OFG Bancorp's (OFG) CEO Jose Rafael Fernández on Q2 2016 Results - Earnings Call Transcript

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OFG Bancorp (NYSE:OFG)

Q2 2016 Earnings Conference Call

July 22, 2016 10:00 AM ET

Executives

José Rafael Fernández - President and Chief Executive Officer

Ganesh Kumar - Executive Vice President and Chief Financial Officer

Analysts

Brian Klock - Keefe Bruyette & Woods

Brett Rabatin - Piper Jaffray

Alex Twerdahl - Sandler O’Neill

Joe Gladue - Merion Capital Group

Presentation

Operator

Good morning. My name is Paula and I will be your conference operator today. Thank you for joining us for this conference call for OFG Bancorp. Our speakers are 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 in the Investor Relations website on the homepage in the What's New Box or on the webcast, presentations and other files page. Please note this call may feature certain forward-looking statements about management’s goals, plans and expectations, which are subject to various risks and uncertainties outlined in the risks 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. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session.

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

José Rafael Fernández

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

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

Please turn to Slide 4. Here is our dashboard of key business strengths. New loan generation remain robust, up more than 5% from the first quarter underscoring our growing retail franchisee. Originated loan balances continue to grow up 2.7% from March 31st and average originated loan yield increased 9 basis points.

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

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

Ganesh Kumar

Thank you, José. Good morning, everyone. I’ll start from Slide 5. This quarter, we closed $238 million in new loans, while higher than the first quarter; production was generally in the range of the last five quarters. Retail business teams had a stellar performance with commercial doing well too. In terms of fee revenues, mortgage banking activity saw higher volumes corresponding to the loan generation levels in the prior quarters. Wealth management also benefited from higher annuity sales and from cyclical insurance revenues.

Moving on to Slide 6. This quarter’s results were very similar to last quarter’s, as we had mentioned it would be so in our last call. Interest income from loans declined $1.5 million from the last quarter. This was due to lower balances from acquired loans as they continue to runoff and there were less cost recoveries.

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

NIM remains fairly leveled at 4.65%. There was a slight increase in provision mainly due to one acquired loan. Total non-interest expenses were down more than $1 million with decreases in compensation and G&A partially offset by increase in credit cost as compared to the first quarter.

In the first quarter, we had a gain on repo sale that explains partially the results. FDIC loss share expense was down a little bit as well.

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

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

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

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

The non-performing loan rates in also down both with and without PREPA and both the early and total delinquency rates are down. This is the result of our prudent lending standards combined with proactive servicing program we’ve put in place consistent with the realities of the economic environment.

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

On Slide 10, this is an update of our credit exposure 90 days or more delinquent, not that these are ledger balances and as such they exclude all allowances, purchase accounting and FDIC loss share amounts.

There are three key points. One, our overall outflows as continues to exceed inflows while we have kept charge-off levels under control. Two, we have actively reduced the delinquent loan inflows. And three, we have acted decisively to reduce the OREO/REPO balances in the last few quarters.

From our balance sheet, you can see this was at $55 million compared to $61.6 million last quarter and $134.4 million last year.

Moving on to Slide 11, you can see our capital ratios continue to exceed the requirements for our well capitalized institution. In addition, compared to 2012 end after our BBVA acquisition, leverage ratio TCETA and our capital ratio are all significantly up, while we have derisked the balance sheet to the extent possible.

On Slide 12, we ended the quarter with tangible book value of 14.98 for quarter per share up from last quarter. These metrics are up from the preceding quarters as well. We expect further steady growth of capital levels in the coming quarters.

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

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

José Rafael Fernández

Thank you, Ganesh. Please turn to Slide 14. We believe our first and second quarters this year demonstrate our plan is working, producing the expected results. To be clear, the operating environment is still challenging, but we continue to successfully adapt to it. Conditions are not favorable to aggressively build the balance sheet, but our retail marketing and our technology initiatives are enabling us to expand our customer base, increase deposits and maintain loan production levels.

As we mentioned in our news release today, in the second quarter of 2016, we introduced the Oriental Biz mobile app, adding mobile check capture for small business customers. We were the first to introduce this feature for retail customers in Puerto Rico in 2013, now we are the first to introduce this feature to small commercial clients.

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

With regards macro situation in Puerto Rico, our priority is to continue to closely monitor developments regarding PREPA. As I mentioned earlier, we’re encouraged by the additional progress been made and look forward to executing on the new jointly approved timetable. While still very early, the business community is only encourage PROMESA will create some certainty lead to a government fiscal solution and create a path toward economic growth, something we all like to see.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Brian Klock of Keefe Bruyette & Woods.

Brian Klock

Hey, good morning, guys.

José Rafael Fernández

Good morning, Brian.

Ganesh Kumar

Hi, Brian.

Brian Klock

So what’s interesting with all the headline risk everything you hear you know when reading the news you know its good job working through a pretty tough environment and the results you get, you put up so far this year and you also put out some pretty innovative products to your customers and kept running the business. So congratulations on that.

I guess with maybe a positive, we finally get in the couple of weeks is we finally had some pretty important things done you know from the fiscal situation with PROMESA, you talked about, so obviously - maybe you can say well there are anything that you guys put up the organic growth that was pretty solid in the quarter, so the only thing that you are starting to see maybe from the retail side or even commercial side that you know the businesses and consumers are starting to feel better about what’s going out and now that there is some progress you know towards some opponent fiscal - maybe translating into that good loan growth.

José Rafael Fernández

So Brian, let me kind of repeat of little bit of what I’ve said in the last several calls. The problem in Puerto Rico is not really the economy, it’s the government, it’s the fiscal situation. So what’s happened in the last several weeks is encouraging because it’s for the first time in several years there is at least a mechanism to address the fiscal situation in Puerto Rico which is mostly the fiscal imbalances that we have.

So I think it’s too early to tell, but certainly the PROMESA law prevented - first and far most prevented a government shutdown, because it allowed for a stand lawsuits and it allows also for Puerto Rico’s government to put a moratorium basically. So from that perspective, kind of the government lives to another day. From the business perspective though I think the business sector looks at PROMESA as a way to first bring stability, it kind of has the - we understand what the rules of the game will be, but there are still some pass that we need to follow which are going to be executed within the next several months which is naming the board and stuff like that.

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

Ganesh Kumar

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

Brian Klock

That’s great, thank you for that color, that’s very helpful. And I guess just one follow-up. You know so there has been lot of progress made on PREPA and I think you know as we’re getting closer to get ball over the goal line, I think you refer to the most recently generally approve timetable. So I think - the only thing we’re waiting right now is the investment grade rating from the rating agencies right, and I guess maybe you can just tell us what you think, the timetable is going forward figuring that last piece of puzzle?

José Rafael Fernández

Yeah, that’s part of one of the kind of tollgates that we need to go through, getting an investment grade rating for the restructure bonds and that is something that should happen in the next several months or at least be submitted to consideration by the credit agencies. Also we are waiting for the energy commission to conclude on the permanent rate increase. They have approved two rates increases, one is temporary and now they are in the analysis stage on the permanent rate increase for PREPA which will come later, it will come in the first quarter of 2017.

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

Brian Klock

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

José Rafael Fernández

Correct, correct, December of 2016. And again, we feel - on our position with PREPA, we feel that not only have we taken the appropriate allow ones, if you look at what happened with the PREPA bonds which is let’s say the proxy to our loan, those - that bond is trading around $0.67, $0.67 on the dollar, we have it on the books the loan which is gone all more tights on you know less than and it won’t have haircut, we have it on the books around $0.65 on the dollar. So we feel very comfortable with the level of provisioning that we’ve taken and how we continue to reduce the exposure on PREPA. And you know if you look at it right now from a government credit perspective, probably PREPA is the best credit that government of Puerto Rico has today.

Brian Klock

Yeah, I would agree with that and it would seem that obviously with the cash flows you’ve got in your PREPA line versus the bond that you guys should have a valuation above what the bonds are trading at. Right, so and I wanted to ask one follow-up but I’ll through this and get back in the queue. So soon could you then think about the reserve you have, what it has to be a final PREPA agreement that all RSA and getting the investment grade and the final before you say what’s real evaluate this reserve again.

José Rafael Fernández

I’ll let Ganesh to that.

Brian Klock

Okay.

Ganesh Kumar

Well we do well reserve technically speaking every quarter. You know I think we have our assumption in our model in terms of not given default and probabilities. I think we’ll continue evaluating. But conceptually speaking, you know I think one would at least assume that if things don’t deteriorate or if even improve, the reserve could be released potentially with the principal payments that’s coming in, because this loan unlike the other bond which has got the principal holiday, it is built in amortization schedule for the principal.

Brian Klock

Got it, that’s very helpful. Thanks for your time guys.

José Rafael Fernández

Yeah, you’re welcome.

Operator

Your next question comes from Brett Rabatin of Piper Jaffray.

Brett Rabatin

Hi guys, good morning.

José Rafael Fernández

Hi, good morning.

Brett Rabatin

I wanted to - I guess first is talk about the funding mix and the changes in the deposits linked quarter, can you guys maybe talk a little bit more about you know the averages versus in the period and just kind of you are obviously trying to grow the core deposits but there was a linked quarter increased in the NOW accounts, can you maybe just talk through that and kind of what’s your expectations might be for you?

José Rafael Fernández

Yeah, I have to tell you the averages are not very far away from the - at quarter end balances, sport balances. The increase in NOW accounts are primarily because of one account that we had opened towards the end of the first quarter and we had to adjust the interest payments schedule during the quarter. So most of the increase could be explained although I think it’ll be a little bit higher but not this high at it indicates in our cost of fund table.

So I think the - two things are there. One thing is the averages are very close to the balances that we do and increases primarily because of a non-recurring item that is there.

Brett Rabatin

Okay. And then just with what’s going on in Puerto Rico you kwon when thinking about your loan generation which you know is a little bit better linked quarter and you saw some CNR growth although the originations were a little lower in that category, are you any more optimistic on maybe net loan growth going forward obviously the run off of acquired loan is a headwind but any thoughts on your optimism level on the organic portfolio growth.

José Rafael Fernández

Ganesh mentioned earlier retail and we certainly are encouraged with the momentum we have having with retail on the retail lending side and that is something that we continue to focus on. On the commercial side is I see it more steady, it’s more you know larger ticket items and we you know from our perspective, we feel we need to see a little bit more clarity in terms of the economy going forward to kind of be more aggressive. But we’ve very encouraged with the retail performance and how we’re generating good yields there too. As you noticed on our numbers, our yields are up 9 basis points on the loan side and it’s primarily because of the retail originations.

Brett Rabatin

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

José Rafael Fernández

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

Brett Rabatin

Okay, great, nice results. Thanks guys.

José Rafael Fernández

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

Operator

Your next question comes from Alex Twerdahl of Sandler O’Neill.

Alex Twerdahl

Hey, good morning.

José Rafael Fernández

Hi, good morning.

Alex Twerdahl

Couple of questions from me, first off, you changed the strategy last year I believe a little bit to instead of selling mortgage production to turn them into mortgage-backed securities and keep them on the balance sheet. And then it looks like this quarter, you did actually want of setting some so, has the strategy shifted back towards doing mortgage banking and selling them in just secondary market or?

José Rafael Fernández

No, Alex, it’s just a - we did not entirely shift what we had in the previous quarters. We are retaining the GNMA securitizations and trading the FNMA. And as the volumes go up, the activity goes up as well and that’s what you see in this quarter.

Alex Twerdahl

Okay, so you retain GNMAs, you sell the FNMAs.

José Rafael Fernández

Exactly, yeah.

Alex Twerdahl

And then Ganesh in the past you’ve given sort of a range and expectations for the margin going forward and I know you’re getting closer to a core margin. Those are the moving parts that happened into quarter. Can you just maybe update that guidance? I think in the past you said us between sort of 4.4 and 4.6 was sort of an expected range, is there any update to that?

Ganesh Kumar

So if you want an average between the 4.4 and 4.6, I would say 4.5, but we hope to beat that thing and I am being - you heard about the margin but I think it depends on the loan mix that we generate. So that’s - basically I would say you know it’s a range of getting 4.5 to 4.6 is what you would see.

Alex Twerdahl

Okay. And then you know you talked about in your prepared remarks and answer to a previous question, you were saying business - the business sector is optimistic volume PROMESA but not yet gone. I mean as you look out sort of things that have been created at control board actual resolves and debt et cetera, what’s the headline in your opinion that we see come across or all this on business leaders go from taking this capital list on the sideline optimistic to actually making investments in the Island?

José Rafael Fernández

I think it will take - it will take - first and foremost you need to restructure the debt you know and that’s going to take a while. First you need to get the board then you get the team that reports to that board and then you got to work on restructuring the debts. And once that gets done and once there is clarity there, then I think the business sector will feel more comfortable because then the equilibrium is achieved between expenses and income hopefully.

And then - and certainly as I said in the call earlier, it’s about economic development, it’s about economic growth. And if the fiscal board come here just to reach a fiscal equilibrium without a focus economic development, I don’t think they are working for the long term. So I am encouraged to see that there is a congressional committee that it’s been appointed already that has a deadline by December of this year to provide recommendations. I hope that they take this very seriously because for the long term sustainability of the economy of Puerto Rico and have a stable growth rate, economic growth rate. We need to make sure that there is an economic development plan, at the same time that the fiscal situation gets resolved.

So from my perspective, I think it’s going to be sometime next year that the restructure will hopefully get significantly done. I am very encouraged to see that PREPA will get done before the end of this year and we can move forward and that’s one of the largest, it’s not the largest credit in the government of Puerto Rico right now, it’s Ex-GOs and COFINA. So from what we’re seeing all the trends and what we’re seeing on all the momentum that is being build, I think I am encouraged to see that we’re moving in the right direction.

But again as you guys to do us, result is what matters. So we’ll be very focus on how things turn out with the fiscal board.

Alex Twerdahl

Okay. And do you think the same sort of commentary on as you look at your capital position and you got the dividend but just in terms of other capital return perhaps being up to buyback share at some point of time, is that pretty much also dependent on sort of the same timeframe that you just laid out for increased optimism on the Island?

José Rafael Fernández

So from our perspective, capital is king and because of what as I said in the past, it’s important for us to build out capital levels, continue to build them because of uncertainties that still remain. But as the uncertainties start to recede, we will feel more comfortable and we will feel more confident and we’ll evaluate that point in time. But we can’t predict the future at this time in terms of how everything is going to play out here in Puerto Rico. There is still few innings to go in terms of getting the fiscal housing order.

Alex Twerdahl

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

José Rafael Fernández

No, I mean the only derisking remaining is PREPA, if you ask me the rest is just blocking and tackling. We have done a very good job as Ganesh mentioned on reducing our repo lot on autos. We done a good job on reducing our REOs and we’ve done a great job on reduction our non-performing loans. I mean the charges are all moving in the right direction at the right speed. So it’s about blocking and tackling on that end. And you know we need deal with the remaining six months on how to finalize the PREPA deal. So that’s kind of our gain plan, while we watch the fiscal situation in Puerto Rico and hopefully this beginning of a discussion on economic development for the Island.

Alex Twerdahl

Great, thank you taking my questions.

José Rafael Fernández

Yeah, you’re welcome. Thank you.

Operator

[Operator Instructions] Your next question comes from Joe Gladue of Merion Capital Group.

Joe Gladue

Hey, good morning.

José Rafael Fernández

Hi, Joe.

Joe Gladue

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

José Rafael Fernández

It’s primary loan mix, Joe.

Ganesh Kumar

Yeah, retail loan mix, yields.

José Rafael Fernández

As the retail and auto loans are higher in proportion than the commercial loan yield, if the yields will up.

Joe Gladue

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

José Rafael Fernández

Thank you, Joe.

Operator

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

José Rafael Fernández

Thank you, operator. Thank you also to all our stakeholders who are listening today. Looking ahead, we’ll be at KBW Community Bank Conference on August 2nd in New York City. In September, we plan to host Piper Jaffray as part of their investor visit to Puerto Rico and we preliminarily schedule our third quarter conference call for October 21st. Until then, thank you all and have a great day and a great weekend.

Operator

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