First Defiance Financial Corp (NASDAQ:FDEF)
Q4 2015 Earnings Conference Call
January 19, 2016, 11:00 ET
Tera Murphy - Director, Marketing
Don Hileman - President & CEO
Kevin Thompson - EVP & CFO
Damon DelMonte - KBW
Daniel Cardenas - Raymond James
Welcome to the First Defiance Fourth Quarter and Year-End 2015 Earnings Conference Call. [Operator Instructions]. I would not like to turn the conference over to Tera Murphy, Vice President and Marketing Director. Please go ahead.
Thank you. Good morning, everyone and thank you for joining us for today's 2015 Fourth Quarter and Year-End 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 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. Hileman for his comments.
Thank you. Good morning and welcome to First Defiance Financial Corporation's fourth quarter conference call. Last night we issued our 2015 fourth quarter and full-year earnings release and now we would like to discuss that release and give some insight into 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 and full year is our CFO, Kevin Thompson.
I'm very pleased with the momentum developed in the fourth quarter in both our financial performance and in several strategic performance areas. Loan growth was a particularly bright spot during the fourth quarter. Fourth quarter 2015 net income on a GAAP basis was $6.6 million or $0.71 per diluted common share compared to $6.4 million and $0.65 per diluted common share in the fourth quarter of 2014. For the year ended December 31, 2015 Defiance earned -- First Defiance earned $26.4 million or $2.82 per diluted common share compared with $24.3 million or $2.44 per diluted common share for 2014.
We're fortified by the year-over-year and linked quarter loan growth. The trend in both healthy loan growth and net interest income growth combined in the fourth -- continued in the fourth quarter. Gross loans at December 31 were up 9.4% over a year ago which follows a solid third quarter.
As we look into 2016 our continued ability to grow our loan portfolio will be a key focus of our strategic plan. We're very satisfied to see one growth across our footprint, even in the face of strong competitive market pressures, particularly in pricing, as all institutions seem to be more aggressively seeking loan growth.
Total new loans originating in the fourth quarter were put on at a weighted average rate of 4.11% compared to 4.30% in the third quarter of 2015. Overall yield on loans for the fourth quarter of 2015 was 4.34%, down only 4 basis points from the fourth quarter of 2014.
We're very satisfied with our margin considering the flat and very competitive rate environment. Our core business strategies continue to both grow in net interest income and solid performance of our non-interest income revenues on a quarterly basis. This is reflected in our solid net interest income growth this quarter of 4.8% over the fourth quarter of 2014 and 6.3% year to date over 2014.
We expect the interest rate environment to be reflective of the continued anticipation of multiple Fed rate increases over the course of 2016. We continue to measure our interest-rate risk position and are managing toward a neutral to slightly asset sensitive position. Kevin will give you more color on this in his comments.
Our net interest margin increased to 3.77% over the fourth quarter of 2014 margin of 3.76%. We did see a slight compression in the margin on a linked quarter basis of 1 basis point, but we're satisfied with our margin trend and will continue to balance pricing discipline with growth.
Non-interest income generally improved across the board over the fourth quarter of 2014. Mortgage banking saw a 15% improvement over the fourth quarter of 2014. We were pleased to see an improving trend in mortgage loan production on a comparative basis with the fourth quarter of 2015 showing a 7% increase in loans originated over the fourth quarter of 2014. We're now up 5% year over year in service fees and service charges. The credit quality metrics continue to reflect a trend of improvement year-over-year and on a linked quarter basis. Nonperforming assets declined approximately $12.7 million or 42% including nonperforming loans which decreased approximately $7.9 million or 33%.
Approximately 56% of the nonperforming loans continue to make payments. We remain committed to working on further reductions in both nonaccrual loans and the nonperforming asset ratio. We saw the 30 to 89 day past-dues remain below the fourth quarter of 2014 level. We believe the overall asset quality trend will remain positive and reflect in a corresponding loan loss provision affect.
We bought back approximately 79,000 shares of our stock in the fourth quarter. Our buyback activity was impacted by our higher stock valuation during the fourth quarter. We also delighted in announcing a 2016 first quarter dividend of $0.22 per share representing a 10% increase and an annual dividend yield of approximately 2.4%.
We anticipate a continuation of a balance of dividends and stock buyback activity reflecting our strong earnings trend and a focus on our utilization of capital. I will now ask Kevin to provide additional financial details for the quarter before I conclude with an overview. Kevin?
Thank you, Don, good morning, everyone. Don stated net income for the fourth quarter was $6.6 million or $0.71 per diluted share, this compares to prior year results of $6.4 million or $0.65 in the fourth quarter of 2014. The fourth quarter this year did not include any significant nonrecurring type items while last year's fourth quarter benefited from a $551,000 or $0.06 per share positive adjustment to the provision for income taxes for the utilization of capital loss carry-forwards.
So, adjusting for last year's tax benefit, it is clear to see substantial improvement in fourth quarter earnings versus last year with EPS up $0.06 or 9% overall and $0.12 or 20% adjusting for last year's tax benefit. We're very pleased with our total performance results and profile for the fourth quarter and the momentum this brings for 2016. Loan and deposit growth were both very strong, enabling us to maintain a very profitable earning asset mix and net interest margin and grow our net interest income.
Non-interest revenues continue to reflect steady growth from a year ago and ongoing credit quality improvement further strengthened our results. Operating expenses, reflecting an increase to support our revenue growth, remain well-controlled as the generation of positive operating leverage was a key to our earnings improvement.
Looking at the details of the income statement, our net interest income was just under $19 million for the fourth quarter of 2015, up from $18.5 million in the linked quarter and up $866,000 from the $18.1 million in the fourth quarter last year. For the fourth quarter of 2015 our margin was 3.77%, down 1 basis point from last quarter and up 1 basis point from 3.76% in the fourth quarter last year.
Our earning asset mix and margin have remained strong and steady over the course of the year. Growth in loans has enabled us to maintain a healthy earning asset yield as we grow our balance sheet. Our yield on earning assets was up 3 basis points from the fourth quarter last year and down just 1 basis point on a linked quarter basis. Our cost of interest-bearing liabilities was up 4 basis points from a year ago and 1 basis point on a linked quarter basis.
Total new loans originated in the fourth quarter were put on at a weighted average rate of 4.11%, a decrease from 4.30% in the third quarter of 2015, primarily due to a greater portion of floating rate loans this quarter. However, our loan portfolio yield overall was 4.34% in the fourth quarter of 2015, an increase of 2 basis points on a linked quarter basis.
As Don said, we plan to keep our interest-rate risk basically neutral to slightly asset sensitive in the face of changing rates. We're pleased with our ability to generate floating-rate loans this quarter as we will not trade off higher near-term earnings for higher interest-rate risk. Instead we expect our loan growth to keep our earning asset mix and margin strong and our risks well balanced going forward.
Total non-interest income was $7.7 million in the fourth quarter of 2015, down from $8 million in the linked quarter which included a higher than normal level of SBA FSA gains, but up 5.3% from $7.3 million in the fourth quarter of 2014. Service fee income on loans and deposits was $2.7 million in the fourth quarter of 2015, a decrease from the $2.8 million in both the linked quarter and the fourth quarter of 2014 mainly due to lower NSF fee levels. Insurance revenue was nearly $2.3 million in the fourth quarter of 2015, up from $2.2 million in the fourth quarter of 2014. And trust income, while a smaller component of revenue, was $367,000 in the fourth quarter of 2015, up from $345,000 in the fourth quarter last year.
Regarding mortgage banking revenues, for the fourth quarter of 2015 they totaled $1.5 million, down seasonally $215,000 from the linked quarter but up $195,000 from the fourth quarter of 2014. Fourth quarter mortgage banking originations were $56.3 million compared to $68.2 million last quarter and $43.8 million in the fourth quarter of 2014.
Gain on sale income was $836,000 in the fourth quarter of 2015 compared to $1.2 million in the linked quarter and $734,000 in the fourth quarter last year. In addition, the quarter included a positive valuation adjustment to mortgage servicing rights of $75,000 compared to positive adjustments of $24,000 last quarter and $11,000 in the fourth quarter of 2014.
At December 31, 2015, 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 72 basis points of the outstanding loan balances serviced. Total impairment reserves which are available for recapture in future periods, totaled $645,000 at year end.
As for the non-interest expense, fourth quarter expenses totaled $17.3 million, up from $16.8 million in the linked quarter and $17 million for the fourth quarter of 2014. The increase was primarily in compensation and benefits expense which in the fourth quarter 2015 was up $798,000 from last year, mainly due to higher incentive compensation costs, merit increases and new staff to expand and support our growth strategies.
Our non-interest expense was -- our other non-interest expense was $3.3 million in the fourth quarter 2015, down from $3.8 million in the same quarter last year, mainly due to reductions in OREO costs and management consulting. Regarding provision expense, the fourth quarter of 2015 totaled $43,000 compared to a credit provision of 27 last quarter -- $27,000 last quarter and $162,000 provision expense in the fourth quarter last year. The fourth quarter of 2015 included net recoveries of 3 basis points compared with net charge-offs of 3 basis points last quarter and net recoveries of 1 basis point in the fourth quarter a year ago.
Our allowance for loan loss at December 31, 2015 was $25.4 million or 1.41% of total loans versus $24.8 million or 1.50% at December 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 nonperforming loans has increased to 156% at year end, up from 103% at December 31, 2014. We expect the allowance to loans percentage to continue to reflect strengthening asset quality.
As for the asset quality numbers, nonperforming loans decreased slightly this quarter to $16.3 million from $16.6 million on a linked quarter basis, but was down 32.6% from $24.1 million at December 31, 2014. Our OREO balance decreased significantly this quarter to $1.3 million from $4.9 million last quarter and from $6.2 million in the fourth quarter last year. Overall nonperforming assets ended the year at $17.6 million or 0.77% of total assets, down from $30.3 million or 1.39% of total assets at December 31, 2014. And we again had a nice in our troubled debt restructured loans this quarter which fell to $11.2 million at year end down from $13.8 million last quarter and $24.7 million last year end.
Moving to the balance sheet, total assets were $2.3 billion at December 31, 2015, up $69.4 million from last quarter end and up $118.7 million or 5.4% from last year end. Gross loan balances increased $68.7 million during the quarter and finished 2015 up $155.4 million or 9.4% year over year. Securities decreased $3 million from a year ago while cash and equivalents declined $33.2 million.
Our loan growth this past quarter was exceptional and our loan growth outlook remains very positive. Total deposits of $1.84 billion at year end reflect an increase of $75.3 million from a year ago and were up $43.1 million on a linked quarter basis. Non-interest-bearing deposits have increased to $420.7 million at December 31, 2015 from $379.6 million at December 31, 2014. We were very pleased to see our deposit growth pick up in the fourth quarter and continued growth in our low-cost deposit base will be a high priority for us going forward.
Looking at our capital position, total period end stockholder's equity finished December 31, 2015 at $280.2 million, up from $279.5 million at December 31, 2014. During the quarter we repurchased approximately 79,000 shares leaving approximately 95,000 shares remaining under our current repurchase authorization. Our capital position remains strong with year-end shareholder's equity to assets of 12.27%, although down from 12.77% last year end.
The Bank's total risk-based capital ratio is approximately 13% at year end December 31, 2015. Our healthy capital position continues to support our growth strategies as well as enhance shareholder value through share repurchases and dividends. As Don mentioned, we announced a 10% increase to our quarterly dividend raising it to $0.22.
Finally regarding our record full-year results for 2015, net income was $26.4 million or $2.82 per diluted share versus $24.3 million or $2.44 per diluted share for the year 2014. That is an EPS increase of $0.38 per share or 15.6% despite prior years' results benefiting from several non-recurring type items which totaled approximately $0.18 per share.
We're very pleased with our 2015 performance, growth and momentum that we're carrying into the New Year. That completes my financial review and now I will turn the call back over to Don.
Thank you, Kevin. I'm very pleased with the results in 2015 and the significant progress we have made to position First Defiance for 2016. Our focus on several key areas believed important to improve financial performance and drive greater shareholder value as we continue to build the momentum gained this year. 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 make steady progress in all of these areas in 2016.
We do believe improvements in loan demand aided by further improvement in the economic environment will carry through 2016. We look to grow our position in the metro markets of Fort Wayne, Indiana, Toledo and Columbus, Ohio. We're seeing strong activities in these areas. As I mentioned last quarter, some additional expense was added in the quarter and we expect some degree of additional expense in 2016 as we build lenders and support structure for this growth.
The size of our current pipeline reflects confidence in our continued ability to build our loans outstanding coming off a strong fourth quarter with outstanding's growing $68 million or 16%. We do not anticipate growth maintaining that pace in 2016, but do believe a growth rate in the high-single-digits is appropriate.
While the lending environment remains very competitive, we feel we can accomplish loan growth without making significant concessions in rates and other terms through a strong process of relationship building and quality client focused service. We understand it will be challenging to drive growth in loans and maintain yield management until markets move higher. We're very focused on relationship management pricing and believe our delivery and service model is effective.
We continually look to enhance our electronic and mobile capabilities giving our customers more choices on how they bank with us and responding to their requests unveiled during our research. We're pleased with the increases in activity in both electronic and mobile transaction including online account opening, mobile deposit, electronic payments and the use of mobile wallet features. The digital delivery environment is changing at an accelerated pace and we're committing to providing our clients a quality choice of products and services like Apple Pay and other digital wallet alternatives.
As part of our commitment to supporting our customers' increasing preferences of the digital channel for banking and access to financial resources, we recently launched our new website. This will improve our user experience on mobile and tablet devices with fully responsive design, improved ease of navigation and improved access to financial resources.
These enhancements will also improve our ability to attract new customers. We will continue to focus on growth in our insurance and wealth management revenues as part of our strategic plan. We acquired a small insurance operation in our Lima, Ohio market this year and look to broaden our insurance agency footprint further in 2016. It is important to reflect on 2015 as a very good year for our Company and the progress made toward achieving our strategic goals. We were particularly pleased by the significant improvement in credit quality reflected by lower charge-offs and overall lower nonperforming assets.
We're very encouraged by the recent performance and look to consistently drive our performance through initiatives that will help us obtain our goal of being a consistently high-performing community bank. We look to accomplish this through a balanced approach and a long-term focus on shareholder value.
We understand that success requires focus and successful execution. We remain confident in our strategy and in the people we have dedicated to executing it. We feel that the performance of the organization reflects on our focus of shareholder value at the same time our commitment to be a strong community partner in areas we serve. An example of this is our commitment to our Pay it Forward initiative.
Each of our employees have provided a sum of money to be used to Pay it Forward by helping individuals organizations or causes that will make a difference in our communities. The employees choose how they make a difference. We remain strongly committed to our customers and shareholders and we appreciate the trust you have placed in us as we work to make First Defiance a bank to be proud of.
Thank you for your interest in First Defiance Financial Corporation and we thank you for joining us this morning. We will now be glad to answer your questions.
[Operator Instructions]. The first question is from Damon DelMonte at KBW.
My first question just relates to the expenses. You alluded to the fact that you are continuing to build out in some of your higher growth markets. And if we look at quarter over quarter, operating expenses were $17.4 million, call it which was up from call it $16.9 million the previous quarter. Should we kind of look out to 2016 and get a quarterly run rate that is kind of in the $17.5 million to $18 million range, is that fair?
Well, I think that might be a little strong. But we would expect our expenses to increase some in 2016 as we continue to build out as Don alluded to. $18 million I think would be on the high end though, Damon.
Okay, all right. But a little bit of a lift though from where we were this quarter but maybe not as high as $18 million?
And then in the noninterest income category, the other category this quarter, was there anything usual in there? That seemed to be a little bit higher than what we were looking for?
The other income.
The other income?
The other income, yes.
There was a small amount of OREO gains, maybe about $100,000 or so. There wasn't anything too singular that really jumped out, Damon, it was just some odds and ends so to speak.
Okay. So, as we kind of look forward into 2016, I know first quarter you tend to have the benefit of the insurance commission line items.
But absent that is something in the high $7 million range reasonable?
I would say.
And then just quickly on loan growth. I noticed this quarter construction loans were a large driver of this quarter's results. Could you talk it little bit about some of those credits that you added, maybe the size of them or the types of projects and what the expectation is for ongoing growth in the construction segment?
Yes. There was a couple large construction projects that current clients that we've had long relationships with initiated in the quarter. And I would expect we would definitely level off and not expect the same kind of growth going forward in that area. The benefit, part of it was -- as Kevin talked about interest-rate risk. A good chunk of that construction was put on a variable rate that will help us a little bit when we position for interest rate risk. But I would not expect the same growth rate going forward at all.
[Operator Instructions]. Your next question is from Daniel Cardenas at Raymond James.
Just a quick question on funding your forward-looking loan growth, I'm looking at your securities to assets and you are a little bit under 11% right now. I mean how much further can you shrink that number and continue to fund fairly robust loan growth?
Probably not much more, Dan, to be honest with you, I think we would expect the loan to asset ratio to stay below 80%, but probably up in the high 70%s. So right about where it is.
And then maybe in terms of deposit competition, are you seeing any increase in competitive factors on the deposit side?
Dan, we really haven't since the Fed move. We thought we might, but we haven't really seen anything at all significant in our marketplace related to a raise in deposit rates.
Regardless of the market whether it's Toledo or Columbus or Fort Wayne?
Well, I can speak more to -- we probably did say a little bit more on Columbus, but that is not where we're really attracting deposits. But in our deposit gathering market that is pretty much across the board and our footprint we have not seen a material change in interest rates and we have not moved accordingly.
Okay. And then maybe some color on the M&A environment. How is that looking for you guys right now? Are you beginning to see the level of discussion pick up or is it kind of what we saw coming into Q4?
I don't know if I have seen a lot of increase from what we saw in the beginning of Q4, but I think according to what I'm hearing is the expectation is a lot greater in 2016. And I think there will be a lot -- appear to be a lot more conversations and opportunities going forward. But I don't know if I've seen it any greater now than I did in the first part of the fourth quarter.
Okay. But it sounds like seller expectations maybe have increased a bit?
I think there is more realization on the seller's part that now might be a good opportunity.
[Operator Instructions]. You’ve a follow-up question from Damon DelMonte at KBW.
I figured I would jump back in. Just a quick question on the margin outlook, you held it pretty steady this quarter. Are you factoring in additional rate increases by the Fed in your outlook for 2016?
We do. Our expectation is pretty consistent probably with the overall market expectation right now that the Fed will probably move up around 100 basis points. Our plans and our outlook and forecasts are all kind of working with that kind of outlook. We expect that obviously that is going to at some point kick in to affecting the pricing. But we believe that our margin with our neutral position pretty much to interest-rate risk we think we can maintain a strong margin.
I would say that in the near-term though that we probably might feel what -- more downward pressure or some challenge, if you will. I guess we're preparing for that. There is maybe a little more uncertainty in the market from that standpoint. So we're not overly expecting the benefit from the rise in rates.
We think we have got our balance sheet and a slightly asset sensitive position, but with maybe some of the uncertainty in terms of disintermediation of deposits and overall market reaction to the changes in rates we're probably -- we're thinking more that that is going to be a challenge. So, we're trying to prepare all of our outlook toward that in making sure that we're managing the Company to anticipate more of a headwind than a benefit.
Okay. And then the variable rate loans that you put on this past quarter, what are some of those characteristics? Are they tied to LIBOR or to the short end of the curve? Or are they three-year fixed and then they -- yes, three-year fixed and then they become floating?
Yes. The bulk of it is either 30-day LIBOR or prime.
Our next question is from Daniel Cardenas at Raymond James.
Just a quick follow-up, as you talked about your buyback program it sounds like you could sweep that up fairly quickly if you so decided. Would you guys consider authorizing an additional share repurchase program once this one is done?
Yes, I think that is something our Board would consider as we look forward in the quarter here. As I said, we're going to look to balance our capital and I think we're consistent and agree with you that we can probably sweep the rest of that up here in a quarter. And we'll probably look to have a discussion with the Board about another authorization.
We have completed now two 5% repurchase -- or nearly completed the second one. So we have made some significant impact from what we have done. Obviously our growth profile is picking up which we're excited about. And obviously we have increased our dividend. The M&A environment is maybe heating up. So we want to have a good discussion with the Board in terms of our capital strategy going forward. But certainly reauthorizing a buyback is one of those considerations.
Okay, good, good. And just a quick question, a follow-up question on loan competition. Is it primarily pricing that you are seeing the pressures or are you beginning to see some structural weakness in competitors' lending?
I would say now both are factors, Dan, that earlier on it was more the price only. But when we look at some of the bigger deals and some of the -- it is more about probably a blend of a very aggressive price and some loosening of terms on some deals. Things like less requirement for guarantees of individual investors and things like that.
Okay and is that from the bigger financial institutions or similar size companies than smaller companies?
It is across the board. I think it is almost on a deal-by-deal basis. If somebody really is attracted to one particular deal they price and structure it to try to be very competitive with that. And I'm really not sure I see a pattern, to tell you the truth, Dan. I wish I would. That would be easier for us to figure out how to compete. But it seems to be kind of hit or miss and across the board with large regionals and community banks our size, so --.
[Operator Instructions]. Our next question is from [indiscernible], a Private Investor.
Just to follow up on the loan trends, could you give us an idea of some of the construction on the commercial real estate that you booked this quarter, what that looked like size wise in terms of the credits?
There was a couple that -- $15 million credits in there. We've kind of tried to cap, our lending limit is a lot higher but we have kind of moderated where we feel comfortable on a size and it is the $15 million to $20 million range. And there was one apartment complex in the Columbus market was one of those credits. Long-term relationship and another was a similar type of project on an apartment complex.
At this time we show no further questions. I would like to turn the conference back over to Tera Murphy for closing remarks.
Thank you for joining us today as we discussed our quarterly and year end results. We appreciate your time and interest in First Defiance Financial Corp. Have a great day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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