Premier Financial Corp (OHIO) (PFC) 2007 Q4 法說會逐字稿

Hello and welcome to the First Defiance fourth-quarter and 2007 earnings conference call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (OPERATOR INSTRUCTIONS). Please note, this conference is being recorded.

Now I would like to turn the conference over to Ms. Carol Merry. Ms. Merry, you may begin.

Thank you. Good morning, everyone, and thank you for joining us for today's fourth-quarter and full-year 2007 conference call. The call is also being web cast, and the replay will be available at the First Defiance website at FDEF.com until February 1, 2008.

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; and that will be followed by a report on the financial performance by Jack Wahl, the Company's Executive Vice President and Chief Financial Officer.

Before we begin, I would 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.

Good morning and thank you for joining us for the First Defiance conference call to review the fourth quarter and 2007 year-end results. It certainly has been an interesting morning, as everyone has been busy reacting to the Fed announcement. However, last night we issued our earnings release for the year end, and also the fourth-quarter results. This morning, we would like to discuss that release, reviewing 2007 and looking forward into 2008. 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 year, and then Jack will give you more financial detail on our performance during the quarter and the year.

The challenges of 2007 were formidable and came from several directions. Most notably was the dramatic impact that sub-prime mortgage lending had on the balance sheet and income statement of many banks across the country. Beyond this direct effect of the now infamous sub-prime mortgages, residential real estate in general suffered from falling property values and, in many areas, a glut of properties on the market. Add to this the fact that the country struggled under an uncertain economic environment which resulted in tentative consumers and business and industry being cautious throughout the year, and especially in the final quarters of 2007.

For many banks, this resulted in a decrease in loan demand and other services, adding to the earnings challenge that was already present due to net interest margin compression and higher credit costs. Despite all of this, we finished strong with a solid fourth quarter resulting in net income for 2007 at $13.9 million, or $1.94 per diluted share. The fourth-quarter net income of $3.6 million or $0.50 per diluted share was a respectable finish to this challenging year.

The general economic environment was challenging enough, but we also face some further drag to earnings again in the fourth quarter due to additional expenses related to the August flooding. With these challenges before us, we did see our 2007 net income decline from the 2006 level of $15.6 million or $2.18 per share. The positive note, however, is the fact that earnings per share increased 13.6% in the fourth quarter of 2007 over our third-quarter results.

This increase, along with quarter-over-quarter improvement in the net interest margin and significant deposit in loan growth, gives us a positive feeling going into 2008.

Looking at our overall performance in 2007, loan growth after getting off to a very slow start in the first part of the year saw considerable pickup in the fourth quarter, and this increased volume helped offset the negative impact of the tighter net interest margin. As a result, this quarter we did see year-over-year increase in net interest income for the first time in 2007. The growth continues to be primarily within our commercial and commercial real estate portfolios and most of this increase comes from new relationships that are being brought into the bank as we continue to develop in many of our newer markets and also benefit from other bank mergers.

On the deposit side of the balance sheet, things were no less competitive as we kept our focus on the non-interest-bearing commercial and retail DDAs. Our average non-interest-bearing deposits for the 2007 fourth quarter increased by 14.4% from last year's fourth quarter, and they were up by more than 10% from the 2007 third quarter. Results like that are critical to our success in increasing net interest income in a falling rate environment. The aggressive marketing and strong sales push that have been part of our strategy resulted in this significant growth.

Net interest margin, even though it was still below the year-end 2006 level, did increase in the fourth quarter over our third-quarter 2007 results. This certainly was a positive sign and was primarily due to the deposit mix mentioned earlier, along with the return to a more normalized yield curve. Credit quality numbers were stable compared to our third-quarter results with one positive exception. Our net charge-offs annualized as a percentage of loans were at 4 basis points for the fourth quarter. This compares to 21 basis points and 30 basis points the last two quarters and 34 basis points in the fourth quarter of 2006.

Given the current operating environment, we have been very cautious in determining the appropriate levels for the allowance for loan losses and in analyzing asset values. Our non-accrual loans increased at year end to $9.2 million from $8.5 million at the end of September, the result of one large mortgage loan going 90 days delinquent. The allowance against that loan, which we recorded in 2006, will be adequate to cover any shortfall that occurs when that loan is resolved.

We also recorded additional expense in the 2007 fourth quarter to write down property and OREO to reflect the general weaknesses in the real estate market. Non-interest income excluding securities gains was up 7% from the 2006 fourth quarter results compared to this year's fourth quarter. For the full year 2007, non-interest income was up by 12.5% over 2006. Insurance commissions, service fees and mortgage banking income were all up for the year. We continue to look for additional ways to enhance these revenues as growth in non-interest income is going to be important to future earnings.

Non-interest expense was up about $1 million in the fourth quarter this year, but basically flat compared to the 2007 third quarter. This category was negatively impacted by our additional OREO write-downs and the flood-related charges.

I will now ask Jack Wahl to give you the financial details for the quarter and the year 2007 before I wrap up with an overview and a look at what we see developing in 2008. Jack?

Good morning, everyone. I'd like to start this morning by giving you some color on our fourth-quarter results and then spend a couple of minutes reviewing some of the highlights for the 2007 year-end period.

As we have already noted, we earned $3.6 million or $0.50 per diluted share for the 2007 fourth quarter compared to $4 million or $0.55 per share for the fourth quarter of 2006. By comparison, we reported earnings of $3.1 million or $0.44 per diluted share in this year's third quarter.

Net interest income for the 2007 fourth quarter was $12.5 million compared to $12.2 million in last year's fourth quarter, an increase of 2.3%. Our yield on loans dropped 11 basis points between the two periods to 7.21% in the 2007 quarterly period from 7.32% in 2006, and our cost of interest-bearing deposits increased by 4 basis points [to] 3.69% in 2007 from 3.65% in 2006.

We also added $15 million of trust preferred subordinated debt in this year's first quarter. As a result, the spread between the yield on our interest-earning assets and the cost of our interest-bearing liabilities decreased to 3.13% in the 2007 fourth quarter from 3.26% in the 2006 period. This compression in our spread was offset slightly by a 14.4% increase in our non-interest-bearing deposits in the 2007 fourth quarter compared to 2006 and a $6.4 million increase in average shareholders equity.

As a result of these factors, the net interest margin on a tax-equivalent basis for the 2007 fourth quarter was 3.52% compared to 3.61% in the 2006 fourth quarter. The '07 quarterly margin was a 5-basis-point improvement over the 2007 third quarter where we reported a net interest margin of just 3.47%, our low point for the year.

Our overall net interest income increased despite a decline in our margin because of growth in our interest-earning assets, where our average balance increased to $1.43 billion in the 2007 fourth quarter from $1.36 billion in 2006.

This morning's 75-basis-point drop in the Fed funds rate will put some pressure on our margin. Our net interest income simulation model shows a 1.5% decline in net interest income when rates drop by 100 basis points over a 12-month period. However, we have thus far been successful in dropping deposit rates more aggressively in what we have modeled to offset the reduction in yield in our prime-based loans. We have already met this morning and dropped deposit rates across the board in reaction to the Fed move. Hopefully, these rate drops will eventually return the yield curve to a more traditional slope. If that happens, I'm optimistic about our ability to successfully manage our net interest margin.

We recorded a provision for loan losses of $603,000 in the 2007 fourth quarter compared with a provision of $318,000 in the 2006 quarter. This provision expense was necessary to increase our allowance for loan losses to $13.9 million at December 31, 2007. The increased allowance for loan losses reflects heightened concerns about the overall economy and credit environment rather than any specific reserves for loans in our portfolio.

Our credit quality ratios generally were strengthened as of December 31, 2007, as a result of the provision adjustment. In addition to expenses related to the provision for loan losses, we also wrote down the value of properties we hold in other real estate owned by $598,000 this quarter. These write-downs reflect the realities of the commercial real estate market. Most of the OREO writedown relates to one large commercial property which comprises more than half of the OREO balance. We are actively marketing that property and are hopeful that it will be out of real estate owned by the end of this quarter.

Our non-interest expenses overall for the quarter were up by $951,000. The OREO adjustments and expenses we recorded this quarter for repairs to our two flood-damaged properties in Findlay and Ottawa accounted for that increase. Our competition and benefits cost, which is our largest expense item, was up only slightly this quarter compared to last year's fourth quarter, primarily because of large adjustments to reduce incentive compensation accruals based on our year-end results. We also continue to have favorable claims experience in our self-funded medical plan for the last half of 2007.

Our non-interest income in the 2007 fourth quarter grew by $346,000 or 7% from the 2006 fourth-quarter level. Those results included the recognition of a $157,000 debt benefit in 2007 related to our bank-owned life insurance program. Our service fees, which include loan fees, overdraft fees on checking accounts and debit card interchange fees, among others, increased by $145,000 quarter over quarter, and our insurance and investment income was up by $146,000, primarily the result of the acquisition of a small insurance agency in Bowling Green during the 2007 first quarter.

Looking at our annual results, our net income was $13.9 million or $1.94 per diluted share compared to $15.6 million in 2006 or $2.18 per share. For the year, our net interest income declined to $48.7 million from $49 million despite a $43.5 million increase in our average interest-earning assets. Our margin for 2007 was 3.55% compared to 3.68% for the full year in 2006. The 2007 annual results also included a $550,000 increase in the provision for loan losses compared to 2006, and a $4.3 million or 9.7% increase in non-interest expenses.

Total flood-related costs recorded in 2007 were $584,000. These cost increases were partially offset by an increase in our non-interest income, which was $22.1 million in 2007 compared to $19.6 million in 2006.

Service fees increased year over year by nearly $1.5 million, and insurance and investment sales commissions were increased by $747,000.

Our effective income tax rate for the 2007 fourth quarter was 29.3% and for the year was 31.8%. That rate was favorably impacted by the BOLI death benefit, which is tax-free income, and the reversal of some tax expense following the expiration of one of our tax exposure items. A more appropriate run rate for our effective tax rate excluding these items is 32.5%.

That concludes my comments this morning. I will now turn the call back over to Bill for some closing remarks, and then we'll try to answer your questions.

There were a number of other initiatives at First Defiance in 2007 that will add to our future growth and strength. In March of 2007, we acquired the Huber Harger Welt & Smith insurance agency located in Bowling Green, Ohio. This agency is now part of our Insurance unit, First Insurance and Investments. Bowling Green has become a very strong banking market for us and the addition of this insurance office will allow us to better serve all of the financial service needs in that market.

This acquisition is also part of our ongoing strategy to develop and grow additional sources of non-interest income. In August, we opened a new banking office in Fort Wayne, Indiana. This is our first entry into the Fort Wayne area with an actual office, but this is a market where we have developed a number of solid loan relationships over the years. We felt we needed to establish an office within this market to develop the full customer relationship. In the five months of 2007 that the office was opened, it generated almost $10 million in deposits.

We also announced in October that we had signed an agreement to purchase Pavilion Bancorp based in Adrian, Michigan. This transaction is projected to close in the first quarter of 2008.

We expect to continue to grow in 2008. Our budget reflects period-end net loans, including the Bank of Lenawee, of $1.65 billion. Most of our growth will be in commercial and commercial real estate loans, which we are budgeting to grow by more than $120 million. We have budgeted year-end deposits to total $1.56 billion with $170 million of those being non-interest bearing.

Our margin for the year is budgeted to be in the 3.6% range in the first quarter, increasing to near 3.9% by year end. Part of that improvement reflects the improved mix of deposits we will have following the acquisition. While a lower Fed funds rate will probably negatively impact that margin, we have thus far been able to offset loan rate decreases with reductions to our deposits. This morning's Fed announcement certainly adds a new dimension to that challenge.

Excluding the Bank of Lenawee, our non-interest income is expected to grow by 5%. On the expense side, our compensation and benefits will increase by 15% over 2007 levels excluding the Bank of Lenawee, primarily because of staffing increases that were modeled in as part of the acquisition's net cost savings. Bank of Lenawee's compensation expense will reflect offsetting staffing reductions. Overall, wages will increase by approximately 4% and we budget a 10% increase in group medical cost.

We believe that 2008 will be a challenging year for everyone in community banking. Asset quality issues will be everyone's focus, and with declining rates, net interest margin will continue to be a challenge. Overall, I believe this environment will offer significant opportunities to companies that stay disciplined in both loan underwriting and in loan and deposit pricing.

As we proceed into 2008, there are still many challenges, but we feel positive with the way we have positioned our company. I see great potential for us to continue to grow in our new markets as well as make our mark as a leader in providing financial services in our established markets. The banking landscape and a large portion of our footprint has been impacted by mergers and acquisitions, and we have and will continue to benefit from this activity. We have a tested and proven banking strategy with a customer-first focus. We will continue to build on this strategy as we strive to become an even higher performing community bank.

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

(OPERATOR INSTRUCTIONS). Christopher Marinac, FIG Partners.

I want to ask about the credit quality at Pavilion and what you know about how their year finished up, and was there any deterioration from where they already were at last quarter?

We have seen some deterioration there, Chris. We have been monitoring that very, very closely, actually trying to make sure that they have everything in place to address those issues. We don't have -- I cannot release any direct numbers or anything on theirs, but we have seen some deterioration that, obviously, the state of Michigan, Southeast Michigan, certainly have felt a major part of the impact of the slowdown in the economy.

However, I still feel very confident about the amount of due diligence that we spent in reviewing credit files prior to reaching the agreement with them as well as the fact that we currently have -- the firm that does our external loan review is currently on-site doing a thorough loan review for us as we speak. We should have those results here probably within the next week to 10 days.

Okay. With that in mind, if you kind of think pro forma in terms of how your allowance and coverage looks once they are in your fold, do you want your coverage ratios to be similar to where you have it now? Are you willing to have those dip down slightly until you work through some of the issues that you inherit from them?

I don't think we want to see them dip any lower than where they are right now. I mean we're very, very comfortable with our allowance and all of our ratios right now as we stand here today. But knowing with -- looking at the portfolio up there and such, I certainly don't think that we're going to want to put ourselves in a position of letting those get any thinner.

The write-down debt Jack mentioned, the $598,000, that's not classified as a charge-off; that's just a write-down to OREO?

That's correct.

Okay, fair enough. The last question just had to do with bigger picture. There has been a lot of discussion about the price of farm land possibly coming down or having peaked. Does that have any issues from a collateral perspective to your loans, whether it's directly in ag or just other loans that have collateral of farms or other related properties?

Well, it has obviously been something we have been watching very closely because we do a fair amount of ag lending, as does the Bank of Lenawee. I think, hopefully, we have seen these land values peak. But at the same time, we are not anticipating any significant drop in those prices anywhere in the near future.

Michael Lipman, FTN Midwest Securities.

I guess I wanted you guys to touch on the margin a little bit. Obviously, this morning was pretty timely. I guess you guided to 3.6% in the first quarter going up towards the 3.9% range. Are you still comfortable with that range with this morning's announcement? What goes into those assumptions for your margin guidance?

That's a good question. I asked Jack the same thing a little while ago.

Basically, Mike, it's right off of our budget for 2008, and it reflects assumptions that we made at the time we did the budget, which basically was a flat rate environment. Declining rates -- as long as we can continue to manage the spread and we have some slope in the yield curve, I think we probably won't be far off of those levels. If we have a systematic drop across the board in rates, then it's going to be a real challenge for us to get to those budgeted levels in 2008.

I guess, following this morning, I'm probably less optimistic about our ability to hit those numbers than I was three hours ago.

On the same lines, in this quarter, was the increase in the margin largely driven by the non-interest-bearing? Are there any other pieces that we should be aware of?

That was the basic driver, Mike, was just an improved mix on the deposit and on the liability side. We had runoff -- runoff is probably too strong a word. We had a reduction in the balances of some of our higher-cost CDs. We had CDs repricing at lower levels, and we had the nice growth in our non-interest-bearing deposits, which were up 10% for the quarter, which I think is phenomenal growth.

And in those non-interest-bearing numbers, some of that's seasonality, or how should I look at that?

Some of it is seasonality. Those balances typically decline in the first quarter. They don't necessarily peak for us in the fourth quarter, they peak in the second half of the year. But they typically decline because commercial customers are making tax payments, consumers are paying their credit card bills and other factors. So we do see a drop in those balances in the first quarter, and when we do our budgeting and our forecasting, this year at least, we budgeted some of that seasonality into our numbers.

And I guess banks in a lot of the other parts of the country, and I'm not intimately familiar with Ohio and Southern Michigan. It seems like deposit rates are still very sticky, and it's kind of difficult to lower them. You guys seem to be much more positive on that side of things, and just comment on that, I guess. Do you feel like with lower rate cuts, you can continue to ramp down deposit costs?

Well, I think that there certainly have been, especially as different credit markets have tightened up, we've seen a lot of the banks that have driven up the cost of funds in our market as well as other markets across the country. It has probably come much more so from the larger banks this time around than what sometimes you see as maybe periodic irrational pricing on the part of smaller banks.

That being said, I think that we -- hopefully we've seen the peak in that. I certainly would have to think that we weren't the only place that was busy this morning reviewing deposit rates and making changes there. But we still -- we are very much aware that there are special rates out there that are continuing to be advertised by many of our competitors, and we have a very active [ALCO] group that tries to react in a proper way to that to prevent massive runoff, but at the same time protect our pricing philosophy.

I do think, again, that we hopefully have peaked as far as some of this higher pricing is concerned. Right after the Fed came out with their auction process, we saw some of the larger banks ease up a little bit, and we hope and expect that to continue.

Were there any buybacks in the quarter, and what's your outlook on buybacks just in general?

We had a modest amount of buyback activity in the quarter. I do have that number here. Bear with me for just a second. We repurchased about 40,000 shares in the quarter. Even though our prices dropped significantly, I have not been successful in getting any -- there aren't a lot of sellers out there and our trading window opens back up on Friday. We will try to get some stock at this level, probably a comparable amount to what we've bought here in the last several quarters.

And I guess -- I don't want to hold up this line forever -- but [frank] on the CRE and commercial side, how are you seeing your pipelines and what's the specific weakness and strength in your different markets going into 2008? Thank you for all the good answers.

We felt that from pretty much the middle of the year on, our second half of the year, our loan growth was good. We had a decent third quarter, and our fourth quarter, I thought our loan growth, again, in this environment, I thought was very good. I think we're definitely benefiting from the Huntington acquisition of Sky. They have been -- they are very prevalent throughout our market. I think we compete against them in maybe every community that we are in, with the exception of one or two. I think, without a doubt, we know we have benefited from that.

We also have benefited from the fact that some of the acquisitions we've done over the last couple of years have put us in some new markets that we've been able to finally start to make some good penetration there. As a result, right now, we ended the year strong as far as loan growth. Our pipeline going into 2008 looks pretty decent. As long as we can keep everybody calm in regards to the economy, I think there's still good potential for us to grow.

(OPERATOR INSTRUCTIONS) Eileen Rooney, KBW.

With the 75 basis points cut this morning, how much did you lower deposit rates? Was it half of that, or just order of magnitude?

It depends on what maturity you are looking at and what product. We had -- actually, our ALCO had met last week, and like everybody else, we were anticipating some level of rate cut, whether it was going to be 50 or 75, whether it was going to happen now or next week at the regular meeting. So we went ahead, at that point, and lowered most of our special CD rates by at least 25 basis points. This morning, we basically went up and down the list and virtually every item except for the very lowest tiers on our savings accounts, which we're only paying 25 basis points for now anyway, we lowered a minimum of 25, and most of those we took down either another 50 from the 25 that we lowered last week or we lowered a full 75 today.

[Barbara Tomoloz], First Manhattan Investments.

I just want to ask about the rise in the non-performers. You mentioned in the press release it's one large mortgage loan. Could you just tell us what kind of mortgage loan it was?

The non-performers, the development loan, a land development loan with a --.

No, it's a mortgage loan. It's a property.

Oh, that's right. I'm sorry; I was thinking of the old [ram], which is already in. It is a single-family property that we had set up reserves, as we said, back in -- ['06 on that?]

Late '06, yes.

-- and actually think we're going to come out with a pretty good resolution on this, the way it looks at this point in time.

So, you're saying that it was a residential mortgage, a single-family?

Yes, it was one large residential mortgage loan.

And that was over $1 million?

No, the balance increased from last quarter by about $650,000, and that one property was $600,000.

And how are the Toledo-based non-performers, the $4.5 million chunk that's really the majority of the nonaccruals?

Those -- obviously, that's a hard-hit market and everything, but that's part of what our additional provision and stuff -- we felt that overall, on an individual basis, we felt that we were pretty well reserved on those as far as specifics. But that was part of the reason that we took some of the additional general reserve.

We're working with that borrower right now to -- he's trying to avoid foreclosure. We're probably going to get some deeds in lieu of foreclosure on some of those properties. So we expect we're going to see some movement in that. Now, that movement may be from non-performing to OREO this quarter, but we feel like at least we've got a plan to get that worked out.

We'll feel better when we are in control of the property in that situation.

And at this point, what is the specific reserve against that?

I'm sorry; I don't have that here, Barbara.

This does conclude the question-and-answer session. I would like to turn the conference back over to Ms. Merry.

Thank you. If there are no other questions, we thank you again for joining us today, and this will conclude our call.

Thank you. This does conclude today's conference call. You may disconnect now.