Premier Financial Corp (OHIO) (PFC) 2003 Q3 法說會逐字稿

Good morning. My name is Trimica, and I will be your conference facilitator today. At this time I would like to welcome everyone to the First Defiance third quarter 2003 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press star, then the number two on your telephone keypad. As a reminder, today's conference is being recorded. I would now like to turn the call over to Miss Carol Mary. You may begin.

Thank you. Good morning, and welcome to the First Defiance third quarter 2003 conference call. We thank you for joining us. This call is also being webcast and it will be available at the First Defiance website at www.FDEF.com until November 28. This morning, we will start with comments on the quarter and the company's outlook from Bill Small, Chairman, President and CEO of First Defiance, and Jack Wahl, the company's Executive Vice President and Chief Financial Officer. That will be followed by a brief question-and-answer session. Before we begin, I'd like to make a Safe Harbor Statement for the call. During this call, management may make certain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results could vary materially depending on risks and uncertainties inherent to general and local banking, insurance and mortgage conditions, competitive factors specific to markets in which the company and its subsidiaries operate, future interest rate levels, legislative and regulatory decisions or capital market conditions. For more details, please refer to the company's SEC filings. I will turn the call over to Mr. Small for his comments.

Thank you, Carol. Good morning everybody. Thank you for joining us today. Hopefully, you've had an opportunity to review the news release we published last evening announcing our third quarter results for First Defiance Financial Corp. In that release we reported net income of $3.7 million or 58 cents per diluted share for the third quarter of 2003. These results represent solid increases over the prior year across our business lines, and we are pleased with the progress.

Throughout 2003, our results have been positively impacted by the historic high levels of mortgage originations as have the results of many other community banks and thrifts. For the just-ended third quarter, gains on sale of mortgage loans totaled $2.3 million, and year-to-date in 2003 the total was $6.6 million. We have, however, started to see a decline in mortgage originations with the recent rise in long-term interest rates, and we anticipate that our gains on sale will parallel that gradual downward trend. We noted in last evening’s news release we expect gains to fall below $750,000 in the fourth quarter of 2003. However, we expect that decline will be partially offset by continued loan growth and margin improvement. All though we have benefited from the gains on sale of mortgage loans, our entire organization has remained focused on improving the fundamentals and growing our business. The growth in our commercial and nonresidential real estate loan portfolios, which increased in the third quarter by 4.6% and 4.5% respectively from the levels at the end of the second quarter, is especially important to our overall growth strategy.

As we have noted in the past, we have selectively added seasoned loan officers as we have expanded our branch network. We have been able to attract and maintain an experienced and knowledgeable lending group who, in most cases, are considered to be among the top lenders in their market areas. Many of these lenders brought books of business with them when they joined us, but they also continue to grow those books through active calling programs and by being involved in their communities. The growth in our commercial loan and nonresidential loan portfolios as well as the continued strong credit quality of those portfolios are the result of these efforts and will be keys to our future profitability. I should note that we were particularly pleased that we have been able to maintain credit quality through this period when loan growth has reached these new levels. That charge-off total for the third quarter was only $26,000, and year-to-date net charge-offs have been just $104,000, or two basis points of average loans on an annualized basis. Also note this quarter is the improvement in net interest margin, which grew to 3.46% for the third quarter, from 3.36% for the second quarter, or 10 basis points from the sequential quarter. This is contrary to the national trend that continues to show margin compression.

Net interest income, driven primarily by the loan growth I just mentioned, as well as increased interest earning assets, increases in non-interest bearing deposits and an improvement in the interest rate spread, increased $1.6 million to $7.8 million for the third quarter. With continued improvement in our operations and if we continue to see rising interest rates, our margin should continue to improve. Also in the third quarter, our results were positively impacted by 10 cents per share after tax, related to recovery of reserves for mortgage servicing rights. Jack Wahl, our CFO, will give you further details on that in a few minutes. Excluding that recovery, earnings for the quarter were still 48 cents per share, our best results since we sold The Leader Mortgage Company in the second quarter of last year. In summary, we had a very strong quarter with fundamentals in our core banking business continuing to improve, and the mortgage loan business remaining heavy for another quarter. At this point, I would like to ask Jack Wahl, our Executive Vice President and Chief Financial Officer to provide more detail on the quarterly results. Jack?

Thank you, Bill. Good morning, everyone. As Bill mentioned in his remarks, our results this quarter were favorably impacted by a recovery of $987,000 of previously recorded mortgage servicing rights and impairment reserves. Over the last several years, through June 30 of this year, we have been required to record reserves from impairment totaling $1.9 million as declining interest rates cause the estimated fair values of MSRs to fall below their recorded values. Increases in market interest rates since June 30 resulted in a recovery in the estimated fair value of servicing, allowing us to recover a portion of those previously recorded reserves. At September 30, our servicing was valued at approximately .73% of the unpaid principal balance of loans serviced for others, or 73 basis points. That servicing was valued at just 48 basis points on June 30 of this year. To give you an indication of just how volatile those market values are, at the end of August we valued our servicing at 90.5 basis points and felt we had potential impairment recovery in excess of $1.3 million. However, market interest rates dropped back down some in September and our servicing value fell by 17.5 basis points in just that one month's time.

Through the first six months of this year, we recorded pre-tax impairment charges of $606,000. Taking those charges into account, year-to-date, the net impairment recovery is $381,000. The $248,000 after tax, which equates to 4 cents per share. We have remaining reserves for impairment of approximately $900,000, which are potentially available for recovery, should interest rates move up from the levels they're at today. Even without the impairment recovery, we still had our best quarter of the year, due both to continued strong mortgage loan sales and improving net interest margins. The mortgage gains of $2.3 million for the quarter resulted from strong origination months in June, July, and August. We originated over $41 million in mortgage loans in both June and July, and nearly $30 million in the month of August. That level dropped to just $16.4 million in the month of September, as higher interest rates dried up the refinance market. We are budgeting approximately $14 million of originations per month for 2004. If those originations fall to more normal levels, obviously, our gains will as well. We expect the gains in the fourth quarter of this year will be slightly less than $750,000, and we're forecasting gains in the range of $200,000, to $250,000 per month for 2004. As we noted in the release, our net interest margin improved ten basis points between the second quarter and third quarter of 2003 from 3.36% to 3.46%. That improvement resulted primarily from a 39 basis point drop in the average cost of all of our interest-bearing liabilities between the two periods, while the yields on our interest earning assets declined by just 19 basis points during those same periods. Our average interest-bearing deposits increased to $691 million for the third quarter, compared to $603 million for the second quarter of 2003, because we had a full quarter with the deposits acquired on June 6 from RFC Banking Company.

The cost of those deposits dropped from 2.27% to 1.91%. Also, the average balance of non-interest-bearing deposits, which are primarily commercial checking accounts, increased by $5.5 million between the two quarters. On the asset side, average loans increased from $634 million in the second quarter to $713 million in the third quarter, and the yields on those loans fell from 6.35% to 6.11%. As our loans continue to grow and the mix of our balance sheet changes, we expect our margin will continue to move up. We also believe we are positioned to benefit from future increases in interest rates. We continue to be encouraged by the increase in our non-interest income, which, excluding gains from the sale of mortgages and securities, increased by $509,000, or nearly 16% quarter-over-quarter. Keys there are continued growth in our service fees, which are up 24%, growth and commission income from insurance and investment product sales, which are up 14%, and income from bank owned life insurance, which we invested in during the fourth quarter of last year. Year-to-date, our non-interest income, excluding mortgages and securities gains, is up nearly $1.3 million, or 21%.

On the expense side for the quarter, if you exclude mortgage servicing, amortization and impairment recovery, expenses increased by $1.1 million, or 17%. For the quarter, compensation and benefits increased by $651,000, while occupancy, data processing, and other expenses were also up. The increase in level of expenses is due both to the addition of the three new banking offices as well as staffing increases, increases in other expenses incurred to support the company's recent and future growth initiatives. Our efficiency ratio fell to 51.8% for the 2003 third quarter, but before anyone uses that as a benchmark, they need to remember that impairment recovery shows up as a negative expense in this quarter's results. Excluding net impairment recovery, our efficiency ratio was at 59.3%. As we grow, we'll continue to focus on ways to improve our efficiency. However, with our community bank focus, and our planned [Inaudible] expansion in the coming months, we will feel upward pressure on that ratio. That concludes my comments this morning. I would like to turn the call back over to Bill Small for his outlook on our future strategy

Thanks, Jack. I would like to take a few minutes now before we get to your questions to discuss our strategies. Last year at this time, we were occupied with finding ways to redeploy proceeds from the sale of The Leader Mortgage Company in a very challenging interest rate environment. We are now seeing the good results of those efforts to restructure our balance sheet. The three banking offices we acquired from RFC Banking Company in the second quarter are fully integrated and contributing to earnings and we have two additional branches under construction. Our third office in Findlay, Ohio which is set to open before year-end and our first full service branch in Maumee, a suburb of Toledo, Ohio, which is scheduled to open in the first quarter 2004. This measured expansion is indicative of our commitment to community banking and the growth potential we continue to see in our immediate and adjacent markets. Our industry is transitioning from the mortgage loan gains it has realized over the past year or so into a more normalized banking environment. I believe we've positioned First Defiance and First Federal Bank to replace the income that has come from gains on selling the mortgage loans we've originated. Our conservative underwriting standards are designed to maintain good credit quality, and our community focus positions us to grow our business, while helping the businesses in our markets to grow theirs. We thank you for joining us this morning and your interest and attention, and we now would be happy to take your questions.

At this time, I would like to remind everyone, in order to ask a question, simply press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Margin Ty (ph) with FTN Midwest Research.

Good morning guys.

Good morning.

First of all, Jack, you mentioned about the loan originations for the next year. It's about $40 million per month. Is that just the mortgage loan or --

That's just the mortgage loan originations. Of that, about 90% of those are sold into the secondary market.

Okay. And so what about the -- on the whole, the mortgage banking income for the next year, the outlook of that? I know the gains on the sales of loans will be reduced, but to what extent will that impact the total earnings of the company?

Those gains will drop to about -- between $200,000 and $250,000 per month, or $600,000 to $750,000 per quarter. We will continue to have increasing level of servicing fees as the servicing portfolio increases. Overall, the profitability for mortgage banking will be significantly lower in 2004, but we think it will be replaced with margin, with increased net interest income from loan growth and margin improvement

And I guess my next question is the margins. For this quarter it is ten basis points increase. What about your sense of going forward into '04?

Expectation for margin for '04?

Yeah, that's right.

I think it will gradually improve from 3.46, but not by a lot. I'm not sure we'll have a ten basis point improvement each quarter. I think it's probably going to -- we'll probably start up the year in the 350 range and probably end the year in something -- you know, 360 to 370. Again, that depends -- that's assuming no movement in interest rates.

Okay.

If interest rates move up, which we expect maybe they will by the end of next year, we'll have slightly better improvement.

Okay. And the loan reserve, you have almost $500,000 for this quarter. That's a bit higher than the previous quarters. I just wonder if that will be the number we should use going forward?

Well, we evaluate that considering our loan delinquencies, our classified loans, our nonperforming assets, also taking into account the growth in the portfolio. Even though our charge-offs have been low, the increase in the provision is consistent with the directional increase in the balances themselves. Kind of a good rule of thumb is, we use about -- we reserve about 1-1.25% of commercial loan growth.

Okay.

That's consistent with our -- what analysis shows when we do specific reserve analysis.

So for the future quarters, are you guys going to pack that ratio to, like, maybe 1.25%? That will be the same scale of loan loss reserves?

Rule of thumb, as loans -- as the loan balances grow, we'll continue to reserve if the accounting rules allow us to continue to reserve because there are some proposed changes in that area. But we will continue to try to reserve appropriately and conservatively based on our expected losses in the portfolio. Like I said, just a rule of thumb to use in projecting would be somewhere in the 1 to 125 basis point range of our new loan growth.

And the next question is about the loan pipelines. Can you give us a little bit of numbers in terms of the current pipelines and going forward into the first quarter or even the first half of next year?

In regards to the mortgage pipeline?

Yeah.

We're definitely starting to see the slowdown here. I don't have specific numbers as far as what's out there right now, but our originations in residential first mortgages is dropping off. We are starting to see some increase in home equity applications coming in to fill some of that void.

Right.

As Jack mentioned, we're looking at production in 2004 probably averaging about $14 million, and in residential mortgage production, compared to this year where we had, you know, several months where we were north of 30 million. As far as the commercial pipeline, the commercial loan volume continues to be very strong, both in -- as a result of moving into some newer markets and with some of the lenders that we've been able to bring on board, bringing some of their business with them, and we're anticipating that that will remain strong throughout 2004. We're in the middle of our budgeting process right now, but in our planning stage and everything, we're anticipating continued strong growth in our commercial and nonresidential real estate lending

All right. I guess that's all my questions. Thank you very much.

Thank you.

Your next question comes from Chris Marinek (ph) from SIG Partners

This is actually David for Chris. Just wondering if you guys could give us color on the competition that you're seeing from big banks on deposits as well as loan pricing?

We are seeing probably as much competition from smaller banks on pricing issues up this way, although we certainly do feel pressure every once in a while in a couple of our markets in particular. There's the Findlay market and Bowling Green market and Defiance right here where we're located right now. We have a couple of the larger banks that are fairly competitive. We're trying to not get caught up in pricing wars. We really try to sell ourselves on our service and build everything on relationship banking, and we've been relatively successful at doing that. You know, we just -- that's the way we've been able to show some improvement in our margin, I think, when nationally that's not happening. But we're seeing some pricing pressure, probably more on the loan side than on the deposit side at this point. However, I think that as the stock market continues to improve and more funds start returning into those types of investments, deposit competition could start to get stronger. Does that answer your question adequately, David?

Yes, thanks.

Once again, if you do have a question, simply press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your next question comes from Ross Haberman from Haberman Brothers.

How are you, gentleman? Could you sort of segregate I guess your markets and tell us sort of where you are seeing real strength in terms of loan demand, putting aside the one to fours I guess for the moment. Are there any sort of weak pockets you might say?

For those of you who are not real familiar, our footprint is, basically, the nine counties in extreme northwest Ohio, bordering Indiana and Michigan. We've had probably our strongest growth -- again, talking about nonresidential loans -- has been in our newer markets, primarily Findlay, Toledo and Bowling Green. Those have been very, very strong growth markets for us in those respects. What we consider our traditional markets --

Put it on hold.

I'm sorry?

Okay. Thank you.

The more traditional markets where we've established a longer period of time, we are certainly starting to make more inroads there as people start to recognize us as a community bank rather than the old traditional thrift that we kind of cut our teeth on. As far as from a weakness stand point, I really don't think there's any particular area that we would identify as being weak. We certainly have some that are -- that we consider stronger than others. But from an economy standpoint, we've got good diversification up here. You know, we're strong agriculture area. The farmers seem to be having a good year this year. The industry that we have here is pretty diversified. Everything from a large GM foundry, in fact having the world largest GM foundry right here in Defiance, to Marathon Oil and Cooper Tire in Findlay, an university economy in Bowling Green and its nicely diversified.

Okay. Thank you, guys.

Thanks, Ross.

At this time, there are no further questions. I will now turn the call over to Carol Mary for any comments or closing remarks.

Thank you for joining us today. At this time, if there are no further questions, we will encourage you to contact us at any time with questions and we'll conclude the call. Thank you.

Thank you for participating in today's conference. You may now disconnect.