Premier Financial Corp.

Bill Small – Chairman of the Board, President Don Hileman – President, CEO, CFO; Jim Rohrs – EVP, Director, President and CEO

Thank you. Good morning, everyone, and thank you for joining us for today's second 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 the current management forecast of projections as a result of the 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, Terra. Good morning and thank you for joining us for the First Defiance Financial Corp.

conference call to review the 2013 second quarter. Last night, we issued our earnings release reporting the second quarter and first half 2013 results.

And 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 is Executive Vice President and 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 at the conclusion of our presentation.

Second-quarter 2013 net income on a GAAP basis was $6.1 million, or $0.60 per diluted common share. This compares to net income of $3.9 million and $0.38 per diluted common share in the 2012 second quarter.

The net income for the second quarter is the second consecutive quarter of record earnings for First Defiance. While the earnings performance for the quarter is notable, there were several other significant positives during the quarter.

Credit quality improvement during the quarter have a significant positive impact on earnings. Mortgage banking remains solid and loan growth was strong, especially late in the quarter.

As credit quality improves, we are benefiting from considerably lower provision expense and the return of many credits to accrual status. In addition, charge-offs remain in check again this quarter and we continue to realize recoveries from earlier charge-offs.

Other improved credit metrics, including classified loans and 30 to 90-day delinquencies, compared to both the linked-quarter and second quarter 2012. All of these improved metrics are consistent with our credit forecast going into 2013.

The strong increase in loan growth in the second quarter was certainly welcome, after the first quarter decline. While we see some improving economic indicators, the uncertainty amongst many businesses as to the overall economic environment is causing to remain cautious regarding new capital investments.

Our loan growth this quarter reflects some increase in new demand from existing relationships, as well as opportunities with new clients. We will continue to look for these opportunities, while maintaining our strong underwriting practices and pricing discipline.

On the liability side of the balance sheet, we saw a decline in deposits in the second quarter, after a strong growth over the last several quarters. Now – and interest deposits were up, compared both to the period ending June 30th 2012 and the linked-quarter on an average basis.

The decline came in our money market accounts and in time deposits. This is the first decline we have in our money market category in quite some time.

This decline is due to a combination of our low-pricing strategy and consumers looking for better returns and other financial products but where rate environment had pushed many depositors to part funds and liquid bank accounts and now they are seeking higher returns and other types of investments. With the increase in loan balances and the shift in the deposit mix, net interest income for the quarter was up compared to the linked-quarter but still lower than the second quarter 2012 results.

Net interest margin, however, was up compared to both periods. The current interest rate environment is a significant factor in managing the margin.

And while there have been some indications that the Fed may be looking to back off their quantitative easing, it does not appear to be any time before 2014. The challenges on the net interest margin and the slow rate environment will persist, as we see sustained competitive pressures on the asset yields.

And as we noted last quarter, the ability to offset declining yields and the asset side with additional reductions on the deposit side are diminishing. These factors could negatively impact margin management.

Our interest income was down on the second quarter of 2013, compared to the linked-quarter, primarily due to the insurance contingent income traditionally recorded in the first quarter each year and the reduction in mortgage banking income in the second quarter as a refinance activity slowed. We did experience an increase in purchase activity again during the quarter.

And even to some increase in rates during the later part of the quarter, we feel this will continue to increase. Fee income was up, compared to the linked-quarter and this is encouraging but it remains below last year's level.

We will need to stay focused on recent regulatory changes and the impact they may have on certain fee structures. The increase in insurance premium revenue and wealth management income continues to positively impact our results.

And these are both areas that we will work to build on. Non-interest expense was up slightly, compared to the second quarter of 2012 but down, compared to the linked-quarter.

The increases in year-over-year results were primarily compensation and data processing-related, while this was partially offset by lower expenses related to occupancy and FDIC insurance premiums. I will now ask Don Hileman to give you the financial details for the quarter and first half of 2013 before I wrap up with an overview and look at what we see developing for the balance of the year.

Don?

Thank you, Bill, and good morning, everyone. We were very pleased with the overall financial results this quarter, which were built on the improvement theme in the past several quarters.

We posted record earnings this quarter. The second quarter saw improvement in several of our key metrics.

We are very satisfied with the increasing improvement in the credit quality and the impact on our overall financial results this quarter. We had the expected pick up in loan demand in the quarter that led to moderate growth and the average balances.

The main drivers of the earnings in the quarter was stability and net interest income, so we're provisioned for loan loss and strong non-interest income led by the mortgage banking. As Bill noted, net income applicable to common shareholders was $6.1 million, which was an increase of 60% over the $3.8 million in the second quarter of 2012.

EPS for the first quarter was $0.60 per diluted share, which was an increase of 58% over the $0.38 per share in the second quarter of 2012. Loan growth was 3.78% in the second quarter, and 2.19% year to date.

The slight pickup in the second quarter of 2013, primarily in the commercial real estate loans and commercial loan areas, which grew $3.6 million and $18.3 million, respectively. Total new loans originating in the second quarter were put on at a weighted average rate of 3.98%, locating over a strong commercial pipeline in the third quarter.

Now, turning to revenues, our interest income was $16.9 million for the second quarter of 2013, up on a linked-quarter basis but down from $17.2 million in the second quarter of 2012. For the second quarter of 2013, our margin was 2.82%, an increase from 3.75% in the second quarter of '12 and up from 3.78% on a linked-quarter basis.

In the second quarter of 2013, we recorded $221,000 of loan interest income from loans returning to accrual status or recoveries from charge-up interest. If we would not have had received those one-time adjustments, the margin would have been 3.77% in the second quarter of 2013.

Our yield on earning assets was flat on a linked-quarter basis, while our cost of interest-bearing liabilities declined 4 basis points on a linked-quarter basis, with the overall margin increasing to 3.82% from 3.78% on a linked-quarter basis. We saw a continued contraction of loan yields in the second quarter of '13 of loan yields on – on loans decline – or yields on loans declining 5 basis points to 4.5% on a linked-quarter basis.

The pace of the decline has slowed over the recent quarters. Non-interest income was $7.8 million in the second quarter of 2013, down from the $8 million in the second quarter of '12.

The income was $2.54 million in the second quarter of 2013 has slightly increased on a linked-quarter basis and down from $2.7 million in the second quarter of 2012. Net NSF fee income was $844,000 in the second quarter of 2012, compared to $1.1 million in the second quarter of 2012 and $850,000 on a linked-quarter basis.

Insurance revenue of $2.3 million in the second quarter of 2013, up from $2.2 million in the second quarter of 2012. Total non-interest income grew $2.5 million year over year, excluding securities gains.

We maintained solid performance in mortgage banking originations, which were $114 million on the second quarter of 2013, down slightly from the second quarter of 2012. The percentage of origination through purchase and construction averaged 36% in the second quarter of '13, up from 21% in the second quarter of 2012, and 20% on a linked-quarter basis.

Overall, our mortgage banking income for the second quarter of '13 were $2.4 million, compared to $2.3 million in the second quarter of '12 and $2.8 million on a linked-quarter basis. We gained our sale of income of $1.9 million in the second quarter of '13, compared with $2.5 million in the second quarter of '12 and $2.2 million on a linked-quarter basis.

We gained our sale income of $1.9 million in the second quarter of ’13, compared with $2.5 million in the second quarter of ’12 and $2.2 million on a linked-quarter basis. We also recorded positive evaluation adjustment to multi-servicing rights or $312,000 in the second quarter of '13, compared with a negative valuation adjustment of $177,000 in the second quarter of 2012.

At June 30th 2013, First Defiance had $1.3 billion in loan service for others. The mortgage servicing rights, associated with those loans had accrual value of $8.7 million or 62 basis point of the outstanding loan balances serviced.

Total impairment service, which are available for recapture in future periods, totaled $1.5 million at quarter-end. Overall, net interest income increased to $15.7 million this quarter, compared with $15.5 million for the second quarter of 2012.

The second quarter compensation benefit expense was $8.5 million, a $500,000 increase from the second quarter of '12, primarily attributable to accruing for estimated and incentive payments, based on exceeding 2013 targets and the performance of the first half of 2013. FDIC costs were $275,000 in the second quarter of 2013, compared to $672,000 in the second quarter of 2012, a $656,000 on a linked-quarterly basis to the improvement of the Company's risk category in the latter part of the first quarter of 2013.

Other non-interest expense was $3.3 million in the second quarter of 2013, basically flat when it compared to the second quarter of '12, and decreased to $900,000 on a linked-quarter basis. Total credit-related expenses, which includes the net gain loss and the sale of OREO, OREO repairs and write downs, corrections and secondary market buybacks were $535,000 in the second quarter of '13, compared with $558,000 in the second quarter of 2012, and $1.2 million on a linked-quarter basis An accrual for estimate secondary buyback losses of $581,000 was established in the first quarter of 2013, which drove that quarter higher.

These losses were accrued and expensed as of March 31st, based on an estimated exposure to repurchase request, resulting from notifications received from Fannie Mae's for a closer review process during the first quarter. We now have any new significant notifications from the agency during the second quarter.

The following has a three-quarter trend of certain significant expenses. Real estate-owned expenses were $374,000 in the second quarter of 2013, compared to $217,000 in the second quarter of 2012, and $400,000 in the first quarter of 2013.

Credit and collection expenses were $174,000 in the second quarter of '13, compared to $289,000 in the second quarter of '12 and $282,000 in the first quarter of 2013. Secondary market buyback losses were $61,000 in the second quarter of '13, compared to $73,000 of losses in the second quarter of '12 and losses of $581,000 in the first quarter of '13.

Really, the overall credit quality will continue to improve in the coming quarters with reductions in non-performing and classified loans. Our provision expense for the second quarter of 2013 totaled $448,000, down from $4.1 million a year ago and basically flat on a linked-quarter basis.

Our allowance for the loan loss decreased to $26.3 million at June 30th 2013 from $26.4 million at June 30th 2012. The allowance percentage decreased to 1.68% from 1.76% a year ago, primarily due to an increase on loans outstanding.

The allowance represents 92% of our non-performing loans up from 63% at June 30th 2012. The allowance to nonperforming assets was 75% at June 30th 3013.

The 2013 second quarter provision was $189,000 lower than that charge-offs for the quarter. As mentioned in the past, we believe that the reserve percentage will attract between the current levels in the 1.5% as asset quality continues to improve.

We've had recoveries of $324,000 and $318,000 over the last two quarters, respectively. We saw a market improvement in the non-performing loans in the second quarter with a 19% decline to $28.7 million.

We did see in OREO as a ($80.9 million) credit moved from non-performing loans and anticipation sale. We also saw a decline in the level of classified levels on a linked-quarter basis as well, as on a year-over-year basis.

Net charge-offs were 17 basis points of average loan, the last (level) in five years. The first quarter of 2008, it was 15 basis points.

We've had two solid quarter of moderate net charge-offs. Annualized net charge-offs were 70 basis points for the second quarter of '13, down from 178 basis points in the second quarter of 2012 and down slightly from 18 basis points in the first quarter of 2013.

Of the total charge-offs, 29% related to commercial real estate loans, 33% commercial loans, 19% residential and 18% home equity. The average of the net charge-off levels, as a percentage of average loans over the last several quarters have been a level Management believes is more consistent with long-term expectation.

Classified loans declined 19.3% this quarter. Total classified loans decreased $14 million to $58.3 million at June 30th 2013 from $72.3 million at March 31st 2013.

We expect continued improvement in 2013 in the level of classified assets. Nonperforming assets ended the quarter at $35.2 million, or 1.7% of total assets, down from 1.94% of total assets at March 31st, and down from $45.2 million, or 2.19% of total assets a year ago.

Accruing and restructuring loans, increased slightly on a linked-quarter basis. We believe related-business decisions were made to focus on protecting the value of those credits.

It was important to note that several of these credits have been upgraded to special mention status but will continue to be classified as TDRs per our interpretation of the TDR guidance and based on a discussion with our primary regulator. The total past due and nonaccrual rate was 2.1% at June 30th 2013, down from 3.1% at June 30th 2012 and gone from 2.65% of March 31st 2013.

The delinquency rate for the loans 90 days past due and on our nonaccrual decreased to 1.2% this quarter from 2.76% in the second quarter of '12 and down from 2.32% on March 31st, 2011. We are encouraged by the steady improvement in the overall levels of 90-day delinquencies on non-accruals.

Of the total non-accrual loans of $27.8 million, $17.4 million, or 61%, are under 90 days past due. We had a decrease in the 30-day and 90-day levels of delinquencies this quarter, compared with the first quarter of 2013 and the second quarter of 2012.

OREO balances increased from the second quarter of 2012 and ended the quarter at – of '13, second quarter of '13, at $6.5 million and was up on a linked-quarter basis of – from the previous quarter of $4.3 million. The OREO balance is made up of $5.7 million of commercial real estate, loans and $700,000 of residential real estate.

We had additions of $3.3 million in the second quarter, offset by sales of $821,000. We saw the balance sheet increased from the first quarter of 2013 with total assets of $2.07 billion at June 30th 2012.

On the asset side, cash and equivalents increased to 100 – $227.7 million from $103.5 million at June 30th 2012. Securities declined over the year to $188.5 million.

Gross loans increased $62 million year over year and increased $55.7 million on a linked-quarter basis. Encouraged by an uptick in our commercial loan balances and expect moderate growth in these balances for the remainder of 2013.

Total deposits increased $22.1 million over the same period of a year ago and but declined $20.6 million on a linked-quarter basis. We are pleased with the mix of deposits, but have seen a slight shift from non-interest-bearing to interest-bearing accounts from year-end 2012.

Non-interest-bearing balances increased to $301.7 million at June 30th from the 262 – $261.2 million at June 30th, 2011. Deposit mix and pricing opportunities are a continued focus of our overall strategy and efforts to reduce and/or maintain our cost of funds in this interest-rate environment.

Total period-end stockholders' equity ended June 30th 2012, at $264.5 million, up from $249.9 million at June 30th 2012. Our capital position is strong with peer and shareholders' equity to assets of 12.8% at June 30th 2012 – 2013, compared to 12.08% at June 30th 2011.

The Bank's risk-based capital ratio is strong at 14.4%. That completes my overview for the quarter, and I'll turn the call back over to you, Bill.

Thank you, Don. As we reflect on the first half of the year and begin to progress through the second half of 2013, we are pleased with the record performance during the first two quarters and look forward to building on that momentum.

Economic indicators are seeing mix on whether this is a sustainable economic recovery but we feel we have positioned the Company to react to a variety of challenges. Throughout the first half of 2013, our primary objectives have been revenue growth and expense control.

We will continue with these efforts and work to maintain the improving credit quality, as we continue to build value for our stakeholders. While we are focused on these, we will be monitoring developments and changes in the economy, locally, nationally and globally.

It remains an extremely challenging business development environment, as we are still seeing limited loan demand in a very competitive market for the good business that is out there. We are actively engaged in a calling program, both on potential and existing clients, to develop new business and solidify existing relationships.

We hope the recent indications have increased opportunities and stronger loan demand continue to build. The overall economic climate throughout our market area has shown indications of gaining momentum, and our area, certainly, has benefitted from the strong automotive recovery.

Instability relative to a variety of issues in Washington, combined with concerns with the global economy, still have many businesses concerned. But we've seen more optimism developing.

Agriculturally, it's been a good start this year. A more normal spring allows crop inputs to be completed, basically, on schedule, and rains, still heavier than normal, have allowed the crops to develop well to this point.

But we'd harvest this pretty much complete and appears to have been a good year for that crowd. Corn and soy bean fields both look very healthy throughout the area and we would anticipate good yields, if the weather cooperates.

The housing market is one of the brighter segments, based on recent indicators. Sales, new home starts and home prices all have shown strength for several months.

These, of all bean factors that evaded our growth in purchase loan activity over the last few months. Our mortgage pipeline has decreased somewhat from record levels but we do not – but we do expect purchase activity to grow and replace at least a portion of the winning refinance request.

We're still keeping a cautious eye on the regulatory and legislative sleeve, as regulators work – well, we work on developing more of the regulations that will implement the Dodd-Frank act. New mortgage regulations released by the Consumer Financial Protection Bureau are set to take effect January 1st 2014.

Our retail lending staff has worked hard to make sure we are ready for the implementation. And we feel we will transition smoothly to the new regulations.

As other regulations work the through formulation process, we will be working with our industry to hopefully reach final regulations that offer protection to consumers without hindering the ability to offer affordable financial products. This continue to be interesting and challenging times for the financial services industry.

Through this, we have stayed true to our mission to be a community-focused institution that provides a complete line of financial services with a relationship-oriented approach on a profitable basis. The staff we have throughout this organization all worked hard so we can achieve that goal.

I thank them for their dedication and loyalty, as they plan integral part in our success. And I thank you for joining us this morning on the call.

And now, we would be happy to take your questions.

Good morning.

Good morning, John.

Hello, John.

Can you guys just talk a little bit more about the sustainability of the long growth you saw this quarter? And also, Bill, I know you mentioned that you saw an increase in loans in the – towards the end of the quarter.

Is there anything specific that drove that? Thank you.

I don't know that there's anything really specific, John. And one of the reasons I think I made of mentioning this later in the quarter because I – I'm really not – I'm pretty sure that we didn't realize the full impact that they had on the margin.

But we did see the momentum just kind of continue to build, and still have a fairly different pipeline. And, Jim, I don't know if there's anything additional that you might want to point to, as part as the loan growth?

Really, I can't point any one particular area but I guess I would credit it to – on commercial business development officers being diligent and staying in touch with clients and finally having some situations that have been (inaudible) for a while start to great. So, we are seeing some net – new loan growth in the market, where people are going ahead with projects that they've been thinking about for some time.

And maybe a little bit of that is the (inaudible) interest rates to get the project on a (inaudible) plans and the plans and commit it before rates do go higher.

Yes, John. This is Don.

I can't look at the – for pick up in the second quarter, kind of an average out of the first and second quarter. You know some of those credits when we look at it get kind of a little rollover from the first to the second.

And that's somewhat the differential between the period and balance growth and the average balance growth of about, I think, the differentials, of course, including the millionaire. So – but I would expect a more moderate growth rate in the second half of the year.

Okay. Thank you.

And just on pricing, you know you spoke to the competition out there. Are you seeing that from any particular set of competitors, be it between the banks, regional banks, and also with the increase of with the benefits and the curves even in – do you get a relief o your CRE pricing?

Thanks.

Our – we are actually seeing the competitional goal then. Some of the smaller community banks that are very, very, very aggressive on a particular transaction they want.

And we're also seeing in some of the regional banks on a particular deals. And in some cases, are not occupied, which they seem to have been avoiding like the plague for the last couple of years.

So, we are seeing on both ends. Although, I would say we're seeing that pressure lessen.

I think all of the banks are looking at – like Federal home loan advances. I'm working at the yield curve and saying, "Hey.

If I didn't match on this, I've got to get a higher rate to get the same spread I was going to get 30 days ago." So, I think some of that pressure is off now.

And we're, quite frankly, seeing in some of our borrowers, who are on taking advantage of the very, very low closing rates and I'm coming back on wanting to fix those rates because our perception is that we passed the trough in interest rates and that the risk is on the outside now, in terms of rationalizing.

Okay. And on the CFO search, do you guys have any updates there?

We expect to have somebody who hired him the third quarter here, John.

Okay. Thanks, Don.

And the last one I had for you. Could you guys just comment on capital priorities?

I mean you have almost 10% (TIKI) ratio, pretty high flexibility there. And maybe if we could rank , where M&A fits in buybacks, they've done organic growth to all those options.

Thanks.

Well, we will continue to be certainly looking at the dividend. We've – we were able to increase that earlier this year and probably still not at the – what we would consider our long range payout level out.

So, we will continue to be focused on dividends. We certainly are open to any acquisition opportunities that might be out there.

To be honest with you, we've had opportunity to look at a couple of situations over the last several months but nothing that we could get comfortable with, as far as bringing the value that we need to this – to our shareholders but we will continue to evaluate those opportunities. We do not currently have a buyback authorization out there but, I guess, we do have a small amount not on an old buyback authorization but it is something that we have been discussing to at least consider getting another program authorized .

So, it's available, if we feel that we want to utilize that.

Great. Thank you very much.

Thank you, John.

Thanks, John.

Hey. Good morning, guys.

Good morning, (Caitlin).

Good morning, (Caitlin).

I was just wondering if you have any insight on whether operating expenses or fade near Q2 levels or possibly fall further.

I think in general terms, we would expect them to be close to this level or slightly decline as we see further credit quality improvement and as we OREO expenses and additional expenses related to credit workouts start to wane. We would expect to see some relief there.

But part of the offset would be some additional costs related to compliance that we don't have fully involved in the number yet and a couple other maybe key additional hires, especially as we said we anticipate hiring a CFO in this – candidate in the third quarter here and how we might have some duplicate comps expenses for a couple of quarters.

Okay. Thank you so much.

And, thanks, (Caitlin).

I'm...

John's back here.

Yes. We'll take one.

I have one more question.

Yes. I think – yes, there's one more question that just posted on there from John Barber, I believe.

Okay. (CROSSTALK)

Thanks. I had just one follow-up and sorry to happen to queue there.

Could you just – could you comment on the right level of liquidity for you, guys. Do you still have the ability to pull a cash into loans?

And how should I think about that impacting the margin on a forward base?

I think we're pretty close to where we – we had that some contraction in the private side and our liquidity contracted a little bit in the second quarter. So, I think we're probably close to where we – it's a pretty good amount of liquidity at the – end of the second quarter, compared to the first quarter, from a cash-on-hand standpoint.

I think there's a little bit more opportunity there but not as dramatic as where we would have seen obviously the last several quarters, John.

Okay. Thanks, Don.

Yes.

Thank you for joining us today. This concludes our second quarter earnings conference call.

Thank you.