Premier Financial Corp.

Mary Beth Weisenburger - Senior Vice President William Small - Chairman, President and Chief Executive Officer Donald Hileman - Executive Vice President and Chief Financial Officer James Rohrs - President and Chief Executive Officer, First Federal Bank

Christopher Marinac - FIG Partners John Barber - KBW

Thank you. Good morning, everyone, and thank you for joining us for today's 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 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 forecast 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.

Thank you, Mary Beth. Good morning and thank you for joining us for the First Defiance Financial Corp.

conference call to review the 2013 first quarter. Last night, we issued our earnings release reporting the first quarter 2013 results, and this morning we would like to discuss that release and look at the balance of 2013.

At the conclusion of our presentation, 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 first quarter is CFO, Don Hileman.

Also with us this morning to answer questions is Jim Rohrs, President and CEO of First Federal Bank. First quarter 2013 net income on a GAAP basis was $5.6 million or $0.55 per diluted common share.

This compares to net income of $4.2 million and $0.37 per diluted common share in the 2012 first quarter. The 2013 first quarter earnings results are an encouraging start to the year and maintain the momentum from a strong finish in 2012.

However, several indicators are evidence of the tentative business environment and the challenges of the low interest rates. In light of these ongoing challenges, it makes me even more gratified with the first quarter results.

In addition to our financial performance during the first quarter, we received notice from both of our regulators that we have demonstrated compliance with the memorandum of understanding at both the bank and the holding company, and these agreements have been lifted at both entities. Among the strong positives from an operational standpoint in the quarter was a significant reduction in provision expense as credit quality continues to improve and collateral values stabilize.

Also, our non-interest income was a key positive area. It was driven again this period by very solid mortgage productions throughout the quarter along with stronger insurance and wealth management income.

These are few of the earnings drivers this quarter that resulted in a return on average assets of over 1.1%. Credit quality has been the most significant factor impacting earnings over the past couple of years.

And while we are still working through certain credits, overall we again saw marked improvement in several key metrics. Reductions in classified loans, lower charge-offs and lower short-term delinquencies are strong indicators of the overall improvement of the credit quality.

However, increases in non-performing loans continue to show the late-period effects of the recent economic recession. The increases in large credits that had previously been identified is having weaknesses, but we have kept these loans on the books continuing to work with the clients and hopes of sustaining the relationship.

While the quality of the loan portfolio has strengthened, loan demand has not returned to pre-recession levels. After three straight quarters of loan growth to end 2012, loan balances dropped during the first quarter of 2013.

Some of this is seasonal, but it is also indicative of the overall conditions in the commercial lending arena. Lingering uncertainty of the economic environment, strong liquidity position on part of borrowers and a very competitive lending environment, all contributed to the decrease in loans this quarter.

One significant characteristic that was very notable this quarter as it was in the first quarter of 2012, was a low level of outstanding balances on farm lines of credit. Many of our agricultural customers have had several consecutive strong performance years that have put them in a position to utilize cash for input expenses, and as a result they have idled or dramatically reduced draws on their operating lines.

This is obviously a positive for our customers, but it does have a negative impact on loan balances. The one strong area of loan production during the first quarter was once again residential real estate loans.

Mortgage production continued its strong performance that goes back to the middle of 2011. First quarter 2013 mortgage production was slightly below the record setting performance of the 2012 first quarter, but was still significantly above historic levels.

This is not only the result of outstanding work by our loan originators, but a tremendous and efficient effort to keep up with the high pace of production. On the deposit side of the balance sheet, the mix continue to change.

The CD balances declined, dropping by over $14 million compared to the linked quarter and non-time deposit balances are up $3 million for the same period. Non-interest bearing deposits were down to the linked quarter, but were up significantly year-over-year.

Net interest income was lower compared to first quarter 2012 and the linked quarter. While loan balances were down compared to the linked quarter, they were $33 million higher than the first quarter 2012 levels.

However, the continued low rate environment coupled with the soft demand brought the net interest income down. As a result, net interest margin on a tax equivalent basis was unchanged from the first quarter 2012, but down compared to the linked quarter.

The change in the deposit mix and disciplined pricing has helped us control the compression of the margin in this challenging rate environment, but margin concerns will remain as the fed continues its accommodative monitory policy. Non-interest income was a solid contributor to our earnings in the first quarter, but as I mentioned earlier, a very strong mortgage loan production.

While this was driven to a large extent by refinancing by homeowners, we have seen more purchase loans in the first quarter this year compared to the early part of 2012. Also, we were able to grow the servicing portfolio, demonstrating our ability to increase market share and mortgage production.

Also related to the mortgage area, we had a recovery of some previously charged mortgage servicing rights impairment. Two other positive factors in the non-interest income performance were insurance and wealth management.

The increase in insurance revenue over first quarter 2012 was positively impacted by increases in contingent revenue as well as increased production. The result of these items is an increase of $500,000 year-over-year in insurance revenue.

Wealth management income was also up compared to the year-ago period and the linked quarter. All of these factors combined help offset a drop of almost $300,000 in service fee income, most of which relates to decreases in NSF fees.

Non-interest expense was down compared with the linked quarter, but up compared to the first quarter 2012. Nearly $700,000 of the increase year-over-year was related to a couple of items that would be considered non-recurring.

I'll now ask Don Hileman to give you further analysis on this, along with all the financial details for the quarter. And after Don's comments, I'll wrap up our presentation with an overview, and look at what we see developing for the balance of 2013.

Don?

Thank you, Bill, and good morning, everyone. We are very satisfied with the continued improvement in our financial results and credit quality this quarter.

While we saw a decline in loan balances during the first quarter, we do anticipate more activity in the second quarter that we expect to lead to moderate growth in balances. The main drivers of the earnings in the quarter were lower provision for loan loss and strong non-interest income led by mortgage banking and contingent insurance income.

As Bill noted, net income applicable to common shareholders was $5.6 million, which was an increase of 53% over the $3.6 million in the first quarter of 2012. EPS for the first quarter was $0.55 per diluted share, which was an increase of 49% over the $0.37 per share in the first quarter of 2012.

Turning to other operating results, our net interest income was $16.5 million for the first quarter of 2013, down on a linked-quarter basis and down from $17.2 million in the first quarter of 2012. For the first quarter of '13, our margin was 3.78%, flat with the first quarter of 2012.

Our yield on earning assets declined 18 basis points on a linked-quarter basis, while our cost of interest-bearing liabilities declined 6 basis points on a linked-quarter basis, with the overall margin decreasing to 3.78% from 3.92% on a linked-quarter basis. Non-interest income was $9 million for the first quarter, up from $8.4 million in the first quarter of 2012.

Fee income was $2.4 million in the first quarter of 2013, a slight decline on a linked-quarter basis and down from $2.7 million in the first quarter of 2012. Net NSF fee income was $850,000 in the first quarter of 2013 compared to $1.1 million in the first quarter of 2012 and $1 million on a linked-quarter basis.

Insurance revenue was $3 million in the first quarter of '13, up from $2.5 million in the first quarter of 2012, primarily due to an increase in contingent income. We saw continued contraction in loan yields in the first quarter of '13, with yields on loans declining 14 basis points to 4.55% on a linked-quarter basis.

The overall loan portfolio saw a net reduction in the quarter with the largest decline in commercial category, along with reductions in construction lending. We did experience marked growth in the commercial real estate area.

We were disappointed in the balance sheet decline in total loans during the quarter, but are encouraged with the pipeline at March 31, 2013. We still expect growth to continue at a moderate rate over the course of the year.

Total non-interest income grew 6.4% year-over-year excluding securities gains. We had continued solid performance in mortgage banking origination with over $108 million in the quarter, down slightly from the first quarter 2012.

The percentage of originations for purchase of construction averaged 20% in the first quarter of 2013 consistent with 19% in the fourth quarter of '12, and up from 12% in the first quarter of 2012. Overall mortgage banking income for the quarter was $2.8 million compared to $2.4 million in the first quarter of 2012 and $2.7 million on a linked-quarter basis.

The gain on sale income of $2.2 million in the first quarter of '13 compared with $2.5 million in the first quarter of '12 and $2.7 million on a linked-quarter basis. We also recorded a positive valuation adjustment to mortgage servicing rights of $473,000 in the first quarter of 2013 compared with a negative valuation adjustment of $79,000 in the first quarter of '12.

At March 31, 2013, First Defiance had $1.3 billion in loan service for others. The mortgage servicing rights associated with those loans had a fair value of $8.4 million or 62 basis points of the outstanding loan balance serviced.

Total impairment reserves, which are available for recapture in future periods totaled $1.8 million at quarter end. In the first quarter of 2013, we had no charges for OTTI or other temporary impairment IR remaining investments in Trust Preferred Collateralized Debt Obligations or CDOs.

Overall, non-interest expense increased to $17.2 million this quarter compared with $16.3 million for the first quarter of 2012. Quarter includes $581,000 for the accrual of buybacks and $98,000 for settlement of a sales tax audit.

The first quarter compensation and benefits expense was $8.8 million, a $333,000 increase from the first quarter of 2012. We also expect to see lower FDIC cost going forward based on the overall improvement at the banking subsidiary.

Other non-interest expense increased to $3.9 million in the first quarter of '13 from $3.3 million in the first quarter of 2012. Totaled credit related expenses, which includes the net gain loss on the sale of OREO, OREO repairs and write-downs, and collections and secondary market buyback cost were $1.1 million in the first quarter of '13 compared to $689,000 in the first quarter of '12.

Accrual estimated for secondary buybacks losses of $581,000 was established in the first quarter of 2013 compared to no losses accrued in the first quarter of 2012. The losses were accrued and expensed as of March 31, 2013, based on an estimated exposure to repurchase requests resulting from notifications from Fannie Mae's post-foreclosure review process during the first quarter of 2013.

The following is a three-quarter trend on certain significant expenses. Real estate-owned expenses were $400,000 in the first quarter of '13 compared to $417,000 in the first quarter of '12 and $231,000 in the fourth quarter of '12.

Credit and collection expenses were $282,000 in the first quarter of '13 compared to $248,000 in the first quarter of '12 and $215,000 in the fourth quarter of '12. Secondary market buyback losses were $581,000 in the first quarter of '13 compared to no losses in the first quarter of '12 in credit of $115,000 in the fourth quarter of 2012.

We believe overall credit quality will continue and improve in the coming quarters. Our provision expense for the first quarter of '13 totaled $425,000, down from $3.5 million a year ago and down from $2.6 million on a linked-quarter basis.

Our allowance for loan losses decreased to $26.5 million at March 31, 2013, from $28.8 million at March 31, 2012. The allowance percentage decreased to 1.76% from 1.96% a year ago.

The overall reserve percentage increased slightly on a linked-quarter basis from 1.75% to 1.76%. The allowance represents 74.99% of our non-performing loans, up from 63.58% at March 31, 2012.

The allowance to non-performing assets was 66.82% at March 31, 2012. The 2013 first quarter provision was $252,000 lower than net charge-offs for the quarter.

As mentioned in the past, we believe that we have a good opportunity for recoveries in the future due to the nature of the conservative approach and charge-offs and some collateral dependent loans within exhibited collateral shortfall. We have had recoveries of $318,000 and $449,000 over the last two quarters respectively.

While we saw a moderate increase in non-performing loans, we had continued improvement in the levels of classified loans on a linked-quarter basis as well as our year-over-year basis. Net charge-offs were 0.18% of average loans, the lowest level in five years.

The first quarter of 2008 it was 0.15%. Net charge-offs were lower on a linked-quarter basis by 69% or $1.5 million and we're down 91%, and $7.2 million from the first quarter of 2012.

Annualized net charge-offs were 18 basis points for the first quarter, down from 218 basis points in the first quarter of '12 and 59 basis points in the fourth quarter. Of the total charge-offs, 27% related to commercial real estate loans, 21% commercial loans, 21% residential and 27% home equity.

The average of the net charge-off as a percentage of average loans over the last several quarters have been at levels, management believes is more consistent with long-term expectations. Classified loans declined 7.4% this quarter.

Total classified loans decreased $5.8 million to $72.3 million at March 31, 2013 and $78.1 million at December 31, '12. We expect the continued improvement in 2013 in the level of classified assets.

Non-performing assets end of the first quarter at $39.6 million or 1.94% of total assets up from 1.78% of total assets at December 31, 2012, but down from $48.8 million or 2.28% of total assets from a year ago. Total non-accrual loans decreased to $35.3 million from $45.4 million at March 31, 2012, but up from $32.6 million at December 31, 2012.

Accruing and restructuring loans declined slightly on a linked-quarter basis. We believe the right business decisions were made to focus on protecting the value of the credit.

It is important to note that several of these credits have been upgraded to special mention but will be continued to be classified as TDRs per interpretation of TDR guidance and based on discussions with our primary regulator. The total past due on non-accrual rate was 2.65% at March 31, 2013, down from 3.4% at March 31, 2012, but up from 2.59% at December 31, 2012.

The delinquency rate for the loans 90 days past due in the non-accrual decreased to 2.32% this quarter from 3.05% in the first quarter of '12, but up from 2.11% on December 31, 2012. While we are not satisfied with the overall levels of 90 day delinquencies in non-accruals, of the total non-accrual loans of $35.3 million, $18.5 million or 52% are under 90 days past due.

We had a decrease in the 30 day and 90 day levels of delinquency this quarter compared with the fourth quarter of 2012 and from the first quarter of 2012. Our OREO balance increased slightly from the first quarter of '12 and ended the first quarter of '13 at $4.3 million, and was up on a linked-quarter basis from $3.4 million.

The OREO balance is made up of $3.2 million of commercial real estate and $1.1 million of residential real estate. In addition, we had additions of $1.1 million in the first quarter of 2013, offset by sales of $759,000.

We saw balance sheet decline from the first quarter of '12, with total assets of $2 billion at March 31, 2013. As previously announced in October 2012, the company executed a balance sheet restructure, then entailed $60 million in securities and paying off $62 million in Federal Home Loan Bank advances.

On the asset side, cash and equivalents declined to $156.3 million from $249.9 million at March 31, 2012. Securities declined $47 million or 19% over the year to $196.6 million.

Gross loan balances increased $33.1 million year-over-year, but decreased $18.2 million on a linked-quarter basis. We're encouraged by the uptick in our commercial loan pipeline and expect moderate growth in these balances in '13.

Total deposits decreased $15 million over the same period a year-ago and decreased $11.1 million on a linked-quarter basis. We are pleased with the mix of deposits, as we have seen a slight shift from non-interest bearing accounts to interest bearing accounts from year-end 2012.

Non-interest bearing deposits decreased to $291.8 million at March 31, 2012, from $315.1 million at December 31, 2012. Deposit mix and pricing opportunities are a continued focus on the overall strategy and efforts to reduce and/or maintain our cost of funds in this interest rate environment.

Total period-end stockholders equity ended March 31, 2013 at $262.6 million down from $281.4 million at March 31, 2012 reflecting reduction in capital due to repurchase of the company's outstanding preferred stock related to TARP. Our capital position remains strong with the average shareholders equity to average assets of 12.8% at March 31, 2013 compared to 13.45% at March 31, 2012.

The bank's risk-based capital ratio is strong at approximately 14.5%. That completes my overview for the quarter and I'll turn the call back over to Bill.

Thank you, Don. As we progress through 2013, I feel very good about the way we have positioned First Defiance as we emerge from the recent recession.

We've come off a record setting earnings performance in 2012 and followed it up with a strong first quarter performance to start 2013. Being able to produce these results and what is still a very soft loan market makes me optimistic as we move forward.

Unemployment rates throughout our market area have stayed fairly steady in recent months, that several counties are still running higher than the national rate. Manufacturing led by the automotive industry has been the primary reason for the rebound from the earlier high levels.

Several recent announcements from the automotive industry of increased production at area facilities along with other positive economic development news, helped to build our optimism for further improvement. Our three areas of focus of First Defiance, our revenue growth, expense control and core deposit growth.

We have made significant strides in all three of these areas in recent quarters. And we must continue with this effort to achieve even higher levels of profitability.

We do feel loan demand will eventual return and when it does, most borrowers will be in a stronger economic position then they were prior to the recession. Balance sheets of clients and their corresponding cash flows continue to improve.

However, there still remains some hesitancy on the part of many to declare the economy totally out of the woods. Many business people express concern about what the future holds in regards to regulation, taxes and especially healthcare cost as more parts of the precedence healthcare plan became effective.

Sustaining and increasing the speed of the recovery is going to depend to a large degree on the level of confidence that can be established within the business community. We see the trend toward optimism.

And if this continues loan demand will certainly build. That being said, we do not see any sudden or huge increase in loan demand on the immediate horizon, but rather a slow, more cautious return to capital investment on the part of businesses.

We are committed to maintaining our underwriting standards and will not compromise on our standards to get loan growth. Pricing will be a challenge in this competitive environment and while we are not going to be out trying to buy business with the illogical rates, we will work hard to maintain and grow our existing relationships.

All of this leads to the need for our focus on building our other revenue sources and controlling cost. We plan to continue the growth of both our insurance and wealth management lines of business.

These business units have become stronger contributors to our non-interest income at a time when traditional revenue expectations of net interest income have been challenged. A new strategic focus of full client relationship building between these units and our lenders will hopefully benefit these revenue sources even more and build on their contribution to our bottomline.

The strong mortgage production that has been such a significant contributor to our performance over the last of couple of years looks to remain strong at least throughout the second quarter. The low interest rates are still attracting refinance business, but as we mentioned earlier we are also seeing an increase in purchase loans in recent quarters.

The strengthening of the housing market should continue to build this momentum. Many area realtors tell us that right now they are facing a shortage of homes for sale and we are hopeful that as home prices continue to rise, this will increase the number of both sellers and buyers.

As we tend to all the customary day-to-day business of financial services, we are also keeping a cautious eye on the regulatory and legislative scene. There are still many unanswered questions regarding the Dodd-Frank legislation passed in 2010, as only about one-third of the legislation has been implemented.

We need to stay attentive to the rule making as it is developed and be prepared to react to the impact each piece of regulation may have on our community financial services business strategy. We also continue to monitor the proposed changes to bank capital requirements as they are being discussed.

Fortunately, prudent capital management at First Defiance has put us in a solid capital position. And our internal testing indicates that even under the strictest interpretation of the proposed capital rules, we would remain well capitalized.

Our mission at First Defiance has not wavered. It is to be a community financial services provider that offers a complete line of financial products with the relationship oriented approach on a profitable basis.

The staff we have throughout this organization understands the importance of this strategy based on relationship banking and the importance of delivering on that mission. All of our people strive to be seen as trusted advisors to their clients.

I thank them for their diligence and loyalty. And I thank you for joining us on this call this morning.

And now we would be happy to take your questions.

Bill or Don, was curious, all I guess, if you think 2013 is a year to consider something strategic in terms of whether it's an acquisition or perhaps a new activity to spur along growth or if this is still a time to be kind of very close to home and (inaudible) down?

Well, I guess I would kind of frame it this way, Chris. We certainly are keeping our eyes and ears open to find out what's going on as far as any opportunities out there whether it's other banks or insurance agencies or any other new lines of business.

We're not out aggressively pounding on doors right now. We do feel that is important for us to maintain our focus on the business at hand and hopefully continue to build some strength in our currency.

And then, can you just elaborate I guess to what extent you are or how you're dealing with the ongoing customer requests to do a longer-term fixed rate lending. And is that something that you're doing occasionally or how are you managing through those demands?

Mostly on the commercial side, we've got the capability to enter in some derivative or swap agreements with the borrowers that we would take up fix rate and convert it to a variable loan in our books. So we're not inclined to take a lot of interest rate risk to go along with the borrower.

Our average seems to be fairly close into the five year range that we're looking at. We're getting more requests now with the rates down.

Maybe I'll let Jim speak, if there is a little bit more activity there, but generally we're not inclined to take along interest rate risk on the commercial side.

We're fairly comfortable in the five year range. We do a lot of five year adjustable with the fixed rate for five years.

And then adjust to spread over an index after that. Customers who want a longer term rate than that will typically offer that, but use the swap arrangement that Don talked about that allows them to get their fixed rate that allows us to earn a floating rate spread, not take that interest rate risk.

And then just last question, I guess, it has to do with land prices and just what you're seeing there. Is there anything seen at all like its changing either up or down this year?

Farm land prices, we're seeing very, very strong prices in our markets. And I think that you can see, but it could be the next bubble, but I think the banking industry is reacting very cautiously to this.

And that we're not alone in this regard because having talked to other bankers, I think we kind of look at the same that we're seeing farm land prices that have traditionally been maybe $5,000 an acre high, up north of $10,000 an acre. And typically as we get above the $5,000 an acre, we are going to ask the borrower to put up collateral or a cash to dollar per dollar over, say, an 80% loan to value at a $5,000 as acre.

So at purchase price for $5,000, we've loaned say $4,000, but if they are going to pay $10,000, they are going to put $6,000 an acre down or pledge other collateral, that the underlying fundamental dynamics are not there at today's prices to have it pay for itself at $10,000, so. And typically, it's the very strong cash rich borrowers that are buying this expensive farm land because their option is to put it in a CD at less than 1%.

Bill, in your prepared remarks you said one of the primary goals is to grow revenue this year. I was just wondering if you could about where you guys are investing incremental capital if there is an emphasis on the bank or the insurance company or if it's somewhere else.

And also any new hires you have made or plan to make?

In the past we've talked about the fact that we certainly see that some opportunities to get stronger in the insurance area. We continue to look for some opportunities along that line in some additional acquisitions.

One of our focus is that we are really dedicated ourselves from a strategic standpoint to strengthening the relationships between insurance agents and lenders and our wealth management private banking people with lenders. Jim really is driving a program on that that is showing early indications of strengthening from a standpoint of additional personnel.

Last year in the latter part of 2012, we added a couple of new financial advisors to give us better coverage without all of our market areas now. And we're finally here as they've got not to speed.

We're starting to realize some certainly stronger returns in that area too. So those have been a couple of our focuses as far as continuing to look for ways to grow revenue as we know that the net interest income will continue to be challenged by the rates and the proactive demand.

As far as any growth beyond that as I answered earlier, well, we're not maybe out pounding on as hard. We're certainly keeping our eyes and ears open to any possibilities of growth through acquisition.

And just the last one I had, could you guys talk about what Fannie Mae saw and kind of drove the establishment for the repurchase request this quarter?

From our understanding it's a program that Fannie Mae has kind of been starting with the largest banks who have been working their way down and doing post-foreclosure reviews. These are reviews of loans that have been foreclosed upon and the property already disposed of.

But we were not singled out in this. It wasn't anything that stood out significantly with us that they're not looking at with other institutions.

At least that's the information that we have been given. And I think that's validated by some of the news in earlier months about some of the larger institutions and reviews that they went through and settlements with Fannie Mae.

We are very, very confident in our underwritings standards. And I think most of these date back to the loans that were originated before 2009.

And we've been working and cooperating. It's still relatively early in the process, but we just felt we needed to take a prudent measure and setup the accrual.

I think we still think they are a strong partner as we continue with our strong mortgage banking, they are one of our REIT companies we sell to and we'll continue to do that.

Well, we'd just like to thank everybody for participating in our call this morning. And we look forward to talking with many of you as we go down the road.

Thank you very much.

Thank you. And this now concludes our call.