Premier Financial Corp (OHIO) (PFC) 2008 Q2 法說會逐字稿

Hello and welcome to the First Defiance Financial Corporation second-quarter 2008 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 Carol Merry. Ms. Merry, the floor is yours, ma'am.

Thank you. Good morning, everyone, and thank you for joining us for today's second-quarter 2008 conference call. The call is also being webcast and the audio replay will be available at the First Defiance website, at FDEF.com, until July 30, 2008.

With us this morning are Bill Small, Chairman, President, and CEO of First Defiance, and Jack Wahl, the Company's Executive Vice President and Chief Financial Officer. Following their prepared comments on the Company's strategy and performance, they will be available to take your questions.

Before we begin, I would like to remind you that certain statements made during this conference call including during the Q&A period are forward-looking statements and subject to the Safe Harbor found in the First Defiance SEC filings. Such statements are based on information and assumptions available at this time and are subject to change risks and uncertainties that may cause actual results to differ materially. First Defiance assumes no obligation to update such statements. For a complete discussion of the risks and uncertainties, please refer to the materials filed with the SEC including the Company's most recent Form 10-K and 8-K filings.

Now I will turn the call over 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 2008 second-quarter results. Last night we issued our earnings release for the quarter and this morning we would like to discuss that release and look forward into the balance of 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 quarter and then Jack will give you more financial detail for the period.

Second-quarter 2008 net income on a GAAP basis was $2.74 million or $0.34 per diluted share, down from $3.61 million and $0.50 per diluted share in the 2007 second quarter. These results include some costs associated with our acquisition of Pavilion Bancorp, which closed on March 14, 2008. Excluding the after-tax impact of those charges, First Defiance had earnings of $2.91 million or $0.36 per diluted share for the quarter ended June 30, 2008.

2008 continues to present many challenges to the banking industry with the current economic conditions and more specifically with the housing industry. Like many of our peers, our second-quarter operating results were negatively impacted by significant provision expense as we continue to address credit issues in our portfolio. A large percentage of those issues are from loans that came on our books through acquisitions and we continue to work at bringing our credit quality numbers more in line with our strong historic performance. I will discuss this in more detail in a moment.

In addition to the challenges presented by the economic environment, we also recognized a charge in the second quarter related to losses associated with the former First Defiance investment advisor. While management believes there is a possibility that part of the loss may ultimately be recovered, the expense was recognized in the 2008 second quarter after our claim under the Company's fidelity bond was denied by the insurance carrier. First Defiance also recognized other than temporary impairment expense on certain investment securities in the 2008 second quarter. Jack will furnish you with the financial details relating to these two items in his remarks.

The second-quarter provision expense of $2.8 million was the difference between a good quarter and the disappointing earning results we ended with. The soft economy, most notably in Michigan, has resulted in some further deterioration within our loan portfolio. We have continued to focus a lot of energy toward staying on top of this and have taken a very realistic approach to evaluating our credits. We have obtained updated appraisals of collateral on several of the credits, which resulted in further write-downs being recorded in the second quarter.

If you exclude the acquired assets, the Company's overall nonperforming assets have increased by just $300,000 since the beginning of 2008 in this tough economy. Net charge-offs at 21 basis points while slightly higher than the last three quarters were lower than the 30 basis points reported in the second quarter of 2007.

Our allowance for loan losses is at 116% to nonperforming loans. We believe it is an accurate reflection of the credit risk in our portfolio at this point in time. The current credit environment will continue to present challenges to the banking industry for the foreseeable future and we will be affected along with everyone else. However, our underwriting standards have always been high and we are working hard to identify credit problems early so they can be addressed and minimized.

Overall, these are among the toughest credit times this industry has seen in quite a while. We certainly are not immune to these difficulties but I think our portfolio has held up well as we look around and see the negative impact others are experiencing.

Despite the bottom-line quarterly results, I believe there are many positive developments we can take from this quarter. Our core operation remains strong. Our margin improved again this quarter and is up 40 basis points from the margin we reported just six months ago for the 2007 fourth quarter.

Our loan growth continues to be very solid. Our mortgage origination business is steady and our deposit mix continues to improve as non-interest-bearing deposits are up to 12.6% of total deposits at June 30 from 10% at December 31, 2007.

Also the integration of the former Bank of Lenawee offices continues to be successful. Overall, our deposit balances in these offices have held steady and our mix there also continues to get stronger, showing we are not having to pay up on CDs to attract or retain deposits in that new market.

One of the significant positive stories in our second quarter was the strong net interest margin growth. We anticipated some margin improvement resulting from the Pavilion acquisition, but we also aggressively cut deposit rates as the Federal Reserve reduced the targeted Fed Funds rate. We expect pressure on our margin will increase for the balance of the year as certificates of deposit rates are rising. We allowed a large number of CDs to run off early in the year rather than match competitors pricing and it has greatly benefited our margin. However, the need to fund our loan growth requires us to be more competitive with those rates.

Also we are starting to see rates on money market and other core savings products creep up. Loan demand, as I said, has been strong throughout the first half of 2008 as the second quarter continued with the momentum from early in the year. On a dollar basis, residential mortgage originations are up almost 70% over the first half of 2007.

Commercial loan demand also remained strong throughout the quarter as we continued to pick up business especially from larger regional banks for a variety of reasons including opportunities created by bank consolidations.

Total deposit balances at period end were up only slightly over the March 31, 2008 balances, but the non-interest-bearing deposits were up over 7.5% from the first-quarter balances. The focus on changing our deposit mix continues to help the margin and has allowed us to be less involved in some of the CD pricing wars in the market. However as I mentioned earlier, we will most likely need to be more aggressive in CD pricing as loan demand stays strong.

First Defiance's noninterest income for the 2008 second quarter increased over the second quarter of 2007, driven primarily by the increase in the mortgage banking activity that I spoke of earlier. Gains from the sale of mortgage loans were up nearly 50% over the second quarter of 2007. Service fee income was up over 25% compared to the June 30, 2007 results.

Income from the sale of insurance products was down slightly compared to last year's second quarter. Insurance premium pricing continues to be soft especially for property and casualty lines. But our agents have worked hard to attract new business to help offset the premium reductions.

Total noninterest expense for First Defiance increased year-over-year, however, much of the increase is attributable to the Pavilion acquisition, which closed late in the 2008 first quarter. Results for the 2008 second-quarter period also included some more one-time acquisition related charges primarily costs to terminate certain contracts of Pavilion and costs related to adding the former Pavilion employees to our retiree medical plan.

Noninterest expense also included the loss recognized in the quarter related to the former investment advisor. As I mentioned previously, this expense was recorded in the 2008 second quarter after coverage under the Company's fidelity bond policy was denied.

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 2008. Jack?

Thank you, Bill, and good morning, everyone. I will give you a little more detail on our results for the quarter and then Bill and I will be happy to answer your questions.

We had three matters that impacted our overall results for the quarter and aside from those three items, we had a very respectable quarter. First and most significant of those three items is the high level of provision for loan losses we've recorded this quarter. As Bill noted, our provision expense totaled $2.8 million as we increased our allowance for loan losses to $20.6 million.

Provision expense was more than three times our charge-offs for the quarter and our provision expense for the year at almost $3.9 million is three times the level of our year-to-date net charge-offs $1.3 million.

We calculate our allowance for loan losses by analyzing all loans on our watch list and making judgments about the risk of loss based on the cash flow, the borrower, the value of any collateral, and the financial strength of any guarantors. Based on those judgments, we recorded specific provision for loan losses against each loan that we analyzed. We also provided general allowance of 1.05% for any commercial or commercial real estate loans that aren't specifically reserved for.

For residential mortgage loans, we record an allowance equal to 20% of the outstanding loan balance on any mortgage loan or home equity loan that is 90 days past due at the end of the quarter and a general allowance of 0.12% on all mortgages that are less than 90 days past due. Consumer loans are a very small part of our overall loan portfolio and we generally provide 75 basis points for loan losses on those loans.

We are using different loss percentages for loans we acquired from Bank of Lenawee. Percentages are higher at 1.9%, 1.22% for mortgage and consumer loans respectively while the percentage for commercial loans is lower at 0.95%. Overall our allowance for loan losses breaks out -- breaks down to $17.2 million for commercial and commercial real estate loans; $2.4 million for mortgage and home equity loans; and $970,000 for everything else.

Our provision for loan losses is the adjustment we make to the allowance for loan losses necessary for that allowance to be adequate based on the losses we estimate to be in the portfolio including the general provisions described above. Provision for loan losses this quarter reflects expense of $385,000 related to overall growth in loan balances; $1.8 million of increases in reserves for classified loan balances; and $542,000 of charge-offs where we did not have adequate reserves. Ten loans accounted for almost $1.7 million of the increase in provision expense in this quarter.

At June 30, our allowance for loan losses represents 1.3% of total loans outstanding and 116% of our nonperforming loans. Our nonperforming assets are essentially right at 1% of our total assets.

The reported asset quality ratios are negatively impacted by the accounting treatment of impaired loans acquired in an acquisition, which are recorded net of any allowance. These hidden allowances totaled $3.9 million at June 31 while our nonperforming loans that are reported net of informant would have been $1.5 million higher if they were recorded at the gross amount due. Had all of these impaired loans been reported at their gross amounts, the allowance would represent 1.5% of total loans outstanding and 127% of nonperforming loans.

The second significant item we recorded this quarter is $752,000 in expense related to losses we incurred associated with one of our former investment advisors. We anticipated that most of those costs would be covered under our fidelity bond coverage. When that coverage was denied, we recorded the expense which amounts to $0.06 per share after tax. We are pursuing recovery of those amounts from a number of potential sources.

The third large adjustment we recorded in our second quarter was $432,000 of impairment expense associated with some securities in our investment portfolio where the decline in market value was deemed to be other than temporary. Mass majority of our investment portfolio consists of high-grade investment quality securities. However, we reach for yield by investing in the equity notes in a couple of pool trust preferred issuances.

Those equity notes bear the initial credit losses when banks that have issued trust preferred security into those pools default. At the time we invested, those investments seemed safe and worth the risk. However, two of the recent high-profile bank failures have resulted in our recognition of permanent impairment.

If you exclude those three items from our results, we had a very strong quarter. Our net interest income of $16.2 million for the quarter was a 33% increase over last year's second quarter. Our net interest margin continues to improve. For the quarter, our margin was 3.92% which was 36 basis points better than last year's second quarter and 40 basis points better than last year's low point in the fourth quarter.

Falling interest rates have impacted us both on the asset and liability side, but we have been able to drop our liability costs by more than what our loans have fallen and we have improved the mix of our liabilities.

A year ago in the second quarter, the average balance of our non-interest-bearing deposits was $101.6 million, which represented 8.8% of our total average deposit balances for that quarter. In the just completed quarter, our average non-interest-bearing deposits was $171.1 million or 12% of total average deposits. We acquired $43.8 million of non-interest-bearing deposits in the Pavilion acquisition. If you exclude those from the total, our balance of that type of deposit has increased by $25.7 million or 25.3% in the last year.

We also continue to have steady growth in our fee income, which increased by $700,000 or 26% quarter over quarter and our mortgage banking income, which increased by $425,000 or 35% in this year's second quarter compared to the same period last year. We also believe our expenses are under control. While our reported efficiency ratio was 67.3% for the quarter, if you exclude the $752,000 of costs associated with the former investment advisor and $262,000 of one-time acquisition related expenses, our efficiency ratio would have been less than 63% for the quarter.

That completes my overview for the quarter. I will turn the call back to Bill and look forward to answering your questions.

Thank you, Jack. As we progress through 2000, we will continue to address the challenges that face all of us. The overall economic climate throughout our market area continues to vary from industry to industry. We have experienced some plant closings and layoffs in recent months but many of our clients continue to express confidence in the balance of 2008.

Agriculturally, we are coming off three consecutive strong years and after some early delays in planning, crops at this point in time are looking very good. Obviously many of our commercial clients are concerned about fuel costs and that will continue to be something to monitor.

We have stepped up our credit monitoring functions even beyond our traditionally strong focus. We continually review credit concentrations by industry and have placed limitations on lending within certain types of loans. With loan demand remaining strong, we need to make sure that we stick with our solid underwriting policies and prudent pricing.

We have worked hard to execute our strategy in this challenging environment and to adapt to the changes in the business cycles. This was not a strong quarter from an earnings performance and certainly not up to our standards or expectations. However, the core fundamentals remain strong and the underlying strengths will keep us on course for the future. We are focused on finding and growing revenue sources as well as focusing on operating efficiently to step up and meet these challenges. I think we have demonstrated that the plan and the team that we have at First Defiance gives us the right components to continue to produce successful results.

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, Bill and Jack. I wanted to ask you about sort of geographically where the loan demand, loan pipeline is coming from, and to what extent is in your core markets in Northwest Ohio versus in the new markets in Michigan.

Right now the Findlay area has been a real strong area for us. We have seen very good loan growth down that way. Toledo market continues to pick up for us as our presence there. We have grown that in recent years and starting to get a little bit more traction there. The Michigan market at this point this early in the game, we haven't seen a lot of new growth there but we certainly think there is potential. But right now I think the Findlay and Toledo probably stand out as probably two as well as then as you know, we opened an office just about a year ago now in Fort Wayne, Indiana. That has been a good, strong market for us.

To what extent has the external changes that have happened in the industry, some of the questions -- a lot of your bigger competitors -- has that played into this pipeline or has it just been more organic blocking and tackling?

I would like to say that it is all because of our fundamentals that we have in place but we certainly have benefited I think from, number one, as I mentioned in my remarks, from consolidation. We do know that there's been a lot -- there has been some tightening of credit especially in some of the larger regional banks that we compete with and that definitely has probably given us some opportunities that in more normal times we wouldn't necessarily have seen at this point.

Okay, the last question just has to do I guess with the sort of farm status and sort of where you think land prices shake out in the next year or two and is not at all an issue from underwriting those type of loans?

We certainly have seen land prices as far as farmland have gone up over the past year especially -- it's been kind of a steady increase probably over a longer period of time than that. We do watch those very carefully and we will continue to be cautious as we review appraisals on any of those credits.

Very well. Thanks, guys.

Eileen Rooney, KBW.

Good morning, guys. I had a question and I'm not sure if I missed it in your comments. When you talk about the increased provision, you say 12 loans primarily attributed to that increase. Could you just talk a little bit about what they were, any particular industries or geographic?

Yes, I can give you some color on that. As far as -- there's really kind of a spread as far as industries. I do know that probably a little over between $4 million and $4.5 million was related to land and land development loans. We did have one in particular outside of that. We had a trucking company that I think was a victim of the fuel prices. But outside of those, it has been I think pretty well spread amongst different -- throughout some different industries.

Okay and just ballpark, what would be the size of those 12 credits, the total?

I said 10 credits in my comments, because the last two were relatively small. The largest of those from a provision standpoint was $400,000 and the 12 in total added up to $1.716 million, but if you take out the smallest two, it's still rounds to $1.7 million.

Okay, but what would the amount of those loans be? I'm just trying to get a sense for how much you have written them down.

Old Granite, which represents -- that is a land development and actually was a combination of three different credits is approximately $3.4 million. That is the largest.

Okay, then jumping over to the expenses, I'm just wondering if this is a good run rate for the comp and benefit line?

It is probably a little low as we reversed some senior management executive or its senior management incentive compensation that we accrue each quarter in anticipation of those payouts being significantly lower given year-to-date results. That was probably a $200,000 adjustment that we made and our expense under our ESOP plan is -- those shares have been fully released now for allocation and so that expense is we have reversed a little bit that we over accrued. That was maybe another $100,000. So I think if you add that amount back in, then you are probably fairly close to the run rate,

Okay, that's great. Thanks, guys.

Michael Lipman, FTN Midwest Securities.

Good morning, Bill is Jack. Just kind of a general question for you on credit. How is your feel for the peak of NPAs? We have a lot of talk on these different calls about being maybe a late 2Q -- 2008 event, early 2009. From your standpoint, what do you kind of think?

I would like to sit here and say that I am pretty confident that we are at the peak, and again, we've tried to stay on top of this as much as possible. It's just such a fluid environment out there right now. As we sit here today, Mike, I don't see anything that I think is going to jump up and surprise us. But one of the credits just kind of self-destructed on us in less than a three-month period that we had this month -- or this quarter. So at this point, I am hoping that we are at least by the end of this year we are going to be through the worst part of this and start seeing improvement after that.

Got you, thanks. A little further, what part of the loan portfolio kind of concerns you the most at this point?

You know, I don't know that because we really try to watch our concentrations. Obviously -- fortunately, we are not a big, big player in development loans, construction, land development loans. We have actually been able to because of our foresight, I guess, for lack of a better description of it been able to bring those balances down as we again we monitor those levels on an ongoing basis and try to be cognizant of certainly of what is going on out there in our environment.

The trucking industry with the fuel costs where they are, we certainly are keeping a very close eye on that. We have several nice sized relationships with I think very solid organizations in the transportation industry right now. So it isn't anything that we are losing sleep over. I think it's just kind of a general keep an eye on everything out there right now.

Okay but you are still seeing -- comfortable with the HELOC portfolio thus far?

Yes, we really are. We have got -- our over 90s in HELOCs are just over $400,000 on a portfolio that is in excess of $100 million. So that is an area that again we have been over the years, we have been taking a fairly conservative approach to our HELOC lending.

Got you. I guess switching gears a bit, on the securities impairment, how do you feel about the securities book going forward? Do you think there are any notable risks to further impairment in that?

Yes, there is a little bit, Mike. The specific trust preferred securities that I mentioned if there are further bank failures of loans that issued into those pools, there's probably another $300,000 of exposure there. And we bought last fall when Fannie and Freddie issued their new preferred shares, we bought $1 million of each of those. The values of those have fallen some since the end of the quarter. They were actually pretty much in line with what we paid for them at quarter end and they've dropped probably 40% since then. So it remains to be seen what will happen with those values between now and the end of the third quarter.

Got you. I guess on the margin side, how many basis points did Pavilion contribute in the quarter? I don't know if you have that handy perchance.

I really don't. Once we combine the company as they kind of lose their separate identity in terms of doing that kind of analysis. Certainly had a very positive impact for us.

Okay, I guess you expect a little bit of margin compression going forward. Can you quantify that at all or is it just basically all based on the CD pricing going forward?

It's based on CD pricing and a continued strong low growth that's requiring us to maybe use a little more CD funding than what we've had to use to this point of the year. So it's probably a few basis points but I can't really quantify it beyond that.

Gosh, what would happen to the NIM if we had rate increases through the end of the year, before the end of the year?

Our simulation shows that if we have like a 100 basis point increase in rates over a 12-month period that we have got about $1 million increase in our net interest income in that environment.

Got you. Lastly, are there any Pavilion-related merger costs left on the books or pretty much done with that at this point?

Pretty much done. There might be a few small ones that still bind their way in there, but we are pretty close to being closed on that.

Great. Thank you, Bill and Jack.

We show no further questions at this time. I would like to turn the conference over to Carol Merry for any closing remarks.

All right, if there are no other questions, we will thank you for having joined us today and this will conclude our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.