OFG Bancorp (OFG) Q3 2015 Earnings Report, Transcript and Summary

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 on the Investor Relations website on the Homepage 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 Risk Factors section of OFG's Securities and Exchange Commission filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call, as a result of developments, which occur afterwards. 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. Fernández. José Rafael Fernández: Good morning. Thank you for joining us. We received good feedback to the shorter format presentation we did last quarter, so we will continue with that and I will address the big picture here in Puerto Rico that affects OFG, then we will open it up for questions-and-answers. We have all our usual quarterly slides in the appendix of today’s presentation, Ganesh and I will be happy to answer any questions on that. To start, please turn to slide three; there are four major points that I would like to communicate today. One, Puerto Rico’s economy remains flat. It is not falling off a cliff as many people outside the island hear. The GDB Activity Index has been mostly stable since early 2014, the Puerto Rico Manufacturers Purchasing Index indicates relatively flat trends and September Unemployment reaches seven low with the private sector adding new jobs. However, there is still a great uncertainty about the future, Puerto Rico’s Government liquidity is declining and the threat of the Government shutdown and/or default still looms. We believe a comprehensive solution is needed and we are encouraged by the attention Puerto Rico has received from the Federal Government in recent weeks. But more needs to be done out of Washington and from the local Government officials. Second, we have continued to make important progress working out our PREPA loan. As everybody knows from news reports, PREPA has reached agreements with the Ad Hoc bondholders and the few aligned banks which we are part. The Government is about to introduce the PREPA Revitalization Act to facilitate needed reforms. Based on what we have seen in the media, there appears to be increase confidence on the part of PREPA to reach an agreement soon with the monolines and it will be our desire to conclude all these by the end of this year or at least at the latest the first quarter of 2016. Three, our core business is strong and stable, we are growing our originated loan balances and income, credit metrics are solid, loan production was strong in the quarter, we are seeing net new retail customer growth, fee income performed well and capital levels are strong. Four, we significantly reduced risk in the third quarter. We reduced our Puerto Rico Government and agency balances by 28% from the second quarter, the recent bulk sale of the former Eurobank and BBVA Puerto Rico non-performing assets will reduce credit cost going forward and our originated loan credit metrics were relatively stable. Please turn to slide four for a summary of third quarter results. We reported a profit of $1.1 million or $0.03 per share. That, of course, included $20 million in pretax costs associated with the bulk sale. It also included $3 million a net benefit from other non-recurring items. Excluding these factors, core profitability was $12.2 million or $0.28 per share. This compares favorably to second quarter’s adjusted results of an $11.5 million profit equal to $0.26 per share. Highlights of the quarter included sequential growth in tangible book value and book value per share, and an expansion of the tangible common equity ratio. We continue to grow the Oriental franchise, we gain market share in conventional mortgage originations, consumer and auto volumes are up this quarter and we announced My Status, an industry first mobile app, for clients to track the status of the residential mortgage application. That is part of our strategy to continue to win business through service and best-in-class customer experience versus reliance only on price competition. During this quarter, we decided to retain some of our GNMA mortgage core production for its recurring income rather than selling it into a secondary market. In addition, non-interest expenses came down as a result of lower OREO and auto repo cost. We expect our core business to continue to do well in spite of the challenging economy and assuming that there is no additional economic contraction due to a government shutdown. However, this will be somewhat affected by lower interest income from former Eurobank loans and from the reduction in Puerto Rico government and agency loans. Ultimately, we look forward to put our Puerto Rico government exposure behind and highlight our core business successes. Please turn to slide five. Now, I’d like to address our Puerto Rico central government and public corporation loan exposure in more detail. As of September 30th, it totaled $216 million, down 28% from June 30. PREPA, even though we placed this loan on non-accrual status in first quarter of 2015, we continue to receive interest payments. During the second and third quarters, the principal balance has come down to $194 million. This does not include the $24 million provision we took in the first quarter. As I mentioned earlier, the Ad Hoc bondholders and banks have reached an agreement to work out PREPA’s bond and bank debt. As a result of this progress, there was no need for additional provision. We had $78 million loan with Puerto Rico State Insurance Fund. This was completely paid off in the third quarter. This resulted in a $3.2 million cost recovery in interest income on prepayment penalty totaling $800,000 that added to bank service revenue. We also have a $21 million in long-term credit facility to the Puerto Rico Housing Finance Authority. It is repaid from inactive and unclaimed customer deposits from local financial institutions. This loan balance declined 17% due to the repayment in the third quarter. To start, two years ago, our Puerto Rico central government and public corporation exposure was $772 million. That has been reduced by $556 million or 72% without a loss. Please turn to slide six. The other local government exposure we have is $203 million in loans to five of the largest municipalities. This balance is also down by about 5% from June 30. These municipalities as we’ve said in the past are autonomous from the Central Government and its agencies, and these loans do not share the same credit characteristics at the Central Government. These municipalities have the most in terms of population and property values. They are also the most important centers of economic activity and have the highest potential to generate property tax revenue among municipalities in Puerto Rico. These loans also are collateralized and guaranteed by first lien on property taxes and secured by money set aside in special accounts held by GDB. We continue to be comfortable with the municipalities debt service capabilities. The weighted average aggregate debt service coverage ratio is around 2.3 times. Our shock scenarios assuming drops in property tax revenues indicate north of 100% coverage. Recently, there has been a legal dispute between CRIM, the agency that collects these taxes, some of the municipalities and the GDB over where these tax deposits should be held. We expect this will be satisfactorily settled soon. Please turn to slide seven. Our capital ratios continue to exceed requirement for well-capitalized institution. And as you can see, we continue to have a strong capital position. Please turn to slide eight. Our tangible common equity remains very strong. Tangible book value per share increased to $14.76 in the third quarter from $14.67 in the second quarter. The TCE ratio expanded to 9.11% from 8.91%. Before we conclude we noted in our release today that Oriental Bank has entered into a consent order with the FDIC. The purpose is to address certain matters related to our Bank Secrecy Act anti-money laundering compliance program. I would like to note that it did not invoke any civil penalties. Please turn to slide nine. To sum up, we will continue to focus on aspects of the business that we can control. Going forward, NIM should be in the 4.5% range. This is due to reductions in higher yielding Puerto Rico government and Eurobank loans. However, our level of success in retail loan production might be able to counteract some of this. We will continue to reduce credit risk when possible. Currently nothing is spending, but we have a track record of acting when opportunities present themselves. We sold off all residential NPLs in 2014, we sold problem MSRs earlier this year and they’re working on bulk sale in this third quarter. We will continue to maintain pricing discipline and prudent underwriting standards. This has served us well. Originated loans have been averaging a 6.4% yield over the past year and net charge-off rate has averaged only 1.2%. We will continue focusing on creating best-in-class customer experience. Over the last two year we have introduced four major consumer technology innovations. This has made it easier than ever for customers to do their banking with us. In turn, this has enhanced our efforts to grow their franchise organically. Over the last five quarters we have averaged more than $250 million in new loans. We have also been averaging about 5,000 net new retail deposit customers the last couple of quarters. Clearly, we cannot control whether Puerto Rico central government will negotiate with bondholders. So we have to stay vigilant, closely monitor our direct exposures, and continue to approach the next quarters cautiously. However, with our solid capital levels, favorable balance sheet, and good expense control, as we have showed you in our credit shock scenarios, we are well-positioned to navigate the challenging environment we face. That ends our formal presentation. Operator, please open up the call for questions.

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

Good morning, gentlemen. José Rafael Fernández: Good morning, Brian.

José Rafael, I guess the question for you would be the other matter that you discussed with the consent order around the BSA/AML. I know it’s early in the process, but I guess what are you thinking about as far as -- it’s a good news that there is no civil monetary penalty, so I guess is there a thought process about I guess expenses going forward about having to either comply with or enhance some of your internal controls? José Rafael Fernández: Hey, Brian, thanks for the question. The way I can easily answer that question for you is that we have been working with this, a, for the last year or so. It’s something that we have been already built in into our expense, the results you’re seeing with our expense levels. So we don’t -- even though we have increased our expenses due to BSA, they have already been baked in into the results that you’ve seen. We do not expect any significant incremental expenses from that part right now. They have already been kind of included in the results.

Okay. Thanks for that. Appreciate that. And I think the quarter and I would say thanks again, like on page four of the release, there was a lot of noise with the bulk sale and some moving parts, so thanks for that reconciliation, it helps to work clearer form of your kind of recurring earnings power. So given how challenging it’s been in the economy, at least the headlines, I would say, I mean it’s challenging economy that you’re dealing with in challenging times, but maybe just talk about, there is some stability though on the ground it seems. As you mentioned, the economic activity index seems to be so much stable and you’re seeing some good origination trends. So maybe just talk about that dichotomy of what you’re reading in the paper if you’re not in Puerto Rico and what you’re seeing on the ground and how you guys are operating through that? José Rafael Fernández: So, we see the numbers and certainly the consumer continues to be resilient to the economic situation in Puerto Rico and the level of consumption remained relatively stable also. You are seeing -- again, we’ve been at this for nine years and the businesses that we visit and I visit clients got often. They continue to tell me a couple of things. One, we have been able to streamline our operations and certainly are preparing ourselves to a difficult economic environment. Two, energy prices are down significantly and therefore, that has given them some cushion in terms of being able to navigate the environment also. So that’s one side of what you are seeing. And I also think that it has to do a lot with two different types of industries. Certainly, industries related to professionals and manufacturing that does not depend on government as a client. They remain strong and this will steer some economies so that the weak are being bought by the stronger and we tend to look towards those types of clients to do business with them.

Okay. Thank you for that. José Rafael Fernández: We are also seeing, Brian, a lower levels of cash on the different businesses that we do business with and that’s because they are trying not to leverage themselves to invest in their different operations. So they are using their access cash to kind of invest in their operations rather than going out and borrowing. We are seeing that on several different industries. But in general, I think that the economy is not falling off the cliff as I said and it’s going to be very much dependent on how the next couple of quarters or months the central government liquidity shortfall plays out and that’s what concerns us.

Sure. And I guess maybe my last question and I will get back in the queue. So when you think about that, so you spend the time to try to go through your exposure. Obviously, you’ve done a great job working through the direct government exposure. But I guess as far as the indirect, how do you think about the potential issues if there really is a government shutdown and is that something that -- I guess, how worried are you in the near-term on that? José Rafael Fernández: We have been proactively analyzing the direct exposure in all our portfolios. We feel comfortable that the exposures that we have, not only are they manageable but they are also focused from our part to make sure that we reduce them or proactively manage and interact with those clients to make sure that they reduce their government exposure. I think we’ve been very successful and really does not have much over of an effect. It’s around $82 million in total that we have of indirect exposure to the Puerto Rico government on the commercial loans.

Okay. Great. Thank you for your time. Appreciate it. José Rafael Fernández: Yeah. You are welcome.

[Operator Instructions] Your next question comes from Emlen Harmon of Jefferies.

Hey. Good morning, guys. José Rafael Fernández: Good morning, Emlen.

Good morning.

I just have a quick follow-up on the BSA consent order. Were there any capital provisions related to that order? José Rafael Fernández: No.

Okay. So no restrictions on capital levels or capital allocation systems. Got it. Okay. And then I would -- second, Brian, thanks on the reconciliation tables. I think those are going to be pretty helpful. When we think about just the interest income effect from those bulks sales, your brook it down into two, kind of two components as a $7 million component and the $3 million component. That $7 million, is that a full quarter’s kind of run rate from the sale, or is there an incremental effect that we should be thinking about as we head into the fourth quarter?

Emlen, this is Ganesh here. The $7 million what we said was because of the accounting effect of this sales. Going forward, we do believe the Eurobank will not -- Eurobank portfolio will not have such a high yield and it should drop. And we are in the process of working our forecast and we need to work on it and do exactly price what is going to be.

Okay. José Rafael Fernández: It’s going to be much lower than the 22%, 32% that we have, we are usually.

Right. José Rafael Fernández: Yeah. Yield wise.

Right. Got you. Okay. And then last one from me. You guys added some, you mentioned you added the, you should be adding more mortgage to the portfolio instead of selling this quarter? Is that something you think you will continue to do?

Yeah. It’s something that makes sense to us from a yield perspective rather than going out and buying mortgage-backed securities at 2.25%. We are holding on to our FHA originations and securitizing at 3% unchanged. So it makes sense for us and it also tax exempt so we make this.

Okay. All right. That was it from me. Thanks. José Rafael Fernández: Thank you.

[Operator Instruction] Your next question comes from Taylor Brodarick of Guggenheim Securities.

Great. Thank you. I guess, really two questions from me. Just looking at the charge-off on delinquency slide, I guess, how much of the decline is from the bulk sale is risky? I’m just trying to get a sense on the four trends? José Rafael Fernández: Can you repeat the question? You got little bit cut-off.

Sorry. I think I am having some telephony issues. I was just wondering, so just looking at the improvement in the delinquency rate. I guess, how much of that is a function of the derisking to the bulk sales and is the core -- is your core improvement tracking that as well? José Rafael Fernández: Well, actually, Taylor, if you look at table six, we show over there excluding acquired loans. And so if you look at that that should give you the idea of what is the decrease in our non-acquired book. And we show a decrease in the earlier delinquency and as well as the NPA level a bit.

Okay. Got it. Okay. Great. And then, I guess, have you updated the credit shock scenario that you released at the last earnings call? José Rafael Fernández: Yeah. We are in the process starting that process, the last one was what we presented last quarter. And we will be continuing to update that starting right now.

Okay. All right. Great. All right. Thank you very much. José Rafael Fernández: You’re welcome.

[Operator Instruction] At this time, there are no further questions. I’ll now turn the floor back over to Mr. José Rafael Fernández for any closing remarks. José Rafael Fernández: Thank you, Operator. Thank you also to all our stakeholders who listen in today. In November, we will be visiting investors in Dallas and at the Sandler O’Neill East Coast Financial Services Conference in Palm Beach. So we look forward to seeing some of you there. And our preliminary date for reporting fourth quarter result is Friday, January 29, 2016. So, thank you again and have a great weekend.

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