Premier Financial Corp (OHIO) (PFC) 2016 Q1 法說會逐字稿

Good morning, and welcome to the First Defiance first-quarter 2016 earnings conference call.

(Operator Instructions)

Please note: This event is being recorded.

I would now like to turn the conference over to Tera Murphy, Vice President with First Defiance Financial Corporation. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us for today's 2016 first-quarter earnings 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 Don Hileman, President and CEO of First Defiance; and Kevin Thompson, 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'd 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'll turn the call over to Mr. Hileman for his comments.

Thank you. Good morning, and welcome to the First Defiance Financial Corporation first-quarter conference call. Last night we issued our 2016 first-quarter earnings release, and now we'd like to discuss that release and give you a look into the remainder of 2016. At the conclusion of our remarks, we will answer any questions you might have. Joining me on the call this morning to give more detail on the financial performance for the quarter is our CFO, Kevin Thompson.

We're very pleased with the continued momentum developed in the latter part of 2015. First-quarter 2016 net income on a GAAP basis was $7.1 million or $0.78 per diluted common share, compared to $6.6 million or $0.69 per diluted common share in the first quarter of 2015.

Our overall core performance this quarter was very strong, creating a good start to the year. We experienced solid year-over-year and linked-quarter annualized loan growth of 8.3% and 5.1%, respectively.

Our loan growth percentage this quarter was down from the strong 9% annualized level in the fourth quarter. However, first-quarter loan growth tends to be seasonally weaker, so we are pleased with the overall growth. Our ability to grow our loan portfolio is a key strategic piece of our plan.

The lending environment is very competitive with rate and structure pressures relating to terms and conditions. All institutions are looking for loan growth, and we're seeing more competition from large financial institutions for larger deals. In some cases, we are seeing very aggressive rates, and loosening of terms and conditions. It is encouraging to us to see contributions from across our entire footprint, despite this environment, and we ended the quarter -- first quarter with a solid pipeline, which was up from year end.

Our Columbus, Ohio, LPO has grown to about $90 million of outstandings, and stronger contributions are expected going forward. We also saw stronger-than-expected growth in the Toledo market, which was offset somewhat by declines in the Fort Wayne market related to the pay-off of a large credit in the quarter. Overall, growth in the Fort Wayne market is still expected this year.

This, coupled with more overall confidence from segments of our clients concerning economic stability and the economic environment, leads us to believe we have positioned ourselves for continued disciplined loan growth during the remainder of 2016. We are also very pleased with our margin improvement this quarter over the fourth quarter of 2015, which we feel is a reflection of our disciplined approach to both asset and liability pricing.

Loan portfolio growth contributed to the improved earning asset mix, increasing our net interest income. The growth in both our net interest income and our non-interest income revenues on a quarterly basis is a result of contributions from our core business strategies. We are also pleased with our resilient net interest income growth this quarter of 5.5% over the first quarter of 2015.

We expect the interest rate environment to be relatively stable at the current levels in the short term, but anticipate an increase in market rates in the second half of this year. We continue to measure our interest-rate risk position, and are managing toward a neutral to slightly positive position.

Growth on the deposit side of the balance sheet was strong this quarter, growing 7.6% on a linked-quarter basis and 5.6% year over year. On a linked-quarter basis, we were able to increase our overall margin to 3.8% from 3.77%. We are very satisfied with this quarterly improvement in today's environment.

non-interest income, driven primarily by service fees, trust income and other income, was offset by a decline in mortgage banking revenue. While down year over year, mortgage banking revenues increased on a linked-quarter basis. non-interest income grew 4.3% year over year.

Total non-interest expense decreased slightly from the fourth quarter of 2015, and increased 2.2% on a year-over-year basis. The credit quality metrics showed continued overall improvement this quarter from the first quarter of 2015. Non-performing assets declined approximately $6.3 million, or 25% year over year.

Non-performing loans decreased approximately $1 million or 5% year over year to $17.7 million. Approximately 60% of the non-performing loans continued to make payments. We also had a decrease of $8.3 million, or 42%, in restructured loans.

We are satisfied with the level of 30-day to 90-day delinquencies at 0.14% of loans for the first quarter of 2016, the same level as the first quarter of 2015. Overall, we expect to see stable to improving asset quality trends across the board. We will continue to focus on asset quality through reducing the non-performing and classified asset levels in the future, leading to improvements in our non-performing asset ratio.

Regarding our capital management plans, we bought back approximately 168,000 shares of our stock in the first quarter. We are also delighted to announce a 2016 second-quarter dividend of $0.22, representing a 10% increase and an annual dividend yield of approximately 2.3%. We anticipate a continuation of the balance dividends and stock buyback, reflecting our strong earnings trend and a focus on the utilization of capital.

I will now ask Kevin Thompson to provide additional financial details for the quarter, before I conclude with an overview. Kevin?

Thank you, Don, and good morning, everyone.

As Don stated, net income for the first quarter was $7.1 million or $0.78 per diluted share. This compares to prior-year results of $6.6 million or $0.69 in the first quarter of 2015. It's always encouraging to start the year with strong results, and we're very pleased with our first-quarter financial performance results, as well as our outlook for 2016.

Starting with growth, our loan and deposit balances both had solid increases in the first quarter, which was a nice continuation after our very strong fourth quarter. Total loans finished the quarter up $22.8 million from year end, and up $140.4 million or 8.3% from a year ago. First-quarter average balances increased $63.7 million on a linked-quarter basis, keeping our earning asset mix strong and profitable.

On the deposit side, we saw balances increase $35 million in the quarter, and $98.5 million or 5.6% from a year ago. And average deposit balances grew $11.9 million in the first quarter of 2016.

Over the past year, we have generally seen our loan growth outpace our deposit growth, and relied a bit more on borrowings to grow our balance sheet. While these sources are a bit more expensive, this has been tempered by a favorable mix in our deposit growth.

Over the past year, our $98.5 million of deposit growth includes $55.1 million of growth in non-interest-bearing demand balances. Overall, our strong, growing balance sheet has continued to generate strong growth in earnings.

Turning to the income statement, our net interest income was $19.2 million for the first quarter of 2016, up from $19 million in the linked quarter, and up $1 million from $18.2 million in the first quarter last year. The increase over the prior year was despite the last year's benefit of $264,000 of recovered interest.

Loan margin this quarter was 3.8%, down 8 basis points from 3.88% in the first quarter last year, which again benefited from the recovered interest, which was about 5-basis-point effect. But our margin was up 3 basis points from last quarter. On a linked-quarter basis, our yield on earning assets was up 6 basis points, as our loan portfolio yield held steady at 4.34%. But our mix improved.

Our cost of interest-bearing liabilities was up 3 basis points on a linked-quarter basis, impacted both by rate and mix. While our earning asset mix has kept our margin strong and steady as we continue to grow our balance sheet, our interest-rate risk position is basically neutral and well balanced for our expectation of a cautious but determined Fed. Our non-interest income was $8.6 million in the first quarter of 2016, up from $7.7 million in the linked quarter, and up from $8.3 million in the first quarter of 2015.

The first quarter of 2016 includes $131,000 of securities gains, plus $317,000 of net gains on the sale of OREO, while the first quarter last year included only $67,000 of net OREO gains. Furthermore, the first quarter is generally when we receive our contingent insurance commissions, which totaled $799,000 this year versus $967,000 a year ago. So, excluding these non-core and seasonal items, our non-interest income was up year over year about $143,000 or 2%.

Service fees, trust income and our core insurance commissions were all up, while mortgage banking declined versus the first quarter last year. Regarding mortgage banking, revenues for the first quarter of 2016 were $1.5 million, up $74,000 from the linked quarter, but down $236,000 from the first quarter of 2015. The first-quarter mortgage banking originations were $51.1 million compared to $56.3 million last quarter, and $52.7 million in the first quarter of 2015.

Gain on sale income was $994,000 in the first-quarter 2016 compared to $836,000 on a linked-quarter basis, and $1.3 million in the first quarter last year. In addition, the first quarter included a negative valuation adjustment to the mortgage servicing rights of $21,000, compared to positive adjustments of $75,000 last quarter and $26,000 in the first quarter of 2015.

At March 31, 2016, First Defiance had $1.3 billion in loan service for others. The mortgage servicing rights associated with those loans had a fair value of $9.2 million or 73 basis points of the outstanding loan balances serviced. Total impairment reserves, which are available for recapture in future periods, totaled $666,000 at quarter end.

As for non-interest expense, first-quarter expenses totaled $17.3 million, even with $17.3 million in the linked quarter, but up from $16.9 million in the first quarter of 2015. The increase was primarily in compensation and benefits expense, which, in the first-quarter 2016, was up $1.3 million from last year, mainly due to higher costs for health benefit plans, incentive compensation, merit increases, and new staff to expand and support our growth strategies. Other non-interest expense was $2.9 million in the first-quarter 2016, down from $3.6 million in the same quarter last year, mainly due to reductions in OREO write-downs, which totaled $522,000 in the first quarter last year and only $53,000 in the first quarter of 2016.

Regarding provision expense, the first quarter of 2016 totaled $364,000 compared to $43,000 last quarter and $120,000 in the first quarter last year. The first quarter of 2016 included net charge-offs of 2 basis points compared with net recoveries of 3 basis points last quarter and net recoveries of 10 basis points in the first quarter a year ago.

Our allowance for loan loss at March 31, 2016, was $25.7 million or 1.41% of total loans, versus $25.3 million or 1.5% at March 31 last year. The change in the allowance ratio reflects the credit quality improvements achieved during the past year, such that the allowance coverage of non-performing loans has increased to 145% at quarter end, up from 135% at March 31, 2015. We expect the allowance to loan percentage to continue to reflect strengthening asset quality.

As for the asset quality numbers, non-performing loans increased slightly this quarter to $17.7 million from $16.3 million on a linked-quarter basis, but was down from $18.7 million at March 31, 2015. Our OREO balance decreased this quarter to $1.1 million from $1.3 million last quarter, and from $6.4 million in the first quarter last year. Overall, non-performing assets ended the quarter at $18.8 million or 0.8% of total assets, down from $25.1 million or 1.14% of total assets at March 31, 2015. Our troubled debt restructured loans this quarter were $11.3 million, up $106,000 from last quarter, but down considerably from $19.6 million a year ago.

Looking at our capital position, total period-end stockholders' equity finished the quarter at $280.4 million, up just slightly from $280.2 million at March 31, 2015. During the quarter, we repurchased 167,746 shares, leaving approximately 377,500 shares remaining under our current repurchase authorization.

Our capital position remains strong, with quarter-end shareholders' equity to assets of 12.06%, although down from 12.84% last year. The total risk-based capital ratio is approximately 13% at quarter end, March 31, 2016.

Our healthy capital position continues to support our growth strategies, as well as enhance shareholder value through share repurchases and dividends. So, in summary, we have a strong balance sheet, solid profitability and good momentum.

That completes my financial review, and now I'll turn the call back over to Don.

Thank you, Kevin.

I'm very pleased with the core results in the first quarter of 2016 and the important progress we've made to position First Defiance for success the remainder of 2016. We continue to focus on several key areas that we believe important to improving financial performance and greater shareholder value. These areas include core balance sheet growth with a focus on loan growth and deposit growth, overall revenue growth, expense control and improved asset quality. We look to continue to making steady progress in all these areas throughout 2016.

We are off to a good start, with the first-quarter asset growth of 3% on a linked-quarter basis, with solid growth in both loans and deposits this quarter. Overall revenues grew 4% in the first quarter of 2016. We do believe improvements in loan demand aided by further improvements in the economic environment will carry throughout 2016.

As we have discussed, we have looked to strategically grow our overall position in the metro markets of Fort Wayne, Indiana, Toledo, Ohio, and increase loan production in Columbus, Ohio. We are seeing strong activity in these areas.

As I mentioned previously, some additional expense was added to the quarter, and we expect some degree of additional expense in 2016, as reflected in Kevin's comments concerning the compensation and benefits expense. We still believe a growth rate in the high-single digits is appropriate for the remainder of the year.

While the lending environment remains very competitive, as previously noted, we feel we can realize loan growth without making significant concessions in rate and other terms through a strong process of relationship building and quality client-focused service, despite seeing declines in offering rates from some competitors. We understand it will be challenging to drive growth in loans and maintain the yield management until markets rates move higher.

We are very focused on relationship management pricing, and believe our delivery and service model is effective, and is contributing to the strong margin performance. We continue to look to enhance our electronic and mobile capabilities, giving our customers more choices on how they bank with us, and are responding to their requests unveiled during our research.

We're seeing a changing pattern in transactions in service on the retail side, driven by our customers. The shifting customer demographics will also have an impact on our business model. We have spent both time and resources to gain understanding of the needs of our current clients and potential clients, as new client relationships are essential to us.

We are looking to better understand the needs and behaviors of millennials, as the market research indicates this is an increasingly important segment of the population. This group is distinct in their needs, and the use of banking products and services, and we must be prepared to serve this generation.

We are pleased with the increases in activity in both electronic and mobile transactions, including online account opening, mobile deposits, electronic payments and the use of mobile wallet features. The digital delivery environment is changing at an accelerated pace, and we are committed to providing our clients, both retail and business, a quality choice of products and services.

In concert with this, we're taking a closer look at how our customers interact with us, both inside and outside the branch. As banking and behaviors of our clients change, we will focus on adopting our service and sales model for more convenient, better banking experience for all our customers.

We will continue to focus on growth in our insurance and wealth management revenues as part of our strategic plan. We believe these revenue sources help in our ability to grow revenue in an environment with added pressure on NSF and other deposit fees. We were pleased by the continued improvement in credit quality, reflected by low charge-offs and our overall lower non-performing assets. We are committed to continuing improving our results relative to our peer group in this area.

We are also very pleased by our recent performance, and look to constantly drive our performance through initiatives that will help us obtain our goal of being a consistently high-performing community bank. We understand the headwinds and challenges ahead, including the economic, regulatory and operational factors. We are also working diligent to address the growing issue of cybersecurity and provide our clients important information to protect their financial information. We believe we can accomplish our goals through a balanced approach and a long-term focus on shareholder value.

We remain confident in our strategy and in the people we have dedicated to executing this. We feel that the performance of the Organization reflects our focus on shareholder value, and at the same time on our commitment to being a strong community partner in the areas we serve, not only by donating funds and employee volunteer hours, but by creating valuable partnerships with community organizations such as the Toledo Public Schools and the Toledo Zoo, to provide educational opportunities by bringing zoo animals into the elementary schools.

We also are very committed to providing financial wellness and additional educational opportunities to the public through our footprint. We remain strongly committed to our customers and our shareholders, and we appreciate the trust you have placed in us as we work to make First Defiance a company to be proud of. Thank you for your interest in First Defiance Financial, and we thank you for joining us this morning.

We would now be happy to answer any of your questions.

(Operator Instructions)

Christopher Marinac of FIG Partners.

Thanks, good morning. Don and Kevin, I wanted to ask a little bit about your thoughts regarding adding mergers to the Bank going forward. Is this something that is possible in the future? And I think more importantly, can you give us a band about where price expectations may be among sellers, and is there a sort of updated tolerance in terms of how much dilution you will or won't accept on any given transaction?

Thanks for the nice simple question there, Chris. I think it's definitely one of our things that we consider when we look at the environment. I believe the M&A activity is going to increase a little bit. We still think it's important that we match up the culture, both of First Defiance with any potential acquisition client, and so we are I guess fairly selective in that part of it because I think that's a key to the execution.

As part of our expectations on where we might be from a pricing standpoint, I think we look at a lot of factors. I don't know if we have one, but I think as far as our buyback, and tangible buyback, those are all factors. But I don't think at this point we have anything that's really specific. We look to make sure it would be an accretive transaction.

Okay. Great. Thanks for that. I appreciate it.

From a standpoint of I guess this current quarter, does the margin get stronger if we see one or two more additional Fed hikes, or would that be a challenge? I know you mentioned in your remarks about moving towards neutral, so just curious I guess. Is that more of a timing issue if it happens right away, it may be a negative, but if it happens later in the year it could be an either non-event or a slight positive?

Yes. Chris, actually I think we really are pretty neutral. Our numbers indicate we maybe have a slightly positive bias to a raise in rates, but I wouldn't look for any kind of windfall impact on our numbers. And in terms of timing, I don't know that's going to make a significant difference.

I think though as we look ahead, with the Fed we think moving on a very measured basis, we think that's probably a pretty good environment for us to operate in, as opposed to any significant and swifter movements, if you will, by the Fed. That could be a little more perhaps a volatile impact. But if the Fed moves as we expect, with maybe one or two more increases over the remainder of the year, we think, again, we're pretty neutral to that impact with maybe a slight benefit.

Okay, thanks, Kevin. I appreciate that.

And just last question, since you had mentioned the cyber topic in the earlier remarks, is cyber covered within your existing budget this year? Are there additional spending you have? And I guess, to what extent is some of your plans go part and parcel with your main systems vendors?

That's a good question. It is, and we look at it from two perspectives. My comments were related to more of what we're trying to do to educate our clients and help them navigate cybersecurity. We have a lot of businesses and small business clients, and how do we provide them the best information for them to make informed decisions to protect them, themselves.

We also have a decent amount of spend in our operating budget for enhancements, if you will, to our core systems and ancillary systems to protect us as best we can. We feel real comfortable with our core system provider and their ability to provide additional protections from a cybersecurity standpoint. But we continually focus on that because I think we all realize that's a big issue for us, today, and will continue to be an issue going forward.

Sounds good, guys. Thanks again for all the background here.

Thank you, appreciate it.

Our next question comes from Damon DelMonte of KBW.

Good morning, guys. How are you doing?

My first question relates to expenses in the outlook there. I think you had mentioned that there might be some higher expenses in 2016 related to compensation cost. Is that correct?

That's correct. We are investing in our growth strategies, and obviously reflecting some elevated expenses versus a year ago. We expect that trend to continue.

Okay. So, as we look for a quarterly run rate, I think last quarter you were talking maybe something in the $17.5 million to $18 million range. Is that still a reasonable expectation for the remainder of the year?

Yes. I would think $18 million might be pushing it. But I think $17.5 million probably isn't a bad number.

Okay. Great. And then, the $317,000 in the OREO gain that you had this quarter, was that captured in the other non-interest income line?

That is correct.

Okay. And then, do you know what the average price was that you bought back the shares this quarter at?

I don't, right off the top of my head, but my estimate would be about $38.

$38, Okay. Great.

And I guess lastly, with respect to the provision expense, with the outlook for continued positive growth in the loan portfolio, should we look at the quarterly run rate on provision to be something similar to this quarter's level?

I think that's probably a reasonable expectation. Our asset quality, again, kind of is a little bit stable or steady, if you will, from fourth quarter to first quarter here. But we're still working hard and expect some continued improvements over the remainder of the year.

And our allowance ratio is quite strong. So, we think, with our continued work there, that we would expect to keep provision in check, despite our growth.

Okay, great. That's all that I had. Thank you very much.

Thank you

(Operator Instructions)

Daniel Cardenas of Raymond James.

Good morning, guys. Maybe some quick comments on competitive factors -- what are you seeing out there in terms of your large and small competitors, in terms of structural weakness, if any? I know pricing is very intense. And is that causing you perhaps to tighten your credit underwriting standards? And then, if that's the case, do you still think you can hit some high single-digit loan growth numbers given all of that?

We still do; we still think we can generate those numbers with our current underwriting standards, which we think are pretty -- will serve us well. The structural issues -- we're seeing some compression in margin on variable rate loans. We are seeing still some very aggressive fixed rate -- longer-term fixed rate on commercial deals, from the rate standpoint. We're still trying to target what we think is the right rate on an extended durational basis, the longer terms, and that's very hard to compete, and in some cases we don't want to compete with that.

From a structure standpoint, I think it goes back to, I think we said previously in a call that a couple years ago we were getting a lot more personal guarantees on small business or business loans, and now that's harder to get. And lot of these are going to be project-specific guarantees rather than more global guarantees. We still ask for it, we still try to get it, but our percentage is probably a little lower on that. And there's some other things that relate to the strength of the global position versus the project that are a little harder to get than they were a few years ago.

And then, is that across the board? Are you seeing the big banks and small banks do it, and what impact are credit unions having on loan growth, if any?

Yes, it's pretty much across the board, I think. We've always had -- if a smaller bank wants some loan growth, I'll go in and structure it to get it. So, it's not -- I wish I could say this one competitor is our biggest problem, and that we have to deal with and figure out that, but it's -- it seems to be across the board on different things.

Credit unions are getting to be more of a competitor, especially on the commercial side. And then we still see, in our market, still very strong competition on some deals from farm credit as well.

And then as you look at your footprint expectations for the majority of growth to come out of the bigger, Fort Wayne, Toledo, Columbus markets?

I think that's what we've seen, and that's what we would expect. Because just if you look at it from a market share standpoint, we have a very small market share in those areas, so the upside to grow it is greater than in some of our legacy markets. We think all of our markets will grow, but clearly the higher opportunity and stronger growth rates will come from some of those metro markets.

Okay. And then, as you talked about fee income, and a focus on growing insurance and wealth management expectations, is the growth going to be entirely organic or do you see opportunities to make small acquisitions throughout the footprint?

I hope, and my plan is it will be both, to grow organically and supplement it with acquisitions, especially on the insurance side. The wealth management side we clearly would look at a possibility there of accruing that through purchase or acquisition as well. We think we can still have a good organic growth rate and then supplement that through acquisition.

And in terms of acquisitions for those two areas, are the pipelines robust or is it hit or miss?

Hit or miss -- I wouldn't say they're robust, at all. I think it's hit or miss. We've had a lot of conversations going on; some are more interested in others. It's clearly hit or miss.

Okay. And then just on the credit side, the numbers are good, but are you seeing any weakness in any of the predictive indicators that you look at?

I would say no, Dan. Our delinquency continues to run really, really well versus historical comparisons. We've had still a loan or two here and there get classified, but the overall trend is still very positive in our portfolio. I don't think we see any concerns on that front, in terms of the performance.

And in terms of our underwriting, as Don said, we are being pretty vigilant, and we're still getting good growth. Our pipelines are still strong. We're not going to win every deal, but we're going to win the deals I think that we want to win.

And we continue to be strong in our underwriting standard. At this point, I think we are very favorable in terms of our outlook in that regard.

Great. Thanks, good quarter.

Thank you.

This concludes our question-and-answer session. I'd now like to turn the conference back to Tera Murphy for any closing remarks.

Thank you for joining us today as we discussed our quarterly results. We appreciate your time and interest in First Defiance Financial Corp. Have a great day.

The conference is now concluded. Thank you for attending today. You may now disconnect your lines.