Premier Financial Corp (OHIO) (PFC) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Defiance Financial Corporation second quarter earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation.

(OPERATOR INSTRUCTIONS).

Also as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Carol Merry.

Thank you, Ms. Merry. You may now begin, Ma'am.

Thank you. Good morning, everyone, 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 website at FDEF.com until August 31st.

This morning, we'll begin with comments on the results and the Company's outlook from Bill Small - Chairman, President, and CEO of First Defiance - and 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 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 the 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 undertake any duty to update any forward-looking statements. And now, I will turn the call over to Mr. Small for his comments.

Thank you, Carol, and good morning and thank you for joining us for the First Defiance Financial Corp. conference call to review the second quarter and first-half 2006 results.

Last night, we issued our earnings release for our 2006 second quarter and this morning we would like to discuss that release and our results to date. At the conclusion of our presentation, we will answer any questions you might have.

I would like to begin by giving you an overview of the quarter and then Jack will keep you more financial detail on our performance during the quarter and the first half of the year.

In the release we reported net income of $3.95 million or $0.55 per share for the quarter ended June 30th, 2006, on total assets of one 1.51 billion. Adjusting out acquisition-related charges from the second quarter of 2005 the 2005 second quarter core earnings would have been $3.6 million or $0.51 per share. The 2006 quarterly results represent an 8% increase over the same quarter last year. This year's second quarter results do include the gain on sale of the Company's $2.1 million credit card portfolio that I will discuss in more detail later.

All in all, we were very pleased with our second quarter performance especially in light of the current yield environment. Our funding costs increased at a faster rate than our loan yield - a story that I am sure you are hearing over and over again from banks this quarter. However, we saw continued strong growth in non-interest income in the quarter while we were also able to limit the growth of non-interest expenses to help offset some of the margin compression.

Looking at our performance in the second quarter, loan growth remained good and was stronger than our first-quarter growth. We budgeted loan growth very aggressively this year and still have not reached our expected levels. The second quarter did show very strong progress as we moved closer to our targets in many categories.

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

On the retail side of lending, residential mortgage loan and home equity loan originations were stronger in the second quarter but were still behind our targeted levels. Other consumer loan balances declined quarter to quarter.

As I mentioned earlier, we made the decision to sell our credit card portfolio and completed that transaction at the end of the second quarter. This was a line of business that we did not aggressively market to our customers, and it maintained a flat balance of about $2 million for quite a while. The change should be transparent for our existing credit card holders.

Our customers will continue to have a First Federal branded card and they will have access to more options and services than we could offer. At the same time, we will continue to share in a portion of the interchange fees generated by cards with the First Federal name on them. We expect to net nearly as much from these interchange fees as we did from the credit card portfolio itself, after factoring in all administrative costs and charge-offs.

On the liability side of the balance sheet, we are finding it difficult in the current rate environment to make progress at improving our deposit mix as we seek to increase the non-interest-bearing commercial and retail DDAs.

As rates have continued to decline, funds continue to flow to the CDs. An aggressive marketing and sales campaign during the first and second quarter resulted in a significant number of new checking accounts being opened. But balances have not grown.

Short-term rate increases driven by the Federal Reserve policies have resulted in the cost of interest-bearing deposits, rising another 33 basis points this quarter. Funding and controlling funding costs is our biggest challenge right now; as we look ahead, it appears the deposit costs will be under pressure for the balance of the year.

Asset quality remains stable, even though non-performing assets increased to $8.9 million at June 30th, 2006. This was the result of one $2.5 million relationship falling 90 days past due and the borrowers filing for bankruptcy. We are confident that the $400,000 allowance we've recorded is adequate to cover any shortfall on the disposition of the property.

Unfortunately this is the second consecutive quarter that we had a credit of this size go to non-performing status. On the plus side, we have made some progress in selling the properties that we took back in the first quarter and remain optimistic that we will not realize any further losses on the remaining properties.

Non-interest income was a highlight again this period, as service fees continued to grow, primarily as a result of our overdraft privilege program initiated late in the first quarter. We anticipate that this program will increase total fee income by more than $2 million for the year. Changes that we have made in our trust area at the beginning of the year are also starting to produce additional fee revenues.

We continue to look for additional ways to enhance these revenues as continued growth and non-interest income is going to be important to help offset the margin pressure.

non-interest expense was up over the second quarter of 2005 when you adjust last year's numbers for the acquisition-related charges. However, the majority of the increases are related to our overall growth initiatives; and we are relatively pleased that we have reduced our efficiency ratio on a core basis by 1.75% over the last quarter and almost 4.5% over the 2005 second quarter.

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 and a look at the rest of 2006. Jack.

Thanks, Bill. Good morning, everyone. There are four key factors that contributed to our results for the just-completed quarter. Margin compression, substantial increases in non-interest income, a leveling off in non-interest expenses, and an increase in our provision for loan losses.

Probably the most significant of these is the net interest margin compression. As we noted in the earnings release, the net interest margin for the 2006 second quarter was 3.69% - an 18 basis point drop from the 2005 second quarter and a 15 basis point decline from this year's first quarter.

Plus, our interest-bearing liabilities increased by 107 basis points over last year's second quarter, and by 30 basis points from the prior quarter of this year. During those same periods, our overall yields on assets increased by just 80 basis points and 14 basis points, respectively.

This is not a situation that we expect to improve in the near future.

For example, over the next three months we have over 160 million of CDs that are scheduled to mature; and we anticipate the rates on those will increase between 80 and 100 basis points. We also face continuous pricing pressure on our money market demand account balances, which exceed $200 million.

While we are seeing some rate improvements on the loan side, those rates seem to be more dependent on the intermediate term rates, which just haven't moved very much. Our interest rate spreads have declined from 3.66% in the 2005 second quarter to 3.59% in the first quarter of this year, to 3.39% in the just-completed quarter. It is not unreasonable to expect those spreads to continue to tighten; and we will hopefully see a third-quarter margin as low as 3.6%.

While we expect loan growth to accelerate in the second half of the year, this will put further pressure on our margins as incremental loan growth is being funded primarily with retail and wholesale CDs.

Fortunately, we have been able to grow our net income because of substantial increases in non-interest income. Last quarter, we indicated that we implemented an overdraft privilege product for our retail checking customers beginning in early March. The just-completed quarter was the first with three full months of fee income from that program, which has significantly exceeded our expectations.

Fees associated with checking accounts increased by $794,000 over the 2005 second quarter; and we believe this is representative of the level of quarterly increase we will see for the balance of 2006.

We also have realized increases in our mortgage banking income over the past year. For the quarter, mortgage banking income was up by 70% over the last year, although a portion of that relates to adjustments to impairment reserves. Mortgage loan gains themselves were up by over 30% in the second quarter when compared to last year. While the mortgage business remains difficult, we do expect that we will continue at least ahead of last year's pace.

Non-interest income also includes gains from the sale of our credit card portfolio of $400,000 which represented a 20% premium. After factoring in all the costs associated with the credit card portfolio, we have just barely broke even over the last several years. As Bill noted, we anticipate that the ongoing revenue stream from the agreed sharing of interchange fees on the First Federal branded cards will effectively offset much of the income that we gave up with the sale of that portfolio. That sale will also help to improve our risk-based capital.

Excluding acquisition-related charges of $2.5 million reported in last year's second quarter, our non-interest expenses increased by $753,000 or about 7.5%. Some of the increases were driven by overall growth, including increases in data processing and occupancy.

In addition approximately $240,000 of the expense increases relates to costs associated with the implementation of the overdraft privilege product, including postage costs for various direct mailing programs as well as fees paid to the program vendor. We are pleased that our overall compensation in benefits cost declined in the second quarter compared to the prior year. Most of that decline is due to adjustments to our overall health insurance costs, resulting from favorable experience in our self-funded program.

To be conservative, we have historically accrued a liability equal to our maximum exposure under the program. Our recent experience has been significantly improved; and we have been able to reduce the monthly estimates accordingly.

We anticipate that compensation costs will increase in the second half of the year as staff positions are being added. And we opened a new branch early this month.

We recorded a larger loan loss provision this quarter - $683,000 - compared to $349,000 in the second quarter of last year. Net increase relates primarily to the one large credit that Bill discussed. Our charge-offs remain relatively low at about .1% of assets on an annual basis.

That concludes my analysis of the financial statements. I will now turn the program back to Bill for some closing remarks; and then we will try to answer your questions. Bill.

Thank you, Jack. As I stated at the beginning, we are pleased with our performance through the first half of 2006. However we are very aware that the second half of the year will be extremely challenging and we will need to find ways to supplement net interest income.

Margin pressure will continue to be our biggest challenge just as it is for most banks. We expect deposit costs to continue to climb in the short term, as well as alternative funding cost. We also must maintain our focus on asset quality to ensure that we maintain the historic strong credit performance of our loan portfolio.

On a positive side, we expect our loan growth to sustain its stronger second-quarter pace and our deposit product initiatives to add non-interest-bearing checking accounts. Fee income will be a strong component going forward this year, due to the sources that I mentioned earlier as well as others that will be introduced in the second half of the year. We will also keep a focus on our improving efficiency ratio for the remainder of 2006.

Operationally, we opened an office in the Shawnee area of Lima last week. It is the Company's 26th office. This is a part of the Lima market that we knew we had to be in from the beginning and are very excited about its potential, especially as a deposit-generating office.

Our newly relocated Northside Napoleon office that opened in April is doing very well in its first couple of months; and the customers in that market seem to appreciate our extended hour format.

Economic conditions in our market area seem to be solid as we go out and talk to business people throughout the area. We continue to see capital investments being made in a variety of businesses and many of them are hiring. At this point in the summer, most of the farm crops look good and with most of the wheat harvest completed, reported yields of that crop are very good.

Based on all this we feel confident about the general business climate in our market area. We have been asked many times about this region and its ties to the automotive industry; and 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 are aware that many of our customers, both commercial and retail, would be impacted to some degree by a significant downturn, we feel that we are in a position to withstand that.

As we move into the second half of 2006, we remain confident in our strategic plan and the business blueprint that we have developed to implement that plan. I know that we have the people that are very capable of carrying out that plan and accomplishing all of our goals. This is a great team of individuals throughout our entire organization; and as a team, they are responsible for our success to date and will carry us on to a successful year.

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

(OPERATOR INSTRUCTIONS) Matthew Clark of KBW.

First, on the margin, it sounds like you are getting to the 360 level a quarter early. Any idea as to where it bottoms out here, given all the pressures you talk about? You know where and when? I know that's not easy to do.

It would be a guess, Matthew, it really would. I think we are going to see pressure for the rest of the year. Unfortunately, if the Fed continues to move, that means we will continue to have a flat yield curve. If the Fed stops moving and rates don't change much our deposit rates will probably continue to go up, just because of the repricing. And our loan rates won't move up because they are prime-based.

So it's sort of, we are in that stage right now where it's going to be touch and go, I think, for the rest of the year. And I don't know where the bottom is.

Are you -- and part of that second half expectation, are you contemplating any type of CD or money market promos?

We have got a number of promos that we have tried to make sure we've had in place throughout the year; and continuing to try to keep an eye on what moves we think the Fed is going to make or not make throughout the remainder of the year; and how to best position ourselves to be able to react to that. Our [outlook] committee has been very very active and will continue to be so.

Then on the credit provision, it sounds as though the Reserve addition for this $2.5 million NPL was taken this quarter. A fairly sizable one. Is there - assuming that the deterioration in credit is not widespread going forward, could we possibly see a lower run rate on the provision going forward? Taking possibly the reserve levels down a little bit?

I think so. Obviously, we hate to come back with a second straight quarter of a credit like this but it is not a problem that we feel is inherent in the entire portfolio by any means. This is, again, an isolated case. And I certainly at this point in time don't expect this to be the run rate that you are going to see for the balance of the year.

Great. Then, lastly, on the hiring and the branch opening, I guess how significant could that bump your comp costs in terms of run rate going forward, do you think?

As far as the branch is concerned, we will have -- part of that expense is already showing up because the people were brought on board for training during the past quarter. We do have a couple of positions that we had put off filling throughout the first half of the year that we probably really from a safety and soundness standpoint, we feel that we are going to have to bring on in the second half of the year.

Unfortunately, those are positions that are not revenue-producing positions for the most part. So again we are -- but they are built into our budget. They were built into our budget and, hopefully, we are prepared to deal with that.

In terms of dollars, it's probably going to be an additional $150,000 over the second half of the year. That's ballpark.

Thank you.

David Darst of FTN Financial.

Could you give us an indication of what you are seeing that would lead you to think your loan demand will improve in the second half of the year, because I guess both the first and second quarter were somewhat under what you thought you might be able to do.

We -- as I mentioned in my remarks earlier, we were very aggressive with what we built into our budget. On the commercial side, our loan demand continues to remain strong. I think we are growing at a rate that most of our competitors in this area wish they had that type of loan demand.

I think, especially, the first two months of the year were extremely below our forecasted levels even though they outperformed the prior year. We are starting to make up some of that. On the retail side, the mortgage business has slowed even more than I think we had anticipated but, again, second-quarter numbers were much better.

We are seeing some early indications that the third quarter, at least, is going to maybe keep pace with where we were second quarter. But obviously we are only a few weeks into that. So got some time to tell.

But, I think that we continue to have our people out on calling programs; and we know we need to be aggressive if we are going to come anywhere close to meeting our objectives.

Then with the overdraft protection program, do you expect to see more normalized growth the second half of the year? Or is there still some room for you to more aggressively grow that product as you (indiscernible) further?

I think that the full second quarter that we had is going to be pretty indicative of what we expect out of that program. Hopefully, as we continue to grow our number of accounts, that that will incrementally add to it but -- .

Just mechanically we put everybody on the program at once so that they've all been through several cycles of it now. And it's been pretty heavily marketed.

So I don't see that -- I don't know that there is anybody out there who is not using the program now that will be in the future. We think we have got them all on.

And you made a reference to some other fee income initiatives for the second half of the year.

Yes. And we have a couple - one in particular that we will launch this month that we think will be a significant boost to us. Our early indications are that, on an annualized basis, it could be between $700 and $800,000 annually from non-interest income.

And we hope to have that program launched by the middle of next month.

Is that a commercial or a retail product?

Retail.

Okay. Then the fees for the [Riverdrop] production (inaudible) . Is that an ongoing fee or is that just one-time expenses implementation?

No. It's a fee that we charge the customer when they use the overdraft privilege product.

I am sorry. The vendor fee?

The vendor fee? The vendor fee, we are committed to pay and it is a percentage of the growth in the overdraft charges. And I will be honest, David, it is either one year or two years.

I can't remember what we ultimately ended up negotiating. We will try to clarify that in a future release.

Thank you.

(OPERATOR INSTRUCTIONS). Chris Marinac of FIG Partners.

I wanted to ask just one more follow-up on the margin and just a general topline revenue. Would you think that the interest income in dollars would be kind of flattened down again like it was this past quarter?

I was trying to do a little math on that myself this morning to try to get a feel for what kind of asset growth we are going to need to offset the decrease in the margin. I think, basically, about 30 million of growth a quarter, with margin falling about 10 basis points will keep us at the level we were at in the second quarter. And, $30 million of growth is sort of consistent with what we have budgeted.

My feeling is at least just doing a back of the napkin type of calculation is that if our margin drops 10 basis points and our loan growth is $30 million, we will end up with net interest income in the same range that we were at in the just-completed quarter.

Great. Two other follow-ups, I guess, one just to drill down on Bill's comments on the economy. Has the wet weather been any issue from the crops the last three, four weeks or has that been sort of a nonevent?

I think the crops were -- first off the when harvest was pretty well along before we got the rain up in our corner of the state. I think the corn, the corn especially was very very well-established. They had a great early corn season that got that you know the phrase knee high by the fourth of July.

I mean you were -- you saw stuff that was shoulder high and above the head in a lot of fields. So the crops were pretty well established. The rains have come a little bit heavier than what we would like to see but at least in our immediate area, it looks like things are going to be able to handle it all right.

We have had some extremely hot temperatures over the past week that, obviously, always raises a little bit of concern. But it is moderated again now and hopefully things are going to continue on for a good strong summer and a good fall harvest.

Last question, Bill. Is the environment that you are struggling with and others are, too, is that changing any of your strategic conversations with people? Are folks more willing to talk with you because they, too, are having some issues?

You say folks. I --.

The other banks.

I don't know that we have seen any definite pick-up in that activity, Chris; but certainly I think that if over an extended period of time it is going to probably promote some of that.

Thanks so much.

Thanks Chris.

(OPERATOR INSTRUCTIONS). Gentlemen, I'm showing no further questions at this time.

If there are no further questions, we will conclude our conference call and thank everyone for participating this morning.

Ladies and gentlemen, this does complete today's teleconference. Thank you again for your participation and you may disconnect your lines at this time.