First Defiance Financial CEO Discusses Q2 2011 Results - Earnings Call Transcript

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 |  Includes: FDEF
by: SA Transcripts

First Defiance Financial Corp. (NASDAQ:FDEF)

Q2 2011 Earnings Call

July 26, 2011 11:00 am ET

Executives

William J. Small – President, Chairman and Chief Executive Officer

Donald P. Hileman – Executive Vice President and Chief Financial Officer

James L. Rohrs – President and Chief Executive Officer – First Federal Bank

Analysts

John Barber – KBW

Bruce C. Baughman – Franklin Templeton

Operator

Good morning and welcome to the First Defiance Financial Corp’s Second Quarter Earnings Conference Call and webcast. All participants will be in a listen-only mode. (Operator instructions) After today’s presentation there will be an opportunity to ask questions. (Operator instructions)

Please note this event is being recorded. I would now like to turn the conference over to [Terra Via]. Ms. Via, please go ahead.

Unidentified Company Representative

Thank you, good morning everyone, and thank you for joining us for today’s second quarter 2011 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’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. Small for his comments.

William J. Small

Thank you, [Terra]. Good morning and thank you for joining us for the First Defiance Financial Corp. conference call to review the 2011 second quarter. Last night, we issued our earnings release reporting the second quarter and first half 2011 results, this morning we would like to discuss that release, and look forward into the second half of the year.

Joining me on the call this morning to give more detail on the financial performance to the second quarter, Executive Vice President, CFO, Don Hileman. Also with us this morning to answer questions is Jim Rohrs, President and CEO of First Federal Bank. We will answer any questions you might have with the conclusion of our presentation.

Second quarter 2011 net income on a GAAP basis was $4.8 million or $0.43 per diluted common share. This compares to net income of $2.1 million and $0.19 per diluted common share in the 2010 second quarter. Net income for the first six months of 2011 is $7.4 million or $0.70 per diluted common share versus $3.6 million and $0.31 per diluted common share for the six months ending June 30, 2010.

The second quarter 2011 performance showed very encouraging progress during a period that still needs a lot of questions about overall economic stability. Again, this quarter as in the past, the lower provision expense was a primary factor in the positive earnings impact.

We also saw an increase in non-interest income over the second quarter of 2010 and the linked quarter at the same time keeping non-interest expense in line. This credit quality issues continue to be dealt with and move to the system, we have been able to benefit from our prudent approach to asset quality management as reflected in our improved performance, while we’re still seeing a degree of stress on certain credits, overall, we saw marked improvement in the majority of the loan portfolio and we feel we have identified and are addressing the remaining issues.

The reduction in non-performing assets, other real estate owned and net charge-offs are all indications of this. But we did not get the reduction in classified assets we had anticipated during the quarter, it was not result of identifying new credit issues that slower progress than we had hoped for on previously identified credits.

As I’ve said in the past, we are going to continue to take a conservative approach to the grading of our credits.

The improvement in overall credit quality has brought most of our key credit metrics below the levels they were at the beginning of 2009, we are focused on driving them lower. As loan quality continued its improvement through the quarter loan balances remained a challenge. The slow on environment have showed some signs revival earlier in the spring has pulled back slightly. This slowness along with the decreases in loan balances resulting from working out problem loans and normal amortization resulted in a reduction in the loan portfolio for the fourth consecutive quarter.

Late in the second quarter we did see some improvement in this trend and we hope we can keep this momentum going. The deposit side of the balance sheet continues to perform well for us as we’ve been able to continue reducing our cost to deposits and build our non-interest bearing deposits.

Non-interest deposits were up over $35 million or almost 19% over the period ending June 30, 2010. As a result this along with additional rate reduction on interest bearing accounts has helped us hold on margin in a relatively narrow range by offsetting over yields on the asset side, although, this has bound to come under pressure eventually.

Net interest income for the quarter was basically flat with the year ago period and the linked quarter. Net interest margin however, drops slightly compared to both periods and the current interest rate environment does not show any sign of abating soon based on most forecasts, so we must remain diligent in our margin management.

Non-interest income was up in the second quarter of 2011, both to the year ago period and the linked quarter. This is encouraging but we will need to remain focused on recent regulatory changes and the impact they will have on certain fee structures. The increase in insurance revenue of wealth management income continue to positively impact our results and these are both areas that we will work to build on.

Non-interest expense was basically flat with the 2010 second quarter, but down about 10% compared to the linked quarter. The primary increase year-over-year was in the compensation related categories that Don, will detail, while we did see reduction in OREO, credit, and collection related expenses.

I’ll now ask Don Hileman to give you the financial details for the quarter and the first half of 2011 before I wrap up with an overview and I look at, we see developing for the balance of the year. Don?

Donald P. Hileman

Thank you, Bill, and good morning everyone. We are pleased with the overall stronger profitability in the second quarter coupled with the progress in improving some of the asset quality metrics. Net income was $4.8 million or $0.43 per share, compared with $2.1 million or $0.19 per share in the second quarter of 2010. The increase in profitability was driven by an improvement in credit quality with lower provision for loan loss and the reduction in credit related costs.

Credit related expenses, which includes net gain loss on the sale of OREO. OREO payers and write-downs, collection costs and secondary market buyback cost remain significant with a total of $918,000 in the second quarter of 2011 compared with $1.4 million in the second quarter of 2010.

Our markets are persistently showing the effects of the difficult economic environment. We are pleased with the trend of reducing unemployment rates in our market area, but meaningful economic growth is developing slowly. We are encouraged that we are seeing indications in our market area that the overall economic activity trend is indicating improvement, however we’ll be irregular and take time to solidly develop with an extended ramp up period well into 2012. We are pleased with the second quarter results and see further opportunities to improve.

I will begin with a discussion of credit quality. Our provision expense totaled $2.4 million down from $5.4 million a year ago and down from $2.8 million on a linked quarter basis. Our allowance for loan loss increased to $40.5 million from $38.9 million at June 30, 2010. The loss percentage increased to 2.80% from 2.47% a year ago.

The change in the percentage is driven by both an increase in the allowance level and by the lower average loans outstanding. The overall reserve decline slightly on a linked quarter basis. The second quarter provision was $268,000 less than net charge-offs for the quarter.

The strength of our reserve in improving asset qualities reflected by increases in the allowance to non-performing loans and the allowance to non-performing asset ratios this quarter. The overall reserve level is adequate based on the continued general weakness in the economy and slower growth prospects in our geographic footprint.

Annualized net charges-offs were 75 basis points for the second quarter of 2011, compared with 144 basis points in the second quarter of 2010, and 85 basis points in the first quarter of 2011. Of the total charge-offs 52% related to commercial real estate loans, 31% to residential, 12% home equity and consumer and 4% commercial loans.

As we see improvements in our asset quality trends as well as in the economy, we will be more confident that significant asset quality stress trends have turned the quarter and are heading toward consistent and steady improvement.

Our OREO balance declined on a linked quarterly basis and ended the second quarter at $7.5 million. The OREO balance is made up of $5.3 million of commercial real estate and $2.2 million of residential real estate.

We had additions of $1.9 million in the second quarter of 2011 offset by sales of $2.4 million and valuation adjustments of $259,000. We are very active in seeking potential bios of these properties and are pleased in the continued reduction of the OREO balance. We expect to see continued movement of credit turning out of OREO as we continue to move problem loans to the resolution state with activity consistent with this quarter. We assume some stabilization of values of the OREO properties in the recent quarter, as well as more interest from potential buyers.

At June 30, 2011 our allowance for loan losses represented 2.80% of total loans outstanding, up from 2.77% on a linked-quarter basis and represents 99.41% of our non-performing loans, up from 89.53% on a linked-quarter basis. The allowance of non-performing assets was 84.16% at June 30, 2011, up from 72.68% at June 30, 2010.

Non-performing assets dropped 12% this quarter ending at $48.2 million or 2.35% of total assets, down from 2.65% of total assets on a linked-quarter basis and down from $53.5 million or 2.62% of total assets at June 30, 2010. Total non-performing loans decreased to $40.8 million from $45.6 million on a linked-quarter basis and were flat with the second quarter of 2010.

Non-accrual loans saw a 16% reduction in the second quarter from the first quarter of 2011. Restructured loans increased $1.6 million from last quarter. Restructured loans are considered non-performing because of the changes in the original terms granted to borrowers. It is important to note that these loans are still accruing.

Total classified loans increased $6.1 million to $137.2 million at June 30, 2011 from $131.1 million at December 31, 2010.

Total delinquency rate was 3.34% at June 30, 2011, up from 2.70% at June 30, 2010 and down from 3.41% on a linked-quarter basis. The delinquency rate for loans 90 days past due or on non-accrual decreased to 2.37% this quarter, from 2.68% in the fourth quarter of 2010 and up from 2.01% at June 30, 2010.

We are not satisfied with the overall levels of 90-day delinquencies in non-accrual. However, the total non-accrual loans of $34.5 million, $6.5 million or 19% are under 90 days past due. We did see an increase in the 30 day and 9 day levels of delinquencies. We did not view it as an indicator of the trend, with 30 day, 89 day past due increase was driven by one large credit that we have previously identified for monitoring.

Mortgage banking was up in the second quarter impacted by rising rates and seasonal patterns. We continue to see a tapering off of mortgage banking activity over the last several months. Overall, the mortgage banking income for the quarter was $1.8 million, compared with $985,000 in the second quarter of 2010 and $1.3 million on a linked quarter basis.

We had a gain on sale income of $1 million in the second quarter of 2011, compared with $1.2 million in the second quarter of 2010 and $726,000 in the second quarter of 2011. We also reported a positive valuation adjustment to mortgage servicing rights of $316,000 in the second quarter of 2011, compared with negative valuation adjustments of $571,000 in the second quarter of 2010 and positive valuation adjustments of $171,000 on a linked quarter basis.

The positive valuation adjustment in the first and second quarters of 2011 reflects the steady change in the level of marking interest rates over the last several quarters that effectively assumed prepayment speeds of the underlying collateral.

At June 30, 2011, First Defiance had $1.3 billion of loan service for others. The mortgage servicing rights associated with those loans had a fair value of $9.8 million or 78 basis points of the outstanding loan balance service. Total impairment reserves, which are available for recapture in future periods, totaled $638,000 at the end of the quarter.

We do not have any OTTI charges in the second quarter of 2011 reflecting a more stable economic environment as it relates to our investments and trust preferred collateralized debt obligations.

Management believes the probability is low that we will have any significant OTTI charges in the future. The stability of the marketplace and the continued analysis of the current portfolio assist us in making this conclusion.

Turning to other operating results, our net interest income was $17.5 million for the second quarter, compared to $17.6 million for the second quarter of 2010, and $17.2 million on a linked quarter basis. For the quarter our margin was 3.86%, down 3 basis points from the second quarter of 2010, as well as on a linked quarter basis.

We have been successful in lowering our cost of funds to offset the decline in asset yields. We have seen more aggressive competitive pricing pressure and the downward re-pricing of variable REIT loans based on the current yield curve. The continued high level of liquidity has also impacted the margin as we have seen an increase in overnight deposits, which were $185 million at the end of the quarter.

We anticipate continuing our increase in securities purchase activities in the third quarter, so actively deploying lower yielding overnight deposits into securities on the short-term to intermediate and of the yield curve. We have been staying in the four or five year weighted average life range.

We believe that the economic outlook remain subdued and it is unlikely that we will see any actions by the Fed to raise rates until well into 2012. We will continue our strategy until we see evidence of sustainable net loan growth.

Even with the give up in the yield associated with the higher liquidity level, we believe our liquidity position continues to be important and gives us added flexibility. We place a strong emphasis on non-interest-bearing deposits and saw the balances grow this quarter. Non-interest-bearing deposits represent 14.4% of total deposits.

We are focusing on pricing opportunities to maintain and expand the margin. We are particularly focused on asset pricing discipline and the challenges of maintaining asset yields. Our yield on assets declined 60 basis points while our cost of funds declined 12 basis points on a linked quarter basis.

We are seeing a broader base of very competitive pricing in our market area, which puts added pressure on loan growth and improvement in asset yields. Non-interest income was $6.8 million in the second quarter, up from $5.8 million in the second quarter of 2010.

The income increased to $2.7 million in the second quarter of 2011 from $2.6 million on a linked-quarter basis and declined from $3.4 million in the second quarter of 2010. The year-over-year decline in fee income is directly attributable to the downward trend in net NSF income, as a result of new regulations. Net NSF fee income was $1.5 million for the second quarter of 2011, compared to $2.0 million for the second quarter of 2010.

We are pleased with the relative stability of our interchange income, as well as our service charge income and service revenue was $1.4 million in the second quarter of 2011 down from $1.7 million on a linked-quarter basis, and up from $1.3 million in the second quarter of 2010.

The linked-quarter insurance revenue decrease is a result of receiving contingent commissions of $329,000 in the first quarter of 2011. The year-over-year insurance revenue increase is driven by the acquisition of a group benefits business line at the end of the second quarter 2010. This acquisition added approximately $218,000 in quarterly revenue. As previously announced on July 1, we acquired the business of an independent property in casualty agency, the two of its locations within our franchise footprint. We expect this acquisition to generate approximately $200,000 additional insurance commission per month.

Other non-interest income increased to $130,000 in the second quarter of 2011 from a loss of $223,000 for the same period in 2010. This was the result of recording net gains of $38,000 on real estate-owned properties sales in the second quarter of 2011 compared with net losses of $207,000 for the same period in 2010.

Overall, non-interest expense increased to $15.1 million this quarter compared to $15 million for the second quarter of 2010 and down from $16.6 million on a linked-quarter basis. The second quarter compensation and benefits expenses decreased to $7.5 million from $7.8 million on a linked-quarter basis and increased from $6.6 million in the second quarter of 2010.

The increase in compensation and benefit expense over the second quarter of 2010 is due to the company freezing pay in 2010, coupled with no bonus accrual in the second quarter of 2010 based on the company not meeting certain performance targets. Healthcare costs also increased $117,000 over the second quarter of 2010.

Other non-interest expense decreased to $3.2 million in the second quarter from $3.8 million in the second quarter of 2010 and declined from $4.1 million on a linked-quarter basis. Decreases between 2011 and 2010 second quarters included credit, collection and real estate-owned expense reductions of $403,000 and a positive adjustment in the second quarter of 2011 of $247,000.

On a linked quarter, other non-interest expense declined $900,000, primarily due to secondary market buybacks losses of $62,000 in the second quarter of 2011 compared to $228,000 in the first quarter of 2011.

The positive client adjustment of $247,000 was expense in the first quarter of 2011, but reversed in the second quarter of 2011.

Checking accounts charge-offs decreased to $122,000 in the second quarter of 2011 from the linked quarter and real estate-owned expenses decreased $40,000.

Finally, as a three quarter trend of certain significant expenses, real estate-owned expenses were $678,000 in the second quarter of 2011, compared to $718,000 in the first quarter and $699,000 in the second quarter of 2010.

Credit and collection expenses were $244,000 in the second quarter of 2011, compared to $192,000 in the first quarter of 2011 and $356,000 in the second quarter of 2010.

Secondary market buybacks were $62,000 in the second quarter of 2011, compared to $228,000 in the first quarter of 2011 and $97,000 in the second quarter of 2010. We saw balance sheet increased slightly from the second quarter of 2010 with total assets of $2.05 billion at June 30, 2011.

On the asset side, cash and equivalents grew $92 million over the year to $240 million at June 30, 2011. Securities grew $52 million over the year to $212 million. Gross loan balances declined to $122 million year-over-year and declined $22 million on a linked-quarter basis.

Loan activity in general continues to be weak, but we are seeing some signs of an increasing commercial loan pipeline. We continue to be prudent on the lending activities; we’ve been disciplined with our underwriting and not focused on growth at the expense of taking greater credit risk or lower rates aggressively to increase loan volume. We’ve been intent on making sure our service levels have not suffered as a result of increased levels of loan workouts. We’ve been able to develop stronger, new relationships with good commercial clients.

Total deposits declined $7 million from June 30, 2010, and declined $19 million on a linked quarter basis. We are pleased with the mix of deposits as we have seen a growth in non-interest bearing account balances. Non-interest bearing balances increased to $226 million at June 30, 2011, up from $190 million at June 30, 2010.

We continue to focus on growth in non-interest bearing balances in correlation with our overall strategy and efforts to reduce our cost of funds in this interest rate environment.

As noted in last quarter, we completed a common stock offering in March of this year and increased shareholders’ equity by $20 million. Total shareholders’ equity ended June 30, 2011 at $269 million up from $238 million at June 30, 2010.

Our capital position remains strong with shareholders’ equity to assets improving to 13.16% at June 30, 2011 from 11.71% at June 30, 2010. The Bank’s risk-based capital ratio was strong at approximately 15.3%.

As our financial performance improves, we continue to evaluate our overall capital levels and our strategy for the repayment of our CPP investment. The Board continually assesses our involvement in this program. As we have previously said, we have targeted repayment of the funds with blended (inaudible) window with loans at the latter part of 2013 without an additional equity offering.

We recently applied for Small Business Lending Funds to refinance our CPP investment. But based on recent changes in the program requirement relating to regulatory restrictions on paying dividend, we think it is unlikely at this point that we will participate in this Small Business Lending Fund program. We’ve been informed by the SEC that our (inaudible) has been tentatively scheduled to start in November. We expect this to be a key process in the switch from the OTS to the FCC and look forward to validating with (inaudible) improving in several key areas such as asset quality.

While we know that there is some major headwinds to deal with such as lack of meaningful economic improvement, lack of borrower and consumer confidence and lower interest rate environment, we feel we have strengthened the financial foundation of First Defiance to help navigate through these challenges.

That concludes my overview for the quarter. I’ll turn the call back to Bill.

William J. Small

Thank you, Don. As we progress through 2011, we are aware that there are still challenges to a sustained economic recovery.

Our three primary focuses throughout the first half of 2011 has been asset quality, expense control and core deposit growth. We’ve made significant strides in all three of these areas in recent quarters and we will continue with this effort to meet the challenges and return to higher levels of profitability.

While we are focused on these we will be directing additional attention toward loan growth. The improvement of the overall credit environment will allow us to direct more time and resources to loan production. There is an extremely challenging business development market out there right now with limited loan demand and all banks in high liquidity positions.

We’re devoting significant time and resources to develop sound loan programs that benefit our community business customers, retain market share, and create a fair return to our shareholders. We are hoping that recent indications of stronger loan demand continue to build and reverse the trend of declining balances.

The overall economic climate throughout our market areas shows indications of strengthening. Several larger corporations throughout our area including General Motors, Campbell Soup, Marathon Petroleum and Johnson Controls have all made announcements of capital investments or structural changes will benefit their facilities within our footprint.

Commercial clients are showing improving cash flows and many are also reporting significant pick up in work orders and in some cases new hiring. Agriculturally, the planting season was dramatically altered with record setting range in May. However most fields are planted, with some well timed rain along with commodity prices remaining strong; we anticipate it will be a decent year. Late harvest came in slightly better than expected in our area earlier this year.

Unemployment continues to run slightly above the national average throughout our market but we have seen this gap narrow as growth throughout our region has actually outperformed national statistics, the last few quarters. Obviously we are pleased to see any improvement in the employment data and the additional consumer confidence that this seems to bring with it.

The housing market continues to be the biggest question facing the full recovery of the economy. The supply is high and prices soft and in some areas still declining, it appears this sectors’ recovery will remain swell. Our mortgage production continues to reflect this, but we are again focusing on product development and enhancements that we feel can give us a competitive edge for the business that is out there.

We are keeping a cautious eye on the regulatory and legislative scene as regulators solely work on developing the regulations that will implement The Dodd–Frank Act. There is still many unanswered questions regarding this legislation and our industry is working hard to help shape the final regulations to have a least damaging affect to banks and their customers.

We do feel that the recent decision regarding the Interchange Fee Amendment may give us an opportunity in the short-term as we’re exempt from the free reduction and the large banks look to raise other fees as their offsets revenue loss.

I mentioned earlier our non-interest income opportunities that we want to focus on and we made a significant commitment toward that with the acquisition of the Payak-Dubbs Insurance Agency effective July 1. This acquisition is a continuation of our strategic plan to be a full service financial service provider throughout our market. This gives us a strong presence in the greater Toledo area with a highly identifiable and respected partner. Our mission is to be a community bank that provides a complete line of financial services with a relationship-oriented approach on a profitable basis.

The staff we have throughout this organization understands the importance of relationship banking and the importance of delivering on that mission. I thank them for their diligence and loyalty, and I thank you for joining us this morning on the call. And now, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) And today’s first question comes from John Barber with KBW.

John Barber – KBW

Good morning.

William J. Small

Good morning, John.

John Barber – KBW

Don, I think you mention that loans 30 to 89 days past due were up largely due to one credit, was that in the CRE portfolio? And can you just give us a little bit of color on that loan?

Donald P. Hileman

Yeah, it is. It was the credit that we’ve been monitoring. I’ll let Jim, if there is any additional comments. It was one that we work with. We still think there is a good opportunity that will improve and become performing move to stay performing, but it was a large credit that we felt that needed to be continue to monitor. So I don’t think there is a, we don’t feel there is lot of risk in that increase in the 30 to 89 days.

John Barber – KBW

Okay. And could you comment on the competition you’re seeing for quality of loans? Who you are competing most? Is it the large regionals or other community banks? And can you just discuss the pricing environment also?

Donald P. Hileman

I’ll let Jim answer that question.

James L. Rohrs

We’re seeing competition from both the community banks of our size and smaller and also from a regional. Regionals have become much more active and are getting active again in areas that they’d really kind of shied away from non-owner occupied commercial real estate. So it’s very competitive market out there and we’re seeing some, what we will classify us irrational pricing out there and we kind of joke the definition of irrational pricing is kind of changed, it seems like it keeps getting lower and lower as we continue through this rate environment is, where rates are stagnant and no increase in size. So it’s a very, very competitive market out there, no body wants to give up any existing business they have and every new piece of businesses looked at by multiple vendors.

Donald P. Hileman

We saw a lot of competition in competitive pricing on the five year fixed commercial product over the last quarter, now we’re seeing that, extent that on the duration of seven years and 10 years.

James L. Rohrs

Even some 10 year and a 15 year, I heard this morning.

John Barber – KBW

Can you talk about your pipeline, just how compares to last quarter and maybe 12 months ago?

William J. Small

Better than 12 months ago, probably about the same as last quarter, we are looking at significant number and size of new opportunities, but they are very, very competitive, so we’re not winning as many of those as we had maybe two years ago. But I'm confident that we’ll hold our own in the marketplace. It’s a tough environment out there, everybody wants to grow top line revenue and there is more demand for loans out there and there are new loans in the marketplace.

John Barber – KBW

All right and my last question, I think you said the OCCs and safety and soundness exam is scheduled for November, would you expect how the results and fourth quarter results or that will be first quarter or 12 events.

William J. Small

That will probably go over into the first quarter, I would anticipate John, by the time they get in and do the field work and get everything processed, we do not anticpate having the firm results prior to 12/31. We’d be delighted to get it before that, but I doubt if it’s going to move quite that fast.

John Barber – KBW

Okay. Great, thank you very much.

Donald P. Hileman

Thanks, John.

William J. Small

Thank you.

Operator

Thank you. And the next question comes from Bruce Baughman from Franklin.

Bruce C. Baughman – Franklin Templeton

Good morning.

William J. Small

Good morning, Bruce.

Bruce C. Baughman – Franklin Templeton

Could you go back over the ground around the retiring the TARP preferred, the different considerations? When they are going to fast?

James L. Rohrs

We have our, initially we will say, we had a target trying to get that repaid organically within the first half, five years, in the first five years is when the rate is flat and now where they increase after that period.

William J. Small

That’s December of 2013.

James L. Rohrs

Correct. We’re somewhat optimistic, originally of lending refinancing out into the Small Business Lending Fund, like some of those parameters changed here recently and as we probably say we are restricted to our memorandum of understanding about meeting prior approval to pay any dividends and that includes dividends on our CPP funds and that restriction while we’ve always received approval and we don’t anticipate any problems in the future receiving approval to do that. Then your mechanics of having to request that approval, that’s going to preclude us from participating in a Small Business Lending Funds.

William J. Small

Our plan is we still feel very confident that without additional equity raised that we would have the resources to repay in full prior to the December 2013, end of our five year period.

Bruce C. Baughman – Franklin Templeton

Is there anything that you are doing currently to prepare liquidity for a transaction like that?

Donald P. Hileman

Yeah, right now, we have our liquidity, we’re keeping that in our strategy that we would need that liquidity. From our standpoint it’s more of a – we look at it in two standpoints. Liquidity, I think we’ve addressed that from a strategic standpoint and a process standpoint it’s getting the metrics improving in such that we can feel comfortable enough to get regulatory approval to do it. And maintain strong capital in where it sorts of balances out both liquidity and capital management.

William J. Small

It’s obviously a component of our liquidity plan and capital plan and has been from the day we got into it.

Bruce C. Baughman – Franklin Templeton

What’s the earliest timeframe you might go the regulators and ask for permission to retire that preferred?

William J. Small

We have not made – gone public with any statement on that yet, Bruce and probably won’t at this point.

Bruce C. Baughman – Franklin Templeton

Okay. Is that reticence a matter of procedure, I’m not really sure, why. I don’t understand whether it’s a – what the hesitation would be?

Donald P. Hileman

Well, I think one of it’s just the transition with the regulators here. We are going from the OTS, we had a specific viewpoint of things and now we’re going to the OCC.

William J. Small

Fabulous.

Donald P. Hileman

And then the Fed as far as, the holding company, so some of that reticence you just understanding the regulatory environment we’re going to be on with two new regulators, part of it, trying to get a feel from them on what the triggers would be to move ahead with approval. As we’ve stated in the past, one of the things we believe is we still improve from our perspective is our level of classified loans and assets, we are still focused on that. As I’ve said, we didn’t see an improvement in that this quarter, somewhat, it’s a disappointment, but we believe we need to have more material improvement in our level of classified assets as well. So I think there is a couple of those things that most is unclear saying really why, when we will start to consider requesting approval.

Bruce C. Baughman – Franklin Templeton

Okay. Thank you.

Operator

(Operator Instructions) There are no more questions at the present time, so I’d like to turn the call back over to management for any closing remarks.

William J. Small

We thank you very much for joining us this morning, and your participation and interest in First Defiance Financial and look forward to coming back and speaking with you next quarter. Thank you very much.

Operator

Thank you and that conclude today’s teleconference. You may disconnect your phone line. Thank you for participating and have a nice day.

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