OFG Bancorp (OFG) Q3 2023 Earnings Report, Transcript and Summary

Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is James, I will be your operator today. Our speakers are Jose Rafael Fernandez, Chief Executive Officer and Vice Chair of the Board of Directors; and Maritza Arizmendi, Chief Financial Officer. A presentation accompanies today's remarks. It can be found on the home page of the OFG website under the Third Quarter 2023 section. This call may feature certain forward-looking statements about management's goals, plans and expectations. These statements are subject to risks and uncertainties outlined in the Risk Factors section of OFG's SEC filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. [Operator Instructions]. I'd now like to turn the call over to Mr. Fernandez.

Good morning, and thank you for joining us. We are very pleased to report our third quarter results. All our businesses performed well, and we continue to generate steady year-over-year revenue and earnings growth. Highlights include increased loan balances, stable core deposits with low cumulative beta, increased operating leverage and strong credit and performance metrics. Our digital-first strategy continues to attract customers and speed the transition of routine transactions from in-branch to digital platforms. This makes it easier for customers to do their banking and for us to increase efficiency and engage in more business development activities. In Puerto Rico, consumer liquidity is sound and the economy is doing well. As always, thanks to our team for helping our customers and the communities we serve achieve their financial goals. Please turn to Page 3 for a summary of our third quarter results. First, looking at the income statement. Earnings per share diluted was $0.95, an increase of 9% year-over-year. Total core revenues were $172.2 million, up 10% compared to last year. Net interest margin was 5.8%, provision was $16.4 million and noninterest expenses were $90.2 million. Pre-provision net revenues totaled $82.3 million, up 18% year-over-year. Now turning to the balance sheet. Total assets increased to $10.3 billion from last quarter. Based on our growth and outlook for next year, we will remain above $10 billion. Customer deposits were stable at approximately $8.5 billion. Loans held for investment totaled $7.3 billion, up 2% from the second quarter. New loan production was approximately $563 million, in line with the last 5 quarters. Investments increased to $2.1 billion and cash declined to $533 million. Moving to capital. The CET1 ratio was 14.03%, level with the second quarter. We bought back about 74,000 OFG shares in the third quarter. Please turn to Page 4 for an update on our digital first strategy. Looking at data year-to-date September compared to the same period a year ago, 87% of all routine retail customer transactions and 92% of all retail deposit transactions are now being made through digital and self-service channels. This has been driven by 11% growth in digital enrollment, 14% growth in digital loan payments, 5% growth in kiosk usage and the success of our recently deployed Oriental Servicing portal. The portal is a cornerstone of our self-service strategy. Customers can manage all loan and deposit accounts in one place. The portal now enables digital account opening for checking, savings and CDs, applying for and accessing loans, managing automatic loan payments, and downloading a wide variety of bank letters and tax documents that customers in Puerto Rico frequently request in our branches or by phone. New features to the portal will continue to be added on a regular basis. All this continues to validate our strategy and investments in technology. As I have mentioned before, they help us provide more value-added service, increase our efficiency and assign more staff for new business development activities. Having said that, branches continue to be an important component of our island-wide sales and service network. During the third quarter, we opened a new branch in Dorado, an area with good commercial and retail opportunities. As you probably already know, Dorado is a growing high net-worth suburb of San Juan that has attracted many new residents from the Mainland. We already have a 9% market share there, and we think we can grow further. These developments, both digital and physical, continue to better position us to serve our customers and communities and grow our businesses. Now here is Maritza to go over the financials in more detail.

Thank you, Jose. Please turn to Page 5 to review our financial highlights. Let me start with total core revenues. Net interest income totaled $142 million, an increase of 1.5% from the second quarter. This reflected the full effect of the fed 25 basis points increase in the second quarter, the partial effect of the 25 basis point increase in the third quarter. Higher yield on higher loan balances, in particular variable rates and new loans, higher balances and yield on investment securities and one extra day, which added around $1 million. Banking and wealth management revenues were $30.4 million, approximately level with the second and year ago quarters. Other noninterest income totaled about $300,000. This compared to a loss of about $800,000 in the second quarter due to the early sales of our $200 million treasury loans. The efficiency ratio was 52.36%, reflected continuous growth, strong operating leverage. Noninterest expense totaled $90 million, $1 million higher than the second quarter. This reflected lower gains on the sale of closed real estate, partially offset by lower G&A expenses. We expect noninterest expenses to continue to average about $90 million to $92 million next quarter and next year. The efficiency ratio will continue in the low to mid-50% range. Other performance metrics remained high. Return on average asset was 1.76%. Return on average tangible common equity was 17.59% and tangible book value per share was $21.01. Please turn to Page 5 to review our operational highlights. Average loan balances increased $188 million from the second quarter. The end-of-period balance increased $144 million. Growth continued to reflect increases in Puerto Rico and U.S. commercial loans and retail auto and consumer loans. This was partially offset by the continued regular paydowns on the residential mortgages. Loan yield was 7.84%, up 8 basis points from the second quarter. This reflected increases from variable rate commercial loans and higher yields on new auto, consumer and commercial loans. Average core deposits increased $90 million for the second quarter, while the end-of-period balance was approximately level with June 30. Retail deposits declined $102 million, commercial increased $73 million and government increased $30 million. We continue to see a shift to time deposit and wealth management. Core deposit cost was 90 basis points compared to 69 in the second quarter. This increase of 21 basis points mainly relates to 6 basis points due to higher rates on government deposits, 6 basis points in time deposits, 4 basis points in commercial now and savings accounts and 4 basis points in retail now and savings accounts. As of the third quarter, our cumulative deposit beta has been 19%. Excluding government deposit, it was 14%. Through this cycle, we continue to expect a cumulative deposit beta of about 25% at the end of this year. Average borrowings were $264 million, while the end of period balance was $452 million. The increase reflected our asset liability management strategies during the quarter. Net interest margin was 5.80%. That compares to $5.90 in the second quarter. Our effective tax rate was 32%, which should be our rate for the next -- for the year. Please turn to Page 7 to review our credit quality and capital strength. Net charge-offs totaled $18.8 million. That compares to $6.6 million in the second quarter. The third quarter included about $7 million for 2 U.S. loans previously and substantially reserved. This compares to the second quarter, which included a $4 million recovery from the sale of older fully charged-off auto and consumer loans. Provision for credit losses totaled $16.4 million. This included more than $11 million due to increased loan volume, $4 million in quantitative adjustment mainly related to the auto loan portfolio and $700,000 for a specific for the sale of a small portfolio of nonperforming Puerto Rico small business commercial loans. Overall, credit continues to be strong. Early and total delinquency rates were 2.75% and 30.78, respectively. The nonperforming loan rate at 1.33% was in the lower ranges seen over the last 5 quarters. Looking at some of our other capital metrics, total stockholders' equity was $1.1 billion, and the TCE ratio was 9.4%. To sum up, during the third quarter, we saw a steady revenue growth from higher yields on higher loan and security balances, good originations driven by auto, commercial and consumer lending. Deposit costs increased from higher average balances during the quarter and higher rates, but betas remained well below peers. End of the year balances were approximate level with the second quarter, credit conditions remained benign, net charge-offs were higher due to U.S. commercial loans and expenses were in line with our expected range. Now here is Jose.

Thank you, Maritza. Please turn to Page 8. Our outlook has not changed from the second quarter call. The economy continues to do well, supported by the flow of federal funds to rebuild the island infrastructure as well as additional federal funding from the inflation reduction on the CHIPS Act. With this as a backdrop, consumers continue to deploy their liquidity, and U.S. private capital and local businesses are investing to acquire, expand and grow their operations on the island. Having said that, we continue to keep our eye on the potential impact of interest rate changes, inflation and a possible mainland recession. Also, and while it's unlikely to affect Puerto Rico directly, the recent incursions in Israel and the mounting events in the Middle East region leave us with a heavy heart, and our wishes for an early end to the fighting and for pace. We can help but be concerned about the possible global economic ramifications as well. All in all, we remain optimistic about Puerto Rico's strength and its continued doubling from mainland economic uncertainties. Now turning to OFG and to sum up on my end, we had another excellent quarter confirming our operational and financial strategies. Results benefited first and foremost, from our efforts over the years to grow our commercial and consumer business capabilities, which are helping us gain market share and increase capital; second, from our stable, low-cost core deposit base; and third, from our new Oriental Servicing portal and other technology investments, which have increased the use of customer self-service channels, allowing our teams to spend more time on new business development activities. Externally, we benefited from the positive and more resilient economic environment in Puerto Rico. All this translates into a strong commercial lending pipeline for us into the fourth quarter and into 2024, and our ability to continue to deploy innovations to better service the banking and financial needs of our customers. Against a higher base, this should result in continued growth across most of our businesses next year. In closing, I want to reemphasize that our performance could not have been possible without the hard work and purposeful commitment of all our team members. We are thankful to them for executing our corporate vision. This ends our formal presentation. Operator, let's start the Q&A.

[Operator Instructions] Our first question today will come from Timur Braziler with Wells Fargo Securities.

Maybe starting on -- maybe a comment around deposit beta expectation and still, call it, a 25% beta by year-end, I mean, that sounds pretty conservative. But then maybe thinking in a longer term, just starting at such a low base and a higher for longer environment, is the expectation that deposit betas and deposit costs continue to might be higher just given such a low starting base? Or do you still see some abatement there as we get a quarter to pass the final rate hike?

Yes. Thank you for your question, Timur. The way we look at this is in terms of deposit costs, and the corresponding data. First, let's look at our market and the market we're operating in certainly is very different from the U.S. market, and that gives us a different -- a very positive landscape to operate in. That's number one. Number two, we also look at it from our business strategy perspective and our customer kind of relationship perspective. So we also want to have some wiggle room to be able to attract additional customers and also to retain some good relationship customers, particularly on the commercial side. So we are sticking with a 25% beta for the end of the year. And we'll take a look at it at the end of the year and see how do we see it as interest rates would probably remain higher for longer and what impact would that have in our market. But as of now, we feel that the -- with the 19% cumulative beta, including government deposits, keeping the 25% beta for the end of the year is the prudent way to go.

Okay. What is the balance of government deposits at quarter end?

The balance of government deposit is in the $350 million range.

Okay. So I guess as we're thinking about next quarter, next year, if deposit betas do lag, if they do go up to that 25%, maybe it's not in 4Q, maybe it's 1Q or 2Q next year, the growth profile still seems pretty strong. Is the expectation that you're able to offset this NIM compression with growth and NII continues to go higher? Or is that going to be more challenging in the current environment?

Yes. So as you saw this quarter and you've seen so far this year, we have pretty good loan growth and we expect that to continue to build throughout the next year. So our way of looking at this is if the scenario plays out next year, where we need to think about higher cost of deposits, we'll mitigate that with our loan growth from a net interest income perspective. So yes, we might have, right now, a lower trending NIM, but that does not necessarily mean it will be a lower trending net interest income because we expect loan growth to compensate for that.

Okay. Great. And then just lastly from me. On the credit front, we saw a bump-up in net charge-offs, and Maritza explained that and kind of the corresponding decline and allowance ratio. I know it's a hard question to really get a good answer for. But as you think about this normalizing credit environment, how should we be thinking about net charge-offs? And then would the allowance ratio still well over 2% of loans, is that pretty flat and kind of goes hand-in-hand with charge-offs? Or is there maybe an ability to reach some of those reserves as the broader Puerto Rico story continues to improve?

Well, thank you, Timur, for your question. This quarter included about $7 million in the charge-off of 2 loans that were previously reserved and we discussed during our last call, in the second quarter, we talked about these loans that were ported in all accrual. And we completed the restructuring of one of them during the quarter, and it requires about $4.2 million in charge-offs. The other one was transferred to held for sale at the end of the quarter, and it requires about $2.7 million in charge-offs. That loan was already sold on October 18. So that reserves were already established in prior quarters. So if you exclude that 2 loans, our net charge-off is about 0.62% for the quarter, which compares really good with the prior quarters. And as we look forward, I think we are starting to see a more normalized level of charge-offs compared to 2021, 2022. But we need to keep monitoring that trend to see what would be the normal trend. We think the credit conditions continue to be benign in Puerto Rico compared to prepandemic levels, and that's how we see it.

Our next question will come from Alex Twerdahl with Piper Sandler.

First off, just it sounds to me, José, now like you're fairly committed to being above $10 billion. And I'm just curious how you're thinking about the overall strategy, the overall growth strategy. If that's no longer sort of an upper level on assets, how you think about how the balance sheet might transition over the next couple of quarters as you continue to deploy the excess capital that you have.

Yes. So yes, look, the way we look at the $10 billion mark this year is very different from the prior 2 years where we managed below the $10 billion mark. And it has everything to do with where interest rates are and how the -- kind of how the balance sheet from the loan side in terms of loan growth and also the deposit side how it's playing out. We feel that it makes sense for us to cross it right now and just make sure that we take advantage of the opportunities to grow the balance sheet from the loan side, particularly here in Puerto Rico. And that's what we're committed to do. We see good opportunities on the commercial side as well as on the retail side. So managing it into next year -- I'm not sure what exactly you mean by the question on how to manage it into next year, but I can tell you that we will have -- our balance sheet will be north of the $10 billion, and it will be impacted by the expected loan growth that I've guided to in my original remarks. So if there is a follow-up, please feel free because I'm not sure if I understood your question.

Yes. I mean it looks like sort of just high level on the balance sheet that you guys added some borrowings, added some securities. I don't know if leverage is the right term there or maybe it's just sort of a mismatch in timing. But I guess, as you look to grow loans, how are you thinking about funding it the complexities there?

I get it. I get it. Now I get it. So that's a very valid and good question, Alex. The way we look at this is the scenario of interest rates that we are using and we expect our interest rate forecast is for interest rates on the Fed fund side to remain kind of plateauing at these levels, 5.25, 5.5, and we also expect into 2024 interest rate to start ticking down the second half of the year. So when we look at that scenario and us being an asset-sensitive bank, we felt that it was prudent to put in some -- now with MBS as yielding 5 60 and north of that with short duration, 4.5, 5 years duration, it will be prudent for us to protect ourselves in an environment where interest rates start moving down. Just recall, 1.5 years ago, we kept dollars cash and we did not go long on duration and that was the prudent right thing to do. I think that it might -- in our scenario and the way we look at interest rates today, the right and prudent thing to do is to go longer on duration, take advantage of the higher yields. It might not be optimal because life is not perfect, right? But it certainly helps us mitigate a potential recessionary environment in the States and the resulting lower interest rates on the Fed. We are financing that also with short-term federal home advances and repos. And today, the spread is not that significant. But again, based on our forecast and our expectations of second half of next year, interest rates starting to go down, we will have -- our cost of borrowings would be declining in that scenario. So that's kind of the picture and that's how we looked at this. and we will continue to manage the balance sheet in that fashion. Because our capital is clearly being deployed, first and foremost, for loan growth and the opportunities that we're having, so that's kind of how we're looking at this. And again, I answered a question earlier on deposits. We're very much focused also retaining good banking relationships on the deposit side.

Okay. That's good. Just expanding on your comments on loan growth and the strong pipeline into the fourth quarter in 2024. I think some of us have been talking about the Metropistas deal that was announced earlier this week, and you guys are listed as a bank that would be potentially participating in some of the financing. Can you talk a bit about your appetite for something like that and sort of how big of a piece you might be willing to take on?

So the way we look at it is we are part of a 3-bank market pretty much. And we are very much part of the community. So we need to be an important participant in those type of privatization. Certainly, it depends on who, how, where and what, right, in terms of the opportunity. But yes, we are a participant. We're not a significant participant by no stretch of imagination, but we are certainly a solid participant for our size and our appetite. We think it's also our way of contributing to the reconstruction and improvement of the infrastructure in Puerto Rico.

Okay. And then I guess as we think about the loan mix going into next year, this year and last year's auto has been a very big component of that, do you expect that to continue? Or do you think we'll see a little bit of a mix shift over the next couple of quarters to more commercial?

So -- yes, yes. So that's a question you guys ask me every quarter. And every quarter, I say, well, I'm happily surprised that loan auto loan growth continue to remain, right? I think we're starting to see that plateauing. In terms of the latter parts of the third quarter, we started to see a little bit of a slowdown. I think it's more from competitive forces than anything else. But we're monitoring it and we're probably going to see not a significant drop, but it's starting to plateau at these levels and trickle down into 2024. That's kind of the way we look at the auto lending business right now.

[Operator Instructions] We'll now hear from Kelly Motta with KBW.

So I love all the detail on Slide 4. It seems like this digital first strategy is really nice penetration here. Just wondering, with the success you're having there, is there opportunities to gain greater efficiencies and with potentially reallocating branch personnel? And how you're thinking about that relative to some other investments you may be making?

Yes. Thank you, Kelly, I-- we've been going at this for the last 4 or 5 years, right? We've be investing in the technology. We're deploying dollars into -- kind of adding capabilities towards commercial lending and consumer lending. And certainly, it's starting to pay off. And you're starting to see not only the adoption levels going up and not only the consolidation of the portal as a vehicle to serve our retail customers, we're also providing similar type of innovations on the commercial side and working on them and more to come. So those are the dollars that we're investing. And as you saw today, Maritza mentioned our guidance for expenses next year, we're keeping it at the same level. And this is the beginning. In our minds, it's the beginning of us starting to extract some efficiencies from the investments we've made in technology. Not all of them will trickle down to a reduction in noninterest expenses, because we also want to utilize some of those efficiencies to continue to innovate and continue to bring technology that will help the market that we operate in here, which is significantly different than the way customers behave than in the States. So some of what you're seeing already into 2024 includes some of the efficiencies that we're seeing. And us, the team in general, is working into 2024 to add additional efficiencies. But again, we're very happy and excited about the innovations that we're bringing in and how our customers are adopting them, and we're going to continue to do so, because that's the way we can differentiate from our competitors in the island.

Thanks for all the color, José. Switching to capital levels remain very strong. You're seeing really nice loan growth, and I think you picked away a little bit at the buyback this quarter. Can you just -- with the stock we're trading here, remind us your comfort and appetite with buybacks and how looking towards capital return towards the back half of and beyond?

Yes. So Kelly, capital for us has, number one, is going to be used for loan growth and the opportunities that present ourselves, and we're going to deploy that capital there. I alluded earlier to Alex's question on the investment that we made on MBSs. It's part of how we're managing capital. But also, I -- we are very much focused on our dividend growth and our buyback. We're going to be having that discussion in the January Board, and we will update. But our expectation is for us to capital manage as we've done in the past, where if there are opportunities here in the market in Puerto Rico, which we are seeing, we will deploy that capital for loan growth, and then at the same time look at dividend growth and buybacks. So the script and the plan has not changed from prior quarters on the capital management front.

Lastly, on the margin. I appreciate color on the MBS purchases. In terms of loans and loan yields, can you remind us where new loan originations, what rates are coming on at? That would be helpful in terms of how to think of the margin.

Yes. So the way we look at this on the short term -- and we'll update you in the fourth quarter call in terms of 2024. But the way we're looking at this is that on the short term, NIM might be trending slightly lower from these levels. But as I mentioned not necessarily net interest income, just simply because we're expecting additional loan growth. So in the near term, we are seeing the plateau and a slight downturn on the NIM. 2024 is still out there, so we'll see in the fourth quarter call how we look at NIM for 2024. But we are early indicators are that we're going to be in a pretty good shape with regards to NIM in 2024.

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

Thank you, operator. Thanks again to all our team members and to all our stakeholders who have listened in. Looking forward to update you in January. Have a great weekend.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.