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Operator: Good morning. Thank you for joining OFG Bancorp Conference Call. My name is Shelby. I will be your operator today. Our speakers are Jose 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 our Investor Relations website on the homepage in the What’s New box, or on the quarterly results page. This call may feature certain forward looking statements about management’s goals, plans and expectations. These statements are subject to risks and uncertainties outlined in the risk factors section of OFG’s SEC filings. Actual results may differ materially from those currently anticipated. We disclaim any obligation to update information disclosed in this call as a result of developments that occur afterwards. I would now like to turn the call over to Mr. Fernandez.
Jose Fernandez: Good morning and thank you for joining us. We are pleased to report our fourth quarter and fiscal year 2022 results. We are extremely proud of the work we did last year and our performance reflects that. We achieved great progress executing our strategies for the benefit of our customers, deploying technology, expanding and improving our network and investing in people and talent. We took major steps forward in our digital first business transformation, solidifying our position as a challenger bank, differentiating us from our competitors. In addition to ATMs, we now have seven self service banking kiosks and 23 interactive teller machines as part of our enhanced sales and service banking network. All this has contributed to our strong financial results.
Our performance metrics are at the highest they’ve ever been to-date. The Puerto Rico economy is also doing well. Businesses and consumers remain in good financial shape. We look forward to another good year with a cautious eye as always on economic and financial uncertainties. Now please turn to page 3 of our conference call presentation. This was our strongest quarter this year. It was driven by total core revenue growth of more than 7% quarter-over-quarter and more than 19% year-over-year. Looking at the income statement, earnings per share diluted was $0.97. Core revenues totaled $168.3 million. Net interest margin was 5.69%. Provision was $8.8 million. Non-interest expenses was $91.6 million and pre-provision net revenues totaled $76.9 million.
When we look at our balance sheet, customer deposits were $8.6 billion. Loans held for investment totaled $6.8 billion and new loan origination remains strong at $616.4 million. Investments totaled $2 billion and cash was $550 million. Capital remain strong with CET1 ratio at 13.64%. Please turn to page 4. When we look at our results for the year, earnings per share was $3.44 up 22%. This was driven primarily by total core revenue of $607.8 million. Net interest margin of 5.05%. Provision of $24.1 million and net interest expenses of $345.5 million. We ended the year with total assets of $9.8 billion. As a result, we remain under the Durbin threshold. As part of our ongoing strategic reviews at the end of the year, we decided to take advantage of an opportunity to sell our retirement plan administration business.
The rationale behind this decision is to focus our efforts on 401K business development while leveraging the service and scale of a larger U.S. player in this segment. There was minimal financial impact from this transaction. And, as we’ve previously reported other capital actions in 2022 included completing $64.1 million of our $100 million buyback authorization plan, and increasing our common stock dividend to $0.20 per share from $0.12 an increase of 66.7%. Then yesterday, we increased the quarterly dividend 10% to $0.22 per share. Now, here’s Maritza to go over the financials in more detail.
Maritza Arizmendi: Thank you Jose. Please turn to page 5 to review our financial highlights. Let me start with total core revenues, they increased $11 million quarter-over-quarter and $27 million year-over-year. Looking at the key components of that interest income was $11 million higher than the third quarter. That reflects the benefit of higher yields on increased average balances of loans and of investment securities. Net interest income for the quarter was $9 million higher compared to the third quarter and $31 million higher compared to the year ago quarter. Of the $9 million, about $11 million came from higher rates on interest earning assets, partially offset by $2.5 million in higher costs of funds. Looking at banking and wealth management revenues.
They increased $3 million from the third quarter. This reflected higher electronic banking activity and gain on sale of mortgages compared to the third quarter when Hurricane Fiona interrupted business. The annual recommendation of insurance commission was $1 million. This was $1.2 million lower than a year ago due to financial aided claims. Year-over-year banking and wealth management revenue declined $4 million. This reflected lower wealth management revenues due to lower equity market valuation. It also reflected the lower annual insurance commissions. Looking at the efficiency ratio. It was 54.45% in the fourth quarter. That’s another nice improvement from the third and year ago quarters. Similar to the last few periods, it reflects our positive operating leverage.
As per net interest expenses totaled $92 million, that’s $4 million higher than in the third quarter. That reflects higher compensation expenses due to hourly salary increases implemented in the third quarter increases in yearend performance bonuses, and other technology staffing. It also reflects increased amortization related to new digital projects and the Hurricane Fiona related expenses. Non-interest expense should average about $90 million to $92 million per quarter in 2023. As we previously mentioned, our efficiency ratio target range is in the mid 50s. As Jose mentioned we sold our retirement and plan administration business in the fourth quarter. This will reduce our wealth management revenues by about $2 million, which will be fully offset by an equal amount of savings in non-interest expenses.
Looking at our performance metrics. They improved nicely quarter-over-quarter and year-over-year. They also continue to exceed our target ranges. Return on average assets was 1.86% that is up 21 basis points from the third quarter. Return on tangible common equity was 20.36%. This is up 231 basis points from the third quarter. Looking at tangible book value per share. That was $19.56, an increase of $1.10 compared to the third quarter. This reflects increase retained earnings and other comprehensive income. Please turn to page 6 to review our operational highlights. Looking at average loan balances. They increased $72 million from the third quarter. End of period loans held for investment increased $150 million. Compared to the third quarter 2022 loan growth reflected increased balances of commercial, auto and consumer loans.
End of period loans increased 2.3% from the previous quarter and 6.8% year-over-year. We’re extremely pleased with our performance this year. Looking at loan yield. It was 7.32%. That is 43 basis points increase from the third quarter. That’s largely the effect of Fed rate increases on new and variable rate loans in our commercial loan portfolio. It is also due to a higher proportion of auto, consumer and commercial loans versus residential mortgages. Looking at average core deposits. They decreased $165 million from the third quarter. End of period deposits declined $287 million. That reflects commercial withdrawals of $172 million which included $59 million in government funds. It also reflects retail withdrawal of $150 million which included $37 million transferred to Oriental wealth management operation.
Looking at core deposit costs. It was 39 basis points. That is an increase of 11 basis points from the third quarter. That was mainly due to government accounts with a specified deal parameters and migration from savings accounts into time deposits. Of the 11 basis point increase, 6 basis points came from government deposits. So far in this rate cycle, our deposit has been 7%. We expect deposits cost to increase given the magnitude and the speed of Fed from the recent and expected increases. But we believe that through this interest cycle, they will continue to be below mainland level. Looking at new loan origination. They totaled $660 million compared to $511 million in the third quarter. This reflected the strong production of commercial loans in Puerto Rico and the mainland.
It also reflected continued high levels of auto loans at a record of $221 million. Looking at net interest margin. That was 5.69% an increase of 46 basis points from the last quarter and 151 basis points year-over-year. This higher net interest margin reflected growth of the loan portfolio at the higher yield, growth of the investment portfolio also at a higher yield and higher yield on cash. This was partially offset by the increasing cost of funds. Please turn to page 7 to review our credit quality and capital strength. Looking at net charges off. They totaled $11 million in the fourth quarter. That’s reflected $5 million for auto loans, $4 million for consumer loans, and $3 million for a commercial loan previously we served. Looking at provision for credit losses.
So that provision was $8.8 million that reflected $9.2 million in higher provision due to the increased loan volume. It also includes a net release of $400,000 mainly related to reduction in the qualitative adjustments due to improved macroeconomic environment in Puerto Rico, as well as a stable delinquency trends. Fourth quarter allowance coverage ex-PPP was 2.24%. That’s down 9 basis points from the third quarter. Looking at non-performing loans. The total non-performing loan rate was 1.61%. That’s down 10 basis points from the third quarter and 37 basis points from a year ago. Overall, credit was a stable without rebound from the last quarter effects of Fiona. Looking at some of our other metrics. The CET1 ratio was 13.64%. That’s up 13.38% in the third quarter.
Total stockholders’ equity was $1 billion up $49 million from the third quarter. The tangible common equity ratio increased to 9.59%. Now here is Jose.
Jose Fernandez: Thank you, Maritza. Please turn to page 8 for our outlook. When we entered 2023, we entered 2023 with strong momentum in loan growth, customer acquisition and market penetration; all of which are helping to transform our company. While we need to keep a watchful eye towards uncertainties from Fed rate hikes, inflation, and a possible mainland recession we should benefit from a full year of higher loan balances and rates combined with a relatively low deposit data as compared to our mainland peers. We should also start to benefit from a full year of the investments in technology and people that we made in 2022. On a macro basis, the Puerto Rico economy should continue to grow, perhaps at a slower pace, but better than the mainland, given the level of continued federal spending here.
All this should enable us to continue to invest in people and technology as part of our digital first strategy. Thanks again to our dedicated team members for their commitment to the customers and the communities we serve. This ends our formal presentation. Operator we can start the Q&A.
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Operator: We’ll take our first question from Alex Twerdahl with Piper Sandler.
Unidentified Analyst: Good morning. This is I’m filling in for Alex Twerdahl today. Today, how are you guys doing?
Jose Fernandez: Good, how you doing?
Unidentified Analyst: Good. Thanks. I just wanted to start off. I know you guys mentioned that you expect the deposit rate to be lower than the last year cycle. But given the rising deposit costs, do you see increased pressure in any specific segment of deposits in the island.
Jose Fernandez: So when we look at betas, we kind of look at the past to use it as a reference. And when we look at our origins, deposit betas in the last cycle, it was somewhere around 16%. So we expect given the speed and the size of the increases that we’ve seen in 2022 we see our betas to be higher than that 16% that we had in the last rate cycle hikes. Now, where do we see that? We definitely have an adjustment with a lag from the Puerto Rico government. We have very little but whatever it is, is going to have some impact on that. And then when we look at the core, I think the ones that will have a higher beta will be in commercial deposits across the board, but in particularly the higher balances accounts.
Unidentified Analyst: Got it. Thanks. And I know you guys had another great quarter of asset yield growth. I’m just curious to know what rates are coming on the books from new loan production right now or moving forward?
Jose Fernandez: So on the commercial book, we’re seeing rates on the 6% handle, more or less, north of 6.5, I’m talking about larger type of loans. And then on the small commercial closer more to the 7%, 7.25.
Unidentified Analyst: Okay, and lastly, I know you’ve had your efficiency ratio target around 54%. Also curious to know where you see going moving forward throughout the year.
Jose Fernandez: So in terms of the efficiency ratio?
Unidentified Analyst: Yes.
Jose Fernandez: Yes. We are targeting mid 50s. So you should expect our efficiency ratio around those levels. And this is the way we think about this and take this opportunity to give you a little bit of our thought process here for 2023. We see loan growth around 3% to 4% for the year as interest rates start to slow down loan growth in the island. I mentioned the beta is slightly higher than what we had in the last cycle of 16%. So given the current yield curve, our net interest margin should start to stabilize at these levels. There’s a slight positive trend during 2023. Remember that in 2023 we also, we will realize the full effect of higher loan balances and interest rates, as Maritzamentioned. So net interest expenses are $90 million to $92 million per quarter.
We keep on investing on our network optimization, self service and process improvement technology, and people on talent and recruitment of additional team members. So that puts it around the mid 50s range for the efficiency ratio.
Unidentified Analyst: Got it. Okay. That’s all for me. Thanks for answering my questions.
Jose Fernandez: Yes, thank you for your questions.
Operator: We’ll take our next question from Timur Braziler.
Timur Braziler: Hi, good morning. Maybe circling up on the loan commentary and the expectation for 3% to 4% growth next year. I mean, you’ve been calling for slowing loan growth here now for a couple of quarters, especially on the auto side and trends seem to be going in the opposite direction. How much of that 3% to 4% is more wishful thinking versus what you’re currently seeing? And then specifically on auto, are we close to an equilibrium there? Or is there still a big delta between supply and the increased demand?
Jose Fernandez: So you bring a very good point. And you’re correct also. We’ve been kind of guiding towards a slowdown in loan originations, particularly on the auto side and hasn’t played out. But we continue to feel that the level of cars inventories in the island, the level of new auto sales are starting to stabilize. And I think the fact that interest rates are going up and the effect that might have on slowing down the economy during 2023, we should see a slowdown. We’ve been wrong for a couple of quarters. But we want to not be wrong on the wrong side of the equation here. So we’ll be also prudent on the auto lending side. On the other buckets, on the commercial side, interest rates also play a game here in terms of the demand for commercial loans.
So we’re also seeing good pipelines but not as strong as they were last year. So we were confident that we will continue to have good strong generation of origination of loans on the commercial and auto but none of the same levels of 2022.
Timur Braziler: Okay, and your competitor reported yesterday, their auto balance, actually I think shrunk a little bit. I’m just wondering, is there kind of a changing of the guard in the auto market on the island? Or I guess what are you seeing from a competitive standpoint in that asset class?
Jose Fernandez: I can’t speak for our competitors. But I can tell you that is a very competitive market. And I do not see any change of guard happening in the near term. We see very strong competition and certainly the largest competitor is a formidable competitor.
Timur Braziler: Got it. And then as you think about funding that loan growth, is the expectation that we should continue to see the bond book being used as a source of funds for both loan growth and then I guess maybe looking at the deposit base, I would love to hear your thoughts on what you think deposit balances do if we’re in a higher for longer type Fed environment?
Jose Fernandez: I could not hear well, the first part of your question. But the second part of your question in terms of deposit balances, first I think we will see a transition of some of those deposits either to wealth management, which we have seen so far. I think for 2022, the full year deposits transferred to our wealth management unit was around 100 million bucks. So that’s one thing that we’re seeing already clients with high deposit balances, putting money in the investment treasuries or whatnot. That’s one shift that we saw. I think we also seeing a shift from savings to CDs to longer term CDs to 12, 18, 24 months So we will continue to see that. And as I mentioned, I think someone asked me earlier about the deposits.
I think commercial deposits, large balance commercial deposits were also — look at different ways to optimize their returns. So that’s kind of what I see in terms of balances. I think internally, we’ll have a little shift there. And we will then have to retain our customers and deal with them on a customer relationship perspective as we look into higher cost of deposits.
Timur Braziler: Got it. And then the first part of my question tying this all together, should we expect the bond book to continue funding the loan growth meaning assets stay flat even though loans grow the 3% to 4%? Or are you envisioning an environment where you actually grow the asset base over and above that $10 billion in ’23.
Jose Fernandez: So we’re not seeing the bond investment portfolio to grow from these levels. We see our deposit balances optimized with investment in our loan origination efforts. So at this point I think we were very patient throughout the last part of the 0% interest rate environment and kind of kept everything except the liquidity in cash. And we’ve been very opportunistic in the last 12 to 15 months slowly but surely investing in higher yields. We’re very comfortable with the current position and we have some repayments that will probably be invest as they come in, but we are not expecting to grow the investment book.
Timur Braziler: Okay. And then last for me on credit quality. Net charge offs are in the mid 60 basis point range for the second consecutive quarter. And you guys are one of the few banks that actually release reserves in the fourth quarter. Maybe just some color on where you see net charge offs normalizing, how close are we to that point and then how should we be thinking about the allowance ratio going forward?
Jose Fernandez: Net charges offs for us are driven by the consumer book and the auto book and we saw the fourth quarter starting to show more normal rate post-pandemic significantly below pre-pandemic but still more of a more realistic way going forward. So depending on loan growth and depending on the macro scenarios, our provision should be driven mostly by replenishing the charge offs from the consumer and the auto book and it’s a good guiding post to utilize the charges of the fourth quarter going forward and we’ll be updating given the different kind of variables of CECL throughout the year.
Timur Braziler: Great, thanks for the caller and nice quarter.
Jose Fernandez: You welcome.
Operator: We’ll take our next question from Kelly Motta with KBW.
Kelly Motta: Hi, Jose, Maritza, good morning.
Jose Fernandez: Good morning, Kelly.
Kelly Motta: I noticed you guys ended up exiting the year at under 10 billion in assets again. Can you remind us what that implies in terms of the implementation of Durbin the timing of that, and also what sort of impact of fees that will have once it does go into effect.
Jose Fernandez: Yes. So, again, we did not cross the 10 billion by the end of the year. So Durbin, the effect of Durbin does not apply for 2023, as you pointed out, and the annual cost for us estimated for Durbin is $10 million. So we are and it usually start six months after crossing the 10 billion on December 31. So for this year, it would have been around $5 million, but yearly will be 10 million.
Kelly Motta: Great, that’s super helpful. And I know we’ve talked at length about the kinds of deposits and also is going down as customers use their funds and search for higher rate. But wondering if there was any kind of decline around year end to if Durbin was a factor at all, in some of that decline, we should perhaps anticipate coming back as you look into 1Q and build into sort of the size of the balance sheet with that?
Jose Fernandez: Yes, so that’s a good point. That was more the case at the end of 2021. 2022 we started the fourth quarter at a lower asset level than 2021. So it was more natural end of the year, clients utilizing, mostly commercial clients utilizing their funds at the end of the year, and we did not have to press at all to be below $10 billion. So it’s part of the natural attrition that we’re seeing from higher interest rates and clients reallocating their cash to higher yielding investments.
Kelly Motta: Got it. That’s really helpful. And I think and please correct me if I’m wrong, but I think you had mentioned that client accounts are still like that overall balance of each account on average running higher than where they were pre-COVID. Do you have any sense of obviously, there has been a search and run off for rates, but has most of that occurred so far, in the taste of that pressure on the overall level of deposit should start to wane a bit? Or is there any way we can kind of ballpark the deposits that could still I would say, at risk of running off, but more likely to run off?
Jose Fernandez: Kelly, I am sorry, but I could not understand your question. Can you repeat it again?
Kelly Motta: I’m sorry. I just, I think in your presentation, please correct me if I’m wrong, but client account balances are still generally higher than where they had been pre-COVID. Obviously, as rates have risen, there’s been pressure on excess deposits as they look for higher rate. Just wondering, in terms of maybe core checking accounts, if you have a sense of whether or not the bulk of the pressure for search for yield and higher rate heads has occurred? Or if there’s any way to ballpark how much could still be at risk of potentially being accessed yield?
Jose Fernandez: Understood, understood. So the way we look at this is after or during the pandemic, we build up around a billion dollars of additional customer deposits. And that’s kind of how the balance sheet was impacted. So far, I think we’re at the early stages. I cannot say here in the market in Puerto Rico that we’ve had the same kind of behavior as I’ve seen in our peers in the state. So the premise of the Puerto Rico markets having a slower beta it’s playing out and I think it will continue to play out. But having said that, I think commercial accounts and I think also the move towards CDs from savings is going to still play out at least the first half of this year as the Fed and its rate cycle hikes or as everyone expects. Still a hope I think.
Kelly Motta: Got it. That’s helpful. Appreciate the color, all the color there. Next turning to capital. It was nice to see the dividend announcement. Just wondering on kind of how you guys are viewing the buyback? And what’s keeping you out of the market and what would be the circumstances that would get you back in buying your again.
Jose Fernandez: So I think throughout the last couple of years you have seen us move more towards increasing our dividend than doing the buyback. We feel that a longer term investors are better served by us increasing the dividend and having a higher payout from a dividend perspective and certainly a higher yield. So that’s one reason. The other reason is also that we want to be opportunistic and be cognizant of the environment we operate in, or the macros are somewhat uncertain, and interest rates are going up. And we want to make sure that we don’t deploy our cash into buybacks too soon. And just being prudent Kelly. Having said that, if there’s an opportunity for us to go in and buy back shares, we have the authorization and we will execute accordingly.
Kelly Motta: Got it. Understood. Thinking through your expenses, I appreciate the range you gave. I think it was, I still look back at my notes, maybe 90 to 93. What sort of builds of that incorporate in terms of, I know there’s some technology initiatives that you’re working on. And how confident do you feel that I know you’ve raised the minimum wage. How confident do you feel like inflationary pressures are hereby captured?
Jose Fernandez: A couple of factors here that I want you to consider and that are, I think, different than in the U.S. market. Number one, the Puerto Rico market comes from a significantly lower rate per hour in terms of the employee compensation on the hourly versus the U.S. So as you’ve seen from us, we’ve been gradually increasing the hourly rate for hourly employees simply because we need to make sure that we serve our customers well and that we reduce the attrition or the turnover that we were seeing. I think that goes across the entire market in Puerto Rico. So the level of hourly pay in Puerto Rico starts in this cycle at a significantly lower level than in the U.S. and it’s catching up. So that’s one component of why you’re seeing higher non-interest expenses on the compensation side.
Number two, we’ve also realized that we need to recruit a talent that has skills that we need to compete and we need to help us continue our transformation and our investments in our digital first division. So we need people with analytical skills. We need more talent with technology background so that we can leverage the technology and the investments that we’re making. So that is another component of a increases in non-interest expenses. And lastly, for making investments in technology, we’ve been doing this. And if you look back for the last five years, we are being very methodical on how we look at the branch network, how do we look at transactionality in those branch networks and how do we leverage technology to provide self service digital solutions for our customers and we certainly come in Puerto Rico market that is significantly behind the curve as opposed to the U.S. market.
So that’s kind of the reason why you’ve seen us making these investments and making sure that we’re thoughtful about them, vis-Ã -vis our strategy and that’s the rationale behind us making these investments. Having said that, we’re very cognizant about mid range 50s efficiency ratio and we would like to leverage the higher interest rates and the higher better economy in Puerto Rico to maintain a positive operating leverage as we’ve had for the last several years.
Kelly Motta: Thank you. Thank you so much for all the color there. I’ll step back.
Jose Fernandez: Thank you, Kelly. I hope that was helpful.
Operator: We’ll take our next question from Alex Twerdahl with Piper Sandler.
Alex Twerdahl: Hi guys. I just have a follow up. I know you guys mentioned the technology investments and efforts you have in 2023. Just wondering if you could reveal like what direction like other technology efforts it is and specifically what the whether there the technology initiatives and investments you’re making for the year are?
Jose Fernandez: So we’re making investments as we’ve mentioned in interactive teller machines. We’re making investments in digital solutions and upgrading our digital platforms for customers. We should be launching some of those in 2023. We’ve been looking at process improvement and how do we leverage technology to simplify processes. So we should see also efficiencies there. We look at underwriting and we’re looking at how do we become more efficient in terms of our consumer underwriting processes. So all those things are being looked at and investing in for the last couple of years. And we continue to look at them. And again, we feel that all this is done for two main reasons. One is to deepen the relationships with our customers.
And also to — by improving the customer experience and number two, by also growing our market share in the products or services that we offer. And that is something that how we measure ourselves. Right. So, so far, we are very optimistic and encouraged with the progress we’ve made and I look forward to 2023 that continues to confirm that progress.
Alex Twerdahl: Got it. Thank you.
Jose Fernandez: You’re welcome.
Operator: At this time, there are no further questions. I will now turn the call back over to Jose Fernandez for closing remarks.
Jose Fernandez: Thank you operator. And thanks again to all our team members for their hard work and dedication. We’re extremely proud of what we have accomplished. We have more to deliver. Thanks to all our stakeholders who have listening today. Looking forward to our next call.
Operator: That concludes today’s teleconference. Thank you for your participation. You may now disconnect.