OFG Bancorp

Good morning. Thank you for joining OFG Bancorp's conference call. My name is Maria, and I will be your operator today. Our speakers are José Rafael Fernández, President, Chief Executive Officer, and Vice Chairman, and Maritza Aramis-Mendi, Executive Vice President and Chief Financial Officer. A presentation accompanying today's remarks can be found on our Redesign Investor Relations website, on the homepage, and 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 All lines have been placed on mute to prevent background noise. After the speaker's remarks, there will be a question and answer session. I would now like to turn the call over to Mr. Fernández.

Good morning to all and thank you for joining us. Before I begin, I want to thank all our team members for their dedication and commitment during these very challenging times. You have done an excellent job and our results show it. I'd like to spend an hour on the big picture. Once we got through the last crisis in January, the economy and OSG performed well. We had only started to see the benefits of the Scotiabank acquisition. Then, the COVID-19 pandemic hit, and by mid-March, the Puerto Rico government had shut down the island. These tough measures, however, enabled Puerto Rico To begin to relax restrictions on economic activity by the end of the second quarter and beginning of the third, with a noticeable rebound in the economy. At the same time, we began to see an increased flow of federal funds for stimulus and reconstruction related to Hurricane Maria, the earthquakes, and the COVID-19 pandemic, in addition to the benefits provided by the bank loan deferrals. All this added to the third quarter's economic rebound and resulted in increased liquidity on the part of businesses and consumers. Altogether, the impact has been much more beneficial on a relative basis than what's happened on the mainland. As it relates to the local banking industry, consolidation, the natural rebound in economic activity, and the growing amount of stimulus combined with the Federal Reserve Bank's significant rate cuts in March created a number of banking crosscurrents in the third quarter. By acting with agility and speed, OFG has been able to take advantage of them to the benefit of our customers, communities, and people. The increased liquidity resulted in continued growth in deposits and cash. This cost virtually all our net interest margin dilution compared to the second quarter. It also encouraged consumers and business customers to step up their loan repayments. Taking advantage of this situation, we continued to expand our customer base and digital migration. There was a large increase in new auto sales, which we translated into a noticeable increase in our own auto loan generation. Mortgage production quadrupled, fee income grew across the board, and deferrals dropped to 2% of loans from 30% Our commitment and preparation enable us to manage these changes fácil, rápido, hecho, as we say at OFG. Branches continue to operate safely, enhanced by our technology. Full-service ATMs and ITMs, our mobile app, and online bill-paying tools continue to facilitate routine transactions in a contactless manner. Online and mobile appointment scheduling continue to make COVID-safe customer meetings possible at branches. In addition, the Scotiabank integration continues on track and we're starting to see improved operating leverage. In the end, we generated strong momentum in our core businesses as we continue to help our customers, communities, and people build better and stronger financial futures for themselves. Let's turn to page 4. We have continued to see strong digital migration trends among both our retail and business customers. More customers are becoming online and mobile users, but they are also using an increasing number of digital features. Here are some new highlights comparing September to January of this year. P2P volume is up 40%. Digital money transfers have increased 55%. Online loan payments are up 87%. Retail and commercial photo deposits have doubled. And we scheduled more than 34,000 COVID-safe appointments with customers through our online mobile tool, almost all of them in the second and third quarters. Clearly, customers are using these features to avoid contact during COVID. But as they experience the ease and convenience of banking like this, The habits will surely stick. More and more customers in Puerto Rico are asking themselves, why would you drive to the branch to deposit a check when you can take a photograph? Why would you even write a paycheck these days? These are positive trends that have accelerated due to the pandemic and play nicely to our retail banking strategy. We continue to look for new and innovative ways to help our customers interact with us in an agile and easy way. Earlier this week, we became the first financial institution in Puerto Rico and the U.S. Virgin Islands to launch a digital portal to make it fast and easy for our commercial clients to apply for PPP loan forgiveness. Let's start on page five to talk about our financial results. Earnings increased significantly. We reported earnings per share of 50 cents, a 28% increase from the second quarter, and more than four times the year-ago quarter. The effective tax rate was 19% compared to 25% in the second quarter. Total core revenues were $127 million. Excluding one-time interest recoveries from acquired Scotiabank loans, net interest income of $99 million was level with the second quarter, while fee income rose 19% to $27 million. Net interest margin was 4.3%. When you exclude interest recoveries in both quarters, net interest margin was 4.28 versus 4.5% in the second quarter. Virtually all the difference was attributable to the increase in cash balances. Non-interest expenses of $83 million fell more than $2 million compared to the second quarter, and that number includes merger and COVID-related costs. Excluding those in both periods, the efficiency ratio improved 369 basis points compared to the second quarter as increased operating leverage from the Scotiabank acquisition began to peak in. Customers' deposits grew more than $212 million from June 30 to $8.5 billion. Due to the increased deposits as well as repayments of loans and securities, cash increased $383 million As a result, total assets grew $84 million to $10 billion. We do not anticipate exceeding this total asset level come December 31, 2020. Loan production was strong, totaling $458 million. Excluding Paycheck Protection Program loans in the second quarter and third quarter, production increased $228 million. The allowance coverage increased to 3.64%, excluding PPP loans. Capital continued to build. Shareholders' equity increased to $1.06 billion. All regulatory capital ratios remained significantly above requirements for a well-capitalized institution. The CET-1 ratio was 12.55% on September 30, 2020. Please turn to page 6. The effects of all this is that we are building tangible book value per share. This increased 50 cents in the third quarter to $16.51. In addition, all three of the key performance ratios we tracked improved sequentially. The efficiency ratio improved to 65.69% on a reported basis. On an adjusted basis, it was 62.17%. Return on average assets was 1.11% and return on average tangible common stockholder equity was 12.23% and 12.10% on an adjusted basis. Return on average tangible common equity is now exceeding our performance as compared to the year-ago second quarter before all the transactions related to the Scotiabank acquisition and increased provisioning affected the business. Please turn to page 7 for our operational highlights. Average loan balances declined $54 million from the second quarter, reflecting net loan repayment in mortgage, commercial, and consumer. Auto increased. Average core deposits, excluding brokered, grew $524 million from the second quarter. End-of-period core deposits are now up more than $1 billion from the end of last year. That is, on top of the $2.8 billion that came with the Scotiabank acquisition. Loan generation, excluding PPP loans by order of magnitude, was driven by $174 million in commercial lending, $156 million in auto, $94 million in residential mortgage, and $24 million in consumer. Loan yield at 657 declined 40 basis points from the second quarter, This was mainly driven by PCD loans due to lower interest recoveries. Non-PCD loan yield declined only 16 basis points. The cost of core deposits declined 5 basis points to 56 basis points. Please turn to page 8 to review credit quality. Credit quality continues to be under control. The net charge of rate declined 30 basis points from the second quarter, mainly due to declines in auto. Provision declined $4 million, largely due to the decline in COVID-related provisioning. Otherwise, provision was approximately level. The non-performing loan rate increased 52 basis points quarter over quarter, mainly in mortgage and auto. We believe this is more about getting customers back in the payment cycle now that most deferrals are over. But we surely are keeping a close watch on it. As for our customer relief program, if you recall, as of June 30th, we had process relief for more than 44,000 retail customers for $1.4 billion, or 32% of our retail loans. For our commercial customers, we had process relief on $685 million in loans, or about 27% of our commercial portfolio. As I mentioned earlier, Our deferrals are now down to 2% of total loans. Most of that relates to about $112 million of commercial loans, mostly long-standing, solid customer relationships in the hospitality industry. Please turn to page 9. The allowance for loan and lease losses increased $2.6 million from the second quarter and is now equal to 3.48% of total loans, excluding SBA guarantee PPP loans. The allowance was 16 basis points higher than in the second quarter. Please turn to page 10. We're in a very strong capital position. Our CET capital ratio is now up 164 basis points since last year after the Scotiabank acquisition. Please turn to page 11. To conclude, We believe our history, culture, team, and approach to business, as well as our most recent results, demonstrate our ability to quickly respond and adapt to changing economic environments. During the second and third quarters, we have built momentum in our core businesses and developed a strong pipeline of new loans. Looking at our liquidity, capital, and balance sheets, we are well positioned financially and strategically. We have $8.5 billion of sticky core deposits with an excess of more than $1 billion, giving us significant amount of dry powder. Our agenda remains the same. Finish integrating the former Scotiabank operations by year-end. Achieve the full benefits of the acquisition by the end of next year. Continue to invest for the future to further simplify our operations and enhance our ability to serve customers. and continue to play a significant role in the economic rebound of Puerto Rico and the U.S. Virgin Islands. From a macro perspective, the increased liquidity from ongoing stimulus should continue to benefit the economy. This favorable environment should be further enhanced by the fiscal board finally working towards a resolution with Puerto Rico creditors and by pharmaceutical companies as they ensure more production back to Puerto Rico. We are now incrementally more confident that the economy will improve further. Let's be clear, we still face tremendous challenges from COVID-19, the elections in Puerto Rico and the USA, and completing our Scotiabank conversion and integration. But we believe the economy is starting to move in the right direction and the future is beginning to look brighter. By staying close to our customers and communities, we should be able to continue to deepen our relationships and all the financial services we provide to them as we enter what appears to be a nascent and potentially expanding recovery. Again, I want to thank all our team members for our excellent results and for their dedication and commitment this year. Crises bring out the best in people to help others. Our team demonstrates that every single day. With this, we end our formal presentation. Thank you all for listening. Operator, let's start the Q&A.

Thank you. The floor is now open for questions. To ask a question at this time, simply press star, then the number 1 on your telephone keypad. Again, that is star 1. If at any point you wish to withdraw your question, press the pound key. Our first question comes from one of Alex Tordal of Piper Sandler.

Hey, good morning. Good morning, Alex. First off, just want to ask a couple of questions on the margin. Specifically, you guys are now sitting on around $2.3 billion in cash, running 13 basis points. And I looked at your CD book at almost the same amount, paying 154. It just seems like a tremendous opportunity to really get aggressive on deposit costs over the next couple of quarters. Is that the case? And how quickly could we see Thank you for your question, Alex.

I think that's a good point. And the way we look at this is, first, we need to make sure we extract the full benefits of the acquisition from Scotiabank. And as you know, we've been We have been very strategic in terms of how we address the cost of funds from our customers because we want to make sure that we extract also the efficiencies from the operations first. Customers come first for us. and we try to focus first on how do we make our operation more efficient and certainly with the acquisition of Scotiabank we had to delay it given COVID-19. We're starting to get back on track and we should see the full effects of the operating efficiencies by the end of next year but as you know we keep a close look at J.D., Milagros Pérez and probably on the longer term. So looking long term, we think that we're in very good shape and we're not in any hurry to play a tactical game here.

Okay, understood. And then just switching over, looking at the reserve increase this quarter, it seems like it was mostly driven by the auto portfolio. Can you talk a little bit about what drove a higher reserve level for auto this quarter specifically? Is it sort of collection trends or is there something else in some of the macro data that got adjusted? What drove the increase and what factors you look forward to eventually drive that to go lower?

I'll let Maritza give you some color.

Hi, Alex. Well, you know, allowance is always a variable of volume, and auto loan was a portfolio that during this quarter increased significantly due to the higher level of production. This is one of the factors for the increase. Also, there was a temporary increase in the MPLs, as we see it, so we provided as the methodology requires to do so. I think that's the main two drivers for the increase during this quarter.

Okay, and then just talking a little bit about the NPLs, and you sort of alluded to it in your prepared remarks, José, but do you attribute the increase in NPLs to just returning on collection efforts that maybe have been off for a couple months? And can you just remind us sort of what you saw after Hurricane Maria with the same sort of thing and how that eventually played out?

So I think the script is playing out similar to Maria, and what we're seeing with the With the pickup in NPLs, we feel it's a little bit of two things. One is deferrals were over and people need to get back into the payment cycle. But also the fact that we're in COVID-19, this has a different dynamic than Hurricane Maria, and that is going out there and into the streets and doing the... The canvassing that requires, particularly on the consumer side, it's harder. So again, we use all methods and I think COVID-19 kind of threw a curve at everyone with some of the tools that we utilize to kind of get people into the payment cycle. And that's how we see it. We are keeping a close eye to it and we'll give you an update in the next quarter's results call. But we're not at this point seeing any deteriorating trends or anything that tells us that we're having incremental MPLs.

Great. Thank you for taking my questions.

You're welcome. Thank you for your questions.

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

Good morning.

Good morning, Joe.

I guess first wanted to ask about the loan originations. Very impressed with the growth there and wondering if you could give us a little color on some of the drivers, but particularly with the The mortgage portfolio, you know, looks like production in the third quarter was more than you did in all of, you know, 2019. And just wondering if there's some, you know, that's market share gains. Is the, you know, is the market growing that much? You're the first ones to report here in Puerto Rico. Just, you know, hoping for a little color on the drivers.

Yep. So, I would say, Joe, on the origination side, you know, Mortgage was a great performer in the quarter. As you recall, before the acquisition of Scotia, we were originating $20 to $30 million, I would say $15 to $20 a month, so it's like more closer to like $50. And this quarter, we almost reached $100 million in mortgage origination, and that is part of the benefit that we're getting from the Scotia Bank acquisition, where we have a A larger platform to originate. Certainly lower interest rates and refi and we're seeing also pent up demand to buy homes and starting to see good pricing bids for homes also. So all that has put into play the increasing originations on the mortgage side. In terms of market share, I suspect we have increased our market share, but we don't have enough data at this point in time to confirm. But it seems to me that with that origination level in the quarter, it looks like we've gained some market share there. On the auto side, also we saw in the quarter, and as I mentioned in my initial remarks, the third quarter really benefited from The pent-up demand that was created from the shutdown and the reopening, so auto sales, new auto sales, and used car sales also went up. And we have a great relationship with the dealers that we serve, and we moved fast and served them as well. Thank you very much. Thank you very much. J.D., Milagros Pérez J.D., Milagros Pérez The benefits of all the stimulus, and it's translating into greater opportunities for us to originate loans, and we're out there. We've got to be out there for our customers and make sure that we serve them and provide them the ability to grow their relationships with us.

Okay. And just in regards to how that Production is affecting the margins. Where are average yields on new production versus what the averages are for the quarter?

On the consumer side, I'll just give you some color on the auto and consumer because on the mortgage, most of it will originate and sell if it's conforming, and most of it is conforming. But on the auto and consumer average yield between the two portfolios is probably close to the 9.5% to 10% among both. On the commercial side, with lower interest rates by the Federal Reserve Bank, we're seeing certainly lower yields there. But we're also seeing Thank you, Joe. Have a great weekend.

Again, ladies and gentlemen, in order to ask a question, simply press star, then the number 1 on your telephone keypad. Our next question comes from one of Gwen Mana of Keith Brewer Woods.

Hi, good morning, José. Good morning, Maritza.

Hi, Glenn.

I just wanted to dig into the fee income a little bit on the banking service fees, and I think, you know, Given the merger happened just before COVID, we really probably never got a really good run rate on what that would be on the combined company. But the current quarters, the 16.3 in the current quarter, does that have any lingering effects of customer activity or is that kind of the run rate that we would have expected after the merger?

So on the fee income, we have several factors there. As you know, we have a A long-standing legacy financial services business. That business did incrementally better this quarter. We also have a larger mortgage business from servicing and all, and we're starting to see the full benefits of that business as we start to stabilize and normalize on the COVID environment. And then on the banking services, What we're seeing is, again, a reflection of the economy and a reflection of the business activity coming back and customers going out and doing their own activities, business activities and personal purchasing activities. So when you look at the results this quarter, probably we're starting to see the full effects of the acquisition in terms of fee income, and we're Very much on the lookout. Now that we're going to do the conversion and we're going to do the systems integration, we'll have better visibility. Because remember, we're running two systems right now and life is a little bit more complicated than what you would imagine on a daily basis, given the two systems plus given the COVID-19 pandemic scenario. So that's why I keep on going back to our team and I keep on saying, that what we have done and what we have accomplished this year just fills me with pride and I can't stop repeating it because this is not normal standard operating conditions and add to that that we're in the process of integrating two banks so again really proud of our team.

Okay and then you know to that point and kind of on the expenses If you take out the merger charges and COVID expenses in the second quarter and the third quarter, it looks like expenses decreased $1.8 million. Annualized, that would suggest about 20% of the $35 million in cost saves that you had guided to when you announced a Scotiabank deal. Is that right internally, and are those really cost saves from the deal, and are we at the 20% range?

I'll let Maritza give you the color, but I just want to make sure that everybody understands that we're working hard toward extracting all the benefits of the Scotiabank acquisition, but very much being cognizant of the COVID-19 environment we're operating in. So, Maritza, why don't you give Glenn some color on that?

Yes. As Jose was mentioning, the consolidation process started later than we planned and during this third quarter we started to see the initial steps that we have taken so far to take full advantage of the consolidation. However, system conversion is a big deal for us to continue realizing these expected savings. So when we completed this process that is scheduled to be completed by the end of this year, we will have a better visibility on what could be the run rate in the long term. We are very, we're looking forward for the operating leverage that the Scotiabank acquisition, the potential of that operating leverage we are expecting for. So I think at the end, last quarter will be key for us To have the full visibility of the long-term savings, and we would be in a better shape to share with you any long-term run rate.

Having said that, Glen, the trends are positive, as you can appreciate. So we're happy with the lower expense trend. We just want to make sure that we go by and go through the fourth quarter to have a better idea of how faster We extract the benefits.

Okay. And then you had touched on it, José. The non-acquired book yields were down 16 basis points quarter over quarter. They were down 59 basis points a quarter before that. Given where LIBOR is now, how much of that back book repricing would you expect? Given that LIBOR is flat now, are we kind of all in on some of that back book repricing?

I would say, as we mentioned throughout this call today, the lower rate environment is here to stay and here to stay for longer. So I think there's still some remnants of... I think we have pretty much all of it already baked in given the lower rate environment we operate in. So I would suspect that we still have a couple more J.D. J.D. J.D. J.D.

Well, that's a good question, Glenn, and I'm glad that you asked it. This year we did have a higher proportion of exam income that I can anticipate won't be repeated during the next two years. So we are looking at a range of 30 to 32 percent as a normalized type of ETR for the next two years.

Okay, and then just the last question on reserving, you know, you guys, you know, with PPP, ex-PPP, you're in that, you know, mid to high 3% range. Could you maybe talk about your economic outlook and if there's no change in kind of the basis of the outlooks that you're using from outside services? Are you well reserved here? Do you expect at some point we could start to see, you know, match charge-offs or maybe even a little reserve release?

So, to answer your first question, are we well reserved? The answer is yes. To talk about the macro, for sure we see the beginnings of an economic rebound and we are encouraged and we see a brighter kind of future for Puerto Rico. But as I said, there are tremendous uncertainties and there are tremendous challenges and there are still several things that need to settle in the near future and beyond for the Puerto Rico economy to have safe sailings into the future. So when we look at our credit The macro, the outlook is improving, but we really have to live with the present, and the present still poses tremendous challenges that we want to make sure they play out in one way or the other so that we can bring the ship to shore safely. But again, I feel that this is the beginning of We have a brighter future for the macro in Puerto Rico in the next several years as we benefit from the stimulus and the reconstruction funds that are starting to flow and particularly longer term with the pharmaceuticals that we have in Puerto Rico with around 30 to 35% of our gross domestic product Onshore, more medical devices and more pharmaceutical production to Puerto Rico. I think we're at a point where it's too early to tell, but it's certainly a good position to be in. And if you add to that the credit, I think you can get the answer to it.

Okay, thank you. Oh, and I just wanted to bring up one point on the taxes, Marisa. Thank you for that guidance. And I just wanted to confirm, if there's a change in administrations on the mainland here and we see an increase in corporate tax rate, OFG would be relatively not impacted at all by an increase in mainland corporate tax rates. Am I correct in still assuming that?

Yes, yes, because at the end, you know, the U.S. income that we have is Our next question comes from the line of Alex Hordal of Piper Sandler.

Hey, thanks for taking my follow-up. So, José, a couple of times during this call, you've kind of seemed a little bit more positive and constructive on some of the economic and banking trends that you're seeing on the island. You've sort of alluded to housing markets showing some signs of recovery and some bidding wars and things like that. But maybe you could just talk a little bit more about what you're seeing. You kind of talked about the cash flow following Maria actually starting to make some impact on the island. Maybe you can give us some sort of a little bit more color from on the ground there in terms of Is there been increased hiring? Is there been increased spending? What is it really that you're looking at when you make those comments?

We're seeing the flow of funds starting to put into play and we're seeing reconstruction efforts across the entire island on roads and bridges and we're starting to see the deployment of all the We also expect additional, let's call it CARES Act 4 or 5 or however number you want to call it, before or after the elections or next year. And Puerto Rico will be benefiting from those also. So what we're seeing on the ground is constructive. What we're seeing into the future is more of those I think that's kind of where we come from, but the statistics in specific in terms of All the federal funds flowing into the island have remained the same. It's just a matter of them starting to put them to play.

Great. And then in terms of the pharmaceutical thesis, which you've alluded to as well, has there been any updates to anything? We've all seen the bills in Congress and the executive order from Trump in August. Anything on the ground there that shows increased activity in terms of that repatriation thesis?

No, nothing on the ground that would confirm the actual unshoring, but very few times you see bipartisan agreement and less times you see bipartisan agreement on Puerto Rico. So here you do. And that's encouraging. And that's certainly encouraging. And I think it's a matter of also the federal government starting to realize that the The end game in Puerto Rico is not about sending federal funds all the time. It's also to assist in creating economic development longer term and in a recurring way. And again, this hasn't been played out yet, but it looks like it's moving in that direction, and certainly that is a lot better than just waiting for a hurricane to receive federal funds. Right.

Have you been seeing any additional, I mean, we've seen the federal money flow down to the island. What about private equity or other money looking for opportunities in Puerto Rico as a result of some of the increased economic activity?

Several of private equity firms are in play in Puerto Rico and also looking into Puerto Rico to looking at opportunities because they're seeing the same thing that we're seeing. Interesting.

And then final question for me.

I know we're going to get it's not just a new administration or potentially a new administration in the mainland, but there's also going to be a change of governor in Puerto Rico, I believe, next year.

Are there any proposals or things that are kind of circulating around a change in administration down there that we as the investment community should be aware of?

So not really. Politics in Puerto Rico are I would use a word that you guys use in the States. Politicians and politics in Puerto Rico are all now lame ducks because everything has to go through the fiscal board. So it's just a political event that we go through. But in reality, at the end of the day, they're going to have to realize that if they want to get reelected, they're going to have to sit down and play with the fiscal board in a more constructive way than they have done in the past. And I expect that will happen, whoever wins, because it's in their own best interest also. But there are no specific proposals here. It's all the same old talk. But at the end of the day, the budget and the strategies are pretty much designed and instructed by the fiscal board. And I think that's kind of what's going to play out.

Great. And then actually, I just have one other follow-up. And, you know, I think you sort of got to ask the question on additional capital returns and capital actions. Obviously, you're still digesting a pretty major acquisition, but sitting with 12.5% common equity tier one and a lot of liquidity in the balance sheet and a huge reserve. I mean, is a share buyback something or a dividend increase something that could be potentially on the table in the next, call it, six to 12 months?

Well, how you describe it is our reality. We are sitting in a very strong, solid balance sheet, and that gives us options for capital management. We look at all the options and we put them on the table. We keep a continuous dialogue with regulators, being cognizant that now we're closer to a $10 billion bank, and that requires us to Thank you very much. Thank you very much. Prepare remarks. We are sitting in a good financial and strategic position, and we look at capital, and we will make the capital decisions that are rational and constructive for us to grow our bank and move in the strategic path that we have designed.

Perfect. Thank you for taking my follow-ups.

Thank you. Have a great weekend.

Again, if you would like to ask a question, simply press star then the number 1 on your telephone keypad. Again, that is star 1. I'm showing no further questions at this time. I would like to turn the floor back over to Mr. Fernández for any additional or closing remarks.

Thank you, operator, and thank you all to Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.