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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 March 31, 2003
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 -
6,330,968 shares outstanding at May 9, 2003
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number
-----------
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - March 31, 2003 and December 31, 2002 2
Consolidated Condensed Statements of Income -
Three months ended March 31, 2003 and 2002 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Three months ended March 31, 2003 5
Consolidated Condensed Statements of Cash Flows
- Three months ended March 31, 2003 and 2002 7
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 31
Item 4. Controls and Procedures 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 34
Certifications Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002 35
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
March 31, 2003 December 31, 2002
-------------- -----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 25,475 $ 17,263
Interest-bearing deposits 6,475 11,395
-------- --------
31,950 28,658
Securities:
Available-for-sale, carried at fair value 196,536 209,604
Held-to-maturity, carried at amortized cost
(approximate fair value $3,730 and $4,129
at March 31, 2003 and December 31,
2002 respectively) 3,527 3,921
-------- --------
200,063 213,525
Loans held for sale 11,391 15,336
Loans receivable, net 586,507 561,041
Accrued interest receivable 4,734 4,533
Federal Home Loan Bank stock and other
interest-earning assets 17,242 18,302
Bank owned life insurance 15,345 15,144
Office properties and equipment 20,460 19,958
Real estate and other assets held for sale 59 206
Goodwill 3,658 3,636
Mortgage servicing rights 2,036 2,090
Other assets 3,131 1,816
-------- --------
Total assets $896,576 $884,245
======== ========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
March 31, 2003 December 31, 2002
-------------- -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 47,673 $ 43,936
Interest-bearing deposits 560,293 555,637
--------- ---------
Total deposits 607,966 599,573
Advances from Federal Home Loan Bank 156,147 149,096
Short-term borrowings and other interest-bearing liabilities 1,997 4,308
Advance payments by borrowers for taxes and insurance 169 316
Deferred taxes 2,017 2,299
Other liabilities 8,133 8,543
--------- ---------
Total liabilities 776,429 764,135
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; 6,347
and 6,412 shares outstanding, respectively 63 64
Additional paid-in capital 50,432 50,702
Stock acquired by ESOP (2,175) (2,387)
Deferred compensation (25) (30)
Accumulated other comprehensive income,
net of income taxes of $3,127
and $3,477, respectively 6,068 6,455
Retained earnings 65,784 65,306
--------- ---------
Total stockholders' equity 120,147 120,110
--------- ---------
Total liabilities and stockholders' equity $ 896,576 $ 884,245
========= =========
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
March 31,
2003 2002
------- -------
Interest Income
Loans $ 9,338 $ 8,961
Investment securities 2,424 751
Interest-bearing deposits 29 17
------- -------
Total interest income 11,791 9,729
Interest Expense
Deposits 3,534 3,928
FHLB advances and other 1,814 81
Notes payable and warehouse loans 9 192
------- -------
Total interest expense 5,357 4,201
------- -------
Net interest income 6,434 5,528
Provision for loan losses 335 582
------- -------
Net interest income after provision for loan losses 6,099 4,946
Non-interest Income
Service fees and other charges 985 798
Insurance commission income 926 883
Dividends on stock 169 181
Gain on sale of loans 1,800 526
Gain/(loss) on sale of securities 631 (15)
Trust income 32 31
Income from Bank Owned Life Insurance 201 --
Other non-interest income 47 21
------- -------
Total non-interest income 4,791 2,425
Non-interest Expense
Compensation and benefits 3,708 3,304
Occupancy 728 692
SAIF deposit insurance premiums 24 32
State franchise tax 281 294
Data processing 432 322
Amortization and impairment of mortgage servicing rights 763 224
Amortization and impairment of goodwill and other intangibles -- 200
Other non-interest expense 1,079 925
------- -------
Total non-interest expense 7,015 5,993
------- -------
Income from continuing operations before income taxes 3,875 1,378
Federal income taxes 1,157 491
------- -------
Income from continuing operations 2,718 877
Discontinued operations, net of tax -- 2,015
------- -------
Income before cumulative effect of a change in accounting principle 2,718 2,902
Cumulative effect of change in method of accounting for goodwill,
net of tax -- (194)
------- -------
Net income $ 2,718 $ 2,708
======= =======
Earnings per share (Note 5)
Basic:
From continuing operations $ 0.45 $ 0.14
Discontinued operations, net of tax -- $ 0.31
Cumulative effect in method of accounting for goodwill -- $ (0.03)
------- -------
Net income $ 0.45 $ 0.42
======= =======
Diluted:
From continuing operations $ 0.43 $ 0.14
Discontinued operations, net of tax -- $ 0.30
Cumulative effect in method of accounting for goodwill -- $ (0.03)
------- -------
Net income $ 0.43 $ 0.41
======= =======
Dividends declared per share (Note 4) $ 0.15 $ 0.13
======= =======
Average shares outstanding (Note 5)
Basic 6,074 6,442
======= =======
Diluted 6,330 6,663
======= =======
See accompanying notes
4
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2003
---------------------------------------------------------
Stock Acquired By
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
----- ------- ---- ----
Balance at January 1 $ 64 $ 50,702 $(2,387) $(30)
Comprehensive income:
Net income
Change in unrealized gains
net of income taxes of $ 350
Total comprehensive income
ESOP shares released 243 212
Amortization of deferred compensation
of Management Recognition Plan 5
Shares issued under stock option plan 516
Purchase of common stock for
treasury (1) (1,029)
Dividends declared (Note 5)
------------------------------------------------
Balance at March 31 $ 63 $ 50,432 $(2,175) $(25)
================================================
See accompanying notes
5
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2003 2002
----------------------------------------------- -------------
Net Unrealized
gains (losses) on Total Total
available-for- Retained Stockholders' Stockholder's
sale securities Earnings Equity Equity
--------------- -------- ------ ------
Balance at January 1 $ 6,455 $ 65,306 $ 120,110 $ 111,021
Comprehensive income:
Net income 2,718 2,718 2,708
Change in unrealized gains (losses)
net of income taxes of $350 (387) (387) (255)
--------- ---------
Total comprehensive income 2,331 2,453
ESOP shares released 455 360
Amortization of deferred compensation
of Management Recognition Plan 5 13
Shares issued under stock option plan 516 363
Purchase of common stock for
treasury (1,326) (2,356) (497)
Dividends declared (Note 5) (914) (914) (850)
---------------------------------------- ---------
Balance at March 31 $ 6,068 $ 65,784 $ 120,147 $ 112,863
======================================== =========
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Three Months
Ended March 31,
2003 2002
-------- --------
Operating Activities
Net income $ 2,718 $ 2,708
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 335 582
Provision for depreciation 396 414
Net securities amortization 289 12
Amortization of mortgage servicing rights 523 157
Net impairment of mortgage servicing rights 240 68
Net impairment of goodwill -- 438
Gain on sale of loans (1,800) (526)
Amortization of Management Recognition Plan
deferred compensation 5 13
Release of ESOP Shares 455 360
(Gains) losses on sales of securities (631) 15
Deferred federal income tax credit 67 (158)
Proceeds from sale of loans 75,619 32,584
Origination of mortgage servicing rights, net (709) (723)
Origination of loans held for sale (69,874) (32,534)
Increase in interest receivable and other assets (1,717) (1,004)
Decrease in other liabilities (432) (1,325)
Increase in assets of discontinued operations -- (5,418)
Decrease in liabilities of discontinued operations -- (35,166)
-------- --------
Net cash provided by (used in) operating activities 5,484 (39,503)
Investing Activities
Proceeds from maturities of held-to-maturity securities 387 503
Proceeds from maturities of available-for-sale securities 23,668 1,948
Proceeds from sale of available-for-sale securities 1,670 423
Purchases of available-for-sale securities (12,657) (520)
Proceeds from sales of real estate and
other assets held for sale 154 105
Proceeds from sale of discontinued operations 1,228 --
Purchases of Federal Home Loan Bank stock (168) (181)
Purchases of office properties and equipment (898) (229)
Net (increase) decrease in loans receivable (25,808) 4
-------- --------
Net cash provided by (used in) investing activities (12,424) 2,053
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2003 2002
-------- --------
Financing Activities
Net increase (decrease) in deposits 8,246 (8,244)
Repayment of Federal Home Loan Bank long-term advances (249) (103)
Repayment of term notes payable (10) (160)
Net increase (decrease) in Federal Home Loan Bank
short-term advances (1,700) 41,500
Net increase in short-term line of credit -- 1,300
Proceeds from Federal Home Loan Bank long term advances 9,000 --
Decrease in securities sold under repurchase agreements (2,301) --
Purchase of common stock for treasury (2,356) (497)
Cash dividends paid (914) (850)
Proceeds from exercise of stock options 516 363
-------- --------
Net cash used in financing activities 10,232 33,309
-------- --------
Increase in cash and cash equivalents 3,292 (4,141)
Cash and cash equivalents at beginning of period 28,658 38,521
-------- --------
Cash and cash equivalents at end of period $ 31,950 $ 34,380
======== ========
Supplemental cash flow information:
Interest paid $ 5,192 $ 4,305
======== ========
Income taxes paid $ 400 $ 400
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ 350 $ 149
======== ========
Transfers from loans to real estate
and other assets held for sale $ 7 $ 163
======== ========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ (737) $ (404)
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 920 $ 850
======== ========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
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, 2002 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 March
31, 2003 and for the three-month period ending March 31, 2003 and 2002
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 presented
as results of discontinued operations. These consolidated condensed
financial statements should be read in conjunction with the financial
statements and notes thereto included in First Defiance's 2002 Annual
Report on Form 10-K for the year ended December 31, 2002. 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 for the three-month period ended
March 31, 2003 are not necessarily indicative of the results that may be
expected for the entire year.
Stock Compensation
At March 31, 2003, the Company had three stock-based compensation plans,
which are more fully described in Note 18 in the financial statements
included in First Defiance's 2002 Annual Report on Form 10-K. The Company
accounts for those plans under recognition and measurement principles of
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees and related interpretations. Under APB No. 25, because
the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of the grant, no
compensation expense is recognized.
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, Accounting for Stock-Based Compensation and has
been determined as if First Defiance had accounted for its employee stock
options under the fair value method of that Statement. Under the
fair-value based method, compensation cost is measured at the grant date
based upon the value of the award and recognized over the service period.
For purposes of the pro forma disclosures, the estimated fair value of the
option is amortized to expense over the options' vesting period.
The following pro forma results of operations use a fair value method of
accounting for stock options in accordance with SFAS No. 123. The
estimated fair value of the options are amortized to expense over the
option and vesting period. The fair value was estimated at the date of
grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
March 31
2003 2002
------------------------------
Risk free interest rate 5.73% 5.74%
Dividend yield 2.96% 2.93%
Volatility factors of expected market price
of stock 0.269% 0.269%
Weighted average expected life 8.63 years 8.62 years
Weighted average grant date fair value
of options granted $3.45 $3.44
Based on the above assumptions, pro forma net income and earnings per
share are computed as follows (in thousands, except per share amounts):
Three months ended March 31
2003 2002
---------------------
Income from continuing operations $ 2,718 $ 877
Stock-based compensation using the fair
value method, net of tax (51) (52)
---------------------
Pro forma net income from continuing
operations $ 2,667 $ 825
=====================
Pro forma earnings per share:
Basic $ 0.44 $ 0.13
=====================
Diluted $ 0.42 $ 0.12
=====================
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Accounting Pronouncements adopted in 2003
Asset Retirement Obligations
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires an entity to record a
liability for an obligation associated with the retirement of an asset at
the time the liability is incurred by capitalizing the cost as part of the
carrying value of the related asset and depreciating it over the remaining
useful life of that asset.
The standard was effective for the Company beginning January 1, 2003, and
its adoption did not have a material impact on the Company's results of
operations, financial position or liquidity.
Accounting for Costs Associated with Exit or Disposal Activities
SFAS No. 146, Accounting for Costs Associated with Exit of Disposal
Activities, was issued in June 2002 and replaces Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of SFAS No.
146 address the accounting and reporting for one-time employee termination
benefits, certain contract termination costs and other costs associated
with exit or disposal activities such as facility closings or
consolidations and employee relocations. SFAS No. 146 is effective for
exit or disposal activities that are initiated after December 31, 2002,
with early application encouraged.
The Company has adopted SFAS No. 146 prospectively as of January 1, 2003.
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others.
On November 25, 2002, the Financial Accounting Standards Board (FASB)
issued Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness
of Others (FIN No. 45) which expands on the accounting guidance of
Statements No. 5, 57 and 107 and incorporates without change the
provisions of FASB Interpretation No. 34, which is being superseded.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
FIN No. 45, which is applicable to public and non-public entities,
significantly changes current practice in the accounting for, and
disclosure of, guarantees. Each guarantee meeting the characteristics
described in FIN No. 45 is to be recognized and initially measured at fair
value, which will be a change from prior practice for most entities. In
addition, guarantors must make significant new disclosures, even if the
likelihood of the guarantor making payments under the guarantee is remote,
which represents another change from prior general practice.
FIN No. 45's disclosure requirements was effective for financial
statements of interim or annual periods ending after December 15, 2002,
while the initial recognition and initial measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002.
The Company has included FIN No. 45's required disclosures in Note 7. FIN
No. 45 recognition and measurement provisions did not have a material
impact on the Company's results of operations, financial position or
liquidity once adopted by the Company on January 1, 2003.
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities". The objective of this
interpretation is to provide guidance on how to identify a variable
interest entity (VIE) and determine when the assets, liabilities,
non-controlling interests and results of operations of a VIE need to be
included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate the entity
if the company's interest in the VIE is such that the company will absorb
a majority of the VIE's expected loss and/or receive a majority of the
entity's expected residual returns, if they occur. FIN No. 46 also
requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The provisions of this
interpretation became effective upon issuance. As of March 31, 2003, the
Company was not party to any VIEs. The Company continues to assess the
impact, if any, the interpretation will have on results of operation,
financial position, or liquidity, as it applies to other areas within the
Company.
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Accounting Pronouncement adopted in 2002
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. Since the first quarter of 2002 no
further amount of goodwill has been deemed to be impaired. The balance of
goodwill recorded at First Insurance totals $3.7 million at March 31,
2003.
3. Discontinued Operations
On April 1, 2002, First Defiance completed the sale of The Leader to US
Bancorp. Discontinued operations as reported for the three months ended
March 31, 2002 include the operating results of The Leader for that
period. Net interest income is allocated to discontinued operations in
accordance with Emerging Issues Task Force (EITF) 87-24, based on interest
earned by First Federal on intercompany loans to The Leader less interest
expense, primarily interest on brokered certificates of deposit and a
portion of FHLB advances utilized to fund those intercompany loans. For
the first three months of 2002, First Federal had a negative spread in its
borrowing relationship with The Leader. The components of discontinued
operations for the three months ended March 31, 2002 are as follows (in
thousands):
Operations of The Leader $ 4,316
Net interest expense allocated to
discontinued operations (1,250)
-------
Income from discontinued operations before income tax 3,066
Income tax on discontinued operations 1,051
-------
$ 2,015
=======
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
4. Dividends on Common Stock
As of March 31, 2003, First Defiance had declared a quarterly cash
dividend of $.15 per share for the first quarter of 2003, payable April
25, 2003.
5. 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 month period ended March 31,
2003 and 2002. 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
months ended March 31, 2003 and 2002, 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 March 31
2003 2002
---------------------------
Numerator for basic and diluted earnings per share -
income from continuing operations $2,718 $ 877
Denominator:
Denominator for basic earnings per share - weighted
average shares 6,074 6,442
Effect of dilutive securities:
Employee stock options 245 199
Unvested management recognition plan stock 11 22
---------------------------
Dilutive potential common shares 256 221
---------------------------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 6,330 6,663
===========================
Basic earnings per share from continuing operations $ 0.45 $ 0.14
===========================
Diluted earnings per share from continuing operations $ 0.43 $ 0.14
===========================
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
6. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities (in thousands):
March 31, 2003
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 81,875 $5,964 $ -- $ 87,839
Corporate bonds 23,515 1,422 -- 24,937
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 53 2,056
Adjustable rate mortgage-backed securities 24,291 289 -- 24,580
Collateralized mortgage obligations 8,338 140 37 8,441
REMICs 9,711 131 -- 9,842
Trust preferred stock 7,238 76 55 7,259
Equity securities 69 -- 6 63
Obligations of state and political
subdivisions 30,192 1,376 49 31,519
------------------------------------------------
Totals $187,338 $9,398 $200 $196,536
===============================================
Held-to-Maturity Securities:
FHLMC certificates $ 815 $ 33 $ 1 $ 847
FNMA certificates 1,546 26 7 1,565
GNMA certificates 576 22 -- 598
Obligations of state and political
subdivisions 590 130 -- 720
------------------------------------------------
Totals $ 3,527 $ 211 $ 8 $ 3,730
===============================================
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
6. Investment Securities (continued)
December 31, 2002
-------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
-------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 95,462 $ 6,373 $ 2 $101,833
Corporate bonds 25,720 1,733 -- 27,453
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 54 2,055
Adjustable rate mortgage-backed securities 15,169 269 -- 15,438
REMICs 12,636 232 -- 12,868
Collateralized mortgage obligations 11,380 201 42 11,539
Trust preferred stock 7,238 53 55 7,236
Equity securities 69 -- 2 67
Obligations of state and political
subdivisions 29,890 1,283 58 31,115
-------------------------------------------------
Totals $199,673 $10,144 $213 $209,604
=================================================
Held-to-Maturity Securities:
FHLMC certificates $ 1,004 $ 32 $ 3 $ 1,033
FNMA certificates 1,691 29 6 1,714
GNMA certificates 636 25 -- 661
Obligations of state and political
subdivisions 590 131 -- 721
-------------------------------------------------
Totals $ 3,921 $ 217 $ 9 $ 4,129
=================================================
16
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
7. Commitments, Guarantees and Contingent Liabilities
Loan commitments are made to accommodate the financial needs of First
Defiance's customers; however, there are no long-term, fixed-rate loan
commitments that result in market risk. Standby letters of credit obligate
the Company to pay a third party beneficiary when a customer fails to
repay an outstanding loan or debt instrument, or fails to perform some
contractual nonfinancial obligation. Standby letters of credit are issued
to address customers' financing needs and to facilitate customers' trade
transactions. In accordance with FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," certain guarantees issued or
modified on or after January 1, 2003, require the recognition of a
liability on First Defiance's balance sheet for the "stand ready"
obligation with such guarantees
If amounts are drawn under standby letters of credit, such amounts are
treated as loans. Both loan commitments and standby letters of credit have
credit risk, essentially the same as that involved in extending loans to
customers, and are subject to the Company's normal credit policies.
Collateral (e.g., securities, receivables, inventory and equipment) is
obtained based on management's credit assessment of the customer.
The Company's maximum obligation to extend credit for loan commitments
(unfunded loan and unused lines of credit) and standby letters of credit
outstanding was as follows:
March 31, December 31,
2003 2002
(in thousands)
--------------------------
Commercial $ 71,260 $103,984
Real Estate 22,195 17,537
Consumer 45,403 41,555
Standby Letters of Credit 3,595 2,997
--------------------------
Total $142,453 $166,073
==========================
The remaining weighted average life for outstanding standby letters of
credit was less than one year at March 31, 2003. Actual lives of the
standby letters of credit are all less than one year.
17
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
8. Loans
Loans receivable and held for sale consist of the following (in
thousands):
March 31, December 31
2003 2002
-----------------------
Real Estate:
One-to-four family residential $149,717 $157,691
Construction 13,342 15,357
Non-residential and multi-family 252,939 227,754
-----------------------
415,998 400,802
Other Loans:
Commercial 106,650 104,070
Consumer finance 35,938 37,579
Home equity and improvement 53,860 49,889
-----------------------
196,448 191,538
-----------------------
Total real estate and other loans 612,446 592,340
Deduct:
Loans in process 5,407 7,255
Net deferred loan origination fees and costs 1,217 1,212
Allowance for loan loss 7,924 7,496
-----------------------
Totals $597,898 $576,377
=======================
Changes in the allowance for loan losses were as follows (in thousands):
Three Months ended March 31
2003 2002
---------------------------
Balance at beginning of period $ 7,496 6,548
Provision for loan losses 335 582
Charge-offs:
One-to-four family residential real estate -- 49
Non-residential and multi-family real estate -- 54
Commercial 25 --
Consumer finance 50 147
---------------------------
Total charge-offs 75 250
Recoveries 168 53
---------------------------
Net charge-offs (93) 197
---------------------------
Ending allowance $ 7,924 $6,933
===========================
18
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 2003 and 2002)
- --------------------------------------------------------------------------------
9. Deposits
A summary of deposit balances is as follows (in thousands):
March 31, December 31,
2003 2002
-------- --------
Non-interest-bearing checking accounts $ 47,673 $ 43,936
Interest-bearing checking accounts 40,718 41,318
Savings accounts 41,375 39,363
Money market demand accounts 132,022 129,036
Certificates of deposit 346,178 345,920
-----------------------
$607,966 $599,573
=======================
10. Pending Acquisition
On February 22, 2003, First Defiance signed a Purchase and Assumption
Agreement with RFC Banking Company and its parent Rurban Financial Corp.
to acquire banking centers located in Findlay, Ottawa, and McComb, Ohio.
Under the terms of the agreement, First Defiance will pay a purchase price
equal to 10.5% of all non-brokered deposit accounts plus an agreed upon
amount for all furnishings and equipment of those branches. In addition,
First Defiance will acquire certain loans of those banking centers. Total
deposit balances of those banking centers as of March 31, 2003 were
approximately $167 million, of which $36 million were brokered deposits.
The approximate balance of the loans to be acquired by First Defiance is
$101 million. On May 8, 2003 First Defiance received regulatory approval
from the Office of Thrift Supervision to complete the transaction. It is
anticipated that the transaction will close during June 2003.
19
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"). First Federal is a federally chartered
savings bank that provides financial services to communities based in northwest
Ohio where it operates 14 full service branches and one commercial loan
production office. First Federal provides a broad range of financial services
including checking accounts, savings accounts, certificates of deposit, real
estate mortgage loans, commercial loans, consumer loans, home equity loans and
trust services. First Insurance sells a variety of property and casualty, group
health and life, and individual health and life insurance products and
investment and annuity products. Insurance products are sold through First
Insurance's office in Defiance, Ohio while investment and annuity products are
sold through registered investment representatives located at two First Federal
banking center locations.
Effective April 1, 2002, The Leader Mortgage Company, LLC ("The Leader"), a
mortgage banking subsidiary of First Federal, was sold to US Bancorp. The
operating results the Leader are reported as discontinued operations for the
three months ended March 31, 2002.
On February 22, 2003, First Defiance signed a Purchase and Assumption Agreement
with RFC Banking Company and its parent Rurban Financial Corp. to acquire
banking centers located in Findlay, Ottawa, and McComb, Ohio. Under the terms of
the agreement, First Defiance will pay a purchase price equal to 10.5% of all
non-brokered deposit accounts plus an agreed upon amount for all furnishings and
equipment of those branches. In addition, First Defiance will acquire certain
loans of those banking centers. Total deposit balances of those banking centers
as of March 31, 2003 were approximately $167 million, of which $36 million were
brokered deposits. The approximate balance of the loans to be acquired by First
Defiance is $101 million. It is anticipated that the transaction, which will be
accounting for as a purchase, will close during June 2003.
First Defiance 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 $3.5 million
at March 31, 2003. 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 $196.5 million at March 31, 2003. The available-for-sale portfolio consists
of U.S. Treasury securities and obligations of U.S. Government corporations and
agencies ($87.8 million), corporate bonds ($24.9 million), certain municipal
obligations ($31.5 million), CMOs and REMICs ($18.3 million), mortgage backed
securities ($24.6 million), preferred stock and other equity investments ($7.3
million) and adjustable-rate mortgage backed security mutual funds ($2.1
million).
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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 $9.2 million at
March 31, 2003, or $6.1 million after considering the related deferred tax
liability.
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 March 31, 2003, First Defiance's total assets, deposits and stockholders'
equity amounted to $896.6 million, $608.0 million and $120.1 million,
respectively, compared to $884.2 million, $599.6 million and $120.1 million,
respectively, at December 31, 2002.
Net loans receivable increased to $586.5 million at March 31, 2003 from $561.0
million at December 31, 2002. The increase in loans receivable occurred
primarily in non-residential and multi-family real estate loans, which increased
by $25.2 million to $252.9 million, home equity and improvement loans, which
increased by $3.9 million to $53.9 million, and commercial loans, which
increased by $2.5 million to $106.7 million. The increase was partially offset
by an $8.0 million decline in one-to-four family residential loans to $149.7
million and a $1.6 million decline in consumer loans to $35.9 million.
The investment securities portfolio decreased to $200.0 million at March 31,
2003 from $213.5 million at December 31, 2002. The decrease in the balance in
the investment portfolio is the result of redeploying funds from securities as
they mature or get called to fund loan growth. At March 31, 2003 there were
approximately $6.5 million of interest-bearing deposits held at other financial
institutions. These funds may be redeployed into higher earning investments as
interest rates rise or will be used to liquidate $24.1 million of brokered
certificates of deposit, $14.1 million of which are scheduled to mature over the
next 12 months and which will not be renewed.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Deposits increased from $599.6 million at December 31, 2002 to $607.8 million as
of March 31, 2003. This growth resulted from a $3.0 million increase in money
market demand accounts, to $132.0 million at March 31, 2003 from $129.0 million
at December 31, 2002, and a $3.1 million increase in interest and non-interest
bearing checking accounts, to $88.4 million at March 31, 2003 from $85.3 million
at December 31, 2002. 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 2003. Despite less aggressive pricing, certificates of deposit
balances still increased by $258,000 to $346.2 million at March 31, 2003, from
$345.9 million at December 31, 2002. This increase occurred even though the
Company incurred a $2.0 million decrease in brokered certificates of deposit
which matured during the 2003 first quarter and were not replaced.
Additionally, FHLB advances increased to $156.1 million at March 31, 2003 from
$149.1 million at December 31, 2002. These borrowings were used to fund loan
growth and investment strategies and were part of management's strategy to take
advantage of the historically low rate environment to lock in long-term funding.
Short-term borrowings decreased to $2.0 million at March 31, 2003 from $4.3
million at December 31, 2002. This is a result of a decrease in the balance of
securities sold under repurchase agreements, which are a function of customer
demand.
Following the pending acquisition of the branches in Findlay, McComb, and
Ottawa, management estimates that total assets, loans and deposits will be $1.07
billion, $724 million and $782 million respectively
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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 reports
interest income from tax-exempt loans and investment on a tax-equivalent basis.
All average balances are based upon daily balances. The average balance sheet
and income statement for 2002 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 March 31,
---------------------------------------------------------------------------
2003 2002
------------------------------------ ---------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 589,837 $ 9,398 6.46% $ 496,671 $ 9,003 7.35%
Securities 206,645 2,591 5.09 53,499 802 6.08
Interest-earning deposits 6,865 29 1.71 13,607 17 .51
FHLB stock and other 17,960 169 3.82 16,308 181 4.50
---------- ---------- ---------- ----------
Total interest-earning assets 821,307 12,187 6.02 580,085 10,003 6.99
Non-interest-earning assets
(including assets of discontinued
operations) 63,231 570,018
---------- ----------
Total assets $ 884,538 $1,150,103
========== ==========
Interest-bearing liabilities (4):
Deposits $ 555,524 $ 3,534 2.58% $ 496,495 $ 3,928 3.21%
FHLB advances and other 156,561 1,814 4.70 7,698 81 4.27
Notes payable 3,010 9 1.21 21,430 192 3.63
---------- ---------- ---------- ----------
Total interest-bearing liabilities 715,095 5,357 3.04 525,623 4,201 3.24
Non-interest bearing deposits 38,339 -- 28,138 --
---------- ---------- ---------- ----------
Total including non-interest bearing
demand deposits 753,434 5,357 2.88 553,761 4,201 3.08
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 10,851 484,257
---------- ----------
Total liabilities 764,285 1,038,018
Stockholders' equity 120,253 112,085
---------- ----------
Total liabilities and stock-
holders' equity $ 884,538 $1,150,103
========== ==========
Net interest income; interest
rate spread $ 6,830 2.98% $ 5,802 3.75%
========== ===== ========== ======
Net interest margin (3) 3.37% 4.06%
===== ======
Average interest-earning assets
to average interest-bearing
liabilities 115% 110%
===== ======
- ----------------
(1) Interest on certain tax exempt loans and securities is not taxable for
Federal income tax purposes. In order to compare the tax-exempt yields on
these assets to taxable yields, the interest earned on these assets is
adjusted to a pre-tax equivalent amount based on the marginal corporate
federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
(4) This analysis does not reflect borrowings to fund discontinued operations.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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 as discontinued operations for all prior periods presented. See Note 3 to
the Consolidated Condensed Financial Statements filed with this Form 10-Q.
Three Months Ended March 31, 2003 compared to Three Months Ended March 31, 2002
On a consolidated basis, First Defiance had net income of $2.7 million or $.45
per share for the three months ended March 31, 2003 compared to $2.7 million or
$0.42 per share in 2002. The 2002 net income included earnings from discontinued
operations of $2.0 million or $0.31 per share. Income from continuing operations
for the 2002 first quarter was $887,000 or $0.14 per share.
Net Interest Income. Net interest income for the quarter ended March 31, 2003
was $6.4 million compared to $5.5 million from continuing operations for the
same period in 2002. Net interest margin for the 2003 first quarter was 3.37%
compared to 4.06% for the same period in 2002. On a tax-equivalent basis, net
interest income for the quarter ended March 31, 2003 was $6.8 million compared
to $5.8 million from continuing operations for the same period in 2002.
Total interest income increased by $2.1 million to $11.8 million for the three
months ended March 31, 2003 from $9.7 million from continuing operations for the
three months ended March 31, 2002. On a tax equivalent basis, total interest
income increased by $2.2 million to $12.2 million for the three months ended
March 31, 2003 from $10.0 million for the three months ended March 31, 2002.
Interest on loans increased $377,000 to $9.3 million in the first quarter of
2003 from $9.0 million in the first quarter of 2002. The increase in interest
from loans was due to a $93.1 million increase in average loan balances between
the first quarter of 2002 and the first quarter of 2003.
Much of the benefit of increased loan volumes has been offset by declining
portfolio yields. The yield on First Defiance's loan portfolio declined from
7.35% for the three months ended March 31, 2002 to 6.46% for the same period in
2003 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 $359.6 million at March 31, 2003, up
from $331.8 million at December 31, 2002. During that same time, one-to-four
family residential loans, excluding loans held for sale, declined from $157.7
million to $151.7 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,
on a tax equivalent basis, increased $1.8 million to $2.8 million for the three
months ended March 31, 2003 compared to $768,000 for the same period in 2002.
The increase is due to the investment of the net proceeds received from the sale
of The Leader. The average balance of securities for the 2003 first quarter
increased to $206.6 million from $53.5 million for the same period in 2002. To
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
compare the tax-exempt asset yields to taxable yields, amounts are adjusted to
pretax equivalents based using a marginal corporate Federal tax rate of 35%. The
tax-equivalent adjustments to net interest income for 2003 and 2002 were
$227,000 and $93,000 respectively.
Total interest expense increased by $1.2 million, to $5.4 million for the first
quarter of 2003 compared to $4.2 million from continuing operations for the same
period in 2002. Interest expense on FHLB advances increased $1.7 million to $1.8
million for the first quarter of 2003 compared to the same period in 2002. The
increase is due primarily to the increase of average balances of FHLB advances.
FHLB advances increased $148.9 million to $156.6 million for the quarter ended
March 31, 2003 from $7.7 million for the quarter ended March 31, 2002. The
average balance sheet and income statement for 2002 have been adjusted to
allocate interest expense associated with financing The Leader's operations to
discontinued operations. For 2003, all FHLB advances are included in operations
as they were used to fund purchases of investment securities and loan growth.
Interest expense on interest bearing deposits decreased by $394,000 to $3.5
million for the quarter ended March 31, 2003 from $3.9 million for the quarter
ended March 31, 2002. This happened despite growth in deposits because of the
change in the mix of deposits from higher costing certificates of deposit to
checking and money market deposit accounts. The average cost of funds decreased
from 3.08% for the first quarter of 2002 to 2.88% for the first quarter of 2003.
The average balances of interest-bearing liabilities increased $189.4 million
from $525.6 million in the first quarter of 2002 to $715.1 million in the first
quarter of 2003. In 2002, all brokered certificates of deposit were included in
discontinued operations and were therefore not a part of the yield analysis. For
2003, those deposits are included in the yield analysis as they fund operations.
Provision for Loan Losses. The provision for loan losses was $335,000 in the
first quarter of 2003 compared to $582,000 for the first quarter of 2002 despite
significant growth in loan balances. The lower provision was due in part to the
Company's very low loss experience in the 2003 first quarter, which showed net
recoveries of $93,000. 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.
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Non-performing assets and asset quality ratios for First Defiance were as
follows (in $000's):
March 31, December 31,
2003 2002
-----------------------
Non-accrual loans $ 2,756 $ 2,525
Loans over 90 days past due and still accruing -- --
-----------------------
Total non-performing loans $ 2,756 $ 2,525
Real estate owned (REO) 59 206
-----------------------
Total non-performing assets $ 2,815 $ 2,731
=======================
Allowance for loans losses as a percentage
of total loans 1.34% 1.32%
Allowance for loan losses as a percentage
of non-performing assets 281.49% 274.48%
Allowance for loan losses as a percentage
of non-performing loans 287.52% 287.52%
Total non-performing assets as a percentage
of total assets 0.31% 0.31%
Total non-performing loans as a percentage
of total loans 0.46% 0.44%
Of the $2.8 million in non-accrual loans, $2.1 million were commercial loans or
non-residential real estate loans and $600,000 were residential mortgage loans.
The allowance for loan losses at March 31, 2003 was $7.9 million compared to
$6.9 million at both March 31, 2002 and $7.5 million at December 31, 2002. For
the quarter ended March 31, 2003, First Defiance charged off $75,000 of loans
against its allowance and realized recoveries of $168,000 from loans previously
charged off. During the same quarter in 2002, First Defiance charged off
$250,000 in loans and realized recoveries of $53,000.
Non-Interest Income. Non-interest income increased $2.4 million in the first
quarter of 2003, to $4.8 million for the quarter ended March 31, 2003 from $2.4
million for the same period in 2002. Individual components of non-interest
income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased
$1.3 million to $1.8 million for the three months ended March 31, 2003 from
$526,000 during the 2002 first 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. Management anticipates
that gains from sale of loans will decline from the current levels in a rising
interest rate environment.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $631,000 in the first quarter of 2003. This was an increase of
$646,000 from a loss of $15,000 in the first quarter of 2002. The realization of
the gains in the investment portfolio was part of a strategy by management to
shorten the duration of assets in the investment portfolio to position the
company to benefit from rising rates and to take advantage of a portion of the
gains in the portfolio while they exist.
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Service Fees. Loan and deposit fees increased $187,000 to $985,000 for the
quarter ended March 31, 2003 from $798,000 for the quarter ended March 31, 2002.
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 $43,000 to $926,000 in the first quarter of 2003
from $883,000 in the same period of 2002. Increases occurred in the property and
casualty lines as well as income from the sale of securities and annuities.
Bank Owned Life Insurance. Income from bank owned life insurance was $201,000 in
the quarter ended March 31, 2003. The Company made an initial $15 million
investment in BOLI during the 2002 fourth quarter and accordingly, there was no
corresponding income in the 2002 first quarter.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, increased to
$248,000 for the quarter ended March 31, 2003 from $233,000 for the same period
in 2002.
Non-Interest Expense. Total non-interest expense increased $1.0 million to $7.0
million for the quarter ended March 31, 2003 from $6.0 million for the same
period in 2002. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $404,000 to $3.7
million for the quarter ended March 31, 2003 from $3.3 million for the same
period in 2002. 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 $157,000 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 $523,000 in the 2003 first quarter
compared to $128,000 in the 2002 first quarter, the result of significant
refinancing activity in the First Federal loan servicing portfolio. Also, the
Company recognized a $240,000 adjustment for impairment in the value of its MSR
portfolio during the 2003 first 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 a $96,000 adjustment for
impairment recognized in the first quarter of 2002. First Defiance has a total
impairment reserve of $1.6 million recorded against an asset with a book value
before reserves of $3.9 million at March 31, 2003. That portfolio represents
approximately 4,615 loans with unpaid balances of approximately $355 million.
Amortization/Impairment of Goodwill. First Defiance is no longer required to
recognize goodwill amortization as an expense but must test for and recognize
any impairment in goodwill. There was no goodwill impairment in 2003. During the
first quarter of 2002, management evaluated goodwill recorded at First Insurance
for the purpose of measuring impairment and
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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, 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. Such impairment totaled $200,000 in the first quarter of 2002. (See
Note 2 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 March 31, 2003 from $2.3 million for the
same period in 2002.
First Defiance computes federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 29.86% for the
quarter ended March 31, 2003 compared to 35.63% for the same period in 2002. The
reduction in the effective tax rate is a result of investing approximately $32.1
million in municipal securities, and $15.3 million of bank owned life insurance
which are both exempt from federal tax. At March 31, 2002, First Defiance had
only $8.7 million invested in tax exempt securities and no investment in bank
owned life insurance.
As a result of the above factors, income for the quarter ended March 31, 2003
was $2.7 million compared to income from continuing operations of $887,000 for
the comparable period in 2002. On a per share basis, basic and diluted earnings
per share for the three months ended March 31, 2003 were each $0.45 and $.43,
respectively, compared to basic and diluted earnings per share from continuing
operations of $0.14 and $0.14, respectively, for the quarter ended March 31,
2002.
Discontinued Operations. Discontinued operations for the 2002 first quarter
period, which represents net income earned by The Leader's operations, were $2.0
million or $0.30 per share.
Pending Acquisition. On February 22, 2003, First Defiance signed a Purchase and
Assumption Agreement with RFC Banking Company and its parent Rurban Financial
Corp. to acquire banking centers located in Findlay, Ottawa, and McComb, Ohio.
Under the terms of the agreement, First Defiance will pay a purchase price equal
to 10.5% of all non-brokered deposit accounts plus an agreed upon amount for all
furnishings and equipment of those branches. In addition, First Defiance will
acquire certain loans of those banking centers. Management expects the
transaction to increase per share earnings by approximately $.06 for the year
ended December 31, 2003.
28
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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.
First Defiance generated $5.4 million of cash from operating activities during
the first three months of 2003. 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, 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 March 31, 2003, First Defiance had $46.8 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $95.6 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 $45.8 million of fixed-rate residential
mortgage loans, including $11.4 million of residential mortgage loans held for
sale at March 31, 2003 and $34.4 million of residential mortgage loans that are
in the process of being originated. Also as of March 31, 2003, the total amount
of certificates of deposit that are scheduled to mature by March 31, 2004 is
$233.9 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.
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. $4.3 million of these securities do not pass
the FFIEC high risk security test as of March 31, 2003. The weighted average
life of these securities exceeds the regulatory test limits in an instantaneous
rate increase scenario of 200 and 300 basis points. However, management does not
believe the underlying risk of these investments has changed from when they were
purchased (and passed the FFIES high risk security test). Also, the overall
interest rate risk as measured by management through net interest income
simulations remains at an acceptable level. See Item 3 of this Form 10-Q. The
remaining $14.0 million of these securities are not classified as high risk at
March 31, 2003 and do not present risk significantly different than other
mortgage-backed or agency securities.
29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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 March 31, 2003.
Core Capital Risk-Based Capital
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
----------- ----------- ----------- -----------
Regulatory capital $ 106,000 $ 106,000 $ 113,770 $ 113,770
Minimum required regulatory capital 35,255 44,069 50,099 62,624
---------- ---------- ---------- ----------
Excess regulatory capital $ 70,745 $ 61,931 $ 63,671 $ 51,146
========== ========== ========== ==========
Regulatory capital as a percentage of assets (1) 12.0% 12.0% 18.2% 18.2%
Minimum capital required as a percentage of assets 4.0% 5.0% 8.0% 10.0%
---------- ---------- ---------- ----------
Excess regulatory capital as a percentage of assets 8.0% 7.0% 10.2% 8.2%
========== ========== ========== ==========
(1) Core capital is computed as a percentage of adjusted total assets of $881.4
million. Risk-based capital is computed as a percentage of total
risk-weighted assets of $626.2 million.
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 2003 are approximately $0.016 per $100 of
deposits.
30
Item 3. Qualitative and Quantitative Disclosure About Market Risk
As discussed in detail in the 2002 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
March 2003 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 management of First Defiance is responsible for establishing and maintaining
effective disclosure controls and procedures, as defined under Rules 13a-14 and
15d-14 of the Securities Exchange Act of 1934. As of March 31, 2003, an
evaluation was performed under the supervision and with the participation of
management, including the Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of First Defiance's disclosure
controls and procedures. Based on that evaluation, management concluded that
First Defiance's disclosure controls and procedures as of March 31, 2003 were
effective in ensuring that information required to be disclosed in the Interim
Report on Form 10-Q were recorded, processed, summarized and reported within the
time period required by the United States Securities and Exchange Commission's
rules and forms.
Management's responsibilities related to establishing and maintaining effective
disclosure controls and procedures include maintaining effective internal
controls over financial reporting that are designed to produce reliable
financial statements in accordance with accounting principles generally accepted
in the United States of America. Management has assessed First Defiance's system
of internal control over financial reporting as described in "Internal Control -
Integrated Framework," issued by the Committee of Sponsoring Organizations of
the Treadway Commission. Based on this assessment, management believes that, as
of March 31, 2003, its system of internal control over financial reporting met
those criteria.
There have been no significant changes in First Defiance's internal controls or
in other factors that could significantly affect internal controls subsequent to
March 31, 2003.
31
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
At the annual meeting of shareholders held on April 22, 2003, in
Defiance, Ohio the shareholders elected three directors to
three-year terms. The following is a tabulation of all votes timely
cast in person or by proxy by shareholders of First Defiance for the
annual meeting:
I. Nominees for Director with Three-year Terms Expiring in 2005:
NOMINEE FOR WITHHELD
Douglas A. Burgei 5,279,553 37,165
Gerald W. Monnin 5,276,315 44,381
Don C. Van Brackel 5,134,225 184,477
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
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
32
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on February 26, 2002 to announce
the execution of a Purchase and Assumption Agreement with Rurban
Financial Corp. and RFC Banking Company for the purchase of certain
assets and assumption of certain liabilities of RFC Banking Company
branch offices located in Findlay, Ottawa and McComb, Ohio.
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on April 24, 2003 which included a
copy of the Company's earnings release for the quarter ended March
31, 2003
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: May 15, 2003 By: /s/ William J. Small
------------ -----------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: May 15, 2003 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
35
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: May 15, 2003
/s/ William J. Small
- --------------------
William J. Small
Chief Executive Officer
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;
36
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: May 15, 2003
/s/ John C. Wahl
- ----------------
John C. Wahl
Chief Financial Officer
37