Earnings Call Transcript - OFG Q2 2024

Operator, Operator

Good morning. Thank you for joining OFG Bancorp's Conference Call. My name is Savannah, and I will be your operator today. Our speakers are Jose Rafael Fernández, 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 and it can be found on the home page of the OFG website under the Second Quarter 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 the information disclosed in this call as a result of developments that occur afterward. 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 second quarter 2024 results, which demonstrate the strength of our strategies and franchise, both in line with our short-term and long-term plans. Performance for the quarter was exceptional. We generated consistent growth through increased loans, deposits, and noninterest income and stable credit quality. Our digital-first strategy continues to help us expand our retail and business relationships, and we deployed close to half of our $50 million share buyback program, purchasing $24.3 million of OFG shares in the open market. At the same time, Puerto Rico's economy continued to grow and steadily decoupled from mainland economic uncertainties. I want to thank the entire OFG team for their commitment to our mission and purpose, which is to make progress possible for our customers, employees, shareholders, and the communities we serve. Please turn to page three for a summary of our second quarter results. Looking at the income statement, earnings per share, diluted, increased more than 16% year-over-year to $1.08 on a more than 5% increase in total core revenues to $179.4 million. Net interest margin was 5.51%. Provision was $15.6 million. Non-interest expenses were $93 million, and pre-provision net revenues totaled close to $87 million. Turning to the balance sheet. Total assets were $11.3 billion, up 12% from a year ago and 1% less than last quarter. Customer deposits were $9.6 billion, including strong commercial deposit growth. Loans held for investment totaled $7.6 billion, and new loan production was a solid $589 million. Investments were level with the first quarter at $2.5 billion, and cash at $740 million was down slightly from last quarter. Looking at capital, the CET1 ratio was 14.29%. Let's turn to page four for an update on our Digital First strategy. As of the second quarter, 94% of all routine retail customer transactions, 96% of retail deposit transactions, and 66% of retail loan payments were made through our digital and self-service channels. This is being driven by year-over-year growth of 13% in digital enrollment, 69% in digital loan payments, 26% in virtual teller utilization, and 4% in customer growth. During the second quarter, 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. Elite offers an exclusive combination of benefits, in particular, cash back on loan payments and full digital account opening and funding. For small business commercial clients, we upgraded Oriental Biz, a complete cash management platform easily accessible through mobile devices with access to remote check deposit. Small businesses now have a complete set of tools to manage their finances anywhere, anytime. We are very excited about the customer reception so far of both products. Our strategy is to continue to take advantage of our unique position in the Puerto Rico market. This includes leveraging our technology investments, our entrepreneurial culture, and our client-centric challenger approach. All this to provide customers with products and services that incentivize them to deepen their relationship with us. We focus on doing it in a way that is fast, easy, agile, and delivers added value. Now here is Maritza to go over the financials in more detail.

Maritza Arizmendi, CFO

Thank you, Jose. Please turn to page five to review our financial highlights. Starting with the components of core revenues. Total interest income was $188 million, up more than 2% or more than $4 million from the first quarter. That mainly reflected higher income from loans due to higher average balances and yields and $2.1 million from the recovery of a non-accrual U.S. commercial loan paid in full. Total interest expense was $40 million, an increase of $1 million from the first quarter. This reflected higher average core deposits and a 7 basis point increase in rates, partially offset by lower average wholesale funding and rate. Total banking and financial service revenues were $32 million, an increase of $2 million from the first quarter, with higher banking service, wealth management, and mortgage banking revenues. Banking and service revenues included $600,000 in prepayment fees on U.S. loans. Wealth Management included $500,000 in annual recognition of certain commercial insurance fees. Looking at net interest expenses, they totaled $93 million, up $1.6 million from the first quarter. Expenses included $1.3 million in higher electronic banking fees due to increased business activity, $1.1 million in different categories of professional services due to improved service to improve business processes, and $400,000 in higher FDIC insurance now that Oriental is more than a $10 billion in assets. This was partially offset by $1.4 million due to a higher gain on the sale of preprocessed properties and lower compensation expenses related to reduced FICA payroll expenses. The second quarter efficiency ratio was 61.81%, a 68 basis point improvement from the first quarter. As revenues continued to expand, we are incrementally investing in our digital-first strategy by adding new technology and investing in people. We expect to average $90 million to $92 million of noninterest expense per quarter for the rest of this year, with the efficiency ratio remaining level with the second quarter. Other performance metrics remained high. Return on average assets was 1.82%. Return on average tangible common equity was 18.24%, and tangible book value per share continued to climb to $24.18, up $0.63 from the first quarter. Please turn to page six to review our operational highlights. Average loan balances were $7.6 billion, increasing 1% from the first quarter. End-of-period balances of loans held for investment increased 1.3% or $100 million. This reflected sequential growth in Puerto Rico commercial, auto, and consumer loans, partially offset by regular paydowns of residential mortgages and prepayment of approximately $66 million of U.S. commercial loans. Year-over-year, second quarter loans held for investment increased more than 7%. Net yield was 80.15%, up 70 basis points from the first quarter. This included the previously mentioned U.S. loan recovery representing 11 basis points. New loan origination increased $52 million from the first quarter. Production increased sequentially across all categories, led by a strong quarter for auto. We have a strong pipeline in commercial and continue to anticipate auto production will moderate. Average core deposits were $9.6 billion, up $67 million from the first quarter. End-of-period balances increased $59 million or 0.6%. This reflected a $125 million increase in commercial deposits, partially offset by a decline of $53 million in retail deposits and a $12 million decline in government deposits. Core deposits were 154 basis points, up 7 basis points from the first quarter. That's the smallest sequential increase over the last five quarters. Excluding public funds, the cost of deposits was 87 basis points, compared to 82 basis points. Average borrowings and broker deposits were $221 million, compared to $280 million in the first quarter. The June period balances were $201 million. The rate paid on wholesale funding decreased 18 basis points to 4.62% in the second quarter. Investment securities held steady from the first quarter at $2.5 billion. During the second quarter, a $200 million treasury note yielding 3.3% that matured in May was replaced with $200 million of government-insured mortgage-backed securities yielding 5.6%. With this, we extended asset duration at a higher yield to lower our asset sensitivity. Net interest margin was 5.51%. Excluding the U.S. loan recovery, net interest margin was 5.44%. Please turn to page five to review our credit quality and capital strength. Credit quality continues to be stable. Net charge-offs totaled $15 million, down $5 million from the first quarter. The net charge-off rate was 79 basis points, down 26 basis points. Auto and consumer net charge-off rates were both down sequentially. The auto net charge-off rate is now below the last two quarters. While there are some time delays in payments, the business is well-managed. Provision for credit losses totaled $15.6 million, up $500,000 from the first quarter. The second quarter provision mainly reflected loan volumes. Looking at other credit metrics, early and total delinquency rates were up from the first quarter at 2.81% and 3.71%, respectively, in line with trends we have seen over the last five quarters. The non-performing loan rate of 1.08% was the lowest of the last five quarters. Looking at some other capital metrics, total stockholders’ equity increased about $12 million from the end of the last quarter, and the tangible common equity ratio increased to 10.09%. Our second quarter effective tax rate was 28.2% compared to 26.8% in the first quarter. We continue to expect a full-year ETR of 29% in 2024. The second quarter included an $800,000 benefit from a tax credit, and the first quarter included a $1.1 million discrete benefit from the stock business. To sum up, during the second quarter, net interest income continued to grow based on the increased volume of interest-earning assets, partially offset by lower net interest margin year-over-year. This mainly reflected higher balances and yields of loans, partially offset by higher moderating core deposit costs. The core deposit trends continue to be positive, benefiting from commercial deposit growth. Loans remain strong. We continue to be on track for 3% to 4% growth this year. Credit quality remains stable and is expected to continue that way. Our net interest margin outlook continues to be in a range of 5.45% to 5.55%. We expect the full benefit from the most recent change in our investment portfolio in the third quarter. We continue to expect three Federal Reserve Bank rate cuts of 25 basis points each. Our anticipated range of noninterest expense continues to be $90 million to $92 million as we invest in technology. While we bought back shares during the second quarter, we remain opportunistic regarding capital allocation, ranging from capital for Puerto Rico and U.S. loan growth to dividends and continued share buybacks. Now here is Jose.

Jose Rafael Fernandez, CEO

Thank you, Maritza. Please turn to page eight. Our outlook for both Puerto Rico and OFG is positive. As I mentioned earlier, the island's economy is continuing to grow and steadily decouple from mainland economic uncertainties. We're seeing ongoing expansion of infrastructure projects, business investments, and strong levels of employment. So we are very optimistic about Puerto Rico and its future. Having said that, we continue to be vigilant regarding the big macro uncertainties, interest rate changes, inflation, possible mainland recession, and ongoing geopolitical conflicts. Turning to OFG. We're well-positioned to continue to benefit from the growth of loans, deposits, and our customer base. Consumer credit trends should continue at current levels. Our digital-first strategy is working, so we will continue to invest in and deploy customer innovations to build out our differentiated business model. Overall, we look forward to a strong second half of 2024. In addition, we'll be celebrating our 60th anniversary in business and our 30th year of OFG shares trading on the New York Stock Exchange. In closing, I want to emphasize that our results could not have been achieved without the hard work and dedication of all our team members, including our Board of Directors. We are thankful to them, and we're excited for what's to come. With this, we end our formal presentation. Operator, please start the Q&A.

Operator, Operator

Thank you. Our first question will come from Timur Braziler with Wells Fargo. Please go ahead.

Timur Braziler, Analyst

Hi. Good morning.

Jose Rafael Fernandez, CEO

Good morning, Timur.

Timur Braziler, Analyst

Maybe starting out on the remaining six asset repricing opportunity. I appreciate the comments on the $200 million of treasury maturities reinvested during the quarter. I guess, what's the cadence look like for the remainder of the year, both for planned bond maturities and fixed loan maturities?

Jose Rafael Fernandez, CEO

So Timur, in terms of our investment portfolio, we really do not have any immediate second-half of the year specific maturities. We do have repayments of our mortgage-backed securities book of around $20 million to $22 million a month. So our way of looking at this is we have the opportunity of kind of maintaining our treasury book, when I call it treasury, I mean investment book as part of our asset management and asset-liability management approach. In terms of the loans, we really do not have any fixed-rate loan maturity large ones, I should say, coming up. So from our perspective, the second half of the year is about loan origination and how we continue to generate good origination levels at a good yield. And on the treasury side, or investment side, be very opportunistic as we have been in the past when we had large amounts of cash, and we decided not to go long duration. So we are now benefiting from those decisions that we made a couple of years ago. And we've been doing it in the last several months, investing longer duration and having less asset sensitivity than we had last year, significantly less.

Timur Braziler, Analyst

Got it. Thanks for that. And then maybe just looking at the deposit base, the large public fund deposit that came in, in the fourth quarter. Is that just in the run rate now? Or is there still an expectation that a larger slug of that is going to come out? Because it seems like it's been embedded in that base maybe longer than initially you expected.

Jose Rafael Fernandez, CEO

Yes. That's a great point, Timur, and thank you for bringing it up. We have been guiding that the deposit would probably mostly flow out in the second half of this year. Now we have been updated from the government account that at least until September. So we will be having the deposit in our books at least until September, and that's already included in some of the guidance that Maritza gave throughout her comments in terms of net interest margin as well as cost of funds. So that deposit, it's collateralized, so it also has a little bit of a relationship to your second question. Part of our cautiousness in terms of the investment book has a lot to do with the $1 billion deposit that is collateralized with pretty much investment securities. So those are kind of a bit of the things that we're managing in the next three or four months, and we'll keep everyone updated on how that deposit plays out. The good thing is that that deposit is parable. It's indexed. So in the next three months, we will have a lower cost of that deposit if the Fed delivers on what the market is expecting and the three interest rate cuts that they're forecasting that they would do in the second half of the year. So we'll keep everyone updated with that. But for now, we're basically managing the relationship with a great customer of ours for a long time.

Timur Braziler, Analyst

Great. And then just the last question for me is on the credit front. Really nice results this quarter, good commentary for expectations in the back end of the year. Maybe just give us an update as to what's happening with the Puerto Rico consumer and some of the volatility we saw over the last three, four quarters. Has much of that abated now? Or do you feel like the seasoning of some of the higher COVID-related spend has now worked its way through the system? Just give us an update as to what's happening on the ground in Puerto Rico from a credit standpoint.

Jose Rafael Fernandez, CEO

Sure. So I'll give you some big picture kind of macro Puerto Rico perspective, and I'll ask Cesar to give you some specifics about our consumer loan books. From the big picture, Timur, most of the COVID incentives and all the cash that came in, it's flushed through. And what the economy is seeing from the consumer is a consumer that is also benefiting from higher wages and the minimum wage being increased here. I mentioned in other calls, where the magnitude percentage-wise of that increase in Puerto Rico is significantly larger than in the states. So the impact is also larger. So we see higher wages. We see lower unemployment levels. So all that is what's keeping the consumer healthy in terms of their finances. So now for our auto and consumer perspective in terms of the loan book, I'll let Cesar give you some details.

Cesar Ortiz, CRO

So for auto, let's start with auto with the bigger portfolio. We continue to see stabilizing non-performing loan rates on auto. The first quarter is usually a better season quarter than the rest of the year because of the tax season. We discussed this last quarter. So the second quarter, with the holidays in place, the customer tends to slow down in terms of collections, but the non-performing loans continue to be positive and stable. For those portfolios, consumer and auto. So we remain positive on the outlook for credit. Remember also that we converted the auto portfolio from a subprime, say 64% prime portfolio during three years ago, and now it's 84% prime and super-prime portfolio, which is improving the charge-off levels too. So we are seeing charge-off levels stabilizing and improving too. So again, we are positive on the outlook for the retail portfolio side. On the other hand, commercial portfolios are also benefiting from the macroeconomics of Puerto Rico. We continue to see good opportunities in the pipeline, but also good behavior in terms of the credit in the commercial portfolio, both small businesses and corporate portfolios.

Timur Braziler, Analyst

Great. Thanks for all that color. I appreciate it.

Cesar Ortiz, CRO

Thank you. Thank you for your questions, Timur.

Operator, Operator

Our next question will come from Brett Rabatin with Hovde Group. Please go ahead.

Brett Rabatin, Analyst

Hey, good morning, everyone.

Jose Rafael Fernandez, CEO

Good morning, Brett.

Brett Rabatin, Analyst

I wanted just to start off on the loan growth outlook for the back half of the year. And I missed, I couldn't quite hear the numerical guidance for the back half of the year, and I wanted just to see what the outlook was specifically on the commercial side. Auto has obviously been a strong driver here in the past year, but I just wanted to hear if the commercial activity in Puerto Rico specifically might be stronger and just how you guys think about that portfolio.

Jose Rafael Fernandez, CEO

Yes. So the first part of the question, we expect 3% to 4% loan growth for the full year. So the second half of the year will be impacted positively by our commercial pipelines. We have seen some delays in the closings of some loans that we had in the pipeline in June, but we expect them to be closing in the September quarter, and we still have a very strong pipeline. We are seeing a lot of activity in Puerto Rico on the commercial side, both small as well as mid- and larger type of credits. We're really encouraged with the small business and their origination levels. We've had consecutive record origination levels in three quarters in a row. And these are mostly, I would say, fixed-rate loans that are small. We're growing our small business clients through the small biz account that I mentioned in my comments, and it's giving us the opportunity to expand those relationships and deepen those relationships. On the larger type of sectors that we have, we do have a very strong pipeline, and we had a great quarter. We think that the second half of the year is commercial as a whole is going to drive our loan growth for the rest of the year. We do expect auto to taper down a little bit from the levels that we saw in the second quarter.

Brett Rabatin, Analyst

Okay. That's helpful. And then on capital, any thoughts on the buyback from here and just the capital levels are obviously robust, but I know you kind of keep them that way in Puerto Rico?

Jose Rafael Fernandez, CEO

Yes. Our approach to capital primarily focuses on loans. We see a significant opportunity in Puerto Rico. We have been somewhat cautious regarding the U.S. market due to uncertainties observed over the past year, which is reflected in the declining portfolio. Our first priority is deploying capital towards loans, enhancing our relationships, and leveraging the economic conditions in Puerto Rico to support our customers and communities. Following that, we assess capital from a dividend standpoint. As indicated by our strong results, we have confidence in OFG's overall outlook. We will continue to evaluate both dividends and share buybacks. I am pleased to report that we completed 50% of our buyback program in the last quarter, and the average price at which we repurchased shares was very beneficial for us. We are satisfied with our capital management and acknowledge that we have excess capital. Our earnings will consistently be returned to shareholders.

Brett Rabatin, Analyst

Okay. If I could sneak in one last one just on the expense guidance. If I heard it correctly, it was $92 million a quarter for the back half. I wanted to confirm that. And then I know it's way too early to think about '25 guidance, but essentially has the platform been invested to the point where you don't have new initiatives that you need to do on technology or other things that might lead to a lift in expenses maybe in '25 relative to the path of '24?

Jose Rafael Fernandez, CEO

So big picture, and I'll let Maritza give you the details. The big picture is that I don't think we can say we're going to stop investing in technology because it's kind of a stable stakes for everyone. And it's part of our strategy, right? We have a different business strategy in our market here in Puerto Rico that requires us to have fewer branches, but also to ensure that we're at the forefront of investments in technology. So that is a good size, and it's not so good size because we need to invest in technology. But I have to add one more thing, and that is its people and the culture. And I think the way we have led the bank in the last couple of decades is how do we make sure that our culture is an entrepreneurial culture with a dynamic, agile kind of approach to business and to look out for the opportunities, but also to transform the way we do banking. We are really proud of what we have accomplished so far, and that will require us to not lower the guard and we're going to have to continue to invest in technology. Having said that, I'll let Maritza give you a little bit of her take on the experience in 2024. And for 2025, I agree with you. It's a little too early for us to give you guidance.

Maritza Arizmendi, CFO

On the guidance, we shared with you in the prepared remarks that we're expecting a range of $90 million to $92 million in expenses. This quarter particularly was a little bit higher than that because of some specific investments, particularly as we continue investing in improving processes. So we did have some higher expenses over that range, but we expect that this will be the average range for the next two quarters as the timing of this investment will define if it is $90 million or $92 million, but we wanted to share that with you.

Jose Rafael Fernandez, CEO

And Brett, if I could add one more thing in terms of technology and investments and net interest expenses. I don't know if you realize this, but we have the capability to open retail and commercial accounts digitally from soup to nuts. And right now, around 20% of our retail customers opened their checking accounts digitally. So around 14% or 13% of small commercial clients do so. That's a differentiator in this market. And that's how we view this. This differentiator is because we have steadily been investing in the technologies that are required. So I'm not emphasizing this to hedge expenses going forward. I'm just emphasizing this to make the point that we have a differentiated strategy. I think it's played out very nicely, and we look forward to continuing to expand it.

Brett Rabatin, Analyst

Okay. That's all great color. Thanks so much.

Jose Rafael Fernandez, CEO

Thank you. Yes, thank you.

Operator, Operator

And our next question will come from Kelly Motta with KBW. Please go ahead.

Kelly Motta, Analyst

Hi. Good morning. Thanks for the question.

Jose Rafael Fernandez, CEO

Hi, Kelly.

Kelly Motta, Analyst

Capital is really strong, and you guys well time on the buyback and such. Just wondering, as you look ahead, given your kind of low mid-single-digit loan growth outlook organically, wondering if there are any opportunities to utilize some of your capital to maybe bolt-on business or portfolio. Just wondering if we could get an update on any thoughts around something of that nature?

Jose Rafael Fernandez, CEO

Yes. At this time, Kelly, we do not have anything that we're looking at inorganically, if that's what you're referring to, in terms of a book of loans or a portfolio or a business. We are growing our customers organically at a clip of 4%, and we're deploying our strategy to deepen the relationships with our existing customers because we have a great opportunity there to deepen those relationships and extract more business from them. So no, we do not have anything to deploy the excess capital. But we do have dry powder, so we will be opportunistic, and we will have the excess capital to take immediate advantage of any opportunity that presents itself.

Kelly Motta, Analyst

Awesome. And clearly, it was another great quarter from you guys. You guys continue to execute very nicely. Just from a high level, Jose Rafael, I'm wondering as you look ahead beyond just this year, like what makes you the most excited at OFG and maybe where do you see the greatest opportunities to gain share or build out a business? Just wondering if you could give us any insight into that from a high level.

Jose Rafael Fernandez, CEO

Sure. To me, the outlook for the next three to five years and what gets me excited and the team excited is deploying our strategy, Kelly. It's working. We're seeing it. Our net customer growth is happening. It's not going to happen in one month or one quarter, but we are steadily executing on our strategy and steadily executing on our business development approach, and it's working and building. So that is really exciting for us. And for us, banking has become boring, but that's great because in the past, our strategy in Puerto Rico, when the macros were not as good as they are right now, they were really bad. The strategy was acquisitions, and we did three, and we're very happy with those three acquisitions. Now, it's about blocking and tackling and executing on a differentiated strategy, and that really keeps me going and keeps our executive team and the whole bank going. And so we're really excited about the prospects for the next three to five years.

Kelly Motta, Analyst

Great. Well, we love boring when it's working so well. Maybe last question for me. Maybe for Maritza, I appreciate the color around margin. I think you reiterated 545 to 555. Just wondering, within that range, what do you think are the biggest drivers that could get you to the top end versus the bottom end? Is it deposit costs kind of stabilizing? Is it a function of putting on new growth at higher rates than on the top end of that, just trying to ballpark the greatest variance between both ends of that range.

Maritza Arizmendi, CFO

Thanks for the question. I think this quarter reflects what is the driver is the loan growth and the higher yield. Our loan book, excluding the recovery, is about 8%. So every quarter, we're growing an inch on the proportion of that loan book in the total balance sheet. Combining that with the fact that the cost of funds are stabilizing and not growing at the same pace as the prior quarter makes that will make us move to the upper range of the margin. But as we're managing different variables, market rates is one that we are looking at, and we are expecting three cuts. Within that range that I provided you, that is another factor. But I think loan growth will be the main driver.

Jose Rafael Fernandez, CEO

And Kelly, also in the last eight to ten months, we have kind of gone longer duration in fixed-rate investments in mortgage-backed securities, which has allowed us to reduce significantly our asset sensitivity. I think you'll get the 10-Q and you'll get the update. But our asset sensitivity has reduced quite a bit, and it's less of an environment where interest rates are going to be going down as the Fed is kind of signaling, and I think we're also well-positioned to manage that.

Kelly Motta, Analyst

Great. I'll step back. Thanks for the questions.

Jose Rafael Fernandez, CEO

Yes. Thank you for your questions, Kelly.

Operator, Operator

And at this time, there are no further questions. I will turn the call back to management for closing remarks.

Jose Rafael Fernandez, CEO

Thank you, operator. Thanks again to all our team members and to all our stakeholders for listening today. Looking forward to catching up with you guys at the end of the third quarter. Have a great day.

Operator, Operator

And this will conclude today's conference. Thank you for your participation, and you may now disconnect.