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OFG Bancorp
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Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Christy and I will be your operator today. Our speakers today 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 home page in the What's New box or on the Webcasts, Presentations & Other Files page.
This call may contain -- 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. We also direct you to the explanation of non-GAAP measurements that are included in our presentation and news release. All lines have been placed on mute to prevent 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.
Good morning. Thank you for joining us. Please turn to slide three. Before the market opened today, we reported fourth quarter and year end results, with an update on our Scotiabank Puerto Rico acquisition and U.S. Virgin Islands and an update on CECL.
I'd like to publicly welcome our new staff, customers, and clients who have joined us as a result of our acquisition. We are committed to providing excellent opportunities for our staff and excellent service, products and technology for our customers and clients. We are excited about the prospects for our future growth.
Because the closing of the acquisition took place on December 31st, our fourth quarter and 2019 income statement and credit metrics reflect our pre-acquisition operations plus acquisition-related expenses. But our year-end balance sheet and capital metrics reflect our newly acquired assets and liabilities.
The fourth quarter was very busy closing on the acquisition while continuing to build our business. We had a loss of $0.04 per share mainly because of the $21.5 million in merger and restructuring charges and $6.6 million in added provision for non-performing loans that we decided to sell in the third quarter.
Core operations were strong. Net interest margin was 5.35%, the same as last quarter as we managed the transition to slightly lower yields on our variable-rate commercial loan portfolio with our proactive effort to reduce high-cost wholesale funding.
Loan production was the highest since the post-hurricane comeback the second quarter of 2018. Most credit metrics improved. During the quarter, we developed our integration plan, obtained all regulatory approvals and closed on the Scotiabank acquisition. That ended -- that added $2.2 billion in net loans, including a 6.44% loan mark, and $3 billion in core low-cost deposits after accounting for a reduction of $200 million of non-resident accounts.
In addition, many of the final transaction details and their impact on OFG were better than originally assumed, including the amount of merger and restructuring charges, core deposit intangible, goodwill, and tangible book value dilution.
Looking at the year as a whole, earnings per share was $0.92. That included merger and restructuring charges and added provision for the previously announced NPL sales. On a non-GAAP basis, earnings per share was $1.62, which compares favorably to 2018. We ended the year with record total assets of $9.3 billion, book value per share of $18.75, tangible book value per share of $15.97, and stockholders' equity of $1.05 billion.
Please turn to slide four; we also want to thank all our teams for their exceptional work, some despite their own difficult personal circumstances in helping evacuees from our recent series of earthquakes. As some of the earliest on the ground in affected areas, Oriental teams helped organize shelters and relief centers.
In coordination and collaboration with some of our clients, we provided more than 4,000 meals, bottled water, batteries, electric fans, and other essentials. We also arranged access to teams of doctors and structural engineers. The quick response would not have been possible without our compassionate staff and clients. We are extremely proud to serve our communities. Thankfully, there was no loss of life on the part of our employees, and in addition, all our operations and main buildings remain intact.
Please turn to slide five to review our financial performance. At $98.4 million, core net revenues were down from a year ago and the third quarter. There were three key factors. First, we continue to generate income from a growing amount of originated loans. Interest income, however, was down from acquired loans due to typical paybacks.
Interest income was also down from investment securities due to the sales of mortgage-backed securities totaling $350 million in the second quarter and $322 million in the third quarter. This generated excess cash for the Scotiabank Puerto Rico acquisition.
I've already covered earnings per share and tangible book value, so let's look at our other performance metrics. They were all affected primarily by merger and acquisition costs, which caused efficiency ratio to go up and return on average tangible common equity and return on average assets to go down.
Efficiency ratio was also affected by some additional cost of non-recurring nature such as a $2.8 million in contingent legal reserve and operational losses and $1.5 million in incremental health insurance expenses and technology development expenses.
As we begin 2020, we will be focusing on full integration and our growth plans. We estimate this will require additional restructuring charges in the range of $7.5 million to $10 million.
Please turn to slide six to review our operational highlights. This is one of the more important slides in today's presentation. Loans were down largely to the NPL sales. With the Scotiabank acquisition, you can see how loans jumped from $4.4 billion to $6.6 billion. We have continued to grow core deposits in 2019. With the Scotiabank acquisition, you can see how core deposits jumped from $4.6 billion to $7.5 billion.
As I noted earlier, we had a very strong quarter for loan generation. All categories did well. In particular, commercial loan production, which totaled $229 million, reflected the closing of large and middle-market corporate loans as well as continued growth in small business customers all in Puerto Rico.
Loan yield held fairly steady at 7.51%, while the cost of deposits ticked down to 69 basis points. That, plus the reduction in cost from brokered CDs and borrowings, enable us to keep net interest margin level with the third quarter and above year ago levels.
Please turn to slide seven to review credit and capital. As we indicated on our last call, with the non-performing loan sales out of the way, our net charge-off rate has begun to fall as well as provision and our non-performing loan rate.
Looking at fourth quarter provision, in addition to the $6.6 million for NPL sales previously disclosed, fourth quarter provision included a $3.6 million allowance for the remaining balance of an originated commercial loan pending insurance recoveries on a property that was completely destroyed by fire.
Because of the effective use of excess capital in the Scotiabank acquisition, capital ratios have now become more comparable to similar-sized peers while continuing to be significantly above regulatory requirements for a well-capitalized institution. So, at December 31st, 2019, the common equity Tier 1 capital ratio was 10.78% and the tangible common equity ratio was 8.97%. While total stockholders' equity declined 0.3% compared to September 30th, it increased close to 5% year-over-year.
Please turn to slide eight for our outlook. We are well-positioned for 2020. The acquisition enabled us to more effectively deploy our excess capital to end 2019 with a record $6.6 billion in loans and a record $7.7 billion in deposits. This provides us with an excellent opportunity to generate future loan and earnings growth.
Integration is well underway. We are moving fast. While we still have to manage some of the effects of the three Federal Reserve Bank interest rate reductions from 2019 and any potential economic impact from the recent earthquakes that hit the southern part of the island, we remain optimistic that we will achieve all the major goals and strategic objectives of our Scotiabank acquisition this year and next. We are very proud of our accomplishments so far and excited with our outlook and look forward to share our progress in the quarters ahead.
That ends our formal presentation. Thank you for listening. Operator, let's start the question-and-answer session.
Certainly, the floor is now open for questions. [Operator Instructions]
And your first question is from Alex Twerdahl of Piper Sandler.
Hey good morning.
Good morning.
Hey my first question is I couldn't help but to notice that the tangible book value dilution pro forma came in a lot less or more favorable than initially expected when the deal was announced back in June. So, I'm just wondering kind of as you've sort of started to integrate things and look out to 2020, the cost saves number, which we thought was potentially a little bit on the conservative side back when the deal was announced, are you prepared to make any adjustments to that or have an update on sort of how we should be thinking about expenses for the year?
Yes. So, regarding the announcement back in June on the acquisition, we created an acquisition model that certainly is conservative, prudent. And certain -- after five or six months, we were able to take a better look at the acquired assets and liabilities. And we're happy to announce that we didn't have to dilute tangible book value as we anticipated, so it played out very nicely for us.
With regards to expenses, we keep the same targets. We think that we will continue to work hard on the integration. It's going to be a very busy year 2020 as we continue to focus on growing while we integrate.
So, I internally say that we need to run the car at 200 miles per hour while we change the tires. So, that's kind of the attitude here. We think we have an excellent opportunity not only 2020 but beyond given this acquisition and where we stand from a competitive landscape. But on the expense side, we keep it where we are, and we like to over-deliver. So, we will stay there.
Maybe to that point, just for expenses, just the right starting point as we go into the year just given that it looked like G&A expenses were a bit elevated in the fourth quarter. What's the right -- I guess I don't even know if you want to do it on a stand-alone basis and layer in the Scotia additions or maybe just give us sort of what you're anticipating the first quarter, what might be the right kind of entry point for the year.
So, we don't want to go into providing any type of guidance above and beyond what we said back when we announced. We're sticking to those numbers. Certainly, on the expense side, you'll see the progression as the year goes by.
As you can imagine, the cost saves don't happen in one day or one quarter. But you'll see -- we'll update you in the quarters ahead, Alex. We're excited for the year that we have in front of us and excited to share the successful news in the future quarters.
Okay. But so just -- sorry to belabor the point, but expenses in the fourth quarter, the core expenses backing out the merger expenses went from like 52 to 57.
Yes, yes, yes. Got it. I'm sorry, I didn't address that one. We -- apart from the legal contingencies that we feel it's a onetime thing. And the other two, it's related on where do we really focus internally, and we focus on our people. And so we've provided better healthcare, and we're investing in them.
The same thing with our customers. So, we continue to invest in our technology, and these are part of our efforts to upgrade our technology platform to serve better our customers. So, that's where the spike comes up in the fourth quarter in terms of general expenses. We do not expect those to be recurring in nature, but we want to make sure that it's highlighted, so you understand the rationale behind them.
Okay. Did you break out the legal contingencies that aren't going to be recurring?
They are all non-recurring.
There are specific assessments that were made during the quarter for specific cases. So, this is not at the current type of expense.
In terms of the dollar amount, I must have missed it. I'm just -- is it somewhere in the release?
Yes, it is. Yes, it is.
Yes, yes, it is.
Okay. And then just kind of as we look at the loan growth, the commercial loan growth in the fourth quarter was kind of the origination volume was like three times the normal quarter, which was great to see. Can you just give us an update sort of on what's going on there? Is that driven by some of the recovery efforts in Puerto Rico? Or is it driven by new opportunities because of the deal and what the pipelines look like as we head into 2020?
Yes, sure. We've been talking about -- last year, we talked about that we had a good pipeline, but things were getting a little bit delayed. And we were very excited and happy with the results that we had last year on the commercial front, particularly in the small commercial, small business, small commercial and an area that we're focusing.
But fourth quarter also, we closed some of the middle-market loans and some other larger loans that were in the pipeline for a while. We were able to close them before the year end. So, we're happy with that, too. If you look into 2020, we do have a healthy pipeline on the commercial side and we look forward to deploy our excess liquidity in growing those buckets.
As pertaining to which type of industry is not necessarily recovering, some of it -- some of the recovery, commercial lending growth might have happened more in the second and third quarter, but on the origination side. But this fourth quarter was more C&I lending, more traditional, different industries from services, healthcare, et cetera.
Okay. And then just a final question for me. You guys are sitting at $9.3 billion in assets. Is 2020 going to be a remixing year where -- you talked about driving 200 miles an hour while changing the tires? Is that 200 miles an hour just going to be on the loan growth side and funded with the securities side of the balance sheet? Or do you think the balance sheet could actually approach $10 billion and potentially cross it at some point in the next few years?
No, we're not targeting crossing the $10 billion mark anytime soon. As you know, there is an incremental cost to operate at that level. So, we will continue to manage the balance sheet strategically to make sure that we grow as expected. And when we talk about growth, we're talking on the loan side and manage the balance sheet so that we don't cross the $10 billion mark.
Great. Thanks for taking my questions.
Yes, welcome. Have a good day.
You too.
Thank you. Your next question is from Glen Manna of KBW.
Hi, good morning guys.
Hi good morning.
Good morning Glen.
So, the net interest margin held up a little bit better than we were expecting. And José, in your comments, you kind of referenced some of the balance sheet management that you've been able to do. And I was just wondering, kind of going forward, what is your outlook in terms of the NIM for OFG on a stand-alone basis.
Yes. So all right, as I mentioned to Alex, we don't want to give any guidance, specific guidance, but I can give you color on how we see it. And we still have some good opportunity in the 2020 to continue to optimize our funding given the excess deposits that we have. And we'll certainly take advantage of that throughout the year as the funding matures and again maximize the use of our -- of the acquisition, which provides us the core funding.
Okay. And what are you seeing in loan pricing down on the island?
Not much change from what we spoke in the last quarter. We're seeing relatively aggressive pricing but not necessarily any change from the third quarter color that I gave.
I guess just to kind of just circle back to expenses and not to belabor the point, I think my understanding from your comments were that you didn't expect the $2.8 million in contingency legal reserves and the $1.5 million in incremental health insurance and technology development expenses to be recurring. Is that correct?
That is correct. That is correct.
Okay. And if I kind of take out the piece of the health insurance out of compensation and employee benefits, it was still a bit elevated. Was that kind of seasonality in the fourth quarter, year-end bonuses? Do you expect that to moderate a bit for OFG on a standalone basis?
So, part of it has to do with year-end. But in reality, we're also making sure that we are competitive on the compensation side. And we made some adjustments throughout the year that you have not -- might not necessarily see the full effect of those adjustments until the fourth quarter. But in our case, first quarter is when we do the end-of-the-year bonuses and all that stuff. So, those -- that has already been accounted for and accumulated as we move forward.
Okay. And then just on the tax rate, if I kind of normalize the tax rate, it was a little bit higher than I was expecting for the company as stand-alone. Was there anything unusual in there? And in the past, you've kind of given guidance for the tax rate for OFG on a standalone basis.
So, I'll let Maritza go--.
Yes. In general, Glen, the last year quarter assessment, we reassessed all the forecasts that we did through the year, so we have a catch-up to compensate for higher taxable income than expected. But going forward, we will see the tax rate getting back to 32%, 33% that has been like the run rate for us for the last two years.
Okay. That looks like all I have. All right. Thank you. Have a good day.
You're welcome. Thank you, Glen.
Thank you. [Operator Instructions]
And your next question is from Joe Gladue of Alden Securities.
Good morning.
Good morning Joe. How are you?
All right. First off, I just wondered if you could share if there are any, I guess, a little bit of some of or one of the major integration milestones are coming up when -- going forward?
Yes. So, let me just first say, we closed the Scotia transaction or acquisition late in December, on December 31st. So we -- before that, we were spending most of our time planning for the integration. As soon as we began the year, integration planning turns into integration execution. And we're, first of all, welcoming all the employees and all the clients. And so far, the plan has been executed to the dot in spite of the fact that three business days after we acquired the operations of Scotiabank in Puerto Rico and the USVI, there were two earthquakes in the southern part of the island.
So, we adapted quickly to our -- to the environment we operate in. We helped the communities we serve while we continue working on the integration and executing on the integration plan as has been planned.
As you know, that effort is led by Ganesh Kumar, our Chief Operating Officer and we've been doing this for -- we have done three of them. Actually, this will be the fourth in our tenure here as leaders of the organization.
So, so far, Joe, we're on target and we are intensely working to get it done as planned and we don't have any quirks to report so far. As you know, integrations always throw you curves once in a while. We, this time, had an environmental curve, but we managed it nicely, and we were able to go out to the communities also and help out.
So, we're extremely proud of what we have accomplished in 2019. We are extremely excited for 2020 and the progress and the earnings growth potential that we see going forward. So, look forward to sharing the results in the upcoming quarters with you and the rest of The Street.
Okay. All right. Just one other question. I guess we -- you've talked about the sort of going slow with the U.S. operations and keeping that to a manageable piece of the loan portfolio. Just wondering if now with the bigger balance sheet, with the Scotia acquisition, if that changes your thinking on the size of the U.S. portfolio.
So, with regards to the U.S. loan operations that we have and in reference to the acquisition that we just did, I think the way we look at this is where is the growth coming from, and it's going to come primarily from Puerto Rico.
If we see some opportunities for us to deploy some capital outside of Puerto Rico, for sure, we'll evaluate them. But as you know, our main operations are here in Puerto Rico. Now, we have the Virgin Islands where we also have opportunities there.
So, I think we're in a very good spot. We have Puerto Rico with a momentum coming in. We have USVI, which is a new market where -- that we are now serving. And then we have the U.S. loan operations where we also have opportunities over there. So, we'll look at all three, but the main two are Puerto Rico and USVI.
Thank you.
Yes, thank you, Joe. Have a great day.
Thank you. You have a follow-up from Alex Twerdahl of Piper Sandler.
Hey just a couple of follow-ups. One, appreciate the CECL guidance that you guys gave, the day one guidance in the press release. Just wondering if you have any sort of color or outlook you can provide us for how we should be thinking about provisioning in the first couple of quarters of 2020.
I'll let Maritza go after that.
Yes. In general, Alex, we continue to work with the model. And in an ongoing basis, what we'll see is that provision will be defined mostly for the loan growth and the level of charge-offs and that's the way we see it.
So, right now, we have current allowance coverage of 2.15%. With the added estimate that we just shared with you, we'd be increasing our allowance coverage to around 2.80%. So, assuming all variables remain equal, any change will come from loan growth.
Okay. And then as I think about charge-offs, obviously, very hard to predict. But just given some of the cleanup, the NPL sales, et cetera and stuff that you did later in the year, would you expect the charge-off level to kind of come down a little bit in 2018?
Well, that's our -- one of the scenarios we're managing. We are expecting a relatively stable net charge-off behavior, but remember that we will be -- keep growing. As José was mentioning, there are some portfolios like for auto loans that charge-offs will continue in dollar-wise to continue that level of trend even though the loss ratio will keep the same. So, level of charge-off relationship-wise probably will remain the same. But volume-wise, we can see more increase because of the loan growth.
Yes. So, on the commercial and residential side, Alex, since -- as you mentioned, since we sold some of those non-performing loans, certainly will come down. But as Maritza says, on the consumer side, we need to replenish charge-offs.
So, assuming that the scenario is the same in terms of the past several quarters, again, it will be affected by growth. The provision will be affected by growth. So, that's how we look at it. But it's -- again, day two comes in March 31st. We'll update you when the quarter ends and on the next conference call. But that's how we look at it.
Okay. And then are you expecting any additional merger restructuring costs in 2020?
Yes, we mentioned in my remarks, we're estimating between $7.5 million and $10 million of additional merger restructure charges, that in total with the $21 and change million that we reported today. It basically comes out in total less than what we anticipated on -- and what we announced back in June of 2019. So, we're -- again, part of getting things done in 2020.
Okay. And then just final question. You guys, as you mentioned a couple of times are basically fully levered and look a lot more like other banks now. But how should we be thinking about capital? Obviously, a lot of wood to chop with the integration and wouldn't expect any additional capital actions for at least a couple of quarters. But is that the right way to think about it or -- I mean do you [Indiscernible]
Right on point. Yes, you're right on point. Right on point, Alex. We're going to execute integration, benefit from the added earnings growth, grow our capital, and then think about other things into 2021.
Perfect. Thanks for taking my follow-ups.
Yes, you're welcome. Have a good day.
Thank you. [Operator Instructions]
And at this time, there are no further questions. I will now turn the call back to management for closing remarks.
Thank you, operator and thank you also to all our stakeholders who have listened in. Thank you again and have a wonderful day.
Thank you. This does conclude today's conference call. You may now disconnect.