Premier Financial Corp (OHIO) (PFC) 2005 Q1 法說會逐字稿

Good morning.

My name is Bonnie and I will be your conference facilitator.

At this time, I would like welcome everyone to the First Defiance first quarter 2005 earnings conference call. (Caller Instructions)

As a reminder, this conference is being recorded today, Tuesday, April 19, 2005.

Thank you.

Ms. Merry, you may begin your conference.

Thank you.

Good morning, every, thank you for joining us for the First Defiance first quarter 2005 earnings conference call.

This call is also being webcast and it will be available at the First Defiance website at www.fdef.com until May 31st.

This morning we’ll begin with comments on the results and the Company’s outlook from Bill Small, Chairman, President and CEO of First Defiance, followed by a report on the financial performance by Jack Wahl, the Company’s EVP and CFO.

But before we begin, I’ll make a Safe Harbor statement for the call.

During this call, management may make certain statements that forward-looking as defined in the Private Securities Litigation Reform Act of 1995.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties.

Actual results could vary materially because of factors discussed in yesterday’s news release, the “Management Discussion and Analysis” section of the Company’s Form 10-K, or other reports and filings with the SEC.

First Defiance Financial Corp. does not undertake any duty to update any forward-looking statements.

Now I’ll turn the call over to Mr. Small for his comments.

Thank you, Carol, and good morning everyone and thank you for joining us for the First Defiance Financial Corp.

Q1 2005 conference call.

Last evening, we released our earnings for the 2005 first quarter and this morning we’d like to discuss our performance in the quarter and what our focus will be in the second quarter and for the balance of the year.

As we typically do, I will review the activity for the quarter.

Then I will turn it over to Jack Wahl, our CFO, to give you a more detailed look at the financial results for the quarter.

2005 is off to a fine start for us here at First Defiance.

Momentum in our core banking operation continues and our fundamentals remain strong.

As we continued to execute our Community Banking business plan in the first quarter, our loan growth was strong and credit quality solid.

We also experienced good deposit growth, especially in demand deposit accounts where we have put our focus.

In addition, our fee income has also increased during the quarter.

As pleased as we were with these core operating performances, it is even more impressive when coupled with the fact that we successfully completed the closing of the ComBank acquisition and the conversion of the four banking offices acquired and prepared for closing and conversion of the Genoa Savings acquisition, which took place on April 8th.

First, let me talk about the core operation.

As you saw in the release, GAAP net income for the first quarter of 2005 was $2.9 million or $0.41 per diluted share, compared to $2.5 million or $0.39 per diluted share at March 31, 2004.

However, the core operating earnings for the first quarter on a dollar basis were up 38%, compared to the same quarter last year, and on a per share basis at $0.50 per diluted share we were up over 28% over a larger share base.

This earnings improvement was primarily fueled by growth of net interest income.

A 25 BP improvement in our net income margin, compared to first quarter last year, was the result of improved asset mix and our ability to grow low cost checking deposits.

As I noted earlier, we continued to produce strong loan growth throughout the first quarter of this year.

While the acquisition contributed to some of the increase, we were able to organically grow the average balances of loans by about $200 million.

On the other side of the margin equation, we were able to grow the average balance of non-interest-bearing accounts by over 40%, with about half of that coming from the acquisition.

Non-interest income for the first quarter jumped considerably.

Part of the growth was the result of non-recurring items such as gains on sale of securities and property sales gains.

However, excluding these items, non-interest income was up almost 9.0% over the first quarter of last year.

This was led by service fee income and insurance commission income, including substantial increases in contingent commission income, which was the result of the good claims experience on our insurance agency’s book of business.

Non-interest expense increased significantly during the quarter and a large part of the increase was due to the ComBank acquisition.

However, on a core operating basis, the efficiency ratio for the first quarter of this year was 64.78%, slightly lower than last year’s first quarter result.

Our credit quality ratios, always an area of focus for us here, continued to be very favorable during the first quarter of 2005.

Charge-offs were 4 BP analyzed for the quarter.

This compares to 3.0 BP in the first quarter of 2004.

The non-performing loan balance did increase from $1.9 million at December 31, 2004 to $3.1 million as of March 31st.

This increase is a result of loans acquired in the acquisition.

We had a third party loan review completed after the acquisition and it found that many of these classified loans are the result of documentation deficiencies rather than absolute credit weaknesses, reaffirming our findings from due diligence.

Our credit administration staff has been working hard at addressing these issues and we are confident that all non-performing loans are accounted for in the loan loss reserves.

The acquisition of ComBank and its banking subsidiary Commercial Bank of Delphos was completed on January 21, 2005.

This acquisition, which we announced in the third quarter of 2004, added four more offices, all located in Allen County, Ohio, immediately south of our existing market footprint.

The hard work and preparation of the conversion team paid off, as we had a very successful conversion.

All systems and processes were converted the weekend of the transaction and all offices are now running full throttle.

Since the conversion in late January, we have grown deposit balances in this four office by a combined total of almost $5.0 million and almost 60% of that growth was checking accounts.

We expect our business strategy to continue to do extremely well in that market area and anticipate significant growth potential on both the deposit and loan sides.

Our second acquisition since our last conference call - Genoa Savings & Loan - was not completed during the first quarter of 2005, but a significant amount of the work and preparation leading up the April 8th closing took place during the quarter.

In light of the significant amount of time and resources devoted to these acquisitions, it makes the first quarter operational performance even more impressive.

We’re not large enough to have a separate acquisition and conversion team here at First Defiance, so this work is done by dedicated staff in addition to their regular duties and responsibilities.

And I want to take this opportunity to congratulate and again express my appreciation to the many employees that worked so hard to make these conversions successful.

As I said at the opening, it was an extremely busy quarter for us here at First Defiance.

In addition to the strength operational performance and acquisition work, we successfully completed our Sarbanes-Oxley Section 404 Internal Controls Audit on time and were able to complete all regulatory filings on schedule.

None of this would have been possible without the outstanding efforts of a lot of dedicated employees.

At this time, I would like to call on Jack Wahl, our CFO, and one person that I know is relieved that this quarter is behind us from a workload standpoint, to give you some insight into the numbers for the quarter.

Jack?

Thanks, Bill, good morning everyone.

As Bill mentioned, our GAAP-based earnings for the quarter were $2,871,000 or $0.41 per share, compared to $2,493,000 or $0.39 per share in last year’s first quarter.

This year’s results include acquisition-related costs of $884,000 or $575,000 after tax, which for us represents $0.09 per share.

Thus our core operating results for the 2005 first quarter were $0.50 per share, a 28% year-over-year improvement.

A key driver in the increase in our core operating earnings for the quarter was the improvement in net income margin that Bill referred to.

In dollar terms, our net interest income increased from $8.0 million in last year’s first quarter to $10.4 million this year, a 30% improvement in our single largest revenue component.

Our margin improved by 25 BP from the first quarter of last year and more impressively improved by 15 BP from 3.67% to 3.82%, between the 2004 fourth quarter and the 2005 first quarter.

We had originally expected that our margin for the quarter would be in line with last year’s fourth quarter level.

However, a couple of factors led to improved results.

First, our asset mix is better than we originally anticipated.

Our loan balances are about $12.5 million higher than we expected, on average, while our investment securities balances are $19.5 million lower than we expected.

And within our loan balances, the balance of commercial loans, which have our highest overall average yield, are a higher-than-expected percentage of the total.

Second, our overall funding costs have not risen at the same rate as our asset yields.

We have remained disciplined in the pricing of our deposits.

Since last quarter, as market rates have generally risen, the overall cost of our deposits actually dropped 3.0 BP.

We also used some the liquidity we picked up in the ComBank acquisition to reduce the average balance of our outstanding Federal Home Loan Bank (FLHB) advances by $15.5 million.

Third, non-interest bearing deposits have become a more significant funding source for us, growing another $13 million on average since last year’s fourth quarter.

Those balances increased by approximately $12 million as a result of the ComBank acquisition.

Historically, our non-interest bearing deposit balances dropped between the fourth quarter and the first quarter, so the increase in those balances, excluding the acquisition, was a welcome change in that trend.

Factoring in non-interest bearing deposits, our total average cost of funds was just 2.15% for the 2005 first quarter, the same as last year’s first quarter, despite Fed funds increases that have totaled 175 BP during that period.

The overall cost of funds, including the impact of non-interest bearing deposits, dropped 7.0 BP between the fourth quarter of last year and the first quarter of this year.

We also are pleased with the continued growth in our non-interest income.

Our services fees, which include loan fees, service charges on deposit accounts, NSF fees, and mortgage loan servicing income increased by more than 20% over last year and our commission income from insurance and investment sales increased by 14%.

On the expense side, excluding acquisition-related changes, our non-interest expense increased by $1.8 million or almost 25%.

Compensation and benefits accounts for $1.2 million of the $1.8 million increase.

And as a result of the acquisition, the addition of product specialists in the commercial loan, cash management and investment areas since last year’s first quarter and additional support personnel in the loan processing, deposit servicing and accounting areas.

We also have had a higher-than-expected percentage of our employees joined our healthcare plan, which has pushed those costs up compared to last year.

In analyzing our results, there are a number of items this quarter that while part of operations are not necessarily recurring items.

The recent increase in longer-term interest rates resulted in an increase in the value of our mortgage servicing rights (MSR) portfolio.

As a result, in the 2005 first quarter, we recaptured $221,000 of previously recognized MSR impairment reserves.

By comparison, last year in the first quarter we recognized impairment expense of $237,000.

We also realized a gain of approximately $115,000 from the sale this quarter of our existing branch property on North Clinton Street in Defiance.

That branch is being relocated, effective next Monday, to a larger, more convenient location.

In our insurance brokerage business, we typically receive contingent payments from insurance carriers during the first quarter.

Those payments are based on prior year results and are driven by a number of factors, primarily loss experience and commission volumes.

We had our best results ever in that regard this year, realizing a total of nearly $356,000 compared to $155,000 last year.

We also periodically take advantage of interest rate movements to lock in gains in our investment portfolio and we did that this past quarter to the tune of $621,000.

The guidance we provided last quarter indicated that we felt the core operating earnings for the year would be between $2.05 and $2.15 per share.

While our net interest income for the first quarter was better than we anticipated, we think that our margin will begin to be squeezed as deposit rates are starting to increase.

Also, our non-interest expenses are running slightly higher than previously expected.

Thus, while gains from securities and property sales and MSR impairment recovery increased earnings by $0.09 per share in the first quarter of 2005, we are raising our expectations for core operating earnings for the full year by just $0.05 per share to a range of $2.10 to $2.20 per share.

We expect the core operating earnings in the second quarter will be between $0.48 and $0.53 per share.

GAAP earnings for the second quarter will include acquisition-related charges attributed to the Genoa Savings acquisition, which we completed on April 8th.

For the Genoa acquisition, those costs will be approximately $2.3 million before tax, or approximately $1.5 million or $0.21 per share after tax.

Onetime costs for the Genoa acquisition include significant charges related to the termination of their data processing contracts.

I’d now like to turn the call back over to Bill for a brief strategic overview.

Bill?

Thanks Jack.

As we progress on into the second quarter and look forward to the rest of the year, we’re continuing to work on the integration of our two recent acquisitions and now want to capitalize on the increased business opportunities that exist in these new markets.

The strong margin improvement that we saw in the first quarter was the result, in large part, to our focus in growing low cost core deposits.

This is important for us to continue, as it’s the most economical source for funding our strong loan demand.

Also, we anticipate that we will be able to continue to find ways of improving efficiencies, as we more fully integrate the new offices and their operations.

Overall, our market area of Northwest and West Central Ohio remains economically stable.

While the Midwest, particularly Ohio, has not been growing as fast as other parts of the country, the business customers targeted by our bank have remained study and are optimistic about the future.

Community banks have a lot to offer these types of businesses, which are generally locally owned and looking for a good local banking partner.

We are proud of our growth over the past three years and also proud of the way we’ve grown.

As we have selectively chosen markets for growth, we have carefully maintained our customer first philosophy for all of our banking clients, including individuals, businesses, and agricultural customers.

We employ good, experienced banking personnel who contribute to the growth and add value to this Company.

We are very confident of the prospects for growth in our new and existing markets and we continue to look at opportunities to bring our Community Banking experience to adjacent markets where there are additional opportunities.

As Jack mentioned, based on the relatively strong results of the first quarter, we now expect the 2005 core operating earnings to be in the range of $2.10 to $2.20 per diluted share.

The excitement and enthusiasm of the First Defiance staff, along with their belief in and commitment to our business strategy, makes me confident that we are on our way to a strong 2005.

I believe that our community bank business plan, along with the right team to execute that plan, gives us what it takes to produce that result.

We want to thank you for joining us this morning and now we will take your questions.

[Operator Instructions] Your first question comes from David Darst of FTN Midwest.

Good morning.

Good morning, David.

Good morning, David.

Can you comment on your asset sensitivity position following the close of the two acquisitions and then give us a percentage of variable rate loans or loans that are actually tied to prime?

Our asset sensitivity is not significantly different after the close of the first acquisition that was before.

We expect that in an environment where rates rise 100 BP over a 12-month period that our net interest income will increase in the vicinity of $200,000.

We have not really factored in the second acquisition at this point.

I don’t have any of the mark-to-market adjustments, for example.

I don’t think it’s going to have a material impact on that sensitivity.

As far as the percentage of our loans that are variable rate, we have approximately $95 million of home equity loans that are all tied to prime.

Our commercial and commercial real estate portfolio, about 50% of that total is adjustable and most of that is prime-based, although some of those prime-based loans only adjust on an annual basis.

Okay.

Thank you.

[Jerry Cronin] (ph) of [indiscernible] Asset Management.

Good morning, guys.

Hi Jerry.

Good morning, Jerry.

A couple of questions.

When you used the term “core” for the $2.10 to $2.20 number, does that include or exclude the $0.09 of gains that you--?

It includes the $0.09 of gains.

The only thing it does not include are the acquisition-related charges.

Got you, okay.

And secondly, I know the acquisition, the ComBank deal, makes the expense number difficult to analyze, so I was hoping that maybe you could give me a little clarification on just what would be a good run rate going forward.

I know the fourth quarter you had basically about $7.7 million expense base and that went up to $9.3 million this quarter.

How much of that was due to the deal?

And excluding Genoa, what would be a good base--is that a good base, I guess, to kind of run off of what was there?

Is that still somewhat elevated because of there was no deal savings?

We realized some of the deal savings because, for example, the positions that we--I take that back.

The positions we eliminated were still with us for a significant part of the quarter.

We will start to see some of the cost savings that we budgeted in the acquisition fully implemented here in the second quarter and Jerry, I’m sorry, I don’t have those numbers off the top of my head.

Okay.

I know there was a fair amount of overtime as a result of the work on the acquisition and conversion teams, too.

So I guess a lot of that does get charged to the onetime.

Okay.

But is it fair to assume that running at, I guess--stripping out the securities gains, the MSR recovery and some of the over items, I get to a core efficiency ratio of about 64.5% and that’s up fairly substantially.

So I’m just kind of wondering, going forward, are we at a new base or is that 64.5% just temporarily inflated?

Yes, I think it has temporarily inflated, but I don’t necessarily think it’s going to get back down to the level it was at in the last quarter.

Think--we had some unusual items that lowered that efficiency ratio towards the end of last year.

Okay.

Very good, thank you.

Okay, Jerry.

Thank you, Jerry.

[Julianne Cassorino] of Prospect Partners.

Hello.

Good morning.

Good morning.

Good morning, Julianne.

You said your deposit costs went down by 3.0 BP.

I was wondering why that was and if you could tell us about how competitive deposit pricing is in your market and how it’s been changing so far this year?

I think the primary reason that the cost of deposits went down is the mix of deposits changed between Certificates of Deposit (CD) and money market accounts and so, overall, the total cost went down as a result of that.

We are starting to see some very competitive deposit pricing, both on the short-term accounts such as money markets and also on CD’s.

I would say probably a month ago, at this time, Julianne, we did now see any CD’s that I can remember of in this market that were paying 4.0% for any term.

And now they’re starting to pop up all over the place, ranging anywhere from I think we’ve seen them as low as 18-month CD’s that are offering 4.0% rates.

So it’s definitely getting more competitive here, over the past 30 days and we expect that to continue.

An 18-month CD at 4.0%, what kind of bank is offering that?

Is that a credit union or is that a public bank or who is--?

We’ve got several smaller community banks in this area that have come out with what we think are some aggressive programs.

But we’re also seeing that strong competition popping up occasionally.

It looks like on a spot basis, by some of the larger competitors in our market, like Sky Bank.

So whereas we’ve always expected to see more aggressive pricing, I guess, from some of the smaller banks, it’s starting to filter on into some of the big banks.

All right.

How about on the asset side, competitive pricing on the loan side?

Loan side, there again, on a select basis, we’ve seen some banks get a little bit more aggressive on certain deals.

But overall, I think it’s become a little bit more disciplined, finally.

I think people--the market here seems to be realizing that rates are going up and there again, on select deals, we’re seeing what we think are some unbelievable rates.

But across the board I would say it’s stabilized quite a bit.

Okay.

Thanks.

Thank you.

Christopher Marinac of Fig Partners, LLC.

Hi guys, good morning.

Good morning, Chris.

Hi Chris.

Can you elaborate on other fee income build and to what extent this quarter has seasonality into it, compared to something larger happening?

Yes.

On the other fee income, I think Jack mentioned in part of his presentation, from our insurance agents, we certainly saw a big bump on their contingent commission income, which usually hits in the month of March.

So that’s a first quarter event that we always see, but this year it was, I think, up $200,000 over what it was last year.

Yes.

So they had an outstanding year, on a rating basis, over at the agency and so that certainly was a big bump.

I guess on the other side of that, though, we actually under-performed in one area in particular in our fee income and that was on NSF fees.

So evidently our customers are balancing their checkbooks better than what they have in the past.

But overall, other than--I can’t think of anything, Jack, other than the contingent commission income that was really out of line then.

Well, gain on loan sales is typically low in the first quarter, as you know, Chris, and that was no exception this year.

And in fact, more than half of our gains that we realized in the first quarter happened in the month of March, so the business has picked up in that area.

And we’re doing very well in the mortgage area in our new offices.

I think we’re going to be very aggressive in mortgage lending in the new market area, much more so than the commercial bank was and I think we’ll see the benefits of that starting here in the next quarter.

I think that, as Jack pointed out, March was strong from the mortgage area.

But I think part of that was because January and February were probably even slower than traditionally because of the bad weather we had up here and I think we ended the quarter not too far above actually our budgeted numbers.

That’s right.

So, from a quarter standpoint, it was it pretty balanced in that particular category.

Okay and then my follow-up had to do with funding.

Obviously you have the blessing and the curse of having more loan growth than you do deposit growth.

And I guess my curiosity is as your funding challenges continue in the future - if they do- does that create any issue on your margin or sort of that you have to accept a lower margin not just in the second quarter but really well beyond, bigger picture?

Yes.

There’s no question that that’s our biggest challenge, is funding our loan growth and we are seeing some successes from initiatives to grow core checking balances, not just in the new markets but throughout our network.

But the reality is we’re not able to grow those balances as fast as we can grow our loan balances, so we do have to look to the wholesale markets and to the federal home loan bank.

And we’re careful when we make those decisions, but those costs are more than what you can do locally, typically.

Really need to lock in some of those borrowings now before rates go higher or how do you want to massage that, Bill?

It’s a decision that we make at the ALCO level.

We have--we sort of use a barbell approach where we do do some longer-term funding, but we also balance that with some 3- and 6-month national market funding.

And frankly, we’ve picked up some liquidity with the ComBank acquisition so a lot of that funding went away here in the first quarter and we’ll probably not have to tap those markets until late second or early third quarter, at this point.

Okay and then retention of ComBank deposits are higher than you had originally thought, right?

Yes, very much so.

Yes.

Yes, we’ve--I think the growth, since conversion, is about $5.0 million in deposits, which we actually anticipate usually in an acquisition like that, the potential, especially in the short-term, for some runoff and we’ve been pleasantly surprised by this.

Early reports on the Genoa acquisition, too, which is only a week old, our deposits there are up $300,000 in that first week, so we’re very pleased with that as well.

Good.

Great, guys, thank you very much for the info.

Thanks, Chris.

Thank you.

At this time, there are no further questions.

All right, then.

We would like to thank everyone for joining us today and to encourage you to please call us if you have any questions.

This will conclude our conference call.

This concludes today’s conference call.

You may now disconnect. 9