Premier Financial Corp (OHIO) (PFC) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the First Defiance third quarter 2007 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, Carol Merry. Thank you. You may begin.

Thank you, Joe. Good morning, everyone. Thank you for joining us for today's third quarter 2007 conference call. This call is also being webcast, and a replay will be available at the First Defiance Financial Corp. website at FDEF.com until November 2, 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, 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 certain statements made during this conference call are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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, are based on information currently available to the management of the Company and 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 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 Corporation conference call to review the 2007 third-quarter results. Last night we issued our earnings release for the third quarter, and this morning we would like to discuss that release and also discuss other recent events at First Defiance. At the conclusion of our presentation we will answer any questions you might have.

I'd like to begin by giving you an overview of the quarter and then Jack will give you more financial details on the results. Third quarter 2007 net income was $3.13 million or $0.44 per diluted share. This is down from $3.82 million and $0.53 per diluted share in the 2006 third quarter. The continuation of margin pressure, along with higher provision costs and higher non-interest expense impacted earnings on the negative side in the third quarter. But continued growth in non-interest income, better loan growth and improving deposit mix were strong positives for the quarter.

Net interest income continued to be pressured by the challenges of the current rate environment, and increases in nonperforming assets. The yield on our loans dropped slightly from last quarter while the costs for interest-bearing liabilities was up six points over the second quarter. Our net interest income was also negatively impacted by an increase of loans over 90 days past due. As it is our policy to reverse accrued interest on all these loans. As a result, net interest margin dipped to 3.47% from 3.58% last quarter as the increased loan production did not offset the tightening spread. The margin was also impacted year-over-year by the issuance of $15 million in trust preferred securities at the end of the first quarter of this year. We hope to see some relief on deposit rates in the coming months following the Fed's rate cut last month. This, along with improving the deposit mix and improving the credit body will be important factors in positively impacting our margin going forward.

We were pleased with the increase in loan production during the third quarter, though we are still behind our forecasted growth for the year. Commercial and commercial real estate balances continued to grow, increasing more than $22 million at September 30 compared to balances at June 30 of 2007. Pricing is competitive in our markets and we continue to stress to our lenders the need to be prudent in underwriting and pricing.

Several deposit initiatives have brought notable increases in the number of new DDA accounts resulting in the improved deposit mix that I referred to earlier. Changes in our cash management program, including setting higher [type] balances and the increase in remote deposit customers also contributed to the growth in non-interest bearing balances. We will maintain our focus on these areas to continue in improving their deposit mix. Credit quality performance in the third quarter of 2007 declined with increases in nonperforming loans and other real estate owned. This is negatively impacted our credit quality ratios, and while we are still in line with peer group numbers, these are not acceptable levels for us.

Our asset review committee is diligently working on these issues and has developed workout strategies for most of these problem credits. Unfortunately, these workouts take some time, and although we do not believe that we have any systemic issues within the loan portfolio, it will be a slow process in bringing the credit ratios back in line with our historic strong performance.

Non-interest income was up almost 8% over the third quarter of 2006 even with the negative impact of losses taken on the sale of REO. Service charges and insurance and investment commission income increased considerably this year over the September 30, 2006 results. The over 20% increase in insurance commissions was partially the result of the acquisition of the Huber, Harger, Welt & Smith agency in Bowling Green that was completed in February of this year. Initiatives that we have put in place over the last year are now producing the type of results that we had expected. The growth of non-interest income remains critical to our success as the margin pressure continues.

Non-interest expense was up in the 2007 third quarter with the total including more than $240,000 in expenses related to the August flooding in Northwest Ohio. Year-over-year compensation expenses increased due in part to the acquisition of the Bowling Green Insurance Agency and the staffing of the new Fort Wayne banking office, which opened in August of this year. These two events also impacted occupancy costs for us this quarter compared to the 2006 results. 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.

I will now ask Jack Wahl to give you the financial details for the quarter before I wrap up with an overview and a look at what we see developing for the balance of 2007 and beyond.

Thank you, Bill. And good morning, everyone. I will try to add some additional coverage to the points Bill made about our financial results for the quarter. Our net interest income was down by $182,000 from last year's third quarter and down by $95,000 from the 2007 second quarter. One factor that contributed to the declining margin is the reversal of previously recorded interest income on loans that became delinquent by more than 90 days. In the quarter just ended we reversed $325,000 of interest on delinquent loans compared to $93,000 in last year's third quarter and $167,000 in the second quarter this year.

To the extent that we are successful in getting those delinquent loans current, we will see some of that interest come back on our income statement in future periods. I have estimated that the nonaccrual interest had a 9 basis point impact on our margin this quarter, a 3 basis point impact in the 2006 third quarter and a 5 basis point impact in the 2007 second quarter. The net interest margin also continues to be impacted by deposit costs increasing faster than loan yields. In the 2007 third quarter the total cost of our interest-bearing deposits increased by 6 basis points from the second quarter while the yields on earning assets declined by 6 basis points.

While the recent 50 basis point cut in the Fed funds rate has helped the yield curve get some slope back, it likely will negatively impact our results at least short-term. We have close to $300 million of prime base loans, to reprice within 30 days of a Fed rate move whose yields have dropped 50 basis points. We have attempted to counter that by dropping our money market savings rates, but it is not a one-for-one offset. For example, in September our prime base commercial loans on average had a 12 basis point decline in their yields, while our savings, money market and interest-bearing checking accounts declined by just 4 basis points.

We also continue to see very competitive CD rates in our market area. Except for our newest locations where we are trying to build traffic in our lobbies, we have taken CD specials off the board. Our expectation is that we will continue to see downward pressure on our margin for at least the balance of the year.

The second factor that contributed to lower earnings this quarter is provision expense and other related asset quality issues. Our provision for loan losses for the 2007 third quarter was $671,000 compared to just $373,000 in the third quarter of 2006. That expense was also up nearly $100,000 from the 2007 second quarter provision of $575,000.

For the '07 third quarter $163,000 of the provision expense related to general reserves allocated to growth in the loan portfolio. Net charge-offs for the quarter totaled $661,000. Specific reserves against loans for the quarter declined by $153,000, which includes the impact of loans charged off that no longer require an allowance for loss. In addition to provision expense, we recognized a total of $285,000 of expense associated with repossessed properties. By comparison, expense for OREO totaled just $19,000 in 2006 third quarter. Two properties in OREO were sold for approximately $115,000 less than their recorded value, and the appraised value of a large commercial OREO property came in at $100,000 below our preliminary evaluation of that building, which we recorded last quarter following a Sheriff Sale.

Also we had a significant property tax bill on that large commercial property. We continued to challenge the appraised values of the remaining properties in our OREO inventory. While we are not ruling out further write-downs, we believe the values of 13 properties on the books as of September 30th are appropriate.

The third factor that negatively impacted our earnings for the 2007 third quarter were the costs we incurred related to some of the worst flooding this area has ever seen. The late August flooding of the Blanchard River attracted national media coverage to both Findlay and Ottawa, and we have significant presence in both of those communities. The worst damage was incurred at our downtown Findlay office where the basement was filled with water, and we had several inches of water on our main floor. Damage caused by the flooding required us to gut the entire first floor of that facility and also required substantial repairs to the building's mechanical systems, most of which had just been upgraded within the last 18 months.

Our cleanup costs for that facility exceeded $80,000. We are still running under temporary power which costs us around $12,000 through September 30th. And the costs to restore the building to usable condition are estimated at $320,000, of which only $30,000 has been completed as of September 30th. We also wrote off furniture and computer equipment which had a book value of $16,000 at that office. The downtown Findlay office remains closed as of today. We expect it will open sometime before the end of October. Fortunately, we have two other offices in Findlay which did not sustain any significant images.

Our Ottawa branch also was damaged by the flooding but to a lesser extent than our Findlay office. Cost to repair the Ottawa office was approximately $35,000. We wrote off fixed assets that were destroyed, totaling $71,000. We did not have flood insurance on either of these facilities that were damaged. We have canvassed all of our commercial clients that were impacted by the flooding in both communities to assess the exposure in our loan portfolio. We are pleased to report that the level of uninsured damage costs to those clients does appear to be significant. Further, as required by regulation, all loans with mortgages on properties located in the flood plain are required to have flood insurance. As a result those specific loan customers were covered by flood insurance.

While our costs associated with the disaster are significant, they pale in comparison to the overall damage cost in these communities. To aid in the massive cleanup and recovery efforts, we made corporate donations to the American Red Cross and the United Way in both Hancock and Putnam counties, totaling $20,000. In total, pretax expense in the third quarter related to this situation totaled $240,000, after tax the impact was $156,000 or approximately $0.025 per share. As noted, we expect to expense an additional $290,000 of repairs at the Findlay office in the fourth quarter, which will impact earnings by $190,000 after tax, or $0.03 per share.

Excluding the impact of the flood costs and the costs of OREO that I have already discussed, our non-interest expense for the 2007 third quarter increased by approximately $700,000 compared to the third quarter of 2006. Compensation and benefits accounted for approximately $213,000 of that increase. Advertising and marketing expenses increased by $179,000. And attorneys' fees are up by approximately $90,000. We had costs in the third quarter of 2007 totaling $85,000 associated with our new Fort Wayne, Indiana office, which opened in August, as well as costs at the Huber, Harger, Welt & Smith Insurance Agency, which we acquired in February.

The increase in total interest -- the increase in non-interest expense was offset somewhat in the 2007 third quarter by a reversal of approximately $225,000 of incentive compensation accruals recorded in previous quarters. That adjustment reflects management expectations of lower bonus payouts, given the nine-month year-to-date results. Year-to-date our net income of $10.3 million is $1.3 million or approximately 11% behind 2006 year-to-date income after nine months. Net interest income lags last year by $644,000, the result of a 15 basis point decline in our year-to-date margin. Also our provision for loan losses is $266,000 higher through nine months this year as compared to last year, and our non-interest expenses are up $3.3 million. Those amounts have been partially offset by a 15% increase in our non-interest income, which increased by $2.1 million in the first nine months of 2007 from the same period in 2006.

That concludes my analysis of our financial results for the quarter and year-to-date periods. I will now turn the call back to Bill for his concluding remarks, and then we will try to answer your questions. Bill.

Thank you, Jack. Outside of normal operations the 2007 third quarter has been an extremely busy time for us. A longtime strategic objective of expanding into Indiana was accomplished with the opening of our 27th banking center in Fort Wayne in August. We've developed a number of strong relationships in that market over the years but knew that in order to further grow those and other potential relationships we needed a physical presence in the market. We have an experienced, well-recognized team of individuals staffing that office, and we are off to a good start in less than two months of operation.

Also earlier this month we announced that we had reached an agreement to acquire Pavilion Bancorp, headquartered in Adrian, Michigan. Pavilion is a parent company of the Bank of Lenawee, a $291 million community bank. This is a well-run organization with an operating strategy and culture very much in sync with our own. This is a natural geographic expansion of our footprint to the north, and will give us a strong position in a good agricultural and recreational area of Michigan.

In addition to these major activities, we 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 diligently to reach the full potential of our new, newer and larger markets such as Findlay, Toledo and Lima. We continue to evaluate new market opportunities where we believe growth potential exists.

These continue to be challenging times in the banking industry, and the news media has given a lot of coverage to the fact that the Midwest has one of the largest foreclosure rates in the nation and our area is not immune to this problem. However, I will again tell you we have never been involved in subprime lending and even though our residential foreclosures have increased, I think our experienced collections staff has done an excellent job of mitigating losses. We will continue to monitor all residential spec construction loans and real estate development lending with added scrutiny as the housing market remains weak.

We have been pleased with the results that we are seeing from several of our strategic initiatives, especially those related to non-interest bearing accounts. The introduction of our remote deposit product earlier this year, as well as some targeted marketing campaigns are helping us to grow these deposits. We continue to look for opportunities to find additional sources of non-interest income to help supplement the net interest income that has softened in the current environment. 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. Many of our commercial customers still report business as steady with a growing pipeline.

Some of our trucking clients do report some spottiness in their business primarily dependent on the industries that they haul for. All of this taken together gives us a positive feel going forward. We have worked hard to execute our strategy in this challenging environment and to adapt to the changes in the business cycles. We are focused on finding and growing revenue sources, as well as focusing on operating efficiently. We thank you for joining us this morning, and now we will be happy to take your questions.

(OPERATOR INSTRUCTIONS) Christopher Marinac, FIG Partners.

Good morning, guys. I want to ask about credit quality at the Pavilion acquisition, what it looked like at the end of September if you know, and then any sort of thoughts on how that may evolve between now and when you close the acquisition.

I don't have right here handy, Chris, the actual September results and everything. But we have been monitoring it throughout our whole process, looking at the figures pretty much on a month-to-month basis and overall we have been relatively pleased with the way it has held up. Their nonperformings are a little bit higher than ours are, but again, not out of line with what industry standards are right now. So we've been very impressed with their overall underwriting. The files that we've reviewed, we did an extensive loan review as part of due diligence. We were very impressed with that.

Okay, they were at 150 NPAs to loans at last quarter. Is that right?

I didn't have them -- I didn't think they were that high, Chris. I thought it was -- I was thinking it was in the 120 range, but I would have to go back and look again. I don't have that right in front of me.

And I guess the separate question going forward is now that you have the Fort Wayne plans, as well as Michigan plans, would this sort of satisfy your cross-border work for the moment or do you think you may push deeper into either state in the coming year or two?

We don't have anything on the drawing board to do that. We like the expansion into both of those states. But there is no definitive plan to really do any major expansion in either of those areas right now.

Okay, and last question goes back to the ordinary mortgage business. Is there any new opportunities for you to do mortgages that things that aren't being done in the traditional mortgage channels, as some of the dislocation from the mortgage players leaving? Does that create any new windows for you?

I think that we are probably going to stick pretty close to our guns as far as our mortgage lending is concerned, especially having seen what has happened over the last year or so. I think it probably it has taken a lot of players out of the market and hopefully it is going to create some opportunities for us just in conventional lending. But beyond that, I really don't see a whole lot.

Okay. Good, Bill. Thank you very much.

(OPERATOR INSTRUCTIONS) Eileen Rooney, KBW.

Good morning, guys. I just had a couple -- I guess two questions mainly. I was just wondering about the inflow into nonperforming this quarter. Just wondering if there was any industry concentrations or regional things going on there? And then also just on your reserve levels, I just wanted to get a sense of your comfort. You guys are a little bit below peers at 106 basis points; I just wanted to get your thoughts on that going forward.

I will talk first about the inflow into the nonperformings. Really one large relationship that caused the biggest ripple there it is real estate development relationship. However, as I said in the call, we don't really expect that, we are trying to keep a very, very close eye on these as far as anything new that we are putting out in those lines. But there is not -- we don't -- I don't think we have a huge, and I don't have the breakdown right here as far as what percentage of our portfolio would be involved in real estate development, but it is not a major line of business for us. So I do not anticipate that we are going to see that as a growing problem.

And as far as the reserves, the allowance that we've set, the reserves, it has -- it is down at 106, is probably starting to skirt the low end of where we would have a comfort level. But again, we do a pretty thorough loan review, loan loss review process each quarter. And I think we are still -- we still have confidence in that number.

I guess I just had one other question on -- you guys had some pretty good loan growth this quarter in commercial and CRE, and I was just wondering where that was coming from, if there are any particular regions that stood out.

I think we are definitely benefiting from the acquisition of Sky by Huntington. That has been delivering some new business our way, probably strongest -- the Findlay market has been very, very strong for us in that respect. Bowling Green, which was the home of Sky Financial also has produced some nice, new accounts for us over that way. So if I had to point to one single reason, it would be the acquisition of Sky by Huntington, creating some great opportunities for us. And I think the other side of it is just continuing to make inroads into some of our newer markets. That is where our growth -- we've got a pretty good job I think of saturating our more mature markets, not that we are out of opportunities there, but there is an awful lot of opportunity in our newer markets, and we are starting to take advantage of that.

That's great. Thanks, guys.

(OPERATOR INSTRUCTIONS) There are no further questions at this time. I would like to turn the call back over to management for closing comments.

Thank you. Thank you for joining us today. If there are no other questions, we will conclude the call at this time. Thank you.

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