OFG Bancorp
NYSE:OFG
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OFG Bancorp
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Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Christie, and I will be your operator today. Our speakers for today are José Rafael Fernández, President, Chief Executive Officer and Vice Chairman, and Maritza Arizmendi, Executive Vice President and Chief Financial Officer.
A presentation accompanying today's remarks can be found on the redesigned Investor Relations website on the homepage in the "What's New" box or on the quarterly results 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 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.
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 turn the call over to Mr. Fernandez. Please go ahead.
Good morning and thank you for joining us. First, I want to wish you all a happy new year and that you all remain safe and healthy. If there was ever a year where we fulfill our purpose to our customers, our people and our communities, it was 2020. We were more than ready – mas que listo.
Our job as managers is to lead through good and bad times. When we look back at 2020, we're so proud of our people who have been so dedicated, so resilient and who have persevered through all the challenges of 2020, while maintaining our high levels of service to our customers, giving back to the communities we serve and delivering excellent results for our investors. To our teams in Puerto Rico, the US Virgin Islands and on the mainland, once again, thank you.
We're extremely pleased with our results. For our customers, despite everything, we swiftly processed their service requests, applications for loan deferrals and the rapid influx of stimulus checks. For commercial customers, we implemented an easy-to-use 100% digital service for applying, processing, disbursing and forgiving PPP loans.
Both retail and commercial customers took full advantage of the digital technology we have been providing. As we say at OFG, fácil, rápido, hecho.
Our people adapted quickly to working remotely. We stepped up spending for COVID-related items such as testing, health care and worksite safety. We made significant investments to ensure our teams had robust remote work capabilities.
We also worked to do our part four communities. At the beginning of 2020, we supported the earthquake affected towns in the southern part of Puerto Rico. After that, it was ccc COVID-related donations and securing more than $100,000 in grants for non-profits in Puerto Rico and the US Virgin Islands. In addition, we converted our internship, scholarship and financial seminar program to virtual formats to maintain a sense of continuity during these challenging times.
We will continue in 2021 to help our customers, people and communities to adapt to the challenging and changing COVID conditions.
Please turn to page 4. As you can see in this slide, we continue to see higher percentage adoption in all banking technologies. I'm particularly pleased with the 50,000 online appointments made through our digital platforms and our online bill and loan payment solution. All of this made life easier for our customers during the pandemic. It also helped further our strategic and operational goals. In all likelihood, digital migration should build on the progress we achieved in 2020.
Please turn to page 5 to review our first quarter results. We reported earnings per share of $0.42. It is important to note that this included three major items. $6.4 million in merger and restructuring charges on our Scotiabank systems conversion and integration, $3.7 million in merger and restructuring charges for branch consolidation in 2021, and $1.5 million in COVID related spending. All of these amounts are pre-tax.
Also keep in mind, our tax rate was 22%. That's higher in the third quarter because of a greater proportion of higher tax income, but it is also lower than our estimated tax rate in 2001, which we currently anticipate being in the 30% to 32% range.
Total core revenues were a record $133 million. Net interest income was $99 million, similar to the third quarter. Banking and wealth management revenues were a record $34 million. Wealth management included $4 million in annual insurance commissions. Approximately $3 million of that was from additional insurance business that came with the Scotia acquisition. Mortgage banking included $2 million in revenues from secondary market sales of mortgages that were held back from the third quarter due to our systems conversion.
Non-interest expenses were $89 million. Excluding the merger and restructuring charge and COVID-related costs, non-interest expenses amounted to $77 million. This reflects significant cost savings, which Maritza will discuss in a few minutes.
Regarding the balance sheet, total assets were under $10 billion as we had anticipated, loan production continued to be solid at $485 million, and capital continued to build with a CET1 ratio increasing to 13.08%.
Looking at our numbers, we continue to see signs of recovery with solid loan production, regular payment activity, stable credit trends, and a sequential orderly increase in banking service fees, which reflect improved day-to-day economic activity.
Now, here's Maritza to go over the financials in more detail.
Thank you, José. Please turn to page 6 for our financial highlight. Let me start with tangible book value per share, one of our key areas of focus. At close to $17, it increased more than $1 year-over-year and by $0.46 from the third quarter.
The efficiency ratio increased sequentially to 67%. When you adjust for merger and COVID-19 expenses, it improved about 400 basis points to 58%.
Return on average assets and tangible common equity was close to 1% and 10%, respectively, on a reported basis. Excluding the merger charge and the COVID expenses, these two methods would have been more in line with our general performance objectives.
Please turn to page 7 for our operational highlights. At José mentioned, loan generation was a solid $485 million. That included commercial lending of $224 million, auto lending of $138 million and mortgage lending of $98 million.
Average loan balances declined slightly from prior quarter due to paydowns and loan yields stood at 6.65%. Average core deposit increased, but end-of-period balances declined $170 million on a linked-quarter basis. The was primarily due to our decision not to renew certain additional higher cost deposits. As a result, the cost of core deposits continued to fall to 53 basis points.
Average cash balances increased $162 million during the quarter. The result was a 6 basis point sequential decline in net interest margin to 4.24%.
Please turn to page 8 to review credit quality. The net charge-off rate increased to 2.67%. That reflects our decision to charge-off to acquire Scotiabank loan that was substantially and previously reserved at the time of the acquisition.
Provision was $14.2 million. This includes $4.7 million to cover the two [indiscernible] commercial loans acquired from Scotiabank that I just mentioned.
First quarter 2020 loan deferrals fell to 1.4% of total loans from 2% in prior quarter and 30% in the second quarter of 2020. The non-performing loan rate for non-PCD loans remained fairly steady at 2.35%, while non-performing loan rates for PCD loans decreased from 4.26% to 2.11%.
Turning to capital, stockholders' equity increased 2% sequentially and 4% year-over-year. The tangible common equity ratio increased to 9% ahead of both the prior quarter and the year-ago period when we made the acquisition of Scotiabank.
Please turn to page 8. After holding off for most of the first half of 2020 due to the pandemic, we completed the Scotiabank cost savings program in the fourth quarter. With the completion of the system conversion, we realized $32 million in annualized savings, exceeding our original estimate of $35 million or about 9%. Looking ahead, we expect to benefit from about two-thirds of these savings in 2021 as we plan to step up investment in the continuing transformation of our business model.
Long term, we are committed to reducing expenses and increasing operating leverage. Our objective is to return to an efficiency ratio in the mid-50 range.
Now, here is José for his outlook for 2021.
Thank you, Maritza. Please turn to page 10. We believe our history, culture, team and approach to business, as well as our most recent results, demonstrate our ability to respond quickly and adapt to changing economic conditions.
During the fourth quarter, we continued to build good momentum in our core businesses and develop a strong pipeline of new loans. We have a strong balance sheet, very well positioned financially and strategically.
Our agenda for 2021 is clear – advance our strategic plan to further grow and improve performance in all operating areas. For that, we need to further increase loan generation growth in income. And as I mentioned, we plan to continue to invest for the future to further simplify operations, increase operating leverage, and enhance our ability to serve customers.
Our outlook is more optimistic than last quarter. We still face challenges from COVID, high unemployment levels, and largely ineffective government operations, to name just a few. But we believe the economy is starting to move in the right direction and the future looks brighter.
With a new administration in Washington, Puerto Rico is on the cusp of receiving significant amounts of approved balance sheet reconstruction and stimulus funds for several years to come.
Key areas that should benefit from the influx of federal funds are the production and distribution of resilient and diversified electricity, improved infrastructure, telecommunication, and government efficiency.
We're also very hopeful with regards to the multiple vaccines that have been proven effective against COVID. I'm not talking about the effect on the economy here and around the world, although that's very important, but the effect they will have on human lives and the people in Puerto Rico, the US Virgin Islands and elsewhere.
A lot of families, small businesses and their employees have suffered because of the pandemic. If the vaccines are as successful as expected, we'll see the end of COVID in a relatively short period of time. We at OFG are more than ready to help our customers rise up and fulfill their lives again, while we all play a major role in the recovery of Puerto Rico and the US Virgin Islands.
With this, we end our formal presentation. Thank you all for listening. Operator, let's start the Q&A.
[Operator Instructions]. And your first question is from Alex Twerdahl with Piper Sandler.
I want to sort of first off start with some of those comments about cash flowing down to Puerto Rico and just get your thoughts on sort of how both the stimulus money and additional stimulus checks as well as some of that Hurricane Maria relief money will actually impact deposit flows at OFG over the next couple of quarters.
That's a tough question, Alex. You saw what happened last year with the first CARES Act, and the PPPs and the $1,200 checks. It not only happened here in Puerto Rico, it happened also in the States. So, as we have a new administration coming in Washington and they're announcing the intention of coming up with additional stimulus packages, given the state of the COVID pandemic. I think hard to predict the level of deposits, but it's certainly easier to predict the economic impact of those funds. And those stimulus programs that will flow through to Puerto Rico also. I think the administration is also telegraphing an infrastructure plan for the United States, and I think Puerto Rico stands to benefit from that also.
So, when I make reference on the remarks about the funds that will flow to Puerto Rico, I'm really addressing more the significant amount and the direct economic impact that it will have short term and longer term. So, from our perspective at OFG, we expect to have higher deposit balances. We certainly will have higher balance sheet, a larger balance sheet, given those deposits, and it's on our best interest to deploy that excess liquidity to help the economy in Puerto Rico and the US Virgin Islands, the operating areas that we operate.
I guess just another way of kind of digging into that a little bit more is just, given all of that, do you view the $10 billion in assets threshold as being inevitable in 2021, just given the outlook for defaults, strong deposit flows or do you have tools to still manage the balance sheet kind of where it is?
We're working to grow. So, regardless of the stimulus coming in or not, assuming that they've come, we'll go through the $10 billion. It's in our radar. We're very close to it. So, I think 2021 will probably be the year where we do that. We need to work hard at making sure that the way we do it, it's in a way where it mitigates the regulatory oversight intensity and the cost associated with that, as well as with a lower fees from Durbin. And we're at it. That's why we keep on making sure that we invest, as I mentioned in my remarks, in our business model to make sure that we transform ourselves every year and keep ourselves as a very good alternative for our customers in the markets that we operate. So, 2021 most likely will be a year where we go by the $10 billion. But we just want to make sure that you understand that we're also planning on the back end of it to deal with the repercussions on the short term.
And in the short term, what is the impact on Durbin from crossing the $10 billion?
Short term, none. At the end of the day, it's at the end of the year where Durbin comes into effect. So, if we crossed the $10 billion by the end of this year, Durbin will have an effect six months, I believe, after that date. So, it's not a 2021 event in terms of the costs of passing the $10 billion. It's 2022. And I believe there is some standing mitigation orders from the regulatory side that will probably push that cost further into end of 2022.
Now that you're done with the systems conversion, you have almost $2 billion of time deposits still on the balance sheet that were around 1.5% during the fourth quarter. I know you've got some promotions that roll over at the beginning of 2021. But maybe you could just give us a sense for how we should be thinking about deposit costs. And just specifically, some of those higher costs in ones whether or not they're going to roll off the balance sheet or reprice and sort of how we can apply that to the NIM going forward?
Most of those higher quality deposits are CDs that were part of the acquisition of Scotia and some CD campaigns that we did at OFG back a couple of years ago. They're rolling over and will benefit from the effect of that through 2021. And those will be repriced according to market conditions at the point they mature.
Do you have a sense for how many mature in the next six months or this year even?
Like $700 million to $800 million.
Just final question for me. Just as I look at the expense guide, and this is a very helpful slide, it talks about the branch consolidation for expense for 2021. If I remember right, branch consolidations were never contemplated in the original cost saves number. So, is that additional cost saves that we should be expecting or how should we think about sort of the run rate of expenses, including both the branch closures as well as, you said, some additional investments?
again, the numbers that you're seeing do not include the branch closings because the branch closes have not taken place yet. So, you're not seeing those savings yet. So, the way we look at the branch closures is more their redundancy. They're very closely located to each other, i.e. from the acquisition. So, the way we're looking at this is we're going to close those redundant branches, but we're going to keep most of the personnel. We need to deal with the volume. We need to deal with the business activity. And we'll have some of those resources also relocated to other areas where we need to add some additional resources. So, when we look at the expenses, and the slide that you make reference to is precisely what we're seeing, 66% of the $38 million in yearly expenses will flow through into 2021. But we do not expect a significant amount of cost benefit coming from the seven or eight branches that we will be closing in 2021.
Your next question is from Glen Manna of KBW.
I just wanted to follow-up on what Alex was asking kind of about the balance sheet a bit. And you have almost $2.2 billion in cash and equivalents on the books right now. Do you have any better idea of how the deposit cadence is going to play out? And would you be comfortable with putting any of that excess liquidity into the securities book?
Again, it's hard for us to justify going long duration with 30 or 40 basis points spread. We'd rather take credit risk. We think the economy in Puerto Rico has stabilized and is moving in towards a very nice spot in the next several years, barring any unforeseen event. So, the way we look at this is we have a market in the island where there are only three banks, and I think there is enough for everyone to deploy their cash and their liquidity. Certainly, it's not going to happen in one quarter or in one year. It's going to take a while because the amount of liquidity that is flowing into the economies in the world is significant, particularly in the United States and Puerto Rico. So, it's going to take a while. But I don't see us deploying assets into the securities portfolio unless interest rates start on the long end, showing some increase, and we were not expecting and/or modeling that into the future, Glen.
You had mentioned that about $2 million in mortgage banking was from gain on loan sales that you had held back from the third quarter. It looks like the fourth quarter mortgage production was better than the third quarter and loans held for sale were still high at about $41 million. Is there anything that's held back for next quarter, in the first quarter? Are we going to see that mortgage banking drop down to its normal run rate? Are we going to stay a little bit elevated here for a bit?
I think it's going to look more – I don't think it's going to be $6 million, but it's going to stay elevated. I think as you saw on the production and the loan generation side, we are doing close to $100 million in mortgages a quarter. Most of that is agency paper, conforming paper. So, our model right now, again, for the same reasons that I explained earlier under securities portfolio, we don't want to hold 30 year mortgages at 2.25% so and have some credit risk embedded in it, at least a little bit. We rather originate and sell, at least for now. Later, as interest rates go up, we'll add that. So, yeah, we see mortgage banking activity remaining at an elevated rate, given the originations that we're having and the model that we're operating in, which is originate and sell. So, you'll see that.
And on the seasonal insurance pickup from Scotiabank, that was really eye popping. I don't think we saw anything in the prior three quarters that would have suggested that. Do you think next year? Well, first, do you think insurance kind of drops down to that run rate and then do you think next year it's a similar amount or was there something special in it this year?
Glen, I'm glad that you asked me that question on insurance. When we bought Scotiabank, two of the main components that added significant scale to us that we did not have that scale, one was mortgage, and including servicing, and you're seeing the benefits of it. And the other one was insurance. And insurance is tightly correlated to the mortgage business because of the title insurance and – what's the other insurance, property insurance, dwelling insurance.
So, when you look at our insurance business this year, we have steadily increased our commissions. And when you look at the fourth quarter, we're getting not only what we used to get from oriental insurance agency prior to the acquisition, but we're also getting the incremental benefit from other dwelling commission that are contingent, that are part of the servicing portfolio that we have and that we serve those clients from our insurance side. So, we're equally happy with the increase in insurance commissions coming at the end of the year and we expect to replicate that in the fourth quarter of this year also.
We're starting PPP round two. Maybe if you could just discuss your thoughts on PPP round two, maybe the cadence of payoffs you're expecting from PPP round one and round two next year. And then if you could just discuss loan growth ex-PPP and what you're thinking about for next year?
First, you saw what we did the first round last year. I think our team was outstanding not only in getting those loans on the books, but also the way we got those loans on the book, which is it's a soup to nuts digital approach, which is what is incrementally differentiating us here in the market.
When you see now the second round, you will probably see less demand for the PPPs. There's going to be significant amounts, but there are some rules that have changed on the second round. And we'll probably see 50% of what we did, maybe a little bit north of 50% on what we did last year on the PPP.
With regards to the balance sheet and loan generation, I think last year, given all the challenges and all the things we have to work through internally and externally, given the integration and COVID and all that, I think our teams did an excellent job in generating loans, new loans. And we reached a high or a record this past year.
I think we're on a very good momentum right now. I think we'll see auto remaining at a good trend. Same with mortgage, as I mentioned earlier. Small business lending is one of the areas where we continue to see good trends and good demand, and we're happy with the way we're executing that strategy on the retail channel and how close we get to our smaller business and professionals and help them out, particularly during these very difficult times, and how close our teams are to those clients and how we help them navigate a very difficult environment.
On the larger commercial lending, I think we have very good pipelines on all. I think that that segment of the market is a lot more competitive. The competitive landscape here with the three banks, they all have a lot of appetite for big tickets. And frankly, we do too. We don't want to do it in ways that we don't feel is within our, should we say, ballpark. And so, when we look at that side of the equation, we see good momentum, but we're keeping ourselves within the guardrails of our strategy. We don't want to get outside of it because it becomes a little undesirable, let's call it, from our, let's say, profitability side.
Thank you. At this time, there are no further questions. I will now turn the call back over to management for closing remarks.
Thank you, operator. And thank you all for listening in today. I hope everyone stays safe and healthy and look forward to the end of the panic and that we can all get back together. Looking forward to a healthy year and see you in the next call. Thank you.
Thank you. This does conclude today's conference call. You may now disconnect.