Premier Financial Corp (OHIO) (PFC) 2006 Q1 法說會逐字稿

Good morning.

My name is Lynn and I will be your conference operator today.

At this time, I would like to welcome everyone to the First Defiance first-quarter 2006 conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded today, April 18, 2006.

Ms. Merry, you may begin your conference.

Thank you, Lynn.

Good morning and thank you for joining us for today's conference call.

This call is also being webcast and the replay will be available at the First Defiance Web site at SDES.com until May 30.

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'd 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 any 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 first-quarter 2006 results.

Last night, we issued our earnings release with our 2006 first-quarter results, and this morning, we would like to discuss those results with you.

I will begin with an overview and then Jack will give you more financial detail on our performance during the quarter.

In the release, we reported net income of 3.85 million or $0.54 per share for the quarter ended March 31, 2006; this is on total assets of 1.48 billion.

This compares to 2.87 million or $0.41 per share for the first quarter of 2005.

The 2005 period did include transaction-related charges associated with the ComBanc acquisition.

Net of those one-time charges, the first-quarter 2005 net income would have been 3 million or $0.50 per share.

Thus, core earnings per share were up 8% year-over-year.

All in all, this was a solid quarter with some very promising indicators for the future, especially related to non-interest income.

Fee income, led by growth in deposit fees, had a major impact on our success in the first quarter.

We also saw improved numbers from First Insurance and Investments, our insurance business unit, that contributed to the increase in non-interest income.

Solid loan growth and better deposit mix result resulted in strong net interest income and credit quality remains good, although we did have one significant credit that deteriorated during the first quarter.

I will discuss that one later.

Loan growth in the first quarter of 2006 was good but not at the pace that we've seen in the last several years.

We continued our trend of growing the commercial loan portfolio, and many of these loans are prime-based and therefore providing increased yields as results of the Federal Reserve's rate increases.

This quarter, there was a significant shift between the balances reported under commercial loans and commercial real estate loans, which was caused by expanded regulatory guidance for these categories.

As a result, C&I loan balances are up 45 million over the fourth quarter of 2005 reported balance, and commercial real estate is reported at a level 10 million lower than last quarter.

The loans that were recategorized to the C&I portfolio continue to have the same real estate collateral as before.

However, it has been determined that it is not considered the primary collateral on these specific loans.

On the retail side of lending, residential mortgage loan, home equity loan and consumer loan balances were flat to slightly down from the prior quarter but still up significantly from the first quarter of 2005.

On the deposit side of the balance sheet, we're making progress on improving our mix as we seek to increase the noninterest-bearing commercial and retail DDAs.

Noninterest bearing balances were down from last quarter, but this is due somewhat to seasonality.

An aggressive marketing and sales campaign during February and March resulted in a significant number of new checking accounts being opened, and balances were starting to build by the end of the quarter.

Even with our success in building additional DDA relationships, the flat yield curve drove interest-bearing deposit rates higher.

As a result, the cost of interest-bearing deposits rose 95 basis points from first quarter 2005 to March 31, 2006.

This increase in funding costs caused a drop in net interest margin from 3.92% in the fourth quarter of 2005 to 3.84% at March 31, 2006.

Controlling funding costs is our biggest challenge right now.

As we look ahead, it appears that deposit costs will be under pressure for the balance of the year.

Asset quality remains strong, although we reported a significant change in nonperforming assets, an increase of 2.2 million from last quarter to 7.6 -- an increase of 2.2 million, excuse me, from the last quarter up to a level of 7.6 million at March 31.

This increase is mostly the result of accepting deeds in lieu of foreclosure on several properties of one creditor and adding them to our REO.

These loans did not previously reach non-accrual status, but circumstances developed during the quarter making it in our best interest to negotiate the transfer of title to the properties to us for disposition.

We are actively negotiating sales agreements on these properties and do not anticipate any significant additional loss.

On the plus side, non-accrual loans declined to 3.9 million from 5 million at year-end, as we continue to work out loans acquired in both acquisitions.

Even more encouraging is the decline in loans classified as substandard or doubtful, which dropped to 44.4 million at March 31 from 52.1 million at the end of 2005.

Non-interest income was a highlight for the period, as service fees and insurance and investment income were up substantially during the quarter.

The deposit service fee income was the headliner on the bank side, as we implemented an overdraft privilege program for our checking account customers in early March.

We anticipate that this program will increase total fee income by more than $1 million for the year.

On the insurance side, we had a record level of contingent income of over $539,000 recorded in the first quarter.

This was due to sound underwriting and favorable claims experience in our Property and Casualty line.

In addition, the investment sales commissions were 256,000, up from 49,000 in the first quarter of last year.

Continued growth in non-interest income is going to be important to help offset the margin pressure that we talked about earlier.

Non-interest expense was relatively flat compared to last quarter but up 1.4 million over first quarter 2005.

A large part of that was compensation related to the additional personnel added as a result of the Genoa Savings acquisition in the second quarter of last year.

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 in an efficient manner.

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

Thank you, Bill, and good morning, everyone.

As Bill noted, our net income for the quarter was 3.85 million or $0.54 per share, which was slightly higher than we anticipated due to the record level of contingent commission income realized by First Insurance during the first quarter.

That amount, 539,000, essentially represents a bonus for writing profitable business for our insurance company partners.

It was an increase of $183,000 or 51% over the 2005 level.

We allow our Property and Casualty agents, whose job it is to write that favorable business, to keep 20% of contingent income, but the benefit to our bottom line was still significant and exceeded our initial forecast by more than $0.02 per share.

Except for that item, there were no major surprises in the quarter.

Net interest income will be our biggest challenge for the rest of the year.

Our loan yields for the 2006 first quarter increased to 6.91% from 6.1% in the first quarter of 2005 and from 6.73% in the 2005 fourth quarter.

At the same time, the cost of our interest-bearing deposits increased from 1.89% in the 2005 first quarter and 2.56% in the 2005 fourth quarter to 2.84% in the 2006 first quarter.

The combination of these items resulted in our interest rate spread dropping from 3.59% in the 2005 first quarter and 3.66% in the 2005 fourth quarter to 3.55% in the just-completed period.

Our net interest margin did improve negligibly over last year's first quarter from 3.83% to 3.84%.

That was primarily the result of an $18 million increase in average stockholders equity between those two periods.

Our net interest margin declined by 8 basis points between last year's fourth quarter and this year's first quarter, 3.92% to 3.84%.

Our net interest margin benefited during the just-completed period from some accretion of loan purchase discounts reported in conjunction with AICPA Statement of Position 03-3.

That accounting guidance requires impaired loans acquired in purchase transactions to be recorded at their fair value based on estimated future cash flows.

Though we accept that those cash flows expectations improve, adjustments are recorded as additions to interest income.

We recognized this type of adjustment for the first time in the 2006 first quarter, and it resulted in additional interest income of $153,000.

Without this adjustment, our net interest margin would have been 3.79%.

Unless our circumstances change dramatically, we do expect that we will see similar-sized adjustments each quarter for the foreseeable future.

Another important factor in the calculation of our net interest margin, as Bill noted, is our ability to attract non-interest deposit balances.

The average balance in those non-interest accounts dropped to 92 million in the 2006 first quarter from 93 million in the fourth quarter of 2005.

However, an encouraging sign is that the average balance of those accounts to grow by approximately 1.5 million between February and March.

Historically, we see a drop in the average balance of those accounts early in the year, and after the first quarter, those balances tend to build back up.

We've looked at where our margin will be in the balance of the year if this flat yield curve persists.

We are seeing significant pressure on our deposit costs, as the rate on both certificates of deposit and money market balances continues to go up.

While asset yields are going up as well, those increases haven't been as significant and are tough to get in the competitive environment we are in.

Overall, we think that our margins could be in the low 3.7% range in the second quarter and drop to as low as 3.60% by the fourth quarter.

This will obviously have a significant impact on our net interest income.

We have forecast the impact of the margin compression to be somewhere between 1.2 and 1.5 million pretax for the entire year, relative to our initial projections.

Of course, we hit some slope in the yield curve and can start seeing some more significant increases in asset yields; that impact may not be that great.

Bill highlighted the importance of non-interest income to our overall results this quarter and obviously if margins are going to be squeezed, growth in this area will be critical.

We implemented the Pinnacle Overdraft Privilege product on March 8, and with just three weeks of that product on our books, we saw an increase of service fee income related to our checking accounts of $145,000 over the income levels experienced in last year's fourth quarter.

If you project our favorable results over the balance of the year, our fee income increase related to that product could exceed $1.5 million, nearly twice what we had initially projected for 2006.

Overall, our non-interest income in the 2006 first quarter was 4.5 million, an increase of 254,000 or 6% over the 2005 first quarter.

However, our actual increase in this area was much greater than that when you consider that last year's first quarter, we had securities gains of $621,000, a gain from the disposal of a former branch facility of another $116,000, and mortgage servicing rights impairment recapture of $221,000 versus just 11,000 in the 2006 first quarter.

Excluding those items, our non-interest income was up 36.3% year-over-year.

If you also exclude the contingent income earned by First Insurance from both periods, non-interest income still increased by 34.5%.

Non-interest expense, excluding acquisition-related costs, increased by more than 14% in the 2006 first quarter compared to 2005.

In raw dollars, that increase was $1.4 million.

Approximately 600,000 of that increase was in compensation and benefits, the result of wage increases that average between 3.5 to 4%, added staffing resulting from the acquisitions, and higher insurance sales commissions resulting from the higher level of insurance and investment sales revenue.

Also in 2006, we started expensing stock options in accordance with FASB statement 123R.

That mostly non-cash deductible expense was $59,000 in the first quarter.

We also had an 18% increase in occupancy costs due to the two 2005 acquisitions, a 12.4% increase in data processing costs, and a 24% increase in other expenses.

The most significant increase in the other category was advertising and promotion expense, which increased by $122,000 or 6.7%.

Overall, our efficiency ratio for the quarter was 63.3%, compared to 64.9% in the first quarter of 2005, excluding acquisition charges.

Our Return On Assets for the quarter was 1.07%, and our Return On Equity was 10.24%.

I will now turn the call back over to Bill for some concluding remarks, and then we will take your questions.

Thank you, Jack.

We continue to be pleased with the assimilation of our products and services throughout our expanded market area.

The First Federal Bank and First Insurance and Investment brands are becoming more and more recognizable in the newer areas.

Along with that recognition is the realization that we stand behind our reputation of high-level customer service.

Targeted marketing campaigns will allow us to continue to build on this and grow market share.

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

Last week, we opened our new office on the north side of Napoleon.

This is a relocation of a branch in that community to a high-traffic retail area of town.

The business plan for this new office will be similar to our Defiance north office with expanded evening and weekend hours.

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

This new Lima location is scheduled to open early in the third quarter.

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

While we never say never, we're not currently looking at any acquisition growth in the near-term.

Profitability, as always, will be a major focus.

A key objective is the full utilization of our production capacity.

With better defined goals in place, we are tracking this performance closely.

Efficiency is very important to us, and many additional staffing requests are being challenged and scrutinized to help ensure that we can meet efficiency objectives.

We feel very good about the general business climate in our area.

We've 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're very aware that many of our customers, both commercial and retail, would be impacted to some degree by a significant downturn, we feel that we're in a position to withstand that.

Area economic surveys and discussions with many of our bank relationships also indicate positive attitudes about the economic picture for our area.

As always, there are some areas that we have underperformed but other areas to have exceeded forecast and have kept us on course through the first quarter.

The challenges are still out there and as Jack noted, margin pressure in this environment will have a negative impact on our net interest income.

But we are encouraged by our fee income growth and think that we will be able to offset a significant portion of the net interest shortfall with higher fee income.

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

We know that 2006 has its challenges, but we're focused on continuing to make it a successful year.

I want to thank you for joining us this morning and would be happy to answer any questions.

(OPERATOR INSTRUCTIONS).

Matthew Clark, KBW.

Good morning, guys.

Just a few quick questions -- the first one, do you want to take the opportunity to touch on guidance?

I know you guys provided it last quarter and I think it stood at 208 to 216.

Based on the results today and given the number of moving parts but an expectation obviously the gain on sales is going to remain under pressure; loan growth looks to be trekking a little bit below expectations and DDAs are obviously seasonally low here, and a rising provision.

I'm just wondering whether or not the deposit overdraft protection product is enough, though, to offset some of those things.

What I'm getting at is could we see some -- a lower earnings run rate I guess for the balance of the year?

Well, I don't know that we are in a position -- and we typically just give that guidance, Matthew, in the fourth quarter.

But we have rerun the forecasts; we've provided guidance on where we think net interest income is going to be.

The increases in our fee income are going to be significant.

Are they going to make everything up?

We're just not sure yet at this point, and we're going to stick with our initial range but probably we will be towards the low end of that range.

Okay, great.

Then, on the loan side, it doesn't appear that you guys reclassified prior periods in the release.

Can you just talk about where you are seeing significant incremental growth in the quarter?

What kind of customer activity or behaviors you are seeing among your commercial real estate and C&I customers in the form of paydowns and in terms of drawing down new lines and so forth?

I don't think we've seen any significant changes in any of those traits.

You know, line usage we always obviously keep an eye on that as those come up for review and everything, and I think the activity for the most part has been fairly standard throughout that area.

We are pleased to see that there are some of our clients that are making some capital investments that we feel are good decisions on their part.

Overall, again, we think that the climate is good; we think that the commercial activity, commercial lending activity, both the C&I and commercial real estate, does not show any tendency at this point to subside.

I had mentioned in my comments that our loan growth had not been at the pace that it's been at in recent years, and those two particular areas of the portfolio, were -- were not really off pace much at all.

On the retail side, we were off some.

We currently have a very aggressive home equity campaign; it looks like that's being successful.

We are still short of some of our goals as far as the mortgage originations, but we've certainly seen an uptick in that it last six weeks, so --.

Okay, great.

Then lastly, on the tax rate, it looked a little bit light.

Is that a good run rate going forward, or can we expect it to bounce back a little bit here in the second quarter?

No, I think that's probably the appropriate rate.

We project what the rate is going to be for the year when we put that together.

So, I think we will be okay.

Great, thank you.

David Darst, FTN.

Good morning, Bill and Jack.

Could you comment on any shifts in the regulatory capital levels that the reclassification will have, and any thoughts on changing the regulator down the road to someone that is more comfortable with your shift in your loan mix?

I will comment on the regulatory capital levels, and then I will let Bill answer the question relative to the change in regulator.

It won't have any impact at all on regulatory capital levels, David, because those loans, even though they were real estate loans, they were commercial real estate, which is 100% risk-weighted.

So there will be no change in our risk-weighted capital with this reclassification.

[Interesting].

David, as far as the regulator\s and our regulator of choice, we've always operated under a thrift charter.

However, as our business plan has changed dramatically over the last eight years or so, it certainly is something that is constantly part of our strategic discussion here.

You know, I think that, as time goes on and we continue to reevaluate that, we have not had I guess at this point a compelling -- what we consider a compelling reason to make that change.

But we are probably -- it's something that certainly garners more and more discussion time here at First Defiance or First Federal at the bank level.

We've had discussions with other regulators as we work through the process of making a determination of if we will make a change and when we do, which type of charter we will take.

So we've certainly been involved in the evaluation process on that.

Okay.

Would you place a probability on it, or a timeframe when -- (multiple speakers)?

I would rather not at this time, David.

Julienne Casserino, Prospector Partners.

Hello, good morning.

I was curious about your comment in the press release about the increase in your average loan balance from 982 million up to 1.18 billion.

That's not average.

I'm sorry, that was average loans outstanding, right?

Okay.

Actually, has there been any significant change in the size of your outstandings, the average size of your loans, you know, to a particular customer?

No, I don't think we've seen any.

The largest single credit we have is to a medical clinic located here in Defiance, Ohio, and that has been our single largest credit for probably five years now.

About what size is that?

I think our -- well, the total credit is around 20 million.

However, we participate out at approximately 5 million of that, so our exposure on it is 15, in round numbers.

Okay.

What would be the average size of your commercial real estate credit?

I would say an average size on those would probably be in the 500 to 750,000 range.

Okay.

The commercial real estate credit that you took the deeds on, what kind of properties were those?

Those were multi-family -- most of them were multi-family.

There were a few single-family.

He was a realtor in one of our communities and had a large number of rental properties.

I mean, it was a situation where we just took a proactive approach.

We recognized the fact that even though those had not gone to nonaccrual with situations that they developed in regards to the borrower, it was going to -- the relationship certainly indicated it was going to deteriorate, so we took a proactive approach, negotiated the transfer of the properties.

We've actually already, at this point, we've actually liquidated a couple of those properties already.

They are in the midst of negotiations on several others.

So, we think we're going to work out of that very well.

What was the total size of that lending relationship?

Just a little over 3 million.

The original size was 3 million?

None of it had gone -- it was all -- none of it had gone nonaccruing?

That is correct.

And so -- (multiple speakers).

We had put it on our watchlist, and we had set up some reserve for it, but it had never gone to nonaccrual.

How much was reserved against it?

Approximately 400,000.

400,000, okay.

Okay, and I was curious about the C revenues.

Is there some seasonality to the insurance and investment revenue -- (multiple speakers)?

There is from -- that contingent income is always paid usually during the first quarter of the year.

It's usually like a February or March event, so that's the big number right there.

This year came in at 539,000 and far exceeded what we had even expected to get.

That's basically just performance rated.

But that is a first-quarter event, and we won't be able to count on that again until -- (multiple speakers) -- quarter of '07, you're right.

However -- (multiple speakers) -- I was going to add that the insurance and investment, the investment side of that business, though, was very much stronger the first quarter of this year, and we have strong hopes that that's going to continue to build.

I was going to ask you about that.

What kind of investment products are selling so well?

Excuse me, I'm battling a cold here;

I had to get some water.

But annuities has been a strong product; they are doing -- we have, over the past couple of years, have been able to develop some more financial planning that is starting to produce a revenue stream for us there also.

So, are you moving any of your deposits customers -- any of your depository customers, their deposits into annuities would you say, or are you offering them alternative products and --?

Our bank personnel are very aware of the products that are available through our other business unit, our investment business unit.

There are some situations where we have had some deposits that have moved over to that side.

But at the same time, we've been able to develop some new bank relationships through investment customers also, so we've not seen that it has really caused us any problems as far as the deposit side of the Bank is concerned.

Just in terms of profitability, is it more profitable for you to hold a deposit on your balance sheet, versus to collect a fee revenue for moving it into an annuity?

Which one is more profitable to you?

That depends on what CD rates are. (LAUGHTER)

On average?

Yes.

It's, you know --

You know, looking at your average deposit costs.

Yes, I think we're still better off on the deposit side, especially from the standpoint that funding our loan growth is so important to us that if we had -- just a blanket reaction to that would be that we would rather see it on the deposit side.

But at the same time, if we could maintain a relationship, we want to maintain the relationship.

Okay.

Then my last question is just looking at the growth and the fact that we are in a flat yield curve, and maybe not growing very fast is a smart thing and looking at your capital level, which went up this quarter, I was just curious maybe why not consider buying back stock, particularly with your dividend yield being where it is, and it just seems like the incremental use of your capital might be compelling at this point in time.

It's always a possibility, if we get a get the stock at the appropriate price, and I would agree with you that the price it's at now is probably an opportunity for us.

We generally follow our own restrictions in terms of being out of the market in advance of earnings, the month in advance of earnings release, so that window opens again this Friday.

We will see what kind of stock we can get.

I agree with your suggestion, Julienne.

Great, so it's something you've considered and -- (multiple speakers)?

Continuously.

We have an active buyback, an open buyback plan out there right now, so.

Great, thank you.

(OPERATOR INSTRUCTIONS).

Christopher Marinac, Fig Partners.

I wanted to follow up on deposit strategies and any type of incentives or perhaps even additional personnel that are focused on being low-cost deposits.

I'm just curious about what do you think will work in this next couple of quarters.

Chris, one of the things we did is we created a position of deposit product manager and an individual that's been with our company for a number of years and is very familiar with our operation.

She, I think, has done an outstanding job here since the first of the year, as far as being able to develop, along with our marketing department, some good, internal programs as far as trying to go out and attract more deposits.

I think we mentioned this in our comments earlier.

That program, during February, the first part of March was very successful at attracting some new accounts.

Now, we're just now starting to see those balances really start to grow and will have an impact for us, but we think that assigning somebody basically ownership of that part of the business was something that probably should have been done sooner but we've done it; we've got the right person in there and it's moving very well for us right now.

Also, our cash management products, we've got a group in charge of our cash management area that we're getting much more aggressive with that, and I think starting to see some successes there, especially working with a lot of our commercial customers in that way.

Then one other thing that's happened here in the state of Ohio, and this will become effective July 3 -- they've approved -- (technical difficulty) -- any public funds that we have on deposit needed to be collateralized; anything over 100,000 we have had to be collateralized with securities, and that really gets to be a problem.

But the State of Ohio now has approved the use of a program called CDARS -- C-D-A-R-S is the acronym, CDARS.

Basically what it is, I guess in Lehman's terms, is it is deposit participations similar to loan participations, where we could take in, say, a $1 million deposit, book 100,000 on our books, run it through the CDARS program and then it's spread amongst nine other banks to give the individual the full FDIC insurance.

So that is a product that we're going to be able to use on the public fund side.

And we get money back.

Yes, and we get money back but it's basically a trade on deposits.

That's been approved on the public fund side effective July 3 of this year.

We think that's going to give us an opportunity to be much more aggressive in going out and seeking some public monies, especially on the operating side.

Bill, does the CDARS program come onto the balance sheet in the -- (technical difficulty)?

Yes, it does.

So almost if you have success there, we should segment out the customer consumer CDs versus the -- or public?

Actually, it will have the same general characteristics of retail CDs, Chris.

You know, perhaps if this program gets sold, the public bonds will break that out, but the general customer -- it's just like we're getting ten $100,000 CDs, and they all have general CD terms.

Sure, I understand.

But hopefully, they might be sticky or under the public format?

Public funds money is always hot.

Yes, what we'd like to see, though, is what this does is, is it gives us an opportunity to sell CDARS CDs to public bonds.

That will free up the collateral so that we can more aggressively bid on operating accounts.

Great.

Then I guess a separate question for you both is are you seeing anything more aggressive from your large bank brethren, or would they have been behaving differently in recent months?

We've actually seen them -- what we would say -- pricing has, on the loan side, has gotten maybe a little bit more sensible with the larger banks.

I think that everybody seems to think -- have come to the realization that you can't go out and just keep trying to undercut each other.

So on the loan side, I think the pricing from the larger regionals has gotten more in line with where we would like to see it.

On the deposit side, though, it's just very, very aggressive out there, both in the CDs and the money market accounts.

The big banks have been, to the benefit of the newspapers in the area, spend a lot of money on advertising some pretty aggressive programs.

Very well, thank you both.

At this time, there are no further questions.

Are there any closing remarks?

Well, if there are no other questions, we would like to thank everyone for participating today and encourage you to, if you have additional questions, give us a call.

Thanks once again, and this will conclude our call today.

This concludes the First Defiance first-quarter 2006 conference call.

You may now disconnect.