Earnings Call Transcript - OFG Q1 2025

Operator, Operator

Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Madison, 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. It can be found on the homepage of the OFG website under the first quarter 2025 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. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question-and-answer session. Instructions will be given at that time. I would now like to turn the call over to Mr. Fernandez.

Jose Rafael Fernandez, CEO

Good morning, and thank you for joining us. We are pleased to report our first quarter results. As we look at Page 3 of our presentation, it was another strong start to the year with solid overall performance. We had consistent financial results generating earnings per share diluted of $1. This was driven by excellent operating execution and loan and deposit growth. Consumer credit reflected higher seasonal customer liquidity in Puerto Rico. And we've bought back shares and raised our dividends supported by our strong capital generation and balance sheet. Please turn to Page 4. Our strategic investment in technology through our digital first strategy continues to drive innovation. This is freeing up our people to build stronger customer relations through a wide branch network. Looking at the numbers, 96% of all retail customer transactions, 97% of retail deposit transactions and 68% of retail loan payments were made through our digital and self-service channels. This has been driven by year-over-year growth of 12% in digital enrollment, 21% in digital loan payments, 40% in virtual teller utilization, and close to 5% customer growth. During the quarter, we launched three digital tools, all first in Puerto Rico. Our omni-channel online mobile app that provides customers with a fast, easy, and seamless banking experience across all digital points. Smart banking insights that offer advice to help customers achieve greater financial progress. This reinforces our innovative position in the banking market in Puerto Rico with intelligent and personalized solutions and tools. And Apple Pay for both debit and credit cards. This is new in the local banking industry, giving our customers another option for easy and secure in-store, in-app and online purchases. I'd like to add that our self-service portal, which we launched in 2023, was nominated for a banking tech award for Best Use of Technology in Consumer Banking, which is another first for a Puerto Rican bank. As you can imagine, we are very proud of all these accomplishments. Now here is Maritza to go over the financials in more detail, then I'll come back and provide our outlook for Puerto Rico and OFG.

Maritza Arizmendi, CFO

Thank you, Jose. Please turn to Page 5 to review our financial highlights. All comparisons are to the fourth quarter unless otherwise noted. Core revenues totaled $178 million. Looking at key components. Total interest income was $189 million, a decline of $941,000. This mainly reflects two fewer business days, which negatively affected interest income by $3 million. Partially offsetting this were higher balances and yields on investment securities and higher loan balances. Total interest expense was $40 million, a decline of $874,000. This mainly reflects the two fewer business days and higher average balances of core deposits at a lower rate were partially offset by higher average balances of borrowings and brokered deposits. Total banking and financial service revenues were $29 million, a decrease of $3.6 million. The first quarter included $4.8 million combined in annual insurance fees and favorable MSR valuation change. Excluding that, total banking and financial services revenues increased for the quarter. Looking at non-interest expense. They totaled $93.5 million, down $6.3 million. First quarter compensation included $1.6 million in increase in seasonal FICA expenses and merit raises. General and administrative expenses included a $3.1 million volume incentive payment from business partners. This also included $1.2 million in higher electronic banking volumes and related costs as compared to the last quarter. Note, that the first quarter included $4.8 million in early retirement, business rightsizing and annual performance incentives. Taking all these factors into consideration, we were in line with our guidance of $95 million to $96 million in quarterly non-interest expense in 2025. Income tax expense was $13.9 million. The tax rate was 23.34%. That reflects an anticipated rate of 26.14% for the year and the benefit of $1.7 million in discrete items. Tangible book value was $26.66 per share. During the quarter, we bought back $23.4 million of shares and raised our dividend 20%. Looking at our performance metrics, efficiency ratio was 52.2%, return on average assets was 1.56% and return on tangible common equity was 15.28%. Please turn to Page 6 to review our operational highlights. Total assets were $11.7 billion, up 5% from a year ago and 2% from the fourth quarter. Average loan balances were $7.8 billion, up close to 1%. End-of-period loans held for investment totaled $7.9 billion, up 4.2% from a year ago and up $61 million from the last quarter. The sequential increase mainly reflects growth in auto and consumer loans, US and Puerto Rico commercial loans and repayments of residential mortgages. Growth of Puerto Rico commercial loans included a higher level of line of credit utilization. Loan yield was 7.99%, down two basis points. New loan origination of $559 million was down 9.3% from the fourth quarter, but up 4.2% from a year ago. First quarter originations reflected seasonal declines in Puerto Rico commercial lending, partially offset by an increase in US commercial. We continue to have a strong commercial pipeline at this time. Average core deposits were $9.6 billion, up close to 1%. End-of-period balances of $9.8 billion increased $308 million or 3.3% quarter-over-quarter and $211 million or 2.2% year-over-year. The sequential increase reflects growth in retail, commercial, and government deposits. It also reflects growth in savings, time deposits, and loan deposits. Core deposit costs were 1.42%, down four basis points from the first quarter. Excluding public funds, cost of deposits was 1% compared to 0.96% last quarter. Average borrowings and brokerage deposits were $517 million, compared to $426 million. The average freight was 4.32%, down eight basis points. End of period balances were $421 million, compared to $557 million. During the first quarter, $145 million in short-term repurchase agreement at Federal Home Loan Bank advances matured. Separately, a two-year $200 million Federal Home Loan Bank advance was renewed at 14% compared to previous rate of 4.52%. Cash at $710.6 million was up 20% and investments totaled $2.8 billion, up 2%. During the first quarter, we acquired $100 million of mortgage-backed securities yielding 5.40%. Net interest margin was 5.42%, compared to 5.40%. First quarter NIM benefited slightly from the investment securities portfolio and lower cost of government deposits. Please turn to page 7 to review our credit quality and capital strength. Credit quality continues to be stable. Net charge-offs totaled $20 million, up $4.5 million. The first quarter included a $2.9 million partial charge-off of a previously reserved commercial loan as compared to the fourth quarter, which included $2.6 million in recoveries from the sale of previously charged-off auto and consumer loans. First quarter total net charge-offs were unchanged at 1.63%. Consumer net charge-off ratio increased 62 points to 4.34%, and there were continued recoveries in mortgage and Puerto Rico commercial loans. Total net charge-off rate was 1.05%, up 23 basis points sequentially. Year-over-year, it was unchanged. Provision for credit losses was $25.7 million, down $4.5 million. The first quarter included $17.4 million for increased volume, $4.8 million for reserves for pre-commercial loans, and $3.5 million to reflect our auto current loss default trends post pandemic. Looking at other credit metrics, the yearly and total delinquency rates were 2.19% and 3.49%, respectively, both down from the fourth quarter. The non-performing loan rate was 1.11%. Looking at other capital metrics, our CET1 ratio was 14.27%. Stockholders' equity totaled $1.3 billion, up about $41 million, and the tangible common equity ratio increased 11 basis points to 10.30%. To summarize the first quarter, net interest income remained stable as growth in loan balances and a decline in deposit costs largely neutralized the impact of two fewer days. Loan growth continued to do well in auto and consumer and U.S. and Puerto Rican commercial. Retail and commercial deposit balances increased as we continue to deepen customer relationships and grow our client base. Net interest margin was slightly higher than expected from higher yielding investment securities and lower cost of government deposits. Credit quality continues to be well managed. The trends are stable, reflecting the solid economic environment in Puerto Rico. Non-interest expenses were in line when you remove the effect of the specific items in the fourth and first quarters. Results also benefited from a lower tax rate and share count. Regarding tariff allocation, in addition to buying back shares, the dividend was increased and our CET ratio provides us with a strong foundation during volatile or challenging times. Now here's Jose.

Jose Rafael Fernandez, CEO

Thank you, Maritza. Please turn to Page 8. As you all know, we are navigating an uncertain environment, and this is how we see things today. On the one hand, in Puerto Rico, wages and employment are at historically high levels that this environment is constructively positive. Investments in public and private projects continue to flow and the economy continues to grow, albeit at a slower pace. On the other hand, higher levels of volatility due to macroeconomic and geopolitical events, if they continue, will eventually have an economic impact. Our team members are in close contact with our customers to make sure we have a good pulse on how they're adapting to the environment and how OFG can better serve them. Turning to OFG. Our Digital First strategy is proving to be highly effective. We will continue to invest in and deploy new customer innovations to further differentiate our business model, increase efficiencies and, most important, help both our retail and commercial customers. Consumer credit trends are good, supported by a strong balance sheet and a well-tested leadership team. We continue to methodically execute our business plan and be there for our clients and the communities we serve. As always, our results could not have been achieved without the hard work and dedication of all our team members. We are extremely thankful to them and excited for what's to come. We hold our Annual Shareholders Meeting next Wednesday. With this, we conclude our remarks and we open the call for questions.

Operator, Operator

And we will take our first question from Frank Schiraldi with Piper Sandler. Please go ahead.

Frank Schiraldi, Analyst

Good morning.

Jose Rafael Fernandez, CEO

Morning Frank.

Frank Schiraldi, Analyst

Jose, regarding the digital channel, you've mentioned some impressive numbers related to transactional use. Are you seeing an increase in deposit account openings through this channel? Is that trend already underway, or is it something we should expect in the future? How is that progressing?

Jose Rafael Fernandez, CEO

Actually, Frank, yes, we do have online digital account opening, and it's through the self-service channel. So, yes, we do have that capability. And as everything that we've done from the Digital First strategy that we have deployed throughout the years, it requires us to be the educators in the market in terms of how things can move into digital channels and all that. So, right now, around 25%, 26% of our checking accounts and certificates of deposits are opened through the digital channel. The rest are opened at the branches. So, we've seen increasing trends there also.

Frank Schiraldi, Analyst

Can you elaborate on the deposit growth moving forward? Is there any seasonality to consider in the first quarter? Additionally, could you discuss the expected public deposit outflow in February? I’m looking for insights on growth from this point onward.

Jose Rafael Fernandez, CEO

Yes. So, first quarter is always somewhat seasonal in terms of deposits. We do have the tax refunds. The Child Tax Credit also is part of the equation on the first quarter in terms of deposits. So, we do acknowledge that the first quarter has some important seasonal components. But we are very encouraged with the way our online and branch network are moving along and growing our client base. So, we do expect to continue to see some deposit growth from here. In terms of your second part of your question, which I forgot, if you can recall,

Frank Schiraldi, Analyst

Regarding government deposits, I believe there is some seasonal variation. We experience tax refunds and the Child Tax Credit contributing to deposits in the first quarter. We recognize that the first quarter has significant seasonal factors. However, we are very optimistic about the progress of our online and branch network in expanding our client base, and we anticipate continued deposit growth moving forward. If you could remind me about the second part of your question, I would appreciate it.

Jose Rafael Fernandez, CEO

Yes, we have about $1 billion in government deposits that we expect to be renewed for several more months. This is something we will update every quarter, but it's still in place and we anticipate renewing it in the next couple of weeks.

Frank Schiraldi, Analyst

Okay. Can you talk about consumer charge-offs? Do you expect to see continued normalization there? I know there's some volatility with commercial charge-offs, but I’m interested in your thoughts on consumer charge-off levels and whether you anticipate that trend continuing.

Jose Rafael Fernandez, CEO

Yes. I'll ask Cesar, our Chief Risk Officer, to give you some color on that one.

Cesar Ortiz, Chief Risk Officer

We have two main portfolios: the auto portfolio, which is the largest, and unsecured personal loans. We anticipate an improvement in trends this quarter, as it typically experiences seasonal growth. The first quarter usually shows positive results for all credit statistics, and we've seen that this time. Regarding the auto portfolio, we're also noticing stabilization in recovery rates from collateral. This is influenced by the issues customers are facing with their cars and the increased demand for used vehicles, which is a favorable trend. Additionally, we are observing improvements in the quality of recent vintages, as we implemented stricter grading standards in 2022. As a result, we are beginning to see those higher quality vintages affecting net charge-offs positively. Although we expected this quarter to perform well, it actually exceeded our expectations. Looking ahead, we foresee some slight growth next quarter due to seasonal factors but overall expect stabilization across both portfolios in all key metrics.

Frank Schiraldi, Analyst

Okay. Thank you.

Jose Rafael Fernandez, CEO

Yes, thank you. Thank you for your questions.

Operator, Operator

And we will take our next question from Timur Braziler with Wells Fargo. Please go ahead.

Timur Braziler, Analyst

Hi, good morning.

Jose Rafael Fernandez, CEO

Good morning.

Timur Braziler, Analyst

The security yields were up nicely again this quarter. I'm just wondering what's the current duration of the bond book and just some of the highlights on what's coming off, maybe from a cash flow standpoint in the next couple of quarters and where those reinvestment rates are coming on right now.

Jose Rafael Fernandez, CEO

Yes.

Maritza Arizmendi, CFO

The current duration of our mortgage-backed security agency paper is approximately five to six years. This quarter, we saw repayments of $84 million. We will continue to monitor the market for opportunities. Currently, cash is yielding around 4.25%. We will keep evaluating the funding side and manage the asset liability as we have been doing.

Timur Braziler, Analyst

Okay. And then maybe more broadly around the margins, they certainly held up better than I was expecting. Part of that was due to the securities yields, and loan yields also seem to hold up better. Just where we are today, setting aside the impact of additional rate cuts, is the next move likely to put some pressure on the margin, or could some of the bond reinvestments and loan growth offset that? What is the expected trajectory for margin here?

Maritza Arizmendi, CFO

Yes. We shared with you in the last call that we have a range between 5.3% to 5.4% margin for the year. That range will move. It depends a lot on the funding side, particularly if the government deposit exits at a certain point because we will need to replace wholesale funding, which should carry a little bit higher funding than these government deposits. But as long as it remains in demand, I will see that range in the upper level, okay?

Timur Braziler, Analyst

Okay. Great. Thanks. And then just last for me. Any additional color for the specific reserve on the commercial loans? Were those Mainland or Puerto Rico? And I guess any similarities across those?

Jose Rafael Fernandez, CEO

Yes. So these are three loans: one in Puerto Rico, a long-standing substandard loan that we placed in non-accrual. And the other two loans are US loans. They're totaling both, in the aggregate, around $10 million. And they were placed in substandard, and we took the provision for that.

Timur Braziler, Analyst

That's great. Thank you.

Jose Rafael Fernandez, CEO

Yeah. Thank you for your questions.

Operator, Operator

And we will take our next question from Brett Rabatin with Hovde Group. Please go ahead.

Brett Rabatin, Analyst

Good morning. Jose Rafael, could you update us? I haven't seen much in the news since the power outage last week regarding the Luna contract and any developments related to the power grid. It seems there are still opportunities for more sustainable and cost-effective power. I'm just wondering if you have any information on that.

Jose Rafael Fernandez, CEO

So the only comment I can add here, Brett, is this is going to be a long process. It's going to take at least a decade, and we are into a two-year kind of privatization program. It's been privatized for just about two years now. So it's going to take a long time. And we're going to have these events sporadically. Probably in the summer, we'll have some tool when the heat comes up and the demand increases because it's a fragile system. That's the reality. The other reality is that we are pretty much ready to cover all these issues because most of the businesses have power generators or solar panels, or they have been able to adapt to these unexpected events. So yes, it does have an impact on the economy. It was said that it was a $100-some million impact because it was a total blackout. And it's unfortunate and there's no way to sugarcoat it. But the reality is that it's going to take a while to get this fixed from the generation as well as transmission and distribution to make it resilient, to make it low cost, to make it diversified. The electric grid in Puerto Rico was destroyed by the hurricanes, and so it's going to take a while. And it requires execution by the privatizer and it requires oversight by the government. And those are areas of opportunity, I should say, taking a bit of your words.

Brett Rabatin, Analyst

Yeah. It also seems like some of the opportunity could still be there for on-shoring pharmaceuticals and that kind of stuff, but I haven't seen anything on that really either other than just talking about potential.

Jose Rafael Fernandez, CEO

I believe the tariff situation presents a significant opportunity for the Puerto Rican government to attract some on-shoring activities. Given our current infrastructure in pharmaceuticals and medical devices, along with our skilled and educated workforce, there are strong incentives for companies to return to Puerto Rico. While there has been a lot of discussion, we haven't seen much concrete evidence of this happening yet. However, I remain optimistic, as tariffs could drive this change. Being a part of the United States, combined with our historical strength in manufacturing—which constitutes 40% of Puerto Rico's economy—positions us favorably. That said, effective execution by the government will be essential.

Brett Rabatin, Analyst

Okay. That's great color. And then maybe, Maritza, on fee income. Typically, wealth management is a little soft in 1Q and then stronger in 2Q. I want to make sure I understood the outlook for fee income from here. And then, obviously, mortgage banking is tough to forecast, but I would assume that that level also improves from here?

Maritza Arizmendi, CFO

This quarter exceeded our expectations, as banking fees were higher despite having two fewer business days. We reported $29 million this quarter, which aligns with our previous estimate of $29 million to $30 million for our annual fee run rate. We're currently observing this fee trend, and particularly this quarter saw significant activity in debit card transactions and point of sale.

Jose Rafael Fernandez, CEO

Brett, if I could add just one thing here that Maritza pointed out in terms of transactionality. We do see a lot more activity from our customers and utilization of our debit cards and our services. So that is definitely very encouraging for us because it validates not only our strategy, right, the digital first strategy, but it also validates that we are being recognized and our brand is gaining additional traction here in the market.

Brett Rabatin, Analyst

Okay. How significant is the Apple Pay rollout for you in terms of transactions, and what are your thoughts on it?

Jose Rafael Fernandez, CEO

It's good to have, to be honest. It's good to have. People in Puerto Rico were not Apple permitted. It was just more of an Apple thing than a Puerto Rico thing. But we were, together with another institution in Puerto Rico, there were only two institutions that were able to get the Apple Pay available for our customers, and we were one of those. And we're proud of that. We're proud of that because we are leaders in innovation and technology, and we continue to improve by delivering on a timely basis, even to the requirements of Apple, which somewhat elusive to some others.

Brett Rabatin, Analyst

Okay. And then just last quick one. Tax rate from here, any thoughts on full year and then maybe where it trends relative to the past two quarters?

Maritza Arizmendi, CFO

We're seeing a 26% effective tax rate for the full year.

Brett Rabatin, Analyst

Okay. Great. Thanks for sharing all the color.

Jose Rafael Fernandez, CEO

Yeah. Thank you. Have a great day.

Operator, Operator

And your next question comes from Kelly Motta with KBW. Please go ahead.

Kelly Motta, Analyst

Hi, good morning. Thanks for the question. Maybe circling back to the margin. Maritza, could you help us out and remind us how much of the asset base is more rate-sensitive and impacted by an immediate reset on Fed funds, how to think through that? And how do you include that in the margin guidance?

Maritza Arizmendi, CFO

Yes. In the asset side, the most elastic asset is the commercial book, which right now, 53% is tied to variable rates and the cash. So, those are the two assets that are more sensitive to any change in markets.

Kelly Motta, Analyst

Okay, that's helpful. It seems that the deposit costs are continuing to perform well. Could you provide an update on the competitive environment in Puerto Rico? What are you observing regarding your competitors? Is the competition still relatively high, or have you noticed a decrease in pressure over the last quarter or two?

Jose Rafael Fernandez, CEO

Competitors are indeed very persistent. We hope they maintain their current approach. The market remains unchanged, and we are focused on delivering the best for our customers. On the deposit front, some credit unions were initially slow with their rates, but this has now stabilized. We're pleased with our core performance, especially in deposits. Our demand, savings, and time deposits have all increased, primarily due to both existing customers adding deposits as we strengthen our relationships and attracting new customers. We are experiencing a net growth of 5% year-over-year in new customers, which contributes to this growth. Additionally, we are seeing an interesting increase in non-interest-bearing deposits this quarter. These are positive indicators. We'll assess how much of this growth is seasonal versus structural, given the economic environment in Puerto Rico. Overall, it has been a strong quarter.

Kelly Motta, Analyst

Thanks for that. And then I also appreciate the commentary about Puerto Rico having a lot of manufacturing in the economy. Wondering if you've seen any movement there. Puerto Rico could theoretically be a beneficiary on a move to greater offshoring into the US. I'm wondering if you're seeing any movement there, what the discussion is on the ground and your thoughts around that as I know it's a moving target here.

Jose Rafael Fernandez, CEO

It's too early to determine any developments, as we haven't observed any notable changes. However, we see it as a good opportunity. The global landscape is currently in a state of adjustment, and we are no exception. We are monitoring the situation worldwide, including the tariffs being imposed. At this point, pharmaceutical products do not appear to be affected by additional tariffs and haven’t yet been included on the list. We are receiving some positive news from the market recently, and we will keep an eye on this as we move forward. This quarter, we need to closely evaluate how things progress. We are actively engaging with our customers, especially on the commercial side, to understand how they are adapting to the current circumstances. While it is still early to draw conclusions, our customers are managing uncertainties by increasing inventories and pausing some projects, but they are not completely halting their initiatives. This is the feedback we are getting from them, and we aim to remain as connected with them as possible, which is essential in our line of work.

Kelly Motta, Analyst

Got it. I really appreciate the color. My questions have been asked and answered. I'll step back. Thank you.

Jose Rafael Fernandez, CEO

Thank you. Have a great day.

Operator, Operator

Thank you all for joining us on the call today. We look forward to seeing you in the next quarter. We'll have our shareholders meeting next week. So thank you for being with us. Have a great day. This does conclude today's presentation. Thank you for your participation. You may disconnect at any time.