Premier Financial Corp (OHIO) (PFC) 2005 Q3 法說會逐字稿

Good morning.

My name is Cheryl Lynn and I will be your conference facilitator.

At this time, I would like to welcome everyone to the First Defiance third-quarter earnings conference call. [OPERATOR INSTRUCTIONS] As a reminder on today, October 18th, 2005, today's conference is being recorded.

I would like to now return the call over to Miss Merry.

You may begin.

Thank you.

Good morning, everyone, and thank you for joining us for the First Defiance third-quarter 2005 conference call.

The call is also being webcast and will be available at the First Defiance website at www.fdef.com until November 30th.

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 statements that are forward-looking as defined in 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, and the management discussion and analysis section of the Company's Form 10-k or in other reports and filings with the Securities and Exchange Commission.

First Defiance Financial Corp. does not take 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. third-quarter conference call.

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

I will begin with an overview of the quarter followed by Jack Wahl, Executive Vice President and CFO, who will give you more financial detail on our performance during the quarter and through the first nine months of the year.

In our release, we reported GAPP earnings of $3.6 million or $0.50 per diluted share for the third quarter of 2005.

We did have a small amount of charges related to our acquisitions that we closed earlier this year included in these results.

Factoring out those charges core earnings were 3.7 million or $0.51 per share for the quarter.

This compares to 2.9 million or $0.46 per diluted share in the third quarter of 2004.

The strengths of the 2005 third quarter continue to be the same --- be the same primary drivers that we have seen throughout the year.

Strong loan growth and better deposit mix resulted in strong net-interest income and credit quality remains good.

Even in light of the increased classified loans most of which came onto our books from the two acquisitions made in the first half of this year.

In addition, to the continued strong performance of net-interest income, non-interest income continues to grow at a good rate.

Loan growth continued at a strong pace throughout the third quarter of 2005, as we continued to have success in growing commercial loans and commercial real estate loans.

Many of these loans are prime based and have benefited us with increasing yields as a result of the Federal Reserves rate increases.

On the consumer and retail side of lending, average balances remain pretty much level from last quarters numbers.

On the deposit side of the balance sheet, we continue to make progress in improving our mix as we seek to increase the non-interesting bearing commercial and retail DDAs.

Non-interest bearing deposits average balances are up over 55% from the end of last year.

And even though part of this is due to the acquisitions, organic growth continues to build momentum.

The ability to attract non-interest bearing deposits must be our focus going forward as interest rates on other deposits continue to experience upward pressure, as we saw a 23 basis-point increase in interest-bearing deposits over the second quarter of this year.

The change in mix on both the asset and liability sides of the balance sheet, along with the rate increases by the Fed, helped offset the increased funding cost and we were able to finish the quarter with only a 2 basis-point drop in our net-interest margin from last quarter.

Credit quality ratio showed a negative trend in the third quarter compared to last quarter, but, again, much of this is related to the loan portfolios that we inherited through our acquisitions.

Many of these loans are in various stages of workout and many have gone delinquent during the pursuit of legal action and other remedies.

However, we have found nothing that we have not previously identified as potential loss exposure and are still confident that we adequately reserved for those loans at the time of the acquisitions.

We continue to pursue an aggressive workout program to address and improve those segments of our portfolio.

The increase in non-interest income, excluding security, was up over 16% from the second quarter of this year, as insurance and investment, commissions, and trust fees showed improvement in the quarter to help along with continued growth in service fees and charges.

Non-interest expense net of the one-time charges related to the acquisitions was relatively flat compared to last quarter.

We are working hard to maintain our focus on expense control and at the same time ensure that we get all of our production up to full speed so we can continue to grow revenue.

We do believe that we have realized the bulk of our projected cost saves from the acquisitions, primarily in the area of personnel reductions.

These have been offset to a certain extend, however, by additional hirings triggered by the continued strong growth and compliance requirements.

On a core operating basis, we did see an improvement in our efficiency ratio compared to last quarter, dropping it from 66.02% down to 63.82% for the third quarter 2005.

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 for the balance of 2005 and on into 2006.

Jack.

Thanks, Bill, and good morning, everyone.

As we noted, our earnings for just completed quarter were 3.6 million or $0.50 per share compared to 1.7 million or $0.26 per share for the 2004 third quarter.

Excluding a small amount of acquisition-related charges in 2005 and the settlement of a contingent liability in the third quarter of 2004 related to our 2002 sale of the Leader Mortgage Company.

Our core earnings totaled 3.7 million or $0.51 per share for the 2005 third quarter.

Compared with 2.9 million or $0.46 per share of core earnings we reported in the third quarter last year.

On a per share basis this represents an 11% improvement.

Much of that increase again this quarter was in net-interest income, which increased from 8.7 million in last year's third quarter to 12.2 million this year.

This growth is a result of both the $280 million increase in the balance of interest-earning assets in a 27 basis-point improvement in the net-interest margin between the third quarter of last year and the third quarter of this year.

For 3.58% to 3.85%.

Net margin improvement is attributed to an improvement in the mix between loans and investment securities and $32 million in growth in the average balance in non-interest bearing liabilities.

As we pointed out in the earnings release, however, we have started to feel some pressure on our margins, which actually declined from 3.87% in the second quarter of this year to 3.85%.

Between those two quarterly periods, our loan rates were up 15 basis-points and our overall assets yields were up 19 basis-points.

While our deposit rates increased by 23 basis-points and overall costs of interest-bearing liabilities was up by 22 basis-points.

Looking ahead to the next several quarters, we think it will be very difficult to maintain our margin at the 3.85% range.

We are also pleased with the growth in our non-interest income this quarter, which increased to $4 million from 2.9 million in last year's third quarter.

I need to point out here that we have changed the way we report our mortgage banking activity.

In the past we've reported gains on sale of loans as a separate line item in our income statement, included mortgage servicing fees and service fees and other charges, and included amortization and impairment of mortgage servicing rights as part of non-interest expense.

Starting with this quarter, we are netting loan sales gains and mortgage servicing income with amortization expense and valuation adjustments, and presenting that total as mortgage banking income on the face of our income statement.

We have included a reconciliation of these amounts in our earnings release.

The amount of mortgage banking revenue reported was in that 1.1 million for the 2005 third quarter, up from 332,000 in the 2004 third quarter.

2005 amount includes the recovery of 240,000 of previously recorded mortgage servicing rights impairment, while the 2004 quarter included 321,000, a $321,000 impairment charge.

A swing of $561,000 between those two periods.

Excluding the impact of impairment, non-interest income increased by approximately $507,000 with most of that increase in loan and deposit service fees and other charges.

While the numbers aren’t particularly large, we are also pleased to have increases in both insurance and investment sales, commissions, and in trust income for the quarter, compared with last year's third quarter.

Looking at non-interest experience, if you exclude acquisition-related charges and the contingent liability settlement, then those cost increase from 7.1 million to 10.4 million between the 2004 and 2005 third quarters.

More than half of that increase is due to compensation and benefits increases, which were almost 1.8 million between the two periods.

Most of the increases were due to the two acquisitions but we've also added people in various central operations positions to help manage the growth, as well as to help with significantly heightened compliance requirements.

Non-interest experience also increased in other areas including occupancy, data processing and advertising.

When we announced the two acquisitions, we anticipated first year cost savings of around 1.1 million related to the ComBanc acquisition and first-year savings of approximately 1.3 million related to the Genoa Savings acquisition.

We believe those cost-savings estimates were accurate.

However, in viewing our results some of the cost savings have been offset by increases in other areas to support the Company's growth and to comply with regulatory requirements.

Since the beginning of 2004, we've added approximately 25 new positions in our operations, accounting, human resources and compliance areas.

We continue to focus on efficiency improvements.

Our efficiency ratio on a core basis for the just-completed quarter, as Bill said, was 63.8%.

A number that we are continually trying to reduce.

However, as we have pointed out in the past, our community banking strategy is a high-touch strategy.

It's expensive to keep decision makers close to the customers.

Our focus continues to be to get the payoff from those community banking relationships in the form of more loans and more deposits and the related growth in revenue.

We have updated our earnings guidance for the remainder of 2005 and anticipate that the fourth quarter will be in the range of $0.47 to $0.52 per share on a diluted basis.

The key for us to reach the top end of that range will our ability to maintain our net-interest margin, which as I noted is becoming a real challenge in the current rate environment.

I would now like to turn the call back to Bill for some concluding remarks, and then we will try to answer your questions.

Bill.

Thank you Jack.

The integration process with the acquired offices is going smoothly.

We remain very optimistic that these new markets offer tremendous growth potential, both for deposits and loans, and we have implemented strategies to take advantage of this.

Deposit growth will continue to be a focus, especially the need to increase in non-interest bearing balances.

The deposit market has gotten more and more competitive over the last year, and pricing pressures continue to build.

Achieving our deposit mix objectives will be critical to maintaining net-interest margin.

We continue to believe that our loan and deposit growth forecast for this year are achievable.

Work is already underway in planning and preparing for 2006 growth strategies, and we have met with all of our department and banking center managers to communicate another aggressive growth strategy for the coming year and are working with them to begin ramping up production now to ensure our success in 2006.

We will continue to focus on efficiency looking for improvement both from the revenue production side, as well as, expense controls.

As we continue to progress through this year, we are very pleased with the strides we have made in many areas.

It's certainly exciting and challenging in many ways, but I am confident in our business plan and in our outstanding teams of employees that work hard to execute that plan.

I want to thank you for joining us on the call this morning, and now we will be happy to take your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Matthew Clark with KBW.

Good morning.

Good morning, Matthew.

A couple quick questions.

Your guidance for the fourth quarter of 47 to 52 seems a little wide, and given your core number, I think, this quarter was closer to 49 or 50, at least based on my estimates.

I'm just wondering, what kind of -- what's in your down-side scenario?

That could get you to $0.47.

Is it just the margin?

It's just the margin.

Okay.

Can you talk--

I'm sorry.

We have seen fairly significant pressure on our deposit pricing.

Especially in the last month to six weeks, and I'm being conservative and anticipating what it might be for the rest of the year.

Okay.

Maybe this is somewhat related.

But given what appears to be 95% of the increase in non-performing loans appears to be tied to your two latest acquisitions, can you comment, I guess, about how that impacts your expectations for a loan growth, I guess, going into the fourth quarter of next year?

And then maybe just talk about the credit environment in general.

What you're seeing.

Well, I think, we still believe there's great potential for another strong year of loan growth coming up.

There is nothing in there that really dampens us from that standpoint.

I don't think the high level of classified loans are currently on our books from those markets are indicative of those markets in general.

We still feel that there's great potential for some very good business relationships to be developed throughout the new market areas.

As far as the whole credit scene throughout this market area, it's, I guess, we're guardedly optimistic for the most part.

Things seem to be turning along fairly good right now.

Obviously, we have the same concerns, I think everybody does, about the economy in general.

Especially looking at some of the energy costs out there.

I know there were some -- I have not has a chance to look at the -- some of the data that came out this morning, but I understand there certainly were some major jumps in some areas that may put even more of a pressure on the Fed to battle perceived inflation.

So I think we'll continue to see the Fed react in that way, which you know, I think, that we've seen -- I think, we've seen some positive trends in loan pricing in this market area that we are, again, hoping we're going to see those continue.

We've talked a couple of times here this morning about the funding side.

What's happening there as far as pricing.

We can hopefully offset some of that if everybody continues with their more sensible pricing decisions on the loan side.

Okay.

And then finally just on the other non-interest income, it looks like up a little bit from the second quarter.

I'm just curious if there's, you know, what moving parts were there?

I think, we're seeing certainly from a couple of our areas, for instance, the commissions in the insurance and our insurance and investment area, we're stronger this quarter.

Trust fees, we're starting to pick up some nice trust accounts that have helped us out, in addition, to just our overall service fees.

Hopefully we're getting much better at making sure that not only that we're priced right on the fee side, but that we're getting those fees to hit the bottom line.

I should add though that the fourth quarter from a mortgage banking standpoint, the fourth quarter historically is a little slower.

So I would anticipate our mortgage banking income probably will be down.

We're not going to have any impairment recovery, because we don't have much impairment left to recover in the fourth quarter.

And I would anticipate that our gains will be off a little bit also in the fourth quarter, compared to the third quarter.

All right, thanks.

Thanks Matthew.

Our next question comes from David Darst with FTN Midwest.

Good morning, Bill.

Good morning, David.

Looks like loan growth slowed this quarter.

What are you seeing going forward or anything unique happened this quarter that slowed it down from where you've been running the past six quarters?

I think some of the loan growth or -- the appearance of the slowing loan growth, part of that, David, is some of our actions in regards to remedies on the -- with the portfolios that we acquired -- that we've been able to walk out of the bank basically.

So and that coupled with the fact that some of our -- some of our production people are also assuming some of the responsibility for working those portfolios.

Hopefully, you know, we're not -- we certainly are trying to be very sensitive to the fact that we don't want to get them out of the production mode, but they are devoting some of their time and energy to that.

We did on one particular credit, a sizeable relationship that we have, a part of that on a new construction on a facility was financed through a bond program that resulted in us being paid off.

I think to the tune of about $6 million. 5 or $6 millions, also.

So those are some of the things that are reflected in that -- in that third quarter.

Going forward you really see no change in your origination pipeline?

We really don't.

Our originations, our loan activity still seems to be relatively strong.

I don't -- again, I don't think it's as much a slow down in production as it is, you know, this one sizeable loan that I mentioned, plus the fact that we have worked to reduce some of the loans that were part of the acquired institutions.

Okay.

It looks like your service fees were down one quarter.

Is there any trend developing there, or is something related to the acquisitions?

I don't believe that was the case.

If you restate the prior quarter for the mortgage banking adjustment that I made, David, and you take the mortgage banking servicing fees were -- if you take that out of servicing fees, then our service fees from the second quarter to the third quarter were up from a million 388 to a million 511.

Our mortgage banking income is up from 522,000 to a million 87.

I think -- if you call me back, I can give you those specific numbers.

Okay.

It just has to do with the reclassification that we made on the income statement.

Okay.

Final question is looking out to 06.

Do you see the opportunities for profitability to improve?

Or do you think you will need to continue hiring to support your growth?

Or do you have any profitability goals for next year?

Yes, nothing that we have gone public with at this point, David.

We're hoping that we've built the infrastructure that can get us to those levels.

I don't have any projections that I can give you, as far as, any additional personnel hires and stuff.

I can tell you this, that we have made everybody else here that is part of the management team very much aware of the fact that we need to work very hard at holding the line, and we're going to look for full justification on any additional hires.

But at the same time, we don't want to get ourselves where our niche is community banking and relationship and we’ve got to make sure that we can service and respond to those customers as quickly as possibly.

That's going to continue to be our operating philosophy.

We have a focus.

We have a group here that's dedicated to what we call our "Efficiency Team" to try to evaluate all of that and keep it in place.

Okay thanks.

Thanks, David.

Your next question comes from Jullianne Cassorino, with Prospect Partners.

Hi, good morning.

Good morning, Jullianne.

Just a couple quick questions.

The tax rate, What's a good tax rate to use going forward?

Good tax rate to use is in the 31 to 31.5% range.

Okay.

So this quarter's a good run rate.

And after adjustings for the one-time charge.

When I look at your balance sheet growth and where you are versus where you've been guiding to all year, I mean, it looks really good to me.

Is it accurate to think that the lowered guidance is largely due to the elevated comp expenses, as opposed to balance sheet growth or even net-interest margin?

I know you're cautious on the net-interest margin but that hasn't really been the issue so far.

It's a combination of -- we're cautious on the margin here in the fourth quarter.

And we've had some higher-than-expected costs.

We're self-insured for our group health insurance.

We've had a couple of very large cases that -- in one case when we took it over in the acquisition, we had to negotiate a higher stop loss than we would typically encounter in a regular situation.

That's probably added a couple of hundred thousand dollars in expenses for us in 2005, the higher-than-expected cases there.

And we've had to make some adjustments to how we account for our deferred compensation plans, and that’s increased our expenses to a greater level than what he with anticipated.

We think most of the charges will be behind us by the end of the year.

Put it this way: Is the comp expenses where -- were where you expected them to be by this point, then you might not need to be changing guidance.

That's true.

Okay.

So it's the comp expenses that are what's really not come in.

Everything else has been at or better?

In general?

Yes..

Okay.

Your guidance includes no security gains or MSR expenses or recapture, right?

You just said there wouldn't be any -- you wouldn't expect more recaptures but?

That's correct.

Does consensus include security gains?

I don't know.

I don't believe it does.

And I was thrilled to see your ROA back above 1%.

So are we.

I was really happy.

I was wondering when you think--if things keep going as they are as you currently expect them to when we might get back to one and a quarter?

How long that would be?

I don't know.

You're a bigger bank now.

I really don't have an answer that I can definitely give you on that.

Again, we know what those targets are out there that we need to get to -- to keep the investment community satisfied and we're working hard to get to those.

Okay.

I was wondering if you could share with us any update with how your HSA deposit accounts are growing?

That's a pet project of yours, isn't it?

Yes.

To be honest with you, we're just getting ready.

In fact, I think we have several seminars, four seminars scheduled here coming up in next month or so, in relationship to those.

Hopefully, we'll going to start seeing activity in that area.

It really has to be driven as much from the insurance plan providers and the types of insurance plans.

Most of the people in our market area have the lower deductible insurance plans and they're just starting to see that as an option through their insurance provider at this point.

You are financing these seminars or are you going in as part of a group?

We're partnering.

You're partnering?

Yes.

And it is aimed at employers or at insurance companies?

It's aimed at employers.

Okay.

You're partnering with some insurance companies, I assume?

Yes.

Anthem.

Anthem.

Do you have an exclusive agreement with Anthem?

No.

Okay.

They’re working with us in our market area, which is a strong market area for them as well.

Well, I meant, an agreement with them in the market, in your footprint?

No.

There's not an exclusive agreement, but, I think, we're taking the lead among the financial institutions in our market area with this type of account.

Okay.

And in terms of capital management, are you considering -- I forget if you have a stock buy back authorization in place right now.

But now that the acquisitions are integrated and done, any reason why you can't start buying back more stock?

Or are you -- have no intention of doing that because you want to keep capital in case some kind of opportunities come along?

What are you thinking in regards to capital management?

In regards to the capital, we still have as far as the regulators are concerned with the risk-based capital we run a little bit thin on that level right now.

We do currently have an authorization for stock buy back that's in place.

I think, there's still over 300,000 shares that are part of that authorization.

We are hoping to, you know, we're looking at some different possibilities that will allow us to get back into a re-purchase program.

We think that's a good capital management tool and it just makes good business sense for us in a lot of different ways.

We are currently looking very hard at some of that.

Thank you.

Okay, thank you, Jullianne.

Thank you.

Your next question comes from Chris Marinac with FIG Partners.

Hi, guys, I wanted to get more clarity on looking at the average balance sheet, what would be the break out on interest-bearing deposits between CD's and non-CD money?

Chris, it probably would be not a whole lot different than the breakdown in the actual balances themselves, which we provide on page 14 of our release.

Got it.

So those same proportions would be a good --

Pretty much.

Yes.

The non-interest bearing accounts are the ones that fluctuate where you can have the different balances at period end compared to averages for the quarter.

Okay, very well.

I may have missed some of this color earlier in your openings statements.

What would be your expectations on sort of the future pipeline of problem loans or watchlists etc.?

Just given to what you've inherited from the two deals this year?

Chris, as far as our loans, our self-originated loans continue to perform very, very well.

And we have no reason to believe that that's not going to continue.

As far as the acquired loans, a number of those, you know, there was a fair percent of those that were classified more from a documentation standpoint than any true credit weakness, and we continue to work at remedying those documentation deficiencies.

The ones that do, certainly, exhibit some credit weakness.

We continue to work on those.

I did mention during the opening comments that even though when you look at the credit ratio numbers, they trended downward this quarter.

A lot of that is because of the fact that several of those loans, we are in the midst of some legal action, as well as some other remedies, that have allowed those loans to get a little bit more delinquent than what they were in the prior period, and, therefore, show up in a different classification.

But at the same time, we have yet to find anything that we feel gives us any more exposure than what we identified even prior to the acquisition when we were doing due diligence.

So we are very comfortable with where we are reserved at right now.

Very well.

Last question, Bill, given the fact that the operating environment might be changing, a little more challenging for everyone going forward -- where does that place acquisitions?

Does that put that -- is it higher on the -- or lower on the totem pole or higher -- or would you just be opportunistic as in the past?

I think opportunistic is the best description.

As we work through our discussions here and everything.

We certainly do not say the door is closed, but at the same time, we challenged ourselves this year with, you know, two acquisition that we closed relatively close together.

We are very pleased with the way those integrations are going.

But at the same time, we need to make sure -- that we've grown substantially over the last several years, and we want to make sure that we keep the business strategy, the basic business strategy, on course.

But, you know, we're not going to pass up taking a good look and doing a full analysis on anything that makes sense.

If it has a strategic fit that adds to the bottom line of this Company going forward, we're going to be in there in the bidding process.

Great.

Thanks, Bill.

Thanks very much.

Thank you Chris.

Thank you Chris.

[OPERATOR INSTRUCTIONS] At the same time there no further questions.

All right.

Then we would like to thank everyone for joining us today and encourage you to contact us if you have any additional questions and this will conclude our call.

Thank you.

This concludes todays First Defiance third-quarter earnings conference call.