Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Carol Merry – Investor Relations

Bill Small – Chairman, President and Chief Executive Officer

Don Hileman – Interim Chief Financial Officer

Jim Rohrs – Executive Vice President, President and COO - First Federal Bank

Analysts

Brett Villaume [ph] – FIG Partners [ph]

Eileen Rooney – KBW

Brad Ness – Choral Capital Management

First Defiance Financial Corp. (FDEF) Q3 2008 Earnings Call Transcript October 21, 2008 11:00 AM ET

Operator

Hello and welcome to the First Defiance Financial Corporation’s 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). Now I would like to turn the conference over to Ms. Carol Merry. Ms. Merry you may begin.

Carol Merry

Thank you, Camele. Good morning everyone and thank you for joining us for today’s third quarter 2008 conference call. The call is also being web cast and the audio replay will be available at the First Defiance website at fdef.com until November 4th, 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 would 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 meaning of the Private Securities Litigation Reform Act 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 risks and uncertainties that may cause future events to differ from the results discussed in these 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, and now I will turn the call over to Mr. Small for his comments.

Bill Small

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 through this role. Don has served as CEO of our insurance unit for the past 15 months and prior to that he was the controller at Sky Financial Group for 19 years. Don will be joining me on the call this morning 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 COO of First Federal Bank.

Third quarter 2008 net income on a GAAP basis was $322,000 or $0.4 per diluted share, down from $3.1 million and $0. 44 per diluted share in the 2007 third quarter. For the nine-moth period ended September 30, 2008, First Defiance earned $6.5 million or $0.83 per diluted share compared to $10.3 million or $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 Bancorp 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 caused 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 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 provided a conservative level of provision expense for all of the problem loans that we have identified in our portfolio.

Despite the disappointing earnings results for the quarter there were several strong performance indicators. One of the significant positive stories in our third quarter was the 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 securities losses due to impairment- related charges, non-interest income for the 2008 third quarter improved by 11% over last year's 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 in the 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 the quarter before I wrap up with an overview and a look at what we see developing for the balance of 2008. Don.

Don Hileman

Thank you Bill and good morning everyone. In Jack’s absence I will try and give you a little bit more details on our results for the quarter and then we will 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 the 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 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 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 residential mortgage loans we record 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 loan portfolio and we generally provide 75 basis points for losses on those loans.

We are 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 that we make to the allowance for loan losses necessary for the allowance to be adequate based on the losses we estimate to the 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 of provision expense this quarter.

Net charge-offs were 55 basis point analyzed for the quarter compared to 21 basis points last quarter and 21 basis points in the third quarter of 2007.

At September 30th, 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 the $2.1 million of expense related to impairment of certain securities in the company's investment portfolio that management deemed to be 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 on its investment in the equity notes of two Trust Preferred Collateralized Debt Obligations (CDOs) in the third quarter of 2008. Those equity notes were the initial credit losses when banks had issued Trust Preferred Securities into those pools default.

Our net interest income of $16.4 million for the quarter was a 36% increase of 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 having impacted us both on the asset and liability side but we have been able to drop our liability cost 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 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 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 by $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 year’s third quarter compared to the same period last year. First Federal remains well capitalized for total risk based capital at quarter-end at 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 the quarter and I will turn the back to you Bill.

Bill Small

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 have at least leveled off in recent months. Agriculturally, the dry summer throughout this area has reduced crop yields from the recent strong performance to the lower end of the historic yields. However, even though commodity prices have retreated -- 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 limitations on lending within certain types of loans. This is the most difficult operating environment I have 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 is a time of great opportunity for community banks like ours. We remain well capitalized with the risk-based capital that is 20% more than regulatory standard to the 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 are positioned to continue following the business plan that has served well over the years and prepares us for times like this. Our core fundamentals remain strong and the underlying strengths will keep 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 met 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.

Question and Answer Session

Operator

Thank you. (Operator instructions) Our first question does come from Brett Villaume [ph], FIG Partners [ph]. Please go ahead.

Brett Villaume - FIG Partners

Hi, good morning.

Bill Small

Good morning Brett.

Brett Villaume - FIG Partners

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

Bill Small

The commercial real estate that is non-owner occupied, I know to be honest with you Brett; I don’t have that breakdown here with me this morning.

Brett Villaume - FIG Partners

Okay.

Bill Small

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 were very comfortable with mortgages. We like real estate as collateral and a vast -- a large percentage of that is -- are loans to small businesses that include their real estate. You know, it is not to say that there certainly are some investment properties in there of different types, but an awful lot of it, a large percentage of it is owner occupied.

Brett Villaume - FIG Partners

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

Bill Small

Yes.

Brett Villaume - FIG Partners

Okay, great. And then on the construction portfolio, do you anticipate that you are going to see a sort of a continuation of that same sort of drawdown in the fourth quarter; I guess it is still about 9%?

Bill Small

Yes, I think that would be probably be pretty consistent with what we would expect because number one, there just is not a lot of construction activity going on out his way and secondly we are certainly being very cautious in anything that we look at in that arena.

Brett Villaume - FIG Partners

Okay, and then lastly I think you may mentioned it, but if you didn’t you would mind repeating the tier one risk-based ratio. You said you had 20% of it well capitalized status, I was wondering if I could just have that exact ratio.

Bill Small

Well, that is not -- we are doing the final calculations right now. At the end of the second quarter we were at 12.18. We know it is still in excess of 12%, but I don’t want to give you an exact figure because I -- at this point I cannot verify or validate that that would be absolutely exact, but I can tell you it is in excess of 12.

Brett Villaume - FIG Partners

Okay, well thank you very much.

Operator

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

Eileen Rooney - KBW

Good morning guys.

Bill Small

Good morning Eileen.

Eileen Rooney - KBW

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

Bill Small

I am going to let Jim Rohrs who is the President of the bank kind of deal with some of the credit issues on this. And so Jim I will let you comment on that.

Jim Rohrs

Okay Bill. Related to delinquencies we haven’t seen a significant increase in the dollar amount of delinquent loans, but we have seen a migration out of the 30 and 60 day into the 90 and 120 days. So, we have seen an increase in the more severe delinquencies and that has been a trend that has kind of marched upward over the last 4 quarters. Classified credits are also up from the June 30th quarter end, although not dramatically, but that trend also has been upward over the last several quarters.

Eileen Rooney - KBW

Okay, and then one unrelated question. In your other fee line was a negative number this quarter and I was just wondering what was included in there?

Bill Small

Okay that relates to a change in value on a different account program [ph] that we have.

Eileen Rooney - KBW

Okay, so we would expect that to go back up again.

Bill Small

Yes.

Eileen Rooney - KBW

Great. Thank you guys.

Bill Small

Okay. Thank you.

Operator

(Operator instructions) Our next question will come from Brad Ness from Choral Capital Management.

Brad Ness - Choral Capital Management

Hi, how are you guys doing?

Bill Small

Hi, Brad how are you?

Brad Ness - Choral Capital Management

Doing fine. I was wondering if you could just discuss if you are considering the (inaudible).

Bill Small

We certainly have been following it very closely as I am sure people would think we would be. We are as each piece of it is being released, we are doing a pretty thorough analysis on it. At this point in time, I am not ready to be able to commit the exactly what we will be doing, but you can be assured that we have been very actively working through analysis of the different segments as it comes out.

Brad Ness - Choral Capital Management

Okay, -- were you going to say something?

Bill Small

No, nothing else.

Brad Ness - Choral Capital Management

Okay. And also how committed are you to your cash dividend right now?>

Bill Small

Again that is something that is ongoing for us as far as our review and analysis of it. We are -- we have a dividend payment that goes out his Friday. Our next dividend is scheduled for January. We will continue to monitor and make determination as things progress.

Brad Ness - Choral Capital Management

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

Bill Small

We will certainly be watching not only current earnings but our forecast in that regards. We will look at payout ratios and then of course naturally capital needs.

Brad Ness - Choral Capital Management

Okay, regarding your nonaccruals, it -- we saw an increase in on the commercial and commercial real estate nonaccruals, you know, if you had to forecast when you would guess that things peak out?

Bill Small

Jim want to comment?

Jim Rohrs

Well that is a $64,000 question. That -- the answer to that question depends on what happens with the economy from here on. As both Bill and Don alluded to in their previous comments, we have a very aggressive and very thorough watch list process to identify problem loans and then to set reserves for those problem loans. So, we are very confident we identified the problems that are in the portfolio right now and reserve for those but we can’t predict the future.

Brad Ness - Choral Capital Management

Okay, lastly here. It looks in your investment securities portfolio you have $23 million or so in CMOs. One, can you just tell me if these are private label or -- and can you just give me a little bit more color about these CMOs?

Don Hileman

I think it is -- this is Don, being on the job today gives me a little disadvantage here. But I think it is a combination of both. I think there are some private label or (inaudible) CMOs in there. It is a kind of mix. We can provide more color on that and there will be more color in our 10-Q filing at a later date, but --

Brad Ness - Choral Capital Management

Okay. I appreciate it guys.

Bill Small

Okay, thank you Brad.

Operator

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

Carol Merry

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: First Defiance Financial Corp. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts