Premier Financial Corp (OHIO) (PFC) 2005 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the First Defiance fourth-quarter 2005 conference call.

This call is being recorded, and all lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Ms. Merry, you may begin your conference.

Thank you.

Good morning.

Thank you, everyone, for joining us for today's conference call.

This call is also being webcast and a replay will be available at the First Defiance website at www.FDEF.com until February 28.

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.

That will be 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 would like to remind you that this call may contain forward-looking statements, such as expectations about the Company's plans, business performance, future initiatives, and results, as well as market conditions in which the Company may operate.

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 in other reports and filings with the Securities and Exchange Commission.

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

Now I will 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. conference call to review the fourth-quarter and full-year results for 2005.

Last night we issued our earnings release with our 2005 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, followed by Jack Wahl, Executive Vice President and CFO, who will give you more financial detail on our performance during the quarter and the year.

In our release, we reported GAAP earnings of 3.4 million or $0.48 per diluted share for the fourth quarter of 2005.

This compares to 3.5 million or $0.55 per diluted share in the fourth quarter of 2004.

This brings 2005 year-end GAAP earnings to 12 million or $1.68 per diluted share, compared to 10.8 million or $1.69 per diluted share in 2004.

In light of the overall increase in earnings, the per share decline was the result of the additional shares issued as part of the ComBanc transaction that we closed on January 21 of last year.

Excluding the onetime charges attributed to the ComBanc and Genoa Savings acquisitions, earnings for 2005 were 14.2 million or $2.00 per share; and excluding a 2004 contingent liability settlement, core earnings for that year were 12 million or $1.89 per diluted share.

During 2005 we grew total assets from 1.12 billion to 1.46 billion through a combination of the acquisitions and continued strong organic growth.

While these results are certainly respectable, we were somewhat disappointed with the fourth-quarter financial results.

There were several factors that Jack will detail for your that caused this.

However, we are pleased with that there are several items this quarter, including margin improvement and fee income growth, that are very positive signs for us. 2005 is a year where we need to look beyond the numbers to really measure our success.

All of the extra time and energy devoted to closing and converting the two acquired banks did not steal momentum from our recent history of strong growth.

Solid loan and better deposit mix resulted in strong net interest income; and credit quality remains good even in light of the increased classified loans, which primarily came on to our books from the two acquisitions.

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 through the end of 2005 as we continue 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 Federal Reserve's rate increases.

On the retail side of lending, home equity balances grew by nearly $2 million over the previous quarter.

On the deposit side of the balance sheet, we continue to improve our mix as we focus on increasing our non-interest-bearing commercial and retail DDAs.

Non-interest-bearing deposits average balances are up over 54% from the end of last year.

Even though part of this is due to the acquisitions, we also are experiencing strong organic growth for this product.

Attracting non-interest-bearing deposits is a critical part of our strategy going forward, as interest rates on other deposits continue to experience upward pressure.

The change in mix on both the asset and liability side of the balance sheet helped offset our increased funding cost, and as a result we were able to improve net interest margin this quarter, after seeing a slight decline last quarter.

Most credit quality ratios improved compared to last quarter, as we made further strides in addressing deficiencies in the acquired loan portfolios.

Our credit administration people have an effective, well-defined plan to work these loans, and we're seeing good results from their efforts.

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

However, we have found no surprises in either of the portfolios to date.

Net charge-offs did increase during the quarter as we dealt with these loans; but at 11 basis points annualized for the quarter, the number still compares favorably with peer groups.

Non-interest income continues to grow as service fees, mortgage banking income, and insurance and investment income were all up substantially during the fourth quarter of 2005 when compared to the same period in 2004.

Non-interest expense was relatively flat compared to last quarter, but up significantly from the fourth quarter of 2004 due to the acquisitions.

We're refocusing our efforts on expense control after putting much of our effort in 2005 on successfully completing the conversions of the two acquisitions.

At the same time, we must ensure that all of our production and support departments are staffed appropriately, so that we can continue to grow revenue and maintain both appropriate internal controls and appropriate levels of customer service.

We 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 extent by additional hirings triggered by strong growth and increased compliance requirements.

I will now ask Jack Wahl to give you the financial results for the quarter and the year before I wrap up with an overview and a look at 2006.

Jack?

Thank you, Bill, and good morning, everyone.

As Bill just noted, we earned $0.48 per diluted share for the just-completed quarter, down from $0.51 in the 2005 third quarter, and down from $0.55 in the fourth quarter of 2004.

In comparing the 2005 fourth quarter to the third quarter, there were three main reasons that our earnings were $0.03 lower.

First of all, our mortgage loan gains were down by nearly $100,000 from the third-quarter level, despite loan volumes that were roughly the same for those two periods.

The margin we realized from the sale of mortgage loans has continued to fall due to competitive pressures.

Secondly, our other non-interest expense line item on our income statement increased to 2.1 million in the '05 fourth quarter, 1.8 million in the third quarter.

Some of the specific items in this catchall category for the quarter included an $84,000 increase in media advertising, which included an awareness campaign in the Toledo and Lima markets and some special product marketing; a substantial increase in charitable contributions, which always tend to be higher in the fourth quarter; noticeable increase in postage costs due to several promotional and compliance mailings; a large increase in management consulting fees, which included sales training, loan review costs, internal control documentation consulting, employee benefit plan consulting, and strategic planning assistance; an increased level of credit and collection expense related to the higher level of problem loans that we are dealing with since the acquisitions; and finally, a substantial increase in bad check charge-offs, which we believe many of our peer banks are also experiencing.

The third item in the costs is significant fluctuation between the third and fourth quarters, was due to the annual review of our tax accounting, which resulted in an increase in our annual effective tax rate to 32.84%.

The adjustments to get to that annual level caused an effective tax rate for the third quarter of 35.12%.

This increase in the effective tax rate resulted in additional tax expense of $117,000 or more than 1.5 cents per share for the quarter.

In comparing the fourth-quarter results of 2005 to the 2004 fourth quarter, you will note that the 2004 results included $732,000 of gains from the sale of investment securities and a $182,000 tax-free life insurance settlement.

Those two items by themselves added $0.10 per share to the results in the '04 fourth quarter.

I also want to point out that our net interest margin improved for the fourth quarter of '05 to 3.92% from 3.68% in the fourth quarter of 2004, and from 3.85% in the 2005 third quarter.

Our overall asset yields have improved by a total of 73 basis points over last year's fourth-quarter level and by 30 basis points from the third-quarter level, 6.55%.

During those same periods, our cost of interest-bearing liabilities increased by just 52 basis points from the 2004 fourth quarter and by just 26 basis points from the 2005 third quarter, to 2.89%.

As a result, our interest rate spread has improved from 3.45% for the 2004 fourth quarter, to 3.62% in the 2005 third quarter, to 3.66% in the quarter just completed.

Further, the average balance of non-interest-bearing checking deposits also has a significant impact on our overall margin.

And those balances have gone from 61.4 million in the '04 fourth quarter, to 87.7 million in the third quarter of 2005, 93 million in the just-completed quarter.

On an annual basis, our margin was 3.87% for 2005, compared to 3.62% for the year ended December 31, 2004.

That was attributable both to an improved interest rate spread and a 54% increase in the average balance of non-interest-bearing deposits year-over-year.

We have started to see some increases in our loan yields beginning in the fourth quarter, which has helped to improve our outlook for interest margins for 2006.

However, having said that, we do expect our margin to be lower in 2006 than it was in 2005 and have included that in the detail of our 2006 projections in the earnings release, which Bill will cover in a few minutes.

Our expectations right now for margins in 2006 is that they will range from approximately 3.85% in the first quarter to approximately 3.56% in the 2006 fourth quarter.

Overall for the year, the margin will average somewhere in the vicinity of 3.7%.

Looking at our annual results for 2005, our net interest income before provision for loan losses increased by 12.9 million or 37.6%.

Our non-interest income increased by 1.9 million or 13.8%.

And our non-interest expenses, excluding acquisition-related charges in 2005 and the contingency settlement costs in 2004, increased by 11.4 million or 39%.

Obviously, most of the increases relate to the two acquisitions we completed in early 2005.

Our efficiency ratio for 2005 for core operations was 64.63%, compared to 61.37% for the year in 2004.

If you exclude the impact of the amortization of core deposit intangibles, which is a non-cash item that increased significantly following the acquisitions, our efficiency ratio for the year 2005 was 63.4%.

Our core ROE did improve slightly in 2005 to 9.81% from 9.57% in 2004.

That completes my comments for the 2005 fourth quarter and annual results; and following Bill's concluding remarks, I look forward to trying to answer your questions.

Bill?

Thank you, Jack.

The integration process with the acquired banks is going smoothly.

These new markets have already demonstrated their growth potential both for deposits and loans, and we are implementing additional strategies to take further advantage of this.

Our focus as we go forward will be to pursue solid organic growth within our 12-county market footprint.

We are currently in the process of constructing a new branch facility in the Shawnee area of Lima that we think has great potential for deposit generation.

Other possible branch fill-in locations may be evaluated during the coming year.

While we never say never, we are not currently anticipating any significant acquisitions in the near term.

In 2005, much of our focus was on successfully integrating the two acquisitions.

For 2006, that focus will shift to better utilization of our production capacity.

Efficiency remains very important to us; but at the same time we know we need to add some additional support staff to maintain appropriate customer service levels.

Looking at the overall business environment in our market, we feel very good about our market's strengths.

We have been asked many times about this region and its ties to the automotive industry.

While that obviously is a big part of this economy, a very small percentage of our direct credits are tied to the industry.

While we were obviously aware that many of our customers, both commercial and retail, would be impacted to some degree by a significant downturn in the automotive industry, we feel that we are in a position to withstand that.

General Motors has recently announced a capital investment in their Toledo facility of nearly $0.5 billion; and this, coupled with other expansion announcements, in the area are certainly encouraging.

Area economic surveys and discussions with many of our customers also indicate positive attitudes about the 2006 economic picture for our market.

For the year 2006, we anticipate the continuation of strong growth as we develop new relationships in our market.

We have forecast almost 16% loan growth, with most of that originating in the commercial and nonresidential real estate segment.

On the deposit side, we also expect strong growth numbers, with interest-bearing average balances growing 10% and non-interest-bearing deposits forecasted to be up over 20%, with major focus on this part of the deposit portfolio.

Even with this deposit mix, the strong loan growth will require us to turn to outside funding sources and this will put pressure on our margin throughout the year.

Based on our current forecast, we see the margin growing from approximately 3.85% in the first quarter down to around 3.65% by the fourth quarter of 2006.

We anticipate that mortgage gain on sale income will increase if we are able to meet our very aggressive goals that we have set for our originators for 2006.

Other non-interest income is also expected to be up about $2 million over last year due to anticipated increases in bank service fees and additional income from an increase in Bank Owned Life Insurance.

Non-interest expense will be up due primarily to compensation expense, which includes a full year of expense for the additional staff added through the acquisitions and the addition of positions that are needed to support the overall growth of the Company.

We also expect higher occupancy costs for the year and a significant increase in Ohio franchise tax in 2006.

The expensing of stock options will also negatively impact earnings in 2006 by about $280,000.

Because our outstanding options are all incentive stock options, that amount of additional expense will not be tax-deductible.

On a per-share basis, stock option expensing will add $0.04 to our expenses for 2006.

Factoring all of this together, we expect earnings per share for 2006 to be in the range of $2.08 to $2.16 per share.

Factors such as changes in interest rates, economic conditions, or competitive pressures certainly could affect this forecast.

Also, any decisions regarding acquisitions or other expansion projects would impact this estimate, as would any unexpected or unusually large credit problems.

We continue to have confidence in our business plan and the people that we have within this organization to properly execute that plan.

We think that 2006 will be another challenging year, but we are focused on making it a successful one.

We thank you for joining us this morning, and we will be happy to answer any questions that you might have.

(OPERATOR INSTRUCTIONS) Matthew Clark with KBW.

Just a few questions.

Can you talk about your gain on sale, mortgage expectations, I guess?

What needs to take place to take the production level up to another level, to help offset what are expected to be contracting margins in that business in '06?

We have added a couple of people that we did not have for the full year of '05, Matthew, that we think have some good potential, especially in our newer markets.

That, coupled with we have done some fairly aggressive sales training with our current staff, and feel that those two combinations and the very (inaudible) goals that we have set out for them is what we are banking on as the reasons that we think we can get those numbers up.

Okay.

Can you discuss the tax rate?

I guess, is it going to drop back down going into '06, or are we going to stay at this level?

I think, Matthew, the tax rate that we are at for the year, which is 32.84%, is a pretty good estimate of what to use for 2006 for the full year.

Okay.

In terms of the other non-interest income growth, I guess, is there any change in pricing structure that you anticipate to help boost your service fees and so forth?

A lot of that boost is going to come from an overdraft protection program that is being implemented late in the first quarter of this year.

We anticipate that will be a significant contributor there.

Also, debit card transaction fees have continued to climb; and we think those will continue to get stronger as we continue to get more and more cards out in the market.

So those are two areas in particular that we see as pushing that number up.

Okay.

Finally, in your guidance there is no real mention about credit provisioning.

I am just curious as to whether or not your forecast is taking into consideration the need to build reserves, given some lofty loan growth expectations.

Generally what we do is we provide in planning about 110 basis points on any loan growth, any loan growth in the commercial portfolio, which is a much higher level than what our actual loss experience has been, but which is consistent with what published statistics on the FDIC website are.

So that is the level that we projected in our budget for 2006.

Okay, thank you.

Christopher Marinac with FIG Partners.

I wanted to ask you about deposit costs; and specifically, what would be your expectation for the types of deposits that will be successful this year?

Are there any new initiatives that you plan to kind of continue to get [new] low-cost or no-cost deposits in?

First off, as far as just the overall deposit cost in the area, seem to have -- [they'll be settled] in a little bit.

They were rising at a pretty rapid pace throughout a good portion of '05, and that seems to have at least settled down a little bit.

We are obviously, as we have talked before, putting a lot of emphasis on the non-interest-bearing deposits.

Again, we have set some pretty aggressive goals.

I think that some of the changes we have made, again, in some staffing regards, as far as putting somebody -- a new deposit product manager out there -- certainly will help us out with that.

We already saw some nice results here in the fourth quarter of '05.

Also, we have put a lot of emphasis right now on a money market account.

We have a premium money market account that is kind of a tiered account.

That has been very successful for us as far as attracting funds.

The other thing that we like about that is that, depending on whose forecast you totally buy into, it certainly looks like the Fed may be nearing the end of the line as far as their rate increases.

If that is the case, and if before too long we start to see the rates start to drop again, that is an account that we can react on very quickly.

But Bill, having said that, it sounds like you're probably more cautious in the press release than what you just described to me.

Is that just to be conservative for the year?

Or do you think you might have a little more relief on, I guess, the deposit cost piece of what (indiscernible)?

Yes, I think that the jury is still out.

I'm sure you know, Chris, they are all across the board as far as predictions on interest rates.

I think that we did try to take a conservative approach when we went through the process this year as far as budgeting for '06; and hopefully we will find out as we get into the year that we were conservative.

Last question, separately, was can you give us, I guess, some color on your decision about options acceleration and not to do that?

Was there any sort of discussion you guys had the last month or two of the year?

We didn't view accelerating option investing as being that -- you know, that should be a business decision, not an accounting decision.

We did want the accounting rules to drive that decision for us.

We felt like most intelligent readers of the financial statements, like yourself, are going to understand the change in our expense related to stock options.

It is going to be disclosed.

Frankly, we view options as both an incentive tool and also a retention tool.

To divest those prematurely would have eliminated one of the two objectives we had in putting those out there for our employees.

Great, that's helpful, Jack.

Thanks, guys, very much.

David Darst with FTN Midwest.

Can you comment on the shift within the loan mix?

It looks like your 1 to 4 declined about 22 million.

Our 1 to 4, I think we were probably a little bit more aggressive on selling throughout the latter part of the year.

Our originations are still strong.

Our originations were certainly up over fourth quarter of last year.

But we, I think, did a better job of getting those out the back door.

Will that continue into 2006?

Yes.

Again, our feeling is that in most cases we are probably better off not holding those mortgages in file or in our vault here.

And we will continue to sell on the secondary market at a pretty good pace.

As most of the loans that are going to be held will be adjustable-rate mortgage loans, but there are even cases we have tried to make sure that our specific targets, as far as our mortgages sales and in some times that even includes selling off some of the adjustables.

Okay.

Then looking at the other part of your earning asset mix, your securities portfolio, do you expect to maintain it around the 110 to 115 million?

Yes, David.

From a safety and soundness standpoint I don't think we can take that portfolio any lower than it is right now.

To the extent that we have opportunities to take gains on that portfolio, we will replace any sales with different securities.

However, our loan demand is such that I don't see us growing the portfolio any from the level that it is at right now.

Okay.

Then looking at your loan yields, what percentage of your portfolio is variable rate?

And what type of structure are you adding (inaudible) commercial real estate growth?

Approximately 50 to 60% of the loans have some type of variable feature in them, either prime based or one or three-year adjustable.

Bill, I will let you comment on what the plan is for structure in that portfolio going forward.

We have -- the interest rate market around here, again, on commercial lending certainly seems to have gotten a little bit better.

There is still a few renegade pricing deals out there.

But most of that is probably going to still be originated in a three to five, three-year to five-year range as far as adjustables are concerned.

Most of our loans, as far as the constantly adjusting, are prime based.

We don't do very much LIBOR lending.

However, as the -- we will continue to react to some of the competitive pressures and be looking at some possibilities along that line.

Okay.

Final question is regarding your growth expectation for the loans.

What are some of the factors that could shift that either way, up or down?

Well, I think on the upside is that we certainly have felt that we had some good potential, especially in some of these newer markets that we have gone into.

We have got experienced lenders that we think are going to certainly be able to take advantage of that.

It may even be stronger than what we are forecasting.

I think that, as I mentioned in my comments earlier from the overall economy in this area, we think is very, very good.

A very positive outlook on that.

So those are the things that we think that -- and if that continues to be the case, we may be even surprised on the upside.

Obviously, the downside would be if all of a sudden there would be a sudden downturn in the economy.

Interest rates -- I don't see anything happening on the interest rate market as we see it out there right now that would have a major impact, either direction, on this.

So I think that from that standpoint, that is kind of a neutral.

I think it just really hinges on the overall economy.

As long as it cruises along at where it is at right now, I think our potential is more to the upside.

Okay, thank you.

Julienne Cassarino with Prospector Partners.

Can you tell me about the leverage program that you said you put on, [you know] 20 million?

The funding that 90-day LIBOR plus 138, which I think is around 6% (multiple speakers).

It really wasn't a leverage program per se.

We added leverage by adding additional trust preferred debt, which is -- those securities also have a feature of being able to be counted as Tier 1 capital for capital purposes.

It was in response to issues from our regulators that they felt like we were on the borderline of where we needed to be from a capital standpoint.

It was an opportunity to add capital at a cost that is higher than other funding costs, but which is low relative to other sources of capital.

Okay, okay.

So that implies probably no buybacks or dividend increases.

One of the reasons we did the trust preferred is it kept the option of doing buybacks available to us.

Without any [increase in] capital that way we didn't have any -- there would have been no opportunities to do buybacks.

So we will continue to do buybacks if the price of the stock warrants that we do buybacks.

Okay, so you can -- the regulators are okay with that? (multiple speakers)

All the regulators can do is restrict our ability to pay dividends from the bank to the holding company, which is our source of doing stock buybacks.

When we issued the trust preferred securities, that added to our resources at the holding company level.

So we can -- we have got the resources available now to do some incremental buybacks without having to go to the regulators to get permission to pay a dividend from the bank to the holding company.

Okay, great.

Can you tell me why a 20% growth in occupancy expenses?

It sounds so high.

A couple of things.

It's a full year of expense on the acquisitions, one of which occurred in the first month of the second quarter last year.

We have added an additional branch or we have relocated a branch in Defiance in 2005, midyear.

There is more expense for the new branch than there was for the old branch, but it is in a higher traffic area.

We're doing a similar relocation of one of our branch offices in the Napoleon market in 2006.

Again it will put us in a higher visibility area, but it will increase our occupancy cost.

We are adding a de novo branch in the Lima Shawnee area which is going to increase our costs in that area.

So those are the primary factors that are increasing the occupancy costs.

So the increase year-over-year is -- you gave the reasons, but I just want to pin down.

It's just one new branch in '06?

One new branch, and a full year of a relocated branch, and a partial year of a second relocation.

Okay, okay, but only one new in next year?

Yes.

And that is towards the beginning of the year?

It will be -- it will come online about midyear.

Okay, all right.

Then if you could just help me understand some of these accounting issues, the tax reassessment, I think you termed it.

Does that have to do with the line item on your income statement called state franchise tax?

No.

Those are different?

Those are different.

That has to do with the line on our income statement called federal income tax expense.

Okay, so that is the -- why is this -- what is this state franchise tax line item?

Why isn't it in the -- I realize -- you don't combine your federal and (multiple speakers) ?

In Ohio that tax is not based on income.

It is based on your net worth at the beginning of the year.

Okay.

So that is your state -- is that equivalent to your state --?

It is a state tax but it's not an income tax.

I see; which is why it's not in the tax expense line.

That is correct.

What was the federal tax reassessment?

It really wasn't a -- it was our own internal analysis of the tax accounts and the tax accrual accounts.

It just resulted in us having to record additional expense.

It had to do with how we treated one of the items that has different tax treatment for books than it does for taxes.

It has to do with accounting under FASB statement 109, which I am not sure I want to get into any more detail than that.

What does 109 have to do -- what line item does it have to do with?

It's federal income tax expense.

The bad check losses that run through the operating expenses, I was just curious why those don't run through charge-offs.

Because it is not related to loans.

It is related to checks that we cash that the funds ultimately are not there when the check is run through.

That is the way we have always handled it.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) Christopher Marinac with FIG Partners.

Bill and Jack, I was curious if you have any more color on deposit pricing from some of your large brethren.

Have they been more aggressive, less aggressive the last 30 or 60 days?

The last 30 or 60 days I think they have been a little bit less aggressive, Chris, which certainly please us.

We had a de novo office that was established here in Defiance, and one that was established over in another community that we have an office in by one of the larger regional banks.

They had some pretty aggressive pricing earlier in 2005.

But they have kind of backed off that strategy, and things have settled into a little bit more of a normal pattern.

Hopefully that will hold.

Great, let's hope.

Thanks very much.

(OPERATOR INSTRUCTIONS) There are no further questions at this time.

All right, then.

We thank everyone for their participation today, and this will conclude our call.

Thank you.

This concludes today's conference call.

You may now disconnect.