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OFG Bancorp (NYSE:OFG)
Q4 2020 Earnings Call
Jan 25, 2021, 10:00 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 Christie, and I will be your operator today. Our speakers for today are Jose Rafael Fernandez, 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 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 any 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. Please go ahead.

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

Good morning and thank you for joining us. First, I want to wish 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. [Foreign Speech].

Our job as managers is to lead through good and bad times. When we look back at 2020, we are 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 U.S. 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, [Foreign Speech].

Our people adapted quickly to working remotely. We stepped up spending for COVID-related items such as testing, healthcare, and worksite safety. We made significant investments to ensure our teams had robust remote work capabilities.

We also worked to do our part for our communities. At the beginning of 2020, we supported the earthquake-affected towns in the southern part of Puerto Rico. After that, it was COVID-related donations and securing more than $100,000 in grants for non-profits in Puerto Rico and the U.S. 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 continued to see higher percentage adoption in all banking technologies. I am 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 fourth 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 [Indecipherable] 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 than the third quarter because of the greater proportion of higher tax income, but it is also lower than our estimated tax rate in 2021, 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 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 the CET1 ratio increasing to 13.08%. Looking at our numbers, we continued to see signs of recovery with solid loan production, regular payment activity, stable credit trends, and a sequential quarterly 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.

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

Thank you, Jose. Please turn to Page 6 for our financial highlights. 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 [Phonetic] sequentially to 67%. When you adjust for mergers and COVID 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 metrics would have been more in line with our general performance objectives.

Please turn to Page 7 for our operational highlights. As Jose 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 6.55%. Average core deposits increased, but end of period balances declined $170 million on a linked quarter basis. This 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 loans that were substantially and previously reserved at the time of the acquisition. Provision was $14.2 million. This includes $4.7 million to cover the two chargers [Phonetic] of commercial loans acquired from the Scotiabank that I just mentioned. Fourth quarter 2020 loan deferrals fell to 1.4% of total loans from 2% in prior quarter and 3% in the second quarter of 2020. The non-performing loan rates 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 by about 9%. Looking ahead, we expect to benefit from our -- 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 Jose, for his outlook for 2021.

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

Thank you, Maritza. Please turn to Page 10. We believe our history, culture -- 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. We're 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 and grow fee 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 the new administration in Washington, Puerto Rico is on the cusp of receiving significant amounts of approved [Technical Issues] reconstruction and stimulus funds for several years to come. Key areas that should benefit from the influx of federal funds might be production and distribution of resilient and diversified electricity, improved infrastructure, telecommunication, and government efficiency.

We are also very hopeful with regards to the multiple vaccines that have been proven effective against COVID. I am not talking about their 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 U.S. 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 U.S. Virgin Islands.

With this, we end our formal presentation. Thank you all for listening. Operator, let's start the Q&A.

Questions and Answers:

Operator

Certainly. [Operator Instructions] And your first question is from Alex Twerdahl of Piper Sandler.

Alexander Twerdahl -- Piper Sandler -- Analyst

Hey, good morning.

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

Good morning, Alex.

Alexander Twerdahl -- Piper Sandler -- Analyst

I just wanted -- first, I'll 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.

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

That's a tough question, Alex, and -- to predict -- you saw what happened last year with the first CARES Act and the PPPs, and the $1,200 checks and 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 is -- stands to benefit from that also.

So, when I make reference on the remarks about the funds that will flow to Puerto Rico, I am really addressing more the significant amount and the direct economic impact that it will have short term and longer term. So, from our perspective [Technical Issues] OFG, we expect to have higher deposit balances. We certainly have -- will have higher balance sheet, a larger balance sheet given the -- those deposits, and it's on our best interest to deploy that excess liquidity to help the economy in Puerto Rico and the U.S. Virgin Islands, the operating areas that we -- the areas where we operate.

Alexander Twerdahl -- Piper Sandler -- Analyst

Okay. That's helpful. And then 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 [Technical Issues] strong deposit flows? Or do you have tools to still manage the balance sheet kind of where it is?

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

So we're working to grow. So, regardless of the stimulus coming in or not, assuming that they'd come, we'll grab through the $10 billion. It's in our radar and 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 the -- a lower fees from Durbin and we're at it. That's why we keep on making sure that we invest in our -- 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 are also planning on the back-end of it to deal with the repercussions on the short term.

Alexander Twerdahl -- Piper Sandler -- Analyst

Okay. And in the short term, what is the impact on Durbin from crossing the $10 billion?

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

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 cross 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 [Phonetic]. And I believe there is some standing mitigation orders from the regulatory side that will probably push that cost further into -- end of 2022.

Alexander Twerdahl -- Piper Sandler -- Analyst

Okay. And then, 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 third -- 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 costing 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.

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

Yeah. Most of those higher cost 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.

Alexander Twerdahl -- Piper Sandler -- Analyst

Do you have a sense for how many mature in the next six months or this year even?

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

Like $700 million to $800 million.

Alexander Twerdahl -- Piper Sandler -- Analyst

Okay. Thank you for that. And then 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 -- there is a branch consolidation 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 it, some additional investments?

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

So again, the numbers that you're seeing do not include the branch closings, because the branch closings have not taken place yet. So you're not seeing those -- seen those savings yet. So the way we look at the branch closing -- closures are -- is more their redundancy, they are very closely located to each other from the acquisition. So the way we're looking at this is, we're going to close those redundant branches but we are 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 are seeing, 66% of the $38 million in yearly expenses will flow through into 2021, but we do not expect a significant amount of cost benefits coming from the seven or eight branches that we will be closing in 2021.

Alexander Twerdahl -- Piper Sandler -- Analyst

Okay. Thank you. I'll get back into the queue for now. Thank you.

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

Yeah. Thank you, Alex.

Operator

Thank you. Your next question is from Glen Manna of KBW.

Glen Manna -- KBW -- Analyst

Hi, good morning.

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

Hi, Glen. How are you?

Glen Manna -- KBW -- Analyst

I'm well. How are you?

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

Good.

Glen Manna -- KBW -- Analyst

So I just wanted to follow-up on what Alex was asking, kind of, about the balance sheet a bit. 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?

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

So, again, it's hard for us to justify going long on duration with 30 basis points or 40 basis points spread. We rather take credit risk. We think the economy in Puerto Rico has stabilized or is -- and is moving in toward 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, so -- 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 are not expecting and/or modeling that into the future, Glen.

Glen Manna -- KBW -- Analyst

You had mentioned that about $2 million in mortgage banking was from a gain on loan [Phonetic] 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 or we're going to stay a little bit elevated here for a bit?

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

So 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 we -- our model right now again for the same reasons that I explained earlier on the securities portfolio, we don't want to have -- hold 30-year mortgages at $2.25 million [Phonetic], 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 adapt. But -- so, yeah, we see mortgage banking activity remaining at an elevated rate, given the originations that we're having and the model that we are operating in, which is originate and sell. So you will see that.

Glen Manna -- KBW -- Analyst

Okay. And on the seasonal insurance pick up 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?

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

So, Glen, I am really -- I am glad that you asked me that question on the 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 the -- what's the other insurance, the property insurance...

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

Dwelling.

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

Dwelling, thank you; 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 all the dwelling commissions that are contingent that are part of the servicing portfolio that we have and we serve those clients from our insurance side. So we are equally happy with the increasing insurance commissions coming at the end of the year and we expect to replicate that in the fourth quarter of this year also.

Glen Manna -- KBW -- Analyst

Okay. And we're starting PPP round two. Maybe if you could just discuss your thoughts on PPP round two. Maybe the cadence of pay-offs 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.

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

Sure. So, first I -- you saw what we did first round last year. I think our team was outstanding and not only in the -- getting those loans on the books, but also the way we got those loans on the book, which is -- it's [Foreign Speech] digital approach, which is what is incrementally differentiating us here in the market.

When you see now the second round, you'll probably see less demand for the PPPs. There's going to be significant amounts, but there is 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 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 way 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 and all. I think 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 what [Phonetic] 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 guard rails 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.

Glen Manna -- KBW -- Analyst

Okay. Thank you.

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

You're welcome.

Operator

Thank you. At this time, there are no further questions. I will now turn the call back over to management for closing remarks.

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

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 pandemic and we can all get back together. Looking forward to a healthy year and see you in the next call. Thank you.

Operator

[Operator Closing Remarks]

Duration: 32 minutes

Call participants:

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

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

Alexander Twerdahl -- Piper Sandler -- Analyst

Glen Manna -- KBW -- Analyst

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