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Edited Transcript of FDEF earnings conference call or presentation 23-Apr-19 3:00pm GMT

Q1 2019 First Defiance Financial Corp Earnings Call

DEFIANCE Apr 25, 2019 (Thomson StreetEvents) -- Edited Transcript of First Defiance Financial Corp earnings conference call or presentation Tuesday, April 23, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Donald P. Hileman

First Defiance Financial Corp. - President, CEO & Director

* Kevin T. Thompson

First Defiance Financial Corp. - Executive VP & CFO

* Paul D. Nungester

First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting

* Tera Murphy

First Defiance Financial Corp. - VP & Marketing Director

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Conference Call Participants

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* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Nicholas Anthony Cucharale

Sandler O'Neill + Partners, L.P., Research Division - Director

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Presentation

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Operator [1]

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Good morning, and welcome to the First Defiance First Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Tera Murphy with First Defiance Financial Corp. Please go ahead.

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Tera Murphy, First Defiance Financial Corp. - VP & Marketing Director [2]

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Thank you. Good morning, everyone, and thank you for joining us for today's 2019 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 Don Hileman, President and CEO of First Defiance; Kevin Thompson, Executive Vice President and Chief Financial Officer; and Paul Nungester, Director of Finance and Accounting.

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. Hileman for his comments.

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Donald P. Hileman, First Defiance Financial Corp. - President, CEO & Director [3]

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Thank you. Good morning, and welcome to the First Defiance Financial Corporation's First Quarter Conference Call. Joining me on the call this morning is our CFO, Kevin Thompson; Paul Nungester, Director of Finance and Accounting; and Brent Beard, our Controller, as we discuss our 2019 first quarter earnings release issued last night and give more detail on our financial performance and provide our outlook for the remainder of 2019. At the conclusion of our remarks, we will answer any questions that you might have.

Net income for the first quarter of '19 on a GAAP basis was $11.5 million or $0.57 per diluted common share compared to $11.7 million or $0.57 per diluted common share in the first quarter of 2018, which was driven by $2 million recovery. Our first quarter 2019 results reflect strong profitability with an ROA of 1.46% and return on tangible equity of 15.93%. We continue to see improvement in asset quality with year-over-year reductions in nonperforming loans in OREO, and net charge-offs at 0.6% remain at historically low levels. We also saw a reduction in the 30-day to 90-day past due loans this quarter compared with year-end. We will also continue to focus on asset quality by reducing the nonperforming and classified asset levels in the future leading to improvements in our opinion on the nonperforming asset ratios.

Our overall core performance this quarter remained solid and provides a foundation for the rest of the year. While we were slower in loan growth during the quarter than we would like, year-over-year loan growth was 8.1% in linked-quarter loan growth was 1.4% annualized. I really expect the growth to increase in the future as the first quarter growth trends seem to be seasonally weaker.

Our ability to grow our loan portfolio remains a key piece of our strategic plan, and we have continued to allocate resources and improved process to efficiently originate and close loans. The lending environment is very competitive with the rate and structure pressures relating to terms and conditions and the uncertain economic environment. Despite this environment is encouraging for us to see contributions from our entire footprint and to end the first quarter with a pipeline up from year-end. We believe that we will -- can still achieve our annual growth goal in loans of upper single digits. We did see an increase in loan yields of 5 basis points on a linked-quarter basis and 38 basis points compared with the first quarter of 2018.

Total deposits were up 8% year-over-year and 10% on a linked-quarter annualized basis.

We were also very pleased with our margin of this quarter growing slightly to 4.03% and increased 8 basis points over the first quarter of 2018 and 1 basis point on a linked-quarter basis.

In regards to our capital management plans, we are also pleased to announce that 2019 second quarter dividend of $0.19 per share representing a 26% increase in an annual dividend yield of 2.69%.

I will now ask Kevin Thompson and Paul Nungester to provide additional financial details for the quarter before I conclude it with an overview. Kevin?

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [4]

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Thank you, Don. Good morning, everyone. As Don stated, net income for the first quarter was $11.5 million or $0.57 per diluted share versus prior year results of $11.7 million or $0.57 in the first quarter of 2018. While our earnings per share was leveled with the prior year for the first quarter, the year-over-year comparison was affected by the large $2 million recovery recorded in the first quarter last year, which resulted in a credit provision of $1.1 million in last year's results.

The pretax pre-provision earnings for the first quarter 2019 were up 8.2% over the first quarter of 2018, reflecting our high profitability with a ROA of 1.46%, return on tangible equity of 15.93%, net interest margin of 4.03%, improved efficiency and credit quality from a year ago and continued growth of our balance sheet.

Turning to the details and starting with the balance sheet. After a very strong growth in the second half of 2018 and particularly, in the fourth quarter last year, first quarter 2019 growth was a bit slower reflecting a reduced level of loan originations, mostly from expected seasonality, which constrained net growth on the long side. In total, loans had net growth of about $9 million in the first quarter after growing $84 million last quarter. You may recall that our loans grew only $10 million in the first quarter last year, but ended the full year of 2018 up $191 million or 8.1%. Here, at the start of the second quarter, we are seeing signs of improving growth over the remainder of 2019 and our outlook continues to be for upper single-digit growth for the year.

As for deposits, we had an increase of about $65 million this past quarter after an increase of $96 million last quarter. So our momentum remains strong on the deposit side, which drove the overall growth in our balance sheet. All things considered, we remain very pleased with our balance sheet, our solid low-cost deposit growth and strong earning asset mix, both supporting our profitable margin, and our full year growth outlook for loans and deposits remaining in the upper single-digit range, which leads me to the income statement.

Our net interest income was $28.3 million for the first quarter of 2019 down slightly from $28.5 million in the linked quarter, but up $2.6 million or 10% from the $25.7 million in the first quarter last year. The increase over the prior year first quarter is primarily driven by growth in average balances, but also reflects margin expansion from a year ago as the loan portfolio yield has increased nicely with the rate hikes over the past year while overall funding costs have been less impacted, which includes the benefit of our strong component of noninterest-bearing deposits. Our margin this quarter was 4.03%, up 1 basis point from last quarter and up 8 basis points from $3.95 in the first quarter last year.

On a linked-quarter basis, our yield on earning assets was up 9 basis points as our loan portfolio yield rose to 5.03%. Our cost of interest-bearing liabilities was up 11 basis points on a linked-quarter basis. However, despite the narrower spread, our noninterest deposit mix, lowering overall funding cost, led to margin expansion again this quarter. Our earning asset mix and funding mix both remained strong. And by maintaining our balanced exposure to interest rate changes, we believe that our margin will continue to perform well considering our growth expectations and outlook for no additional Fed rate increases this year.

Now before moving to noninterest components of earnings, you may recall last quarter we made a change in our accounting for deferred compensation. The change which involved a onetime adjustment last quarter was made expecting to reduce the volatility of any bottom line impacts from the plan and market fluctuations. While I'm glad to say that for the first quarter the net bottom line impact was basically neutral, the swing in the market from year-end still had an impact on both the assets and liabilities of the plan, which inflated both noninterest income and noninterest expense by about $560,000 in the first quarter.

So total noninterest income was $10.8 million in the first quarter of 2019, up from $8.4 million in the linked quarter and up from $10.7 million in the first quarter of 2018. Recall that the first -- that the fourth quarter 2018 included a negative impact of $690,000 due to the market value reduction in the deferred compensation plan assets, while the first quarter 2019 had a $559,000 positive pickup in deferred compensation plan assets from the improvement in the market. The deferred compensation plan impact in the first quarter of 2018 was a negative $37,000. In addition, the first quarter is generally when we receive our contingent insurance commissions, which were good this year totaling $920,000, however, down from strong $1 million a year ago. So excluding the deferred comp and the contingent income from each year, noninterest income was down year-over-year, about $406,000, as our uptick in mortgage banking was more than offset by decreases in our other businesses.

Regarding mortgage banking, revenues for the first quarter of 2019 were $1.8 million, up $396,000 from both the linked quarter and up $99,000 from the first quarter of 2018. While the first quarter mortgage banking originations were $45.9 million, seasonally down compared to $60.9 million last quarter and down from $50.7 million in the fourth quarter 2018 with a favorable movement in rates during the quarter, the pipeline at quarter-end was $23.1 million, the highest it's been in 21 months. And gain on sale income was strong at $1.3 million in the first quarter of 2019, well up from $758,000 in the linked quarter and up from $1.1 million in the first quarter last year.

In addition, somewhat trimming the mortgage banking improvement, the downward movement in rates at quarter end reduced the valuation of mortgage servicing rights in the first quarter causing a negative adjustment of $113,000 compared to positive adjustments of $41,000 last quarter and $37,000 in the first quarter 2018. Other noninterest income sources tented to be a bit down this quarter with service charges, insurance commissions and trust all slightly down compared to a year ago. The increase in other income was again related to deferred compensation plan. Looking ahead, overall, we expect seasonal pickup in noninterest income to keep our revenue in the next 2 quarters in the $10.5 million to $10.7 million range before seasonally tapering in the fourth quarter.

As for noninterest expense, first quarter expenses totaled $24.9 million, up from $21.2 million in the linked quarter and $23.3 million for the first quarter of 2018. This comparison is again affected by the deferred compensation plan fluctuations specifically rated -- related to the deferred compensation plan, the first quarter 2019 included about $559,000 of other expense due to the market movement in the quarter basically, offsetting the other income amount. However, last quarter's expenses included both the credit of $1.1 million -- the credit expense of $1.1 million and a onetime credit adjustment of $806,000, and in the first quarter 2018 included an expense of $130,000 related to the deferred compensation plan. Also, in the first quarter of 2019, other expenses included $264,000 of OREO write-downs, while the first quarter 2018 included $544,000 of OREO write-downs. Excluding these unusual items, noninterest expenses would be about $24 million for the first quarter 2019 compared to $22.6 million a year ago, up about $1.4 million or 6.5%. This still included some seasonal costs and items that tended to raise expenses this quarter. Looking ahead, we expect total noninterest expenses in the $23.5 million to $24 million level per quarter.

Now, I will turn it over to Paul for the rest of the details.

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [5]

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Thank you, Kevin, and good morning, everybody. Regarding asset quality, provision expense for the quarter was $212,000 compared to last quarter's expense of $472,000, and the first quarter 2018's credit provision of $1.1 million. Provision this quarter was lower than anticipated primarily due to the lower loan growth, as noted earlier, while the credit provision last year reflected a large loan recovery in that quarter.

Our allowance for loan loss at March 31, 2019 was $28.2 million, down slightly from $28.3 million at year-end 2018, but up versus $27.3 million on March 31 of last year with the year-over-year change primarily driven by the growth in loans.

Our allowance to total loans ratio at March 31, 2019, was 1.10% compared to 1.12% last quarter and 1.16% a year ago, which reflects reduced levels of nonperforming loans and improving asset quality metrics. As for the nonperforming balances, our nonperforming loans declined this quarter to $17.6 million from $19 million at last quarter and were down 37% from $27.9 million at March 31, 2018.

Our OREO balance also decreased this quarter to $941,000 from $1.2 million last quarter and $1.4 million in the first quarter last year. As noted earlier, we did take an OREO write-down of $264,000 in the first quarter. Our accruing troubled debt restructured loans this quarter edged up slightly to $11.9 million from $11.6 million last quarter, but we're still down about 13% from $13.7 million a year ago. With the change in NPA, the allowance coverage of nonperforming assets at quarter end improved to 152% compared to 140% at December 31, 2018 and 93% a year ago.

Needless to say, we are very pleased with our recent trends and improvement from a year ago and we remain confident in our overall portfolio strength and asset quality as we continue to pursue our growth strategies.

Looking at our capital position, total period end stockholders' equity was $395.8 million, up from $379.2 million at March 31, 2018.

During the quarter, we did repurchase approximately 515,000 shares for $15.1 million yet our capital position remains strong with quarter end equity to assets of 12.41% down only slightly from 12.56% last year. The bank's total risk-based capital ratio is approximately 12.6% at quarter end March 31, 2019. Our healthy capital position continues to support our strategies for growth and shareholder value enhancement.

In summary, we are off to a very good start to 2019. Our balance sheet is solid, our margin is performing well, our operating profitability is strong, asset quality continues to improve and our outlook for the year remains very positive. And that completes our financial review. And I'll turn the call back over to Don.

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Donald P. Hileman, First Defiance Financial Corp. - President, CEO & Director [6]

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Thank you, Paul. I'm very pleased with the core results this quarter. Our overall strategic goals remain focused on several key areas. We are concentrated on core balance sheet growth with a focus on loan growth and deposit growth, overall revenue growth, expense control measured by efficiency ratio and improved asset quality. As I mentioned, we have started the year slower than we would like in loan growth, we feel confident that we will hit our annual target of upper single digits. We are pleased that we maintained a positive trend in the margin as well as the growth loan -- gross loan yield. We understand it will be challenging to drive growth in the loans and maintain yield management and know that some trade-offs might be necessary as we are heavily focused on relationship management pricing.

We are very pleased with the deposit growth this quarter. We are concentrated on deposit growth initiative to overcome the challenges and attracting core deposit relationships. The expenses were challenging this quarter and reflected higher levels than we expect going forward. This negatively affected the efficiency ratio while asset quality did improve in the quarter.

Throughout 2019, we'll place emphasis on technology and our digital strategy to differentiate our organization. By increasing our ability to innovate and use data to better serve our customers, we will be able to exceed our customers' rapidly changing expectations. We believe the first step is to gain a deeper understanding of where we are as a company through a comprehensive assessment of our current digital capabilities. This will allow us to define short- and long-term vision and strategies for digital banking. Though our teams of talented employees working towards the same goals, we are confident that together, we can make a positive impact and grow as a consistently high-performing community-focused financial institution. We feel that our performance reflects our focus on shareholder value and at the same time our commitment to serve our customers and the communities we serve.

As announced in our press release, Kevin will be retiring at the end of the month. I would like to personally thank Kevin for his dedication and service to me as the CEO and First Defiance and wish him well in the next chapter of his life.

We remain dedicated to all of our customers and shareholders, and we appreciate the trust you have placed on us as we build pride in First Defiance. Thank you for your interest in First Defiance Financial Corporation, and we thank you for joining us this morning. And we now will be happy to take any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Nick Cucharale of Sandler O'Neill and Partners.

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Nicholas Anthony Cucharale, Sandler O'Neill + Partners, L.P., Research Division - Director [2]

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First off, best wishes to Kevin on your well-deserved retirement and congratulations to Paul. So first, I heard your commentary that you expect the NIM to continue to perform well. After 3 consecutive quarters of expansion, can you help us think about the trajectory and the magnitude in coming quarters?

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [3]

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Paul?

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [4]

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Sure. Happy to take that. Our NIM has performed very well, continues to exceed even our expectations here, and we do continue to expect it to maintain similar levels. But pressures are increasing on the downside, specifically, deposit costs have been climbing, the beta has been increasing quarter-to-quarter and you saw in our results here the spread did compress. So we see that in our outlook that, that could continue. Now we're optimistic about our chances there. We've got very good growth opportunities that will help lift that, and to the extent that we can continue to do well on our noninterest-bearing component of deposits just like this quarter, that will help maintain that margin level. So while we do, at least for outlook purposes, see it potentially coming down a bit into the high 3.90s there, it's still going to perform strong.

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Nicholas Anthony Cucharale, Sandler O'Neill + Partners, L.P., Research Division - Director [5]

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Okay. Great. And then secondly, you stepped up the share repurchases this quarter. Can you give us some color on your priorities for capital and if we should be expecting a re-upping of the authorization if and when the 9,000 shares remaining is exhausted?

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Donald P. Hileman, First Defiance Financial Corp. - President, CEO & Director [6]

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Yes, yes, Nick. I think we still -- we're focused on dividends. We included our $0.19 a share dividend which is up from a year ago in the second quarter in a row. So we'll be focusing on that, but share repurchases are part of our longer-term capital strategic plan, and we would expect to have that tool going forward.

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Nicholas Anthony Cucharale, Sandler O'Neill + Partners, L.P., Research Division - Director [7]

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Okay. And then lastly, the allowance split down a little bit in the quarter. Do you expect that trend to continue or stay relatively consistent in future periods with where you are?

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [8]

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Yes. In terms of the allowance, at least as a percentage of loans, given the trends that we've been seeing on the asset quality front, we would expect it to be comparable to that. It could improve if we continue to see additional credit quality improvements on that front. But we did have some charge-offs this quarter versus recoveries in the last quarter or so, and just got to see where that lands at the end of the day. It was a little low provision-wise this quarter, as we said earlier, in part because of the low loan volume, the low growth there, but we also had not -- while we had charge-offs, they weren't that high either. So the trends continue on the economic front and on the internal credit quality front. We should be able to certainly maintain those levels.

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [9]

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I would say, Nick, just to -- further onto what Paul said that with a trend in our asset quality, which has been improving, it's more likely to go down 1 basis point or so then up, okay? So that would be more in line with our expectations. But we don't see any significant change really.

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [10]

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No.

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Operator [11]

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(Operator Instructions) The next question is from Damon DelMonte of KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [12]

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Kevin, congratulations and best of luck on the next chapter and Paul, congrats on the promotion and look forward to working with you. So first question, just wanted to touch a little bit on the outlook for mortgage banking. Pretty strong quarter, and we usually see some positive seasonality in the second and third quarter. So how are you, kind of, thinking about the state of your pipelines today going into the second quarter? And what your outlook is for that?

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [13]

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Like I said, the pipeline hasn't been this high in 21 months. So, I mean it's very strong coming into the quarter. And given where rates are, I mean we think it's -- that is favorable and environment probably as we've had in a while, so we are looking for that seasonal pickup in terms of mortgage banking. So we did have a strong quarter, but we would still be looking for 20%, 25% increase over the first quarter into the second quarter or something like that.

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [14]

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Similar trends as...

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [15]

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As we've seen at last year.

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [16]

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Exactly.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [17]

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Okay. Got it. All right. Great. And then as far as -- obviously, the credit is very strong here, but could you maybe put a little perspective on the expectation for the provision going forward?

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [18]

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Yes. So like we were saying earlier, on the allowance front, we expect it to maintain around the same level, maybe tick down a little bit. But on the provision side, that will be tied to loan growth, obviously. So as our loan growth starts to accelerate here in the coming quarters, that will get back up to normal levels around $1 million plus/minus depending on actual volumes in the quarter.

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Donald P. Hileman, First Defiance Financial Corp. - President, CEO & Director [19]

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Yes. The other thing we don't see in the horizon significant recoveries. I think we've kind of run that benefit out. So it will be basically, like Paul said, driven in our loan growth and the overall quality of the portfolio.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [20]

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Got it. Okay. Great. And then lastly, the average loan balances during the quarter were pretty strong quarter-over-quarter compared to the end of period. Did you experience some like late-in-the-quarter payoffs or something like that?

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [21]

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Not really, Damon. It was more of just a slower origination quarter again, but does -- pipelines at all indicate we're expecting that to increase here in the second quarter or so. But the lift in average balances was certainly more connected to the big growth in the fourth quarter and the growth in the first quarter.

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Paul D. Nungester, First Defiance Financial Corp. - Executive VP and Director of Finance & Accounting [22]

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And a lot of that happened late in the year.

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Kevin T. Thompson, First Defiance Financial Corp. - Executive VP & CFO [23]

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Correct.

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Operator [24]

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It concludes our question-and-answer session. I would like to turn the conference back over to Tera Murphy for closing remarks.

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Tera Murphy, First Defiance Financial Corp. - VP & Marketing Director [25]

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Thank you for joining us today as we discussed our quarterly results. We appreciate your time and interest in First Defiance Financial Corp. Have a great day.

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Operator [26]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.