OFG Bancorp Q3 2024 Earnings Call Transcript

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October 16, 2024

There are 4 speakers on the call.

Operator

Good morning. Thank you for joining the OFG Bancorp's Conference Call. My name is Connie, and I will be your operator today. Our speakers are Jose Rafael Fernandez, Chief Executive Officer and Chairman of the Board of Directors Maritza Arizmendi, Chief Financial Officer and Cesar Ortiz, Chief Risk Officer. A presentation accompanies today's remarks.

Operator

It can be found on the homepage of the OFG website under the Q3 2024 section. 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.

Operator

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. At that time, I will give instructions. I would now like to turn the call over to Mr. Fernandez.

Operator

Please go ahead.

Speaker 1

Good morning and thank you for joining us. We are pleased to report our Q3 2024 results. It was another solid performance. Earnings per share were 5.3% year over year were up 5.3% year over year on a 1.1% increase in total core revenues. We continue to produce consistent core operating results and digital adoption of our new and upgraded products, services and self-service tools keeps steadily growing.

Speaker 1

Puerto Rico's economy continues to do well with high levels of business activity and employment. In addition, today marks our 60th anniversary in business. While that is cause for celebration, it is a time to renew our commitment to bring progress to our customers, employees, shareholders and the communities we serve. Thanks to all our team members for always being more than ready to help our clients and customers today and tomorrow. Before I go on, I would like also to comment on the recent hurricanes in the Southeast United States.

Speaker 1

As an island where people have suffered through many of them, our prayers and heart go out to everybody who has been affected by Helene and Milton. Please turn to Page 3 for a summary of our 2nd quarter results. Looking at the income statement, we reported earnings per share diluted of $1 on total core revenues of $174,100,000 Net interest margin was 5.43 percent. Provision was $21,400,000 Non interest expenses were $91,600,000 and pre provision net revenues totaled $83,100,000 Turning to the balance sheet. Total assets were $11,500,000,000 up 12% from a year ago and up 2% from last quarter.

Speaker 1

Customer deposits were $9,500,000,000 Loans held for investment totaled $7,800,000,000 and new loan production was $572,000,000 Investments were $2,600,000,000 up 26% from a year ago and up 5% from last quarter. Cash at $681,000,000 was up 28% from a year ago and down 8% from last quarter. Looking at capital, the CET1 ratio was 14.37%. There were 2 corporate developments of note during the Q3. Durbin took effect, which reduced debit card interchange fees by $2,700,000 and we acquired Servicing Rights in late August to a $1,700,000,000 Puerto Rico residential mortgage loan portfolio.

Speaker 1

Please turn to Page 4 for an update on our Digital First strategy. As of the Q3, 95% of all routine retail customer transactions, 97% of retail deposit transactions and 67% of retail loan payments were made through our digital and sales service channels. This has been driven by year over year growth of 13% in digital enrollment, 53% in digital loan payments, 40% in virtual teleutilization and 4.6% in customer growth. In addition, customer reception to the Oriental servicing portal continues to expand. By the end of September, 30% of all retail clients were using it to transact business with the bank, up from 24% at the end of June.

Speaker 1

All this frees up our branch bankers to grow business and provide value added advice to our customers. As I mentioned on our last call, we launched the Elite deposit account for retail customers, a combined checking and savings account that rewards customers for expanding their relationship with Oriental. This represents a unique value proposition in our market. Since then, we have further enhanced the account with the launch of the first of its kind debit card in the Puerto Rico market, offering World Elite benefits exclusively for Elite account holders. In addition, we offer fully digital account opening with funding for all our retail checking and savings accounts.

Speaker 1

Now here's Maritza to go over the financials in more detail.

Speaker 2

Thank you, Jose. Please turn to page 5 to review our financial highlights. Starting with the components of core revenues, total interest income was $189,000,000 up 1% or $1,400,000 from the 2nd quarter. This mainly reflects higher balances of investment securities and yields, higher balances of loans and the absence of a $2,000,000 loan recovery in the Q2. If you recall, since late last year, we have been growing the investment portfolio to help manage the anticipated lower rate environment going forward, adding higher yielding U.

Speaker 2

S. Guaranteed longer duration securities. Total interest expense was $41,000,000 an increase of less than $1,000,000 from the 2nd quarter. This mainly reflects higher balances higher average balances of higher cost borrowings and brokerage deposits as well as slightly reduced average cost deposits core deposit balances and costs. Total banking and financial service revenues were $26,000,000 a decrease of $5,800,000 from the 2nd quarter.

Speaker 2

This mainly reflects the $2,700,000 in reduced interchange fees that Jose mentioned, dollars 2,100,000 in reduced MSR valuation due to lower long term rates, $300,000 in 1 month revenue from the new mortgage servicing portfolio and the absence of $1,000,000 from the 2nd quarter's loan prepayment fees and annual recognition of certain insurance commissions. If you exclude the reduced MSR valuation, total banking and financial service revenues were in line with our original expectations. Please turn to page 4. Looking at non interest expenses, they totaled $91,600,000 down $1,400,000 from the 2nd quarter. This mainly reflects a $2,300,000 one time credit and debit card processing business contract renewal rebates in general and administrative expenses and $1,300,000 in expenses related to lower gain on real estate owned sales.

Speaker 2

The 2nd quarter efficiency ratio was 52.6% or 79 basis points higher than the 2nd quarter. This was generally in line with trends we have seen over the last 5 quarters. Other performance spending remained high. Return on average assets was 1.66 percent. Return on average tangible common equity was 15.94 percent and tangible book value per share was $26.15 That's up 8% from the 2nd quarter due to our earnings performance and increased value of our investment securities portfolio.

Speaker 2

Please turn to page 6 to review our operational highlights. Average loan balances were $7,600,000,000 up slightly from the 2nd quarter. End of period balances of loans held for investments increased 1.5 percent or $111,000,000 from the 2nd quarter. This mainly reflects growth in Puerto Rico and U. S.

Speaker 2

Commercial and Puerto Rico auto and consumer loans, also the regular pay downs and securitization of residential mortgages. Year over year, 3rd quarter loans held for investment increased almost 7%. Loan yield was 8.05%, down 10 basis points from the 2nd quarter. 3rd quarter new loan origination mainly reflects a higher amount of U. S.

Speaker 2

Commercial loans and Puerto Rico consumer loans and a lower level of Puerto Rico commercial and auto loans. In Puerto Rico, we continue to have a strong commercial pipeline. And as we have said, we had anticipated oral lending will moderate at some point from record levers. Now that interest rates are falling down and inflation has come down in the U. S, we expect our U.

Speaker 2

S. Lending pipeline to strengthen. Average core deposits were $9,600,000,000 down slightly from the 2nd quarter. End of period balances decreased $72,000,000 0.7%. This mainly reflects increases in time and saving deposits and reduced demand deposits.

Speaker 2

Core deposit cost was 100 and and 53 basis points, down 1 basis point from the 2nd quarter. Excluding public funds, cost of deposit was 90 basis 91 basis points compared to 87 basis points last quarter. Average borrowings and brokerage deposits were $262,000,000 compared to $221,000,000 in the 2nd quarter. The average rate base was 4.6%, down 2 basis points. End of period balances were $346,000,000 compared to $201,000,000 in the 2nd quarter.

Speaker 2

Net interest margin was 5.43%. Excluding the previously mentioned loan recovery in the 2nd quarter, NIM was basically flat from the previous quarter. Please turn to page 7 to review our credit quality and capital strength. Credit quality continues to be stable. Net charge offs totaled $17,000,000 up $2,000,000 from the 2nd quarter.

Speaker 2

Sequentially, auto net charge offs were higher at 1.64%, but lower than the high point last year. Consumer net charge offs now at 4.70% appear to be resuming the traditional level for this business, which typically runs in the high 4% range. At the same time, there were continued recoveries in mortgage and in both Puerto Rico and U. S. Commercial loans.

Speaker 2

As a result, the net charge off rate was 90 basis points, up 11 basis points sequentially, but below 1.05% in the year ago quarter. Provision for credit losses totaled $21,400,000 up $5,800,000 from the 2nd quarter. This mainly reflects $11,700,000 from increased loan volume, $5,200,000 related to the annual update of other risk drivers, consumer loan loss factors and the extension of cash flows of a Puerto Rico commercial loan up for renewal in the 4th quarter. And a $2,700,000 reserve release mainly due to an improved U. S.

Speaker 2

Macroeconomic perspective. Looking at other credit metrics, the early and total delinquency rates were 2.78 percent and 4.10 percent, respectively. The non performing loan rate was 1.11%. The total delinquency rate increased from the 2nd quarter. This was due to booking of the Ginnie Mae buyback options programs related to the mortgage servicing portfolio acquisition.

Speaker 2

To sum up, during the Q3, net interest income grew, driven by the investment portfolio and loans. The 4 deposit balances have held pretty steady since the beginning of the year with a shift from demand into savings and time deposits as we continue to grow and deepening customer relationships with recent value added growth and services. Loan growth continues to be strong, credit quality is well maintained and the trends are mostly positive reflecting the good economic environment in Puerto Rico. Our 4th quarter NIM outlook is now between 5.3% and 5.4%, given the size of the first Fed rate cost. We continue to expect 2 additional 25 basis points Federal Reserve Bank rate cuts by the end of the year.

Speaker 2

Non interest expense should range from $91,000,000 to $93,000,000 going forward with an efficiency ratio in line with the strength we have seen during the last several quarters. We will update you more precision on the Q4 call about our interest rate, net interest margin and credit outlook for 2025. Regarding capital allocation, we continue to remain opportunistic, focusing on Puerto Rico and U. S. Loan growth and always looking at dividends and share buybacks.

Speaker 2

Now here's Jose.

Speaker 1

Thank you, Maritza. Please turn to Page 8. Our outlook for both Puerto Rico and ORG continues to be positive. The island's economy is steadily growing, wages and employment are at high levels in Puerto Rico and the start of a lower interest rate cycle by the Federal Reserve supports the continued strong financial condition for both businesses and consumers. Altogether, the business environment here remains optimistic.

Speaker 1

As always, we remain vigilant regarding the big macro uncertainties, changes in interest rates and inflation, the impact of unfortunate weather events and ongoing geopolitical conflicts. Turning to OFG. We continue to be well positioned for growth of loans, deposits and our customer base. Consumer credit trends should remain at current levels. Our digital first strategy will continue to evolve.

Speaker 1

Now that we have established a strong platform for fast, easy to use convenient customer self-service, we plan to further enhance experience through increased personalization. And that means we will continue to invest in and deploy new customer innovations with the twin goals of further differentiating our business model, while at the same time increasing efficiencies. Altogether, we look forward to a strong finish to our 60th year, more than ready to make progress possible for our customers, employees, shareholders and the communities we serve. Our results could not have been achieved without the hard work and dedication of all our team members. We are thankful to them and excited for what's to come.

Speaker 1

With this, we end our formal presentation. Operator, please start the Q and A.

Operator

Thank you. And we'll take our first question from Kelly Motta from KBW.

Speaker 3

Hi, good morning. Thanks for the question.

Operator

Hi, Kelly.

Speaker 3

I thought I would kick it off with the loan growth that you've had. It's been very strong in the past two quarters, kind of broad based, but continued strength in auto. And on the commercial side, you mentioned, Jose, in your prepared remarks about the U. S. Pipeline.

Speaker 3

So I was hoping to get a sense of what you're seeing on the island as well, what pipelines look like there and how we should be thinking about the loan growth that you're it sounds like you're continuing to expect as we look ahead here?

Speaker 1

Yes. So, Kelly, thank you for your question. It hasn't changed. I mean, we feel that there is quite a bit of economic activity here in Puerto Rico that supports a strong growth in terms of our commercial as well as our auto and consumer. So we feel that the forecast hasn't changed.

Speaker 1

So what we have seen this quarter is kind of steady originations, steady loan production. We had some delays on the commercial in Puerto Rico, loan originations that are going to be pushed into the Q4. But all in all, we are we have a pretty strong pipeline on the commercial side. And then as to your question on the U. S, we have been quite cautious in the last, let's say, 4 to 6 quarters with regards to our U.

Speaker 1

S. Business, simply because we felt that the U. S. Economy was still kind of figuring out if it was a soft landing or a hard landing or a no landing. Frankly, I don't have the crystal ball.

Speaker 1

I don't think anybody does, but we feel more encouraged with what's going on in the U. S. Economy in terms of inflation coming down and economic growth remaining steady with low unemployment. It's similar to what we have seen in Puerto Rico for the last couple of years where we kind of called it out and said, look, Puerto Rico is going to do well and we're going to have a good economy. And what we're seeing now going forward here in Puerto Rico and I'm trying to compare here, we continue to see Puerto Rico having a pretty steady growth in the economy.

Speaker 1

It's a different paradigm that we have been living in the last couple of years, and I think it will continue for the next several years given the low employment levels, high wages, higher wages that we have as well as the support from the reconstruction funds continuing to flow down to Puerto Rico. So really optimistic about Puerto Rico, more constructive on the U. S. Side. All in all, we're excited to finish the year, a record year this year and looking forward to start 2025 with strong momentum.

Speaker 3

Okay. That's super helpful. And then on the other side of the balance sheet, on the deposit side, your demand deposits fell. It looks like that wasn't government deposits. It was more retail and commercial, but it looks like there was some migration among accounts.

Speaker 3

And in your slides, you highlight the optimism about the ability to grow deposits. I was hoping we could spend a moment talking about with rates cut, is this do you see the leveling off of migration? Or is there a continuation of that? As well as with the growth you're expecting, how much of that is market share gains versus continued growth in deposits on the island?

Speaker 1

Yes. So there's some variables that we can control, as you clearly point out, in terms of how interest rate move and how demand and flow of liquidity into the island flows, right? But we can control some things that internally, and that is our business model. And I think the way we're seeing our business model evolve and how we have invested in technology and bringing in the new products and services with digital account opening and funding, something that is unique in the Puerto Rico market, It's giving us a competitive advantage in a slight way, so that we feel into 2025 as we see interest rates starting to trickle down, we see deposits starting to level off and we potentially see core deposits growing into 2025. What we have seen so far in this quarter, you have seen ups and downs on the government deposit balances.

Speaker 1

If you look at it from average balances as or as end of the period, because we do have a pretty big deposit from the government that is still on the books. But all in all, what we're seeing is a transition from checking towards slightly savings and mostly time deposits. We think that that is going to start shifting into 2025, and we continue to build our core franchise on the retail side. On the commercial side, we're very excited given what we're seeing in terms of the liquidity levels in Puerto Rico in terms of the businesses. And we see our small base accounts, which is a small and midsized type of checking accounts, getting good momentum on the market.

Speaker 1

So again, we look at 2025 as a year where we see deposits stabilizing and starting to grow back steadily.

Speaker 3

That's super helpful. And can you remind us, my notes on the government deposits, I think you were projecting, at least at the last quarter that they would be saying through September. Just any updated thoughts about flows on those? [SPEAKER JOSE RAFAEL

Speaker 1

FERNANDEZ:] Yes. So we have a large deposit that was supposed to exit the balance sheet in September. It did not, and it extended until November. So right now, what we're seeing is a tentative exit in November of this year, reminding everyone in the call that this is an index government deposit fund in their index government deposits, which is indexed to the 3 month treasury bill at a discount to that rate. So as interest rates have gone down, that is helping us also on the cost of funds as the deposit remains in the books.

Speaker 1

So again, it's going to stay until November, and we will update the market accordingly.

Speaker 3

Okay. That's helpful. And then turning to your margin guidance, the 5.3% to 5.4% margin, it seems like it's trending lower than what we expected this time last quarter, but your balance sheet is also bigger. It looks like you purchased more MBS securities. Just wondering how much of that kind of reduction in the outlook is a function of rates versus potentially if you could discuss the REITs and perhaps the securities purchases and kind of the outlook for an appetite for additional ones in relation to the size of the balance sheet?

Speaker 1

Yes. I'll let Harissa give you the Yes.

Speaker 2

Kelly, it's mostly related to rates. When we shared with you last quarter the estimate and the expectation was based on a 3 25 basis points Fed cost. And the actual one in September was 50 basis points. So given the size of that cost, we adjust the estimate for the Q4, okay?

Speaker 3

Okay. And then again, the securities, it looks like EOP was about $2,600,000,000 It was higher than what I was modeling. Just any appetite around securities repurchases from here and kind of managing the size of the balance sheet?

Speaker 2

Yes. Yes. And that's part of what I mentioned also in the prepared remarks about we have been since last year extending the duration of the assets, prepare the balance sheet for the new low rate environment in the long term. So that's what we did this quarter also. [SPEAKER JOSE

Speaker 1

RAFAEL FERNANDEZ:] And again, adding to that, we will continue to look into the investment portfolio as we use it as a way to reduce our asset sensitivity. We used to be 5% asset sensitive. We're now in the 2 handle asset sensitive And extended the duration at 5% on mortgage backed securities from the U. S. Government kind of makes sense for us.

Speaker 1

So we are going to be constructive about the investment portfolio going forward as we manage the lower interest rate environment, as Melissa mentioned.

Speaker 3

Got it. I guess kind of tying into that is capital return. You guys even with Durbin kicking in, you make you're super profitable and even growing the loan book from here in kind of the low mid single digit range, you're going to create capital. Any updated thoughts on dividends, buybacks and how you're managing?

Speaker 1

So we will review dividends and buybacks in the with the board in our off-site strategic session coming up, and we will also look at it in the January board. But if you ask me, Kelly, if we kind of were a little behind the ball in the Q3 from management perspective is that we could have been a little bit more intentional about the buyback. And we did some repurchases, but not significant. And with the level of capital that we're accumulating and the earnings that we're generating and the loan growth prospects that we're seeing, we again look at loan growth, we look at dividends, we look at buybacks. But if you put a fault into us, it's probably that we are kind of a little bit slow on the capital return.

Speaker 3

Great. Thanks for the color. Maybe the last one for me is on the servicing portfolio you purchased this quarter. Hoping you can provide some insight as to the strategic the decision around that? And any thoughts on how that contributes to the servicing income from there?

Speaker 1

[SPEAKER JOSE RAFAEL FERNANDEZ:] Yes. So first, we it's a portfolio that we had a self servicing agreement with. So in the end, it's just us owning the whole servicing rights and having the ability to own the customer relationship from a servicing perspective. And it's part of us building our servicing book, which, as you know, requires a critical mass. And here in Puerto Rico, it has these opportunities, but it also has these limitations.

Speaker 1

So that's kind of the logic behind it. I think it was just complementary to what we have been doing. It was part of our operating model already, except that now we own it versus subservicing it. And we're going to be generating approximately $900,000 if you use the balance today a quarter in terms of mortgage banking fees. And we felt that it was the right thing to do.

Speaker 3

Great. Thank you so much for the time and all the color.

Speaker 2

I will step back.

Speaker 1

Thank you, Kelly. Have a great day.

Operator

And at this time, with no questions in the queue, I'll turn the call back over to Jose.

Speaker 1

Thank you, operator. Thanks again to all our team members and thanks to all our stakeholders that have listened. Have a great day.

Operator

And this concludes today's conference. We appreciate you joining us. Have a great day.

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Earnings Conference Call
OFG Bancorp Q3 2024
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