1
UNITED STATES
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SECURITIES AND EXCHANGE COMMISSION
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Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 For the Quarterly Period Ended June 30, 2002
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OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period from ___________to__________
Commission file number 0-26850
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First Defiance Financial Corp.
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(Exact name of registrant as specified in its charter)
Ohio 34-1803915
- ------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification) Number)
601 Clinton Street, Defiance, Ohio 43512
- ------------------------------------------------- ------------
(Address or principal executive office) (Zip Code)
Registrant's telephone number, including area code: (419) 782-5015
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date. Common Stock, $.01 Par Value -
6,816,483 shares outstanding at August 9, 2002.
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number
-----------
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - June 30, 2002 and December 31, 2001 2
Consolidated Condensed Statements of Income -
Three and six months ended June 30, 2002 and 2001 4
Consolidated Condensed Statement of Changes in
Stockholders' Equity - Six months ended
June 30, 2002 5
Consolidated Condensed Statements of Cash Flows
- Six months ended June 30, 2002 and 2001 7
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 31
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings 32
Item 2. Changes in Securities 32
Item 3. Defaults upon Senior Securities 32
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 33
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
June 30, 2002 December 31, 2001
------------- -----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 19,210 $ 37,334
Interest-bearing deposits 62,335 766
---------- ----------
81,545 38,100
Securities:
Available-for-sale, carried at fair value 217,506 48,691
Held-to-maturity, carried at amortized cost
(approximate fair value $4,784 and $5,678
at June 30, 2002 and December 31,
2001 respectively) 4,624 5,580
---------- ----------
222,130 54,271
Loans held for sale 610 672
Loans receivable, net 514,888 499,141
Accrued interest receivable 5,115 2,940
Federal Home Loan Bank stock and other
interest-earning assets 21,716 16,306
Office properties and equipment 20,228 20,067
Real estate and other assets held for sale 335 136
Goodwill, net 3,569 3,749
Deferred taxes -- 35
Mortgage servicing rights 2,211 1,821
Other assets 2,198 652
Assets held for sale 5,834 6,304
Assets of discontinued operations -- 488,454
---------- ----------
Total assets $ 880,379 $1,132,648
========== ==========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
June 30, 2002 December 31, 2001
------------- -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 32,388 $ 25,428
Interest-bearing deposits 569,608 589,420
----------- -----------
Total deposits 601,996 614,848
Advances from Federal Home Loan Bank 131,192 196,302
Notes payable and other interest-bearing liabilities 2,414 20,724
Advance payments by borrowers for taxes and insurance 2,305 390
Deferred taxes 606 --
Other liabilities 13,791 6,517
Liabilities associated with assets held for sale 5,887 6,242
Liabilities of discontinued operations -- 176,604
----------- -----------
Total liabilities 758,191 1,021,627
STOCKHOLDERS' EQUITY
Preferred stock, no par value per share:
5,000 shares authorized; no shares
issued -- --
Common stock, $.01 par value per share:
20,000 shares authorized; 6,810
and 6,854 shares outstanding, respectively 68 69
Additional paid-in capital 53,590 53,725
Stock acquired by ESOP (2,494) (2,813)
Deferred compensation (56) (82)
Accumulated other comprehensive income,
net of income taxes of $1,679
and $410, respectively 3,174 763
Retained earnings 67,906 59,359
----------- -----------
Total stockholders' equity 122,188 111,021
----------- -----------
Total liabilities and stockholders' equity $ 880,379 $ 1,132,648
=========== ===========
See accompanying notes
3
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
- --------------------------------------------------------------------------------
For the Three Months Ended For the Six Months Ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest Income
Loans $ 9,081 $ 11,054 $ 18,041 $ 22,348
Investment securities 2,424 917 3,175 1,860
Interest-bearing deposits 409 149 427 210
-------- -------- -------- --------
Total interest income 11,914 12,120 21,643 24,418
Interest Expense
Deposits 4,461 5,394 8,389 11,161
FHLB advances and other 1,690 1,167 1,774 2,544
Notes payable and warehouse loans 38 279 227 587
-------- -------- -------- --------
Total interest expense 6,189 6,840 10,390 14,292
-------- -------- -------- --------
Net interest income 5,725 5,280 11,253 10,126
Provision for loan losses 156 252 738 387
-------- -------- -------- --------
Net interest income after provision for loan losses 5,569 5,028 10,515 9,739
Non-interest Income
Loan service fees and other charges 955 743 1,753 1,381
Insurance commission income 827 723 1,710 1,456
Dividends on stock and other interest income 285 282 466 554
Gain on sale of loans 549 802 1,075 1,302
Loss on sale of securities -- (15) (15) (58)
Trust income 24 26 54 55
Other non-interest income 97 34 119 61
-------- -------- -------- --------
Total non-interest income 2,737 2,595 5,162 4,751
Non-interest Expense
Compensation and benefits 3,494 3,011 6,798 5,963
Occupancy 722 674 1,413 1,361
SAIF deposit insurance premiums 33 29 65 60
State franchise tax 351 313 645 677
Data processing 465 335 691 686
Amortization and impairment of mortgage servicing rights 305 241 529 373
Amortization and impairment of goodwill and other intangibles -- 79 200 155
Other non-interest expense 943 769 1,964 1,635
-------- -------- -------- --------
Total non-interest expense 6,313 5,451 12,305 10,910
-------- -------- -------- --------
Income from continuing operations before income taxes 1,993 2,172 3,372 3,580
Federal income taxes 607 725 1,099 1,183
-------- -------- -------- --------
Income from continuing operations 1,386 1,447 2,273 2,397
Discontinued operations, net of tax 7,332 1,139 9,347 3,244
-------- -------- -------- --------
Income before cumulative effect of a change in accounting principle 8,718 2,586 11,620 5,641
Cumulative effect of change in method of accounting for goodwill,
net of tax -- -- (194) --
-------- -------- -------- --------
Net income $ 8,718 $ 2,586 $ 11,426 $ 5,641
======== ======== ======== ========
Earnings per share (Note 5) Basic:
From continuing operations $ 0.22 $ 0.22 $ 0.35 $ 0.37
Discontinued operations, net of tax $ 1.14 $ 0.18 $ 1.46 $ 0.51
Cumulative effect in method of accounting for goodwill $ -- -- $ (0.03) --
-------- -------- -------- --------
Net income $ 1.36 $ 0.40 $ 1.78 $ 0.88
======== ======== ======== ========
Diluted:
From continuing operations $ 0.21 $ 0.22 $ 0.34 $ 0.37
Discontinued operations, net of tax $ 1.09 $ 0.17 $ 1.40 $ 0.49
Cumulative effect in method of accounting for goodwill $ -- -- $ (0.03) --
-------- -------- -------- --------
Net income $ 1.30 $ 0.39 $ 1.71 $ 0.86
======== ======== ======== ========
Dividends declared per share (Note 4) $ 0.13 $ 0.12 $ 0.26 $ 0.24
======== ======== ======== ========
Average shares outstanding (Note 5)
Basic 6,418 6,394 6,426 6,381
======== ======== ======== ========
Diluted 6,689 6,603 6,672 6,571
======== ======== ======== ========
4
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2002
-----------------------------------------------------------
Stock Acquired By
-----------------
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
----- ------- ---- ----
Balance at January 1 $ 69 $ 53,725 $ (2,813) $ (82)
Comprehensive income:
Net income
Change in unrealized gains
net of income taxes of ($1,237)
Total comprehensive income
ESOP shares released 242 319
Amortization of deferred compensation
of Management Recognition Plan 26
Shares issued under stock option plan 677
Purchase of common stock for
treasury (1) (1,054)
Dividends declared (Note 5)
--------------------------------------------------------
Balance at June 30 $ 68 $ 53,590 $ (2,494) $ (56)
========================================================
See accompanying notes
5
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2002 2001
---------------------------------------------- -------------
Net Unrealized
gains (losses) on Total Total
available-for- Retained Stockholders' Stockholder's
sale securities Earnings Equity Equity
--------------- -------- ------ ------
Balance at January 1 $763 $59,359 $111,021 $99,473
Comprehensive income:
Net income 11,426 11,426 5,641
Change in unrealized gains (losses)
net of income taxes of ($1,237) 2,411 2,411 499
----- ----
Total comprehensive income 13,837 6,140
ESOP shares released 561 411
Amortization of deferred compensation
of Management Recognition Plan 26 58
Shares issued under stock option plan 677 97
Purchase of common stock for
treasury (1,184) (2,239) (669)
Dividends declared (Note 5) (1,695) (1,695) (1,560)
------------------------------------------ --------
Balance at June 30 $3,174 $67,906 $122,188 $103,950
========================================= ========
6
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Six Months
Ended June 30,
2002 2001
--------------------
Operating Activities
Net income $ 11,426 $ 5,641
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 738 387
Provision for depreciation 822 788
Net securities amortization 220 11
Amortization of mortgage servicing rights 265 373
Net impairment of mortgage servicing rights 264 --
Amortization of goodwill -- 155
Net impairment of goodwill 438 --
Gain on sale of loans (1,075) (1,302)
Gain on sale of discontinued operations (16,912) --
Amortization of Management Recognition Plan
deferred compensation 26 58
Release of ESOP Shares 561 411
Net securities losses 15 61
Deferred federal income tax credit (187) (59)
Proceeds from sale of loans 55,120 76,856
Origination of mortgage servicing rights, net (919) (762)
Origination of loans held for sale (53,983) (76,048)
Increase in interest receivable and other assets (3,772) (586)
Increase in other liabilities 3,062 212
Decrease in assets held for sale 470 1,051
Decrease in liabilities held for sale (405) (143)
Increase in assets of discontinued operations (5,418) (7,032)
Decrease in liabilities of discontinued operations (35,166) (69,508)
--------- ---------
Net cash provided by operating activities (44,410) (69,436)
Investing Activities
Proceeds from maturities of held-to-maturity securities 934 896
Proceeds from maturities of available-for-sale securities 3,595 2,915
Proceeds from sale of available-for-sale securities 423 1,894
Proceeds from sales of real estate and
other assets held for sale 236 158
Proceeds from sales of office properties and equipment -- 27
Proceeds from sale of discontinued operations 367,921 --
Purchases of available-for-sale securities (169,398) (2,535)
Purchases of Federal Home Loan Bank stock (376) (553)
Purchases of office properties and equipment (987) (371)
Net (increase) decrease in loans receivable (16,920) 4,415
--------- ---------
Net cash provided by investing activities 185,428 6,846
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Six Months Ended
June 30,
2002 2001
---- ----
Financing Activities
Net increase (decrease) in deposits (10,937) 33,334
Repayment of Federal Home Loan Bank long-term advances (25,110) (255)
Repayment of term notes payable (19) (18)
Net decrease in Federal Home Loan Bank
short-term advances (40,000) (56,750)
Net increase (decrease) from short-term line of credit (18,250) 4,600
Proceeds from Federal Home Loan Bank long term notes -- 90,000
Purchase of common stock for treasury (2,239) (669)
Cash dividends paid (1,695) (1,560)
Proceeds from exercise of stock options 677 97
-------- --------
Net cash used in financing activities (97,573) 68,779
-------- --------
Increase in cash and cash equivalents 43,445 6,189
Cash and cash equivalents at beginning of period 38,100 22,002
-------- --------
Cash and cash equivalents at end of period $ 81,545 $ 28,191
======== ========
Supplemental cash flow information:
Interest paid $ 10,872 $ 14,239
======== ========
Income taxes paid $ 5,756 $ 3,440
======== ========
Transfers from loans to real estate
and other assets held for sale $ 435 $ 161
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ (1,237) $ (384)
======== ========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ 3,648 $ 883
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 848 $ 778
======== ========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
1. Principles of Consolidation
The consolidated condensed financial statements include the accounts of
First Defiance Financial Corp. ("First Defiance" or "the Company"), its two
wholly owned subsidiaries, First Federal Bank of the Midwest ("First
Federal"), and First Insurance and Investments, Inc. ("First Insurance")
and First Federal's wholly owned mortgage banking company, The Leader
Mortgage Company, LLC ("The Leader"). Operations of The Leader were sold to
US Bancorp in a transaction that was completed on April 1, 2002. In the
opinion of management, all significant intercompany accounts and
transactions have been eliminated in consolidation.
2. Basis of Presentation
The consolidated condensed statement of financial condition at December 31,
2001 has been derived from the audited financial statements at that date,
which were included in First Defiance's Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of June 30,
2002 and for the six-month period ending June 30, 2002 and 2001 have been
prepared by First Defiance without audit and do not include information or
footnotes necessary for the complete presentation of financial condition,
results of operations, and cash flows in conformity with accounting
principles generally accepted in the United States. For the purposes of
these statements, operations of The Leader are reported in results of
discontinued operations and all prior time periods presented have been
restated to reflect The Leader's operations as discontinued operations.
These consolidated condensed financial statements should be read in
conjunction with the financial statements and notes thereto included in
First Defiance's 2001 annual report on Form 10-K for the year ended
December 31, 2001. However, in the opinion of management, all adjustments,
consisting of only normal recurring items, necessary for the fair
presentation of the financial statements have been made. The results of
continuing operations for the six-month period ended June 30, 2002 are not
necessarily indicative of the results that may be expected for the entire
year.
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
3. Discontinued Operations
On April 1, 2002, First Defiance completed the sale of The Leader to US
Bancorp. Discontinued operations as reported include the operating results
of The Leader for the periods owned, the gain realized by the Company from
the sale of The Leader, net of all expenses of the sale, and the cost to
the Company for early payment of certain Federal Home Loan Bank (FHLB)
advances. The components of discontinued operations are as follows (all
shown net of tax, in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Operations of The Leader -- $ 1,139 $ 2,015 $ 3,244
Gain from sale of The Leader 7,682 -- 7,682 --
Cost to terminate financing associated
with discontinued operations (350) -- (350) --
------- ------- ------- -------
$ 7,332 $ 1,139 $ 9,347 $ 3,244
======= ======= ======= =======
4. Change in Accounting Method
On January 1, 2002, First Defiance adopted Financial Accounting Standards
Board Statement No. 142, Goodwill and Other Intangible Assets. As required
by FAS No. 142, goodwill is no longer amortized into the income statement
over an estimated life but rather is tested at least annually for
impairment based on specific guidance included in FAS No. 142. Based on an
impairment test performed as of January 1, 2002, the Company determined
that a portion of previously recorded goodwill related to its First
Insurance business unit was impaired. The amount of impairment as of
January 1, 2002, which was $238,000 or $194,000 after tax, is reflected in
the financial statements as an adjustment for the cumulative effect of an
accounting change.
During the quarter ended March 31, 2002, management reached a settlement
with the former shareholders of one of the agencies acquired to form First
Insurance related to an earn-out provision of the original purchase
agreement. The payment of $200,000 was recorded as additional goodwill for
First Insurance and was considered impaired. This $200,000 impairment
adjustment is reported as an operating cost by First Defiance in the 2002
first quarter. The balance of goodwill recorded at First Insurance totals
$3,569,000 at June 30, 2002.
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
4. Change in Accounting Method (continued)
Results from continuing operations for the three and six months ended June
30, 2001 include goodwill amortization expense of $79,000 and $155,000,
respectively. Had FAS No. 142 been in effect for that period, the Company
would have reported income from continuing operations of $1,510,000 for the
three months ended June 30, 2001 and $2,522,000 for the six months ended
June 30, 2001. This amount was determined as follows (in thousands, except
for earnings-per-share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Reported income from continuing operations $ 1,386 $ 1,447 $ 2,273 $ 2,397
Add back: Goodwill amortization -- 79 -- 155
Deduct: Tax benefit from deductible goodwill -- (15) -- (30)
------- --------- ------- ---------
Adjusted income from continuing operations 1,386 1,511 2,273 2,522
Basic earnings per share:
Reported income from continuing operations $ .22 $.22 $ .35$.37
Add back: Goodwill amortization -- .01 -- .02
Deduct: Tax benefit from deductible goodwill -- -- -- --
------- --------- ------- ---------
Adjusted income from continuing operations $ .22 $ .23 $ .35 $ .39
Diluted earnings per share:
Reported income from continuing operations $ .21 $ .22 $ .34 $ .37
Add back: Goodwill amortization -- .01 -- .02
Deduct: Tax benefit from deductible goodwill -- -- -- --
------- --------- ------- ---------
Adjusted income from continuing operations $ .21 $ .23 $ .34 $ .39
5. Dividends on Common Stock
As of June 30, 2002, First Defiance had declared a quarterly cash dividend
of $.13 per share for the first quarter of 2002, payable July 26, 2002.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
6. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been calculated
by dividing net income by the weighted average number of shares of common
stock outstanding for the three and six month periods ended June 30, 2002
and 2001. First Defiance accounts for the shares issued to its Employee
Stock Ownership Plan ("ESOP") in accordance with Statement of Position 93-6
of the American Institute of Certified Public Accountants ("AICPA"). As a
result, shares controlled by the ESOP are not considered in the weighted
average number of shares of common stock outstanding until the shares are
committed for allocation to an employee's individual account. In the
calculation of diluted earnings per share for the three and six-months
ended June 30, 2002 and 2001, the effect of shares issuable under stock
option plans and unvested shares under the Management Recognition Plan have
been accounted for using the Treasury Stock method.
The following table sets forth the computation of basic and diluted earning
per share (in thousands except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
2002 2001 2002 2001
---- ---- ---- ----
Numerator for basic and diluted
earnings per share - net income $1,386 $1,447 $2,273 $2,397
====== ====== ====== ======
Denominator:
Denominator for basic earnings per
share - weighted average shares 6,418 6,394 6,426 6,381
Effect of dilutive securities:
Employee stock options 257 177 228 144
Unvested Management Recognition
Plan stock 14 32 18 46
------ ------ ------ ------
Dilutive potential common shares 271 209 246 190
------ ------ ------ ------
Denominator for diluted earnings
per share - adjusted weighted average
shares and assumed conversions 6,689 6,603 6,672 6,571
====== ====== ====== ======
Basic earnings per share $ .22 $ .22 $ .35 $ .37
====== ====== ====== ======
Diluted earnings per share $ .21 $ .22 $ .34 $ .37
====== ====== ====== ======
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
7. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities (in thousands):
June 30, 2002
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 119,342 $ 3,289 $ 7 $ 122,624
Corporate bonds 30,739 692 59 31,372
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 55 2,054
Adjustable rate mortgage-backed securities 3,695 71 27 3,739
Collateralized mortgage obligations 27,546 296 -- 27,842
Trust preferred stock 4,000 42 42 4,000
Equity securities 70 7 -- 77
Obligations of state and political subdivisions 25,209 631 42 25,798
--------------------------------------------------
Totals $212,710 $ 5,028 $ 232 $ 217,506
==================================================
Held-to-Maturity Securities:
FHLMC certificates $ 1,272 $ 25 $ 3 $ 1,294
FNMA certificates 1,998 25 28 1,995
GNMA certificates 724 24 -- 748
Obligations of state and political subdivisions 630 117 -- 747
---------------------------------------------------
Totals $ 4,624 $ 191 $ 31 $ 4,784
===================================================
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
7. Investment Securities (continued)
December 31, 2001
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 17,708 $ 905 $ -- $ 18,613
Corporate bonds 9,322 294 -- 9,616
Adjustable rate mortgage-backed security
mutual funds 2,548 -- 70 2,478
Adjustable rate mortgage-backed securities 4,134 52 71 4,115
Collateralized mortgage obligations 3,546 69 16 3,599
Trust preferred stock 2,000 12 80 1,932
Equity securities 70 17 -- 87
Obligations of state and political subdivisions 8,216 131 96 8,251
--------------------------------------------------
Totals $ 47,544 $1,480 $ 333 $ 48,691
==================================================
Held-to-Maturity Securities:
FHLMC certificates $ 1,690 $ 25 $ 25 $ 1,690
FNMA certificates 2,389 26 52 2,363
GNMA certificates 871 22 -- 893
Obligations of state and political subdivisions 630 102 -- 732
---------------------------------------------------
Totals $ 5,580 $ 175 $ 77 $ 5,678
===================================================
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
8. Loans
Loans receivable and held for sale consist of the following (in thousands):
June 30, December 31,
2002 2001
---- ----
Real Estate:
One-to-four family residential $165,072 $167,738
Construction 8,977 7,875
Non-residential and multi-family real estate 191,471 174,052
-------- --------
365,520 349,665
Other Loans:
Commercial 80,844 83,690
Consumer finance 39,279 40,739
Home equity and improvement 43,990 36,179
-------- --------
164,113 160,608
-------- --------
Total real estate and other loans 529,633 510,273
Deduct:
Loans in process 6,028 2,888
Net deferred loan origination fees and costs 1,079 1,024
Allowance for loan loss 7,028 6,548
-------- --------
Totals $515,498 $499,813
======== ========
Changes in the allowance for loan losses were as follows:
Three Months ended Six Months ended
June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of period $6,933 $6,367 $6,548 $6,331
Provision for loan losses 156 252 738 387
Charge-offs:
One to four family residential real estate 15 26 64 26
Non-residential and multi-family real estate 20 31 74 31
Consumer finance 93 151 240 300
------ ------ ------ ------
Total charge-offs 128 208 378 357
Recoveries 67 69 120 119
------ ------ ------ ------
Net charge-offs 61 139 258 238
------ ------ ------ ------
Ending allowance $7,028 $6,480 $7,028 $6,480
====== ====== ====== ======
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 2002 and 2001)
- --------------------------------------------------------------------------------
9. Deposits
A summary of deposit balances is as follows (in thousands):
June 30, December 31,
2002 2001
---- ----
Non-interest-bearing checking accounts $ 32,388 $ 25,428
Interest-bearing checking accounts 39,949 35,304
Savings accounts 39,766 36,952
Money market demand accounts 125,657 114,253
Certificates of deposit 364,236 402,911
-------- --------
$601,996 $614,848
======== ========
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
General
- -------
First Defiance is a holding company which conducts business through its two
wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal")
and First Insurance and Investments, Inc. ("First Insurance"). Effective April
1, 2002, The Leader Mortgage Company, LLC ("The Leader), a mortgage banking
subsidiary of First Federal was sold to US Bancorp and its operating results are
reported as discontinued operations. First Federal is primarily engaged in
attracting deposits from the general public through its offices and using those
and other available sources of funds to originate loans primarily in the areas
in which its offices are located. First Federal's traditional banking activities
include originating and servicing residential, commercial and consumer loans;
providing a broad range of depository services; and providing trust services.
First Federal is subject to the regulations of certain federal agencies and
undergoes periodic examinations by those regulatory authorities. First Insurance
is an insurance agency that does business in the Defiance, Ohio area. First
Insurance offers property and casualty, life insurance, group and individual
health insurance, and investment products.
First Defiance also invests in U.S. Treasury and federal government agency
obligations, money market mutual funds which are comprised of U.S. Treasury
obligations, obligations of the State of Ohio and its political subdivisions,
mortgage-backed securities which are issued by federal agencies, corporate
bonds, and collateralized mortgage obligations ("CMOs") and real estate mortgage
investment conduits ("REMICs"). Management determines the appropriate
classification of all such securities at the time of purchase in accordance with
FAS Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities.
Securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the security to maturity. Held-to-maturity
securities are stated at amortized cost and had a recorded value of $4.6 million
at June 30, 2002. Securities not classified as held-to-maturity are classified
as available-for-sale, which are stated at fair value and had a recorded value
of $217.5 million at June 30, 2002. The available-for-sale portfolio consists of
U.S. Treasury securities and obligations of U.S. Government corporations and
agencies ($122.6 million), corporate bonds ($31.4 million), certain municipal
obligations ($25.8 million), CMOs and REMICs ($27.9 million), mortgage backed
securities ($3.7 million), preferred stock and other equity investments ($4.0
million) and adjustable-rate mortgage backed security mutual funds ($2.1
million). In accordance with FAS No. 115, unrealized holding gains and losses
deemed temporary on available-for-sale securities are reported in a separate
component of stockholders' equity and are not reported in earnings until
realized. Net unrealized holding gains on available-for-sale securities were
$4.8 million at June 30, 2002, or $3.1 million after considering the related
deferred tax liability.
First Defiance's investment portfolio increased substantially from December 31,
2001 and March 31, 2002 amounts as proceeds from the sale of The Leader were
reinvested in investment securities. In addition, at June 30, 2002 First
Defiance also had $62.3 million deposited in interest-bearing depository
accounts. These liquid funds are also a result of the sale of The Leader.
17
The profitability of First Defiance is primarily dependent on its net interest
income and non-interest income. Net interest income is the difference between
interest and dividend income on interest-earning assets, principally loans and
securities, and interest expense on interest-bearing deposits, Federal Home Loan
Bank advances, and other borrowings. The Company's non-interest income includes
deposit and loan servicing fees, gains on sales of mortgage loans, and insurance
commissions. First Defiance's earnings also depend on the provision for loan
losses and non-interest expenses, such as employee compensation and benefits,
occupancy and equipment expense, deposit insurance premiums, amortization and
impairment of mortgage servicing rights and miscellaneous other expenses, as
well as federal income tax expense.
Forward-Looking Information
- ---------------------------
Certain statements contained in this quarterly report that are not historical
facts, including but not limited to statements that can be identified by the use
of forward-looking terminology such as "may", "will", "expect", "anticipate", or
"continue" or the negative thereof or other variations thereon or comparable
terminology are "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21B of the Securities Act
of 1934, as amended. Actual results could differ materially from those indicated
in such statements due to risks, uncertainties and changes with respect to a
variety of market and other factors.
Changes in Financial Condition
- ------------------------------
At June 30, 2002, First Defiance's total assets, deposits and stockholders'
equity amounted to $880.3 million, $602.0 million and $122.2 million,
respectively, compared to $1.133 billion, $614.8 million and $111.0 million,
respectively, at December 31, 2001. Total assets of discontinued operations,
included in total assets at December 31, 2001, were $488.5 million. The
discussion below focuses only on assets and liabilities from continuing
operations.
Net loans receivable increased to $515.5 million at June 30, 2002 from $499.8
million at December 31, 2001. The increase in loans receivable occurred
primarily in non-residential and multi-family real estate loans, which increased
$17.4 million to $191.5 million and home equity and improvement loans, which
increased $7.8 million to $44.0 million. The increase was partially offset by a
$2.7 million decline in one-to-four family residential loans to $165.1 million
and a $2.8 million decline in commercial loans to $80.8 million.
The investment portfolio increased to $222.1 million at June 30, 2002 from $54.3
million at December 31, 2001. Approximately $168.9 million of the proceeds from
the sale of The Leader were used to purchase securities in the investment
portfolio. At June 30, 2002 there were approximately $62.3 million of
interest-bearing deposits held at financial institutions. These funds will be
redeployed into higher earning investments as interest rates rise or will be
used to liquidate $37.5 million of brokered certificates of deposit which are
scheduled to mature over the next 12 months and which will not be renewed.
Deposits decreased from $614.8 million at December 31, 2001 to $602.0 million as
of June 30, 2002. Certificates of deposit balances declined by $38.7 million to
$364.2 million at June 30, 2002, from $402.9 million at December 31, 2001. This
decrease was the result of a $35.3 million decrease in brokered certificates of
deposit and a $3.4 million decrease in certificates of deposit originated
through First Federal's branch network. The decline in certificate of deposit
balances was partially offset by a $11.4 million increase in money market demand
accounts, to $125.7 million at June 30, 2002 from $114.3 million at December 31,
2001, and a $11.6 million increase in interest and non-interest bearing checking
accounts, to $72.3 million at June 30, 2002 from $60.7 million at December 31,
2001. The Company has focused on increasing its lower cost core deposits, and at
the same time has been less aggressive in retaining higher cost CDs during 2002
due to the sale of The Leader early in April, 2002.
Additionally, FHLB advances and notes payable decreased to $131.2 million and
$2.4 million, respectively, at June 30, 2002 from $196.3 million and $20.7
million, respectively, at December 31, 2001. The proceeds from the sale of The
Leader were used to pay down all short term advances from the FHLB and notes
payable as well as $25 million of fixed rate long term FHLB advances that were
retired early.
18
Average Balances, Net Interest Income and Yields Earned and Rates Paid
- ----------------------------------------------------------------------
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in thousands of dollars and rates, and the net interest margin. Dividends
received on FHLB stock are included as interest income. The table does not
reflect any effect of income taxes. All average balances are based upon daily
balances. The average balance sheets and income statements have been adjusted to
allocate interest expense associated with financing The Leader's operations to
discontinued operations. The average balance of FHLB advances for this yield
analysis does not include those advances which were used to finance The Leader's
operations. The interest-bearing liabilities reflect only those funds
attributable to First Defiance's continuing operations.
Three Months Ended June 30,
--------------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
Interest-earning assets:
Loans receivable $ 511,238 $ 9,081 7.12% $ 526,193 $ 11,054 8.43%
Securities 188,361 2,424 5.16 59,688 917 6.17
Interest-earning deposits 96,337 409 1.70 16,906 149 3.54
FHLB stock and other 34,580 285 3.31 15,530 282 7.28
---------- ---------- ---------- ----------
Total interest-earning assets 830,516 12,199 5.89 618,317 12,402 8.05
Non-interest-earning assets
(including assets of discontinued
operations) 54,620 447,456
---------- ----------
Total assets $ 885,136 $1,065,773
========== ==========
Interest-bearing liabilities (3):
Deposits $ 574,461 $ 4,461 3.11% $ 446,262 $ 5,394 4.85%
FHLB advances and other 131,472 1,690 5.16 93,794 1,167 4.99
Notes payable 2,430 38 6.27 18,806 279 5.95
---------- ---------- ---- ---------- ---------- ----
Total interest-bearing liabilities 708,363 6,189 3.50 558,862 6,840 4.91
Non-interest bearing deposits 33,559 -- 35,210 --
---------- ---------- ---------- ----------
Total including non-interest bearing
demand deposits 741,922 6,189 3.35 594,072 6,840 4.61
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 24,048 368,754
---------- ----------
Total liabilities 765,970 962,826
Stockholders' equity 119,166 102,947
---------- ----------
Total liabilities and stock-
holders' equity $ 885,136 $1,065,773
========== ==========
Net interest income; interest
rate spread $ 6,010 2.39% $ 5,562 3.14%
========== ==== ========== ====
Net interest margin (2) 2.90% 3.61%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 117% 111%
==== ====
- ------------------------------------------
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
(3) This analysis does not reflect borrowings to fund discontinued operations.
19
Six Months Ended June 30,
--------------------------------------------------------------------------------
2002 2001
------------------------------------- -------------------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
Interest-earning assets:
Loans receivable $ 503,955 $ 18,041 7.22% $ 527,269 $ 22,348 8.55%
Securities 120,930 3,175 5.29 59,863 1,860 6.27
Interest-earning deposits 54.972 427 1.57 9,815 210 4.31
FHLB stock and other 25,444 466 3.69 15,392 554 7.26
---------- ---------- ---------- ----------
Total interest-earning assets 705,301 22,109 6.32 612,339 24,972 8.22
Non-interest-earning assets
(including assets of discontinued
operations) 312,319 444,950
---------- ----------
Total assets $1,017,620 $1,057,289
========== ==========
Interest-bearing liabilities (3):
Deposits $ 535,478 $ 8,389 3.16% $ 443,943 $ 11,161 5.07%
FHLB advances and other 69,585 1,774 5.14 96,753 2,544 5.30
Notes payable 11,930 227 3.84 17,831 587 6.64
---------- ---------- ---- ---------- ----------
Total interest-bearing liabilities 616,993 10,390 3.40 558,527 14,292 5.16
Non-interest bearing deposits 30,849 -- 33,378 --
---------- ---------- ---------- ----------
Total including non-interest bearing
demand deposits 647,842 10,390 3.23 591,905 14,292 4.87
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 254,152 363,577
---------- ----------
Total liabilities 901,994 955,482
Stockholders' equity 115,626 101,807
---------- ----------
Total liabilities and stock-
holders' equity $1,017,620 $1,057,289
========== ==========
Net interest income; interest
rate spread $ 11,719 2.92% $ 10,680 3.06%
========== ==== ========== ====
Net interest margin (2) 3.35% 3.52%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 114% 110%
==== ====
- -------------------------------------------
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
(3) This analysis does not reflect borrowings to fund discontinued operations.
20
Results of Operations
- ---------------------
On April 1, 2002, First Defiance completed the sale of The Leader to US Bancorp.
As a result of this sale, management has included the operating results for The
Leader in discontinued operations for all periods presented. Also included in
discontinued operations is the $7.7 million gain realized from the sale of The
Leader and the cost associated with early payment penalties incurred in retiring
certain FHLB advances which were used to fund operations of The Leader. See Note
3 to the Consolidated Condensed Financial Statements filed with this Form 10-Q.
Three Months Ended June 30, 2002 compared to Three Months Ended June 30, 2001
- -----------------------------------------------------------------------------
On a consolidated basis, First Defiance had net income of $8.7 million or $1.30
per share for the three months ended June 30, 2002 compared to $2.6 million or
$0.39 per share in 2001. Income from continuing operations totaled $1.39 million
or $0.21 per share for the 2002 second quarter, down slightly from $1.45 million
or $0.22 per share in the same period in 2001.
Net Interest Income. Net interest income from continuing operations for the
quarter ended June 30, 2002 was $5.7 million compared to $5.3 million for the
same period in 2001. Net interest margin for the 2002 second quarter was 2.90%
compared to 3.61% for the same period in 2001.
Total interest income from continuing operations decreased by $206,000 from
$12.1 million for the three months ended June 30, 2001 to $11.9 million for the
three months ended June 30, 2002. Interest on loans decreased $2.0 million to
$9.1 million in the second quarter of 2002 from $11.1 million in the second
quarter of 2001. The decrease in interest from loans was due to a reduction in
both the average balance of loans outstanding and the yields on those loans
between the second quarter of 2001 and the second quarter of 2002. The reduction
in loan balances is attributable to a reduction in the balance of mortgage loans
outstanding, from $203.4 million at June 30, 2001 to $165.1 million at June 30,
2002 as loans refinanced out of the Company's portfolio were sold into the
secondary market. Growth in First Defiance's commercial loan and commercial real
estate loan portfolios, from $246.2 million at June 30, 2001 to $272.3 million
at June 30, 2002 offset some of the loss in mortgage loan balances. The yield on
First Defiance's loan portfolio declined from 8.43% for the three months ended
June 30, 2001 to 7.12% for the same period in 2002 because of falling interest
rates over that time period.
Interest earnings from the investment portfolio and interest-earning deposits
increased $1.8 million to $2.8 million for the three months ended June 30, 2002
compared to $1.0 million for the same period in 2001. The increase is due to the
proceeds received from the sale of The Leader. The average balance of securities
for the 2002 second quarter increased to $188.4 million from $60.0 million for
the same period in 2001. In addition, First Defiance held an average of $96.3
million in overnight or interest-earning deposit accounts for the three months
ended June 30, 2002 as The Leader sale proceeds were not fully invested.
Interest expense from continuing operations decreased by $651,000, to $6.2
million for the first quarter of 2002 compared to $6.8 million for the same
period in 2001. The decrease is due primarily to a 141 basis point decrease in
the average cost of interest-bearing liabilities, from 4.91% for the first
quarter of 2001 to 3.50% in the first quarter of 2002. The average balances of
interest-bearing liabilities increased $149.5 million from $558.9 million first
quarter of 2001 to $708.4 million in the first quarter of 2002. The average
balance sheets and income statements have been adjusted to allocate interest
expense associated with financing The Leader's operations to discontinued
operations. Therefore, the average interest-bearing liabilities reflect only
those funds attributable to First Defiance's continuing operations.
21
Provision for Loan Losses. The provision for loan losses decreased $96,000, to
$156,000 for the three-months ended June 30, 2002 from $252,000 during the same
period in 2001. Provisions for loan losses are charged to earnings to bring the
total allowance for loan losses to the level deemed appropriate by management
based on historical experience, the volume and type of lending conducted by
First Defiance, industry standards, the amount of non-performing assets and loan
charge-off activity, general economic conditions, particularly as they relate to
First Defiance's market area, and other factors related to the collectibility of
First Defiance's loan portfolio. The decrease in the provision for loan losses
for the second quarter of 2002 compared to the same period in 2001 is a function
of the required allowance for loan loss balances and net charge-offs recognized
in these periods. Management believes the balance of the allowance for loan
losses is appropriate.
Non-performing assets and asset quality ratios for First Defiance were as
follows (in $000's):
June 30, December 31,
2002 2001
---- ----
Non-accrual loans $ 3,052 $ 2,255
Loans over 90 days past due and still accruing -- --
--------- ---------
Total non-performing loans 3,052 2,255
Real estate owned (REO) 335 136
--------- ---------
Total non-performing assets $ 3,387 $ 2,391
========= =========
Allowance for loan losses as a
percentage of total loans 1.35% 1.29%
Allowance for loan losses as a
percentage of non-performing assets 207.50% 273.86%
Allowance for loan losses as a
percentage of non-performing loans 230.28% 290.38%
Total non-performing assets as a percentage
of total assets from continuing operations 0.38% 0.37%
Total non-performing loans as a
percentage of total loans 0.59% 0.45%
Of the $3.1 million in non-accrual loans, $2.2 million were commercial loans or
non-residential real estate loans and $813,000 were residential mortgage loans.
The allowance for loan losses at June 30, 2002 was $7.0 million compared to $6.5
million at both June 30, 2001 and December 31, 2001. For the quarter ended June
30, 2002, First Defiance charged off $128,000 of loans against its allowance and
realized recoveries of $67,000 from loans previously charged off. During the
same quarter in 2001, First Defiance charged off $208,000 in loans and realized
recoveries of $69,000.
22
Non-Interest Income. Non-interest income increased $140,000 in the second
quarter of 2002, to $2.7 million for the quarter ended June 30, 2002 from $2.6
million for the same period in 2001. Individual components of non-interest
income are as follows:
Service Fees. Loan and deposit fees increased $212,000 to $955,000 for the
quarter ended June 30, 2002 from $743,000 for the quarter ended June 30, 2001.
Increases occurred primarily in loan servicing fees on sold loans, debit card
interchange fees, which is a result of a marketing program to promote the use of
debit cards, and an increase in checking NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $104,000 to $827,000 in the second quarter of 2002
from $723,000 in the same period of 2001. Increases occurred in the property and
casualty lines as well as income from the sale of securities and annuities.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, gain on sale of loans, and other miscellaneous
charges, decreased to $955,000 for the quarter ended June 30, 2002 from
$1,129,000 for the same period in 2001. This decrease is due primarily to a
reduction of gain on sale of loans, which is a result of the slowdown in
refinance activity in the 2002 second quarter compared to the same period in
2001.
Non-Interest Expense. Total non-interest expense increased $860,000 to $6.3
million for the quarter ended June 30, 2002 from $5.5 million for the same
period in 2001. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $483,000 to $3.49
million for the quarter ended June 30, 2002 from $3.01 million for the same
period in 2001. The increase was the result an increase in total workforce of
approximately 10% between June 30, 2001 and June 30, 2002, cost of living and
merit increases for existing employees which averaged approximately 4%, higher
level of sales commissions at First Insurance due to higher commission premium
income and a $77,000 increase in the estimated cost of First Defiance's
self-insured group health insurance plan.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of
mortgage servicing rights ("MSRs") totaled $137,000 in the 2002 second quarter
compared to $241,000 in the 2001 second quarter. Impairment in the amount of
$168,000 was recognized in the second quarter of 2002 as a result of falling
interest rates during the 2002 second quarter which negatively impacted the MSRs
market value. There was no impairment recognized in the second quarter of 2001.
First Defiance has a total impairment reserve of $1.1 million recorded against
its $3.4 million servicing portfolio at June 30, 2002. That portfolio represents
approximately 4,000 loans with unpaid balances of approximately $265.0 million.
While First Defiance exited the mortgage banking business on the national level
with the sale of The Leader, it continues to service mortgage loans originated
through its First Federal community banking center network and sold into the
secondary market.
Amortization of Goodwill. First Defiance is no longer required to recognize
goodwill amortization as an expense. Such amortization totaled $79,000 in the
second quarter of 2001. (See Note 4 to the Consolidated Condensed Financial
Statements).
23
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $2.5 million for the quarter ended June 30, 2002 from $2.1 million for the
same period in 2001.
First Defiance has computed federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 30.46% for the
quarter ended June 30, 2002 compared to 33.38% for the same period in 2001. The
reduction in the effective tax rate is a result of investing approximately $26.5
million in municipal securities which are exempt from federal tax. As a result
of the above factors, income from continuing operations for the quarter ended
June 30, 2002 was $1.39 million compared to $1.45 million for the comparable
period in 2001. On a per share basis, basic and diluted earnings per share for
the three months ended June 30, 2002 from continuing operations were each $0.22
and $.21, respectively, compared to $0.22 and $0.22, respectively, for the
quarter ended June 30, 2001.
Discontinued Operations. Income from discontinued operations for the 2002 second
quarter totaled $7.3 million or $1.09 per diluted share. It was comprised
primarily of a $7.7 million after-tax gain recognized from the sale of The
Leader and an after-tax charge of $350,000 resulting from the payment of
$539,000 of prepayment penalties on certain FHLB advances that were retired
early. Those advances were used to fund a portion of The Leader's operations.
Discontinued operations from the 2001 period were $1.1 million or $0.17 per
share and include the net income earned by The Leader prior to the sale.
Six Months Ended June 30, 2002 compared to Six Months Ended June 30, 2001
- -------------------------------------------------------------------------
On a consolidated basis, First Defiance had net income of $11.4 million or $1.71
per share for the six months ended June 30, 2002 compared to $5.6 million or
$0.86 per share in 2001. Net income before the cumulative effect of a change in
accounting for goodwill was $11.6 million, or $1.74 per share for the six months
ended June 30, 2002 and income from continuing operations totaled $2.3 million
or $0.34 per share for 2002 six month period, down slightly from $2.4 million or
$0.37 per share for the same period in 2001.
Because the continuing operations of First Defiance do not reflect the
reinvestment of any of the proceeds from the sale of The Leader for the first
three months of 2002, management does not believe the results of continuing
operations for the first six months of 2002 accurately represent what the
results of First Defiance will be on a going-forward basis. See the Pro Forma
Income statement section of Management's Discussion and Analysis.
Net Interest Income. Net interest income from continuing operations for the six
months ended June 30, 2002 was $11.3 million compared to $10.1 million for the
same period in 2001. Net interest margin for the 2002 second quarter was 3.35%
compared to 3.52% for the same period in 2001.
Total interest income from continuing operations decreased $2.8 million from
$24.4 million for the six months ended June 30, 2001 to $21.6 million for the
six months ended June 30, 2002. Interest on loans decreased $4.3 million to
$18.0 million in the second quarter of 2002 from $22.3 million in the second
quarter of 2001. The decrease in interest from loans was due to a reduction in
both the average balance of loans outstanding and the yields on those loans
between the first half of 2001 and the first half of 2002. The year to date
average balance of loans decreased $23.3 million to $504.0 million in the 2002
period from $527.3 in 2001. The decrease is due to the decrease in the year to
date average balance of mortgage loans, a result of heavy refinance activity
over the period. The yield on First Defiance's loan portfolio declined from
8.55% for the six months ended June 30, 2001 to 7.22% for the same period in
2002 because of falling interest rates over that time period.
24
Interest earnings from the investment portfolio and interest-earning deposits
increased $1.5 million to $3.6 million for the six months ended June 30, 2002
compared to $2.1 million for the same period in 2001. The increase is due to the
reinvestment of the proceeds received from the sale of The Leader. The average
balance of securities for the six-month period in 2002 increased to $175.9
million from $69.7 million for the same period in 2001.
Interest expense from continuing operations decreased by $3.9 million, to $10.4
million for the first six months of 2002 compared to $14.3 million for the same
period in 2001. The decrease is due primarily to a 176 basis point decrease in
the average cost of interest-bearing liabilities, from 5.16% for the first half
of 2001 compared to 3.40% in the first half of 2002. The average balances of
interest-bearing liabilities increased $58.5 million from $558.5 million in the
first six months of 2001 compared to $617.0 million in the same period of 2002.
The average balance sheet and income statement have been adjusted to allocate
interest expense associated with financing The Leader's operations to
discontinued operations. Therefore, the average interest-bearing liabilities
reflect only those funds necessary for First Defiance's continuing operations.
Provision for Loan Losses. The 2002 provision for loan losses totaled $738,000,
an increase of $351,000 from the 2001 provision. That increase was due both to
the continued change in mix in the loan portfolio from mortgage loans to
commercial loans and commercial real estate loans, and an increase in
non-performing mortgage loans during the 2002 first quarter. The status of the
mortgage loans improved during the 2002 second quarter. First Defiance charged
off $378,000 of loans against its allowance for loan losses for the six-month
period ended June 30, 2002 and realized recoveries of $120,000 from loans
previously charged off. During the same period in 2001, First Defiance charged
off $357,000 in loans and realized recoveries of $119,000.
Non-Interest Income. Non-interest income increased $411,000 in the first six
months of 2002, to $5.2 million from $4.8 million for the same period in 2001.
Individual components of non-interest income are as follows:
Service Fees. Loan and deposit fees increased $372,000 to $1.8 million for the
six months ended June 30, 2002 from $1.4 million for the six months ended June
30, 2001. Increases occurred primarily in loan servicing fees on sold loans,
commercial loan fees, debit card interchange fees, and NSF fees.
Insurance and Investment Sales Commissions. Insurance and investment sales
commission income increased $254,000 to $1.7 million in the first half of 2002
from $1.5 million in the same period of 2001. Increases occurred in the property
and casualty lines as well as income from the sale of securities and annuities.
Insurance commissions also include $84,000 related to the placement of
force-placed insurance for The Leader. This portion of First Insurance's income
is not recurring with the sale of The Leader. First Insurance also incurred
$67,000 of related expense associated with the force-placed insurance which also
will not be recurring.
25
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, gain on sale of loans, and other miscellaneous
charges, decreased to $1.7 million for the six months ended June 30, 2002 from
$1.9 million for the same period in 2001. This decrease is due primarily to a
reduction of gain on sale of loans, which is a result of slightly lower levels
of refinance activity in the first half of 2002 compared to 2001.
Non-Interest Expense. Total non-interest expense increased $1.4 million to $12.3
million for the six months ended June 30, 2002 from $10.9 million for the same
period in 2001. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $835,000 to $6.8
million year to date in 2002 from $6.0 million for the same period in 2001. This
increase was the due a 10% increase in the overall size of staff, merit and cost
of living increases which were approximately 4% on average, higher sales
commission expense at First Insurance and higher group health insurance costs.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of MSRs
totaled $265,000 in the six months ended June 30, 2002 compared to $373,000 in
the same period of 2001. Impairment in the amount of $264,000 was recognized in
the first half of 2002. There was no impairment recognized in the first half of
2001. Impairment results from a decline in the market value of MSRs principally
due to falling interest rates
Amortization of Goodwill. During 2002, First Defiance adopted the provisions of
FAS No. 142, Goodwill and Other Intangible Assets. As required under the
standard, management evaluated goodwill recorded at First Insurance for the
purpose of measuring impairment and determined that such goodwill was impaired
by $238,000 ($194,000 or $0.03 per share after tax) as of January 1, 2002. As
permitted, this amount is reflected in the income statement as the cumulative
effect of a change in accounting principle. In addition to the $238,000 of
impaired goodwill, during the first quarter First Defiance paid additional
consideration of $200,000 to settle a contingent payout clause under its
agreement to acquire First Insurance. The impairment of the goodwill created by
that settlement was recorded as an operating expense during the 2002 first
quarter. Amortization expense recognized by First Defiance in the first half of
2001 totaled $155,000. Such amortization is no longer required. (See Note 4 to
the Consolidated Condensed Financial Statements).
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $4.78 million for the six months ended June 30, 2002 from $4.41 million for
the same period in 2001.
The effective tax rate utilized for the six months ended June 30, 2002 was 32.6%
compared to 33.0% for the six months ended June 30, 2001.
26
As a result of the above factors, income from continuing operations for the six
months ended June 30, 2002 was $2.2 million compared to $2.4 million for the
comparable period in 2001. On a per share basis, basic and diluted earnings per
share for the six months ended June 30, 2002 from continuing operations were
$0.35 and $.34, respectively, compared to $0.37 for both basic and diluted
earnings per share for the six months ended June 30, 2001.
Discontinued Operations. Income from discontinued operations for the six months
ended June 30, 2002 totaled $9.3 million or $1.46 per share. It was comprised of
the $7.7 million after-tax gain recognized from the sale of The Leader, $2.0
million of net income earned by The Leader prior to the sale, and an after-tax
charge of $350,000 relating to prepayment penalties incurred in the retirement
of certain FHLB advances. Discontinued operations from the 2001 six month period
were $3.2 million or $0.49 per share which represents net income of The Leader
for that period, net of inter-company financing charges.
First Defiance's board of directors declared a dividend of $.13 per common share
as of June 30, 2002. The dividend amounted to $886,143, including dividends on
unallocated ESOP shares. It was paid on July 26, 2002. Dividends are subject to
determination and declaration by the board of directors, which will take into
account First Defiance's financial condition and results of operations, economic
conditions, industry standards and regulatory restrictions which affect First
Defiance's ability to pay dividends.
Liquidity and Capital Resources
- -------------------------------
As a regulated financial institution, First Federal is required to maintain
appropriate levels of "liquid" assets to meet short-term funding requirements.
With the completion of the sale of The Leader early in the second quarter, First
Defiance has a significant amount of liquidity.
First Defiance used $44.4 million of cash from operating activities during the
first six months of 2002. Excluding discontinued operations, First Defiance used
$3.8 million of cash from operations during that same period. The Company's cash
from operating activities resulted from net income for the period, adjusted for
various non-cash items, including the provision for loan losses, depreciation
and amortization, including amortization of mortgage servicing rights, goodwill
write-offs, ESOP expense related to release of shares, and changes in loans
available for sale, interest receivable and other assets, and other liabilities.
The primary investing activity of First Defiance is the origination of loans
(both for sale in the secondary market and to be held in portfolio), which is
funded with cash provided by operations, proceeds from the amortization and
prepayments of existing loans, the sale of loans, proceeds from the sale or
maturity of securities, borrowings from the FHLB, and customer deposits.
At June 30, 2002, First Defiance had $67.2 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $79.9 million committed under existing consumer and
commercial lines of credit and standby letters of credit. Also at that date,
First Defiance had commitments to sell $610,000 of loans held-for-sale. Also as
of June 30, 2002, the total amount of certificates of deposit that are scheduled
to mature by June 30, 2003 is $229.2 million. First Defiance believes that it
has adequate resources to fund commitments as they arise and that it can adjust
the rate on savings certificates to retain deposits in changing interest rate
environments. If First Defiance requires funds beyond its internal funding
capabilities, advances from the FHLB of Cincinnati and other financial
institutions are available.
27
Upon the sale of The Leader, First Defiance had net investible funds of
approximately $365 million. Of this, $81.5 million was used to pay off FHLB
overnight advances and $19.6 million was used to pay off term debt. Management
also elected to prepay $25 million of fixed rate FHLB advances, incurring a
prepayment penalty of $539,000 in the 2002 second quarter discontinued
operations. Approximately $170 million of the funds from the sale of The Leader
were added to the investment portfolio, with $130 million of those funds
invested long-term to earn a yield of 5.65% and the balance invested in
short-term or overnight securities in anticipation of rising rates. The balance
of the proceeds from the sale of The Leader have been used to fund loan growth
and brokered CD runoff.
First Defiance utilizes forward purchase and forward sale agreements to meet the
needs of its customers and manage its exposure to fluctuations in the fair value
of mortgage loans held for sale and its pipeline. These forward purchase and
forward sale agreements are considered to be derivatives as defined by FAS 133,
Accounting for Derivatives and Hedging Instruments. The change in value in the
forward purchase and forward sale agreements is approximately equal to the
change in value in the loans held for sale and the effect of this accounting
treatment is not material to the financial statements.
First Defiance also invests in on-balance sheet derivative securities as part of
the overall asset and liability management process. Such derivative securities
include REMIC and CMO investments. Such investments are not classified as high
risk at June 30, 2002 and do not present risk significantly different than other
mortgage-backed or agency securities.
First Federal is required to maintain specified amounts of capital pursuant to
regulations promulgated by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
The following table sets forth First Federal's compliance with each of the
capital requirements at June 30, 2002.
Core Capital Risk-Based Capital
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
----------------------------- -----------------------------
Regulatory capital $ 108,916 $ 108,916 $ 115,917 $ 115,917
Minimum required regulatory capital 34,736 43,420 44,807 56,009
---------- ---------- ---------- ----------
Excess regulatory capital $ 74,180 $ 65,496 $ 71,110 $ 59,908
========== ========== ========== ==========
Regulatory capital as a percentage of assets (1) 12.5% 12.5% 20.7% 20.7%
Minimum capital required as a percentage of 4.0% 5.0% 8.0% 10.0%
assets ---------- ---------- ---------- ----------
Excess regulatory capital as a percentage of 8.5% 7.5% 12.7% 10.7%
assets ========== ========== ========== ==========
- ---------------------------
(1) Core capital is computed as a percentage of adjusted total assets of $868.4
million. Risk-based capital is computed as a percentage of total
risk-weighted assets of $560.1 million.
28
Pro Forma Income Statement
Management does not believe that year-to-date income from continuing operations
for the six months ended June 30, 2002, as presented in the consolidated
condensed financial statements, accurately represents what the results of
operations for First Defiance will be on a going-forward basis because the
continuing operations results for the first three months of 2002 do not reflect
the reinvestment of any of the proceeds from the sale of The Leader.
The following pro-forma income statement for the six months ended June 30, 2002
attempts to present what First Defiance's results from continuing operations
would have been had the sale of The Leader occurred as of January 1, 2002 and
the proceeds from the sale fully invested for the entire quarter. Management has
estimated that the additional assets added to the balance sheet as a result of
the sale of The Leader would have been reinvested to yield a weighted average
rate of 4.44% for the period from January 1, 2002 to April 1, 2002. Also, to the
extent possible, management has assumed that proceeds of the sale have been used
to prepay advances. Dollars are in thousands (except per share amounts).
Continuing Operations
Pro Forma As Reported
Interest income $24,686 $21,643
Interest expense 12,906 10,390
--------- ------
Net interest income 11,780 11,253
Provision for loan losses 738 738
--------- ------
Net interest after provision 11,042 10,515
Non-interest income 5,162 5,162
Non-interest expense 12,305 12,305
--------- ------
Income before income taxes 3,899 3,372
Income taxes 1,284 1,099
--------- ------
Net income from continuing operations $2,615 $2,273
========= ======
Net income per share from continuing
operations $ .39 $ .34
========= ======
FDIC Insurance
The deposits of First Federal are currently insured by the Savings Association
Insurance Fund ("SAIF") which is administered by the FDIC. The FDIC also
administers the Bank Insurance Fund ("BIF") which generally provides insurance
to commercial bank depositors. Both the SAIF and BIF are required by law to
maintain a reserve ratio of 1.25% of insured deposits. First Federal's annual
deposit insurance premiums for 2002 are approximately $0.018 per $100 of
deposits.
29
Item 3. Qualitative and Quantitative Disclosure About Market Risk
- -----------------------------------------------------------------
As discussed in detail in the 2001 Annual Report on Form 10-K, First Defiance's
ability to maximize net income is dependent on management's ability to plan and
control net interest income through management of the pricing and mix of assets
and liabilities. Because a large portion of assets and liabilities of First
Defiance are monetary in nature, changes in interest rates and monetary or
fiscal policy affect its financial condition and can have significant impact on
the net income of the Company. First Defiance does not use off balance sheet
derivatives to enhance its risk management, nor does it engage in trading
activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis
through simulation analysis which measures the impact changes in interest rates
can have on net income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, nonmaturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise or fall 100 basis points over a 12 month period, using
June 2002 amounts as a base case, First Defiance's net interest income would be
impacted by less than the board mandated guidelines of 10%.
FIRST DEFIANCE FINANCIAL CORP.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
First Defiance is not engaged in any legal proceedings of a material
nature.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
Exhibit 99.1 - Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
Exhibit 99.2 - Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
30
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: August 14, 2002 By: /s/ William J. Small
--------------- ------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: August 14, 2002 By: /s/ John C. Wahl
--------------- ---------------------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
31