UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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 September 30, 2002
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
First Defiance Financial Corp.
(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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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 -
6,577,010 shares outstanding at November 11, 2002.
1
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number
-----------
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - September 30, 2002 and December 31, 2001 2
Consolidated Condensed Statements of Income -
Three and nine months ended September 30, 2002 and 2001 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Nine months ended September 30, 2002 5
Consolidated Condensed Statements of Cash Flows
- Nine months ended September 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 32
Item 4. Controls and Procedures 32
PART II.-OTHER INFORMATION:
Item 1. Legal Proceedings 33
Item 2. Changes in Securities 33
Item 3. Defaults upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 34
Certifications Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 35
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
- ----------------------------
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- -----------------------------------------------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 19,809 $ 37,334
Interest-bearing deposits 27,561 766
-------- ----------
47,370 38,100
Securities:
Available-for-sale, carried at fair value 208,983 48,691
Held-to-maturity, carried at amortized cost
(approximate fair value $4,568 and $5,678
at September 30, 2002 and December 31,
2001 respectively) 4,358 5,580
-------- ----------
213,341 54,271
Loans held for sale 8,920 672
Loans receivable, net 537,289 499,141
Accrued interest receivable 4,924 2,940
Federal Home Loan Bank stock and other
interest-earning assets 21,950 16,306
Office properties and equipment 20,308 20,067
Real estate and other assets held for sale 371 136
Goodwill, net 3,602 3,749
Deferred taxes -- 35
Mortgage servicing rights 1,680 1,821
Other assets 3,994 652
Assets held for sale -- 6,304
Assets of discontinued operations -- 488,454
-------- ----------
Total assets $863,749 $1,132,648
======== ==========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 34,542 $ 25,428
Interest-bearing deposits 556,250 589,420
--------- -----------
Total deposits 590,792 614,848
Advances from Federal Home Loan Bank 131,184 196,302
Short-term borrowings and other interest-bearing liabilities 3,229 20,724
Advance payments by borrowers for taxes and insurance 226 390
Deferred taxes 2,353 --
Other liabilities 11,077 6,517
Liabilities associated with assets held for sale -- 6,242
Liabilities of discontinued operations -- 176,604
--------- -----------
Total liabilities 738,861 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; 6,737
and 6,854 shares outstanding, respectively 67 69
Additional paid-in capital 53,136 53,725
Stock acquired by ESOP (2,387) (2,813)
Deferred compensation (43) (82)
Accumulated other comprehensive income,
net of income taxes of $3,497
and $410, respectively 6,493 763
Retained earnings 67,622 59,359
--------- -----------
Total stockholders' equity 124,888 111,021
--------- -----------
Total liabilities and stockholders' equity $ 863,749 $ 1,132,648
========= ===========
3
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
- --------------------------------------------------------------------------------------------------------------------------
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest Income
Loans $ 9,281 $ 10,642 $ 27,322 $ 32,990
Investment securities 2,728 833 5,903 2,693
Interest-bearing deposits 192 17 619 227
------- -------- -------- --------
Total interest income 12,201 11,492 33,844 35,910
Interest Expense
Deposits 4,227 5,185 12,616 16,346
FHLB advances and other 1,702 721 3,476 3,265
Notes payable and warehouse loans 23 264 250 851
------- -------- -------- --------
Total interest expense 5,952 6,170 16,342 20,462
------- -------- -------- --------
Net interest income 6,249 5,322 17,502 15,448
Provision for loan losses 386 272 1,124 659
------- -------- -------- --------
Net interest income after provision for loan losses 5,863 5,050 16,378 14,789
Non-interest Income
Service fees and other charges 968 776 2,721 2,157
Insurance commission income 810 740 2,520 2,196
Dividends on stock and other interest income 234 279 700 833
Gain on sale of loans 1,179 667 2,254 1,969
Gain/(loss) on sale of securities 36 (45) 21 (103)
Trust income 32 25 86 80
Other non-interest income 12 23 131 84
------- -------- -------- --------
Total non-interest income 3,271 2,465 8,433 7,216
Non-interest Expense
Compensation and benefits 3,630 3,043 10,428 9,006
Occupancy 671 670 2,084 2,031
SAIF deposit insurance premiums 32 32 97 92
State franchise tax 351 305 996 982
Data processing 362 344 1,053 1,030
Amortization and impairment of mortgage servicing rights 1,033 257 1,562 630
Amortization and impairment of goodwill and other intangibles -- 79 200 234
Other non-interest expense 1,105 912 3,069 2,547
------- -------- -------- --------
Total non-interest expense 7,184 5,642 19,489 16,552
------- -------- -------- --------
Income from continuing operations before income taxes 1,950 1,873 5,322 5,453
Federal income taxes 568 625 1,667 1,808
------- -------- -------- --------
Income from continuing operations 1,382 1,248 3,655 3,645
Discontinued operations, net of tax -- 1,722 9,347 4,966
------- -------- -------- --------
Income before cumulative effect of a change in accounting principle 1,382 2,970 13,002 8,611
Cumulative effect of change in method of accounting for goodwill,
net of tax -- -- (194) --
------- -------- -------- --------
Net income $ 1,382 $ 2,970 $ 12,808 $ 8,611
======= ======== ======== ========
Earnings per share (Note 5)
Basic:
From continuing operations $ 0.22 $ 0.19 $ 0.57 $ 0.57
Discontinued operations, net of tax $ -- $ 0.27 $ 1.46 $ 0.78
Cumulative effect in method of accounting for goodwill $ -- -- $ (0.03) --
------- -------- -------- --------
Net income $ 0.22 $ 0.46 $ 2.00 $ 1.35
======= ======== ======== ========
Diluted:
From continuing operations $ 0.21 $ 0.19 $ 0.55 $ 0.55
Discontinued operations, net of tax $ -- $ 0.26 $ 1.40 $ 0.76
Cumulative effect in method of accounting for goodwill $ -- -- $ (0.03) --
------- -------- -------- --------
Net income $ 0.21 $ 0.45 $ 1.92 $ 1.31
======= ======== ======== ========
Dividends declared per share (Note 4) $ 0.13 $ 0.12 $ 0.39 $ 0.36
======= ======== ======== ========
Average shares outstanding (Note 5)
Basic 6,400 6,405 6,416 6,389
======= ======== ======== ========
Diluted 6,652 6,601 6,665 6,581
======= ======== ======== ========
See accompanying notes
4
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 ($3,110)
Total comprehensive income
ESOP shares released 358 426
Amortization of deferred compensation
of Management Recognition Plan 39
Shares issued under stock option plan 763
Purchase of common stock for
treasury (2) (1,710)
Dividends declared (Note 5)
------------------------------------------------
Balance at September 30 $ 67 $ 53,136 $(2,387) $(43)
================================================
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 12,808 12,808 8,611
Change in unrealized gains (losses)
net of income taxes of ($3,110) 5,730 5,730 1,017
Total comprehensive income 18,538 9,628
ESOP shares released 784 598
Amortization of deferred compensation
of Management Recognition Plan 39 90
Shares issued under stock option plan 763 114
Purchase of common stock for
treasury (2,015) (3,727) (748)
Dividends declared (Note 5) (2,530) (2,530) (2,329)
--------------------------------------------- --------
Balance at September 30 $ 6,493 $ 67,622 $ 124,888 $106,826
============================================= ========
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- ------------------------------------------------------------------------------------------
Nine Months
Ended September 30,
2002 2001
---- ----
Operating Activities
Net income $ 12,808 $ 8,611
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,124 659
Provision for depreciation 1,176 1,172
Net securities amortization 496 23
Amortization of mortgage servicing rights 777 630
Net impairment of mortgage servicing rights 785 --
Amortization of goodwill -- 234
Net impairment of goodwill 438 --
Gain on sale of loans (2,254) (1,969)
Gain on sale of discontinued operations (16,912) --
Amortization of Management Recognition Plan
deferred compensation 39 90
Release of ESOP Shares 784 599
(Gains) losses on sales of securities (21) 103
Deferred federal income tax credit (313) (3)
Proceeds from sale of loans 107,092 113,837
Origination of mortgage servicing rights, net (1,421) (1,125)
Origination of loans held for sale (113,086) (111,900)
Increase in interest receivable and other assets (5,411) (652)
Increase (decrease) in other liabilities 361 (571)
Decrease in assets held for sale 6,304 1,096
Decrease in liabilities held for sale (6,292) (230)
Increase in assets of discontinued operations (5,418) (18,864)
Decrease in liabilities of discontinued operations (35,166) (70,985)
--------- ---------
Net cash provided by operating activities (54,110) (79,245)
Investing Activities
Proceeds from maturities of held-to-maturity securities 1,197 1,494
Proceeds from maturities of available-for-sale securities 18,313 4,579
Proceeds from sale of available-for-sale securities 2,459 3,079
Proceeds from sales of real estate and
other assets held for sale 439 222
Proceeds from sales of office properties and equipment -- 27
Proceeds from sale of discontinued operations 367,921 --
Purchases of available-for-sale securities (172,674) (2,535)
Purchases of Federal Home Loan Bank stock (576) (832)
Purchases of office properties and equipment (1,421) (1,133)
Net (increase) decrease in loans receivable (39,946) 15,071
--------- ---------
Net cash provided by investing activities 175,712 19,972
========= =========
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
Nine Months Ended
September 30,
2002 2001
---- ----
Financing Activities
Net increase (decrease) in deposits (24,220) 61,321
Repayment of Federal Home Loan Bank long-term advances (25,118) (353)
Repayment of term notes payable (29) (27)
Net decrease in Federal Home Loan Bank
short-term advances (40,000) (96,000)
Net increase (decrease) in short-term line of credit (18,250) 5,500
Proceeds from Federal Home Loan Bank long term advances -- 90,000
Increase in securities sold under repurchase agreements 779 --
Purchase of common stock for treasury (3,727) (748)
Cash dividends paid (2,530) (2,329)
Proceeds from exercise of stock options 763 114
--------- --------
Net cash used in financing activities (112,332) 57,478
--------- --------
Increase in cash and cash equivalents 9,270 (1,795)
Cash and cash equivalents at beginning of period 38,100 22,002
--------- --------
Cash and cash equivalents at end of period $ 47,370 $ 20,207
========= ========
Supplemental cash flow information:
Interest paid $ 16,889 $ 20,533
========= ========
Income taxes paid $ 9,451 $ 5,570
========= ========
Transfers from loans to real estate
and other assets held for sale $ 674 $ 243
========= ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ (3,110) $ (612)
========= ========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ 8,840 $ 1,649
========= ========
Noncash financing activities:
Cash dividends declared but not paid $ 835 $ 769
========= ========
See accompanying notes
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 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
September 30, 2002 and for the nine-month period ending September 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 nine-month period ended September 30, 2002
are not necessarily indicative of the results that may be expected for the
entire year.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 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 Nine months ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Operations of The Leader -- $1,722 $ 2,015 $4,966
Gain from sale of The Leader -- -- 7,682 --
Cost to terminate financing associated
with discontinued operations -- -- (350) --
------ ------ ------- ------
$ -- $1,722 $ 9,347 $4,966
====== ====== ======= ======
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
$3.6 million at September 30, 2002.
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2002 and 2001)
- --------------------------------------------------------------------------------
4. Change in Accounting Method (continued)
Results from continuing operations for the three and nine months ended
September 30, 2001 include goodwill amortization expense of $79,000 and
$234,000, respectively. Had FAS No. 142 been in effect for that period, the
Company would have reported income from continuing operations of $1.5
million for the three months ended September 30, 2001 and $2.5 million for
the nine months ended September 30, 2001. This amount was determined as
follows (in thousands, except for per share amounts):
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Reported income from continuing operations $ 1,382 $ 1,248 $ 3,655 $ 3,645
Add back: Goodwill amortization -- 79 -- 234
Deduct: Tax benefit from deductible goodwill -- (15) -- (45)
------ ------ ------ ------
Adjusted income from continuing operations 1,382 1,312 3,655 3,834
Basic earnings per share:
Reported income from continuing operations $ .22 $ .19 $ .57 $ .57
Add back: Goodwill amortization -- .01 -- .04
Deduct: Tax benefit from deductible goodwill -- -- -- (.01)
------ ------ ------ ------
Adjusted income from continuing operations $ .22 $ .20 $ .57 $ .60
Diluted earnings per share:
Reported income from continuing operations $ .21 $ .19 $ .55 $ .55
Add back: Goodwill amortization -- .01 -- .04
Deduct: Tax benefit from deductible goodwill -- -- -- (.01)
------ ------ ------ ------
Adjusted income from continuing operations $ .21 $ .20 $ .55 $ .58
5. Dividends on Common Stock
As of September 30, 2002, First Defiance had declared a quarterly cash
dividend of $.13 per share for the third quarter of 2002, payable October
25, 2002.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 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 nine month periods ended September 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 nine-months
ended September 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 Nine months ended
September 30, September 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----
Numerator for basic and diluted
earnings per share - income from
continuing operations $ 1,382 $ 1,248 $ 3,655 $ 3,645
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 6,400 6,405 6,416 6,389
Effect of dilutive securities:
Employee stock options 242 175 234 154
Unvested Management Recognition
Plan stock 10 21 15 38
------- ------- ------- -------
Dilutive potential common shares 252 196 249 192
------- ------- ------- -------
Denominator for diluted earnings
per share - adjusted weighted average
shares and assumed conversions 6,652 6,601 6,665 6,581
======= ======= ======= =======
Basic earnings per share from
continuing operations $ .22 $ .19 $ .57 $ .57
======= ======= ======= =======
Diluted earnings per share from
continuing operations $ .21 $ .19 $ .55 $ .55
======= ======= ======= =======
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2002 and 2001)
- -----------------------------------------------------------------------------------------------------------
7. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities (in thousands):
September 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 $106,317 $ 6,238 $ 4 $112,551
Corporate bonds 28,738 1,600 16 30,322
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 54 2,055
Adjustable rate mortgage-backed securities 5,371 174 -- 5,545
Collateralized mortgage obligations 26,943 527 20 27,450
Trust preferred stock 4,250 49 42 4,257
Equity securities 70 -- 12 58
Obligations of state and political subdivisions 25,195 1,552 2 26,745
-------- ------- ---- --------
Totals $198,993 $10,140 $150 $208,983
======== ======= ==== ========
Held-to-Maturity Securities:
FHLMC certificates $ 1,153 $ 31 $ 2 $ 1,182
FNMA certificates 1,896 27 14 1,909
GNMA certificates 679 28 -- 707
Obligations of state and political subdivisions 630 140 -- 770
-------- ------- ---- --------
Totals $ 4,358 $ 226 $ 16 $ 4,568
======== ======= ==== ========
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2002 and 2001)
- ----------------------------------------------------------------------------------------------------------
7. Investment Securities (continued)
December 31, 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 $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 September 30, 2002 and 2001)
8. Loans
Loans receivable and held for sale consist of the following (in thousands):
September 30 December 31,
2002 2001
---- ----
Real Estate:
One- to four-family residential $165,113 $167,738
Construction 11,646 7,875
Non-residential and multi-family real estate 202,069 174,052
-------- --------
378,828 349,665
Other Loans:
Commercial 96,537 83,690
Consumer finance 38,725 40,739
Home equity and improvement 46,558 36,179
-------- --------
181,820 160,608
-------- --------
Total real estate and other loans 560,648 510,273
Deduct:
Loans in process 6,049 2,888
Net deferred loan origination fees and costs 1,134 1,024
Allowance for loan loss 7,256 6,548
-------- --------
Totals $546,209 $499,813
======== ========
Changes in the allowance for loan losses were as follows:
Three months ended Nine months ended
September 30, September 30,
2002 2001 2002 2001
---- ---- ---- ----
Balance at beginning of period $7,028 $6,480 $6,548 $6,331
Provision for loan losses 386 272 1,124 659
Charge-offs:
One to four-family residential real estate 18 7 82 33
Non-residential and multi-family real estate 110 92 184 123
Commercial 20 -- 20 --
Consumer finance 64 170 304 470
------ ------ ------ ------
Total charge-offs 212 269 590 626
Recoveries 54 56 174 175
------ ------ ------ ------
Net charge-offs 158 213 416 451
------ ------ ------ ------
Ending allowance $7,256 $6,539 $7,256 $6,539
====== ====== ====== ======
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2002 and 2001)
- --------------------------------------------------------------------------------
9. Deposits
A summary of deposit balances is as follows (in thousands):
September 30, December 31,
2002 2001
---- ----
Non-interest-bearing checking accounts $ 34,542 $ 25,428
Interest-bearing checking accounts 35,842 35,304
Savings accounts 39,569 36,952
Money market demand accounts 129,563 114,253
Certificates of deposit 351,276 402,911
-------- --------
$590,792 $614,848
======== ========
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
General
First Defiance Financial Corp. ("First Defiance" of "the Company") 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, obligations of municipal and other 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 $4.4 million
at September 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 $209.0 million at September 30, 2002. The available-for-sale
portfolio consists of U.S. Treasury securities and obligations of U.S.
Government corporations and agencies ($112.6 million), corporate bonds ($30.3
million), certain municipal obligations ($26.7 million), CMOs and REMICs ($27.5
million), mortgage backed securities ($5.5 million), preferred stock and other
equity investments ($4.3 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 $10.0 million at September 30, 2002, or $6.5 million after considering the
related deferred tax liability.
17
Item 2. Management's Discussion and Analysis of Financial Condition and Results
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of Operations - Continued
- -------------------------
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 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 September 30, 2002, First Defiance's total assets, deposits and stockholders'
equity amounted to $863.7 million, $590.8 million and $124.9 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 $546.2 million at September 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
$28.0 million to $202.1 million, and home equity and improvement loans, which
increased $10.4 million to $46.6 million. The increase was partially offset by a
$2.6 million decline in one- to four-family residential loans to $165.1 million
and a $2.0 million decline in consumer loans to $38.7 million.
The investment securities portfolio increased to $213.3 million at September 30,
2002 from $54.3 million at December 31, 2001. The increase in the balance in the
investment portfolio is the result of the investment of a portion of the net
cash realized from the sale of The Leader after all liabilities were settled. At
September 30, 2002 there were approximately $27.6 million of interest-bearing
deposits held at other financial institutions. These funds will be redeployed
into higher earning investments as interest rates rise or will be used to
liquidate $31.5 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 $590.8 million as
of September 30, 2002. Certificates of deposit balances declined by $51.6
million to $351.3 million at September 30, 2002, from $402.9 million at December
31, 2001. This decrease was the result of a $57.4 million decrease in brokered
certificates of deposit, which was partially offset by a $5.8 million increase
in certificates of deposit originated through First Federal's branch network.
The decline in certificate of deposit balances was partially offset by
18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
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of Operations - Continued
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a $15.3 million increase in money market demand accounts, to $129.6 million at
September 30, 2002 from $114.3 million at December 31, 2001, and a $9.7 million
increase in interest and non-interest bearing checking accounts, to $70.4
million at September 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
$3.2 million, respectively, at September 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.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
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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 September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------ ----------------------------------
Average Yield/ Average Yield/
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $535,149 $ 9,281 6.88% $521,165 $10,643 8.10%
Securities 216,845 2,728 4.99 56,817 833 5.82
Interest-earning deposits 42,200 192 1.81 5,003 17 1.35
FHLB stock and other 21,730 234 4.27 15,807 279 7.00
-------- ---------- -------- ------ -----
Total interest-earning assets 815,924 12,435 6.05 598,792 11,772 7.80
Non-interest-earning assets
(including assets of discontinued
operations) 56,884 531,619
-------- ----------
Total assets $872,808 $1,130,411
======== ==========
Interest-bearing liabilities (3):
Deposits $561,660 $ 4,227 2.99% $461,414 $ 5,185 4.46%
FHLB advances and other 131,913 1,702 5.12 61,000 721 4.69
Notes payable 2,466 23 3.70 19,576 264 5.35
-------- ---------- -------- ------ -----
Total interest-bearing liabilities 696,039 5,952 3.39 541,990 6,170 4.52
Non-interest bearing deposits 32,120 -- 35,749 --
-------- ---------- -------- ------
Total including non-interest bearing
demand deposits 728,159 5,952 3.24 577,739 6,170 4.24
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 21,158 447,296
-------- ---------
Total liabilities 749,317 1,025,035
Stockholders' equity 123,491 105,376
-------- ---------
Total liabilities and stock-
holders' equity $872,808 $1,130,411
Net interest income; interest
rate spread $ 6,483 2.66% $ 5,602 3.28%
======== ==== ========== ====
Net interest margin (2) 3.15% 3.71%
== ==== ====
Average interest-earning assets
to average interest-bearing
liabilities 117% 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
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
Nine Months Ended September 30,
----------------------------------------------------------------------------
2002 2001
------------------------------------ ----------------------------------
Average Yield/ Average Yield/
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $514,352 $ 27,322 7.10% $525,235 $32,990 8.40%
Securities 152,902 5,903 5.16 58,847 2,693 6.12
Interest-earning deposits 50,715 619 1.63 8,211 227 3.70
FHLB stock and other 24,206 700 3.87 15,530 833 7.17
-------- ---------- -------- ------ -----
Total interest-earning assets 742,175 34,544 6.22 607,823 36,743 8.08
Non-interest-earning assets
(including assets of discontinued
operations) 227,174 473,840
-------- ----------
Total assets $969,349 $1,081,663
======== ==========
Interest-bearing liabilities (3):
Deposits $544,206 $ 12,616 3.10% $449,766 $16,346 4.86%
FHLB advances and other 90,361 3,476 5.14 84,835 3,265 5.15
Notes payable 8,775 250 3.81 18,414 851 6.18
-------- ---------- -------- ------ -----
Total interest-bearing liabilities 643,342 16,342 3.40 553,015 20,462 4.95
Non-interest bearing deposits 31,272 -- 34,168 --
-------- ---------- -------- ------
Total including non-interest bearing
demand deposits 674,614 16,342 3.24 587,183 20,462 4.66
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 176,488 391,483
-------- ---------
Total liabilities 851,102 978,666
Stockholders' equity 118,247 102,997
-------- ---------
Total liabilities and stock-
holders' equity $969,349 $1,081,663
======== ==========
Net interest income; interest
rate spread $ 18,202 2.82% $16,281 3.13%
======== ==== ======= ====
Net interest margin (2) 3.28% 3.58%
== ==== ====
Average interest-earning assets
to average interest-bearing
liabilities 115% 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.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
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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 September 30, 2002 compared to Three Months Ended September
- --------------------------------------------------------------------------------
30, 2001
- --------
On a consolidated basis, First Defiance had net income of $1.4 million or $.21
per share for the three months ended September 30, 2002 compared to $3.0 million
or $0.45 per share in 2001. The 2001 net income included earnings from
discontinued operations of $1.7 million or $0.26 per share. Income from
continuing operations for the 2001 third quarter was $1.2 million or $0.19 per
share.
Net Interest Income. Net interest income from continuing operations for the
quarter ended September 30, 2002 was $6.2 million compared to $5.3 million for
the same period in 2001. Net interest margin for the 2002 third quarter was
3.15% compared to 3.71% for the same period in 2001.
Total interest income from continuing operations increased by $709,000 to $12.2
million for the three months ended September 30, 2002 from $11.5 million for the
three months ended September 30, 2001. Interest on loans decreased $1.4 million
to $9.3 million in the third quarter of 2002 from $10.6 million in the third
quarter of 2001. The decrease in interest from loans was due to a reduction in
the yield on loans between the third quarter of 2001 and the third quarter of
2002. The yield on First Defiance's loan portfolio declined from 8.10% for the
three months ended September 30, 2001 to 6.88% for the same period in 2002
because of falling interest rates over that time period. The Company also has
experienced a change in the mix of its loan portfolio as commercial loans and
non-residential real estate loans were $298.6 million at September 30, 2002, up
from $257.7 million at December 31, 2001. During that same time one- to
four-family residential loans, excluding loans held for sale, declined from
$172.1 million to $161.8 million. The decline in the one- to four-family
residential loan portfolio is the result of increased mortgage loan refinance
activity. The Company sells most of its new mortgage loan originations into the
secondary market.
Interest earnings from the investment portfolio and interest-earning deposits
increased $1.9 million to $2.7 million for the three months ended September 30,
2002 compared to $833,000 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 third quarter increased to $216.8 million from $56.8
million for the same period in 2001. In addition, First Defiance held an average
of $42.2 million in overnight or interest-earning deposit accounts for the three
months ended September 30, 2002 as The Leader sale proceeds were not fully
invested.
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
Interest expense from continuing operations decreased by $218,000, to $6.0
million for the third quarter of 2002 compared to $6.2 million for the same
period in 2001. The decrease is due primarily to a 113 basis point decrease in
the average cost of interest-bearing liabilities, from 4.52% for the third
quarter of 2001 to 3.39% in the third quarter of 2002. The average balances of
interest-bearing liabilities increased $154.0 million from $542.0 million third
quarter of 2001 to $696.0 million in the third 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.
Provision for Loan Losses. The provision for loan losses increased $114,000, to
$386,000 for the three-months ended September 30, 2002 from $272,000 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. 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):
September 30, December 31,
2002 2001
---- ----
Non-accrual loans $ 3,287 $ 2,255
Loans over 90 days past due and still accruing -- --
--------- ---------
Total non-performing loans 3,287 2,255
Real estate owned (REO) 371 136
--------- ---------
Total non-performing assets $ 3,658 $ 2,391
========= =========
Allowance for loan losses as a
percentage of total loans 1.33% 1.29%
Allowance for loan losses as a
percentage of non-performing assets 198.36% 273.86%
Allowance for loan losses as a
percentage of non-performing loans 220.75% 290.38%
Total non-performing assets as a percentage
of total assets from continuing operations 0.42% 0.37%
Total non-performing loans as a
percentage of total loans 0.60% 0.45%
Of the $3.3 million in non-accrual loans, $2.7 million were commercial loans or
non-residential real estate loans and $490,000 were residential mortgage loans.
The allowance for loan losses at September 30, 2002 was $7.3 million compared to
$6.5 million at both September 30, 2001 and December 31, 2001. For the quarter
ended September 30, 2002, First Defiance charged off $212,000 of loans against
its allowance and realized recoveries of $54,000 from
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
loans previously charged off. During the same quarter in 2001, First Defiance
charged off $269,000 in loans and realized recoveries of $56,000.
Non-Interest Income. Non-interest income increased $806,000 in the third quarter
of 2002, to $3.3 million for the quarter ended September 30, 2002 from $2.5
million for the same period in 2001. Individual components of non-interest
income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased
$512,000 to $1.2 million for the three months ended September 30, 2002 from
$667,000 during the 2001 third quarter. The increase is due to high mortgage
loan origination activity in the low interest rate environment. While the
Company exited the mortgage banking business at the national level with the sale
of The Leader, the origination and servicing of mortgage loans continues to be a
core activity of First Federal in its local market areas.
Service Fees. Loan and deposit fees increased $192,000 to $968,000 for the
quarter ended September 30, 2002 from $776,000 for the quarter ended September
30, 2001. Increases occurred primarily in loan servicing fees on sold loans,
debit card interchange fees, and checking NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $70,000 to $810,000 in the third quarter of 2002
from $740,000 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 and other miscellaneous charges, increased to
$314,000 for the quarter ended September 30, 2002 from $282,000 for the same
period in 2001.
Non-Interest Expense. Total non-interest expense increased $1.6 million to $7.2
million for the quarter ended September 30, 2002 from $5.6 million for the same
period in 2001. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $587,000 to $3.63
million for the quarter ended September 30, 2002 from $3.04 million for the same
period in 2001. The increase was the result of an increase in staffing,
including several support positions at central operations, staff increases at
several banking centers due to growing volumes, and the addition of a commercial
loan origination office in the Toledo, Ohio market which commenced operations in
May of 2002. Compensation and benefits also increased due to 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 $231,000 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 ("MSR's") totaled $512,000 in the 2002 third quarter
compared to $257,000 in the 2001 third quarter, the result of significant
refinancing activity in the First Federal loan servicing portfolio. Also, the
Company recognized a $521,000 adjustment for impairment in the
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
value of its MSR portfolio during the 2002 third quarter, the result of the
decline in the market value of MSRs in the face of falling interest rates and
increased prepayment speeds on mortgage loans in general. There was no
impairment recognized in the third quarter of 2001. First Defiance has a total
impairment reserve of $1.6 million recorded against an asset with a book value
before reserves of $3.3 million at September 30, 2002. That portfolio represents
approximately 4,000 loans with unpaid balances of approximately $290.5 million.
Amortization of Goodwill. First Defiance is no longer required to recognize
goodwill amortization as an expense. Such amortization totaled $79,000 in the
third quarter of 2001. (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 $2.5 million for the quarter ended September 30, 2002 from $2.3 million for
the same period in 2001.
First Defiance computes federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 29.13% for the
quarter ended September 30, 2002 compared to 33.37% 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. At
September 30, 2001, First Defiance had only $8.5 million invested in tax exempt
securities.
As a result of the above factors, income from continuing operations for the
quarter ended September 30, 2002 was $1.4 million compared to $1.2 million for
the comparable period in 2001. On a per share basis, basic and diluted earnings
per share for the three months ended September 30, 2002 from continuing
operations were each $0.22 and $.21, respectively, compared to $0.19 and $0.19,
respectively, for the quarter ended September 30, 2001.
Discontinued Operations. Discontinued operations for the 2001 third quarter
period, which represents net income earned by The Leader's operations, were $1.7
million or $0.26 per share. There was no income from discontinued operations for
the 2002 third quarter.
Nine months ended September 30, 2002 compared to nine months ended September 30,
- --------------------------------------------------------------------------------
2001
- ----
On a consolidated basis, First Defiance had net income of $12.8 million or $1.92
per share for the nine months ended September 30, 2002 compared to $8.6 million
or $1.31 per share in 2001. Income before the cumulative effect of a change in
accounting for goodwill was $13.0 million, or $1.95 per share for the nine
months ended September 30, 2002 and income from continuing operations totaled
$3.7 million or $0.55 per share for the 2002 nine month period, compared to $3.6
million or $0.55 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 nine months of 2002
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
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 nine
months ended September 30, 2002 was $17.5 million compared to $15.4 million for
the same period in 2001. Net interest margin for the first nine months of 2002
was 3.28% compared to 3.58% for the same period in 2001.
Total interest income from continuing operations decreased $2.1 million from
$35.9 million for the nine months ended September 30, 2001 to $33.8 million for
the nine months ended September 30, 2002. Interest on loans decreased $5.7
million to $27.3 million in the first three quarters of 2002 from $33.0 million
in the first three quarters 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 nine months of 2001 and the first nine months
of 2002. The year to date average balance of loans decreased $10.9 million to
$514.4 million in the 2002 period from $525.2 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 8.40% for the nine months ended September 30, 2001 to
7.10% 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 $3.2 million to $5.9 million for the nine months ended September 30,
2002 compared to $2.7 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 nine-month period in 2002 increased to
$203.6 million from $67.1 million for the same period in 2001.
Interest expense from continuing operations decreased by $4.2 million, to $16.3
million for the first nine months of 2002 compared to $20.5 million for the same
period in 2001. The decrease is due primarily to a 155 basis point decrease in
the average cost of interest-bearing liabilities, from 4.95% for the first nine
months of 2001 to 3.40% in the first nine months of 2002. The average balances
of interest-bearing liabilities increased $90.3 million from $553.0 million in
the first nine months of 2001 to $643.3 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 related to First Defiance's continuing operations.
Provision for Loan Losses. The 2002 provision for loan losses totaled $1.1
million, an increase of $465,000 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 non-residential real estate loans, and an increase in
non-performing loans since December 31, 2001. First Defiance charged off
$590,000 of loans against its allowance for loan losses for the nine-month
period ended September 30, 2002 and realized recoveries of $174,000 from loans
previously charged off. During the same period in 2001, First Defiance charged
off $626,000 in loans and realized recoveries of $175,000.
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
Non-Interest Income. Non-interest income increased $1.2 million in the first
nine months of 2002, to $8.4 million from $7.2 million for the same period in
2001. Individual components of non-interest income are as follows:
Service Fees. Loan and deposit fees increased $564,000 to $2.7 million for the
nine months ended September 30, 2002 from $2.2 million for the nine months ended
September 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 $324,000 to $2.5 million in the first nine months of
2002 from $2.2 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.
Gains on Sale of Loans. Gains from the sale of residential mortgage loans
increased to $2.3 million during the first nine months of 2002 from $2.0 million
during that period in 2001, an increase of $285,000 or 14.5%. This is due to
significant mortgage origination activity.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, increased to
$938,000 for the nine months ended September 30, 2002 from $894,000 million for
the same period in 2001.
Non-Interest Expense. Total non-interest expense increased $2.9 million to $19.5
million for the nine months ended September 30, 2002 from $16.6 million for the
same period in 2001. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $1.4 million to
$10.4 million year to date in 2002 from $9.0 million for the same period in
2001. This increase was due to an 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 $777,000 in the nine months ended September 30, 2002 compared to
$630,000 in the same period of 2001. The Company also recorded adjustments
totaling $785,000 during the first nine months of 2002 to reflect impairment in
the value of MSRs. There was no impairment recognized in the first nine months
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
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
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 $234,000. 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 $7.3 million for the nine months ended September 30, 2002 from $6.7 million
for the same period in 2001.
The effective tax rate for the nine months ended September 30, 2002 was 31.3%
compared to 33.2% for the nine months ended September 30, 2001. The 2002
effective rate is lower because of an increase in tax exempt municipal
securities in the investment portfolio.
As a result of the above factors, income from continuing operations for the nine
months ended September 30, 2002 was $3.66 million compared to $3.65 million for
the comparable period in 2001. On a per share basis, basic and diluted earnings
per share from continuing operations were $0.57 and $0.55, respectively, for
both the 2002 and 2001 nine-month periods.
Discontinued Operations. Income from discontinued operations for the nine months
ended September 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 nine
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.
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 $54.1 million of cash from operating activities during the
first nine months of 2002. Excluding discontinued operations, First Defiance
used $18.9 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 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
28
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
existing loans, the sale of loans, proceeds from the sale or maturity of
securities, borrowings from the FHLB, and customer deposits.
At September 30, 2002, First Defiance had $77.1 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $83.2 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 $8.9 million of loans held-for-sale. Also
as of September 30, 2002, the total amount of certificates of deposit that are
scheduled to mature by September 30, 2003 is $223.8 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.
Upon the sale of The Leader, First Defiance had net investable 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 September 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 September 30, 2002.
29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
Core Capital Risk-Based Capital
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
Regulatory capital $110,544 $110,544 $117,523 $117,523
Minimum required regulatory capital 33,958 42,448 44,646 55,808
-------- -------- -------- --------
Excess regulatory capital $76,586 $68,096 $72,877 $ 61,715
Regulatory capital as a percentage of assets (1) 13.0% 13.0% 21.1% 21.1%
Minimum capital required as a percentage of 4.0% 5.0% 8.0% 10.0%
assets -------- -------- -------- --------
Excess regulatory capital as a percentage of 9.0% 8.0% 13.1% 11.1%
assets -------- -------- -------- --------
(1) Core capital is computed as a percentage of adjusted total assets of $849.0
million. Risk-based capital is computed as a percentage of total
risk-weighted assets of $558.1 million.
30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations - Continued
- -------------------------
Pro Forma Income Statement
- --------------------------
Management does not believe that year-to-date income from continuing operations
for the nine months ended September 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 nine months ended September 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 $36,887 $33,844
Interest expense 18,858 16,342
------- -------
Net interest income 18,029 17,502
Provision for loan losses 1,124 1,124
------- -------
Net interest after provision 16,905 16,378
Non-interest income 8,433 8,433
Non-interest expense 19,489 19,489
------- -------
Income before income taxes 5,849 5,322
Income taxes 1,852 1,667
------- -------
Net income from continuing operations $3,997 $3,655
======= =======
Net income per share from continuing
operations $0.60 $0.55
======= =======
FDIC Insurance
- --------------
31
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 $0.017 per $100 of
deposits.
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%.
Item 4. Controls and Procedures
- -------------------------------
The Chief Executive Officer and Chief Financial Officer have conducted an
evaluation of the effectiveness of disclosure controls and procedures pursuant
to Exchange Act Rule 13a-14(c) and 15d-14 as of a date within 90 days prior to
the filing date of this quarterly report. Based on that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the disclosure
controls and procedures are effective in ensuring that all material information
required to be disclosed in this quarterly report has been made known to them in
a timely fashion. There have been no significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date the Chief Executive Officer and Chief Financial Officer completed their
evaluation.
32
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
33
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: November 12, 2002 By: /s/ William J. Small
----------------- --------------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: November 12, 2002 By: /s/ John C. Wahl
----------------- --------------------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
34
First Defiance Financial Corp.
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
-------------
I, William J. Small, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Defiance
Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
-----------------
/s/ William J. Small
-------------------
William J. Small
Chief Executive Officer
35
CERTIFICATION
-------------
I, John C. Wahl, certify that:
1. I have reviewed this quarterly report on Form 10-Q of First Defiance
Financial Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002
-----------------
/s/ John C. Wahl
-------------------
John C. Wahl
Chief Financial Officer
36