Premier Financial Corp (OHIO) (PFC) 2007 Q1 法說會逐字稿

Greetings ladies and gentlemen, and welcome to the First Defiance Financial Corporation first 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). 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, everyone, and thank you for joining us for today's first quarter 2007 conference call. This call is also being webcast and a replay will be available at the First Defiance website at www.FDEF.com until May 4, 2007. This morning we will begin with comments on the results and the Company's outlook from Bill Small, Chairman, President and CEO of First Defiance. That will be followed by a report on the financial performance by Jack Wahl, the Company's Executive Vice President and Chief Financial Officer.

Before we begin I would like to remind you that certain statements made during this conference call such as the expectations about the Company's plans, business performance, future initiatives and results, as well as market conditions in which the Company may operate are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on information currently available to the management of the Company. Current expectations and assumptions are subject to risks and uncertainties. Actual results could vary materially because of 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. assumes no obligation to update any of the forward-looking statements, and now I will turn the call over to Mr. Small for his comments.

Thank you very much, Carol. Good morning, and again thank you for joining us for the First Defiance Financial Corp. conference call to review the 2007 first quarter results. Last night we issued our earnings release for the first quarter results, and this morning we would like to discuss that release and look forward at the balance of the year. 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.

First quarter 2007 net income was $3.61 million or $0.50 per diluted share, which is down from $3.85 million, $0.54 per diluted share in the 2006 first quarter. The continued drop in net interest income along with higher non-interest expense brought the earnings down. Net interest income continued to be pressured by the challenges of the current rate environment. The first quarter is usually a period of lower loan demand, but loan growth was even slower than we had projected during this quarter.

On the deposit side the seasonal runoff of deposits early in the year was in line with expectations but the cost of funds continues to experience upward pressure. All of this resulted in a drop in the net interest margin compared to the first quarter of 2006. However, on the positive side the margin actually came in higher than we had forecast at 3.63%, up 3 basis points from the 2006 fourth quarter. The slower loan growth was partially driven by less demand as I mentioned, 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, and we continue to stress to our lenders the need to be prudent in underwriting and pricing.

Several deposit initiatives resulted in notable increases in the number of new DDA accounts. However, as mentioned earlier the normal first quarter drawdown in balances does not reflect substantial growth. We do anticipate that these new accounts will help us grow these balances as the year progresses.

Non-interest income was very strong for us again this quarter, increasing by over $1 million compared to the 2006 first quarter. A significant part of that increase is due to the overdraft privilege program that was implemented in March of 2006, so we benefited from a full quarter of that program this year. We also had a significant increase in contingent income from our insurance unit, First Insurance and Investments as a result of growth of premiums and favorable claims experience.

We've expanded our insurance unit with the acquisition of the Huber, Harger Welt & Smith agency based in Bowling Green, Ohio. We feel that growing this line of business will benefit us going forward as we look to diversify our revenue sources. The growth of non-interest income, as we've said many times, is an important part of our strategy, and this line of business is a major component.

Non-interest expense showed an increase over first quarter 2006 levels due primarily to compensation. The additional staffing cost associated with the expanded Napoleon Woodlawn office and the new Lima Shawnee office were not part of the 2006 numbers and over several new positions that we added to support our growth strategy. The acquisition of the insurance agency at the end of February also contributed to some of the compensation increase.

As we have stepped up our marketing in our newer our markets to establish First Federal as the bank of choice we have devoted additional resources to advertising and promotions. It is important for us to keep our focus on efficiency in this tougher revenue environment, and we are delivering that message throughout our organization. The asset quality numbers while still in line with our peer groups are not at the levels that we have historically performed at, and we need to work to bring them back to those levels. Our nonperforming assets took an upward move early last year, and we were hopeful that some of those assets would have been cleared by now. It has been a long process working through several of these larger properties within the legal framework, and while we're making progress it is frustrating not to see faster results. We are devoting significant time and manpower to these assets and hope to see positive results in the near future.

Our net charge-offs for the quarter returned to a more normal level of 9 basis points annualized after spiking to 15 basis points annualized in the fourth quarter of 2006. I will now ask Jack Wahl to give you the financial details for the quarter before I ramp up with an overview and a look at what we see developing for the balance of 2007.

Thank you, Bill and good morning. I will begin my remarks by focusing on our net interest margin, which was actually slightly improved from the 2006 fourth quarter and significantly better than we had forecast. Overall our asset yields which were 7.22% improved by 49 basis points between the first quarter of 2006 and first quarter 2007, and they were 10 basis points higher than last year's fourth quarter. Our average yield on loans for the quarter was 7.38%, which was 47 basis points higher than last year's first quarter and a 6 basis point improvement over the 2006 fourth quarter.

By comparison our interest-bearing liabilities cost us 3.96% on average in the just completed quarter compared to 3.18% in last year's first quarter and 3.86% in the 2006 fourth quarter. Our interest-bearing deposit costs increased by 91 basis points over last year's first quarter and by 10 basis points from the fourth quarter. In addition, the average balance in our non-interest bearing deposits have increased by nearly $6 million over the last year, and though those balances dropped by almost $2 million on average from the 2006 fourth quarter. That decline in balance is a seasonal trend that we have experienced every year.

We actually have had a lot of success adding new accounts as we have increased the number of retail checking accounts, both interest and non-interest bearing by 490 accounts for the year through March 31st, and we've increased the number of commercial checking accounts by 130 since the start of the year. If our historic trends repeat themselves, we will start to see noticeable increases in those balances over the next several months.

Our margin was aided again this quarter by accretion of impairment reserves which were recorded at the time of our recent acquisitions. The accounting rules require that we record certain loans at fair value as of the acquisition date. To the extent that those loans are performing better than anticipated, the improvement is reflected as an increase in our overall yields. For the first quarter the amount of impairment that we accreted to income was $190,000, which added approximately 6 basis points to our yield. We anticipate that we will continue to realize impairment accretion for the balance of the year but I hesitate to predict whether it will be either significantly higher or lower than the accretion we recorded in the first quarter.

As Bill noted, while our net interest margin has been 20 basis points higher than we had initially forecast our loan growth for the first part of the year is behind plan. In total our average loans for the month of March were more than $35 million lower than what we had budgeted. While our commercial loan demand continues to be pretty good and we anticipate that we will see tremendous opportunities from the significant consolidation pending in our market, it is unlikely that our loan growth will hit our original year end targets.

We also issued $15 million of trust preferred securities at a fixed rate of 6.44% on the last day of the quarter. We will use those proceeds to retire other borrowings and repurchase stock. In projecting our margin for the balance of the year you need to take those securities into account. We have estimated that those securities will lower our quarterly margin by 1 basis point relative to other sources of funding.

The other area I would like to focus on is our non-interest expense which increased by approximately 10% over last year. In total non-interest expense for the 2007 first quarter was $11.8 million and approximately 55% of that total is for compensation and benefits. Our compensation and benefits grew by 7.3% over last year for $445,000. We estimate that $200,000 of that increase is attributable to wage increases over last year, which averaged between 3.5 and 4%. We also have increases associated with the branch expansions we did last year and the March compensation expense for the Huber, Harger Welt & Smith acquisition. Those factors account for approximately $125,000 of the total increase.

Also, we've added 4.5 new positions since last year including a senior risk management officer which accounts for the balance of the increase. We continue to have favorable experience with our group medical plan through the first quarter of the year, though we are concerned that we will see costs go up in that area based on some recent trends we're seeing in our overall level of claims. Our health insurance plan year ends at the end of this month.

Aside from compensation our occupancy costs increased over last year by $184,000 or 15%. Most of those costs are associated with our new branch in Shawnee and the relocated branch in Napoleon. The new branch in Napoleon was moved to a much more attractive location from our customers perspective, but the branch it replaced had a very low-cost basis and virtually no remaining depreciation expense.

Other significant cost increases year-over-year included approximately $160,000 associated with the overdraft privilege product which included $110,000 in fees paid to the vendor and $50,000 of increased bad check write-offs. We will be paying fees to the overdraft privilege vendor through next year's first quarter.

We also had a $78,000 increase in our advertising and promotion costs. Overall our efficiency ratio for the first quarter was 66.3% compared to 63.3% last year. There were several accounting matters that were addressed in the 2007 first quarter. We recorded a $200,000 reduction to our opening retained earnings balance in accordance with financial interpretation number 48, which deals with accounting for uncertain tax positions.

We also have been working on completing the allocation of the purchase price of the Huber Harger acquisition in accordance with FASB statements 141 and 142. In accordance with the accounting guidance we have identified $820,000 of identifiable and tangible assets associated with the acquired entity. The amortization of those intangibles will be a non-cash expense of approximately $35,000 per quarter beginning in the 2007 second quarter.

We also spent time reviewing the recently issued fair value standards number 157 and 159, and we have decided based on guidance we have received from our auditors and recently published discussions regarding the position of the SEC, that we will not be early adopting those standards. That concludes my comments. I will turn the call back to Bill for some closing remarks, and then we look forward to taking your questions.

Thank you, Jack. As we progressed through 2007 and beyond we need 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 continue to evaluate new markets where we believe significant growth opportunities exist. As a result of this approach, we have made the decision to enter the Fort Wayne, Indiana market with a branch that we hope to have open this summer. This is an area contiguous to our current footprint that offers a larger and faster growing market.

We have established a number of good, long relationships there already, and we feel we need a physical presence to be able to grow deposits. The process of combining our trust department and our investment services into a new wealth management group that will better serve our customers and will be more efficient is well underway, and we feel this will become a growing source of fee revenue. The news media has given a lot of coverage to the sub prime mortgage problems and the high foreclosure rate associated with these instruments. Ohio does have one of the highest foreclosure rates in the nation and our area is not immune to this problem.

However, we have never been involved in sub prime lending, and even though our foreclosures have increased any losses related to our foreclosures have been minimal. The overall economic climate through our market area continues to be one of guarded optimism. We've experienced some plant closings and layoffs in recent months but on the whole employment numbers have improved over the previous year. We see many companies, large and small, making capital investments in their facilities and many of our clients express confidence in the balance of 2007.

Agriculturally commodity prices remain strong, and the continued growth of ethanol production plants has the corn farmers smiling. All of this taken together gives us a positive feel for the economy in Northwest Ohio. We've worked hard to execute our strategy in this challenging environment and to adapt to the changes in the business cycles. We said at the beginning of the year that it was going to be a tough year, and the first quarter certainly bore that out. We are focused on finding and growing revenue sources, as well as focusing on operating efficiently. That is pretty simple blocking and tackling, but that is what it takes in times like this to be successful.

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

(OPERATOR INSTRUCTIONS) Bret Villaume, FIG Partners.

Good morning. I understood the guidance you were giving on the impairment on fair value to the loans, and I understand that may be difficult to gauge in the future. But could you also repeat what you said about the securities portion basically impacting margin by about a basis point?

Trust preferred securities -- what I did is I just calculated the difference between the 6.44% rate we are paying on the trust preferred securities in our marginal funding costs, which is about 535, and I calculated that for one quarter, added it in and the increase in our margin was one basis point.

Okay and my second question is I was wondering if you wouldn't mind expanding a little bit more on Fort Wayne. From what I perceive this is a really good direction you are going in, and one is maybe you can just expand on the market more. And also how much cost is going to be involved in that and possibly how long you think it is going to be before you see profitability.

We've had our eye on the Fort Wayne market for quite some time. It seems like a natural extension for us. Fort Wayne is actually located just over 40 miles southwest of us here in Defiance. And as I mentioned in my remarks, we've already developed some very good business relationships over there. We think it is a stronger housing market and probably a stronger business climate right now than many of the other communities that we have opportunities to do business in or might have opportunities to do business in. So certainly made sense being a little bit larger market than many of our communities. It also presents some great opportunities for us.

Our approach in going in over there, right now the relationships we have are primarily on the commercial side. We have located, although it has not been finalized so I can't give you a specific location right now, but we are very excited about a location that we are just finishing up negotiations on right now. That will also lend itself to I think some good very good retail traffic with where it is positioned. Our approach in going in there has been one of trying to get in on a relatively low-cost level. We are going into an existing facility. We are not building a building from ground up. We want to take this in kind controlled steps and feel out the market that way. As far as profitability I think our pro formas, Jack, showed about 15 to 18 months to --.

The model shows it will cost us about $0.02 per share in the first year, but that won't start probably until the third quarter -- late in the second quarter, early third quarter of this year. So it will impact the current year earnings probably by $0.01. From a cost standpoint the staffing that we plan on initially is relatively small staff. We have two existing lenders who already have significant relationships in the Fort Wayne market who will be relocating to that market for the majority of their time. So whether they are replaced in their existing roles hasn't really been determined yet. So the net startup costs are going to be relatively low, much lower than when we do a full service de novo branch that we build from scratch.

Thank you very much, gentlemen.

Julienne Cassarino, Prospector Partners.

Good morning. So it sounds like you have decided to buy back stock.

That is part of the strategy; part of the reason that we issued the trust preferred security, yes.

Wonderful. Can you tell me what your current authorization, what is left under your current authorization and just what is left?

It is 290, approximately 290,000 shares.

290,000 shares, okay, and we wouldn't be expecting to see the new authorization until this one is completed?

That is correct.

And you mentioned in your comments that I didn't write down the exact words so I am paraphrasing, but there were some opportunities for consolidation in your market. I was just wondering if you could expand upon that. Do you see consolidation happening, and if so what do you see as your part in that?

The biggest one that has been announced already is the Huntington acquisition of Sky. We compete virtually in every community we are in with the exception of maybe two or three head-to-head with Sky Bank. And we certainly feel that their strong presence having been based in Bowling Green, Ohio, which has become a very strong market for us will create some market disruption that we fully expect to be able to take advantage of. Beyond that I still think the climate is ripe for additional consolidation. What role will we play? We certainly will be opportunistic in just like in the past of watching those situations as they are announced and evaluating whether it makes sense for us to maybe make additional moves into those markets. And at the same time we will always be keeping our eyes and ears open for anything that might be taking place that we may even get involved in from an acquisition standpoint. As I've said before we are not aggressively out knocking on doors looking for opportunities to acquire anybody, but at the same time we don't want a deal to happen in our backyard without us at least having a chance to evaluate it and determine whether or not we want to be a player in it.

So you see yourselves benefiting from consolidation in the market and possibly being a consolidator yourself?

Probably right now I would lean more toward the first part. We think the consolidation and again with the one big one in particular that's already public we certainly think about is going to create some opportunities for us.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Kenneth James, FTN Midwest.

Good morning, gentlemen. Do you think you're going to be able to continue to hold your margin here excluding the impact of the loan -- kind of the loan fees or the loan amortizations you are talking about? That hold the margin at this level, or do you think that there is room for your interest-bearing liabilities cost to get you to move up throughout the year to kind of bring this in a little bit?

Yes, I think we are getting closer to the peak. I don't know that we are at the peak yet, but the CD portfolio that is repricing is repricing from a higher rate now than it was repricing from three months ago when we talked to you. Probably 25 basis points higher now than it was three months ago. And so the repricing cost as we go forward is narrowing significantly. So yes, we are going to continue to feel some pressure. But I think the pressure is going to be less than what we felt three and six months ago.

Okay, and on the asset yield side, given that you are talking about slower loan growth, I mean I would imagine all the asset yield gain you were looking for this year would have come from a richer mix towards commercial loans. And with that maybe not coming to pass to the magnitude that you expected previously do you think asset yields are close to being on the top here?

I think we've seen some improvement in our mix and while our loan growth has been slower than we projected, the commercial loan area is the one area where we feel like we've got the most opportunities to get back on track with our budget. We are behind budget in mortgage loan balances. We are behind budget in home equity loan balances and commercial loan balances, all three. Of those three I think if you hold our management team they would unanimously agree that the one area we've got at least the opportunity to get back on track is in the commercial area. That is where we are going to see the opportunities both with the Fort Wayne initiative and with the pending Sky Huntington merger. The other balances which are lower yielding loans we are probably not going to be able to get close to what we budgeted.

On fee income you referenced in your press release a slower rate of growth obviously year-over-year in your service charges related to your new overdraft privilege product. Can you give any kind of color on what you expect that rate of growth to be or how that is working relative to your plan?

It is working absolutely great relative to our plan, probably better than anybody expected when we got into this a year ago at this time. The growth question -- that is a question I think we'll have to wait and see what happens as we go through the next quarter. Our experience has been that those fees took off right away and probably peaked during the November/December time frame, November, December, January -- they fell off a little bit in February. They've rebounded some for us in March, and we kind of have our fingers crossed that we certainly believe we will be higher than we were last year but I do not know that it will be significantly higher than it was last year. Be higher to the extent we have more accounts and more people in the program but those people continue to use it and continue to like it. So I am not sure I answered your question, but the reason we say the growth is going to slow is because we were growing against zero from the prior year.

Right, but I mean most of the people that I see kind of a market seasonal kind of swing in that first quarter being a low and that's what I was wondering. Obviously you were up 60% year-over-year or something in the first quarter; obviously it is not going to be up that much in the second. But I was wondering if you had any idea what you are budgeting as far as low double-digit, mid-teen, high ten growth.

In terms of growth I think we budgeted maybe 5% growth over the prior year once we got to the second quarter because we are doing -- we had the program all three months of the second quarter in 2006. We will have it all three months of the second quarter of 2007. The growth between those periods I think we only budgeted about 5% growth, and that reflected more projected growth in the number of accounts than anything else.

Okay, fair enough. And on the expense line is that a good run rate for the year or do you expect that there was some typical first quarter stuff that may cause that number to back (multiple speakers)

I think there is some first quarter stuff posted associated with mailing year end statements and the annual report always hits in the first quarter so it is higher. We are going to -- we're trying to do a better job of on some of our staples that we buy like paper and toner that right now we might buy five-months supply at a time and that gets expensed when it is purchased. We're trying to do a better job to make sure that gets expensed as it is used. But in the first quarter that was probably higher than what it will be for the balance of the year. What we didn't have in the first quarter were any of the amortization costs associated with the intangible assets that we acquired at the new insurance agency. That's going to increase our noninterest expense by about 35,000 a quarter.

Last question. On our last call you said you thought you could generate modest net income growth for the year. You guys sticking by that? That looks kind of a difficult goal to achieve.

We are actually $0.02 ahead of budget for the quarter, but I'll be honest we kind of lowballed the first quarter. So I kind of agree with you, Ken. It is going to be -- and I will let Bill add his remarks, but it is going to get tougher. There is no question about that.

We knew going into this year that it was going to be extremely tough, and while the first quarter obviously you see the difference between '07 and '06. But I am hopeful and we are going to continue to work hard at it, but it is going to be a challenge for us to stay on course. It is going to be at best I think moderate growth.

Okay. Fair enough. Thank you.

[Steve Reinery], Franklin Advisory Services.

Good morning. You mentioned that loan growth was $35 million below your budget, and I was just wondering if you could tell us what your budget is for the year in terms of growth.

I would rather not. That is not a number that we publish.

Again, as Jack said that is not a number we publish, and as we said, it was basically across the board in all of our categories. We did see I think better growth in March, closer to what we had anticipated. January and February were way off. It just remains to be seen whether that all picks back up.

I notice when I look back to one of the tables here that the total amount of loans you had outstanding were basically flat for the last four quarters. And although we did see it jump from the first quarter of '06 to the second quarter of '06, we haven't really eclipsed that second quarter number. What do you think -- what were you expecting to be the drivers of the loan growth to break you out of this slump that you've been in over the last several quarters that didn't materialize?

I think the commercial demand was lower than we thought it would be. Certainly again we always anticipate the first quarter to be the slowest quarter as far as that growth is concerned. For whatever reason and I think it is probably a combination of just the overall economy, as well as the competitive nature as we talked about. It seems that there are more banks chasing fewer deals right now out there, and the weather in the month of February probably didn't help at all either. But those all combined to really impact the commercial side of it very, very strongly.

We also had several large payoffs that we did not anticipate. And in a few of those cases these were payoffs of large projects that basically in several cases went to insurance companies that decided to get more active in the commercial arena. So those payoffs certainly did not help us. I think our new business we were relatively pleased with that, but we were certainly finding out that we've got to run a lot faster just to keep up now that we got so used to double-digit growth for a long period of time. Mid to upper teens in percentage of growth, that is with the portfolio now at its size takes an awful lot more production just to maintain level balance let alone build the balance.

Are you noticing a change in the rate of -- we'll call it portfolio turnover?

No, I don't think on a wholesale basis that we are, Steve. Again, there were a couple of sizable projects that just by their nature are very attractive to some of the nontraditional lenders. And they came out and put deals in front of people that will continue to be our customers I think on an ongoing basis, but resulted in a couple of these big projects going off our books.

Okay. When I look at the first quarter '06, the second quarter '06 we obviously had a big jump in loans. Is that a seasonal? Was that a seasonal thing?

As far as the total loans?

Yes, we went from 1203 to 1237 -- is it reasonable to expect that we go from 1237 this year to 1267. Or is that still steady as she goes? Flat?

I think it will be higher, but I don't know that it will be anywhere near that rate that it was last year. It will grow between the first quarter and the second quarter but I don't believe it will be $30 million like it was last year.

And lastly, if you could talk a little bit about terms and conditions for your commercial loans. And if there is a way to compare those terms and conditions to the residential portfolio you have, I am just trying to understand if the standards there are similar or tighter or looser.

As far as terms and --.

Terms and conditions. Yes, terms and conditions. Documentation so on and so forth, some of the -- a lot of the issues we have had on the residential side because terms and conditions have been so lose.

On the residential side virtually all of our production now -- I say virtually all -- I will say over 80% of our production is sold on the secondary market. It is originated to Freddie and Fannie standards and sold on the secondary market. On the commercial side we -- I think have a pretty good set of underwriting standards that we adhere to. Our internally credit administration group and our asset review committee is very active in staying on top of our credit. I don't have really a standard I guess that I would compare that (multiple speakers)

I can add on the residential side we did just complete an audit by Freddie Mac of our underwriting procedures and standards, and we received very high marks from them for our underwriting. And we underwrite all of our loans to those standards, whether we sell the loan or whether we keep it in our portfolio. And we have an ongoing review done of appraisers and some of the other areas that have been cause for concerns in other places.

Steve, on the commercial side we continue as we have for years we have -- we do have an external loan review that has done a third party loan review that is done semi-annually also to give us another set of eyes looking at that. I know one of the things that we have dramatically improved in I think is just on our overall documentation on our loans has improved tremendously, based on some guidance we give from our loan review specialist.

Okay because I see here we have loans over 90 days past due and still accruing at $8.2 million versus $3.9 million last year.

Those are non-accrual.

They are not accruing.

Right but that number is higher so I guess I am just wondering if that is any indication of perhaps looser standards.

I honestly don't think it is. Number one, both the acquisitions -- actually all three of the acquisitions we did, the one in '03 and the two in '05, some of those credits as time went on did deteriorate. But again, there were no real surprises in there. A couple of these were certainly our own, were originated under our own standards also that are on that. We had two relatively large credits, about a couple million a piece in the first two quarters of last year. One was a series of apartment buildings and rental properties over in the Findlay market. We are in the process of getting a number of those worked out right now. And also a commercial property up in Toledo, Ohio that is scheduled for share of sale coming up here I think middle of June. And as I mentioned in my remarks it just takes a while to work through the legal framework on these items. But I feel that we are on top of them. We do not, I think they are properly reserved for. I do not anticipate any major surprises along those lines.

Thank you very much for your time.

Gentlemen, there are no further questions at this time. I would like to turn the call back over to management for closing comments.

Well, if there are no other questions we thank you very much for joining us, and this will conclude our call. Thank you.

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