Premier Financial Corp (OHIO) (PFC) 2009 Q3 法說會逐字稿

Good morning and welcome to the First Defiance third-quarter 2009 conference call. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Carol Merry. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us for today's third-quarter 2009 conference call. This call is also being webcast, and the audio replay will be available at the First Defiance website at FDEF.com.

Providing commentary this morning will be Bill Small, Chairman, President and CEO of First Defiance, and Don Hileman, 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 during the conference call today, including during the question-and-answer period, you may hear forward-looking statements related to future financial results and business operations for First Defiance Financial Corp. Actual results may differ materially from current management forecasts and projections as a result of factors over which the Company has no control. Information on these risk factors and additional information on forward-looking statements are included in the news release and in the Company's reports on file with the Securities and Exchange Commission.

And now I will turn the call over to Mr. Small for his comments.

Thank you. Good morning and thank you for joining us for the First Defiance financial Corp. conference call to review the 2009 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 to the balance of 2009.

At the conclusion of our presentation, we will answer any questions you might have. Don Hileman, our CFO, will be joining me on the call this morning to give you more financial details on the quarter. Also present this morning for the question-and-answer session is Jim Rohrs, President and CEO of First Federal Bank.

Third-quarter 2009 net income on a GAAP basis was $329,000 or a negative $0.02 per diluted common share compared to $322,000 and $0.04 per diluted share in the 2008 third quarter. For the nine month period ended September 30, 2009, First Defiance earned $6.6 million or $0.63 per diluted common share compared to $6.5 million or $0.83 per diluted share for the nine-month period ended September 30, 2008. Excluding the after-tax impact of acquisition-related charges in 2008, First Defiance had earnings of $7.1 million or $0.91 per diluted share for the nine months ended September 30, 2008.

2009 continues to present many challenges to the banking industry with the current economic conditions and for our market area in particular. These challenges are certainly reflected in our results for the quarter. While most core operating metrics were again solid, we felt the negative impact of higher provision expense, additional expenses for OREO and collections, other than temporary impairment charges and lower mortgage servicing rights valuation.

To offset these charges, we had an improved net interest margin, coupled with a larger loan base resulting in an increase in net interest income of over $1.2 million and a $1.4 million increase in total non-interest income, and an over $400,000 production in non-interest expense compared to third quarter of 2008. All of this netted out to basically flat net income compared to the prior year period.

Credit quality remains the biggest challenge as it has been for the past several quarters. We did see some improvement in lower delinquency numbers and net charge-offs this quarter compared to the last quarter, and non-accrual loans were flat compared with the linked quarter.

We also have not seen any significant new deterioration in the loan portfolio. These are certainly signs of encouragement, but we need to see this improvement on a sustained basis to really identify it as a trend. The primary factor behind the provision expense this quarter is not specific to any particular loans or relationships but a general valuation allowance to insulate the portfolio.

Even with the positive signs I just noted, property values continue to show weakness, and some collateral dependent loans no longer have enough collateral value to support the outstanding balance. Based on this and the economic forecasts calling for a slow recovery, we felt it was necessary to build our general reserves as we work through this tough economy.

Despite the disappointing net income results for the quarter, there were several strong performance indicators. One of the significant positive stories in our third quarter was a strong net interest margin. Net interest margin at the end of the quarter was 3.88%, a 27 basis point improvement over the second-quarter 2009 margin.

Also, our strong performance in generating non-interest income continued during the third quarter even though the record-setting residential mortgage production experience in the first half of 2009 has subsided. Mortgage originations did drop-off in the third quarter compared to the first six months of the year, but we are still running significantly ahead of the same period last year.

Annualized average balance loan growth was a little over 5% compared to second quarter as borrowers continue to be cautious in taking on new debt. Most of the growth is coming from new relationships where these customers are refinancing existing debt with our bank. These new loan customers bring along deposit relationships, and as a result, noninterest bearing deposits were up at quarter end over 10% compared to end of third-quarter 2008. Period-end total deposits were up about 7.5% over the September 30, 2008 period ending balance.

Total non-interest expense for First Defiance decreased year over year and linked quarter due to expense control initiatives and reduced compensation expense.

I will now ask Don Hileman to give you additional financial details for the quarter before I wrap up with an overview and look at what we see developing for the balance of 2009. Don?

Thank you, Bill, and good morning, everyone. The third quarter continued to be difficult and as we saw a continuation of high unemployment and weak economic activity in our markets. This has been especially true in Southern Michigan and the extreme northwest corner of Ohio where most of the counties are well into double-digit unemployment. We anticipate overall weak economic activity throughout the remainder of the year in our market area.

While we did not have a direct concentration of unrelated commercial lending, we do have retail customers whose livelihood depends on the automotive and related industries. We anticipate more stabilization in these segments as the auto industry improves.

As we review our financial performance, credit quality remains a key component. But we also had several other additional significant items that contributed to the flat year-over-year third quarter core income. I will begin with a discussion of credit quality.

This quarter we had a large loan loss provision with a corresponding build in the allowance for loan losses. In light of the continued environment of high unemployment, declining real estate values, and sustained economic weakness in the Midwest, as well as our current regulatory environment, we believe it is prudent to build our general loan loss reserves. Our provision expense totaled $8.1 million, up from $4.9 million in the third quarter of 2008 and $4 million in the second quarter of 2009. Our allowance for loan loss increased to $31.2 million, or 1.92% of total loans at September 30, 2009 and from $25.8 million and 1.6% on June 30, 2009, and $23.4 million and 1.47% on September 30, 2008. The third-quarter provision exceeded net charge-offs by $5.5 million. Annualized net charge-offs were 66 basis points of loans for the third quarter of 2009, down from 96 basis points in the second quarter and up from 55 basis points in the third quarter of 2008.

Of the total net charge-offs, 57% or $1.6 million were related to poor credit relationships. Of the commercial real estate total charge-offs of $1.2 million, $763,000 or 66% related to two of those relationships. $611,000 or 92% of the total commercial charge-offs of $658,000 related to one credit relationship.

We maintain a continuous process of analyses and review of our loan portfolio and have made decisions to reallocate resources to work with past-due clients to determine a course of action that we hope will mitigate potential losses on client relationships. We have two experienced individuals dedicated to handling problem commercial credit and developing action plans to move the credit through the workout process.

We have also been actively working with residential borrowers to determine qualification for loan modifications. We have modified approximately 93 residential mortgage loans in 2009. We calculate our allowance for loan losses by analyzing all loans on our classified and special mention lists and making judgments about the risk of loss based on the cash flow of the borrower, the value of any collateral and financial strength of any guarantors. Based on those judgments, we record a specific amount of loan loss against each loan that we analyze.

The 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 in the portfolio.

In our review we have determined that it is appropriate to increase the economic, environmental and regulatory factors we use in determining the general portion of the reserve for loan loss while determining the adequacy of the reserve. We believe this is consistent with the operating environment we foresee for the remainder of 2009 and into 2010.

At September 30, our allowance for loan losses represent 1.92% of the total loans outstanding, an increase of 32 basis points over the last quarter and 78% of our nonperforming loans, which was up from 64% on nonperforming loans at June 30, 2009. Nonperforming assets ended the quarter at $49.4 million or 2.45% of total assets, up from $48.9 million last quarter, which was 2.42% of total assets.

Total nonperforming loans remained basically flat from last quarter at $40.1 million on September 30. The non-accrual loans basically remained flat as well as for the quarter compared to June 30, 2009, and restructured loans decreased $271,000 from last quarter. Restructured loans are considered nonperforming because of the changes in the original term spread to borrowers. These loans are still accruing interest. This is the way we can work with the borrowers that have the ability to repay to mitigate the loss potential. The delinquency rate for loans 90 days past due and/or on non-accrual decreased slightly to 2.15% this quarter from 2.19% in the second quarter of 2009. The slight decline in the level of 90 plus days past due from the last quarter is due to a decrease in commercial real estate past dues of $2.4 million and an increase in commercial 90 days past dues of $2 million and an increase in the one to four family residential of $400,000 with home equity and home improvements going down slightly. The total delinquency rate increased to 2.77% at December -- increased from 2.77% at December 31, 2008 to 3.49% at September 2009, but was down from 3.78% at June 30, 2009.

The composition of the 90 plus days past due non-accrual totals at the end of the third quarter breaks down into certain sectors. With the comparison on a linked quarter basis, commercial real estate, 2.90, down from 3.34; one to four family residential, 2.50 up from 2.33; commercial, 1.50 up from 0.94; home equity, 0.38 down from 0.41; construction, 0.36 up from 0.13; and consumer, 0.13 up from 0.10.

We believe that our portfolio continues to be well positioned with the diversified portfolio and low average loan size. Very little presence of problematic segments such as big-box retailers and large office buildings, and credits are generally underwritten on a cash flow basis and require meaningful equity and personal guarantees.

We have also strengthened our credit review process and increased the overall scope of loans we individually review on a quarterly basis.

Mortgage banking was still strong in the third quarter with continued momentum from earlier in the year. We had a gain on sale of income of $1.5 million in the third quarter of 2009 compared with $2.9 million in the second quarter of 2009 and $624,000 in the third quarter of 2008. We also recorded a negative valuation adjustment in mortgage servicing rights of $772,000 in the third quarter compared with a negative adjustment of $36,000 in the third quarter of 2008.

At September 30, First Defiance had $1.2 billion in loan service for others. The mortgage servicing rights associated with those loans had a fair value of $8.4 million or 70 basis points of the outstanding loan balance of service.

Total impairment reserves, which are available for recapture in future periods, totaled $1.9 million at the end of the quarter. While we are pleased with the mortgage loan activity in the first nine months of the year, we have seen signs of slowing refinance activity with a slight increase in purchase activity.

The economic environment continues to add stress on our investments and trust preferred collateralized debt obligations, or CDOs, and required additional other than temporary impairment write-downs in the third quarter. The CDOs are made up of pooled investments of trust preferred securities issued primarily by commercial banks and thrifts.

As the issuing institution experienced financial difficulties, they can defer payments, and in many cases we have seen these institutions default on their issue, which is a negative impact on the collateral supporting the pooled investments. The other than temporary charge recognized in the third quarter of 2009 totaled $994,000. The other than temporary charge for the quarter related to one security with the book value of $163,000 at June 30, 2009, which was written down to zero in the third quarter and four other trust preferred collateralized debt obligations with a remaining book value of $2.2 million.

First Defiance also has another CDO investment that had an other than temporary charge in the first quarter of 2009, which has a remaining book value of $243,000 and a market value of $170,000 at September 30, 2009, which has seen positive upper movement in its discounted cash flows resulting in no additional OTTI charge for the quarter, current quarter and previous quarter. Other than temporary charges are due to the deterioration of the underlying collateral and relate to the credit component of the security. The rest of the trust preferred CDO investments in the portfolio have a total book value of $2.9 million and market values of $1.2 million at September 30, 2009. The decline in the value of those investments is primarily due to the continued lack of liquidity in the CDO market. These investments continue to pay principal and interest in accordance with the contractual terms of the securities. Management has not deemed the impairment in value of these CDO investments to be other than temporary and, therefore, has not recognized a reduction in value of those investments and earnings. The other than temporary charge was partially offset by $154,000 gain on the sale of securities.

Turning to other operating results, our net interest income of $17.6 million for the quarter was an increase of $1.4 million on a linked quarter basis and up from $16.4 million in the third quarter of 2008.

For the quarter our margin was 3.88%, which was a 7 basis point increase from the third quarter of 2008 and a 27 basis point increase on a linked quarter basis. Falling interest rates continue to impact us on both the asset and liability side. We have been successful in continuing to lower our cost of funds. This remains challenging, and we feel we have hit the floor on some products. There are still some opportunities on term accounts.

Fee income continues to be strong, but declined slightly to $3.6 million in the third quarter of 2009 or $3.7 million last year. Insurance revenue was $1.1 million in the third quarter of 2009, basically flat with the third quarter of 2008.

Overall noninterest expense decreased to $14.8 million this quarter compared with $15.2 million the third quarter of 2008 and $16.1 million on a linked quarter basis. The third-quarter compensation and benefit in the expenses were down primarily due to the reversal of variable compensation based on the overall corporate performance, as well as a reduction in FTEs.

FDIC insurance expense increased to $649,000 in the third quarter of 2009 from $327,000 in the same period of 2008 as a result of the FDIC rate increases and higher insured deposit balances. It was down on a linked quarter basis from $1.5 million, which had a 5 basis point special assessment of $900,000. We are still waiting for the final determination of any future special assessments.

Other noninterest expense increased to $3.7 million in the third quarter from $2.8 million in the third quarter of 2008. Increase in expenses of $778,000 for credit, collection and OREO; $462,000 related to deferred compensation evaluation, which was partially offset by cost reductions in various areas such as advertising and loan-related expenses.

We saw balance sheet growth with total assets growing $95.4 million from September 2008 to $2.02 billion, but shrinking $6.1 million on a linked quarter basis.

Total deposits grew $107.3 million from September 2008, but decreased $10.1 million on a linked quarter basis. This is somewhat reflective of our pricing decision and efforts to reduce our cost of funds. Loan balances increased $13.2 million on a linked quarter basis, while cash and equivalents decreased $11.5 million.

We are pleased with the loan growth and the new activity during the quarter. We have been able to develop strong new relationships with good commercial clients. We believe that controlled growth is reflective of the environment, and we are well positioned for future growth.

That completes my overview for the quarter, and I will turn the call back to Bill.

Thank you, Don. As we progress through 2009, we will continue to address the challenges that face us. The overall economic climate throughout our market area continues to be tentative, but we have seen some signs of improvement.

Unemployment numbers continue to run higher in this region compared to national numbers but seem to have at least leveled off. Some manufacturing entities and automotive-related industries have recalled employees in recent weeks, and agriculturally the harvest season is facing weather challenges following a good growing season. The crops that had been harvested have reduced good yields. So there are some positive indicators out there.

However, we remain cautious in this economic environment and have expanded our credit monitoring functions even beyond our traditionally focused approach.

Additional asset review functions and more delinquent loan reporting requirements have been added to assist in this monitoring. Detailed action plans are being utilized on all watch list credits and are updated monthly to chart the progress. We continually review credit concentrations by industry and have placed limitations on lending within certain industry segments. The large provision expense this quarter positions us to work out the problem credits and dispose of OREO properties.

We are seeing more interest from buyers of these properties, and we hope to continue working on getting these nonperforming assets off the books.

We have worked hard to execute our strategy in this challenging environment and to adapt to the fluctuations in the business cycles. This was a disappointing quarter from an earnings performance perspective and certainly not acceptable to us. But I believe it is a time of opportunity for community banks like ours. We remain well-capitalized, and First Federal Bank and First Defiance are positioned to be able to attract new relationships and grow by following the business plan that has prepared 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. There are certainly 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.

(Operator Instructions). Eileen Rooney, KBW.

I was just wondering if you could give us the amount of that comp reversal that was in the compensation line?

It was approximately $800,000.

I'm sorry, $800,000?

Yes.

Okay. And what was the inflows into nonperforming this quarter?

I'm trying to remember offhand. I really cannot give you the specific credits that went into that.

Okay. No, I was just kind of wondering the dollar amount if you took out charge-offs and all if you backed that stuff out.

Well, the nonperformings were essentially flat, and we had charge-offs of about $2.5 million, right?

Right.

So I would say if they were flat, then we have added inflow of about $2.5 million into the nonperforming.

Okay. Yes, I was not sure if there were things that paid down or moved to OREO.

Some of it, so it is probably a little north of that, but not a lot.

Okay. And then just a question on the loan growth this quarter. I'm sorry if I missed this in your comments, but the commercial real estate categories seem to have quite a bit of growth. I was just wondering where that was coming from, what types of credits, any particular region?

The commercial real estate loans that we are booking now primarily are multifamily residential apartment complexes. That is a category that has performed well for us. There is a major real estate developer and owner in the Toledo area that passed away and literally put about $30 million of apartment complexes on the market. So we have financed a few of those for good borrowers. But that is a category that has performed well for us.

We have looked at how we underwrite those credits over the course of this year in line with the economic environment we are in, and we have improved and required a little bit more down payment. We have required more collateral, a little stronger guarantors on some of those credits. So I think we -- the newer credits are underwritten a little bit stronger than they were in prior periods.

What would be like a typical loan to value now?

Maximum 80%; in more cases, 75%, and in cases where it is a property that needs improvements, we are requiring that cash to be put in front. We will hold that cash until the improvements are made.

Okay. All right. That is great. Thanks, guys.

(Operator Instructions). It seems we have no further questions.

All right. If we have no other further questions, we will thank you for joining us today, and this will conclude our conference call. You can now disconnect.

Thank you very much.