OFG Bancorp (NYSE:OFG) Q4 2023 Earnings Call Transcript

OFG Bancorp (NYSE:OFG) Q4 2023 Earnings Call Transcript January 24, 2024

OFG Bancorp isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Thank you for joining OFG Bancorp’s Conference Call. My name is Todd, and I’ll be your operator today. Our speakers are Jose Rafael Fernandez, Chief Executive Officer and Vice Chair of the Board of Directors, and Maritza Arizmendi, Chief Financial Officer. A presentation accompanies today’s remarks. It can be found on the homepage of the OFG website under the fourth quarter 2023 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 any 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. Please go ahead.

Jose Rafael Fernandez: Good morning, and thank you for joining us. We are pleased to report our fourth quarter and year-end results. 2023 was an outstanding year with record levels of loans, customer deposits, assets, and stockholders’ equity. For the first time, commercial loan balances exceeded $3 billion and tangible common equity was more than $1 billion. Our Digital First strategy continues to empower existing customers and attract new ones. 93% of all routine retail transactions and more core deposits now take place through self-service channels, enabling our teams to focus more on business development opportunities. While consumer credit has begun to normalize post-pandemic, consumer liquidity and employment levels continue to be solid.

Our commercial clients are doing very well in a strong economy. We are very proud of our accomplishments and thank the entire Oriental team for making this record year possible. Please turn to Page 3 for a summary of our fourth quarter results. Looking at the income statement, earnings per share diluted was $0.98, total core revenues were $175.6 million, and net interest margin was 5.62%. Provision was $19.7 million, primarily due to increased loan volume, non-interest expenses were $94.1 million and pre-provision net revenues totaled $88.2 million. Quarterly performance included two items of note. First was closing on the sale of non-performing Puerto Rico small business loans. We mentioned the planned sale last quarter. This resulted in a $6.3 million pre-tax gain.

Second was workforce early retirement and rightsizing. This resulted in a $3.2 million non-interest expense for severance and lease cancellations. This stemmed from increased productivity in certain areas, in part as a result of our technology investments. Turning to the balance sheet, total assets increased to $11.3 billion from $10.3 billion last quarter. Customer deposits increased to $9.6 billion from $8.5 billion. This was due primarily to a $1.2 billion deposit of public funds in mid-December, giving us a total of $1.6 billion of government deposits. Loans held for investment totaled $7.5 billion, up 4% from the third quarter, with new loan production or loan origination of $664 million, up 17% from the third quarter. Investments increased to $2.7 billion from $2.1 billion in the third quarter.

This was due to purchases of short-term treasury bills and long-term government-mortgage-backed securities. Cash increased to $748 million from $533 million. During the second half of 2023, we redeployed our higher-than-normal cash levels and maturing treasury positions into longer-term mortgage-backed securities. These moves position OFG balance sheet well for the expected lower interest rate environment in the second half of 2024. Looking at capital, the CET1 ratio was 14.12%, up from 14.06% in the third quarter. Please turn to Page 4 for a summary of our 2023 results. Earnings per share diluted for the year was $3.83, up 11% year-over-year. Total core revenues were $683 million, up 12% year-over-year. Net interest margin was 5.8%, provision was $60 million.

Non-interest expense, $363 million and pre-provision net revenues totaled $326 million. Our capital actions in 2023 including increasing the quarterly dividend by 10% to $0.22 and completing $18.7 million of share buyback. We have approximately $17 million of remaining authorization. Please turn to Page 5 for an update on our Digital First strategy. As of December, 93% of all retail customer transactions and 96% of retail deposit transactions are now being made through digital and self-service channels. That is being driven by year-over-year growth in December of 11% in digital enrollment, 54% in digital loan payments, and 21% in virtual teller utilization, as well as the continued success of our Oriental Servicing Portal, which was introduced mid-2023.

For new listeners, the portal is a cornerstone of our self-service strategy. Customers can manage all loans and deposit accounts. It enables them to originate and open checking, savings, and CD, applying for and accessing loans, managing automatic loan payments, and downloading bank letters and tax documents. We will continue to add new features on a regular basis. Our 2023 performance continued to validate our strategy and investments in technology. As I mentioned, they help us provide more value added service, increase our efficiency, and assign more staff for new business development activities. Now I’d like to welcome Maritza to the call to go over the financials in more detail.

Maritza Arizmendi: Thank you, Jose. Please turn to Page 6 to review our financial highlights. Starting with revenues, total interest income was $176 million, up $10 million from the third quarter. Key factors were a $7 million increase from loans, a $6 million increase from investment securities, and a $2 million decline from cash. Loans benefited from a higher average volumes and yields. The same factors affected investment securities, mainly due to fixed rate, higher yielding securities purchased late in both the third and fourth quarters. Average cash balances declined as we put more funds to work in loans and investment securities. Total interest expense was $33 million, an increase of $9 million from the third quarter. Key drivers were a $5 million increase due to a higher level of short-term wholesale funding and a $4 million increase due to higher average balances of core deposits at a higher rate.

Total banking and financial services revenues were $33 — $32 million, up $2 million from the third quarter. Wealth management revenues reflected annual insurance commission recognition of $2.5 million. Bank service revenues increased due to higher levels of economic activity. And mortgage banking revenues declined due to lower MSR valuation, reflecting the fall in long-term interest rates during the quarter. As a result of all of these factors, total core revenues were $176 million, up $3 million from the third quarter. Other noninterest income totaled $7 million, up $6 million from the third quarter. This was due to the gain from the sale of non-performing Puerto Rico small business loans. Looking at noninterest expenses, they totaled $94 million, up $4 million from the third quarter.

The efficiency ratio was 53.59%, up slightly from the third quarter. Most of the difference between the third and the fourth quarter was because of workforce early retirement and facilities rightsizing. We plan to use the resultant savings to continue to invest in technology. This should enable us to continue to average about $90 million to $92 million of noninterest expense per quarter in 2024, with the efficiency ratios continuing in the low- to mid-50 percentage range. Other performance metrics remained high. Return on average asset was 1.76%, the same as in the third quarter. Return on average tangible common equity was 18.22%, a nice increase from the third quarter. Tangible book value per share was $23.13, up more than $2 from the third quarter.

Tangible equity benefited from the increase in both retained earnings and AOCI. Please turn to Page 7 to review our operational highlights. Average loan balances were $7.4 billion, an increase of 3% from the third quarter. End of period balances were about the same. December 31 balances reflected sequential growth of 9% in Puerto Rico commercial loans, 7% in US commercial loans, 3% in auto loans, and 1% in consumer loans. Residential mortgage loans declined 3%, reflected continued regular paydowns and the securitization and sale of conforming loans. Loan yield was 7.96%, up 12 basis points from the third quarter. This reflected increases from variable rate commercial loans, higher entry yields on new loans and a smaller proportion of residential mortgages in the loan book.

Average core deposits were $8.7 billion, an increase of 1% from the third quarter. End of period balances were $9.6 billion, an increase of 12% from September 30. This reflected the $1.2 billion deposit of public funds in mid-December. Core deposit cost was 107 basis points compared to 90 basis points in the third quarter. This increase mainly relates to 30 basis points due to higher rates on government deposits and 20 basis points in time deposits. As of the fourth quarter, our cumulative beta was 27% for interest bearing deposits and only 19% for total deposits. Excluding government deposit, it was 15%. Average borrowings and brokered deposits were $602 million compared to $266 million in the third quarter. The December 31 balance fell to $363 million, the rate paid on these wholesale funding increased 54 basis points to 5.21% in the fourth quarter.

The interim quarterly increase in wholesale funding balances reflected asset and liability management strategies that involved a short-term need for increased liquidity. Most of the December 31 brokered deposit balance of $162 million will mature early in the current first quarter. We expect to use excess deposits to reduce wholesale funding. Net interest margin was 5.62%, that compares to 5.80% in the third quarter. Assuming some catch up in the deposit costs as well as the potential rate costs, we believe NIM could easily above 20 basis points over the first of 2024. Please turn to Page 8 to review our credit quality and capital strength. Net charge-offs totaled $16 million, down $3 million from the third quarter. The net charge-off rate was 88 basis points, down 17 basis points from the third quarter.

The first quarter reflected net charge-off rate declines in residential mortgages due to recoveries and an improvement in commercial loans due to the absence of a $7 million charge-offs in the third quarter related to two US loans. Included in the fourth quarter net charge-off rates were increases in auto and consumer loans, mainly due to the higher level of delinquencies. Looking at other metrics, provision for credit losses totaled $20 million, most of which relates to increased volume. Fourth quarter early and total delinquency rates were in line with the third quarter at 2.76% and 3.76% respectively. The non-performing loan rate of 1.22% was the lowest of the last five quarters. Overall, credit continues to be good. With COVID cash stimulus fading away, we expect increased net charge-offs in auto and consumer, but with increased employment and our growing Puerto Rico economy, net charge-offs and delinquency should be lower than pre-pandemic levels.

Looking at some of other capital metrics, total stockholders equity was $1.2 billion and tangible common equity ratio was 9.68%. To sum up, during the fourth quarter, we saw revenue growth continued to benefit from higher yields and higher balances of both loans and securities. Good loan originations driven by commercial, retail, auto, and consumer lending, increased core deposit costs mainly higher but betas continue to remain well below peers. Significantly higher end-of-period core deposits, higher short-term wholesale funding, credit conditions normalization, and core noninterest expense in line with our expected range that includes continued investment in our Digital First strategy. Now here’s Jose.

Jose Rafael Fernandez: Thank you, Maritza. Please turn to Page 9. Our outlook remains positive for both Puerto Rico and OFG. The flow of federal funds to rebuild the island’s infrastructure continues. Local businesses are expanding, the consumer is doing well, private capital continues to make investments in the island. We still have to watch out for all the big uncertainties, interest rate changes, inflation, possible mainland recession as well as the ongoing global contracts. But we remain optimistic about Puerto Rico and look forward to continued economic and business growth as well as strong levels of employment. Turning to OFG, 2023 results were driven by loan growth, good credit quality, and higher interest rate environment, and low deposit beta.

We saw strong traction with beta adoption and client acquisition as Oriental self-service portal and other innovations are helping to build our businesses. As a result, we had a record year in earnings. As I mentioned earlier, assets, loans, customer deposits, and stockholders equity ended the year at new highs. Overall, our strategies have proven highly effective. Looking ahead, we are starting 2024 with strong momentum, excellent strategic positioning and a significantly larger balance sheet for both loans and investments. With this as a starting point, we anticipate continued loan and client growth. This will be partially offset by net interest margin easing over the course of the year due to expected lower interest rates by the Fed and by higher provision as consumer credit continues to normalize.

As Maritza mentioned, we plan to continue to invest in and deploy more customer friendly technology. All in all, we look forward to a strong year in 2024. 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. We are thankful to them and we’re excited for what’s to come in 2024 as we mark our 60th year in business and our 30th year trading on the New York Stock Exchange. With this, we end our formal presentation. Operator, please open up the call for the Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions]. Our first question will come from Alex Twerdahl with Piper Sandler. Please go ahead.

Alex Twerdahl: Good morning.

Jose Rafael Fernandez: Good morning, Alex.

Alex Twerdahl: First off, Jose, I was hoping you can give us a little bit more color on the $1.2 billion government deposit, where it came from, and whether or not it’s something that’s going to stick around on your balance sheet for a prolonged period of time?

Jose Rafael Fernandez: Yeah. So it’s a longstanding client of ours and they had a one-time inflow of liquidity, and certainly, we are honored to be their bank. So again, at this point, we don’t have full visibility on the uses of the funds. So for now, we’re modeling it within our balance sheet as a short-term deposit. But in the meantime, we are again servicing longstanding customer that we have full banking relationship with them. We will definitely update you guys as we get more color from the customer. But it’s a — it’s going to take a couple of more weeks for us to figure it out.

Alex Twerdahl: Okay. So I mean, I guess, when you’re thinking about the NIM guidance. I think the 20 basis points of NIM compression throughout the year, should we just assume that on the balance sheet, excluding that $1.2 billion?

Maritza Arizmendi: Well, it’s just on the basis scenario, as Jose was mentioning that, it will be in for a short-term period. Yeah.

Jose Rafael Fernandez: Yeah. So it excludes that one-time, that deposit, our modeling excludes that deposit for the better part of 2024.

Alex Twerdahl: Okay. And is that government deposit just sitting in non-interest bearing now or is it something that’s going to impact interest expenses in the first quarter?

Jose Rafael Fernandez: So it’s a government deposit that is index based as all government deposits are these days. So it’s earning interest right now on based on the formula that the government has established.

Alex Twerdahl: Understood. And then, I guess, as I think about the size of the balance sheet, you guys are obviously over $10 billion now. It’s something you projected, something we expected. And your capital levels are building to a level where it suggests that you could have a much larger balance sheet than where you are today. How are you thinking about just overall managing the balance sheet over the next, I guess, year or coming years? And does the strategy shift at all now that you’re firmly above the $10 billion mark?

Jose Rafael Fernandez: So our game plan remains pretty much the same. We see great opportunities for us to continue to grow our loan book here in Puerto Rico and somewhat in the States too, but mostly here in Puerto Rico. We are seeing a good economic environment that supports us in that effort. And that’s the game plan that we have. We are basically now with good liquidity levels, excess deposits, and we want to deploy them first and foremost into the jurisdictions, in the locations that we operate in primarily here in Puerto Rico. So that’s kind of how we’re seeing it, Alex. We’re not really planning or having any extraordinary event on the agenda for us. We just simply need to keep on going forward. And just to go back to the question on the deposit, on the government deposit, I just want to mention to you that, really, it’s providing us — gives us flexibility on our balance sheet because as Maritza mentioned in her remarks, she will — and we have kind of canceled or let mature some of the wholesale funding that we took in the November, December month.

So that cost of that, there is a differential that also benefits, a slight differential, but it benefits us. So it’s also short-term, something that is going to help us to be more flexible and nimble with our balance sheet.

Alex Twerdahl: Got it. And then just final question for me, just on the workforce rightsizing and some of the actions. Can you just tell us what you did? And I guess what the impact is?

Jose Rafael Fernandez: Yeah, so first, it starts with, we’ve been investing in our Digital First strategy for several years. You’ve seen the investments. And part of thesis and hypotheses for us is that we’re investing in technology to improve the customer experience and also to generate and incrementally start generating some efficiencies. So some of what you’re seeing in the fourth quarter is our pointed effort towards starting to extract some efficiencies with the intention of using those efficiencies as the way we invest forward in technology and on our Digital First Strategy, as we’ve talked about. So we’ve seen some workforce reduction in some of the areas that have been invested mostly. And some of it is on branches but mostly on the operational side, and we’re also seeing how we can be more nimble in terms of our facilities, and we were able to cancel and terminate one of the leases that we had.

So again, it’s all about how do we take advantage of the investments that we made to get the second part of the thesis that we presented to you guys several years ago, which is starting to get some efficiencies out of the investments too. So we’re being very intentional with that. And that’s why we can keep the expenses at the 90, 92 kind of quarterly level, as Maritza mentioned.

Alex Twerdahl: I mean, is the presumption then going forward that as the digital strategy continues to play out through the next year that maybe there’d be further rightsizing or further efficiencies found, I guess, sort of the end of next year?

Jose Rafael Fernandez: It’s, for me, too early to tell, Alex. This is something really that we look very closely. And we will look at it on a quarter-to-quarter basis to see what opportunities surface. But we are certainly looking at it. Can’t promise anything though.