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Executives

José Rafael Fernández - President, Chief Executive Officer and Vice Chairman

Ganesh Kumar - Executive Vice President and Chief Financial Officer

José Ramón González - Senior Executive Vice President, Banking and Corporate Development

Norberto González - Executive Vice President and Chief Risk Officer

Analysts

Emlen Harmon - Jefferies

Robert Greene - Sterne, Agee & Leach

Brian Klock - Keefe, Bruyette & Woods

Oriental Financial Group, Inc. (OFG) Q1 2013 Earnings Call April 26, 2012 9:00 AM ET

Operator

Thank you for joining us for this conference call for OFG Bancorp. Our speakers are José Rafael Fernández, President, Chief Executive Officer and Vice Chairman; and Ganesh Kumar, Executive Vice President and Chief Financial Officer.

There is a presentation that accompanies today's remarks. It can be found on the Investor Relations website, under the webcast presentations and other files page.

Please note, this call may feature certain forward-looking statements about management's goals, plans and expectations, which are subject to various risks and uncertainties outlined in the risk factor section of OFG's Securities and Exchange Commission filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments which occur afterwards.

(Operator Instructions) I would now like to turn the call over to Mr. Fernández.

José Rafael Fernández

Thank you and good morning to all. As always, I'll cover the big picture, and Ganesh will discuss key aspects of our financials.

We'll start on Slide 4. Welcome to the new OFG. As you know, Wednesday we announced the change of name of Oriental Financial Group to OFG Bancorp. Our shareholders approved that proposal on Wednesday. And this new name OFG Bancorp better reflects what our company is all about. We're a well-diversified banking and wealth management company.

Please turn to Slide 5. This year is off to a great start. First quarter was our first full quarter of the merged companies between OFG Bancorp and BBVA Puerto Rico operations. Our fourth quarter 2012 was all about closing the transaction, deleveraging the balance sheet, growing organically our operations and our business, and really transforming our balance sheet.

Our first quarter 2013, we are showing the results of that balance sheet transformation to our income statement. Our strategy this year is to continue to work on our integration efforts; smoothly transition our clients, our commercial and retail clients into the oriental platform, so we can create one full platform by the end of the year; and certainly hit our financial targets and our financial objectives.

Our first quarter highlights from a financial perspective were really well ahead of our expectations on our ROA, ROE and our efficiency ratio targets. And if we are not even hitting them, we are very close to that and we are very excited with that.

Significantly greater amount and proportion of interest income from loans, this is a key aspect of the results this quarter. We continue to decline the cost of deposits and we are very encouraged with the progress that we made. This has translated in a major expansion in net interest margin with strong fee income increase from a year ago.

Our credit remains stable. We are the healthiest and best quality financial institution here in Puerto Rico, with strong capital ratios, all in excess of regulatory requirements as well as a very stable credit portfolio, a loan portfolio in terms of credit. Bottomline earnings of $0.37 per share for the quarter fully diluted. This is in line with our initial target of $1.40 per share diluted for 2013.

If we turn to Slide 6, major difference today or this quarter from a year ago and from the last quarter is loan production. We are hitting on our targets. Our loan pipeline is building. Our first quarter production of around $275 million was up 86% quarter-over-quarter and 149% year-over-year. We continue to focus on our strategy of attracting quality retail and commercial clients, and its working.

When we look at each one of our portfolios starting with automobile lending, we have a strong niche position and it continues to perform very well. Production was more than $100 million for the quarter. And we continue to work and expanding our additional auto dealers in our portfolio.

I have visited some of those dealers as recently as yesterday, and they are very excited with having a local bank reacting and working hard on helping them grow their own sales. So we have a great relationship there and great leadership in Puerto Rico.

Regarding residential mortgage lending, production of $77 million is on track. This first quarter we achieved those results in spite of the fact that we spent most of our efforts this quarter on integrating mortgage business, which is fully integrated today with new organizational structure, new facilities as well as the technological integration.

So with all of that working in the first quarter, Oriental still hit $77 million of production for the first quarter. We expect increased production in the second quarter.

Commercial lending production was $74 million is also on track. As you know, first quarter of the year is a slightly less active quarter, given all the administrative issues that need to be worked on the commercial lending side, financial statements and alike. But we feel that we have great pipeline, and we expect production to continue to increase into the second quarter.

Consumer and credit card lending production was $23 million was very good. As we have noticed through our visits in the branches, our Oriental branch network is starting to work on cross-selling and adding the personal loan and the credit card into a different services that we offer. So these numbers increasingly validate our strategy and our opportunities in this market.

I have been, as I said, visiting most of our offices and branches as well as some of our most important clients. Morale is great all along. Excitement among our client is very noticeable. And we started this process with a motto that said, together we are more. I think when you look at this first quarter results, that motto is coming to fruition right away. So we are very happy with our first quarter results.

I'd like to pass it now to Ganesh, so that he can go into more detail on the financials, and I'll come back later.

Ganesh Kumar

Thank you, José Rafael. Let's now turn to Slide 7, where I can talk about the loan interest income. The results you see over here represent the first full quarter, and it has one notable difference. It is a loan income both in amount and its proportion.

We crossed $100 million mark for the first time in a quarterly income from loans. It is also up 153% year-over-year and 110% quarter-over-quarter. The primary contributing factor has been the size of our loan portfolio. The balance has grew 215% year-over-year and up slightly quarter-over-quarter as well.

Also to note, the loan yields are higher. Our non-covered loan yield is now at 6.64%, compared to this it was 6.05% prior year and $6.09% last quarter. This improvement is mostly due to a better mix and higher yielding loan book. It is also partly due to purchase accounting. As you can see, there is a complete transformation in our income statement. We are happy to note that loan income is now 88% of the total interest income and a year ago this was just 57%.

Turning to Slide 8, where you can see the deposit interest expense was $10.5 million, which is up only 15% year-over-year versus 153% increase in loan income for the same period. Quarter-over-quarter as well similarly it is up 39% versus 140% growth in loan income. The balances of $5.6 billion is up 140% year-over-year and down more than 2% quarter-over-quarter. The quarter-over-quarter decline reflects maturities of certain higher price retail and broker CDs.

The transformation from year-ago quarter is again evident over here. The balances are higher as mentioned, and more importantly the loan-to-deposit ratio is improved from 71% to 94%. The cost of deposit is down to 75 basis points. This is down from 158 basis points from a year-ago quarter and 112 since last quarter. We are particularly glad to see our efforts to lower the deposit cost are showing results.

Cost of deposit also benefited this quarter from $3.4 million purchase accounting premium amortization on certain higher price CDs that were acquired from BBVA PR. Around 25% of this retail CDs had scheduled maturities during the quarter, and OFG chose not to renew them at that rate.

Turning to Slide 9, interest income from securities was $13 million, which is down 57% year-over-year and down 20% quarter-over-quarter. We ended the quarter with an investment portfolio of $2 billion. This is down 44% year-over-year, primarily due to our deleverage efforts and partially due to prepayments. It is also down 8% quarter-over-quarter. Yield on this portfolio for the quarter was 191 basis points. This is down from 2.8% year-ago quarter, and however it is up from 1.8% last quarter.

I would like to highlight that interest income from investment security is now 12% of the total interest income. This used to be a major component of our revenues, and due to strategic transformation that also Rafael alluded to of the balance sheet, we have shifted the quality and the risk profile of the balance sheet considerably.

On borrowings, you can see our size of the borrowings have been vastly reduced due to deleverage, we spoke about. As you might know, we use such borrowings solely to fund our investment securities. Borrowings interest expense was $10.6 million. This is down 52% year-over-year versus 57% decline in investment income for the same period. It is also down 24% versus 20% decline in investment income quarter-over-quarter.

The decrease in interest expenses is due to OFG's continued efforts to rely less on this type of funding, compared to $2.1 billion of borrowings, we had $3.4 billion year ago, prior to our deleverage efforts. During the quarter, we also reduced our borrowings further by way of pay down of $200 million repurchase agreements and early extinguishment of a $50 million BBVA PR subordinated note. Despite the pay downs, utilizing available cash, OFG continues to maintain strong liquidity levels.

Turning to Slide 11, perhaps one of the most interesting slide for you. You can see the acquisition has resulted in a significant expansion of our net interest margin. The net interest margin increased to 4.65% in first quarter. This compared to 2.6% in year-ago quarter and 2.95% last quarter. The NIM expansion reflect increases in loans and yield, I mentioned before. And it's also due to the reduction in cost of the process we talked about.

I am sure you have questions on why the NIM is considerably higher than our initial guidance of 3.95%. The original guidance was based on our initial assessment of the loan pools and associated credit marks. Then, there were some refinements to purchase accounting, which was disclosed in the 10-K issued last quarter.

And finally, due to better than expected cash flow behavior seen during the quarter, we also had a positive impact to our NIM. Based on our continuing understanding of portfolio behaviors, we are now comfortable in raising the normalized NIM for 2013 to 4.20% to 4.25% range for the entire year.

Moving on to Slide 12, a goal in acquiring BBVA PR was to further expand our recurring core non-interest income. Core revenues totaled $23 million in the first quarter. This is up 102% year-over-year and 58% quarter-over-quarter. And I am happy to highlight, the acquisition has doubled our core fee generation capabilities.

Most of the fee increases were in banking services and mortgage banking activities. Potential opportunities still do exist in growing our wealth management business through cross-sell efforts, once the integration is complete.

Assets under management also continued to grow $5.4 billion, and this is up 22% year-over-year and up 3% quarter-over-quarter. This growth is primarily organic, although the underlying investment market values valid in 2012 very well as well. AUM is generally a lead indicator of our future revenue prospects in wealth management.

On Slide 13, we would like to present certain items that impact our first quarter income. As you can see, the quality of income has changed dramatically in the first quarter with relatively a fewer non-recurring items. The following are in addition to the benefits of lower interest expense due to CD premium amortization I mentioned earlier.

First, non-core non-interest income was impacted by two items. One, there is a $1 million gain from the early extinguishment of the BBVA note. And two, it also includes $13 million in net amortization of FDIC indemnification asset related to the Eurobank acquisition. The $13 million is about $3 million greater than what we've discussed earlier in our call last quarter.

This is primarily due to improvements in performance of certain covered loan pools. We are increasing our current estimate for FDIC indemnification asset amortization in 2013 to $44 million to $48 million.

I have gotten couple of calls recently from you, on accounting guidelines ASU 2012-06, just FYIing, we managed the indemnification asset, taking into consideration the duration of loss share agreement all along. And therefore, this increase pertains to the performance that we are seeing in the covered pools.

Non-interest expenses include merger and restructuring expenses of $3.8 million accrual for planned termination of a third-party servicer for the former Eurobank loan. Once we complete the transfer and integrate into our operations, this is expected to generate $3 million to $4 million in annualized savings, starting next year. It also includes $1.7 million in integration cost against our estimate of $8 million for such cost during the year.

The effective tax rate is now currently estimated to be 25%. This is significantly higher than the tax rate we used to have, because of grater proportion of taxable income from loan versus the tax exempt income from securities we used to have.

On Slide 14, you can see our credit quality continues to be stable. The data on this Slide refers only to OFG legacy loans and new loans generated since the acquisition. The acquired portfolios from BBVA PR and Eurobank both have credit marks and loss-share in the case of Eurobank.

Total provision for loan and lease losses net was $8.6 million. It is down $1.6 million year-over-year and up $4.2 million quarter-over-quarter in line with significantly higher loan production during the quarter. The total delinquencies are remaining relatively flat quarter-over-quarter as well. The credit quality of the acquired BBVA PR loans is in line with our initial assessment.

On Slide 15, you can see the shareholders equity is increasing again after the acquisition. Total stockholders equity of $870 million is up 26% year-over-year, explained by capital raises related to the acquisition, higher retained earnings and as well as the other comprehensive income increases. It is also up 1% quarter-over-quarter, primarily from additional retained earnings. On a per common share basis, both book value and tangible value increased from the end of last year as well.

And finally, I would like to bring your attention to Slide 16, where you can see our capital ratios have improved from last quarter. They are well in excess of the regulatory minimums. In addition, we anticipate our capital position will continue to strengthen further. This concludes my part of the presentation.

Let me hand it over to José Rafael for continuing his part of the presentation.

José Rafael Fernández

Thank you, Ganesh. We continue to be very excited about the way things are rolling out for us and coming together as far as the integration. You can see that businesses are on track with both, integration is moving on time and on budget, and our operations are having good success. We dwell into Puerto Rico economy. We continue to see some stability, but we still see the challenge that there is no growth engine in the economy that would push-forward growth in Puerto Rico.

The government has taken a major step in addressing government pensions. They have closed the sale of the Puerto Rico airport, but there is still some fiscal issues that need to be addressed and will be a drag on the economy. And we expect them to be a drag on the economy going forward.

We continue to be comfortable with our initial outlook of $1.40 per share diluted for 2013. And we are very excited with the results of this first quarter of 2013.

We are also here with José Ramón González, our Senior Executive Vice President of Banking and Corporate Development; and Norberto González, our Executive Vice President and Chief Risk Officer. All four of us will be available for the question-and-answer. So with this I end my formal remarks.

I'd like to pass it to the operator to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Emlen Harmon with Jefferies.

Emlen Harmon - Jefferies

Maybe to kick it off, it's good to hear your comments just on kind of a strong outlook for the loan portfolio. Would you slightly give maybe a little bit more color on the commercial side, about where you're seeing strengths? Particularly, whether that's specific industry types kind of from the legacy Oriental or legacy BBVA portfolio, just kind of where you're seeing that strong growth? And maybe a little bit more color on your expectations there?

José Rafael Fernández

On the commercial side, let me just give you an indication on how we're seeing this, and then I'll pass it to José Ramón, so he can give you more specific color. But in general, we're seeing both the middle market segment, which are companies with sales of $10 million to $50 million. We're seeing some good opportunities there. We're also seeing some initial good opportunities on the wholesale side, more at the level of larger companies, $50 million in sales and above, and we see some opportunities there.

I'd like to also highlight, Emlen, that we do recognize that there is a niche in Puerto Rico more into the smaller type of commercial loans that we feel that we have a good opportunity also to grow there. But I'll pass to José Ramón, if he wants to add any additional color.

José Ramón González

You've covered the main points and the main segments. I think in the overall loan portfolio, the strongest growth has been in auto lending. And as José Rafael said, we have a very strong market position in that business. And we've started the year with a very good volume in that business and strength in that market. It is also a very profitable business, because of the spreads in that business.

On the commercial side, as José Rafael said, I think the sweet spot currently for us is the middle market, which is locally-owned midsized companies, midsize by our market spend is, to what José said with sales between $10 million $50 million. There has been of course a reduction in the number of banks servicing that business over the last few years with the consolidation in the markets.

We are perhaps the best positioned bank to serve that market currently, because of the breadth of our retail branch network, which help service that market. And because of course our strong credit quality position allows us to be a little bit more aggressive in pursuing that business for local clients with good quality profiles.

In that segment, the food distribution business, supermarket business, some healthcare providers, some educational providers are perhaps standout as segments, where we have grown. And we also expect to see strength in the small business market, where again we have a very strong branch network to facilitate distribution to those clients.

In both segments, pricing remains reasonable in terms of us being to able price appropriately the credit risk. And it has allowed us to continue growing BBVA's franchise and lending it with our legacy franchise, which had strong growth in the last two or three years.

On the wholesale banking side that business has smaller margins, but good fee generating capabilities. And it continues to be a traditional strength of the business we acquired from BBVA. And we continue to grow there, but mostly from a fee generating side rather than actual volume of loans. And I think that's a profile in general of the commercial lending business.

Emlen Harmon - Jefferies

I guess, within that do you feel like from a production standpoint kind of beat up the BBVA's side of the house, so it was kind of up to a run rate in terms of production or is there some lag there just some kind of the integration in the conversion period?

José Rafael Fernández

I think in that there is some level of disruption, because of the integration. And there is a lot of effort and time spent working with integrations. So we feel that 2013 might not show the entire full potential of our production capabilities. Having said that though, they are showing good results vis-à-vis our budget and our targets for the 2013 year. So we clearly recognized that that this is a year where we need to kind of have a two-pronged approach, which is integration and running the business. And there is going to be a lot of more focus in the next three quarters on integration, because of the timeline that we have.

Emlen Harmon - Jefferies

And then just one more. On the margin guidance, I mean you guys are saying 4.20% to 4.25%. I did resist to know kind of what size balance sheet you're assuming within that margin guidance. I guess is there anymore kind of balance sheet restructuring yet to come? And also, if kind of run rate this quarter's margin rate after backing out the deposit accretion, I guess something closer to kind of like the mid 4% range. So just curious kind of what the potential adjustment is as we go forward?

José Rafael Fernández

I'll let Ganesh go into the details of that question.

Ganesh Kumar

Emlen, I know, as you see the balance sheet, the total assets or the whole balance sheet has dropped down to 8.7%, primarily because of the pay downs of repos and the subordinated notes using the cash. So the cash position has come down to similar extent. But, however, the earning assets are in level with the end of the last quarter. So I think that's one thing that basically this quarter we did not see a whole lot of drop in the earning assets.

But for a few big loans that are coming to maturities, which we need to kind of further see on whether we can roll them over and keep them or let them go, because of other reasons. So I think what I am trying to say is the NIM normalized, if you want to use it, you can use an average of $7.5 million earning assets for the whole year. That's $1 billion for the whole year. And $420 million is what I said is a normalized NIM. When I say normalized, it does not include the purchase accounting fluctuations that accrete, because of the actual cash flow behavior.

At this point in time, I don't know to predict those things, because the event haven't occurred yet. So I think that's our baseline guidance at this point in time and as we go further we can add some color to it through the quarters.

Emlen Harmon - Jefferies

So based on your comments it sounds like it would be fair to say that just kind of a 25-ish basis point contribution from just purchase accounting from the BBVA deal this quarter?

Ganesh Kumar

Correct.

Operator

Your next question comes from the line of Robert Greene with Sterne, Agee & Leach.

Robert Greene - Sterne, Agee & Leach

Just on the expense side, I thought the expenses came in pretty well in the quarter, at about $59 million run rate. And I was wondering if you kind of break that out just a little bit. Obviously, you've got the restructuring charge. I'm wondering what are the various puts and takes in terms of investment spend with the new platform versus potential cost savings and sort of what you think the timing of that might be?

Ganesh Kumar

As basically we have said that the $8 million throughout the year is the one-time savings that we're going to have for the integration expenses, that of course, does not include the $3.4 million for termination of BBVA contract that we talked about. The capital spend we explained last quarter about the whole $35 million total estimate and the capital spend, finally, we said that $18 million we might spend on integrating organizations technology, buildings and all of those kind of things, that would be amortized over X number of years, right.

So this year, the amortization of such items would not have a much impact because we have not incurred them yet. And they would happen throughout the second quarter and the third quarter and fourth quarter, it might have a very minimal impact. So I don't see that to be a big factor. What you're seeing over here is that the $59 million run rate is not what we expect for the whole year because some of the marketing expenses and one-time expenses have not kicked in, so they would happen in the second quarter and third quarters.

Robert Greene - Sterne, Agee & Leach

And then secondly, I wanted to revisit the margin question because obviously there is a lot of moving parts. And so just to clarify, is the 4.20% to 4.25% is that what you expect for the full year or is that sort of your normalized run rate?

Ganesh Kumar

It is the normalized run rate for the full year. And what I mean by that is if we take the portfolio from pre-acquisition and apply the purchase accounting mark that we did on day one, that's what we think that number would be, 4.20% to 4.25%. What happens because of the purchase accounting, because of the actual cash flow behaviors, then we have to do something and that's what gives us the bump over and above the 4.20%.

Robert Greene - Sterne, Agee & Leach

So for that sort of I guess 25 basis points that you mentioned, do you have sort of the accretable yields. Obviously, there is the BBVA deal, but do you have that for, like I guess, the legacy Eurobank, what's flowing through on the accretive yield side?

Ganesh Kumar

The accretable yield for Eurobank is still on our books. You would see that on the Q, and still we have a $167 million and this was supposed to flow over the, let's say, eight to nine quarters.

Operator

The next question comes from the line of Brian Klock with Keefe, Bruyette & Woods.

Brian Klock - Keefe, Bruyette & Woods

I guess, my question is really kind of following up I think you kind of hit some of the answers on the NIM that the other guys were asking. I guess, Ganesh, do you have what the accretable yield impact was on net interest income in the quarter from the BBVA, PCI book and the non-PCI book or do we need to wait for the Q for that?

Ganesh Kumar

I can clarify that a little in the Q, but the accretable yield that we have on the BBVA PR book is around $510 million and we expect this to flow in maximum of let's say three year, four years rather. So the $508 million actually you might have seen in the 10-K, Brian, we took the acquired book and we have two trenches in that one.

One, which is the SOP, which is under the purchase accounting, another one is I recorded it under FASB 91. So the SOP $2.5 billion and the other portfolio is around $857 million or $860 million. So the SOP book is when we say accretable yield as you know it's related to the SOP book. So that $2.5 billion book is what I'm saying it has $508 million of accretable yield.

José Rafael Fernández

That already discounts the first quarter.

Ganesh Kumar

That discounts in the first quarter and remaining is $508 million for another three years up to the end of the 2016.

Brian Klock - Keefe, Bruyette & Woods

I guess, maybe thinking about on the asset quality side, maybe thinking about the provision acts that covered. So maybe if you guys can kind of talk about what you're seeing there and thinking about where would you think provisions would go and maybe talk about some of the flows in NPAs for the quarter?

Ganesh Kumar

In the earnings table we just show on the last page the originated and the new book. And you see that total delinquencies are staying flat. In terms of the acquired book, when I mentioned the BBVA PR is in line with the expectations, obviously, the SOP doesn't have the technical delinquency. But there is also a book the FASB 91 portfolio, it's primarily its auto portfolio and certain revolvers. The only thing that's not represented sort of you can get represented over here is that book. And auto portfolio as we always mention that the auto portfolio loss ratios are anywhere around 1.52% depending on the FICO scores and we have not seen any changes for a long time even with the historical data that we have prior to acquisition.

Brian Klock - Keefe, Bruyette & Woods

And I guess just thinking about from a provision level on that again NPAs have come down. So it seems like your provision levels are probably slightly lower going forward. How should we think about the provisions on the non-covered?

Ganesh Kumar

Well, if you look at a dollar-to-dollar replacement on the portfolio, the $270 million that José Rafael was talking about mostly that the auto production was $35 million, right.

Brian Klock - Keefe, Bruyette & Woods

$100 million?

Ganesh Kumar

$35 million a month and then $105 million a quarter, and I think that is a portfolio that we might provision a little bit higher than traditionally, because of the shorter duration and the FICO scores and things like that. So it would require a little bit more. So the newer production probably I'm saying that the provisioning percentage will be higher than what you saw in with our legacy Oriental production in the past.

José Rafael Fernández

But Brian, I think when you ask about provisioning I think you'll see levels around what you're seeing in the first quarter, at least for the foreseeable future as we continue to feel and get more comparable with the performance of the new portfolio businesses that we have acquired. So if you're asking on in terms of your modeling, I think it will be good to maintain same the levels. And if we feel that there is a divergence on the positive side, we'll certainly adjust.

Operator

Your next question comes from the line of (Joe Gladue) (inaudible) analyst.

Unidentified Analyst

One, I was hoping you could give us a little color on what you're seeing in the mortgage and housing market in Puerto Rico, just what's going on in terms of absorption inventory and just sales levels? And also touch on if you see any opportunities for market share gains?

José Rafael Fernández

Regarding residential mortgage, I would say that on the lower balance type of residences, we're seeing at pent up demand and there is price stability. And we feel encourage with that, because that's exactly our focus on our residential mortgage business. We originate average around $130,000 to $150,000 per loan. So as what we're seeing there and on the higher-end condos and higher properties, there is still excess supply. Some encouraging signs are starting to be seen as some of the other banks have been both selling residential loans that were construction projects.

And they are selling at a significant discount and we're seeing or starting to see some movement on those portfolios by the new acquiree or acquirer just bringing down the prices. So there is still excess supply out there. I don't have the exact number as of this first quarter, but certainly is slowly moving the inventory as residential construction projects are being bulk sold and the corresponding purchasers are reducing the values or the prices on there properties.

So that's what we're seeing. I think it still going to take a couple of more years for those higher-end residences projects to flow through and stabilize that market.

Unidentified Analyst

And just one another question, just I guess on the deposit rates, I'm just wondering if you're still seeing any opportunities for any further reductions in deposits rates that they reached bottom yet?

José Rafael Fernández

I think our larger scale and our stronger leadership position in the banking market here in Puerto Rico gives us an opportunity to drive the cost of deposits down as you have seen in the results in the first quarter. I'd like to highlight that we have already in the first quarter announced some significant reduction in the cost of funds to our purchased BBVA retail clients that are now Oriental clients. So the good thing is that we announce that.

And so far we have not seen any type of erosion from those reductions. And we will see additional benefit into the second quarter from those announcements of reduction in the cost of those deposits as we are implementing them now in the month of April, but so far so good. We are seeing that we have more leverage in terms of cost of deposits. We're acting on it in the first quarter. Results should be seen in the second quarter. And we're looking forward to see how things move.

We do have excess deposits as Ganesh mentioned earlier. So we are in a very good position to continue to help bring down cost of deposit in Puerto Rico. Having said that though, there are a still a couple of players who continue to be rational on the retail deposit side and on the CD market and that is part of the reality we need to deal with here in Puerto Rico.

Operator

Your next question comes from the line of Emlen Harmon with Jefferies.

Emlen Harmon - Jefferies

I had a quick follow-up, actually two quick follow-ups for you. You have clearly maintained your GAAP, EPS guidance around $1.40. Putting up a GAAP number a couple of cents in excess of that run rate in the quarter, do you feel like that estimate is more of a kind of conservative estimate relative to where you were a quarter ago?

Ganesh Kumar

Emlen, I'd like to say that guidance is not aggressive and it's not conservative, it's realistic. And you need to realize that we as managers want to make sure that we get a good grip on all the integration efforts on the acquired operations and we want to over deliver and that's kind of the objective here. So we feel comfortable with the guidance of $1.40. And we are working hard to surpass those results, but I'd like to say it again that I think those are very good and realistic numbers for this first year.

Emlen Harmon - Jefferies

And just lastly with the rating agencies downgrading Puerto Rican sovereign debt this quarter, and I think a couple of sovereign negative outlook. Are there any operational complication, should Puerto Rican debt be downgraded another notch. And I think if memory serves from the K you did guys hold some municipal debt on there. So just kind of curious how that may affect you guys operationally?

José Rafael Fernández

Let me just answer a couple of things here, first, I think the government is doing what they need to do fiscally to prevent that from happening. And what we're seeing in the first quarter is that they have, as I mentioned, acted on the pension reform and they got it passed, and they follow through on the sale of the airport and reduced around $600 million in debt from the Puerto authority. I think there are still some challenges going forward. And the jury is still out there but I think the agencies are feeling somewhat more comfortable with the progress that the current administration is having regarding that.

Now, into your other question regarding how Oriental will be affected? Yes, we do have some Puerto Rico government loans. Those are loans that will not be affected by the downgrading in terms of operations. These are loans that shorter term and/or are municipal loans that are packed by property taxes that are very much securing our loans. So we feel comfortable with that. Having said that, I would like to add that downgrade will not be positive for the Puerto Rico economy and Puerto Rico in general. So we feel okay with all the credit risk that we have discussed in this call and particularly with the municipal and government loans that we have. We have dedicated quite a bit of time to that. And we feel very comfortable with the exposure there as we have a good coverage from a cash flow prospective and the different entities that we're lending to.

Operator

And that was our final question. Now, I'd like to turn the floor back over to José Rafael for any closing comment.

José Rafael Fernández

Thank you, Operator. Before we close we wanted to thank our customers who are placing their trust on our ability to serve them. It's been a wonderful beginning for our new journey here at OFG Bank Corp and our customers have been very loyal. And we're very happy to receive the large amount of new commercial and retail clients that we are in the process of getting to know.

Also, I'd like to thank our employees. This is a hard work and our employees are the key to this success, not only for an integration perspective, but also from a business perspective. We're doing two things at the same time and we're doing them both well. So I want to thank them also.

And lastly, I'd like to thank our investors for their support. I'm very honored to receive the support from the investors to Oriental as we embark on this wonderful journey to become the leading bank in Puerto Rico. So with that I look forward to talking to you in July, when we hold our second quarter 2013 call. I really appreciate the time spent on this call and we'll be looking forward for the second quarter results. Have a great day and a great weekend. Thank you.

Operator

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

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