rico and U.S. and increased demand for consumer loans. Please keep in mind, year-ago production included $126 million in PPP loans.

During the quarter, as interest rates moved up, we opportunistically increased our investment securities portfolio. The average portfolio increased 6% from the fourth quarter. End-of-period balances increased $363 million. Average core deposits totaled $8.8 billion. That is a decline of $275 million from the fourth quarter. That primarily reflected withdrawals that occurred at the end of last year. As José mentioned, deposits rebound over the course of the quarter. End-of-period core deposits increased $375 million from the end of last year.

Core deposit cost continued to fall. They were 25 basis points in the first quarter. That is a reduction of 1 basis point from the fourth quarter. They have now fallen 44 basis points from the first quarter of 2020. End-of-period borrowings fell to $28 million from $65 million. The decline reflects the paydown of $36 million of subordinated notes. This followed the fourth quarter paydown of $33 million of 3% Federal Home Loan Bank advances.

Average cash balances totaled $2 billion. This is a decline of 19% or $481 million from the fourth quarter. End-of-period cash balances totaled $1.86 billion. That is a decline of 8% or $168 million. Most of the end-of-period decline reflects redeployment of cash into loans and securities and paydown of subordinated notes and paying for share repurchases.

Net interest margin expanded 29 basis points from last quarter to 4.47%. This was primarily due to improved asset mix where loans and investment volume make up a higher proportion of assets.

Please turn to Page 6 to review our credit quality and capital strength. Asset quality metrics continued to trend positively. First quarter net charge-offs totaled $577,000. The net charge-offs fell to 4 basis points. NCOs included a $2.8 million loan recovery from an acquired PCD commercial loan. They also included a $1 million recovery as part of the final settlement of the sale of nonperforming mortgage loans that we transferred to held for sale last quarter. This compares to fourth quarter net charge-off of $32 million at an NCO rate of 2%. Fourth quarter net charge-offs included $30 million related to past due loans transferred to held for sale during last quarter.

The early and total delinquency rates were 1.97% and 3.17%, respectively. Total NPL rate, including PCD, was 1.49%. All 3 of these metrics fell compared to the previous and year-ago quarters. As a result, provision for credit losses was $1.6 million compared to $7.2 million in the fourth quarter. The first quarter included $3.7 million related to growth of loan balances; $4.2 million increase for a commercial loan previously placed in nonaccrual; and a $5.7 million reduction in qualitative adjustment due to improved economic conditions. This reduction was mainly due to improved employment situation as José discussed. Our macroeconomic scenarios remain the same.

Our allowance coverage was 2.4% on a reported basis.

The CET1 ratio was 13.24%. The tangible common equity ratio was 9.54%, and stockholders' equity was $1 billion. All 3 metrics were lower than the previous and year-ago quarter. This reflected increases in assets -- in total assets, risk-weighted assets and the common stock buyback, partially offset by the increase in retained earnings.

Now here is José.

Thank you, Maritza. Please turn to Page 7 for our outlook. As I mentioned earlier, the Puerto Rico economy continues to show strength. Unemployment, employment participation, manufacturing, residential home values, they're all moving in the right direction. Our commercial clients are experiencing a higher demand for their products and services. Consumer demand also remains strong, and at long last, Puerto Rico has exited bankruptcy. But as the rest of the world is experiencing, we're also seeing higher prices due to supply chain disruptions and the effects of the war in Ukraine. Although it is too early to quantify their impact, for now, the high levels of reconstruction and stimulus funds are serving as a good cushion to dampen the negative effects. Puerto Rico's economy should continue to grow, and Puerto Rico and OFG should perform better on a relative basis than the states or mainland banks.

With this environment as a backdrop, we will continue to execute the strategies that have been working for us so well, namely taking advantage of the growing economy, growing loans, investing in people and technology, speeding our digital transformation and enhancing the customer experience. We, at OFG, are more than ready. Thanks to all our team members for their continued dedication and commitment.

With this, we end our formal presentation. Thank you all for listening. Operator, please start the Q&A.

(Operator Instructions) Our first question comes from Alex Twerdahl from Piper Sandler.

First off, I was hoping, José, maybe you could expand a little bit on what drove the commercial loan growth that we saw in the first quarter. And then you talked about maybe thinking that, that might moderate a little bit as the year goes on. What are you seeing out there in terms of the pipelines? And what makes you think that, that growth is going to slow against the backdrop of what you said about the economy being strong?

Yes. So let me start by repeating a little bit of what I said in the call earlier, and that is our first quarter was very strong. We had a great start for 2022. And really, it's the first quarter that we have in many years where we have such strong performance. Typically, the first quarter of the year is a slower quarter in terms of -- particularly commercial loan production. So we're really excited about our results and the loan generation and loan originations that we had, I think, throughout the quarter.

So I would give you some color in terms of how we are -- first of all, which industries we are seeing some opportunities, and then I'll give you a little color also on the outlook on how we see commercial going forward. Most of our commercial loan originations in the quarter and really in the last 3 or 4 quarters have been pretty much focused on hospitality, trade and services, some manufacturing, certainly construction services, now mostly on the infrastructure, but we're seeing also businesses building up, and we've been seeing that throughout the last several quarters, building up their capacity and coming to us for financing, and to some degree, health services, too.

So we're seeing that, and that is across the different buckets on the commercial market here. When I say the different buckets, I'm referring to small businesses and midsized companies. Those are the industries that we're kind of focused on, and we've been able to serve those customers.

So when we look at loan growth and what we saw this quarter, you know my formula, right? Our production was above our expectations.

We had very few paydowns, utilization of the lines of credit for working capital, et cetera. They're still running at a significantly lower level than normal, so there's still excess liquidity in the system. And our pipeline coming in into the fourth quarter, as I mentioned on the call a quarter ago, was pretty strong. So we delivered on the production. And now when you look at the next several quarters, we see paydowns staying relatively neutral. Maybe we have a couple but -- because, usually, there is a little bit of a movement there.

We expect line utilization to slightly start moving up and starting to increase, and our pipeline remains strong, so our commercial loan origination outlook continues to show strength. And we're confident that the rest of the year, we will be able to deliver.

So that's a little bit of how we see the commercial side of the business and really excited, really excited on how we have been able to be close to our customers and attract new customers, too.

Right. I mean, it seems like everything you just said was pretty optimistic about the pipeline and the state of the industries that you're serving. How come the guidance is only single digits, given that commentary?

Well, when I say -- when we say for the rest of the year single-digit loan growth, we have to take into consideration that we still have a residential mortgage book that we will have -- we expect to have lower originations there. And as you know, we originate and sell. So we have -- that book of business is going to show continued downturn.

We had a very strong consumer and auto, also, levels of loan originations in the quarter. It will be difficult to replicate that going forward. It doesn't mean that it's going to go back to levels that are significantly lower. But we have to think of where do we start kind of plateauing in terms of the levels of origination.

So that's kind of how we're seeing it, Alex. I hope we're wrong. I hope we can keep on growing at the same rate. But you guys know me, I'm trying to also be cautious on the outlook.

Got it. And does anything change with the mortgage model, just given the move-up in those rates? Did it become something that you would consider putting on balance sheet?

We have yet not to decide on that. We continuously look at it. Remember, with the acquisition of Scotiabank, we bought a very -- a pretty large servicing book, so we have a lot better critical mass on the business. So yes, it's something that is on the table for us to decide. Remember, we also -- the FHA loans that we originate, we securitize, and we book them on the investment portfolio with north of 3% yield.

So it's not like we sell everything and not keep anything on the balance sheet. We keep it on the investment portfolio and the FHA loans. So we still have the rest of the agency paper that we need to decide how we're going to manage it going forward. But as of now, we are continuing to originate and sell and generating the fees.

Okay. Great. And then just talking about the impact of these rate hikes that we're now seeing and expecting. It was at my notes that about 60% of commercial loans float with prime. Can you just confirm that number for me? And then just maybe give us some thoughts about rate sensitivity and how you plan to manage the balance sheet through these rate hikes?

Yes. So 60% of our commercial loan book is variable, not necessarily prime, but a mix of prime and LIBOR or / the alternative, which is -- but again, we're transitioning the LIBOR thing to mostly prime. So I just want to just comment on that a little bit, just to be precise. So 60% is relatively -- is variable rate, okay?

In terms of interest rate increases by the Fed, as everybody's talking about it, you saw our 10-K and our shocks and how we are well positioned to benefit from it. Certainly, we have $2 billion in cash, in addition to the 60% variable commercial book. So we'll definitely be benefiting from rate increases. And this quarter is really not showing any of that benefit yet, so we're really looking forward to how everything plays out. And our outlook is pretty optimistic in terms of the benefits of the rate hikes.

Yes. During the quarter, you guys purchased a pretty good slug of securities. Looks like it happened mostly towards the end of the quarter. Just given that the 10-year is now approaching 3%, can you talk about sort of the cash management strategy over the next couple of quarters, especially with the prospects of potentially some pretty strong commercial loan growth?

Yes. So we did get our feet wet a little bit deeper this quarter at the end, just benefiting from a significant repricing on the investment side of the equation. So we benefited from that at the end of the quarter. We will look at it on a monthly basis, and we are pretty much close to that dynamic. And we will make the appropriate decisions in terms of asset mix.

The reason why we are very optimistic is because we're seeing how our asset mix is transitioning very nicely towards a higher-yielding asset base. And the reason for that is you hit on the nail by it's the cash. So our first option is cash going to loans. Our second is cash going to investment securities. So it's all part of the equation, Alex.

And our next question comes from Kelly Motta from KBW.

Great quarter. I believe on your last call, you've guided to efficiency in the low 50% range in the quarter, but you had some nice NIM expansion, and expenses were well controlled, and you dipped down below that in the first quarter. For -- as you look out for the remainder of the year, I know you're making some investments in tech. Is the low 60% efficiency ratio still a good outlook for this quarter -- or for the remainder of the year? Or should we be thinking of maybe lower? And maybe if you could also tie that into some of the pushes and pulls of expenses as we look out to the remainder of the year, that would be really helpful.

I'll let Maritza answer the question.

So how we see expenses this first quarter, we still haven't reflect the full effect of our deployment in our strategies. I see this as a timing matter. As we continue deploying into technology and in our people, we will see levels of capital assets and expenses to go up. And we still have the same plan that we shared with you during the last quarter. We will continue investing, and we will see capital assets as well as expenses to grow.

And if I can add a little bit here, too, we are very much cognizant of how well positioned we are for a hike in interest rates. So going back to your point about efficiency ratio, we do see -- we realize that interest rates are going to have a very positive effect on us and on our results. So we just want to make sure that we have the flexibility to take advantage of accelerating some of the investments that we need to make above and beyond what we have planned, just because we want to make sure that we take advantage of the environment we're operating in right now. So as Maritza says, we're sticking to our low 60s efficiency ratio for the time being in spite of the 2 variables that moved that number working in our favor.

Got it. That's really helpful. Switching to the NIM, it looks like you had some nice expansion loan yields, and the rate hike was towards the end of the quarter. So I was just wondering if that was a function of mix, how spreads are holding up and how confident you're able to continue to expand loan yields from here beyond just the rate hikes.

Well, Kelly, at the end of this quarter, the 21 basis points that increased the NIM, 16 basis points relates to asset mix. So it's mostly driven by the change in our asset mix, having more loans and investment portfolio in the earning asset side.

Got it. That's helpful. Maybe a last question for me. You had really strong deposit growth. I believe some of that was from the exit towards the end of 2021 coming back. As we look and as you continue to gain share in Puerto Rico, wondering how we should be thinking about that line because there is still quite a bit of liquidity, but I would imagine not so much growth as we've seen in the past year as people start looking for credit. Can you -- I know it's hard to have a crystal ball but maybe some thoughts about the cadence of deposit growth going forward.

So we kind of got back on track in this quarter after we managed a little bit the balance sheet down last quarter, as we mentioned a quarter ago. What we're seeing here in Puerto Rico is maybe not the same levels of liquidity on the consumer side and the businesses as they have started to deploy it. But we're also seeing like, for example, the Child Tax Credit in Puerto Rico is having its effect in this first quarter and continues to have that effect as the tax season just ended.

For Puerto Rico, that's a big number. And because we used not to have the benefit of the Child Tax Credit as the rest of the states would have had it, and now we are in parity with the rest of the states. So this first quarter, first half of the year, we're seeing that as another positive in terms of deposits. But certainly, the rest of the year is, in our models, it does not replicate the deposit growth that we've seen in -- on years before, given the liquidity from the stimulus in the pandemic.

So -- and then going to the earlier part of your questions regarding the $10 billion, we're at $10.2 billion. This is the first quarter. Let's see how everything plays out in the next several quarters, but our goal and our expectation is to grow. And we want to break the $10 billion, and we want to do it with the right asset mix so that we can increase our margins and increase our profitability. And in the past, we were trying to be a little cautious because keeping money in cash was not generating a positive return. It actually was returning as a negative carry. So now that we're seeing and we've been seeing incrementally, and this quarter, we saw the loan growth, we are certainly looking forward to grow the balance sheet.

(Operator Instructions) Our next question comes from Brett Rabatin from Hovde Group.

Congrats on a good start to the year. Wanted to first talk about the fee income for the quarter and the outlook. You usually have a little bit of seasonality in the first quarter with banking Service and Wealth Management. Mortgage banking obviously held in due to servicing but was hoping to get some color around the seasonality of those other 2 line segments in the first quarter and then how meaningfully they bounce back, if so, during the rest of the year and your thoughts generally on driving those 2 lines on the income statement.

Yes. So fourth quarter on a fee income basis is really strong for us. So the comparison with the first quarter, as you pointed out, has some seasonality. So we're seeing banking services continue to trend positively. We see our customers' utilization of our banking services continuing to increase. We're adding new customers, and we are growing the different services, particularly on the commercial, small commercial and midsized kind of commercial clients, certainly on the consumer side, too.

On the Wealth Management side, I think it's too early to tell in terms of how it's moving forward. We think it's moving positively. I think higher rates will help that business as we start to see some consumers and commercial clients starting to think about moving money from deposits to investments, and we have a pretty strong legacy business there that can benefit from that. But it's still too early in the cycle.

So that's how we see that. We see insurance as an important business for us and one that continues to show some growth, particularly on the cross-selling that we do with commercial clients and consumer clients and the different loan businesses that we have on the mortgage side, as well as in the consumer side and commercial.

And lastly, mortgage banking. Mortgage banking, I mentioned on the call that we were seeing a slowdown on the origination side. But we also have now a $7 billion, $8 billion servicing book that -- with higher rates, and we should do well there, too. So we're excited about how those different lines on the fee income side are trending and how would that complement the rest of the income statement from the loan side and the investment side. So again, we're pretty happy.

Okay. That's good color. And then wanted to circle back to -- you talked about, in the outlook, the inflationary pressures that many are seeing. And I think early on, one of the pushbacks around Puerto Rico was that the inflationary pressures might disproportionately affect the consumer base there versus the mainland. And obviously, the economic stats haven't bore that out at all, and I continue to be surprised with the resiliency of the auto sales, which are up again this year for the first 3 months year-over-year again. I guess, Puerto Ricans just drive them into the ocean and will buy another one.

Wanted just to get any color that you have on where you're seeing the inflationary pressures. And as a part of that, I also wanted to ask about how many vacancies you have from a personnel perspective due to competition from the mainland and how the inflationary pressures might be affecting your own merit increases this year as well.

So I'm not sure if I heard you well on the second part of your question. I believe you are asking me about U.S. banks doing business in Puerto Rico and competition here in Puerto Rico, in general. Is that right, Brett?

Well, just I know that with remote work, there's Puerto Ricans that can now work in the U.S. and do it remotely in Puerto Rico, so there's competition for talent. So I was trying to get a sense, José Rafael, what -- how many maybe job postings you had open, how many jobs you're helping to fill this year. Just kind of just -- yes. Go ahead, I'm sorry.

Yes, yes, yes. So let me just start by saying that recruiting is a tough business as it is in the States also, given The Great Resignation and all that. But having said that, we are seeing those trends normalizing. And we saw a lot of pressure last year on the kind of individual contributors in the bank, meaning at the branch level or the call centers. We did make the salary adjustments, and we made the different compensation adjustments that were needed to be done to make sure that we stabilize that, and we're starting to see those trends stabilizing.

We're not seeing any high-quality, big contributors turnover on the manager side or senior manager level. So on that side, we're fine. But if we're going to be transforming as we have been doing for many years, we need to continue to look out for talent and upgrade our skills internally. And that is something that we're very much focused on, and we look at the U.S. as well as the Puerto Rico market to attract that talent. So that's kind of what kind of color I can give you regarding that, Brett.

Can you remind me the first part of your question?

Okay. Just the inflationary pressures that you might be seeing, where they're showing up in the economy. The statistics don't really bear out any kind of pressures at this point. But I assume as the year progresses, those will start to show up in some form.

Yes. So I would say we need to be -- as everybody else in the world, inflation is a factor, and the cost of living in Puerto Rico is going up, and the housing market is pretty strong, so -- and the pricing are going up. So it's very -- it's too early to quantify, as I mentioned. But those are areas that we need to be cognizant of because our consumers and businesses are paying higher prices for the goods that they consume and for the services and the goods that they provide and to be able to offer to customers.

So at the end of the day, the Fed needs to get going, and that's what they're telegraphing to everybody. So hopefully, we have a soft landing in the next 1 or 1.5 years.

Okay. And then lastly, want to just circle back to the margin discussion. And as I look at it, if you just take the static balance sheet, I know that there's obviously changes that are going to affect the outcome. But it would seem to me that a 50 basis point hike would raise the margin by about 15 basis points. And Maritza, would you have any pushback on the -- any color that you'd want to say, positive or negative, relative to that number?

So the margin, Maritza, we're not hearing you well, Brett, and that's kind of the problem that we're having. But if I understood the question correctly, I'll repeat it, so that Maritza can respond to it. Regarding the margin and if we expect a 50 basis point increase by the Fed, Brett is saying that our net interest margin would be impacted positively by 15 basis points. And he wants you to confirm or at least give some color regarding that.

I think that at the end, José mentioned it before in the call in one of the questions, we -- you saw our 10-K. We are very well positioned for rate hikes, the shock analysis of 100 basis points put us in a positive 9% net interest income increase. So I don't know how to get into your equation. But from there, you can know that it will be a relatively important impact for us, any move in the market rates.

Brett, you can get more color from Maritza on that. I'll tell you that much.

And our next question comes from Timur Braziler from Wells Fargo.

Just wanted to follow up on a couple of questions. Maybe looking at the strength that you're seeing within the consumer segment and within the auto segment, how much of that is still being driven by stimulus and the Child Tax Credit? And I guess, what does normalized consumer demand look like? And how far away are we from reaching that level?

Yes. That's a very good question because, remember, this is uncharted territory because of the stimulus. But for Puerto Rico, in particular, it's additionally uncharted territory because we're just coming out of 2 decades of economic contraction where consumers were very much squeezed. So thinking that the consumer is going to level off at pre-pandemic levels or at levels before the pandemic, significantly earlier in the pandemic, I think it's not what's going to happen.

Our expectation is that the consumer is going to start leveling off sometime at the end of this year, and we are very much focused on how is that behavior moving right now. And -- but we should end up at a new normal, if you want to call it that way, in terms of consumer in Puerto Rico given the velocity of money that continues to be acting in the Puerto Rico economy. And in addition to that, the reconstruction funds that are -- even though they're not coming in at the pace that we desire, in reality, we see that as a blessing in disguise, not from a quality-of-life perspective, but from a capacity perspective. Because with all the things that are going on in terms of building the economy back and building the infrastructure back, beware what we wish for if we want all those funds to come down.

Having said that, I think the effect and the ongoing effect of the stimulus money that was deployed in the last couple of years is continuing to have a significant impact on the island's consumers. And that's going to start leveling off some time, I would expect at the end of the year. And then we will hope that we think the reconstruction funds will start coming down as some of the projects get approved and the federal government starts releasing those funds.

So I think we have quite a bit of a runway here in terms of the Puerto Rico economy. And the big question mark here is now how is inflation and supply chain and all those issues affecting. But I think on a relative basis, as I said, given the size of our economy and the size of the reconstruction and stimulus funds, the mathematics tells me that, on a relative basis, we will have better performance than some of the states in the United States.

Got it. Okay. And then circling back to expenses, so in Maritza's commentary, it sounds like about $4.5 million versus last quarter might have been onetime in nature. So I guess on the legal -- lower legal expense, was that a charge in the other direction and that more or less normalizes in the second quarter and then the $2-plus million of other items? Maybe you could just frame what a good starting point for expenses is in the second quarter once we remove some of the noise from the first quarter numbers.

So remember, the first quarter, when we talk about legal and when we talk about some of the operating losses, it happened on the fourth quarter. So that -- the delta that you're seeing positively this quarter is because of that. And what Maritza mentioned earlier is that if you net that out, that's the base where we're starting, which is this quarter's number.

But when you look at going forward, we have some investments that we are making. And we're probably going to see -- from a timing basis, we're going to see those expenses later in the second half of the year. So that's why we're making sure that you are all aware that we're making -- continuing to make the technology and the people investments to move our business model and accelerate some of the digital investments that we're -- we'd be making for years.

Understood. Okay. Great. And then last for me. Just looking at allowance for loan losses, the ratio went down a little bit, but dollars of allowance actually increased for the first time kind of post CECL. Have we found kind of a floor for dollars of allowance and the expectation should be that the ratio goes lower as loans get bigger? Or is there incremental opportunity here to actually reduce allowance kind of releases later in this year?

Yes, Timur. As it happened this quarter, we said the variable -- the balance -- the loan balance growing, that variable is adding to our allowance. It add about $3.7 million. Also the qualitative adjustment, as the economy continues to improve, we continue to adjust them in a positive way. So also, the net charge-off is the other variable that will impact the levels of allowance going forward.

So right now, we are keeping our quarterly analysis, and volume factor will be one element, but also the economic environment will continue to be an element that definitely will make us reflect on how to manage it. And probably if it continues to be positive, we will see that coverage going down. But that's a variable that we have every quarter.

Yes. It's ongoing, Timur, and it's how the equation works. But at the end of the day, what we're starting to see also on the consumer lending side is if you see this quarter, we saw around $4 million of net charge-offs. We will have to cover for that and if we grow the loan book also. So again, we -- because we're optimistic with the economy, we're also optimistic on how we can continue to manage our asset side of the equation and particularly on the reserve.

And it looks like we have another question from Alex Twerdahl from Piper Sandler.

Just a couple of follow-ups for me, if it's okay. First off, Maritza, do you have the contribution to net interest income from the PPP in the first quarter?

Well, it was really lower than prior quarters. I don't have it here with me, but I can share off-line with you.

Yes. I don't think it's too meaningful.

It's not meaningful, yes.

It's not a very significant number, but Maritza can provide to you off-line.

Okay. And then do you have -- in the mortgage banking line, the -- do you have a breakout of the contribution from the -- sort of the MSR valuation adjustment versus just the mortgage banking volume?

Yes. The MSR valuation for the quarter was positive but in a lower extent than the prior quarter, and volume factor was impacted also because it was -- the portfolio is running down. But I don't have the exact amount, but the delta probably is around $300,000. I have to check that, and I can go back to you on that number, okay?

$300,000 contribution or $300,000 swing from the prior quarter?

Yes.

$300,000 swing, yes.

Okay. And then just digging a little bit more into the reserve. You guys released $5.7 million for qualitative factors. Was that mostly due to Omicron? Or what kind of were the pieces of that, that contributed to that reserve release?

Yes. I talked a little bit in the prepared remarks, that mostly relates to a qualitative adjustment that we were doing, adding to the allowance related to unemployment levels in Puerto Rico. And as José mentioned, unemployment has been steadily going down, and we have historical levels recently. So it was, for us, no longer necessary to keep that adjustment into the allowance.

Just given the improving unemployment, yes.

I'm sorry. Is there a component to the reserve that you could still sort of attribute directly to COVID that over the next couple of quarters, if things continue, not going the way they have been that could be released out of the reserve?

Well, we do have qualitative adjustment that has been tied to the most recent developments in the economic environment, not only due to COVID, but other areas. And yes, we do have that within the qualitative element of the allowance.

Are you able to share how much that is?

I don't have it here with me. But probably, we can share with you off-line.

Okay. And then just a final question. The $2.8 million recovery on a PCD loan, I'm just curious if you can give us a little bit more color on what drove that, current quarter.

Yes. I can give you color. This is a Scotiabank-acquired loan that we had written down, and it was paid back to us as part of the government bankruptcy settlement. And we received from that settlement, I think it was $4 million, and the difference is what you're seeing there in terms of the recovery. So that's what it is. It's a Scotia legacy government loan that was on our books written down to $1 million. They paid us $4 million, and we got $3 million. That's kind of how we would in general numbers.

Directly correlated to the bankruptcy exit. So in terms of kind of loans that were acquired from Scotia or from other institutions that have been marked down and with real estate values doing what they're doing, I mean, you could assume that you're going to see more recoveries in the future but you wouldn't be able to point to this as sort of a leading indicator of that.

Correct, correct.

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

Thank you, operator. Thanks to all for their -- thanks to all our team members for their hard work and dedication to this great start of the year, and thanks to all our stakeholders who are listening. Looking forward to our next quarter results. Have a good day.

This does conclude today's program. Thank you for your participation. You may disconnect at this time. Have a great day.