Premier Financial Corp (OHIO) (PFC) 2008 Q3 法說會逐字稿

Hello and welcome to the First Defiance Financial Corporation third 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 Ms. Carol Merry. Ms. Merry you may begin.

Thank you. Good morning everyone and thank you for joining us for today's third quarter 2008 conference call. . The call is also being webcast and the audio replay will be available at the First Defiance's website at FDEF.com until November 4, 2008. Hosting the call this morning is Bill Small, Chairman, President and CEO of First Defiance. Following prepared comments on the Company's strategy and performance, we will be available to take your questions.

Before we begin, I'd like to remind you that certain statements made during this conference call, that are not historical including statements made during the Q&A period are forward-looking statements within the meanings of the Private Securities Litigation Reform of 1995. Such forward-looking statements are based on information and assumptions available to management at this time and are subject to change. Actual results may differ materially. First Defiance assumes no obligation to update such statements. For a complete discussion of the risk and uncertainties that may cause future events to differ from the results discussed in theses forward-looking statements, please refer to the earnings release and materials filed with the SEC, including the Company's most recent Form 10-K and 8-K filings. Now, I'll turn the call over to Mr. Small for his comments.

Thank you, Carol. Good morning and thank you for joining us for the First Defiance Financial Corp. conference call to review the 2008 third 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. Before we begin, I want to tell you that we issued an 8-K earlier this morning disclosing that Jack Wahl, our CFO will be off for a period of time for medical reasons. Don Hileman has been appointed interim CFO in Jack's absence and brings strong experience and thorough knowledge of our operation to this role. Don has served as CEO of our Insurance Unit for the past 15 months and prior to that he was a controller at Sky Financial Group for 19 years. Don will be joining me on the call to give you more financial details on the quarter. Also, present this morning to answer your questions on credit quality is Jim Rohrs, President and CEO of First Federal Bank.

Third quarter 2008 net income on a GAAP basis was $322,000 or $0.04 per diluted share, down from $3.1 million and $0.44 per diluted share in the 2007 third quarter. For the nine month period ended September 30, 2008, First Defiance earned $6.5 million or $0.83 per diluted share compared to $10.3 million or a $1.44 per diluted share for the nine month period ended September 30, 2007. The 2008, nine month results included 1.0 million of acquisition related charges associated with the March 14, 2008 acquisition of Pavilion Bank Corp. of Adrian, Michigan and its subsidiary, The Bank of Lenawee. Excluding the after tax impact of those charges, First Defiance had earnings of $7.1 million or $0.91 per diluted share for the nine months ended September 30, 2008.

2008 continues to present many challenges to the banking industry with the current economic conditions and for our market area in particular. These challenges are reflected in our results for the quarter. From the national perspective, we recognized other than temporary impairment in our investment portfolio when the Federal Government placed Fannie Mae and Freddie Mac in conservatorship in September. We have an investment in preferred stock of those Government sponsored enterprises that cost $2 million when purchased but which declined substantially in value during the year. Those securities were written down to the September 30, market value of $151,000.

Also, in the 2008 third quarter, we recorded a Provision for Loan Losses of $4.9 million, due primarily to the deterioration of a number of large credits in our commercial portfolio. We've historically taken great pride in our asset quality and I still believe our underwriting standards are sound; however, we now have situations where good customers are struggling to make their payments. In some cases they're in industries that are in the thick of the current downturn and in other cases health issues or other factors have cause them to fall behind. At the same time, real estate values have declined and some collateral-dependent loans no longer have enough collateral value to support the the outstanding balance. We are proactively working to identify all potential problems and mitigate our losses as much as possible. At this time, I believe we have provided a conservative level of provision expense for all the problem loans that we have identified in our portfolio.

Despite the disappointing earning results for the quarter, there are several strong performance indicators. One of the significant positive story in our third quarter was a strong net interest margin. Net interest margin at the end of the quarter was 3.81%, a 34 basis point improvement over the third quarter 2007 margin. Also our strong performance in generating non-interest income continued during the third quarter, excluding investment security losses due to impairment-related charges, non-interest income for the 2008 third quarter improved by 11% over last years third quarter with service fees up by more than 34% between those two periods.

Loan demand is softening in some areas, both in commercial lending opportunities and in mortgage lending. The average balance of total loans grew about 2.6% this quarter due both to this softening and more cautious underwriting.

Total deposit balances at period end were also up only slightly over the June 30, 2008 balances. Customers are currently migrating to CDs to get yield. This flow of funding sources from savings and money market accounts to CDs has had a negative impact on our overall cost of funds. With a 50 basis point cut in the Fed's fund rate last week combined with the cost of funds increase, the possibility of further cuts-- and further cuts by the Fed we anticipate pressure on the margin.

Total non-interest expense for First Defiance increased year-over-year, however most of the increase is attributable to the Pavilion acquisition, which closed as I said late in the 2008 first quarter. The efficiency ratio for 2008 third quarter was 66.8% compared to 69.2% in the third quarter of 2007.

I will now ask Don Hileman to give you additional financial details for quarter before I wrap up with an overview and a look at what we see developing for the balance of 2008. Don.

Thank you, Bill, and good morning, everyone. In Jack's absence I'll try and give you a little more detail on the results for the quarter and then we'll answer your questions. We had a few significant matters that impacted our overall results for the quarter and aside from those two items, we had solid results. The first and most significant of those items is the high level of Provision for Loan Losses we recorded this quarter. As Bill noted our Provision expense totaled $4.9 million as we increased our allowance for loan losses to $23.4 million. The provision expense was 2.3 times our charge-offs for quarter and our Provision expense for the year at almost $8.8 million is 2.5 times the level of our year-to-date net charge-offs of $3.5 million. We calculated 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 of the borrower, the value of any collateral, the financial strength of any guarantors. Based on those judgments we recorded specific provision for loan losses against each loan that we analyze. We also provided general allowance of 1.05% for any commercial or commercial real estate loans that aren't specifically reserved for, with the residential mortgage loans we record our allowance equal to 20% of the outstanding loan balance on any mortgage loans and 30% of home equity loans that are 90 days past due at the end of the quarter.

Consumer loans are a very small part of our overall portfolio and we generally provide 75 basis points for losses on those loans. We're using different loan loss percentages for loans we acquired from the Bank of Lenawee in March of this year. The percentages are higher at 1.9% and 1.22% for mortgage and consumer loans respectively. Overall, our allowance for loan losses breaks down to $20.2 million for commercial and commercial real estate loans, $2.7 million for mortgage and home equity loans and $480,000 for everything else.

Our provision for loan losses is the adjustment we make to the allowance for loan losses necessary for the allowance to be adequate based on the losses we estimate to be incurred in the portfolio. Provision expense this quarter reflects expense of $624,000 related to the overall growth in loan balances, $3.1 million of increases in reserves for classified loan balances and $1.2 million of charge-offs where we did not have adequate reserves. 30 credits accounted for the $3.1 million in provision expense this quarter. Net charge-offs were 55 basis points (inaudible) for the quarter compared to 21 basis points last quarter and 21 basis points in the third quarter of 2007.

At September 30, our allowance for loan losses represented 1.4% of our total loans outstanding, an increase of 10 basis points over last quarter and 91.82% of our non-performing loans and non-performing assets were at 1.58% of total assets. The second significant item we recorded this quarter is $2.1 million of expense related to impairment of certain securities in the Company's investment portfolio that management deemed other than temporary. The majority of the other than temporary impairment recognized in the third quarter is related to 1.9 million write down of the preferred stock issued by Fannie Mae and Freddie Mac. First Defiance invested 1.0 million in the preferred shares of each agency in January of 2008, and wrote those investments down to 87,000 on the Fannie Mae and 64,000 on the Freddie Mac at September 30, 2008.

The Company also recorded 150,000 of additional other than temporary impairment of its investment in the equity notes of two trust preferred collateralized debt obligations in the third quarter of 2008. Those equity notes bare the initial credit losses were in banks that issued trust preferred securities into those pools default. Our net interest income of 16.4 million for the quarter was a 36% increase over last year's quarter. For the quarter, our margin was 3.81%, which was 34 basis points better than last year's third quarter.

Falling interest rates have impacted us both on the asset and liability side but we have been able to drop our liability costs more than our loans have fallen and we have improved the mix of our liabilities. A year ago in the third quarter the average balance of our non-interest bearing deposits was 103.2 million, which represented a 8.8% of our total average deposit balances for the quarter. In the just completed quarter, our average non-interest bearing deposits were 169.3 million or 11.8% of the total average deposits. We acquired 40.7 million of non-interest bearing deposits in the Pavilion acquisition. We also continue to have steady growth in our fee income, which increased 953,000 or 34% in the third quarter of 2008 over the third quarter of 2007.

In addition, our mortgage banking income increased by 90,000 or 10% in this years third quarter compared to the same period last year. First Federal remains well capitalized with total risk base capital at quarter end of 12.05% compared to the minimum regulatory requirement of 10%. This represents excess regulatory capital of 34.3 million at September 30, 2008.

That completes my overview for quarter and I'll turn call back to you, Bill.

Thank you, Don. As we progress through 2008 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. Unemployment numbers continue to run higher in this region compared to national numbers but seemed to at least leveled off in recent months. Agriculturally, the dry summer throughout this area has reduced crop yields from the recent strong performance to lower end of the historic yields. However, even though commodity prices have retreated some from their mid-summer highs with the combination of price and yield, our farming clients continue to do well.

We have expanded our credit monitoring functions even beyond our traditionally strong focus. Additional asset review functions and more delinquent loan reporting requirements have been added to assist in this monitoring. We continually review credit concentrations by industry and have placed limitation on lending within certain types of loans.

This is the most difficult operating environment I've experienced in my 30 years in banking. We have worked hard to execute our strategy in this challenging environment and to adapt to the changes in the business cycles. This was a very disappointing quarter from an earnings performance perspective and certainly not acceptable to us. But I believe it's a time of great opportunity for community banks like ours. We remain well capitalized with risk based capitals that is 20% more than the regulatory standard to be considered well capitalized. We have never been involved in the subprime lending market, which is at the heart of the recent crisis. First Federal Bank and First Defiance our positioned to continue following the business plan that has served us well over the years and prepares us for times like this. Our core fundamentals remain strong and the underlying strengths will keep us on course for the future.

In addition to working to improve our asset quality, we are focused on finding and growing revenue sources as well as focusing on operating efficiently to step up and meet today's challenges. Needless to say, there are better environments to operate in but we will continue to work with our customers and offer the best in products and services as we look forward to better times. We thank you for joining us this morning and now we will be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS). Our first question does come from Brett Villaume with Fig Partners, please go ahead.

Good morning.

Good morning, Brett.

I wanted to ask you on your commercial real estate portfolio, what percentage of that is non-owner occupied?

The commercial real estate that's non-owner occupied? To be honest with you, I don't have that breakdown with me this morning.

Okay.

We can get that for you. I will tell you that the general characteristic of that portfolio -- it really kind of relates back to our thrift roots where we are very comfortable with mortgages, we like real estate as collateral and a vast -- a large percentage of that -- are loans to small businesses that includes their real estate. It's not to say that there certainly are some investment properties in there of different types. An awful lot of it, a large percentage of it is owner occupied.

If I were to go back and look at last quarter, percentage from regulatory sources, would it probably be about the same?

Yes.

Okay. Great. And then on the construction portfolio, do you anticipate that we're going to see a continuation of that same sort of draw down in the fourth quarter? I guess it fell about 9%.

I think that would probably be pretty consistent with what we would expect. Number one, there's not a lot of construction activity going on out this way. And secondly, we are certainly being very cautious in anything we look at in that arena.

I think you may have mentioned it, would you mind repeating the Tier 1 risk base ratio. You said you add 20% above well capitalize status. I was wondering if I could have that exact ratio.

That is not -- we're doing the final calculations right now. At the end of the second quarter we were at 12.18. It's still in excess of 12%. But I don't want to give you an exact figure because at this point I cannot validate that that would be exact. It has in excess of 12.

Thank you very much.

Our next question will come from Eileen Rooney from KBW. Please go ahead.

Just had a question on your watch list and delinquency trends. How those looked in the third quarter?

I'm going to let Jim Rhors who is the President of the Bank, kind of deal with some of the credit issues on this and so Jim, I'll let your comment on that.

Okay, Bill. Relative to delinquencies, we haven't seen a significant increase in the dollar amount of delinquent loans. We have seen a migration out of the 30 and 60 day into the 90 and 120 day so we have seen an increase in the more severe delinquencies. And that has been a trend that has kind of marched up ward over the last four quarters. Classified credits are also up from the June 30, quarter end, although not dramatically. But that trend also has been up ward over the last several quarters.

Okay. And then one unrelated question. In your other feline, it was a negative number and I was wondering what was included in there.

That relates to a change in value on a comp program that we have.

Okay. So we would expect that to go back up again.

Yes.

Okay great thank you guys.

Thank you.

(OPERATOR INSTRUCTIONS). Our next question will come from Brad Ness from Choral Capital Management.

I was wondering if you could discuss if you're considering the TARP program?

We have been following it closely as I'm sure people would think we would be. As each piece is being released, we're doing a pretty thorough analysis on it. At this point in time, I'm not ready to be able to commit that exactly what we will be doing. You can be assured that we've been very actively working through analysis of the different segments as they've come out.

Okay. Were you going to say something?

No, no.

And also, how committed are you to your cash dividend right now?

AGain, that's something an ongoing for us as far as our review and analysis of it. We have a dividend payment that goes out this Friday. Our next dividend is scheduled for January. We will continue to monitor and make determination as things progress.

And when you're looking at that determination for the cash dividend, what are your primary factors in that decision making process?

Well, we will certainly be watching not only current earnings but our forecast in that regard. We'll look at payout ratios and then, of course, naturally capital needs.

Okay. Regarding your non-accruals, we saw an increase on the commercial and commercial real estate non-accruals. If you had to forecast, when would you guess that things peak out?

Jim --

That's the $64,000 question. The answer to that question depends on what happens with the economy from here on out as both Bill and Don alluded to in their previous comments, we have an aggressive and thorough watch list process to identify problem loans. And then to set reserves for those problem loans. We are very confident we've identified the problems that are in the portfolio right now and reserve for those. But we can't predict the future.

Okay. Lastly here, it looks like in your investment securities portfolio, you have 23 or so million in CMOs. Can you tell me if these are private label or more color about these CMOs?

I think -- this is Don. For being on the job a day gives me a little disadvantage here. I think it's a combination of both. I think there are some private label or pooled CMOs in there. It's kind of a mix. We can provide more color on that and more color on our 10-Q filing at a later day.

Okay. Appreciate it, guys.

Thank you, Brad.

This does conclude today's question and answer session. I would like to turn the call back over to Ms. Merry for any closing remarks.

Well, if there are indeed no more questions, thank you for joining us today. And this will conclude our conference call. Thank you. Goodbye.

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