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OFG Bancorp (NYSE:OFG)
Q2 2019 Earnings Call
Jul 22, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Maria and I'll be your conference operator today. Our speakers are Jose Rafael Fernandez, President, Chief Executive Officer and Vice Chairman; and Maritza Arizmendi, Chief Executive -- 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 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 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. Fernandez.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Good morning. Thank you for joining us. Please turn to Slide 3. We're extremely pleased with our second quarter results. OFG has continued to deliver on all fronts. Our levels of small business, auto and consumer loan production, core deposit growth, credit quality, and capital and the number of net new customer growth all confirm the effectiveness of our differentiation strategy. As a result, we generated a 23% increase in earnings per share and more than a 3% increase in net revenue. And our return on assets, net interest margin and efficiency ratios are continuing at levels similar to the top performing peer mainland banks.

Looking ahead, Oriental will further consolidate its position as the premier retail bank on the island with the recently announced acquisition of Scotiabank Puerto Rico and U.S. Virgin Islands operations. Thanks to our entire OFG team for their commitment and dedication and to all our retail and commercial customers for their support and loyalty.

Let's turn to Slide 4 to review our financial highlights. Net revenues increased 3.3% year-over-year to $99 million. The key driver was a 7.1% increase in net interest income. Efficiency ratio was 51.89%, a 260 basis point improvement year-over-year. We're increasing productivity, and this is enabling us to continue to invest in our operations without affecting our overall non-interest expense levels.

As a result, earnings per share came in at $0.43 fully diluted, 23% ahead of a year ago. Tangible value per share increased 6.7% to more than $17. Return on average assets increased 25 basis points to 1.48%, and return on average tangible common equity expanded 112 basis points to 10.32%.

Please turn to Slide 5. There were three other items that affected second quarter results. First, we sold $350 million in low yielding mortgage-backed securities in May, reducing $191 million and $63 million of high cost repurchase agreements and brokered CDs respectively. The sale also resulted in a $4.8 million gain.

Second, we're selling $54 million of unpaid principal balance acquired distressed residential mortgage loans. The sale is expected to occur in the third quarter taking advantage of improving market conditions in Puerto Rico. The decision to do so resulted in an $8.8 million net increase in the acquired loan provision. Third, we incurred $1 million in expenses related to our previously announced Scotiabank Puerto Rico and U.S. Virgin Islands acquisition.

Please turn to Slide 6 to review our operational highlights. Total net loans increased 3.7% to $4.47 billion, with the growth of originated loans at 8.5%, more than offsetting the continued pay down of acquired loans. Compared to the preceding quarter, originated loans increased 2.5%. Loan production has been picking up. Second quarter production totaled $327 million. Auto and consumer lending remain high at $136 million and $48 million respectively, while residential mortgage lending totaled $22 million.

Commercial lending at $64 million reflected continued growth of small business customers in Puerto Rico. OFG USA added another $56 million in primarily mainland small business commercial loans. Core deposit average balance has increased 2% to $4.47 billion. That reflects growth in commercial loans and customers as well as the success of our efforts to build a larger core retail funding base.

The low yield increased 25 basis points reflecting higher returns on originated commercial loans. This stem in part from the effect of Federal Reserve rate hikes last year, but also a larger proportion of higher yielding commercial and auto loans in the originated portfolio. Core deposit costs continue to remain relatively low up only 16 basis points year-over-year. The end result was a net interest margin of 5.37%, 14 basis points higher year-over-year.

Please turn to Slide 7 to review credit and capital. Credit quality continued to improve year-over-year and from the first quarter. We're seeing a clear favorable improving trend with customers showing increased liquidity and stronger finances. The net charge off rate at 1.32% was the lowest in seven quarters. Non-performing loan and delinquency rates showed steady and or declining trends. Excluding the $8.8 million related to the transfer to held for sale of distressed acquired mortgages mentioned earlier, provisioning fell $5.8 million year-over-year due to better credit trends and improving economic conditions in Puerto Rico. Capital continue to build, our ratios increased across the board to new multi-year highs remaining significantly above regulatory requirements for a well capitalized institution.

Please turn to Slide 8 for outlook. We are very excited about our current market position and how we view our strategic path taking shape in the future. Our strategies are clearly proving effective in growing loans, deposits and customers and improving productivity. With our strong team of bankers and the ongoing deployment of technology that benefits both customers and operations, our performance continues to demonstrate excellent momentum.

As the economy began to show signs of recovery after hurricanes Irma and Maria, and with our strong capital position building fast, we recognize the importance of effectively deploying our excess capital for the benefit of our investors. We believe we have done just that with our recently announced Scotiabank Puerto Rico and U.S. Virgin Islands acquisition. Upon closing, Oriental Bank will become the second largest bank in several important categories in Puerto Rico, core deposits, branches, ATMs, and interactive teller machines, insurance and mortgage servicing, in addition to expanding to our neighboring U.S. Virgin Islands.

This will strengthen our businesses by providing enhanced scale, the addition of Scotiabank's talented team and an improved competitive position as Puerto Rico's premier retail bank. As we have said before, the acquisition is expected to be significantly accretive, generating strong capital thus increasing further our return on average tangible common equity. To sum it up, we're capturing the positive economic shift that we're seeing in Puerto Rico, building excellent momentum for growth now and more so in the future.

With this, we end our formal presentation. Thank you for listening. Operator, please open the call for questions.

Questions and Answers:

Operator

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from the line of Brett Rabatin of Piper Jaffray.

Brett Rabatin -- Piper Jaffray -- Analyst

Hey. Good morning, everyone.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Good morning, Brett.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Good morning.

Brett Rabatin -- Piper Jaffray -- Analyst

Wanted to first ask Jose Rafael what -- I saw that the CIO Portela resign and the Governor is not going to run for reelection. Can we talk about just the macro and how this is impacting Puerto Rico and what's going on with the recovery funds and maybe just some thoughts on the broader implications of the current events?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Sure. So, it's been -- we're going to have -- the latest events have been developing. It's a fluid process as we speak. You heard last night, the Governor is not running for reelection and resigning to his own party presidency. So, right now, it's too early to tell what the economic impact is. We are not seeing any impact so far. So from that perspective that's what we're seeing.

Longer-term, if this situation is not addressed proactively by the leadership of the legislature in Puerto Rico. It could have economic consequences on the longer-term. I am confident that the levelheaded minds will prevail and confident that the legislature will assume their role and make the right decisions to stabilize the situation here in Puerto Rico in terms of a political situation, and let's get on with business. That's kind of how I see it. Certainly it provides opportunities going forward to continue to achieve higher levels of governance, higher levels of transparency and focus on what's really important for the people of Puerto Rico, which is economic growth. And I view this albeit -- on the short-term, I see this as an opportunity also to execute on the right path for the future of Puerto Rico.

And again, focusing on having a true governance and having total transparency and focusing on economic development, which is at the end what's going to bring credibility from Washington and from investors alike.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay, that's a good summary. And talking about economic activity and you talked about market conditions continuing to improve. And I see that June auto sales are actually up year-over-year. A lot of the other data is kind of mixed. Can you maybe elaborate a little further on market conditions? Is that purely on the credit side or are there other things that you would point to that are notable in terms of improvement?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

So, you mentioned auto. That's one aspect of consumer strength continues to build. Certainly our commercial client finances are stronger, and that is clearly being seen in the last year or so either growing and improving significantly. We're seeing more liquidity on the consumer side. And therefore, spending is steady and slightly growing. So, from our perspective and what we're seeing from our client base and what we see here on the ground is that the economy continues to benefit from the back win of insurance funds, federal funds as well as the rebuilding efforts that are being put in place.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. Maybe if I can just sneak one last one in. Just thinking about growth, is it fair to assume that the recent improvement continues or can you give us any color on what you see from the pipeline and just I expect the back half of the year to unfold from a growth perspective?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

So, Brett, may I clarify your question? Are you referring to growth -- Oriental growth or economic growth?

Brett Rabatin -- Piper Jaffray -- Analyst

Oriental growth, the loan portfolio.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah, yeah, yeah. We're encouraged with what we're seeing honestly. We see good pipelines on the commercial side. We continue to take advantage of the disruption going on in the auto portfolio or the auto market and with the consolidation that occurred last year, and we're seeing good opportunities there. We're very focused on the retail side and particularly on the small commercial businesses. What we're seeing is a good pipeline and we're seeing good opportunities with good credit. So we're encouraged by that.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. Great. Appreciate all the color.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Thank you, Brett.

Operator

Our next question comes from the line of Alex Twerdahl Sandler O'Neil.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Hey, good morning.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Good morning.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Hi, Alex.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Just first wanted to drill into the provision a little bit, I mean if you exclude that $8.8 million that was specific to a loan sale, provision came down quite a bit down to $8.9 million, which is kind of much lower than the sort of the run rate you guys have been running at, yet charge offs were pretty much in line, loan growth is pretty solid during the quarter and loan NPLs declined. It wasn't that huge of a decline. So, I mean, can you talk a little bit about sort of the -- as it relates to some of the improved economic conditions you've cited in the past, specific metrics, etc., is this new level of provisioning or is this a new level of provisioning at kind of $8.9 million per quarter or is there something else kind of that we're not seeing that might be working underneath the surface that we should be considering?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah. So, Alex, from our perspective, a little bit of adding to what I already have mentioned regarding the economic conditions and the strength of the commercial client's finances, that is the reflection that you're seeing on the reduced provisioning. It is a reflection of a stronger economy and a stronger balance sheet and certainly stronger consumers. As we go forward, we feel that as the economy continues to grow and we continue to -- we will continue to see improving trends. And that's what we will be looking at in terms of provisioning. We will look at the environment, we will look at the current credit performance, and we'll provision accordingly, but we don't give any guidance in terms of our provisioning going forward.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Okay. So, I mean, kind of -- probably putting some words into your mouth, if everything kind of continues along the path as it has been, the provisioning level should be more similar to what we saw in the second quarter than the first quarter or prior?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

So -- well, let me just repeat a little bit. We're very encouraged with what's going on. We're really excited about the growth prospects that we're seeing, and that is directly related to how the economy is behaving as opposed to the last 10 years and how the strength of the commercial clients continue to build. And as to the provision going forward, we don't give a guidance, but it will reflect whatever the environment on our portfolio -- credit portfolio performs. We don't want to give a guidance on the provision.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Okay, understood. And then, just talking a little bit about -- you said it improved market conditions prompting the loan sale. What metric specifically do you look after that? Is that just purely appetite for distressed loan purchases on the island?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

So, remember, we sold residential mortgage loans. These are distressed that we acquired from BBVA. The way we monitor it, it has a couple of variables, but let's just share with you a couple of them, two of them, which is -- one of it, one of them is demand. There is a higher demand for these type of assets in the recent months. And certainly residential home prices have stabilized and started to show some upticks. So that's what kind of give us -- gave us a good moment to sell those or put them for sale. And we should be closing in the third quarter.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Okay. So with the loan sale or any sort of reduction of NPLs, was that required by regulators or internally before you were able to announce the Scotiabank deal?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

No, no, no. This is something of our business plan, and this is something that we are on the lookout every day. If you think of it, we don't want to have non-performing assets in our balance sheet. So if there is an opportunity that it's opportunistic and we feel it makes sense for us, we'll do it. If there is no opportunity for us and it makes more sense for us to work those loans out, we will work them out. It's an MPV analysis that we do. So I have nothing to do with anything related to the previously announced acquisition.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Great. And then just final question from me. It looks like deposit costs kind of in several of the categories increased in the second quarter, higher than we've seen some of the increases at least in the first quarter and maybe kind of average over the last couple of quarters. Is that reflective of the whole market moving higher in Puerto Rico for deposit costs or is it more specific to OFG related to some deposit promotions that potentially were offered in the second quarter?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

A couple of -- I think all the above. I think, on the term CD kind of a market, there's a little bit more competition. Some of our competitors have in the past been somewhat more aggressive on the one, two-year, three-year term. And we also saw a great opportunity for us to reduce our institutional funding. So when you see us growing CDs, it is because the cost of those CDs is lower than the brokered CDs or the other type of institutional funding that we might use. So that's kind of the spirit behind it, Alex. It's a little bit of the market kind of addressing the market price, but also it makes sense to us to become a -- to increase our core retail funding base through the CD market.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Okay, great. Thanks for taking my questions.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah. You're welcome.

Operator

[Operator Instructions] Our next question comes from line of Glenn Manna of Keefe, Bruyette & Woods.

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

Hi. Good morning.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Good morning, Glen.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Good morning.

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

I just wanted to get a little bit better handle on the NIM obviously with the average balance sheet and the timing of the security sales and kind of pay down to the broker deposits. When I pencil it out, I would get an end of quarter NIM that was probably heading into the third quarter about 10 basis points higher than the average NIM for the second quarter. I guess, Maritza, Am I thinking about that right?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

We don't try to forecast here our guidance in terms of NIM. We again -- we look at the NIM relatively stable as we're seeing it in this quarter, but it's not too far from what you're saying, Glen. I just put it that way.

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

Okay. And when you think about the sales and kind of the buildup in excess cash that happened in the quarter, looks like you'd be holding some cash. Is that kind of getting ready ahead of the acquisition or could we see the possibility that you could sell down or pay down some more broker deposits or a repulse?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Hey, Glen, we will be using that excess cash to continue, we're using our dependency on or our reliance on wholesale funding, brokered CDs, repurchase agreement and just use our core deposit our main source of fund.

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

Okay. And on the tax rate, it looks like a couple of percentage points lower than we were maybe expecting over here, what can we expect in the second half of the year?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

So, at the end, the effective tax rate came at 32-point-something, and we will see that as the effective tax rate for the next two quarters.

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

Okay. Super. Thanks for taking my questions.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

You're welcome.

Operator

Our next question comes from line of Joe Gladue of Alden Securities.

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

Hey. Good morning.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Good morning.

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

I'll just ask, Jose, at the end of the first quarter, you had mentioned that there were some (Technical Difficulty)

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Hello.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Hello, Joe?

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

Yeah. Can you hear me?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

No.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

No, we could not hear your question.

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

Okay, OK. I guess, at the end of first quarter, you mentioned that there were opportunities for growth in Puerto Rico. And clearly we've seen that come to fruition, but you also talked about there being some potential opportunities on the mainland. Just wondering if any of those things are on hold or if you're still looking at some potential there?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

We're -- on the U.S. what we're seeing is, we continue to deliver on our U.S. loan strategy as we mentioned earlier, I think, in the previous investor call. We are at this point focused on getting regulatory approval for the Scotiabank acquisition and regulatory approvals for the USVI side of it too and then moving to the conversion and merger process. At this point in time, the U.S. strategy remains the same, which is originating or lending into the small business and doing few participations on a quarterly basis.

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

All right. Thank you.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah. You're welcome.

Operator

[Operator Instructions] Our next question comes from the line of Brett Rabatin of Piper Jaffray.

Brett Rabatin -- Piper Jaffray -- Analyst

Hey. Just two follow-up items. One, wanted to follow up on that on the OFG USA strategy and the loans that you booked this quarter, $56 million. Can you give us some color on that? What industries? How many loans? Any color on the OFG USA strategy as part one?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah. I mean, these are small commercial business loans. These are mostly SBA loans that we're lending also over there in the States, and they are from a variety of industries. And they're smaller in the range of $2 million to $3 million or less. So that's kind of the description of the loans that we've done over in the U.S. in this quarter.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. And then, secondly, on expenses, can you give us some color on the back half of the year expenses that will continue related to the deal. They had $1 million related to 2Q. What does that look like for the back half? And then, just thinking about expenses, I mean, you've held them flattish to even down a little bit year-over-year. How are you being able to do that and where are you investing versus being able to pull back on terms of expenses?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Well, in general, Brett, we have only $1 million this quarter related to the acquisition. If we exclude that, the performance in expenses was better than expected in the sense that it kept going down. We have been able to deploy a new technology for keeping our cost well controlled. And as we see going forward, we will keep -- we will see the expenses being level with this quarter. We cannot anticipate what will be the additional cost regarding the acquisition quarter-by-quarter, but we do know that they will come from expenses. So, as we goes by, we will see it as expenses coming into the efficiency ratio. However, we don't see big ticket item at least in the ongoing basis.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Also recall that most of the transactions expenses will also become part of the modeling that we did with the Scotiabank acquisition and the related merger one-time expense.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay. And then, just following up on that from Scotia, just since that deal has been announced, what's been your experience in terms of thinking about the expenses, the franchise you're acquiring the opportunities to grow their book?

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

So everything that we have modeled, so far it's been as we speak being validated and we're really excited about bringing in the team from Scotia later in the year, but Brett, we're right now focusing on what's really important, which is the regulatory approval process, and that's what our focus is. Certainly we've had extensive discussions with the Scotia team already, and we're collaborating as we speak as much as we can before regulatory approval.

Brett Rabatin -- Piper Jaffray -- Analyst

Okay, great. Appreciate the additional color.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah, thank you.

Operator

[Operator Instructions] Our next question comes from the line of Alex Twerdahl of Sandler O'Neill.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Hey. Just wanted to see if you guys wanted to get on the record with any preliminary expectations for CECL?

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Well, at this point, Alex, we are -- they are down in the process, and what we're seeing is that probably for next quarter we would be able to provide you some as specific or more specific regarding the possible impact of CECL next year.

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Fantastic. We'll be looking forward to hearing that. Thank you for taking my call.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Okay.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Yeah.

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Great.

Operator

[Operator Instructions] There appears to be no further questions at this time. I would like to turn the floor back over to Mr. Fernandez for any additional or closing remarks.

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Thank you, operator, and thank you everyone for listening in today. We'll be at the KBW conference on June 30th in New York. We'll be coming back to you on a conference call for earnings late in October when we report our third quarter results. Until then, thank you again and have a great day.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

Jose Rafael Fernandez -- President, Chief Executive Officer, Vice Chairman

Maritza Arizmendi Diaz -- Executive Vice President and Chief Financial Officer

Brett Rabatin -- Piper Jaffray -- Analyst

Alexander Twerdahl -- Sandler O'Neill -- Analyst

Glenn Manna -- Keefe, Bruyette and Woods -- Analyst

Joseph Gladue -- J. Alden Associates, Inc. -- Analyst

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