Premier Financial Corp (OHIO) (PFC) 2006 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the First Defiance Financial Corp. 2006 fourth quarter and year end 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). 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.

Thank you. Good morning. Thank you for joining us for today's fourth quarter and full year 2006 conference call. This call is also being webcast and the replay will be available at the First Defiance website at www.fdef.com until February 2.

This morning we will begin with comments on the results and the Company's outlook from Bill Small, Chairman, President and CEO of First Defiance followed by a report on the financial performance by Jack Wahl, the Company's Executive Vice President and Chief Financial Officer.

Before we begin, I 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 the forward-looking statements.

And 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 2006 year end results. Last night we issued our earnings release for the 2006 year and also the fourth quarter. This morning we would like to discuss that release reviewing 2006 and looking forward into 2007. At the conclusion of our presentation we will answer any questions you might have.

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

With a strong fourth quarter to finish the year, we reported net (technical difficulty) in 2006 at $15.6 million or $2.18 per diluted share. The fourth quarter net income of $4 million or $0.55 per diluted share was a strong finish to a challenging year. The full year results represent an 8.5% increase in earnings per share over 2005 core operating results. We got to the finish line in good shape but had to be able to adapt and run a slightly different course than we laid out at the beginning of 2006.

We are very pleased with this level of earnings increase especially in light of how difficult the banking environment has been. For most of the year we had an inverted yield curve as the buy market refused to buy into the Feds' concerns over inflation and as a result, net interest margin continued to erode during the year. When the Feds stopped raising rates in the third quarter, it made it even tougher as treasury yields on the short end remained high, keeping deposit rates up with no corresponding price increase opportunities on the loan side.

For us the answer to the challenge was to find new revenue sources to offset the pressure on net interest income. With the hard work and dedication of many of our people we were able to do that and produce a solid year for First Defiance and its shareholders.

Looking at our overall performance in 2006, loan growth slowed somewhat during the midpart of the year but we still produced double-digit growth for the full year. The slowdown was partially driven by less demand, but we also backed away from several deals because of pricing issues and more selective approach on credit factors. With fewer opportunities out there, pricing has become very aggressive, especially on stronger credits, and we continue to stress to our lenders the need to be prudent in underwriting and pricing.

On the deposit side of the balance sheet, things are no less competitive as we focused on the non-interest bearing commercial and retail DDAs. As deposit rates have remained high, funds continued to flow to CDs. Aggressive marketing and sales efforts are producing a significant number of new checking accounts being opened, but it will take some time for the balances of these new accounts to come up to normalized levels.

One thing that we are very happy to see was the deposit growth that we had in our newer markets. Already holding significant market share in most of our older established markets, we knew that it was imperative to get strong growth in the newer larger markets that we have entered in recent years. The aggressive marketing and strong sales push by our employees in these markets resulted in very significant growth at many of the newer banking centers.

Credit quality remained stable even though we had a sharp increase in charge-offs during the fourth quarter. Approximately half of the $1 million in charge-offs during the quarter were from loans that we brought on the books through our recent acquisitions.

The loans that we did charge-off were fully reserved. We remain confident that the allowance for loan losses at $13.6 million is adequate and all probable charge-offs are properly reserved. We were somewhat disappointed that our non-performing assets did not decrease more this quarter, but we are encouraged by the progress that we have made on several large items in this category and are confident that we will soon start seeing improvement.

We experienced another quarter of strong growth in non-interest income as we continue to see the positive fee impact of our overdraft privilege program. We completed a full service fee review during the last half of the year and have added some new fees to the schedule and implemented several increases that are effective as of the beginning of 2007.

Commission income from First Insurance and Investments, our insurance and investment business unit, was also up in 2006. This was accomplished in a very soft property and casualty premium environment due to new business booked and strong quality performance related to loss control. We continue to look for additional ways to enhance these revenues as continued growth in non-interest income is going to be important to help offset the margin pressure.

Non-interest expense, excluding acquisition-related charges, was up slightly more than 8% for the year 2006 compared to 2005, in part due to the fact that 2006 represents a full twelve months of operating expenses for the two companies acquired in 2005, and the opening of our 26th banking office in the Shawnee area of Lima in midyear. Also, a portion of the increase in non-interest expense can be attributed to increased marketing to establish our brand in new markets. Regulatory and compliance costs also increased significantly.

I will now ask Jack Wahl to give you the financial details for the quarter and the 2006 year before I wrap up with an overview and look at what we see developing in 2007. Jack?

Thanks, Bill, and good morning, everyone. I will begin by providing a few highlights for the 2006 fourth quarter and annual results.

For the quarter, our earnings were $4 million, or $0.55 per share, an increase over 2005 fourth quarter earnings of $3.4 million or $0.48 per share. For the year, our earnings were $15.6 million, or $2.18 per share compared to 2005 earnings of $12 million or $1.69 per share. Excluding acquisition-related charges from the 2005 results, core earnings were $14.2 million or $2.01 per share. Our net interest income for the 2006 fourth quarter was $12.2 million, which was 2.8% lower than net interest income in the 2005 fourth quarter despite the fact that our average interest-earning assets were $74 million higher.

Overall, our asset yields for the quarter were up 56 basis points while the costs for our interest-bearing liabilities was up 97 basis points. Our net interest margin for the 2006 fourth quarter was 3.60%, 32 basis points lower than the 3.92% margin in the 2005 fourth quarter. As bad as that sounds, we actually were pleased at the margin for the fourth quarter increased by a basis point from the 2006 third quarter margin of 3.59%.

While we were aided this quarter by $148,000 of accretion of previously recorded loan purchase discounts, if you exclude that item, our 2006 fourth quarter margin would have been 3.56%, which is about 6 basis points higher than we anticipated it would be when the quarter started. While core earnings for the year were up almost 10% and earnings per share increased by 8.5%, our net interest income for the year in 2006 increased by only 3.7% despite growth in earning assets of $109 million or almost 9% and average loan growth of almost $120 million or 10.9%. These results reflect the margin compression that we have emphasized for most of 2006.

Overall for the year, our margin was 3.68% or 19 basis points lower than the 2005 margin of 3.87%. As we noted in our release, we expect our margin to continue to be under pressure for 2007 where we will likely be somewhere in the 3.50% range.

As Bill noted, we have overcome the compression in our net interest margin by achieving significant growth in our non-interest income. For the quarter, non-interest income grew by nearly $1.2 million or 30.6%. For the year, our non-interest income was up by $3.7 million or 23.2%, and when you exclude $1.2 million of 2005 securities gains, our non-interest income was up year-over-year by $4.9 million or nearly 36%.

The majority of the increase was in service fee income related to our checking accounts for both the quarter and annual periods. The overdraft privilege product that we have described previously was implemented in March of 2006, so we have one more quarter that will show a significant period-over-period increase in that category.

Our non-interest expense for the quarter was up by $526,000 or 4.9%, and for the year increased by $3.4 million or 8.3% when you exclude 2005 acquisition-related charges. We are pleased that our compensation and benefits costs showed virtually no increase between the 2005 and 2006 fourth quarter periods. This was achieved primarily through favorable claims experience with our self-insured group medical plan. While we certainly hope this trend continues, we realize that this item could also move the other way in 2007.

Other quarterly expense increases such as printing and advertising are in response to efforts to improve our visibility in our newer markets. For the year, compensation and benefits were up by just $706,000 or 3%, as the lower level of claims in the group health plan offset both wage and staffing increases. Also, our annual expense results were impacted by the fact that the Genoa Savings acquisition was completed early in the second quarter of 2005, and the ComBanc acquisition was closed in late January of 2005. The overall results reported for 2005 therefore had less than a full year worth of expenses related to those acquired locations versus a full year of such expenses in 2006.

Other areas that had increases for the year include audit and exam fees, which are higher in response to a higher level of audit needs in light of both our larger size and the regulatory environment we operate in, in advertising, postage, and printing. We also had fees associated with the overdraft privilege product of $120,000 in the fourth quarter and $372,000 for the year. This was a new item in 2006.

Under our contract, we will be paying this level of fees to the overdraft privilege vendor through the second anniversary of our agreement, which is in March of 2008. We also realize the benefit in the 2006 fourth quarter and to a lesser extent, for the full year, of a lower effective tax rate. For the 2006 fourth quarter, the overall income tax rate we used was 29.5% compared to 35.1% in the fourth quarter of 2005. This resulted from both a more thorough analysis of the tax accounts as part of the year end audit, as well as the reversal of previously recorded tax reserves of approximately $125,000, the result of some older tax exposure items going away as prior year tax returns closed.

Had the annual effective tax rate of 32.3% been used in the 2006 fourth quarter, tax expense would have been approximately $150,000 higher in that quarter. For the year, the overall effective tax rate would have been approximately 50 basis points higher without the reversal of the previously reported reserves. We expect our overall tax rate for 2007 to be in the [3.28] to 33.0% range.

Focusing for a minute on the provision for loan losses, we recognized a quarterly provision of $318,000 in 2006 fourth quarter, our lowest level of expense in this area since the fourth quarter of 2004. This was despite the fact that our charge-offs were higher than they had been. While on the surface this appears to be inconsistent, we note that the level of provision that we recorded previously for loans that we felt had probable losses turned out to be correct, and that when we finally determined it was appropriate to write those loans off, the expense had already been recognized through the allowance. We are very confident that the remaining allowance for loan on lease losses of $13.6 million at December 31 is adequate.

That concludes my commentary on the financial statements for the 2006 fourth quarter and annual periods. I'd like to turn the call back to Bill for some closing remarks and then we will try to answer your questions. Bill?

Thank you, Jack. As you see, in 2006 we stayed on course with our performance and ended with another strong earnings year. The path to getting there was slightly different than we had anticipated, but we found new revenue sources to help offset the lower-than-expected net interest income caused by the margin compression.

Looking ahead to 2007 and beyond, we must continue to be innovative in our approach to offering relationship banking services that meet our customers' needs and produce the returns expected by our investors. We are working hard to reach the full potential of our newer and larger markets such as Findlay, Toledo, and Lima. We will continue to evaluate new markets where we believe significant growth opportunities exist.

We have already begun the process of combining our trust department and our investment services into a new wealth management group that we believe will better serve our customer base, be more operationally efficient, and hopefully allow us to grow revenue in this area more quickly.

The overall economic climate throughout our market area is one of guarded optimism. We have experienced some plant closings and layoffs in recent months, but on the whole, employment numbers have improved over the previous year. We continue to see many companies, large and small, make capital investments in their facilities, and the general tone in talking with many of our clients is for a steady to improving 2007.

Agriculturally, we are coming off a record year for corn yields in 2006 and a record-tying year for soybeans. This is the third consecutive good harvest and this year's strong prices made it a very good year for the farming community.

All of this taken together gives us a positive feel for the economy in Northwest Ohio. 2007 will be another challenging year and while we expect earnings to be higher than 2006 earnings, the increase will be more in line with industry expectations of 3% to 5% earnings growth.

Pressure on the net interest margin will continue as our 2007 budget anticipates a first quarter margin of 3.40% with slight improvement throughout the year, resulting in a full year 2007 margin in the 3.5% range.

The fee income that we have talked about will be very key to us achieving our goals. We have budgeted a very aggressive growth of 18% in non-interest income for 2007 and it will require a lot of hard work to attain that.

On the expense side, we expect non-interest expense to be up approximately 9% over last year. Much of this relates to our growth strategy and the need to actively market and promote our franchise in the newer markets, and the need to add some additional support staff because of the growth.

We cannot control what happens in the overall economic and interest rate environment. What we can do and will do is be prepared with a business plan that will give us the direction we need to meet the economic forecast and the flexibility to adapt to changes as they develop. We were successful at doing that in 2006 and we've worked hard at preparing to do the same for 2007 and beyond.

We have an outstanding team that is innovative and hard-working, and they understand the plan and what is needed to successfully implement it. This strong team along with a complete menu of financial products and services will be our foundation for the future.

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

(OPERATOR INSTRUCTIONS). Kenneth James, FTN Midwest Securities.

The first question is on your margin outlook. Obviously held up better this quarter than you guys thought in the product we had modeled, even excluding the $140,000. Can you just kind of talk about what the pieces of your outlook are going forward? It seems to me if the Feds stay on the sidelines that the pressures that you're feeling will be the same if not alleviating some instead of getting worse. So I'm just kind of curious where you're looking for giving up 16, 15, 20 basis points in the first quarter?

I will start answering this now and let Bill finish. We did the budget several months ago so when we put the budget together, we had the same outlook that basically we had at the start of the fourth quarter, which was that we would continue to see margin pressure. It was due as much to the fact that we continue to have certificates of deposit mature at a rate that's lower than the rate that new certificates of deposit are going on the books at. That's going to continue for another several months at least.

I think what's happened since the end of the third quarter is that our mix has improved relative to what we anticipated both on the loan side and on the deposit side. I also think we've gotten a little bit of relief in loan pricing, especially in the last month or so. And so, I'm probably not as bearish today as I was when we put that budget together, and 3.4% is probably the minimum that the margin is going to be -- it will likely be maybe 10 basis points or so higher than that.

I think, just in -- kind of add a little bit to that. Jack made the observation in regards to pricing and mentioning the loan side. It seemed like in the last half of the fourth quarter we were starting to see, I think, some pricing relief on both sides of the balance sheet. Some of the deposit rates were starting to ease back a little bit and with maybe a little bit more sensibility, I guess, coming into the pricing market on the loan side out there and our stressing the need to be disciplined I think started to pay off for us really in the second half of the quarter.

And a question that's kind of on the loan growth -- that kind of slowdown you noted in the second half of the year. Was that more attributable to you guys just not wanting to play the pricing game? Or how much of that is attributable to a common genuine decline in demand?

I think it was -- most of that slowdown took place really in the third quarter. We started to see things pick up again in the fourth quarter. I think there still are going to be some opportunities out there. But the slowdown was somewhat caused by probably internally some of the time and efforts that we were spending on maybe cleaning up some of the portfolio, especially some of the acquired loans. A lot of effort and time was devoted to that. But we're, overall, we're, again, guardedly optimistic that demand is going to be there for us to continue some decent growth throughout 2007.

What would be a realistic kind of growth expectation you guys feel for the coming year?

Trying to think back on the numbers --

The budget calls for approximately $90 million of growth in the commercial portfolio, with the mortgage portfolio essentially staying flat at the level it's at, at the end of 2006.

So kind of mid single digit, mid to high single digit?

That would be high single digit.

Yes.

Christopher Marinac, FIG Partners.

Wanted to ask just a continued question about the whole idea of loan yields. You mentioned the favorable pricing. Is there any scenario where you could see actual the nominal level of loan yields come down during this year? Or do you think that's unlikely?

Well, I think a lot of that is going to depend on if and when the Fed starts to move down. I think that we felt a lot of competitive pricing pressure, especially during the, I would say, the midpart of 2006. That has subsided some, but if the Fed does start to make cuts and you're going to see, I'm sure, a lot of people looking -- a lot of creditors looking at that as an opportunity to go out and get some stuff rewritten at better rates. But that's probably going to be the biggest driver.

Bill, if the Fed were to do nothing for awhile, would yields then hold, all things being equal?

Yes, I would certainly expect that they would. I think that again, we've been pretty pleased with the way our people have been able to price the loans.

Although, Chris, for our loans, the bond market drives the rates because they're driven off the five year treasury rate to a certain extent. So, if you can predict that you're better than we are. But, as Bill said, I don't expect, unless the environment changes significantly, which we know it will because it always does, but if the environment stays the same, I don't see our loan yields moving much more than they were in the fourth quarter.

Could either of you elaborate on the impact that you expect over time with Sky's sale to Huntington? I know it's early to see much change just yet, but as the next four or five quarters unfold, what would you anticipate? Are you doing anything differently to plan and staff for that sale?

First off, any time a consolidation move of that type takes place we certainly see that as an opportunity. Those are two companies that we compete against in many of our markets. There's very few communities that we have locations in that Sky is not in right now. So, just as I said, any consolidation of that type, we always feel creates great opportunities for a community banking business plan.

We have spent an awful lot of time talking about it and kind of laying out some groundwork and such. But you know, it's kind of the -- you go back over the last eight or ten years and you look at where our new growth has come from and it's been us taking advantage of opportunities in many cases that have been created by mergers and acquisitions. So, this one's certainly being as involved in our market area as it is, we definitely would anticipate it might create some opportunities for us.

(OPERATOR INSTRUCTIONS). Julienne Cassarino, Prospector Partners.

Quick question on the credit. The 50%, roughly, of the charge-offs that were due to the acquired loans, that sounds like that was something you saw coming for awhile. It just took a little longer than expected. But the 50% that was not due to the acquired loans, what kind of credits were those? Are those very recent developments? Is that something that surprised you at all? And are there any kind of concentrations there?

No, it was not a surprise. These are credits that had been on the watchlist. We just really got to the point where we felt that it was time to make the move. They were all fully reserved for and had been over a period of time. Nothing that indicates any concentration issues as far as those and no really large credits in there; it's just more a series of smaller credits.

It just seemed like it was time to finally get them -- I think we rode them as far as we felt we could with any reasonable chance of recovering. And so we went ahead and did the charge-offs, but none of it was a surprise.

And no concentrations there, either.

Right.

In size as well as type of --?

In size or as, well, type of industry or type of loan.

And you mentioned in your commentary things might get -- I mean in the written commentary, things might -- there might be -- you said you're likely to see additional charge-offs in 2007. Is that due to both the acquired loans as well as loans you originated?

Yes, there certainly are some of our own originated loans in there. But again, there's -- we feel that we're -- we've spent an awful lot of time on asset review and trying to make sure we've got a very, very good handle on what's in that portfolio and making sure that we properly reserve for it and track those loans. So, there will be a mixture. I mean some of that will be coming out of our own organic portfolio. But again, a fair portion of that mix will be cleaning up some of the acquired portfolios, also.

And just looking at the balance sheet growth, wondering why not consider using some of your capital to buy back stock?

We get that question quite frequently, because when you look at the capital, a big reason for that is that our business plan as a thrift is certainly not the norm. We get a lot of regulatory pressure because of the amount of commercial lending, commercial real estate lending, that we do to keep our capital level at a little bit -- I shouldn't say a little bit -- at a higher level than what many people would like to see it at. Until we are able to establish a comfort level with the regulators, we'll probably be on the sidelines as far as buybacks are concerned.

Eileen Rooney, KBW.

Just wondered if you could talk a little bit about your fee income goal of 18%. It just sounds a little challenging and I was wondering what kind of assumptions you guys were factoring in that.

As I mentioned in my comments, we did a very extensive review of our fee schedule and taking a close look at other fee schedules of competitors throughout our market area. We have pretty much revamped that effect of the first of the year. In the latter part of 2006 we also implemented a couple of other new fees over and above the overdraft privilege program that we've talked about extensively. So, with one more quarter of the significant increase attributable to the overdraft privilege program along with some new fee structures, fee schedule structuring that we did, a restructuring, and again, that certainly keeps us very much in the ballpark as far as competitors are concerned but gave us some opportunities to bump some of those up. That's where it's going to come from but we're going to have to be disciplined and making sure that we're not out there waiving fees and things of that sort. If we can maintain that discipline -- I mean, it's a tough goal but we can reach that.

I'll point out that that's a goal that we have in our 2007 budget and quite frankly, we needed that level of growth in fee income in the budget to get to a budgeted level of net income that was acceptable to our Board. Whether we achieve that or not, as somebody like yourself does an estimate of our earnings going forward, I think you have to take that into account that that's a goal we've set in the budget that will take a significant amount of effort to realize, as opposed to an estimate that we would make if we were in your situation doing a projection of earnings for a company.

(OPERATOR INSTRUCTIONS). Kenneth James, FTN Midwest Securities.

My question has been answered.

Gentlemen, there are no further questions.

If there are no further questions, we thank everyone for calling in today, and this will conclude our conference call.

Thank you, ma'am. 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.