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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 June 30, 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 -
6,291,093 shares outstanding at July 12, 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 - June 30, 2003 and December 31, 2002 2
Consolidated Condensed Statements of Income -
Three and six months ended June 30, 2003 and 2002 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Six months ended June 30, 2003 5
Consolidated Condensed Statements of Cash Flows
- Six months ended June 30, 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 21
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 35
Item 4. Controls and Procedures 36
PART II.-OTHER INFORMATION:
Item 1. Legal Proceedings 37
Item 2. Changes in Securities 37
Item 3. Defaults upon Senior Securities 37
Item 4. Submission of Matters to a Vote of Security Holders 37
Item 5. Other Information 37
Item 6. Exhibits and Reports on Form 8-K 37
Signatures 39
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
June 30, 2003 December 31, 2002
------------- -----------------
Assets Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 26,367 $ 17,263
Interest-bearing deposits 46,220 11,395
---------- --------
72,587 28,658
Securities:
Available-for-sale, carried at fair value 177,028 209,604
Held-to-maturity, carried at amortized cost
(approximate fair value $3,486 and $4,129
at June 30, 2003 and December 31,
2002 respectively) 3,280 3,921
---------- --------
180,308 213,525
Loans held for sale 9,731 15,336
Loans receivable, net 690,379 561,041
Accrued interest receivable 4,834 4,533
Federal Home Loan Bank stock and other
interest-earning assets 17,414 18,302
Bank owned life insurance 15,549 15,144
Office properties and equipment 22,670 19,958
Real estate and other assets held for sale 63 206
Goodwill 20,412 3,636
Mortgage servicing rights 1,861 2,090
Other assets 12,806 1,816
---------- --------
Total assets $1,048,614 $884,245
========== ========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
June 30, 2003 December 31, 2002
------------- -----------------
Liabilities and stockholders' equity
Liabilities:
Non-interest-bearing deposits $ 51,798 $ 43,936
Interest-bearing deposits 699,907 555,637
----------- ---------
Total deposits 751,705 599,573
Advances from Federal Home Loan Bank 154,408 149,096
Short-term borrowings and other interest-bearing liabilities 8,785 4,308
Advance payments by borrowers for taxes and insurance 218 316
Deferred taxes 1,961 2,299
Other liabilities 9,952 8,543
----------- ---------
Total liabilities 927,029 764,135
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; 6,281
and 6,412 shares outstanding, respectively 63 64
Additional paid-in capital 50,026 50,702
Stock acquired by ESOP (2,068) (2,387)
Deferred compensation (20) (30)
Accumulated other comprehensive income,
net of income taxes of $3,449
and $3,477, respectively 6,695 6,455
Retained earnings 66,889 65,306
----------- ---------
Total stockholders' equity 121,585 120,110
----------- ---------
Total liabilities and stockholders' equity $ 1,048,614 $ 884,245
=========== =========
See accompanying notes
3
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
Three Months ended Six Months ended
June 30, June 30,
2003 2002 2003 2002
------- ------- ------- --------
Interest Income
Loans $ 9,974 $ 9,081 $19,312 $ 18,041
Investment securities 2,108 2,424 4,532 3,175
Interest-bearing deposits 80 409 109 427
------- ------- ------- --------
Total interest income 12,162 11,914 23,953 21,643
Interest Expense
Deposits 3,412 4,461 6,946 8,389
FHLB advances and other 1,895 1,690 3,709 1,774
Notes payable and warehouse loans 13 38 22 227
------- ------- ------- --------
Total interest expense 5,320 6,189 10,677 10,390
------- ------- ------- --------
Net interest income 6,842 5,725 13,276 11,253
Provision for loan losses 353 156 688 738
------- ------- ------- --------
Net interest income after provision for loan losses 6,489 5,569 12,588 10,515
Non-interest Income
Service fees and other charges 1,133 955 2,149 1,753
Insurance commission income 967 827 1,893 1,710
Dividends on stock and other interest income 172 285 341 466
Gain on sale of loans 2,515 549 4,316 1,075
Gain/(loss) on sale of securities 288 -- 919 (15)
Trust income 38 24 70 54
Income from Bank Owned Life Insurance 204 -- 405 --
Other non-interest income 20 97 35 119
------- ------- ------- --------
Total non-interest income 5,337 2,737 10,128 5,162
Non-interest Expense
Compensation and benefits 3,976 3,494 7,684 6,798
Occupancy 741 722 1,469 1,413
SAIF deposit insurance premiums 31 33 55 65
State franchise tax 285 351 566 645
Data processing 427 465 859 691
Amortization and impairment of mortgage servicing rights 1,122 305 1,885 529
Amortization and impairment of goodwill and other intangibles 8 -- 8 200
Other non-interest expense 1,111 943 2,189 1,964
------- ------- ------- --------
Total non-interest expense 7,701 6,313 14,715 12,305
------- ------- ------- --------
Income from continuing operations before income taxes 4,125 1,993 8,001 3,372
Federal income taxes 1,246 607 2,403 1,099
------- ------- ------- --------
Income from continuing operations 2,879 1,386 5,598 2,273
Discontinued operations, net of tax -- 7,332 -- 9,347
------- ------- ------- --------
Income before cumulative effect of a change in accounting principle 2,879 8,718 5,598 11,620
Cumulative effect of change in method of accounting for goodwill,
net of tax -- -- -- (194)
------- ------- ------- --------
Net income $ 2,879 $ 8,718 $ 5,598 $ 11,426
======= ======= ======= ========
Earnings per share (Note 6)
Basic:
From continuing operations $ 0.48 $ 0.22 $ 0.93 $ 0.35
Discontinued operations, net of tax -- 1.14 -- 1.46
Cumulative effect in method of accounting for goodwill -- -- -- (0.03)
------- ------- ------- --------
Net income $ 0.48 $ 1.36 $ 0.93 $ 1.78
======= ======= ======= ========
Diluted:
From continuing operations $ 0.46 $ 0.21 $ 0.89 $ 0.34
Discontinued operations, net of tax -- $ 1.09 -- 1.40
Cumulative effect in method of accounting for goodwill -- -- -- (0.03)
------- ------- ------- --------
Net income $ 0.46 $ 1.30 $ 0.89 $ 1.71
======= ======= ======= ========
Dividends declared per share (Note 5) $ 0.15 $ 0.13 $ 0.30 $ 0.26
======= ======= ======= ========
Average shares outstanding (Note 6)
Basic 6,013 6,418 6,044 6,426
======= ======= ======= ========
Diluted 6,254 6,689 6,293 6,672
======= ======= ======= ========
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 $28
Total comprehensive income
ESOP shares released 374 319
Amortization of deferred compensation
of Management Recognition Plan 10
Shares issued under stock option plan 650
Purchase of common stock for
treasury (1) (1,700)
Dividends declared (Note 5)
------------------------------------------------------------
Balance at June 30 $ 63 $50,026 $(2,068) $(20)
============================================================
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 5,598 5,598 11,426
Change in unrealized gains (losses)
net of income taxes of $28 240 240 2,411
-------- ---------
Total comprehensive income 5,838 13,837
ESOP shares released 693 561
Amortization of deferred compensation
of Management Recognition Plan 10 26
Shares issued under stock option plan 650 677
Purchase of common stock for
treasury (2,201) (3,902) (2,239)
Dividends declared (Note 5) (1,814) (1,814) (1,695)
- -----------------------------------------------------------
Balance at June 30 $6,695 $66,889 $121,585 $ 122,188
== ===========================================================
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
Six Months
Ended June 30,
2003 2002
--------- ---------
Operating Activities
Net income $ 5,598 $ 11,426
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 688 738
Provision for depreciation 810 822
Net securities amortization 468 220
Amortization of mortgage servicing rights 1,279 265
Net impairment of mortgage servicing rights 606 264
Amortization of core deposit intangible 8 --
Net impairment of goodwill -- 438
Gain on sale of loans (4,316) (1,075)
Gain on sale of discontinued operations -- (16,912)
Amortization of Management Recognition Plan
deferred compensation 10 26
Release of ESOP Shares 693 561
(Gains) losses on sales of securities (919) 15
Deferred federal income tax credit (310) (187)
Proceeds from sale of loans 180,178 55,120
Origination of mortgage servicing rights, net (1,656) (919)
Origination of loans held for sale (170,257) (53,983)
Increase in interest receivable and other assets (988) (3,772)
Increase in other liabilities 770 3,062
Decrease in assets held for sale -- 470
Decrease in liabilities held for sale -- (405)
Increase in assets of discontinued operations -- (5,418)
Decrease in liabilities of discontinued operations -- (35,166)
--------- ---------
Net cash provided by operating activities 12,662 (44,410)
Investing Activities
Proceeds from maturities of held-to-maturity securities 629 934
Proceeds from maturities of available-for-sale securities 45,488 3,595
Proceeds from sale of available-for-sale securities 9,958 423
Proceeds from sales of real estate and
other assets held for sale 241 236
Proceeds from sale of discontinued operations 1,228 367,921
Purchases of available-for-sale securities (22,195) (169,398)
Purchases of Federal Home Loan Bank stock (340) (376)
Purchases of office properties and equipment (1,495) (987)
Acquisition of banking center offices (Note 3) 59,823 --
Net (increase) decrease in loans receivable (51,017) (16,920)
--------- ---------
Net cash provided by investing activities 42,320 185,428
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
Six Months
Ended June 30,
2003 2002
-------- --------
Financing Activities
Net decrease in deposits (14,478) (10,937)
Repayment of Federal Home Loan Bank long-term advances (688) (25,110)
Repayment of term notes payable (10) (19)
Net decrease in Federal Home Loan Bank short-term advances (3,000) (40,000)
Net decrease in short-term line of credit -- (18,250)
Proceeds from Federal Home Loan Bank long term advances 9,000 --
Increase in securities sold under repurchase agreements 3,189 --
Purchase of common stock for treasury (3,902) (2,239)
Cash dividends paid (1,814) (1,695)
Proceeds from exercise of stock options 650 677
-------- --------
Net cash used in financing activities (11,053) (97,573)
-------- --------
Increase in cash and cash equivalents 43,929 43,445
Cash and cash equivalents at beginning of period 28,658 38,100
-------- --------
Cash and cash equivalents at end of period $ 72,587 $ 81,545
======== ========
Supplemental cash flow information:
Interest paid $ 10,263 $ 10,872
======== ========
Income taxes paid $ 2,214 $ 5,756
======== ========
Transfers from loans to real estate
and other assets held for sale $ 98 $ 435
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ (28) $ (1,237)
======== ========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ 212 $ 3,648
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 894 $ 848
======== ========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited)
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 June
30, 2003 and for the three and six-month periods ending June 30, 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 six-month period ended June
30, 2003 are not necessarily indicative of the results that may be
expected for the entire year.
Stock Compensation
At June 30, 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.
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
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
2. Basis of Presentation (continued)
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:
June 30,
2003 2002
------------------------------------
Risk free interest rate 5.66% 5.74%
Dividend yield 2.97% 2.93%
Volatility factors of expected market price
of stock 0.266% 0.269%
Weighted average expected life 8.70 years 8.62 years
Weighted average grant date fair value
of options granted $3.51 $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):
Six months ended
Three months ended June 30, June 30,
2003 2002 2003 2002
-----------------------------------------------------------
Income from continuing operations $ 2,879 $ 1,386 $ 5,598 $ 2,273
Stock-based compensation using the
fair value method, net of tax (50) (48) (101) (100)
-----------------------------------------------------------
Pro forma net income from
continuing operations $ 2,829 $ 1,338 $ 5,497 $ 2,173
===========================================================
Pro forma earnings per share:
Basic $ 0.47 $ 0.21 $ 0.91 $ 0.34
===========================================================
Diluted $ 0.45 $ 0.20 $ 0.87 $ 0.32
===========================================================
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
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 or 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.
Accounting for Guarantees
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 (continued)
(Unaudited)
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 8. 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 June 30, 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 operations,
financial position, or liquidity, as it applies to other areas within the
Company.
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
2. Basis of Presentation (continued)
Accounting Pronouncement Adopted in 2002
On January 1, 2002, First Defiance adopted FASB 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.
3. Banking Center Acquisition
On June 6, 2003, First Defiance completed the acquisition of three banking
centers from RFC Banking Company, a subsidiary of Rurban Financial Corp.
The banking centers are located in Findlay, Ottawa, and McComb, Ohio.
Under the terms of the agreement, First Defiance paid 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 acquired certain loans of those banking centers. As a
result of the acquisition, First Defiance acquired deposits of $166.5
million, including $32.8 million of brokered certificates of deposit, net
loans of $80.6 million, and premises, furnishings and equipment of $2.0
million. First Defiance also recorded intangible assets resulting from the
acquisition of $16.7 million, including goodwill of $15.9 million and core
deposit intangibles of $772,000. The core deposit intangible will be
amortized over approximately 10 years.
4. Discontinued Operations
On April 1, 2002, First Defiance completed the sale of The Leader to US
Bancorp. Discontinued operations as reported for the six months ended June
30, 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 six
months of 2002, First Federal had a negative spread in its borrowing
relationship with The Leader. The components of discontinued operations
for the three and six-month periods ended June 30, 2002 are as follows (in
thousands):
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
4. Discontinued Operations (continued)
Three months Six months
ended ended
June 30, 2002 June 30, 2002
-----------------------------
Operations of The Leader $ -- $ 4,316
Net interest expense allocated to discontinued
operations -- (1,250)
Gain from sale of The Leader 16,959 16,959
Cost to terminate financing and other expenses
associated with discontinued operations (465) (465)
-------------------------
Income from discontinued operations
before income taxes 16,494 19,560
Income tax on discontinued operations 9,162 10,213
-------------------------
Income from discontinued operations $ 7,332 $ 9,347
=========================
5. Dividends on Common Stock
As of June 30, 2003, First Defiance had declared a quarterly cash dividend
of $.15 per share for the second quarter of 2003, payable July 25, 2003.
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
6. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been
calculated by dividing net income by the weighted average number of shares
of common stock outstanding for the three and six-month periods ended June
30, 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
and six-months ended June 30, 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 Six Months
Ended Ended
June 30 June 30
2003 2002 2003 2002
------------------------------------------------
Numerator for basic and diluted earnings per share -
income from continuing operations $2,879 $1,386 $5,598 $2,273
Denominator:
Denominator for basic earnings per share -
weighted average shares 6,013 6,418 6,044 6,426
Effect of dilutive securities:
Employee stock options 235 257 241 228
Unvested management recognition plan stock 6 14 8 18
------ ------ ------ ------
Dilutive potential common shares 241 271 249 246
------ ------ ------ ------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 6,254 6,689 6,293 6,672
====== ====== ====== ======
Basic earnings per share from continuing operations $ 0.48 $ 0.22 $ 0.93 $ 0.35
====== ====== ====== ======
Diluted earnings per share from continuing operations $ 0.46 $ 0.21 $ 0.89 $ 0.34
====== ====== ====== ======
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
7. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities (in thousands):
June 30, 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 $ 70,455 $ 6,368 $ -- $ 76,823
Corporate bonds 16,507 1,449 -- 17,956
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 52 2,057
Mortgage-backed securities 21,826 324 -- 22,150
Collateralized mortgage obligations 5,762 59 10 5,811
REMICs 12,840 57 89 12,808
Trust preferred stock 7,238 99 5 7,332
Equity securities 69 3 -- 72
Obligations of state and political
subdivisions 30,078 1,952 11 32,019
---------------------------------------------------
Totals $166,884 $10,311 $167 $177,028
===================================================
Held-to-Maturity Securities:
FHLMC certificates $ 789 $ 29 $ 1 $ 817
FNMA certificates 1,400 26 5 1,421
GNMA certificates 501 22 -- 523
Obligations of state and political
subdivisions 590 135 -- 725
---------------------------------------------------
Totals $ 3,280 $ 212 $ 6 $ 3,486
===================================================
16
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
7. 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
===================================================
8. 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
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.
17
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
8. Commitments, Guarantees and Contingent Liabilities (continued)
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
was as follows:
June 30, December 31,
2003 2002
------------------------------
(In Thousands)
Commercial $ 104,698 $ 103,984
Real Estate 20,421 17,537
Consumer 51,308 41,555
Standby Letters of Credit 4,252 2,997
------------------------------
Total $ 180,679 $ 166,073
==============================
The remaining weighted average life for outstanding standby letters of
credit was less than one year at June 30, 2003. The Company had $37,000 of
standby letters of credit with a life longer than one year.
18
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
9. Loans
Loans receivable and held for sale consist of the following (in
thousands):
June 30, December 31
2003 2002
-------------------------
Real Estate:
One-to-four family residential $167,412 $157,691
Construction 15,559 15,357
Non-residential and multi-family 307,871 227,754
------------------------
490,842 400,802
Other Loans:
Commercial 124,332 104,070
Consumer finance 42,189 37,579
Home equity and improvement 59,450 49,889
------------------------
225,971 191,538
------------------------
Total real estate and other loans 716,813 592,340
Deduct:
Loans in process 7,431 7,255
Net deferred loan origination fees and costs 1,167 1,212
Allowance for loan loss 8,105 7,496
------------------------
Totals $700,110 $576,377
========================
Changes in the allowance for loan losses were as follows (in thousands):
Three Months ended June 30 Six Months ended June 30
2003 2002 2003 2002
-----------------------------------------------------
Balance at beginning of period $7,924 $6,933 $7,496 $6,548
Provision for loan losses 353 156 688 738
Charge-offs:
One-to-four family residential real estate 18 15 18 64
Non-residential and multi-family real estate 162 20 162 74
Commercial 38 -- 63 --
Consumer finance 39 93 89 240
------------------------------------------------
Total charge-offs 257 128 332 378
Recoveries 85 67 253 120
------------------------------------------------
Net charge-offs 172 61 79 258
------------------------------------------------
Ending allowance $8,105 $7,028 $8,105 $7,028
================================================
19
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited)
10. Deposits
A summary of deposit balances is as follows (in thousands):
June 30, December 31,
2003 2002
---------------------------
Non-interest-bearing checking accounts $ 51,798 $ 43,936
Interest-bearing checking accounts 65,320 41,318
Savings accounts 51,693 39,363
Money market demand accounts 146,803 129,036
Certificates of deposit 436,091 345,920
---------------------------
$ 751,705 $ 599,573
===========================
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
First Defiance Financial Corp. ("First Defiance" or "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 17 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 and the associated gains from the sale are reported
as discontinued operations for the three and six month-periods ended June 30,
2002.
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 June 30, 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 $177.0 million at June 30, 2003. The available-for-sale portfolio consists of
U.S. Treasury securities and obligations of U.S. Government corporations and
agencies ($76.8 million), corporate bonds ($18.0 million), certain municipal
obligations ($32.0 million), CMOs and REMICs ($18.6 million), mortgage backed
securities ($22.1 million), preferred stock and other equity investments ($7.4
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
$10.1 million at June 30, 2003, or $6.6 million after considering the related
deferred tax liability.
21
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
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.
Branch Acquisition
On June 6, 2003, First Defiance completed the acquisition of three banking
centers from RFC Banking Company, a subsidiary of Rurban Financial Corp. The
banking centers are located in Findlay, Ottawa, and McComb, Ohio. Under the
terms of the purchase and assumption agreement, First Defiance paid 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 acquired certain loans of those banking centers. As a result of the
acquisition, First Defiance acquired deposits of $166.5 million, including $32.8
million of brokered certificates of deposit, net loans of $80.6 million, and
premises, furnishings and equipment of $2.0 million. In addition, First Defiance
also recorded intangible assets resulting from the acquisition of $16.7 million,
including goodwill of $15.9 million and core deposit intangibles of $772,000.
The core deposit intangible will be amortized over approximately 10 years.
Changes in Financial Condition
At June 30, 2003, First Defiance's total assets, deposits and stockholders'
equity amounted to $1.05 billion, $751.7 million and $121.6 million,
respectively, compared to $884.2 million, $599.6 million and $120.1 million,
respectively, at December 31, 2002.
Net loans receivable increased to $690.4 million at June 30, 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 $80.1 million to $307.9 million at June 30, 2003, $35.4 million of which is
from the branch acquisition. In addition, commercial loans increased by $20.3
million to $124.3 million at June 30, 2003, $16.8 million of which resulted from
the branch acquisition. Also, home equity and improvement loans, increased by
$9.6 million to $59.5 at June 30, 2003, including $1.8 million acquired as part
of the branch acquisition. One-to-four family residential loans increased by
$9.7 million to $167.4 million at June 30, 2003 because $18.5 million
22
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
of residential mortgage loans were acquired as part of the branch acquisition.
Without the acquisition, residential mortgage loans declined because of the
substantial refinancing activity, most of which is sold into the secondary
market. Also, consumer loans increased by $4.6 million to $42.2 million at June
30, 2003 because $8.1 million were added due to the acquisition.
The investment securities portfolio decreased to $180.3 million at June 30, 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 June 30, 2003 there were
approximately $45.2 million of interest-bearing deposits held at other financial
institutions. These funds, which resulted from acquiring more deposits in the
branch acquisition than loans, will be redeployed into loans or higher earning
investments as interest rates rise, or will be used to liquidate $47.4 million
of brokered certificates of deposit, $28.5 million of which are scheduled to
mature over the next 12 months and which will not be renewed.
Deposits increased from $599.6 million at December 31, 2002 to $751.7 million as
of June 30, 2003. As a result of the acquisition and other deposit growth
initiatives, money market demand accounts have increased by $17.8 million, to
$146.8 million at June 30, 2003 from $129.0 million at December 31, 2002, and
checking accounts, both interest and non-interest bearing, have increased by
$31.9 million, to $117.1 million at June 30, 2003 from $85.3 million at December
31, 2002. While the Company has focused on increasing its lower cost core
deposits, and has been less aggressive in retaining higher cost certificates of
deposit during 2003, those balances still increased by $90.2 million to $436.1
million at June 30, 2003, from $345.9 million at December 31, 2002. Of that
increase, $107.3 million resulted from the branch acquisition, including $32.8
million of brokered CDs. Excluding the acquisition, CDs declined by $17.1
million. Most of the decline is due to the maturing of brokered CDs, which were
primarily acquired to fund the operations of The Leader, as well as less
aggressive retail CD pricing.
Additionally, FHLB advances increased to $154.4 million at June 30, 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 increased to $8.8 million at June 30, 2003 from $4.3
million at December 31, 2002. This is a result of an increase in the balance of
securities sold under repurchase agreements, an alternative source of funding
for the Company, which fluctuates, based on customer demand.
23
Item 2. Managements' 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 June 30,
---------------------------------------------------------------------------------
2003 2002
-------------------------------------- -----------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 633,755 $ 10,030 6.35% $ 511,238 $ 9,140 7.17%
Securities 189,448 2,284 4.84 188,361 2,548 5.43
Interest-earning deposits 24,697 80 1.30 96,337 409 1.70
FHLB stock and other 17,244 172 4.02 34,580 285 3.31
---------- --------- --------- --------
Total interest-earning assets 865,144 12,566 5.83 830,516 12,382 5.98
Non-interest-earning assets
(including assets of discontinued
operations) 73,933 54,620
--------- --------
Total assets $ 939,077 $885,136
========= ========
Interest-bearing liabilities (4):
Deposits $ 603,045 $ 3,412 2.27% $ 574,461 $ 4,461 3.11%
FHLB advances and other 154,658 1,895 4.91 131,472 1,690 5.16
Notes payable 4,225 13 1.23 2,430 38 6.27
---------- --------- --------- --------
Total interest-bearing liabilities 761,928 5,320 2.80 708,363 6,189 3.50
Non-interest bearing deposits 46,505 -- 33,559 --
---------- --------- --------- --------
Total including non-interest bearing
demand deposits 808,433 5,320 2.64 741,922 6,189 3.35
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 9,756 24,048
--------- ---------
Total liabilities 818,189 765,970
Stockholders' equity 120,888 119,166
--------- ---------
Total liabilities and stock-
holders' equity $ 939,077 $ 885,136
========= =========
Net interest income; interest
rate spread $ 7,246 3.03% $ 6,193 2.48%
========= ===== ======== =====
Net interest margin (3) 3.36% 2.99%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 114% 117%
===== =====
- ----------
(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.
24
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Six Months Ended June 30,
---------------------------------------------------------------------------------------
2003 2002
---------------------------------------- -----------------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 611,796 $ 19,428 6.40% $ 503,955 $ 18,143 7.26%
Securities 198,046 4,875 4.96 120,930 3,350 5.59
Interest-earning deposits 15,782 109 1.39 54,972 427 1.57
FHLB stock and other 17,602 341 3.92 25,444 466 3.70
----------- --------- ---------- ----------
Total interest-earning assets 843,226 24,753 5.92 705,301 22,386 6.40
Non-interest-earning assets
(including assets of discontinued
operations) 68,581 312,311
--------- ----------
Total assets $ 911,807 $1,017,612
========= ==========
Interest-bearing liabilities (4):
Deposits $ 579,285 $ 6,946 2.42% $ 535,478 $ 8,389 3.16%
FHLB advances and other 155,610 3,709 4.81 69,585 1,774 5.14
Notes payable 3,618 22 1.23 11,930 227 3.84
----------- --------- ---------- ----------
Total interest-bearing liabilities 738,513 10,677 2.92 616,993 10,390 3.40
Non-interest bearing deposits 42,421 -- 30,849 --
----------- --------- ---------- ----------
Total including non-interest bearing
demand deposits 780,934 10,677 2.76 647,842 10,390 3.23
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 10,307 254,144
----------- ----------
Total liabilities 791,241 901,994
Stockholders' equity 120,566 115,626
----------- ----------
Total liabilities and stock-
holders' equity $ 911,807 $1,017,612
=========== ==========
Net interest income; interest
rate spread $ 14,076 3.00% $ 11,996 3.00%
--------- ----------
Net interest margin (3) 3.37% 3.43%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 114% 114%
===== =====
- ----------
(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.
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 prior periods presented. See Note 4 to
the Consolidated Condensed Financial Statements filed with this Form 10-Q.
25
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Three Months Ended June 30, 2003 compared to Three Months Ended June 30, 2002
On a consolidated basis, First Defiance had net income of $2.9 million or $.46
per share for the three months ended June 30, 2003 compared to $8.7 million or
$1.30 per share in 2002. The 2002 net income included earnings from discontinued
operations of $7.3 million or $1.09 per share. Income from continuing operations
for the 2002 second-quarter was $1.4 million or $0.21 per share.
Net Interest Income. Net interest income for the quarter ended June 30, 2003 was
$6.8 million compared to $5.7 million from continuing operations for the same
period in 2002. Net interest margin for the 2003 second quarter was 3.36%
compared to 2.99% for the same period in 2002. On a tax-equivalent basis, net
interest income for the quarter ended June 30, 2003 was $7.2 million compared to
$6.2 million from continuing operations for the same period in 2002.
Total interest income increased by $248,000 to $12.2 million for the three
months ended June 30, 2003 from $11.9 million from continuing operations for the
three months ended June 30, 2002. On a tax equivalent basis, total interest
income increased by $184,000 to $12.6 million for the three months ended June
30, 2003 from $12.4 million for the three months ended June 30, 2002. Interest
on loans increased $890,000 to $10.0 million in the second quarter of 2003 from
$9.1 million in the second quarter of 2002. The increase in interest from loans
was due to a $122.5 million increase in average loan balances between the second
quarter of 2002 and the second quarter of 2003, although 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 7.17% for the three months
ended June 30, 2002 to 6.35% 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 $379.9 million at
June 30, 2003, excluding the loans acquired as part of the branch acquisition,
up from $331.8 million at December 31, 2002. An additional $16.8 million of
commercial loans and $35.4 million of non-residential real estate loans were
acquired as part of the branch transaction. During the six-month period
one-to-four family residential loans, excluding loans held for sale, increased
from $157.7 million to $167.4 million. However, that number includes the $21.4
million in loans acquired as part of the branch acquisition, which was offset
substantially by a decline in the one-to-four family residential loan portfolio
as a 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, decreased $706,000 to $2.5 million for the three
months ended June 30, 2003 compared to $3.2 million for the same period in 2002.
The decrease is due primarily to a combination of declining yields in the
investment portfolio and a significant decline in interest-bearing deposits as
the proceeds from the sale of The Leader, which were received on April 1, 2002,
have been reinvested in loans or used for other purposes. The rate decline is
due both to the historically low rate environment in the 2003 second-quarter
along with managements' decision to invest primarily in shorter-term investments
in anticipation of continued loan growth and other requirements. The average
balance of securities for the 2003 second quarter increased slightly to
26
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
$189.4 million from $188.4 million for the same period in 2002. However, the tax
equivalent yield on those securities dropped 59 basis points, from 5.43% for the
three months ended June 30, 2002 to 4.84% for the three months ended June 30,
2003. The average balance on interest bearing deposits decreased $71.6 million
to $24.7 million from $96.3 million. To 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 $233,000 and $183,000 respectively.
Total interest expense decreased by $869,000, to $5.3 million for the second
quarter of 2003 compared to $6.2 million from continuing operations for the same
period in 2002. Interest expense on interest bearing deposits decreased by $1.1
million to $3.4 million for the quarter ended June 30, 2003 from $4.5 million
for the quarter ended June 30, 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
interest-bearing deposits decreased from 3.11% for the second quarter of 2002 to
2.27% for the second quarter of 2003. Interest expense on FHLB advances
increased $205,000 to $1.9 million for the second quarter of 2003 compared to
the same period in 2002. The increase is due to the increase of average balances
of FHLB advances, which increased to $154.4 million in the second quarter of
2003, up from $131.2 million for the quarter ended June 30, 2002.
Provision for Loan Losses. The provision for loan losses was $353,000 in the
second quarter of 2003 compared to $156,000 for the second quarter of 2002.
While the quarter over quarter increase is significant, the 2003 second-quarter
amount is consistent with recent quarterly experience for the Company. Net
charge-offs for the 2003 second quarter were $172,000, compared to $61,000 for
the same period in 2002. Provisions for loan losses are charged to earnings to
bring the total allowance for loan losses to the level deemed appropriate by
management based on historical experience, the volume and type of lending
conducted by First Defiance, industry standards, the amount of non-performing
assets and loan charge-off activity, general economic conditions, particularly
as they relate to First Defiance's market area, and other factors related to the
collectibility of First Defiance's loan portfolio. The provision expense exceeds
the net charge-offs, in part, because net charge-offs have been low. Also, the
portfolio has grown rapidly over the last several years and management believes
that as the portfolio becomes more seasoned, charge-offs will likely increase.
Overall, management believes the balance of the allowance for loan losses is
appropriate.
27
Item 2. Managements' 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):
June 30, December 31,
2003 2002
-------------------------------
Non-accrual loans $ 3,273 $ 2,525
Loans over 90 days past due and still accruing -- --
-------------------------------
Total non-performing loans $ 3,273 $ 2,525
Real estate owned (REO) 63 206
-------------------------------
Total non-performing assets $ 3,336 $ 2,731
===============================
Allowance for loans losses as a percentage
of total loans 1.16% 1.32%
Allowance for loan losses as a percentage
of portfolio loans (excludes loans held for sale) 1.17% 1.34%
Allowance for loan losses as a percentage
of non-performing assets 242.96% 274.48%
Allowance for loan losses as a percentage
of non-performing loans 247.63% 296.87%
Total non-performing assets as a percentage
of total assets 0.32% 0.31%
Total non-performing loans as a percentage
of total loans 0.47% 0.44%
Of the $3.3 million in non-accrual loans, $3.0 million were commercial loans or
non-residential real estate loans and $232,000 were residential mortgage loans.
The allowance for loan losses at June 30, 2003 was $8.1 million compared to $7.0
million at both June 30, 2002 and $7.5 million at December 31, 2002. For the
quarter ended June 30, 2003, First Defiance charged off $257,000 of loans
against its allowance and realized recoveries of $85,000 from loans previously
charged off. During the same quarter in 2002, First Defiance charged off
$128,000 in loans and realized recoveries of $67,000.
In addition to the existing allowance for loan losses, management also evaluated
the expected collectibility of the loans acquired as part of the branch
acquisition. In conjunction with that evaluation, those balances were discounted
by approximately $2.9 million in recording the acquisition to reflect potential
credit losses. That $2.9 million discount is in addition to First Federal's $8.1
million allowance for loan losses.
Non-Interest Income. Non-interest income increased $2.6 million in the second
quarter of 2003, to $5.3 million for the quarter ended June 30, 2003 from $2.7
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
$2.0 million to $2.5 million for the three months ended June 30, 2003 from
$549,000 during the 2002 second- 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.
Gain on Sale of Securities. Gains realized from the sale of investment
securities were $288,000 in the second quarter of 2003. There were no securities
gains in the second quarter of 2002. The
28
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
realization of the gains in the investment portfolio was, in part due to a
callable agency security purchased at a discount being called prior to the
maturity date. When called, the remaining unamortized discount was recognized as
gain on sale. In addition, management has taken some gains in an effort to
shorten the duration of assets in the investment portfolio to position the
Company to benefit from rising rates.
Service Fees. Loan and deposit fees increased $178,000 to $1.1 million for the
quarter ended June 30, 2003 from $955,000 for the quarter ended June 30, 2002.
Increases occurred primarily in loan servicing fees on mortgage loans serviced
for others, debit card interchange fees, and checking non-sufficient funds (NSF)
fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $140,000 to $967,000 in the second quarter of 2003
from $827,000 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 $204,000 in
the quarter ended June 30, 2003. The Company made an initial $15 million
investment in BOLI during the 2002 fourth quarter.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, decreased to
$230,000 for the quarter ended June 30, 2003 from $406,000 for the same period
in 2002.
Non-Interest Expense. Total non-interest expense increased $1.4 million to $7.7
million for the quarter ended June 30, 2003 from $6.3 million for the same
period in 2002. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $482,000 to $4.0
million for the quarter ended June 30, 2003 from $3.5 million for the same
period in 2002. The increase was the result of an addition of 13 staff members
between June 30, 2002 and June 30, 2003 (excluding the branch acquisition), as
well as an additional $58,000 in compensation expense related to the new
branches. 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 $139,000 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 $756,000 in the 2003 second quarter
compared to $137,000 in the 2002 second quarter, the result of significant
refinancing activity in the First Federal loan servicing portfolio. Also, the
Company recognized a $366,000 adjustment for impairment in the value of its MSR
portfolio during the 2003 second 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 $168,000 adjustment
for impairment recognized in the second quarter of 2002. First Defiance has a
total impairment reserve of $1.9 million recorded against an asset with a
29
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
book value before reserves of $4.1 million at June 30, 2003. That portfolio
represents approximately 4,915 loans with unpaid balances of approximately $388
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 or 2002. In
conjunction with the branch acquisition, First Defiance recognized a core
deposit intangible of $772,000, which is subject to amortization. Amortization
expense for 24 days in the 2003 second-quarter was just $8,000.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $2.6 million for the quarter ended June 30, 2003 from $2.5 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 30.20% for the
quarter ended June 30, 2003 compared to 30.46% for the same period in 2002. The
difference between the effective tax rate and the statutory rate is a result of
investing approximately $32.6 million in municipal securities, and $15.5 million
of bank owned life insurance which are both exempt from federal tax. At June 30,
2002, First Defiance had $26.4 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 June 30, 2003 was
$2.9 million compared to income from continuing operations of $1.4 million for
the comparable period in 2002. On a per share basis, basic and diluted earnings
per share for the three months ended June 30, 2003 were each $0.48 and $.46,
respectively, compared to basic and diluted earnings per share from continuing
operations of $0.22 and $0.21, respectively, for the quarter ended June 30,
2002.
Discontinued Operations. Discontinued operations for the 2002 second quarter
period, which represents primarily the after-tax gain realized from the sale of
The Leader, were $7.3 million or $1.09 per share.
Six Months Ended June 30, 2003 compared to Six Months Ended June 30, 2002
On a consolidated basis, First Defiance had net income of $5.6 million or $0.89
per share for the six months ended June 30, 2003 compared to $11.4 million or
$1.71 per share in 2002. The 2002 net income included earnings from discontinued
operations of $9.3 million or $1.40 per share. Income from continuing operations
for the first six months of 2002 was $2.3 million or $0.34 per share.
Net Interest Income. Net interest income for the six months ended June 30, 2003
was $13.3 million compared to $11.3 million from continuing operations for the
same period in 2002. Net interest margin for the 2003 first half was 3.37%
compared to 3.43% for the same period in 2002. On a tax equivalent basis, net
interest income for the six months ended June 30, 2003 was $14.1 million
compared to $12.0 million from continuing operations for the same period in
2002.
Total interest income increased by $2.3 million to $23.9 million for the six
months ended June 30, 2003 from $21.6 million from continuing operations for the
six months ended June 30, 2002. On a
30
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
tax equivalent basis, total interest income increased by $2.4 million to $24.8
million for the six months ended June 30, 2003 from $22.4 million for the six
months ended June 30, 2002. Interest on loans increased $1.3 million to $19.4
million in the first half of 2003 from $18.1 million in the first half of 2002.
The increase in interest from loans was due to a $107.8 million increase in
average loan balances between the first half of 2002 and the first half 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
7.26% for the six months ended June 30, 2002 to 6.40% for the same period in
2003 because of falling interest rates over that time period.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, increased $1.1 million to $5.3 million for the six
months ended June 30, 2003 compared to $4.2 million 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 half
increased to $198.0 million from $120.9 million for the same period in 2002.
However, the tax equivalent yield on those securities dropped 63 basis points
from 5.59% for the six months ended June 30, 2002 to 4.96% for the six months
ended June 30, 2003. The average balance on interest-earning deposits decreased
$39.2 million to $15.8 million for the period ending June 30, 2003 from $55.0
million for the same period in 2002.
Total interest expense increased by $287,000 to $10.7 million for the first half
of 2003 compared to $10.4 million from continuing operations for the same period
in 2002. Interest expense on FHLB advances increased $1.9 million to $3.7
million for the first six months 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 $86.0 million to $155.6 million for the six
months ended June 30, 2003 from $69.6 million for the six months ended June 30,
2002. The average balance sheet and income statement for 2002 were 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 $1.4 million to $6.9
million for the six months ended June 30, 2003 from $8.4 million for the six
months ended June 30, 2002. This happened despite growth in deposits because of
the declining interest rate environment and 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 3.16% for the six months
ended June 30, 2002 to 2.42% for the same period in 2003. The average balances
of interest-bearing liabilities increased $121.5 million from $617.0 million in
the first half of 2002 to $738.5 million in the first half of 2003.
Provision for Loan Losses. The provision for loan losses was $688,000 for the
first half of 2003 compared to $738,000 for the first half of 2002. Despite
significant growth in loan balances, net charge-offs for the 2003 first half
were only $79,000, compared to $258,000 for the same period in 2002.
Non-Interest Income. Non-interest income increased $4.9 million in the first
half of 2003, to $10.1 million for the six months ended June 30, 2003 from $5.2
million for the same period in 2002. Individual components of non-interest
income are as follows:
31
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased
$3.2 million to $4.3 million for the six months ended June 30, 2003 from $1.1
million during the first half of 2002.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $919,000 for the six months ended June 30, 2003 compared to a
loss of $15,000 in the first half of 2002. The realization of 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. In addition the Company realized securities gains in
the second quarter of 2003 due to the early call of an investment security with
a significant unamortized discount.
Service Fees. Loan and deposit fees increased $396,000 to $2.1 million for the
six months ended June 30, 2003 from $1.8 million for the six months ended June
30, 2002. Increases occurred primarily in loan servicing fees on mortgage loans
serviced for others, debit card interchange fees, and checking NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $183,000 to $1.9 million in the first half of 2003
from $1.7 million 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 $405,000
for the six months ended June 30, 2003. The Company made an initial $15 million
investment in BOLI during the 2002 fourth quarter.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, decreased to
$446,000 for the six months ended June 30, 2003 from $639,000 for the same
period in 2002.
Non-Interest Expense. Total non-interest expense increased $2.4 million to $14.7
million for the six months ended June 30, 2003 from $12.3 million for the same
period in 2002. Significant individual components of the increase are as
follows:
Amortization and Impairment of Mortgage Servicing Rights. Amortization of MSRs
totaled $1.3 million in the first half of 2003 compared to $265,000 in the 2002
first half, the result of significant refinancing activity in the First Federal
loan servicing portfolio. Also, the Company recognized a $606,000 adjustment for
impairment in the value of its MSR portfolio during the first six months of
2003. This is the result of the decline in the market value of its MSRs in the
face of falling interest rates and increased prepayment speeds on mortgage loans
in general. There was a $264,000 adjustment for impairment recognized in the
first half of 2002.
Compensation and Benefits. Compensation and benefits increased $886,000 to $7.7
million for the six months ended June 30, 2003 from $6.8 million for the same
period in 2002.
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
32
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
no goodwill impairment in 2003. During the first half of 2002, management
evaluated goodwill recorded at First Insurance for the purpose of measuring
impairment and determined that such goodwill was impaired by $238,000 ($194,000
or $0.03 per share after tax) as of January 1, 2002. As permitted, this amount
is reflected in the income statement as the cumulative effect of a change in
accounting principle. In addition to the $238,000 of impaired goodwill, 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 half. Such impairment totaled $200,000 in the first half of 2002.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $5.1 million for the six months ended June 30, 2003 from $4.8 million for the
six months ended June 30, 2002.
The effective federal income tax rate for the six months ended June 30, 2003 was
30.0% compared to 32.6% for the six months ended June 30, 2002.
As a result of the above factors, income for the six months ended June 30, 2003
was $5.6 million compared to income from continuing operations of $2.3 million
for the comparable period in 2002. On a per share basis, basic and diluted
earnings per share for the six months ended June 30, 2003 were each $0.93 and
$0.89 respectively, compared to basic and diluted earnings per share from
continuing operations of $0.35 and $0.34, respectively, for the six months ended
June 30, 2002.
Discontinued Operations. Discontinued operations for the 2002 first half, which
represents net income earned by The Leader's operations plus the $7.3 million
net gain from the sale of The Leader, were $9.3 million or $1.40 per share.
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 $12.7 million of cash from operating activities during
the second quarter 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 June 30, 2003, First Defiance had $72.2 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $108.5 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 $36.6 million of loans held-for-sale.
Also
33
Item 2. Managements' Discussion and Analysis of Financial Condition and Results
of Operations - Continued
as of June 30, 2003, the total amount of certificates of deposit that are
scheduled to mature by June 30, 2004 is $300.3 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. Securities totaling $2.2 million do not pass
the FFIEC high risk security test as of June 30, 2003, which is an indicator
related to the underlying interest rate risk of those securities. The weighted
average life of these securities exceeds the test limits in an instantaneous
rate increase scenario of 200 and 300 basis points. The company feels that at
this time the return being realized is worth this risk. The remaining $16.4
million of these securities are not classified as high risk at June 30, 2003 and
do not present risk significantly different than other mortgage-backed or agency
securities.
First Federal is required to maintain specified amounts of capital pursuant to
regulations promulgated by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
The following table sets forth First Federal's compliance with each of the
capital requirements at June 30, 2003.
34
Item 2. Managements' 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 $ 87,367 $ 87,367 $ 95,367 $ 95,367
Minimum required regulatory capital 40,642 50,802 57,958 72,448
--------- --------- --------- ---------
Excess regulatory capital $ 46,725 $ 36,565 $ 37,409 $ 22,919
========= ========= ========= =========
Regulatory capital as a percentage of assets (1) 8.6% 8.6% 13.2% 13.2%
Minimum capital required as a percentage of assets 4.0% 5.0% 8.0% 10.0%
--------- --------- --------- ---------
Excess regulatory capital as a percentage of assets 4.6% 3.6% 5.2% 3.2%
========= ========= ========= =========
(1) Core capital is computed as a percentage of adjusted total assets of
$1,016.0 million. Risk-based capital is computed as a percentage of total
risk-weighted assets of $724.5 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.
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
June 2003 amounts as a base case, First Defiance's net interest income would be
impacted by less than the board mandated guidelines of 10%.
35
Item 4. Controls and Procedures
As of June 30, 2003, we performed an evaluation under the supervision and with
the participation of our management, including the CEO and CFO, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c)). Based on that
evaluation, our management, including the CEO and CFO, concluded that our
disclosure controls and procedures were effective as of June 30, 2003 to provide
reasonable assurance that material information relating to the Company would be
made known to them by others within the Company, particularly during the period
in which the Form 10-Q was being prepared. During the period covered by this
Form 10-Q, there have been no changes in our internal controls or in other
factors that materially affected, or are reasonably likely to materially affect,
these internal controls.
36
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
(a) Exhibits
Exhibit 31.1 - Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - 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 32.2 - 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
37
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on July 18, 2003 which included a copy
of a press release announcing the Board of Directors approval to
repurchase 5% of the outstanding shares of the Company over a 12 month
period.
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on July 22, 2003 which included a copy
of the Company's earnings release for the quarter ended June 30, 2003.
38
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: August 14, 2003 By: /s/ William J. Small
---------------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: August 14, 2003 By: /s/ John C. Wahl
---------------------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
39