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Executives

José Rafael Fernández - President, CEO & Vice Chairman

Ganesh Kumar - EVP & CFO

José Ramón González - Senior EVP, Banking & Corporate Development

Norberto González - EVP & CRO

Analysts

Joe Gladue - CVB

Brian Klock - Keefe Bruyette & Woods

Robert Greene - Sterne Agee

Emlen Harmon - Jefferies

OFG Bancorp (OFG) Q2 2013 Earnings Call July 23, 2013 10:00 AM ET

Operator

Good morning. My name is Christie and I will be your conference operator today. 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 will be a presentation that accompanies today's remarks. It can be found on the Investor Relations website under the webcast presentations under the file 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 sections of OFG Securities and Exchange Commission filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments, which occur afterwards.

All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. During the question-and-answer session, we ask questioners to not use cell phones or Blackberries as they might call loud static on the line.

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

José Rafael Fernández

Good morning and thank you for being here today. This is our second conference call for the year and as always I will cover the big picture and then Ganesh will discuss key aspects of our financials.

Please turn to Slide 4. OFG Bancorp had an excellent second quarter performance. On a GAAP basis, we earned $0.68 a share diluted. This compares to $0.37 in the first quarter. There were some special items during the quarter, which we will discuss later. With or without those items, our performance was very strong as it was in the first quarter.

There were a number of other significant accomplishments during the quarter. You can see this in a variety of metrics. We saw record level of loan income and production, and retail and commercial deposits. I would like to point out that we achieved important growth in deposits, despite consolidation of eight branches during the quarter. In addition, we experienced significant expansion of net interest margin. And we reported record wealth management and banking fee income. Our client base both commercial and retail continues to expand and we are gaining a lot of traction with our customers for our highly service oriented approach. All this highlight the increased market recognition of our brand.

Operationally, we continue to optimize and manage our non-interest expenses well as we have always done. And the integration of Oriental and the former BBVA Puerto Rico business continues very smoothly with the end insight. The result will be a larger even more effective platform that will drive our future growth plans.

There were two major items of note that impacted results during this quarter. Corporate income taxes went up significantly in Puerto Rico from 30% to 39% as the government instituted new higher tax rates for businesses. We are also subject to a new 1% tax on gross proceeds. While these actions increased our tax expense and provisions, it did enable us to record a one-time benefit on our deferred tax asset.

Partially offsetting this favorable adjustment was our decision to move about $59 million of non-performing residential mortgage loans into held-for-sale. These loans represent substantially all residential mortgage NPLs that were originated prior to 2009. While loan had very strong credit metrics this action further reduces nominal risk exposure in this category, putting us in even stronger shape going forward. Combining the effect of our higher tax rate, the DTA benefit, and the increase in provision related to moving the NPLs to held-for-sale, our original guidance $1.40 GAAP EPS is now $1.55.

I am happy to report that our second half core business indicators look very promising, with continued growth expected in all the businesses and progress towards our established goals.

Now, I would like to turn the call over to Ganesh, so he can discuss details on the financials.

Ganesh Kumar

Thank you, José Rafael. Good morning everyone. Continuing with José comments on the overall cadence of the business, I would walk you through the financial aspects of our second quarter results.

Turning to Slide 5, here I start with the details on our loan portfolio and as well as the loan generation. As you know, a key element of our strategy for this year is building our loan generation capability. In second quarter, we saw higher levels of new loan originations. We increased the production 19% from the preceding quarter to our all time high of $327 million. Commercial and mortgage loan production were more than $100 million each. Consumer production was $26 million, a 17% growth quarter-over-quarter. The auto production was slightly lower in line with the overall market.

To give you some color on these businesses in commercial and institutional we are building a good pipeline which looks promising. In mortgages, we are seeing the benefit of fully integrated operations, and in auto we are maintaining our leadership position in the market. In consumer, we are also benefiting from our combined origination capabilities and stellar efforts from our retail channels.

While the total loan portfolio is far greater than it was a year ago, the loans declined slightly by $200 million quarter-over-quarter. Primarily, we had scheduled pay downs and maturities in non-covered portfolio and some cost recoveries in covered portfolio. There were some reduction in loans held for investment due to reclassification of certain residential NPOs José Rafael mentioned to held-for-sale. In this quarter, we also adjusted some day one balances of acquired commercial loans as part of our remeasurement efforts.

Moving on to Slide 6, the second component of our strategy is to expand our deposit base and to drive down funding cost as we have done so in the past. In the second quarter, the total deposits increased to $5.7 billion. As José Rafael mentioned, we consider this as a noteworthy achievement especially considering we consolidated eight branches during the quarter as part of our integration efforts.

Retail deposits increased $275 million or 7%, while the commercial deposits were up $51 million or 9%. Also we further reduced our reliance on broker CDs by more than $160 million. At the same time, we managed our interest expenses as we have done so in past. Total interest expense declined 9% to $14 million. The cost of deposits declined 10 basis points to 0.99%. We believe these positive trends in deposits and as well as the associated costs, positions well to focus on the loan generation in the second half of the year.

On the spread income side, we are achieving significantly higher amount and proportion of the interest income from loans resulting in expansion of our net interest margin. Net interest income increased 14% from the preceding quarter to a $105 million. New loans are more than compensating for the outflows preserving our interest income. In our acquired portfolio, we are beginning to see some cost recoveries on loans and as well as more than expected inflows on these loans which have been treated under SOP. This will continue to have a positive effect on our net interest income.

We saw a nice quarterly increase in NIM to 5.56%. This is a big increase year-over-year while quarter-over-quarter differences mainly coming from positive variations in cash flow differences I mentioned above.

NIM has definitely increased, so many might have questions on that. To facilitate better understanding, we have included some information in our newly formatted earnings table. First I would like to bring your attention to the loan balances where you can see there are some differences in loan balances between the 10-Q and as well as the earnings tables beginning as we show for the 3/31 quarter.

The remeasurement of certain acquired portfolio especially in the commercial loans will continue as we refine our SOP model. For example, the accretable yield, which was $508 million at the beginning of the quarter as disclosed in the 10-Q is now shown as $542 million in this earnings table. It also shows how much of that has flown into the interest income. Table 5, also shows loan yields quarter-over-quarter for tracking purposes so that you can see if there is any one-time adjustments or impact.

What I can't tell you however is exactly what the cash flows we would expect to realize every quarter. As the cash flows vary from our forecast, it would definitely have an impact on the interest income associated with the loans under SOP model. Such differences are primarily due to the day two purchase accounting and one that we consider unavoidable. Overall this reflect the soundness and the timing of the strategic acquisition last year. This has enabled us to replace the lower margin investment securities with higher spreads associated with loans and core deposits.

Moving on to Slide 8, you can that a larger client base and our combined operation are fueling our growth in our fee revenues. Total bank and wealth management revenues increased 3% from the preceding quarter to $24 million. We also continued to see steady growth in Assets Under Management both in trust assets, which is around $2.6 billion, a 1.7% quarter-over-quarter increase, and broker dealer assets, which is at $2.8 billion, that's also up nearly a percent.

We are well on way to achieve $95 million that we forecasted at the beginning of the year for the core non-interest income.

Turning on to now Slide 9, here I'm listing few quarter specific items that have impacted either positively or negatively our second quarter results. First the impact of recent Puerto Rico tax amendment. This has two components, both of which were made effective backdated for the entire year of 2013.

First, a new 1% gross proceeds tax, half of which can be claimed as credit in computation of our effective tax rate, and second higher corporate income taxes where the rate increased to 39% from 30% as José Rafael mentioned earlier.

Regarding the gross proceeds tax, we estimate that it would roughly be $1 million a quarter in 2013. We will be recording this as part of our operating expenses.

Second quarter results include both first quarter and as well as the second quarter tax expense. Regarding the higher income tax rate, going forward we estimate our revised effective tax rate will go up to 35.5% from 25.2%. Again this quarter includes a tax provision at this rate, new rate and a true-up provisions for the first quarter.

On the positive side, this tax increase also results in one-time tax benefit of $37 million reflecting the increase in our DTA. This increase is roughly a third of our DTA that you saw at the end of 2012, which was at $117 million.

Second quarter specific item was the reclassification of residential non-performing loans to held-for-sale. This quarter we elected to reclassify substantially all of residential loan originations and/or purchases we did 2009 or earlier, that are currently non-performing.

The UPB on these loans were approximately $59 million. Consequently there was an increase of $21 million in provisions. There might be questions on why we're pursuing a possible sale of these loans when we already have maintained our credit exposure in a relatively small manner.

First we've always been prudent in managing our risks; a sale of non-performing loans from especially from these vintages gives us additional flexibility to go further our loan book.

These mortgage NPLs were non-performing and most were under legal proceedings for repossession or bankruptcy claims, which takes longer to resolve. Second, recent market transactions indicate growing interest from potential buyers and we have received indicative bids with pricing at what we consider as optimal for exit compared to the carrying coast.

Getting back to the quarter specific, the other item is the increase of $7.1 million in FDIC indemnification asset over the last quarter. This roughly translates to 80% of the cost recoveries that we received in the covered portfolio. The last item is a $2.1 million gain on the sale of Lehman Brothers bankruptcy claim. We took a full write-off back in 2009 as our assessment of possible outcome of such a bankruptcy proceeding, while pursuing the claim through the legal process. This gain of $2.1 million represents the entire proceed from this sale of the claim.

Moving on to Slide 10, on asset quality front, second quarter shows improvements all around. On this slide, I'm showing data on legacy and new loans, which excludes the acquired or covered loans, which have their own day one markdowns. Regarding the non-performing loans, mortgage NPL ratio declined to 7.37% from 12.58%, primarily due to reclassification of loans to held-for-sale. Overall, the NPLs also declined significantly to $88.5 million from $130.5 million. This is nearly one-third reduction in non-performing loans. Total non-performing assets, including the held-for-sale is also lower at $134 million from $149.5 million a quarter before. We expect the provision levels to normalize back next quarter once the loan sale closes.

Allowance, for the quarter, excluding the $21 million is higher as we step-up activities to handle the residual risk in this quarter.

On shareholders' equity, we were virtually level as the retained earnings for the quarter offset the decline in accumulated OCI. There were two moments during the quarter besides the preferred dividend. One, the net income increased shareholders' equity by $37.5 million, the accumulated OCI declined $30.8 million as the unrealized gains on our securities portfolio diminished due to spike in MBS yields towards the end of the quarter. Tangible book value per share increased slightly to $13.49.

We consider we are well on our way to rebuild tangible book value from the dilution that occurred as part of the BBVA PR acquisition.

Capital ratios also have continued to improve across the board, the increased ranges from 0.5 or higher across different ratios shown in this space. You can find all of this numbers in our new and expanded financial supplement that we released along with the earnings. We anticipate our capital position will continue to further strengthen as we continue to be successful in our execution of our strategies.

Moving on to Slide 13, here I explain José Rafael comments in the release and as well as earlier in the call about the guidance of diluted EPS. Our guidance for GAAP earnings remains on track albeit the diluted EPS changes taking into consideration two major quarter specific items that we discussed earlier.

If we start with the original guidance of $1.40, if we just layer on the additional burden, tax burden and as well as the gross proceed 1% tax on the gross proceed, the $1.40 would be really $1.12, which after the tax impact. This is $0.28 instead of $0.35 per quarter tax adjusted.

Next, combined the impact of the quarter specific transaction the tax gain associated with DTA, which is roughly $0.70, and the second item is additional loan loss provision cost is about $0.27, the net positive is around $0.43 per share. And if you combine all these things we get a end result of $1.55 and that's how we come with the $1.55 guidance as opposed to the $1.40 before. I hope that this math gives you, provides you some clarification on why as to the new guidance that we are now providing.

And this concludes my part of the presentation and let me turn this over back to José Rafael for his closing comments.

José Rafael Fernández

Thank you, Ganesh. If we turn to Slide 14, I'll like to sum it up by saying that we are very excited about the way things are rolling out and coming together for us at Oriental. As Ganesh indicated our businesses are on track to achieve our forecasted goals despite additional tax burden, the integration is going on smoothly and on schedule. And I also like to note our balance sheet is well-positioned should rates rise.

Turning to Puerto Rico's fiscal economic situation, the good news is that the government approved the budget with higher revenue and a smaller deficit that seems to have potentially averted the threat of a ratings downgrade. However we're yet to fully understand the implications of the new tax amendments will have on the overall credit profile of the market. And with regards to our outlook, the second half of the year looks very promising as all the business indicators continue to improve.

With this we end our formal presentation. We're also here with José Ramón González, our Senior EVP of Banking and Corporate Development, and Norberto González, our Executive Vice President and Chief Risk Officer. All four of us will be available for question-and-answer.

Operator, you can open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) As a reminder, we ask questioners to not use cell phones or BlackBerrys as they might cause loud static on the line. Your first question comes from the line of Joe Gladue with CVB.

Joe Gladue - CVB

Let me start off with a couple of questions on asset quality. With the movement of the non-performing loans to held-for-sale, the balance in held-for-sale stayed pretty much the same. So I assume that that implies that there was a similar amount of loans sold during the quarter if that's correct, can you just tell us what sort of prices you're selling them at in relation to the book value or unpaid principal balance?

José Rafael Fernández

Joe, first a couple of things. In the past quarter any loans held-for-sale were conforming loans that we sell in the market on a regular basis. So that's kind of a, our origination gets put on held-for-sale and there might be some balances there at the end of the quarter. I'm referring to the first quarter, and that's why the math might not add up to you.

Now, when you add the transfer of held-for-sale that we did this quarter of around $59 million, those are the ones that are non-performing loans that we're potentially going to be selling in this third quarter.

Joe Gladue - CVB

All right. Fair enough. Could you just I guess give us what the trends are in loans migrating to non-performing status and early stage delinquencies that are trending any better?

José Rafael Fernández

Yeah, I'm going to give you some general comments here in terms of our inflows. If you go to table 6 on our --

Ganesh Kumar

Earnings Supplement.

José Rafael Fernández

Earnings.

Ganesh Kumar

Supplement.

José Rafael Fernández

Supplement, yeah. You can see there how our non-performing loans are improving. Actually and they have gone down on mortgage, they have gone down significantly from $99 million to $55 million and commercial relatively flat. Also in terms of the inflows, what we have seen in the two portfolios the acquired and the legacy, we have seen a consistent improvement on the inflows, and across the board in each one of the different businesses, mortgage, commercial, and auto. So I don't have specific information in front of me with that, but Ganesh can share that with you too.

Ganesh Kumar

Joe, again I don't want to repeat what's in Table 6, but since you asked the early delinquency 30 to 89 really dropped from $95 million down to $48 million. And also keep this in mind there will be some calendar day differences, so it would probably be a little bit higher if you consider the 90 day, full calendar days. But it's definitely much lower than the previous quarter and therefore its positive trend is in reduction of early delinquency. The total delinquency similarly reduced from 220 to 139 and obviously you need to take the held-for-sale reclassification into consideration as well over there. The non-performing loans is 88.5 which compares to 130.5 previous quarter. So there are improvements in all those three categories all around.

Joe Gladue - CVB

I have just one more and then step back. Just in regards to the loan portfolio and I guess specifically your commercial loans, great increase in originations, but the balance is still coming down. Just like to get a little bit better understanding for how the inflows and the [loan] [ph] production and I guess scheduled amortization works?

José Rafael Fernández

I'll give you some general and let José Ramón go more specific on that one. But in general what we're seeing is, first a very good quarter in terms of production as you pointed out. Secondly, there were in the quarter a couple of large loans that were repaid and there were a couple of maturing loans that we did not renew in this quarter and might be renewed in the third quarter. So we're very encouraged with continuing to increase our level of originations and catching up on some of the level of loan balances that we have right now. You want to get any more specific Ramón.

José Ramón González

You gave the gist of it José Rafael, but essentially Joe the first half of the year is always lower volume than the second half of the year in terms of loan origination in the commercial area. We did have a few significant loans in the first half that were loans that we did choose not to renew or we let go to the competition, because we weren't particularly happy with them. And so, to some extent the lower volume is in line with our management and expectations of the portfolio.

I would say that the third quarter and second half in general look very strong in terms of pipeline and we expect growth during that period. But again we continue to be prudent in terms of our loan originations and we will not go for volume at the expense of quality. And during the first half, some of that small reduction in total volume even in light of a strong production has to do with our deciding not to pursue some opportunities or to let go some loans that we rather not have in our books.

José Rafael Fernández

I also like to point out Joe that at the same time we grew deposits by a significant amount in the first half of the year and I think that should serve as confirmation on the good track and reception that the oriental brand is having here in Puerto Rico. Usually, deposits come first and loans come afterwards especially, when you build up the balance on the deposits, we will have more flexibility going forward to originate more loans. So we're very happy with the way we work things out in terms of the first half of the year, giving all the integration efforts that are being happening at the branches and with mortgage and commercial businesses and auto. And we are very happy and encouraged with what's going to happen in the second half in terms of loan production.

Operator

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

Brian Klock - Keefe Bruyette & Woods

So I kind of want to dig into the weeds a little bit. So Ganesh, forgive me if I ask you a bunch of questions again that you've already talked about. And thank you for the disclosures you guys put out this quarter, a lot of helpful information. I just want to kind of confirm, so as when I think about the impact of the change in the corporate tax rate for the quarter and you noted in your slide deck this morning. So then, on page nine of the slide deck, the gross proceeds tax at 1%, does that sounds like the second quarter had a $1 million of extra expense in other expenses because that was the first quarters?

Ganesh Kumar

Correct. Brian, I saw that you missed that in your calculation on this morning's note as well.

Brian Klock - Keefe Bruyette & Woods

Ganesh, you didn't have to highlight that to everybody. All right. Anyways, I would think that going forward obviously, that you're going to have the $1 million that's in operating expense going forward, okay.

Ganesh Kumar

Correct.

Brian Klock - Keefe Bruyette & Woods

Sorry, I missed that part. The other thing I think I missed, I guess if I'm being truthful. The corporate tax rate when I adjust for all the non-recurring items here for the quarter, I was getting about a 43% effective tax rate on your operating pre-tax net income. It sounded like you said there was a true-up in the second quarter because it was going back to the first quarter, correct?

Ganesh Kumar

Correct. Yes. And that's right.

Brian Klock - Keefe Bruyette & Woods

So am I right in thinking that there's may be about $5 million or $6 million of expenses in the second quarter that is related to this true-up?

Ganesh Kumar

You know $1 million definitively from the tax proceeds. And then, if you look at the tax benefit that we got, it was around $32 million, may be versus the $37 million DTA gain. So yes, you might be -- it will be in that range.

José Ramón González

Yeah, minimal, yeah.

Brian Klock - Keefe Bruyette & Woods

Okay. So really, I guess it's probably $0.09 of stuffs in there in the quarter related to just the tax impact that you're not going to have as drags as actually going forward?

Ganesh Kumar

Right. Right. That is correct.

Brian Klock - Keefe Bruyette & Woods

Got it, okay. All right. That's helpful. And then, on this provision, I just was thinking I want to make and try to get this right as well. So if I take what you booked as a reported $37.50 million provision on the non-covered, takeout the $21 million adjustment related to what was moved to held-for-sale, the non-covered provision still looks higher at $16.50 million versus $7.9 million in the first quarter sale. May be you can talk about what's in there and what should we expect to see? Should we expect that it go back down towards that $8 million level going forward?

Ganesh Kumar

First of all, as I said in while I was going through the slide, I expect that to normalize back whether it's going to be at $7 million level or $8 million level or $9 million level, it depends on the profile of the loans, because as you know we are replacing our loans that we acquired with higher levels of auto loans. Therefore, there would be a recalculation, a recalibration of the allowances. But it should normalize back at something close to that as you talked about.

Brian Klock - Keefe Bruyette & Woods

And then, just one last question, I'll get back in the queue. On the accretable yield, so I guess related to the loss share, amortization had increased by the $7.1 million. The cost recoveries was that showing up in your accretable yield, so as on your covered portfolio?

Ganesh Kumar

Basically, the cost recoveries would be from -- these loans were entirely written off the carrying amounts were zero or close to zero. And the recoveries flow into the interest income directly.

Brian Klock - Keefe Bruyette & Woods

Okay. So, I mean, I guess it's just related to that $7.1 million this quarter you probably had almost $9 million of net interest income related?

Ganesh Kumar

$8.8 million.

Brian Klock - Keefe Bruyette & Woods

$8.8 million?

Ganesh Kumar

Yes, exactly.

Brian Klock - Keefe Bruyette & Woods

So, I would think that if we go to?

Ganesh Kumar

We recorded the.

Brian Klock - Keefe Bruyette & Woods

Sorry, go ahead.

Ganesh Kumar

Yes. We recorded the interest income increased, not non-interest income, it was interest income that increased and then we kind of.

José Rafael Fernández

Correct.

Ganesh Kumar

We took the $7 million additional cost recoveries as part of the amortization. So that's why you also see an impact on the net interest margin there.

Brian Klock - Keefe Bruyette & Woods

So, if that isn't expected to recur, do we think we go back to the $12 million of core amortization on the LSA and then we -- so we pull about $8.8 million out of net interest income but pull $7.1 million out of the loss share amortization expense?

Ganesh Kumar

Correct. And going forward we still say as we said in the last quarter we go -- we project a run rate of $48 million for the FDIC amortization, but if we do a good job in achieving some cost recoveries on the covered portfolio, 80% of that would obviously a 100% would flow into spread income and the 80% would flow out through the FDIC amortization.

Operator

And your next question comes from the line of Robert Greene with Sterne Agee.

Robert Greene - Sterne Agee

Just couple of quick questions, more high level questions on the margin and the accretable yield. I know it's already unpredictable on a quarter-to-quarter basis. But as far as the underlying core portfolio, I mean, I was still looking at a 4.20% to 4.25% normalized margin for the portfolio?

José Rafael Fernández

I think when we look at our normalized name excluding all the noise from the purchase accounting and the whole issue, I think its closer to the higher end of the 4.25% may be we can 4.30%. But we really want to make sure that we communicate prudentially the real run rate of our net interest margin because it's going to be volatile in the next couple of quarters, given the efforts that we're doing on the cost recoveries on the covered portfolio, as well as the efforts that are being initially made now on the acquired portfolios. So those are going to have implications on NIM and that's something it's unavoidable for us right now.

Robert Greene - Sterne Agee

Right. Now, if I remember correctly I think a lot of the acquired commercial portfolio comes up for renewal in the third quarter, which is expected to I guess impact the accretable yield and sort of smooth out if you will. I mean, are you expecting as far as timeframe, are we still expecting a third quarter sort of normalization trajectory?

Ganesh Kumar

I'm not sure well, if we ever said that a lot of them come through renewal. Obviously there are some annual loans, some institutional loans, which repay in the second quarter end, and if we do originate them again, extend the line it will come into as inflows in the third quarter. But commercial per se, they are term loans and so there might be some repayments in scheduled maturities but not they don't come in a block, we don't expect them to be in a block.

Having said that I just wanted to bring your attention in the new supplement, as I said in the call during -- when I was walking through the slides may be I was not clear on Table 8. We recap the accretable yield and I would like typically this information is in the Qs and the Ks and this time we started providing this information.

So if you see the balance at the beginning of the period for the acquired non-covered loans is $542 million. If you go back to our 10-Q it was $508 million. And if you see such differences that difference is probably you should take it as a one-time because that's what is part of the remeasurement. But the line under that is more important it's the $54 million and that's roughly what has flown as accretable interest income into the quarter from those portfolio. So basically, you would know exactly tracking quarter-over-quarter whether there has been any one-time remeasurement effects or is it according to the cash flows.

Robert Greene - Sterne Agee

Just one more question on the margin, as far as you see leveraging actions in the quarter I was wondering that's changed your asset sensitivity, more or less asset sensitive. And additionally, if you put on any swaps in the quarter anything else that may have affected the margin?

José Rafael Fernández

No. First, the analysis and the forecasting that we're doing regarding different shifts in the yield curve put those again asset sensitive and even a little bit more asset sensitive than we were a quarter ago. So, we are well-positioned for an increase in interest rates. And secondly, we have not entered into any swaps or hedging strategies going forward regarding interest rates.

Operator

(Operator Instructions) Your next question comes from the line of Emlen Harmon with Jeffries.

Emlen Harmon - Jefferies

Hoping to, I want to address just the GAAP EPS guidance another way. And if I look at EPS for the last two quarters, it sums to $1.05, which I think might be would apply a pretty significant reduction relative to what we've seen in this kind of core quarter earnings in the first and second quarters. And even if -- even taking into account kind of the $0.20 impact from the tax rate that you guys called out in the deck. Can you kind of walk through what your general expectation is for the back half for the year and kind of what could impact that EPS run rate?

Ganesh Kumar

Well, let me start by saying Emlen that our guidance, we chose not to change our guidance. We chose to adjust our guidance based on the couple of factors that we mentioned. We feel that that we're very well positioned to over deliver versus under delivering and we're confident on that. But we chose half way through the year as we enter now in to the, crux of the integration efforts in systems and everything that we should not make a statement out there in terms of our guidance albeit beyond the adjustments that we discussed.

So I'm not sure if I'm answering your question. But we're very encouraged with what we're seeing on the second half. We have been quite consistent with our guidance and we plan to work hard to over deliver as the second half of the year come through.

Emlen Harmon - Jefferies

So essentially what you're saying is the update in your GAAP guidance it really only reflects kind of those three adjustments that you laid out in the deck today and not anything else going on?

Ganesh Kumar

Yeah, and certainly we're working hard to compensate for the additional tax increases organically. So we're working hard to make sure that we deliver a resource that to some degree mitigate the effects of the tax changes that have been imposing Puerto Rico. But I would like to deliver on those instead of promise.

Emlen Harmon - Jefferies

And then just on loan growth, you guys noted kind of a strong production in the quarter. As you lookout to the second half, do you feel like production is going to be strong enough to overcome kind of the runoff on some of the acquired stuff, so that you'll ready to be able to generate loan growth on an absolute basis?

Ganesh Kumar

I think on a worst case scenario, we will be flat in terms of loan growth at the end of the year, best case scenario we will be showing some level of loan growth by the end of the year. But from what we're seeing so far a -- this first half of the year and what we're seeing into the third and fourth quarter, I think we are very well-positioned to catch up in terms of loan balances.

Emlen Harmon - Jefferies

And then, one last one for me, just on the -- kind of I'm not sure if you addressed this directly with kind of the last couple of questions on the margin. But just in terms of the quarter margin and widening out some of the accretion and the recoveries that run to interest income, give me a sense of what you're seeing on a -- what you saw on kind of a core basis, if that's possible?

José Rafael Fernández

Well, look at the yield in our loans. And if you go to Table 5, you'll see there that our loan yield has gone up from the first quarter from 667 to 767, so a 100 basis points increase, yes take a little bit out the noise on purchase accounting. But certainly, we are increasing the yield on our loans and that's part of what you probably are going to get from our NIM.

And then, you look at the cost of funds. And we're also gaining traction with deposits but at the same time pushing down the cost of those deposits, at retail and institutional both. So again I think organically trying to exclude all the noise. And then, when we look at our margin guidance of 4.20% to 4.25%, I think it will be fair to say that we will be north of that guidance, just about the second half of the year, including the noise.

Operator

Your next question is a follow-up from Joe Gladue with CVB.

Joe Gladue - CVB

Just a quick question on the expenses, particularly related to the branch closing in the second quarter. Will there be any additional expenses, what's the latest estimate on any expense savings from those closings and you anticipate any other closings?

José Rafael Fernández

I'll let Ganesh to answer.

Ganesh Kumar

Joe, I think going back we initially projected what would be the savings and that was factored into the $1.40 guidance now it's $1.55. To tell you about the expenses what we've charged, taken as merger and restructuring, we've taken about $10.7 million in merger and restructuring. If you remove the $3.7 million out there for termination of a servicing contract, remaining $7 million goes towards integration expenses.

At the beginning of the year, we kind of projected that we would be spending around $8.5 million during the year, which means there is $1.5 million to go. So definitely as José Rafael pointed out the integration program is winding to a close. But however I think that third quarter will have, third quarter and fourth quarter put together will have other one $1.4 million, $1.5 million in expenses.

Operator

At this time there are no further questions. I will now turn the call back over the management for closing remarks.

José Rafael Fernández

Thank you, operator. Before we close, I wanted to thank our customers for placing their trust in our ability to serve them, our employees for their great contribution so far in the first half of the year and our investors for their continued support.

OFG Bancorp is poised to realize its potential as one of Puerto Rico's leading banking solutions. We have no legacy issues winding us down, we have a strong capital base, and we have a significantly improved market position. We look forward to talking to you soon and if not we will be again in touch in October when we hold our third quarter conference call. Thanks to all and have a great day.

Operator

This does conclude today's conference call. You may now disconnect.

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