OFG Bancorp

NYSE:OFG

Earnings Call Transcript 2020-Q2

[Operator]

Good morning. Thank you for joining OFG Bancorp’s Conference Call. My name is Lorry, and I will be your operator today. Our speakers are José Rafael Fernández, President, Chief Executive Officer and Vice Chairman; and Maritza Arizmendi, Executive Vice President and Chief Financial Officer. A presentation accompanies today’s remarks. It can be found on the Investor Relations website on the homepage in the What’s New box or on the Webcast, Presentations & Other Files page. 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 factor 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. All lines have been placed on mute to prevent background noise. After the speakers’ remarks, there will be a question-and-answer session. I'd now like turn the call over to Mr. Fernández.

[José Fernández]

Good morning. Thank you for joining us. Please turn to page 3. First, I would like to thank all our team members for their dedication and commitment during these very challenging times. Like other banks, we faced a number of Covid-19 related challenges during the second quarter. But for us, at OFG, the pandemic also followed the earthquakes we experienced in January and occurred while we were in the process of integrating the Scotia Bank acquisition. Certainly no small challenge. But by acting quickly and with foresight, we produced excellent results for our customers, communities and people and continue to help them build better financial futures. In March, governments in Puerto Rico and U.S Virgin Islands shutdown businesses and personal activities. Restrictions were eased in late May, but recent spikes in new cases have forced Puerto Rico to reduce some of the flexibility. The Federal Reserve Bank cut rates to 150 basis points in March following the 75 basis points reduction in the second half of 2019. Our commitment and preparation enable us to successfully manage these challenges, Facil, Rapido, Hencho - easy, fast, done as we say at OFG. All our branches operated safely throughout the quarter enhanced by our technology platform. Our full service ATMs and ITMs mobile app and online built-in tools facilitated routine transactions in a contactless manner. Online and mobile appointment scheduling help make COVID safe customer meetings possible at branches. We deployed 100% digital client friendly application and funds disbursement process for PPP loans. About half of our team members are still working remote. We also implemented extensive new safety protocols for our customers and people on site. And we continue to offer new benefits for our people such as free COVID on-site testing and daily online health check-ins, as well as incentives. The results speak for themselves. We provided high levels of customer safe service, safety and knowledge throughout all channels. Loan production in the second quarter total more than $500 million. Customer deposits increase $760 million. Our online loan deferral tool and call centers process relief for more than 44,000 retail customers. We reduce higher cost wholesale funding, maintain a strong level of net interest margin and continued to build liquidity and capital. And we secured a $100,000 in federal home loan bank of New York grants to support local, non-profit and small businesses in Puerto Rico and the U.S Virgin Islands. Please turn to Page 4. We have continued to see strong technology utilization trends among both our retail and business customers since the beginning of the year and in particular since March. Online bill pay enrollment were up 12% as of March and 24% as of June. Mobile banking users jumped 17% by the end of the second quarter from the beginning of the first. The numbers of remote deposit capture users are up 68% from the end of March. In another area of success for us, during the second quarter, we scheduled more than 18,000 COVID safe appointments with our customers through our online and mobile tool. We are very pleased with this to see these trends; technology is a core part of our overall corporate strategy. We continue to look into new ways and innovative ways to use it to help our customers. Turn to Page 5. Looking at our SBA PPP program, we continue to exceed our market share in Puerto Rico. We generated a total of $286 million in new loans. This enabled us to help more than 4,000 small businesses save more than 50.000 jobs. It also enabled us to attract new accounts in this strategically important customer base. And we were able to distribute these funds electronically within five days of application approval. This is a great example of our ability to act quickly in response to changing conditions to the benefit of both existing and new customers and the communities we serve. Let's talk about our results on Page 6. We reported EPS of $0.39 and $0.37 on a non-GAAP basis. Total core revenues were $128 million, most of that was due to a large increase in interest earning assets, chiefly loans and cash. This was partially offset by a declining yield due to significantly lower rates on cash and lower yields on variable rate commercial loans. In addition, we had lower investment security balances. As a result, we generated net interest income of $105 million with a net interest margin of 4.78%. Banking and wealth management revenues totaled $23 million. Noninterest expenses were $86 million primarily due to the addition of the Scotia Bank acquisition. Second quarter results included several items. $9.5 million in revenues from Scotia Bank interest recoveries and bargain purchase gain. We added $5 million in provision for the pandemic and within noninterest expenses, we had a $5 million emergent and restructuring charges and COVID related operating costs. Please turn to Page 7. The effects of these results are that we're building tangible value and our return on asset and return equity continues to improve sequentially from the fourth quarter. Please turn to Page 8 for operational highlights. Average loan balances increase 52% year-over-year and 2% quarter-over-quarter. Average core deposits excluding brokered increased 76% year-over-year and 5% quarter-over-quarter. Loan generation was strong; increased production from PPP and other commercial loans was partially offset by reduced production in our retail category, primarily due to the economic shutdown. We ended the quarter with good momentum and good pipelines in the mortgages and auto businesses. Loan yield at 6.97% continue to hold up well despite the recent Federal Reserve cuts. The cost of core deposits declined 4 four basis points year-over-year. Net interest margin declined to 4.78%. Please turn to Page 9 to review credit quality. The net charge-off and non-performing loan rates decline year-over-year and quarter-over-quarter reflecting loan paydowns and the effects of deferrals. Provision for credit losses of $18 million was level with last year. I'd like to note the year ago provision included an extra $9 million related to loans transferred to help for sale. Please turn to Page 10 to review our loan deferrals. After disruptions in economic condition caused by COVID-19, we offered several loan payment deferral programs ranging for one to four months. As I've mentioned we've enhanced this effort by quickly developing unique and first-to-market digital tools to help consumers apply for forbearance on an individual basis. Our online loan deferral tool and call centers process relief for more than 44,000 retail customers. In total, we have about $1.4 billion or 32% of our retail loans on deferral. The pace of retail request is significantly slowing. In addition, we have about $685 million or 26% of our commercial loans on deferral. Please turn to Page 11. The allowance for loan and lease losses of $233 million increase $70 million year-over-year and we have almost doubled the level of research from December 31st, 2019. Compared to March 31st, 2020, the allowance increased $2 million. Excluding SBA guaranteed PPP loans; second quarter 2020 allowance was 3.49% of loans, eight basis points higher than the first quarter. Please turn to Page 12. We are in a strong capital position. Our CET capital ratio as you see on that slide at 12.03% is up 112 basis points since last year. Please turn to Page 13. While we still face and much uncertainty regarding COVID and the economy, we are in a strong financial position, ready to help our customers during these trying times. Once we get through this Puerto Rico stands to benefit significantly from COVID stimulus and still unspent, undistributed Maria and earthquake related stimulus programs. At OFG, we believe our results and our history demonstrate our ability to quickly respond and adapt to changing economic environments. During the second quarter, we continue to build momentum in our core businesses and develop a good pipeline of new loans. From a liquidity, capital and balance sheet point of view, we are well positioned both financially and strategically. Our agenda going forward is clear. We plan to continue integrating the former Scotia Bank operations and finish by the end of this year. At the same time, we must achieve the full benefits of the acquisition by the end of 2021. We also plan to continue to invest in the future to further simplify our operations and enhance our ability to serve customers. And ultimately we intend to continue to play a significant role in the recovering Puerto Rico and the U.S Virgin Islands. Again I want to thank all our team members for our excellent results and for their dedication and commitment throughout these trying months. Crisis brings out the best in people to help others. Our people demonstrate that with purpose every single day. With this we end our formal presentation. Thank you for listening. Operator, please open the call for the Q&A session.

[Operator]

[Operator Instructions] Your first question comes from the line of Alex Twerdahl of Piper Sandler.

[AlexTwerdahl]

Hey. Good morning. I'm well. Thanks. Just to start off on the reserve and the provision. Maybe you could help us kind of just break down the provision for this quarter and the $5 million that you put aside for COVID. Was that related mostly to a change in the Moody's S3 scenario or was it related to internal downgrades of credits related to COVID or how should we be thinking about that?

[JoséFernández]

Yes. I'll give you a high level; I'll let Maritza answer you in more detail. But we actually have the S3 Moody's scenario. We have kept that S3 Moody's scenario and we feel that it's -- the COVID-19 has proven to be extremely uncertain across the globe and we feel that here in Puerto Rico is no exception. So we decided to keep the S3 Moody's as the scenario where we drive our provisioning. So that's the big side of it; the big picture of it. I'll let Maritza give you the details on the rest.

[MaritzaArizmendi]

Hi, Alex. Regarding the additional $5million as Jose mentioned, we keep the Moody's S3 scenario and we also evaluate the all qualitative adjustment that we did during the last quarter. We update them and as a result of that we added a $5 million in the retail portfolio mostly based on most recent information and that's $5 million adjustment for the COVID related provision.

[AlexTwerdahl]

Okay. So is retail oriented mostly but I'm just kind of curious if there was a specific factor in retail that you're looking at just kind of thinking about the amount of stimulus money that's flowing down to the island and seeing the deposits really balloon at you and some of your peers. It seems like the retail might be in better shape today than they normally would without that stimulus. So kind of how should we think about -- how you're expecting the retail portfolios to perform?

[JoséFernández]

Yes. I think the assumptions that you pose are correct. There's certainly stimulus flowing down from COVID and still from the hurricane Maria and the earthquakes and that's going to play out. I think there's a portion of it that will play out on the short term and we would like to see the deferral program ended in June 30th and see how the retail portfolios behave forward to feel more comfortable on the scenarios. But I agree with you longer term, we just think that the economy, it's hard for us to pinpoint how the economy is going to be doing the next six months. But we do agree that the economy with the stimulus and all the items that you mentioned should have a good momentum on a more longer-term scenario. So we will update as we see and feel more comfortable with the data on the credit side.

[AlexTwerdahl]

Right and you guys have done the full reviews at this point on all your commercial customers and gone through and of course if there's something that you saw you would have added to the reserve this quarter.

[JoséFernández]

Yes. So on the commercial side I can tell you that we are keeping a close eye on different industries, but particularly on the hospitality. That's the industry that we are most focused on in terms of the effects of the COVID-19 pandemic. Right now most -- all of the deferrals on the large and middle market commercial portfolios ended on June 30th and we just have 12 loans on the hospitality that asks for three additional months. So we feel positive about our commercial portfolio on the middle and large commercial portfolio. We're also feel good about our efforts on the small business side and how we're monitoring those. So again, we're okay on that side and we're happy to see commercial clients coming back as they are. But again, when we look at the provisioning, we felt that on the retail side, the effects of the pandemic are still quite uncertain. And we don't know how the government is going to react to the recent spikes.

[AlexTwerdahl]

Understood and then just to switch gears a little bit and looking at expenses. If you kind of back out the COVID adjustment as well as some merger expense you get to kind of like an $80.5 million run rate for expenses. Is that the right run rate to use going into the third quarter or I guess where's the starting point and then kind of as you near the end of the integration of Scotia where do you expect expenses to kind of end the year and start 2021?

[JoséFernández]

So on the expense side; remember the second quarter has lower activity. So we we're showing lower cost of the transactionality of the lower transactionality that we're seeing from the customer. So as the economy picks up, we expect those expenses to come back up. But on the other hand, we started the efforts on extracting the savings from the Scotia acquisition in this third quarter and we're very, very cautious simply because of environment in terms of the COVID, but we are going to see some benefits from those efforts and we feel more comfortable giving you a comfort on us extracting the 25% cost saves from the acquisition by the end of 2021 because again, we're operating in a different environment than normal. So that's kind of the best I can give you, Alex, on the expenses. I really think that we are in good shape there as we are executing on our efficiencies albeit at a slower pace than we anticipated given the COVID-19.

[Operator]

Your next question comes from the line of Glen Manna of KBW.

[GlenManna]

Hi. Good morning. I just wanted to discuss the NIM for a minute, maybe we could talk about what portion of the quarter-over-quarter decline came from excess liquidity? And what portion came from rates and PPP? And if you could discuss it in the context excluding the interest rate recovery that would be helpful.

[JoséFernández]

Including the interest rate recovery, you said Glen.

[GlenManna]

Right. The final -- no excluding, right, excluding.

[JoséFernández]

Okay. Now I understand. All right. I'll let Maritza answer that one. That's --

[MaritzaArizmendi]

Hey, Glen. So to your question, in general, the 34 basis point reduction excluding the recovery. We have done several assumptions regarding what -- it depends on how much cash we will keep going forward. But in general our assessment is about one-third about 15 basis points relates to the cash balances that we hold during the quarter. And the balances that we added in the PPP loan program, it's about 15 basis points.

[GlenManna]

So that would be one-third from excess liquidity and two-thirds of the drop was just on rate -- was on rates.

[MaritzaArizmendi]

Yes because cash balances as you know, were impacted because of the fed cost rate cuts and also the deposit of the commercial portfolio that is indexed variable rates that we have around 52% of our portfolio of the commercial portfolio is viable, but we are expecting that this quarter already have the full effect of different cuts. So going forward we are expecting a more stable type of NIM as we will see during the third quarter. The full effect of the PPP loan program in the loan yields, but also we will experience lower cost of borrowing [with us]. They continue to mature during the third quarter.

[GlenManna]

Right. I was looking at the repo balances and it looked like on an average basis they were still in there but on a spot basis you've paid off, you've got -- you've taken off all the repos?

[MaritzaArizmendi]

Yes.

[JoséFernández]

And, Glen, we still have some maturities coming in the next several quarters and into 2021 but will certainly will use the excess liquidity to cancel them.

[GlenManna]

Okay and on the PPP loans what was the average yield you used in the quarter? And what's your expectation on forgiveness for those loans going forward?

[JoséFernández]

I'll tell you, I'll talk to you about the expectations and forgiveness and I'll let Marisa talk about the view. On the forgiveness, we're still expecting the federal government to give more guidelines on the forgiveness, but we feel that there is a large proportion, more than 80% of those loans that will be forgiven. It's hard for us to pinpoint when that will occur but we are more and more of the opinion that there's going to be a larger percentage of our PPP loans that will be forgiven. And on the rate, I'll let Maritza follow.

[MaritzaArizmendi]

Yes. The all-inclusive deal including the amortization of the fees, we are expecting to be around 2.95% - 3% considering the life of the loans, but also remember that as Jose mentioning if they are repaid before maturity we will be able to recognize the unamortized portion of that fee.

[GlenManna]

Okay and you're using the level yield method?

[MaritzaArizmendi]

Yes.

[GlenManna]

Okay and on the deferrals with some of them beginning to roll off have you got an idea of what redeferral rates are or redeferral request rates?

[JoséFernández]

It's too early to tell. We're not seeing that much activity on the -- as I mentioned the large and middle commercial so far what we're focusing are more on the hospitality industries. On the retail side, it's too early. It's been three weeks into the quarter and in the third quarter. So we'll be able to update later in the next quarter's call. But the first indications are positive for sure, but at the end of the day it depends on how it plays out at the end of the third quarter when you have the full effect of the end of the deferrals. How many ask for an additional deferral program or process or how many come back to take.

[Operator]

Your next question comes from the line of Joe Gladue of Alden Securities.

[JoeGladue]

Good morning. Just one quick question, just wondering if you could give us since the economy started opening up a little bit more lately in the quarter just wondering if you could sort of walk us through some of the trends you're seeing in the different lending markets, mortgage and auto and whatever.

[JoséFernández]

Yes. We're seeing good momentum on the mortgage lending business. We have good pipelines there. Same with auto, we're also seeing a good pipeline there. Obviously that's a reflection on the one side. We're doing around 50% on the mortgage side. We're doing 50% is refi. There's 50% that it's purchased in terms of buying a home. So that's actually encouraging for us. We're seeing some more residential activity and that's extracting the benefits of the Scotia acquisition which they had important servicing portfolio as well as more significant residential mortgage operation. So we're happy with that and we're seeing that pipeline coming through. On the other side, we are seeing higher new car sales. And we're -- that's translating into more volume for us also as I'm sure for the rest of the market. So those are the two main ones. We're not seeing much yet in on the consumer lending side meaning on the installment lending side. And on the commercial side, we are having-- we're building a pipeline but it's still below the trends that we've had before the pandemic. There's still some consciousness from business people and there's still the uncertainty still can be felt across the different industries. And we're seeing that in our commercial side and on commercial lending site.

[Operator]

You now have a follow-up question from Alex Twerdahl of Piper Sandler.

[AlexTwerdahl]

I wanted to -- I was just looking at slide 5 here on the PPP and just specifically the bullet where it talks about attracting new clients and strategically important small business segments. If you can maybe expand a little bit on that? If that's obviously it's meaningful enough to put it as a bullet here but kind of what the opportunity could be? How big that is that kind of stuff?

[JoséFernández]

Yes. For us that's always been a focus on the small business side. And we've been for the last three or four years incrementally doing more business in that segment. PPP gave us a great opportunity to act quickly to be agile and to deploy our technology and deploy our processes to be there for our customers. And we got great reviews from our customers throughout the PPP process and the fast and agile way that we dispersed the funds particularly in the middle of the lockdown that we were operating in which no other state of the -- or any other jurisdiction in the United States had a situation like that. So I have to tell you the results from that program have given us quite good momentum in that segment. And excellent credibility by being close to our customers. But also reputationally and we're getting -- we're benefiting from that slowly but surely. It's not going to move the needle from your perspective in terms of the results at the end of the day, but for us it's important be close to the communities and our team on the retail channel they just put their heart out and they demonstrated what living a life with purpose at Oriental means. And I'm really proud of that and that's why I wanted to highlight that effort.

[Operator]

You have a follow-up from Glen Manna of KBW.

[GlenManna]

Hi. I just wanted to ask a question on the ACL. I think when we look at your competitor that report yesterday and you guys we've seen some stability in ACL to loans versus last quarter. So could you talk about what's kind of giving you comfort with that level? And some of the banks on the mainland have talked about whether or not they expect continued reserve building in forward quarters. And maybe if you could just discuss that a little bit too.

[JoséFernández]

So again, Glen, what I can tell you is that we're looking at this from a longer-term perspective. We're not trying to figure out what's going to happen next quarter or next half of the year. It's very hard to predict. We're living in different times and it requires a lot of adaptation. It requires a lot of flexibility and from our operation we are ready to tackle those uncertainties and those challenges, but going and trying to predict how is life going to be in the next three months, it's really difficult. So I say this in terms of your question because when we look at the different scenarios that we review to determine the provisioning, we really we want to be cautious and that's kind of why we feel more comfortable with maintaining the Moody's S3 and the good thing is that we are -- we have a resilient bank, a fortress balance sheet that gives us the opportunity to build for the long term in a market that it's a 3-bank market. And we have a great opportunity here to do the right thing longer term. So we're not interested in trying to figure out how close am I or are we to pinpointing the next quarter or the following quarter. We're here to do the longer term and to make sure that we win this long road. So sorry for my long-winded answer but I can't give you a specific on any of the numbers that you're inclining to get.

[GlenManna]

No. I appreciate what you did give. And just I wanted to follow up on Alex's question a little bit. You guys have been considered a challenger bank on the island high digital. When you look at some of the numbers of your customers that are moving into to using more digital platforms. I mean it's no secret that that Puerto Rico has lagged the mainland and some of the adoption of digital. Is COVID kind of pushing down that wall? There's a feeling that once customers start depositing a check online, they don't go back and is this really an opportunity for Puerto Rico to push past that kind of resistance that may have been there before?

[JoséFernández]

You're hitting on the nail. We've been in for the last 10 years and actually more than that. We've always said technology, technology, technology and now if the pandemic is forcing the speed of adoption at a higher speed. And I think that's -- that plays completely into our -- into the strategy that we have deployed in the last several years. So again, we are showing you those charts particularly because of what you mentioned which is, yes, the pandemic is accelerating the adoption here in Puerto Rico. Having said that though, we do have a great opportunity but we also have to do what we need to do in terms of continuing to invest in technology, continuing to finding ways to do things more fast, agile and proactively for our customers because at the end of the day we have great competitors here in the island with a great resources and we need to do what we need to do. So it's exciting for us. And again, our teams are all focused on how to achieve that and pull out the benefits of having a strong balance sheet, resilient bank with a culture that is proactive, that is agile and it's looking to do simple, more simple things for customers. And again, the journey continues and that's what gets up -- gets us up every morning to come to the bank or to stay at home remotely but work for the bank. And I can repeat how exciting times we have ahead of us in spite of the short-term pandemic we're operating in. And I can't underestimate the tremendous amount of work and dedication our teammates are putting during this pandemic. And also throughout the last three or four years, but particularly in the last three or four months. So again, I'm optimistic of the future and a cognizant of the uncertainties of the short term and looking forward to continuing that path.

[Operator]

There are no further questions. Mr. Fernandez, are there any closing remarks?

[José Fernández]

Thank you, operator. Thank you also to all our stakeholders who have listened in. Our concern goes out to those who have suffered from this pandemic. Our hope is that it ends as soon as possible. And that everybody stays safe and healthy. Thank you again. And have a nice day and a great weekend.

[Operator]

Thank you. That does conclude the OFG Bancorp second quarter 2020 earnings conference call. You may now disconnect your lines. And have a wonderful day.