Premier Financial Corp (OHIO) (PFC) 2005 Q2 法說會逐字稿

Good morning. My name is [Pishasha], and I will be your conference facilitator. At this time, I would like to welcome everyone to the First Defiance second quarter 2005 conference call. This conference call is being recorded today, July 19th, 2005. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. [OPERATOR INSTRUCTIONS] Thank you.

Ms. Merry, you may begin your conference.

Thank you. Good morning, everyone. Thank you for joining us for the First Defiance second quarter 2005 results conference call. This call is also being webcast and it will be available at the First Defiance website at www.FDEF.com until August 31st.

This morning we will 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 Executive Vice President and Chief Financial Officer.

Before we begin, I’ll make a Safe Harbor statement for the call. During this call, management may make certain statements that are 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, in the “Management Discussion and Analysis” section of the Company’s Form 10-K, or other reports and filings with the Securities and Exchange Commission. First Defiance Financial Corp. does not undertake any duty to update any forward-looking statements.

And now, I’ll turn the call over to Mr. Small for his comments.

Thank you, Carol. Good morning and thank you for joining us for the First Defiance Financial Corp. second quarter conference call.

Last night, we issued our earnings release with our 2005 second quarter results, and this morning we’d like to discuss those results with you and answer any questions that you might have.

I'll begin with an overview of the quarter, followed by Jack Wahl, our Executive Vice President and Chief Financial Officer, who will give you more financial detail on our performance during the quarter and through the first half of the year.

In our release we reported GAAP earnings of $2 million, or $0.28 per diluted share for the second quarter of 2005. Those results include the one-time charges relating to the completion of the acquisition and conversion of Genoa Savings, which took place on April 8th, 2005, as well as a small amount of additional acquisition-related cost associated with the January 21st, 2005 acquisition of ComBanc.

Factoring out the expenses related to the two transactions, income from continuing operations would have been $3.6 million, or $0.51 per diluted share for the quarter. This compares to $3.1 million, or $0.49 per diluted share in the second quarter of 2004.

The strengths of the 2005 second quarter, mirrored the primary drivers of the first quarter of this year. Strong loan growth and better deposit mix, produced an increase in net interest margin and credit quality remains good, even in light of the increased classified loans that came on the books as a result of the two acquisitions made in the first half of this year.

We did benefit from the gains on sales of securities again during the second quarter, but these security sales were driven by the desire to realign the securities portfolio for the future, in anticipation of rising rates.

The biggest drawback for the period was the increased expense was not matched by overall production increases to keep our efficiency ratio in line.

Loan growth continued at a strong pace throughout the second quarter of 2005, especially in the categories of commercial loans and commercial real estate loans. On the consumer side, home equity loans also continued strong growth. Many of the loans in each of these categories are prime-based and have benefited us with increasing yields as a result of the Fed rate increases to date.

While some of this increase in loan balance is a result of the two acquisitions, we had projected 16% organic loan growth for 2005, and we remain on pace to reach that target.

On the deposit side of the balance sheet, we continue to make progress in improving our mix, as we seek to increase the non-interest bearing commercial and retail DDAs. Non-interest bearing deposit average balances grew over $37 million, compared to the second quarter of 2004, and even though part of this is due to the acquisitions, 40% of that increase was organic.

The ability to attract non-interest bearing deposits must continue to be our focus going forward, as interest rates on other deposits continue to see upward pressure.

The change in mix on both the asset and liability sides of the balance sheet, along with the continued rate increases by the Fed, resulted in net interest margin improvement through the second quarter of this year. This, along with the improved mix, produced solid net interest income for the quarter.

The strong loan growth that we experienced in the quarter, once again, came with strong credit quality ratios. While our reported credit quality ratios at First Defiance, as of June 30th, 2005 are not as good as what we have historically reported, that is the result of non-performing loans that came on the books through the acquisitions, rather than a deterioration of our existing portfolio.

In fact, the non-accrual loans at the end of the quarter from the First Defiance originations were lower than they had been in over a year. As we have said throughout the acquisition process, we were very aware of the credit quality of the loans that we were taking on and remain confident we have fully reserved for them and have implemented procedures to address and improve those segments of our portfolio.

The increase in non-interest income in the quarter was aided by the gain on security sales transactions that I mentioned earlier, a part of our business plan for rising rate environment, and also increases in service fee income. These increases were offset somewhat by lower than projected income from our insurance and investment subsidiary, primarily due to lower investment sales revenue.

Non-interest expense was up significantly in second quarter 2005, over the same period last year. Net of the one-time charges related to the acquisitions and some MSR impairment charges, we still had significant increases, particularly in compensation, for the additional staffing for the new offices, as well as additional support staffing [are] reflected.

We need to make sure that we get the revenue production up to speed with all of our new production personnel as soon as possible to offset this expense and improve our efficiency.

I will now ask Jack Wahl to give you the financial details for the quarter and the year-to-date, before I wrap up with an overview of the second half of 2005. Jack?

Thanks, Bill, and good morning, everyone. As Bill mentioned, our earnings for the quarter were $2 million, or $0.28 per share on a GAAP basis, and $3.6 million, or $0.51 per share on a core operating basis. By comparison, last year's second quarter was $3.1 million, or $0.49 per diluted share.

Core operating earnings excludes the after-tax effect of acquisition-related costs and other one-time items. If you exclude the impact of securities gains, you also exclude the impact of securities gains, which were $515,000 in the 2005 second quarter, and $293,000 in the 2004 second quarter, and also exclude mortgage servicing rates impairment adjustments, which decreased income by $95,000 in the 2005 second quarter and increased income by $524,000 in the 2004 period.

Our earnings per share after tax would have been $0.47 in the 2005 second quarter, compared with $0.41 in the 2004 second quarter, a period over period improvement of almost 15%, but somewhat disappointing results none the less.

On the plus side of the results for the quarter, net interest income increased by 43% over last year and our margin remains strong. On the down side, our non-interest income growth was less than expected for the quarter and our non-interest expenses were higher than we budgeted them to be.

Net interest income for the second quarter of 2005, increased to $11.7 million, from just $8.1 million in the second quarter of 2004, and our net interest margin improved by 31 basis points, to 3.87% this past quarter, from 3.56% in the second quarter of last year.

In addition to growth in net interest income resulting from the acquisitions, we have benefited from an improved mix between loans and investment securities. During the 2004 second quarter, investment securities made up 16% of interest earning assets, while loans comprised 82% of the average balance.

In the 2005 second quarter, investment securities made up just 10% of the average balance of interest earning assets, while loans, which have a higher yield, comprised 87.5% of the total.

This change in mix is due to our very strong loan growth, a trend we expect to continue and our willingness to take gains in the investment portfolio when opportunities present themselves. We've essentially invested the proceeds from our securities gains in loans, rather than back in securities. I expect that we will reinvest some of those funds back in investment securities when the yield curve steepens.

Overall, the average of our--the yield on our average interest earning assets has gone up 45 basis points, from 5.61% to 6.06% between the second quarter of last year and this year, while the cost of interest bearing liabilities has increased by just 13 basis points during the same period, to 2.41% from 2.28%. As a result, interest rate spread has improved by 32 basis points, to 3.65%.

Also aiding the margin has been continued growth in our non-interest bearing checking accounts, which had an average balance of $91.9 million during the 2005 second quarter, up from just $54.8 million in the second quarter of last year.

Of that $37.1 million increase, $17.7 million was due to the ComBanc acquisition, $4.6 million was acquired as part of the Genoa Savings acquisition and almost $15 million has resulted from Company initiatives to grow these balances.

In terms of percent growth, our non-interest bearing balances grew organically by over 25% between last year's second quarter and this year's second quarter. In terms of percentage of total deposits for the second quarter of 2005, our non-interest bearing deposits comprised 8.75% of total deposits, an improvement over the same period in 2004, where non-interest bearing deposits were just 7.4% of total deposits.

Our goal over time is to increase that percentage so we are in line with our bank peer group in the 13% to 15% range.

Looking at the net interest income results for the six-month year-to-date period results in a similar picture. In total, our net interest income is up by nearly $6 million, or 36.8%, and our margin has improved to 3.85% from 3.57%.

Elsewhere in our income statement, as I noted, we recognized $515,000 of gains from investment securities during the just completed quarter, up from $293,000 in the second quarter of last year.

Part of our strategy in this area is to try to offset anticipated MSR impairment with securities gains. However, in the end, impairment ended up being much less than we initially anticipated.

Excluding securities gains, our non-interest income increased by just $56,000 between the 2004 and 2005 second quarters. Service fee income is up by $382,000. The gains from loan sales is down by $216,000 between the two periods. And insurance and investment sales commissions are down by $173,000.

Our mortgage loan production for the quarter was up over last year by more than 12%, but a higher percentage of our mortgage originations have been adjustable rate loans, which we generally keep in the portfolio.

Year-to-date we have sold only 65% of our production, instead of the 75% that we expected to sell and the margin we realize on those sales has been slightly below our target levels.

In looking at our insurance and investment commission income, our property and casualty and group health lines are both performing about where we expected, but our sale of non-insured deposit products is well behind both budget and 2004 levels. A situation that is exacerbated by the fact that we hired two new investment representatives late in 2004 and early in 2005, whose production levels haven't yet ramped up.

On the expense side, we initially projected the first year cost savings of $1.1 million and $1.3 million would be achieved in the ComBanc and Genoa Savings acquisitions, respectively. Those amounts translated to quarterly savings on a pretax basis, would amount to approximately $275,000 for ComBanc, and $300,000 for Genoa Savings in the 2005 second quarter.

Actual quarterly cost savings realized, based on ComBanc's 2004 annual expenses, were approximately $200,000, while actual Genoa Savings cost savings realized for the second quarter were in that projected range of approximately $300,000.

From the standpoint of our operating results, these savings were offset by increased cost in other places. For example, we added new commercial lenders in the [Finley] and Toledo markets earlier this year and incurred their salary and benefit cost for the full quarter, but their loan production is just now starting to hit the books.

We also have added two producers in the cash management area and two new investment representatives of first insurance and incurred the wages for those individuals in the second quarter, with very little revenue as their production ramps up.

Also, our benefit costs were about $150,000 higher than we expected, due to some large healthcare claims and in unanticipated adjustments to our deferred compensation plan. We anticipate that we'll have similar expenses in those areas in both the third and fourth quarters.

Also, the amortization of the core deposit intangibles for both acquisitions was higher than we originally anticipated, by approximately $150,000 in the 2005 second quarter.

Looking ahead to the second half of the year, we had originally budgeted net income of approximately $1.15 to $1.20 for that six-month period. Based on June's results, we think we'll be close to our targets for both net interest income and non-interest income, but that non-interest expense could be higher than originally expected for the balance of the year, by between $600,000 and $750,000, or between $0.06 and $0.08 per share after tax.

That would put our estimate of full-year earnings at somewhere between $2.08 and $2.15 per share, which implies earnings in the second half of between $1.07 and $1.14 per share.

That concludes my remarks this morning. I'll now turn the call back over to Bill for some final comments and then we'll try to answer your questions.

Thanks, Jack. I mentioned earlier the closing and conversion of Genoa Savings took place during the second quarter and was the second acquisition we completed this year. I'm very pleased to report that this acquisition went as smoothly as the commercial bank transaction in January. And this is, in a large part, due to the hard work and dedication of many of our staff members.

We now look forward to continuing the integration process with these new offices as we continue to build a bigger and stronger franchise. Based on early indications, we feel that both of these new markets have the tremendous growth potential, both for deposits and loans that we had anticipated.

Deposit growth will continue to be a focus, especially the need to increase the non-interest bearing balances. The deposit market has gotten more and more competitive over the last year and pricing pressure continues to build. Achieving our deposit mix objectives will be critical to maintaining net interest margin improvement.

As I mentioned earlier, we feel that loan growth targets are achievable. We have added additional lenders to the staff and we expect to see their production numbers start to grow as they become fully integrated.

We will put renewed focus on efficiency, going forward. We placed so much attention on the acquisitions and the integration process, that we probably diverted too much attention from the overall efficiency of the Company. We know that we must get this back in line and we're committed to doing that.

I want to thank you for joining us on this call this morning. And now, we'll be happy to take your questions.

[OPERATOR INSTRUCTIONS] Christopher Marinac, Fig Partners.

I wanted to ask you about your use of wholesale funds in the future. This quarter did not have that, which was positive. And I was curious if you think that you may have to rely on that in the future to take care of the loan pipeline?

That's a good observation that we were able to essentially fund our growth this quarter without using wholesale funds. However, we expect that on a regular basis, that we will go to the national CD market to utilize that source of funds when we need to. We don't really have any projections though, Chris, for how much that's going to be. Our deposit growth, especially our retail CD growth, has been pretty strong here for the last six-months or so.

Are there any new initiatives on the deposit front that you have in store or is it just continuing the same progress?

We've got a couple of things that Jack mentioned in part of his presentation, Chris, that we have added some additional people on the deposit side, especially in the cash management area. We think that there really is some good potential there for us to be able to go out and get that product out into more customers.

And one of the things that we definitely have identified is the fact that there are substantial deposit opportunities out there--deposit customer opportunities out there that are not necessarily currently seeking, or in many cases, will ever need anything on the loan side. And that's a segment that in the past we've not paid much attention to, that we're trying to be much more aggressive at identifying and marketing to those types of sources.

Okay. And then last question is, on the loan growth side, are there any concessions or sort of stretching that you think is necessary to keep the loan pipeline full the next couple of quarters?

I really don't. We have not had to do that. It is competitive around here. We've got some aggressive competition throughout this market area. But, we have been able to continue to maintain a pretty decent pipeline and attract the business without having to get into any pricing wars with the competition, and certainly have not done anything to reduce our credit standards in trying to attract business.

Steve Covington, Stifel Nicolaus.

Just one quick one. It sounds like you obviously have a lot on your plate and some pretty lofty internal goals. And I was just wondering what your view, at least in the near-term, would be on any future acquisitions?

Well, as you mentioned, we do have a lot on our plate. We did, I think, a tremendous job with our people in being able to pull off the closings and conversions as smoothly as we did. But, we do have some integration to do with those. We're not--I guess the best way to say it, Steve, is we're not out beating on doors right now, like we were over the last year and a half. But at the same time, if an opportunity comes along that we think is going to certainly give us the potential to build value, we're going to give it a good look.

Okay. Thank you very much. And I guess secondly, from a credit quality perspective, it's really still very strong, even despite the tick up in the overall balances, but how do you view your overall reserve methodology? What's the easiest way for me to model that? Whether it be a percentage of overall loans or--?

Generally, we try to provide about 1.15% on our commercial loan growth, so that's probably the best way to model it. We're actually struggling a little bit to support that level, given our recent history and our recent favorable history. And so, it's possible that that percentage, over time, will decline. But Steve, in trying to model it, that's probably the best way to estimate where the reserve's going to be.

[OPERATOR INSTRUCTIONS] David Darst, FTN Midwest.

Could you comment about your strategy as far as your earning asset mix going forward? Are you comfortable with the securities portfolio where it is or would you like to bring it down--are you more comfortable bringing it down further?

I think the securities portfolio, as a percentage of the total, is as low as I'm comfortable and as low as probably the Board's comfortable, from a liquidity standpoint. So, I don't anticipate that it's going to go down any further. We've taken some investment gains and frankly, we have a little bit of cash right now sitting in cash, waiting for the yield curve to steepen, so that we can get that reinvested.

Okay. And you indicated you'd hired some commercial lenders. Can you comment on the number and their level of experience?

We've added a couple; one over in the Finley market who I think has--I think she brought with her almost 20 years of experience, primarily in the Finley market. And she just came onboard about two months ago. And then, we also added one up in--and she was, excuse me, she was with Bank One, by the way. That's where most of her experience was.

And then we added one up in the Toledo market that we think is going to--is very familiar and has worked for the last 8 or 10 years in the greater Toledo market, especially on the East side, which should be a benefit to us in the Genoa and Oregon areas that we picked up as part of the Genoa acquisition.

Okay. And do you expect to see a little bit more cost savings coming out of ComBanc, maybe overall, some expense leverage, as in your expenses dropping a little bit or is it--?

Yes, there's going to be a little bit, probably a little bit more coming out of Genoa. I struggle a little bit in how you measure the cost savings, because we ended up hiring a number of individuals from the commercial bank, from ComBanc, who are part of our central operations staff. And so, we didn't have cost savings as a result of that.

How many of those people would we have had to hire, regardless of whether or not we did the acquisition, just to service additional growth? I'm not sure I can quantify that. So, the cost savings are a little bit less than what we had anticipated, but at the same time, I'm not sure there's a whole lot left.

Now, there is some. We anticipate that our legal expenses will be a little bit lower on a going forward basis as we work through the credit issues on the loans. And we anticipate that our marketing expenses and promotional expenses will go down over time, as we become more and more familiar with the market and the market becomes more and more familiar with us.

And so, when we budgeted $1.4 million of cost savings on an annual basis, with 75% being realized in the first year, that 25% that's left to be realized in the future periods, relates to things like marketing, legal, some further reductions in office supply, some further reductions in communication expenses, stuff like that, as we just kind of get more and more acclimated into that market.

Okay. And then a total, in your overall Company base, what would be the initiative that you'll pursue in the second half of the year to control your expenses?

Well, I think it's--I look at it, I think, David, as much from an efficiency standpoint instead of just expenses. I think we've got some production people that we need to get more, better production, stronger production out of. I mentioned--we talked about a couple of them that had recently joined. And we need to make sure we get them up to full production as soon as possible.

That's not to say that there aren't--there certainly are some items on the expense side that we need to take a good look at. And we've already--we're kind of in the early stages of that process right now. I didn't mean it to be an excuse at all when I talked about the fact that we probably took our eye off the ball.

I guess I view that as a reason, not an excuse. We should have had some things in place probably to watch the cost controls a little bit more on some of these. But I think that there certainly are probably some areas on the expense side that we can look at. But I'm also as anxious to make sure that we are getting all the production, all the revenue out of our operation that we should be getting.

Matthew Clark, KBW.

Just a couple of quick questions. Can you talk about some of the moving parts? And I know that we've touched on a few of them. But, in getting from a core EPS number in the second quarter of roughly $0.48, to what you're targeting the second half of $0.55 to $0.57, it sounds like obviously you need to get production up with some of your new hires. There's probably some roll-off of some up-front guarantees on some of those people. And you're going to re-deploy some of the gains in higher yielding securities. And possibly, maybe the loan pipeline is picking up in recent months or so.

Yes. Actually, both the loan pipeline--the commercial loan pipeline and the mortgage pipeline. We had our biggest month of the year by far in June and we think a lot of those gains will hit in the third quarter.

And then you did a good job, Matthew, of touching on the others. We expect our net interest income, in the second half, is going to be higher than it was, consistent with where were in June, and frankly, consistent in growing from where we were in the second quarter.

Non-interest income, the insurance and investment sales commissions is going to continue to be a little bit of a struggle. But we expect our gain on sale to pick up. We do expect to have higher yields in the investment portfolio, as we get some of those assets re-deployed that we've had sitting in short-term investments in this flat yield curve. And, just as Bill said, just increase production levels from the producers that we've added in the latter part of last year and the first part of this year.

Okay. And can you maybe size up how far along some of these guys are? I assume these new guys, there's a couple, it sounds like, in investment sales and a couple of commercial lenders and a couple of mortgage people. I guess, how far along are they? Did they come with books of business and can they ramp-up full steam in the third?

I'm pretty confident that the lenders on the commercial side definitely can. They're going to bring some business with them. We've already seen some of that start to hit the books now. And I think there's good potential for that to continue coming on.

We've got one of the mortgage people that we picked up, I already would classify as probably hitting the numbers that we would expect. But we've got some others. And to be honest with you, we've got a couple of people that have been on board for a little while that we've got to take a serious look at, because we just can't carry. We've got to be able to get production out of everybody on this.

On the investment side, I think that part of the slowdown there is a result of the changing deposit market out there, where they were getting a lot more referrals from our branches when CD rates were 2% and below. Now that CD rates have gone back up above 4% in many categories, people are more likely to leave their money in an insured deposit product. And that has had some impact.

But, we've got a couple of new producers that we've added on the staff, as Jack mentioned earlier. And, one of them I do anticipate is going to be able to add some--bring some business in from their prior affiliation. The other one is more into a newer market and that's probably going to take us maybe another quarter, before we get that up to the levels that we think it should be.

Okay. And then lastly, on the margin, you guys are obviously tracking at the higher end of your expectations. I think you had previously talked about a 3.80 to 3.90 range for the year. Is there an expectation that you could see some modest expansion from here? Despite having to rely more on wholesale, and just going forward.

Yes. I expect that as we re-deploy some of the assets in the investment portfolio and perhaps have to rely on a little more wholesale funding, that the margin's probably not going to expand much from where it's at right now.

However, further Fed rate increases are going to benefit us. We've been very successful at pushing those increases out to the market and holding on the deposit side. And we've got a significant amount of prime-based loans, both in the commercial portfolio and in the home equity portfolio, that go up when prime goes up. And so, that fact in itself should help our margin a little bit, Matthew.

Okay. And I assume you're budgeting for 50 more basis points this year?

I don't know that that's the thing. Our budget actually, I think has one more 25 basis point increase in it. I'm not going to predict rates beyond that.

At this time there are no further questions. I'll turn the call back over to you.

All right, if there are no further questions this morning, we thank you for joining us and encourage you to contact us with any questions you may have. Thank you. This will conclude our call.

[OPERATOR INSTRUCTIONS]