Premier Financial Corp (OHIO) (PFC) 2006 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the First Defiance Financial Corp. 2006 third quarter earnings conference call. At this time, all participants are in a listen-only node. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). 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 begin.

Good morning, everyone, and thank you for joining us for today's conference call. The call is also being Webcast, and the replay will be available at First Defiance web site at www.FDEF.com until November 30.

This morning, we will begin with comments on the results in 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'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 press release, in the management discussion and analysis section on 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 third-quarter 2006 results. Last night, we issued our earnings release for 2006 third quarter. 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 give you more financial detail on our performance during the quarter and the year to date.

In the release, we reported net income of $3.82 million or $0.53 per share for the quarter ended September 30, 2006, on total assets of $1.52 billion. Adjusting out acquisition-related charges from the third quarter of 2005, the 2005 third-quarter core earnings would have been $3.69 million or $0.51 per share.

In light of the current yield environment, we are pleased with our third quarter performance. Our funding costs continue to increase at a faster rate than our young loan yields, and as a result, margin compression left net interest income virtually flat compared to third quarter 2005. While this is certainly not a unique situation in our industry today, it continues to be our biggest challenge. We saw continued growth in non-interest income in the quarter, which was up over 25% from last year's third quarter, and this helped offset some of the margin compression.

Looking at our overall performance in the third quarter, loan growth slowed somewhat during the period. The slowdown was partially driven by less demand, but we also backed away from several deals because of pricing issues and a more selective approach on credit factors. With fewer opportunities out there, pricing has become very aggressive, especially on stronger credits. We are stressing to our lenders they need to be prudent in underwriting and pricing.

On the deposit side of the balance sheet, the environment is no less competitive as we work to increase the non-interest bearing commercial and retailed DDAs. As deposit rates have remained high, funds continue to flow to the certificates of deposit. Aggressive marketing and sales efforts are producing a significant number of new checking accounts being opened, but balances have not grown. With the inverted yield curve keeping interest-bearing deposit rates high, the cost of deposits was up another 35 basis points this quarter over the second quarter.

Funding and controlling funding costs is an ongoing challenge; and as we look ahead, deposit costs show no sign of abating for the balance of the year.

Credit quality remains stable but is certainly getting more of our attention as nonperforming assets increased to $10 million as of September 30. Our credit quality ratios overall are in line with our peer group, but are higher than we have seen them historically at our bank. Net charge-offs were at 10 basis points annualized at the end of the third quarter, which is in line with our recent experience. However, we have implemented additional monitoring programs and action plans to bring all of our credit ratios back in line with our strong past performance.

Non-interest income again this quarter produced a significant increase over the same period last year. The 25% increase in the third quarter this year over third quarter of 2005 was instrumental in allowing us to grow earnings in this tough rate environment. We continue to look for additional ways to enhance these revenues as ongoing growth in non-interest income is going to be important to help offset the margin pressure.

Non-interest expense was up compared to last quarter and third quarter 2005. However, the majority of the increases are related to our growth initiatives; and we're relatively pleased with our overall performance in controlling other expenses, in particular, compensation and benefits, and our efficiency ratio is in line with our forecast.

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 look at the rest of 2006. Jack?

Thanks, Bill, and good morning, everyone. As we've already mentioned, our net interest income was flat between the 2005 and 2006 third quarters at $12.2 million. This despite the fact that we've been able to grow our balance sheet over the last year as our average interest-earning assets have increased to $1.36 billion in the just completed quarter from $1.275 billion in the same period last year - an increase of almost 7%.

Our net interest margin for the 2006 third quarter was 3.59%, down from 3.69% in the second quarter and down from 3.85% in last year's third quarter. Like most other banks, we are being significantly impacted by the flat yield curve. Between this year's second and third quarters, the yield on our total interest-earning assets is up 18 basis points and the yield on our loan portfolios is up 19 basis points. However, during that same period, the cost of our total interest-bearing liabilities has increased by 30 basis points and the cost of our interest-bearing deposits has gone up 35 basis points.

As a result, our interest rate spread has tightened by 12 basis points in just the last quarter from 3.39% to 3.27%. By comparison, our spread in last year's third quarter was 3.60%.

Frankly, we see things continuing to tighten for at least the next quarter. We have a certificate of deposit portfolio that totals more than $653 million at September 30. The average rate on that portfolio is 4.51%. In October, November and December, we have a total of $175 million of CDs in that portfolio that will mature at a weighted average cost of 4.42%. In September, the average rate for new or renewing CDs was 4.93%. So you can see if nothing changes, we're looking at those $175 million of CDs replenishing up by approximately 50 basis points at some point during the fourth quarter. At the same time, we do not think our loan rates will move up much from where they are at right now.

Based on these factors, we expect our margin will fall, probably by another 10 basis points in the fourth quarter, somewhere in the 350 range.

We have been able to offset the margin pressure by growing our non-interest income, which increased by more than $1 million in the 2006 third quarter or by nearly 26% when compared with the third quarter of last year. Year-to-date, our non-interest income is up by more than $2.5 million or almost 21%.

I do need to note that the 2006 amount includes a $400,000 gain in the second quarter from the sale of our MasterCard portfolio and a $115,000 gain in the third quarter from the sale of a former branch facility. However, the 2005 year-to-date total included $1.2 million of gains from securities sales, including $86,000 in last year's third quarter. If you exclude gains from securities sales, and gains from -- and other onetime gains from the total, our third quarter 2006 non-interest income increased by 25.8% over last year, and for the nine-month period ended September 30, our non-interest income grew by 29.7%.

As we mentioned last quarter, we implemented a very successful overdraft privilege program late in the 2006 first-quarter. Our fee income associated with checking accounts increased by $972,000 in the 2006 third quarter compared with the same period of 2005 and we're very confident that that level of income will be recurring. Interestingly, we saw a noticeable increase in the use of the overdraft privilege product in August, corresponding with the back to school shopping season.

We believe we will see another uptick in the fourth-quarter corresponding with the Christmas shopping season.

I would also like to note that our net mortgage banking revenue declined slightly in the 2006 third quarter, compared with last year's third quarter. However, last year's results included the recapture of $240,000 of previously recorded mortgage servicing rates valuation adjustments while this year's quarterly results included a $16,000 impairment charge - a swing of $256,000 between the two periods. Our mortgage loan gains year-to-date are slightly ahead of last year and our servicing revenue continues to grow steadily as a mortgage servicing portfolio experiences gradual growth.

On the non-interest expense side, our total overhead costs increased by $595,000 or 5.7% in the third quarter of 2006 when compared with the same period in 2005. Our compensation and benefits costs, which comprise more than half of our non-interest expense, were up just 2.5% in that period, and that includes approximately $77,000 of charges associated with the expensing of stock options.

The earnings release highlights a number of other areas where we have had increases, most of which are growth-related. I should note that the $972,000 increase in checking fees - related to the overdraft privilege product - cost us approximately $108,000 in new fees to the overdraft privilege vendor and an additional $81,000 in increased checking account charge-offs.

We are obligated to pay the vendor through the second anniversary of the implementation of the product or through March of 2008.

Our effective tax rate for the quarter of 34.1% was slightly higher due to an adjustment related to the tax effective expensing stock options. We expect the tax rate for the balance of the year to be consistent with our effective tax for the nine-month period or 33.2%.

Focusing for a minute on the provision for loan losses, we recognized a quarterly provision of $373,000 - a level of expense that is consistent with our recent charge-off activity. We are very confident that the resulting allowance for loan and lease losses of $14.3 million at September 30 is adequate.

That includes my commentary on the third quarter financial statements. I would like to the call back to Bill for some closing remarks, and then we will try to answer your questions. Bill?

Thank you, Jack. For the first nine months of 2006, we have stayed on course with our earnings projections. The path to getting there has been slightly different than we anticipated, but we have found new revenue sources to help offset the lower than expected net interest income caused by margin compression.

However, we are very aware that the remainder 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 and alternative funding costs will level off in the short term. However, we do not see any near-term decline in funding rates. We must keep our focus on asset quality to assure that we maintain our historically strong credit performance of our loan portfolio.

On the positive side, we expect our loan growth to continue but not at the 15% to 18% annualized rate that we have seen in recent years. This is due to the reasons I mentioned earlier, as well as the fact that as our portfolio has grown, it becomes more difficult to add the new business at these same high levels.

Our deposit product initiatives continue to add non-interest-bearing checking accounts, and last week we introduced our remote deposit capture product that we think will significantly increase our opportunities for commercial deposit accounts. Fee income will be a strong component this year due to the overdraft privilege program and some new ATM fees that are now in place and other sources that we continue to research and implement. We will focus on improving the efficiency ratio as we continue on through the remainder of 2006, especially realizing the challenge on the revenue side.

Economic conditions in our market area are fairly positive as we get out and talk to business people throughout the region. We continue to see capital investments being made in a variety of businesses and many are continuing to hire. On the agricultural scene, the fall harvest season is underway. Most farmers are reporting very good yields at this point, along with good prices. Based on all this, we feel very good about the general business climate in our area.

As we begin the final quarter 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. We have a great team of individuals throughout this organization and as a team they are responsible for our success to date and will carry us on to a successful year. They are very aware of the challenges out there and are ready to meet them.

I want to thank you for joining of this morning, and now we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Matthew Clark. KBW.

Can you discuss your view on share process in the light of margin pressures and some slowing in on the loan side and what maybe your target capital ratio might be?

We have been purchasing about 25,000 shares a quarter. That is determined by a number of factors, including capital levels and the level of stock being shown into the Company. I expect short term, we will continue at about that level, Matthew. It depends on the price of the stock we can repurchase, it depends on the feedback we get from regulators on capital levels.

It depends on a number of factors. But I expect it will be in the range that we have been at here in the last several quarters.

Can you also touch on any expense initiatives that you might -- that you are considering maybe related to be realigning trust or along those lines, maybe talk of any targeted efficiency ratio in your timing?

Some of the things that -- one of the things we are doing as we are looking at, with the trust area, we have gone through and revamped -- are seeing some much better results with our fee structure in the trust area. We also are -- we have an investment division that is actually part of our First Insurance & Investment business unit. And we are looking at the concept of merging those into more of a wealth management area here at the bank.

So that is something that we are looking at. We think there's potential for us to probably grow that a little bit more than we have.

As far as some other expense initiatives, I think that one of the things that we have done this year and it has helped us control our compensation and benefits costs is that we have hired at a slower pace than what we originally anticipated this year. We've tried to take a pretty strict approach at do we really need to add a body here or there?

As a result, we've been able to control those costs much better than what we had anticipated it might be as we went into the year.

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higher levels of check charge-offs. However, as you can see as Jack went through the numbers, it has been a pretty good trade-off for us. $972,000 increase in revenue from that product versus $81,000 in charge-off fees. I do not know, I think that I do not know that we really anticipate that those will go a lot higher. I would guess that they would probably flow with the level of revenue that comes along with that.

Okay, but you do not see anything systemic?

Definitely not. As I said, this was anticipated when we introduced this program.

(indiscernible) Partners.

I was wondering if you could comment on your appetite for future acquisitions over the next year or two? And basically what you see in the region as potentials.

Well, there is always a lot of -- everybody is always speculating who might be on the block, I guess, at different times. We are not, right now, Bret, we are not out aggressively knocking on doors as we were a few years ago. We did three acquisitions between the middle of 2003 and April of 2005; and that was a pretty aggressive schedule, I felt, for a company our size.

We are pleased with the way those integrations have gone, but at the same time, we felt that we took on an awful lot in a relatively compact period of time.

So we are not totally opposed to taking a look at acquisition opportunities and in fact have reviewed a number of different opportunities over the past year or so. But none of them that we felt had enough strategic value for us to move forward on. We will continue to keep our eyes open. But as I said earlier, we're not out beating on doors pushing for it right now.

As far as the overall climate is concerned, I would anticipate that there probably will be some additional opportunities that will come forward and just the general climate out there, the environment, it's tough - especially for small companies. So I think there may be some opportunities that might present themselves.

Okay, well, that was my only question. Thank you very much.

(OPERATOR INSTRUCTIONS). David Darst. FTN Midwest.

You indicated in the release that you think your yields on loans will probably come close to topping out. Can we get some idea of what our new CRE yields are and maybe elaborate a little bit more on the other yields?

On the Commercial Real Estate -- hang on just a second, I can get you some more accurate information on that. But as I mentioned my comments today, it is very aggressive out there with some of the pricing.

But our commercial loans as a whole, at the end of September, total commercial loans had a yield of 7.18%. And that had gone up slightly from prior periods. But right now, based on what we have seen over the past several weeks, and forecast as far as interest rates are concerned out there in general, I would anticipate that we are going to probably see that is kind of leveling off at that point right now. I am hoping that we don't see any decline in that.

Again, that is part of what we need to do as far as staying disciplined in our pricing.

Okay, so you are distributing a portion of this to competition?

Definitely. As fewer deals are available out there and the number of players in the market are still -- that is a constant number. Everybody gets pretty aggressive. And I think again, we have to be careful as to where we take this pricing.

And then on the service charges, you indicated that you expect Christmas to be strong as well as what you saw at the back to school on the overdraft side. So, do you expect that to defer the growth on a link quarter basis with that product, or at Christmas -- ?

I would say, David, it's probably more than of a hope than an expectation. Since we have not been through a holiday season yet with this program, we are just going by what we saw in August with back to school bounce that we got, and potential for another increase in the level of fees if the same thing happens with the Christmas shopping season.

The last question is, have you looked at a rebranding initiative recently?

A rebranding initiative as far as --?

Changing the name, moving away from the First Federal name into something that might allow you to change your charter?

Charter option is definitely something that we are evaluating. One of the things, in fact, we've done -- we did some checking to see whether or not we would be able to keep the name First Federal. I do know that that has got some thrift connotations to it just by name, regardless of what charter you're operating under.

But there is also a lot of expense and risk involved with the branding change. But the charter option is certainly one that we are looking at very, very closely.

And I think, David, what Bill is referring to is we've got the ability to change charters without changing our name, and that is something we have researched and confirmed over the last quarter.

Julienne Cassarino. Prospector Partners.

Just to clarify the last question, you are thinking of -- you are thinking or considering changing the charter for the entire -- for the holding company?

Yes.

Okay. And just to clarify what you said earlier in your comments about the loan growth, it is primarily due to your internal underwriting standards as opposed to the market growth?

Actually, I think it is a combination of those things. I think there is -- I think demand is down slightly, and I don't want to give the impression that it has dried up totally, but I do not think it is quite as robust as it was earlier this year.

But also from our standpoint, we are stressing the importance of making sure that we are pricing our deals appropriately and also that we are making sure that they are underwritten properly. We do not want to get caught up in going after opportunities that we would not be chasing in a more conventional type of market, where there is more opportunities out there.

Okay. So there is some market growth change, but it's -- ?

Right. And really, a big part of the reason that we have been growing at probably a 15% to 20% per year organically with our loan growth and now that we have got that loan portfolio the size that it is, it's exponentially to stay at those levels, I mean it is just -- makes it very tough.

Plus it requires work of our lenders just to service the loans they've already made as opposed to when we did not have a -- when we had a small portfolio they could grow loans just by focusing on new growth. They did not have to worry about servicing existing customers.

From my perspective, as a shareholder, I would much rather see you do exactly what you're doing, which is dial back profitable growth, focus on the profitability levels and use this period of time within a flatter inverted yield curve rather than growing unprofitably to really actively manage capital and in particular buy back stock. I mean, how much is left on your authorization, which I think was way back in 2003?

Yes, it's a couple hundred thousand shares.

I mean, honestly, I do not think the regulators can fault you for returning capital in this kind of environment. If anything, they should applaud you for not taking on balance sheet risk.

Yes. We do not disagree with that.

(OPERATOR INSTRUCTIONS). Gentlemen, there are no further questions.

All right; and thank you very much. This will conclude our call for today.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.