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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year Ended December 31, 2003
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-26850
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FIRST DEFIANCE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
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OHIO 34-1803915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
601 Clinton Street, Defiance, Ohio 43512
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (419) 782-5015
---------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
(Title of class)
---------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes |X| No |_|
As of March 5, 2004, there were issued and outstanding 6,398,202 shares of
the Registrant's common stock.
The aggregate market value of the voting stock held by non-affiliates of
the Registrant computed by reference to the average bid and ask price of such
stock as of June 30, 2003 was approximately $126.9 million and as of March 5,
2004 was approximately $175.5 million.
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Documents Incorporated by Reference
Part III - Portions of the Proxy Statement for the Annual Meeting of
Shareholders to be held on April 20, 2004 are incorporated by reference into
Part III thereof.
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PART I
Item 1. Business
First Defiance Financial Corp. (First Defiance or the Company) is a
unitary thrift holding company that, through its subsidiaries (the
"Subsidiaries") focuses on traditional banking and property and casualty, life
and group health insurance products. The Company's traditional banking
activities include originating and servicing residential, commercial, and
consumer loans and providing a broad range of depository services. The Company's
insurance activities consist primarily of commissions relating to the sale of
property and casualty, life and group health insurance and investment products.
During 2003, First Defiance acquired $166.7 million of deposits, $79.0
million of loans, and three banking center offices from RFC Banking Company, a
subsidiary of Rurban Financial Corp (the "RFC acquisition"). First Defiance
successfully completed the RFC acquisition on June 6, 2003. This transaction was
accounted for as a purchase.
At December 31, 2003, the Company had consolidated assets of $1.041
billion, consolidated deposits of $729.0 million, and consolidated stockholder's
equity of $124.3 million. The Company was incorporated in Ohio in June of 1995.
Its principal executive offices are located at 601 N. Clinton Street, Defiance,
Ohio 43512, and its telephone number is (419) 782-5015.
First Defiance previously owned The Leader Mortgage Company ("The
Leader"), a mortgage banking company located in Cleveland, Ohio. Effective April
1, 2002, First Defiance sold The Leader to U.S. Bank Home Mortgage, a unit of
U.S. Bank. The gain from the sale of that business, as well as all operating
results associated with The Leader, are reported as results of discontinued
operations for all periods. The results of operations of the subsidiaries and
the holding company are reflected in continuing operations.
First Defiance's Internet site, www.fdef.com contains a hyperlink under
the Investor Relations section to EDGAR where the annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 are available free of charge as soon as
reasonably practicable after First Defiance has filed the report with the SEC
The Subsidiaries
The Company's core business operations are conducted through the following
Subsidiaries:
First Federal Bank of the Midwest: First Federal Bank of the Midwest
(First Federal) is a federally chartered stock savings bank headquartered in
Defiance, Ohio. It conducts operations through its main office and nineteen full
service branch offices in Defiance, Fulton, Hancock, Henry, Lucas, Paulding,
Putnam, Seneca, Williams and Wood Counties in northwest Ohio. The 19th office,
located in Maumee Ohio, opened on February 26, 2004. First Federal's deposits
are insured by the Federal Deposit Insurance Corporation (FDIC) under the
Savings Association
- 2 -
Insurance Fund (SAIF). First Federal is a member of the Federal Home Loan Bank
(FHLB) System.
First Federal is primarily engaged in community banking. It attracts
deposits from the general public through its offices and uses those and other
available sources of funds to originate residential real estate loans,
non-residential real estate loans, commercial loans, home improvement and home
equity loans and consumer loans. In addition, First Federal invests in U.S.
Treasury and federal government agency obligations, obligations of the State of
Ohio and its political subdivisions, mortgage-backed securities which are issued
by federal agencies, including REMICs and CMOs and corporate bonds.
First Insurance & Investments: First Insurance & Investments (First
Insurance) is a wholly owned subsidiary of First Defiance. First Insurance is an
insurance agency that does business in the Defiance, Ohio area. First Insurance
offers property and casualty insurance, life insurance, group health insurance,
and investment products.
Securities
First Defiance's securities portfolio is managed in accordance with a
written policy adopted by the Board of Directors and administered by the
Investment Committee. The Chief Financial Officer, the Chief Operating Officer,
and the Chief Executive Officer of First Federal can each approve transactions
up to $1 million. Two of the three officers are required to approve transactions
between $1 million and $5 million. All transactions in excess of $5 million must
be approved by the Board of Directors.
First Defiance's investment portfolio includes 17 CMO and REMIC issues
totaling $23.7 million, all of which are fully amortizing securities. All such
investments are considered derivative securities. One of the securities with a
balance of $1.0 million is considered to be "high risk" based on the stress test
developed by the banking regulators. The other 16 securities are not considered
to be high risk. Management does not believe the risks associated with any of
these investments, including the security considered high risk, are
significantly different from risks associated with other pass-through
mortgage-backed securities. First Defiance does not invest in off-balance sheet
derivative securities.
Management determines the appropriate classification of debt securities at
the time of purchase. Debt securities are classified as held-to-maturity when
First Defiance has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost. Debt
securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value.
The amortized cost and fair value of securities at December 31, 2003 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Money market mutual
funds and other mutual funds are not due at a single maturity date. For purposes
of the maturity table, mortgage-backed securities, which are not due at a single
maturity date, have been allocated over maturity groupings based on the
weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
- 3 -
Contractually Maturing Total
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Weighted Weighted Weighted Weighted
Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average
Year Rate Years Rate Years Rate Years Rate Amount Yield
----------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage-backed
securities $ 9 9.35% $ -- -- $ 5,427 4.99% $16,371 5.30% $ 21,807 5.65%
Corporate bonds 997 5.75 6,213 6.77 -- -- -- -- 7,210 6.63
REMICs and CMOs -- -- 114 2.67 36 5.00 23,531 4.35 23,681 4.34
U.S. Government and
federal agency
obligations 10,268 6.21 31,598 5.17 30,680 5.94 361 5.00 72,907 5.64
Obligations of states
and political
subdivisions (1) 1,243 8.67 3,477 7.89 16,463 6.87 10,759 7.44 31,942 7.24
Trust preferred stock -- -- -- -- -- -- 7,238 5.03 7,238 5.03
-------- ------- -------- ------- --------
Total $ 12,517 $41,402 $ 52,606 $58,260 164,785
======== ======= ======== =======
Equity securities 69
Unrealized gain on
securities
available for sale 6,181
--------
Total $171,035
========
(1) Tax exempt yield based on effective tax rate of 35%. Actual coupon rate is
approximately equal to the weighted average rate disclosed in the table times
65%.
The carrying value of investment securities is as follows:
December 31
2003 2002 2001
----------------------------------------
(In Thousands)
Available-for-Sale Securities:
Corporate bonds $ 7,716 $ 27,453 $ 9,616
U. S. Treasury and federal agency obligations 76,875 101,833 18,613
Obligations of state and political
subdivisions 32,835 31,115 8,251
CMOs, REMICS and mortgage-backed securities 43,433 39,845 7,714
Other 7,400 9,358 4,497
----------------------------------------
Total $168,259 $209,604 $ 48,691
========================================
Held-to-Maturity Securities:
Mortgage-backed securities $ 2,186 $ 3,331 $ 4,950
Obligations of state and political
subdivisions 590 590 630
----------------------------------------
Total $ 2,776 $ 3,921 $ 5,580
========================================
For additional information regarding First Defiance's investment portfolio
refer to Note 6 to the consolidated financial statements.
Interest-Bearing Deposits
First Defiance had interest-earning deposits in the FHLB of Cincinnati
amounting to $1.3 million and $1.5 million at December 31, 2003 and 2002,
respectively.
- 4 -
Residential Loan Servicing Activities
Servicing mortgage loans for investors involves a contractual right to
receive a fee for processing and administering loan payments on mortgage loans
that are not owned by the Company and are not included on the Company's balance
sheet. This processing involves collecting monthly mortgage payments on behalf
of investors, reporting information to those investors on a monthly basis and
maintaining custodial escrow accounts for the payment of principal and interest
to investors and property taxes and insurance premiums on behalf of borrowers.
At December 31, 2003, First Federal serviced 5,387 loans totaling $433.1
million. The vast majority of the loans serviced for others are fixed rate
conventional mortgage loans.
As compensation for its mortgage servicing activities, the Company
receives servicing fees, usually 0.25% per annum of the loan balances serviced,
plus any late charges collected from delinquent borrowers and other fees
incidental to the services provided. In the event of a default by the borrower,
the Company receives no servicing fees until the default is cured.
The following table shows the delinquency statistics for the mortgage
loans serviced by the Company as of the dates presented. Information for years
prior to 2001 is not available.
As of December 31
2003 2002 2001
---------------------------------------------------------------------------
Number Percentage Number Percentage Number Percentage
of of Servicing of of Servicing of of Servicing
Loans Portfolio (2) Loans Portfolio (2) Loans Portfolio (2)
---------------------------------------------------------------------------
Loans delinquent for:
30-59 days 2 0.04% 4 0.09% 21 0.65%
60-89 days 1 0.02 1 0.02 1 0.03
90 days and over 5 0.09 1 0.02 3 0.09
---------------------------------------------------------------------------
Total delinquencies 8 0.15% 6 0.13% 25 0.77%
===========================================================================
Foreclosures 2 0.04% -- -- 1 0.03%
===========================================================================
The following table sets forth certain information regarding the number
and aggregate principal balance of the mortgage loans serviced by the Company,
including both fixed and adjustable rate loans, at various interest rates:
As of December 31
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2003 2002 2001
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Percentage Percentage Percentage
Number Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
of Principal Principal of Principal Principal of Principal Principal
Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance
- ------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Less than 5.00% 694 $ 66,512 15.36% 6 $ 967 0.30% -- $ -- --
5.00% - 5.99% 2,476 213,267 49.24 1,010 91,620 28.20 61 7,426 3.36%
6.00% - 6.99% 1,591 122,338 28.24 2,005 156,888 48.28 1,309 99,647 45.05
7.00% - 7.99% 522 26,634 6.15 1,092 66,835 20.57 1,492 95,557 43.21
8.00% - 8.99% 99 4,179 0.96 178 8,408 2.59 335 18,058 8.17
9.00% and over 5 203 0.05 5 206 0.06 10 457 0.21
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Total 5,387 $433,133 100.00% 4,296 $324,924 100.00% 3,207 $221,145 100.00%
==============================================================================================================
- 5 -
Loan servicing fees decrease as the principal balance on the outstanding
loan decreases and as the remaining time to maturity of the loan shortens. The
following table sets forth certain information regarding the remaining maturity
of the mortgage loans serviced by the Company as of the dates shown.
2003 2002
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% of % of
% of Unpaid Unpaid % of Unpaid Unpaid
Number Number of Principal Principal Number of Number Principal Principal
Maturity of Loans Loans Amount Amount Loans of Loans Amount Amount
- ------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
1-5 years 302 5.61% $ 22,838 5.27% 154 3.58% $ 8,956 2.76%
6-10 years 673 12.49 47,819 11.04 560 13.04 38,098 11.73
11-15 years 2,130 39.54 156,847 36.21 1,652 38.45 115,385 35.51
16-20 years 762 14.15 66,135 15.27 605 14.08 49,694 15.29
21-25 years 74 1.37 5,147 1.19 92 2.14 5,503 1.69
More than 25
years 1,446 26.84 134,347 31.02 1,233 28.71 107,288 33.02
---------------------------------------------------------------------------------------------
Total 5,387 100.00% $433,133 100.00% 4,296 100.00% $324,924 100.00%
=============================================================================================
2001
---------------------------------------------
% of
% of Unpaid Unpaid
Number Number of Principal Principal
Maturity of Loans Loans Amount Amount
- ----------------------------------------------------------------------------------
(Dollars in Thousands)
1-5 years 59 1.84 $ 676 0.31%
6-10 years 397 12.38 19,303 8.73
11-15 years 1,194 37.23 78,623 35.55
16-20 years 380 11.85 28,136 12.72
21-25 years 115 3.59 6,646 3.01
More than 25
years 1,062 33.11 87,761 39.68
---------------------------------------------
Total 3,207 100.00% $221,145 100.00%
=============================================
Lending Activities
General. A savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. Real estate is not considered "readily marketable
collateral." Certain types of loans are not subject to these limits. In applying
these limits, loans to certain borrowers may be aggregated. Notwithstanding the
specified limits, a savings bank may lend to one borrower up to $500,000 "for
any purpose". At December 31, 2003, First Federal's limit on loans-to-one
borrower was $15.4 million and its five largest loans (including available lines
of credit) or groups of loans to one borrower, including related entities, were
$11.7 million, $11.0 million, $10.6 million, $9.0 million and $8.0 million. All
of these loans or groups of loans were performing in accordance with their terms
at December 31, 2003.
Loan Portfolio Composition. The net increase (decrease) in net loans
outstanding over the prior year was $164.8 million, $76.6 million, and ($30.2)
million in 2003, 2002, and 2001, respectively. The loan portfolio contains no
foreign loans nor any concentrations to identified borrowers engaged in the same
or similar industries exceeding 10% of total loans.
- 6 -
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31
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2003 2002 2001 2000 1999
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Amount % Amount % Amount % Amount % Amount %
-------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Real estate:
One to four family
residential $167,983 22.2% $157,691 26.6 $167,764 32.9% $229,791 42.5% $203,743 44.3%
Five or more family
residential(1) 30,322 4.0 32,324 5.5 21,757 4.3 15,686 2.9 11,086 2.4
Non-residential real estate(1) 311,101 41.1 195,430 33.0 152,274 29.8 120,529 22.3 12,571 2.7
Construction 16,830 2.2 15,357 2.6 7,875 1.5 9,627 1.8 7,808 1.7
-------------------------------------------------------------------------------------------------
Total real estate loans 526,236 69.5 $400,802 67.7 349,670 68.5 375,633 695 235,208 51.1
Other:
Consumer finance 39,808 5.3 37,562 6.3 40,721 8.0 52,113 9.6 64,183 13.9
Commercial(1) 120,677 15.9 104,070 17.6 83,690 16.4 81,138 15.0 138,125 30.0
Home equity and improvement 70,038 9.2 49,889 8.4 36,179 7.1 31,836 5.9 22,781 4.9
Mobile home 449 0.1 17 -- 12 -- 29 -- 46 --
-------------------------------------------------------------------------------------------------
Total non-real estate loans 230,972 30.5 191,538 32.3 160,602 31.5 165,116 30.5 225,135 48.9
-------------------------------------------------------------------------------------------------
Total loans 757,208 100.0% 592,340 100.0% 510,272 100.0% 540,749 100.0% 460,343 100.0%
----- ----- ----- ----- -----
Less:
Loans in process 6,079 7,255 2,887 3,415 3,291
Deferred loan origination
fees 1,158 1,212 1,024 1,041 764
Allowance for loan losses 8,844 7,496 6,548 6,330 6,504
-------- -------- -------- -------- --------
Net loans $741,127 $576,377 $499,813 $529,963 $449,784
======== ======== ======== ======== ========
(1) For 1999 most non-residential real estate loans were reported with all other
commercial loans.
Included above, First Defiance had $5.9 million, $15.3 million and
$672,000 in loans classified as held for sale at December 31, 2003, 2002 and
2001, respectively. The fair value of such loans, which are all single-family
residential mortgage loans, approximated their carrying value for both years
presented. This information for years prior to 2000 is not available.
Contractual Principal Repayments and Interest Rates. The following table
sets forth certain information at December 31, 2003 regarding the dollar amount
of gross loans maturing in First Defiance's portfolio, based on the contractual
terms to maturity. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdrafts are reported as due in one year or less.
Due 3-5 Due 5-10 Due 10-15 Due 15+
Due Due Years Years Years Years
Before Before After After After After
12/31/04 12/31/05 12/31/03 12/31/03 12/31/03 12/31/03 Total
-----------------------------------------------------------------------------------
(In Thousands)
Real estate $ 86,116 $31,654 $ 91,481 $259,252 $28,255 $29,478 $526,236
Non-real estate:
Commercial 52,773 25,289 32,716 9,007 675 217 120,677
Home equity and
improvement 3,015 498 6,498 1,654 768 57,605 70,038
Mobile home 47 51 170 153 28 -- 449
Consumer finance 15,595 9,896 13,383 719 158 57 39,808
-----------------------------------------------------------------------------------
Total $157,546 $67,388 $144,248 $270,785 $29,884 $87,357 $757,208
===================================================================================
- 7 -
The schedule above does not reflect the actual life of the Company's loan
portfolio. The average life of loans is substantially less than their
contractual terms because of prepayments and due-on-sale clauses, which give
First Defiance the right to declare a conventional loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid.
The following table sets forth the dollar amount of gross loans due after
one year from December 31, 2003 which have fixed interest rates or which have
floating or adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Total
----------------------------------
(In Thousands)
Real estate $ 87,584 $352,536 $440,120
Commercial 34,020 33,884 67,904
Other 30,423 61,214 91,639
----------------------------------
$152,027 $447,634 $599,661
==================================
Originations, Purchases and Sales of Loans. The lending activities of
First Defiance are subject to the written, non-discriminatory, underwriting
standards and loan origination procedures established by the Board of Directors
and management. Loan originations are obtained from a variety of sources,
including referrals from existing customers, real estate brokers, developers,
builders, and existing customers; newspapers and radio advertising; and walk-in
customers.
First Defiance's loan approval process for all types of loans is intended
to assess the borrowers ability to repay the loan, the viability of the loan,
and the adequacy of the value of the collateral that will secure the loan.
A commercial loan application is first reviewed and underwritten by one of
the commercial loan officers, who may approve credits within their lending
limit. Another loan officer with limits sufficient to cover the exposure must
approve credits exceeding an individual's lending limit. All credits which
exceed $100,000 in aggregate exposure must be presented for review or approval
to the Senior Loan Committee comprised of senior lending personnel. Credits
which exceed $500,000 in aggregate exposure must be presented for approval to
the Executive Loan Committee, a committee of First Federal's Board of Directors.
A mortgage loan originator initially reviews a mortgage loan. Approval for
conforming mortgage loans which are sold to the secondary market occurs
centrally by the Senior Vice President of Mortgage Lending or approved
underwriters. Either the Senior Vice President of Mortgage Lending or the Chief
Lending Officer must approve non-conforming mortgage loans.
Consumer loan officers underwrite and may approve direct consumer credits
within their lending limits. Another loan officer with limits sufficient to
cover the exposure must approve credits exceeding an officer's lending limits.
All indirect consumer credits are underwritten and approved by a centralized
underwriting department.
- 8 -
First Defiance offers adjustable-rate loans in order to decrease the
vulnerability of its operations to changes in interest rates. The demand for
adjustable-rate loans in First Defiance's primary market area has been a
function of several factors, including customer preference, the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the interest rates offered for fixed-rate loans and
adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable-rate loans represented 14.71% of First Defiance's total
originations of mortgage loans in 2003 compared to 14.80% and 2.31% during 2002
and 2001, respectively.
Adjustable-rate loans decrease the risks associated with changes in
interest rates, but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates.
The following table shows total loans originated, loan reductions, and the
net increase in First Defiance's total loans during the periods indicated:
Years ended December 31
2003 2002 2001
-----------------------------------
(In Thousands)
Loan originations:
Single family residential $291,481 $241,138 $ 202,528
Multi-family residential(1) 58,370 58,111 50,507
Non-residential real estate(1) 165,164 98,116 76,680
Construction 20,553 17,751 9,693
Commercial 104,007 86,329 68,881
Home equity and improvement 38,150 32,310 20,521
Consumer finance 19,366 23,112 18,783
-----------------------------------
Total loans originated 697,091 556,867 447,593
Loans acquired in branch acquisition 79,094 -- --
Loan reductions:
Loan pay-offs 275,076 190,485 242,468
Mortgage loans sold 293,673 207,348 187,969
Periodic principal repayments 42,687 82,470 47,306
-----------------------------------
611,436 480,303 477,743
-----------------------------------
Net increase in total loans $164,749 $ 76,564 $ (30,150)
===================================
The loans acquired in the branch acquisition by category were as follows:
Single family residential -- $21.4 million, non-residential real estate -- $35.4
million, Commercial -- $16.8 million, Home equity and improvement -- $1.8
million and Consumer finance -- $3.6 million.
Asset Quality
First Defiance's credit policy establishes guidelines to manage credit
risk and asset quality. These guidelines include loan review and early
identification of problem loans to ensure sound credit decisions. First
Defiance's credit policies and review procedures are meant to
- 9 -
minimize the risk and uncertainties inherent in lending. In following the
policies and procedures, management must rely on estimates, appraisals and
evaluations of loans and the possibility that changes in these could occur
because of changing economic conditions.
Delinquent Loans. The following table sets forth information concerning
delinquent loans at December 31, 2003, in dollar amount and as a percentage of
First Defiance's total loan portfolio. The amounts presented represent the total
outstanding principal balances of the related loans, rather than the actual
payment amounts that are past due.
30 to 59 Days 60 to 89 Days 90 Days and Over Total
---------------------- -------------------- --------------------- -------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
---------------------- -------------------- --------------------- -------------------
(Dollars in Thousands)
Single-family residential $1,529 0.21% $ 7 -- $ 471 0.06% $ 2,007 0.27%
Non-residential and Multi-
family residential 3,068 0.41 1,756 0.24% 1,092 0.15 5,916 0.80
Home equity and
improvement 421 0.06 20 -- 30 -- 471 0.06
Consumer finance 265 0.04 16 -- 3 -- 284 0.04
Commercial 1,512 0.20 426 0.06 949 0.13 2,887 0.39
--------------------------------------------------------------------------------------------------
Total $6,795 0.92% $2,225 0.30% $2,545 0.34% $11,565 1.56%
==================================================================================================
Non-Performing Assets. All loans are reviewed on a regular basis and are
placed on a non-accrual status when, in the opinion of management, the
collectibility of additional interest is deemed insufficient to warrant further
accrual. Generally, First Defiance places all loans more than 90 days past due
on non-accrual status. When a loan is placed on non-accrual status, total unpaid
interest accrued to date is reversed. Subsequent payments are either applied to
the outstanding principal balance or recorded as interest income, depending on
the assessment of the ultimate collectibility of the loan. First Defiance
considers that a loan is impaired when, based on current information and events,
it is probable that it will be unable to collect all amounts due (both principal
and interest) according to the contractual terms of the loan agreement. First
Defiance measures impairment based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price, or the fair value of the collateral, if collateral dependent. If
the measure of the impaired loan is less than the recorded investment, First
Defiance will recognize impairment by creating a valuation allowance.
This policy excludes large groups of smaller-balance homogeneous loans
that are collectively evaluated for impairment such as residential mortgage,
consumer installment, and credit card loans. Loans having recorded investments
of $563,000, $593,000 and $370,000 were considered impaired as of December 31,
2003, 2002 and 2001, respectively. There was $29,000 of interest received and
recorded in income during 2003 related to impaired loans including interest
received and recorded in income prior to such impaired loan designation. There
was $46,000 and $40,000 recorded in 2002 and 2001 respectively. Unrecorded
interest income based on the loan's contractual terms on these impaired loans
and all non-performing loans in 2003, 2002 and 2001 was $73,000, $93,000, and
$67,000, respectively. The average recorded investment in impaired loans during
2003, 2002 and 2001 was $892,000, $697,000 and $501,000, respectively. The total
allowance for loan losses related to these loans was $297,000, $359,000, and
$202,000 at December 31, 2003, 2002 and 2001, respectively.
- 10 -
Real estate acquired by foreclosure is classified as real estate owned
until such time as it is sold. First Defiance also repossesses other assets
securing loans, consisting primarily of automobiles. When such property is
acquired it is recorded at the lower of the restated loan balance, less any
allowance for loss, or fair value. Costs relating to development and improvement
of property are capitalized, whereas costs relating to holding the property are
expensed. Valuations are periodically performed by management and an allowance
for losses is established by a charge to operations if the carrying value of
property exceeds its estimated net realizable value.
As of December 31, 2003, First Defiance's total non-performing loans
amounted to $2.5 million or 0.34% of total loans, compared to $2.5 million or
0.43% of total loans, at December 31, 2002. Non-performing loans are loans which
are more than 90 days past due. The non-performing loan balance includes
$339,000 of loans also considered impaired
The following table sets forth the amounts and categories of First
Defiance's non-performing assets (excluding impaired loans not considered
non-performing) and troubled debt restructurings at the dates indicated.
December 31
2003 2002 2001 2000 1999
-------------------------------------------------------
(Dollars in Thousands)
Non-performing loans:
Single-family residential $ 471 $ 404 $1,151 $ 671 $ 146
Non-residential and multi-family residential
real estate 1,092 1,217 972 572 --
Commercial (1) 949 879 110 140 737
Mobile home -- -- -- -- --
Consumer finance 33 25 157 66 147
-------------------------------------------------------
Total non-performing loans 2,545 2,525 2,390 1,449 1,030
Real estate owned 397 175 81 -- 136
Other repossessed assets 7 31 55 41 92
-------------------------------------------------------
Total repossessed assets 404 206 136 41 228
-------------------------------------------------------
Total non-performing assets $2,949 $2,731 $2,526 $1,490 $1,258
=======================================================
Troubled debt restructurings $ -- $ -- $ -- $ -- $ --
=======================================================
Total non-performing assets as a
percentage of total assets of
continuing operations 0.28% 0.31% 0.39% 0.22% 0.22%
=======================================================
Total non-performing loans and troubled
debt restructurings as a percentage of
total loans 0.34% 0.43% 0.47% 0.27% 0.22%
=======================================================
Total non-performing assets and
troubled debt restructurings as a
percentage of total assets 0.28% 0.31% 0.39% 0.22% 0.22%
=======================================================
Allowance for loan losses as a percent of
total non-performing assets 299.90% 274.48% 259.22% 424.83% 517.01%
=======================================================
(1) - In 1999 non-residential and multi-family real estate loans were
included in commercial loans
- 11 -
In addition to the $2.5 million of loans reported above and the $224,000
of loans considered impaired, which are not included in the loans reported
above, there are approximately $5.3 million of performing loans where known
information about possible credit problems of the borrowers causes management to
have doubts as to the ability of such borrowers to comply with the present loan
repayment terms and which may result in the inclusion of such loans in
non-performing loans at some future date.
Allowance for Loan Losses. First Defiance maintains an allowance for loan
losses to absorb probable losses in the loan portfolio. The balance of the
allowance is based upon an assessment of prior loss experience, the volume and
type of lending conducted by First Defiance, industry standards, past due loans,
general economic conditions and other factors related to the collectibility of
the loan portfolio. The Company generally uses its own loss experience in
calculating its loan loss provision. However, in those instances where the
Company's experience with certain types of lending is new or recent and
therefore historical losses are less meaningful, management will consider such
other factors as industry loss statistics, experience of other financial
institutions operating in the same geographic area, and inherent risks
associated with the borrower in determining the required allowance. In
evaluating the adequacy of its allowance each quarter, management grades all
loans in the commercial portfolio using a scale of one to eight. Loans graded in
the three worst categories (substandard, doubtful and loss) are generally
reserved at 20%, 50% and 100% respectively unless other facts and circumstances
warrant a different percentage. Management also engages a third-party to perform
an independent loan review on a semi-annual basis. That third party reviews all
loan relationships in excess of $250,000 and, among other things, challenges
management's loan grades.
Loans charged-off are charged against the allowance when such loans meet
the Company's established policy on loan charge-offs and the allowance itself is
adjusted quarterly by recording a provision for loan losses. As such, actual
losses and losses provided for should be approximately the same if the overall
quality, composition and size of the portfolio remains static. To the extent
that the portfolio grows at a rapid rate, such as the Company has experienced,
or overall quality deteriorates, the provision generally will exceed
charge-offs. Although management believes that it uses the best information
available to make such determinations, future adjustments to the allowances may
be necessary, and net earnings could be significantly affected, if circumstances
differ substantially from the assumptions used in making the initial
determinations.
- 12 -
At December 31, 2003, First Defiance's allowance for loan losses amounted
to $8.8 million compared to $7.5 million at December 31, 2002. As of December
31, 2003 and 2002, $87,000 and $42,000, respectively, constituted an allowance
with respect to specific loans or assets held for sale. The following table sets
forth the activity in First Defiance's allowance for loan losses during the
periods indicated.
Years ended December 31
2003 2002 2001 2000 1999
--------------------------------------------------------
(Dollars in Thousands)
Allowance at beginning of year $7,496 $6,548 $6,330 $6,504 $8,595
Provision for credit losses 1,719 1,451 993 635 155
Charge-offs:
One to four family residential real estate 18 110 152 -- --
Commercial real estate 162 184 130 182 --
Commercial 375 36 151 155 107
Consumer finance 170 390 599 692 1,364
Mobile home -- -- -- 2 1,054
--------------------------------------------------------
Total charge-offs 725 720 1,032 1,031 2,525
Recoveries 354 217 257 222 279
--------------------------------------------------------
Net charge-offs 371 503 775 809 2,246
--------------------------------------------------------
Ending allowance $8,844 $7,496 $6,548 $6,330 $6,504
========================================================
Allowance for loan losses to total non-
performing loans at end of year 347.5% 296.9% 274.0% 436.9% 631.5%
Allowance for loan losses to total loans at end
of year 1.18 1.32 1.29 1.17 1.41
Allowance for loan losses to net charge-offs
for the year 2,383.82 1,490.26 844.90 782.45 289.58
Net charge-offs for the year to average loans 0.06 0.10 0.15 0.16 0.50
The provision for credit losses has increased steadily over the
five-year period shown in the above table in conjunction with significant growth
in the commercial loan and non-residential real estate loan portfolios over
those same periods.
The percentage of the allowance for loan losses to total loans declined at
December 31, 2003 compared with the prior year primarily because classified
assets have grown at a slower rate than the loan balances as a whole, indicating
an overall improvement in the credit quality of the portfolio. In addition, in
conjunction with the RFC acquisition, management recorded a discount of $2.9
million to offset expected credit losses in the acquired portfolio which
resulted in loans being recorded at their estimated fair value. Given that
discount, no allowance for loan losses was required for the $63.2 million of
loans remaining in that portfolio at December 31, 2003. Non-performing assets
increased to $2.9 million at December 31, 2003 from $2.7 million at December 31,
2002, an increase of 8%. However, during that same period, total loan balances
increased by 30%.
- 13 -
The following table sets forth information concerning the allocation of
First Defiance's allowance for loan losses by loan categories at the dates
indicated. For information about the percent of total loans in each category to
total loans, see "Lending Activities-Loan Portfolio Composition."
December 31
2003 2002 2001
-------------------------------------------------------------------------
Percent of Percent of Percent of
total loans total loans total loans
Amount by category Amount by category Amount by category
-------------------------------------------------------------------------
(Dollars in Thousands)
Single family
residential $ 386 24.4% $ 587 7.8% $ 613 9.3%
Non-residential and
Multi- family
residential Real
estate 6,265 45.1 4,293 57.3 2,847 43.5
Other:
Commercial loans 1,424 15.9 1,729 23.1 1,734 26.5
Consumer and home
equity and
improvement loans 769 14.6 887 11.8 1,354 20.7
-------------------------------------------------------------------------
$8,844 100.0% $7,496 100.0% $6,548 100.0%
=========================================================================
December 31
2000 1999
------------------------------------------------
Percent of Percent of
total loans total loans
Amount by category Amount by category
------------------------------------------------
(Dollars in Thousands)
Single family
residential $ 396 6.4% $ 843 13.0%
Non-residential and
Multi- family
residential Real
estate 2,310 36.4 -- --
Other:
Commercial loans 1,355 21.4 2,317 35.6
Consumer and home
equity and
improvement loans 2,269 35.8 3,344 51.4
------------------------------------------------
$6,330 100.0% $6,504 100.0%
================================================
(1) In years prior to 2000, the breakdown between commercial real estate and
non-real estate commercial loans was not available. As a result, all commercial
real estate loans were reported in the commercial classification.
Sources of Funds
General. Deposits are the primary source of First Defiance's funds for
lending and other investment purposes. In addition to deposits, First Defiance
derives funds from loan principal repayments. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings
from the FHLB may be used on a short-term basis to compensate for reductions in
the availability of funds from other sources. They may also be used on a
longer-term basis for general business purposes.
Deposits. First Defiance's deposits are attracted principally from within
First Defiance's primary market area through the offering of a broad selection
of deposit instruments, including checking accounts, money market accounts,
regular savings accounts, and term certificate accounts. Included among these
deposit products are individual retirement account certificates of approximately
$74.5 million at December 31, 2003. Deposit account terms vary, with the
principal differences being the minimum balance required, the time periods the
funds must remain on deposit, and the interest rate.
To supplement its funding needs, First Defiance also utilizes brokered
Certificates of Deposit. Such deposits, which were primarily acquired in prior
years to fund operations now discontinued, have maturities ranging from three
months to one year. The total balance of brokered certificates of deposit were
$27.5 million at December 31, 2003, including $16.4 million acquired in the RFC
Branch acquisition. Brokered CDs at December 31, 2002 totaled $26.1 million.
Brokered certificates of deposit are not included in the following tables for a
portion of 2002 and all of 2001 as the interest associated with those deposits
were allocated to discontinued operations.
- 14 -
Average balances and average rates paid on deposits are as follows:
Years ended December 31
2003 2002 2001
--------------------- ---------------------- ---------------------
Amount Rate Amount Rate Amount Rate
-------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest bearing
demand deposits $ 47,505 -- $ 33,089 -- $ 31,684 --
Interest bearing
demand deposits 198,039 0.74% 162,664 1.66% 129,470 2.99%
Savings deposits 47,047 0.36 39,129 0.94 36,670 1.55
Time deposits 387,948 3.04 345,740 3.89 293,130 5.63
-------------------------------------------------------------------------------
Totals $680,539 1.97% $580,622 2.84 $490,954 4.26%
===============================================================================
The following table sets forth the maturities of First Defiance's
certificates of deposit having principal amounts of $100,000 or more at December
31, 2003.
(In Thousands)
--------------
Certificates of deposit maturing in quarter ending:
March 31, 2004 $ 27,312
June 30, 2004 14,500
September 30, 2004 25,816
December 31, 2004 19,535
After December 31, 2004 20,456
--------
Total certificates of deposit with
balances of $100,000 or more $107,619
========
The following table details the deposit accrued interest payable as of
December 31:
2003 2002
--------------------
(In Thousands)
Interest bearing demand deposits and
money market accounts $ 16 $ 23
Savings Accounts -- --
Certificates 520 301
--------------------
$ 536 $ 324
====================
For additional information regarding First Defiance's deposits see Note 11
to the financial statements.
Borrowings. First Defiance may obtain advances from the FHLB of Cincinnati
upon the security of the common stock it owns in that bank and certain of its
residential mortgage loans, non-residential loans and investment securities
provided certain standards related to creditworthiness have been met. Such
advances are made pursuant to several credit programs, each of which has its own
interest rate and range of maturities.
- 15 -
The following table sets forth certain information as to First Defiance's
FHLB advances and other borrowings at the dates indicated.
December 31
2003 2002 2001
--------------------------------------------
(Dollars in Thousands)
Long-term:
FHLB advances $ 153,522 $ 146,096 $ 156,302
Weighted average interest rate 4.60% 4.95% 5.12%
Notes -- $ 10 $ 49
Weighted average interest rate -- 7.50 7.50%
Short-term:
FHLB advances $ 11,000 $ 3,000 $ 40,000
Weighted average interest rate 1.12% 1.50% 4.32%
Revolving borrowings -- -- $ 20,675
Weighted average interest rate -- -- 3.85%
Securities sold under agreement
to repurchase $ 12,267 $ 4,289 --
Weighted average interest rate .85% 1.20% --
The following table sets forth the maximum month-end balance and average
balance of First Defiance's Long-term FHLB advances and other borrowings during
the periods indicated.
Years ended December 31
2003 2002 2001
---------------------------------------
(Dollars in Thousands)
Long-term:
FHLB Advances:
Maximum balance $154,930 $156,269 $196,567
Average balance 152,939 140,399 164,692
Weighted average interest rate 4.78% 5.08% 5.25%
Term Borrowings:
Maximum balance $ 7 $ 46 $ 82
Average balance 1 30 68
Weighted average interest rate 7.50% 7.50% 7.50%
- 16 -
The following table sets forth the maximum month-end balance and average
balance of First Defiance's short-term FHLB advances and other borrowings during
the periods indicated.
Years ended December 31
2003 2002 2001
-------------------------------------------
(Dollars in Thousands)
Short-term:
FHLB Advances:
Maximum balance $ 14,250 $ 90,500 $111,000
Average balance 2,296 17,118 62,695
Weighted average interest rate 1.31% 2.08% 4.32%
Revolving credit agreements:
Maximum balance $ -- $ 21,900 $ 20,647
Average balance -- 6,787 18,840
Weighted average interest rate -- 3.68% 5.62%
Securities sold under agreement to repurchase:
Maximum balance $ 12,860 $ 4,298 --
Average balance 7,569 777 --
Weighted average interest rate 1.02% 1.29% --
First Defiance borrows funds under a variety of programs at the FHLB. As
of December 31, 2003, there was $153.5 million outstanding under various
long-term FHLB advance programs. First Defiance utilizes short-term advances
from the FHLB to meet cash flow needs and for short-term investment purposes.
There were $11.0 million and $3.0 million in short-term advances outstanding at
December 31, 2003 and 2002, respectively. At December 31, 2003, $11.0 million
was outstanding under First Defiance's Cash Management advance line of credit.
The total available under the line is $15.0 million. Additionally, First
Defiance has $50.0 million available under a REPO advance line of credit.
Amounts are generally borrowed under these lines on an overnight basis.
As a member of the FHLB of Cincinnati, First Federal must maintain an
investment in the capital stock of that FHLB in an amount principally equal to
..15% of total assets plus an amount of at least 2% but no more than 4% of its
non-grandfathered mission asset activity (as defined in the FHLB's regulations).
First Federal is permitted to own stock in excess of the minimum requirement and
is in compliance with the minimum requirement with an investment in stock of the
FHLB of Cincinnati of $17.8 million at December 31, 2003.
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLB. The standards take into account a member's performance
under the Community Reinvestment Act and its record of lending to first-time
homebuyers. All long-term advances by each FHLB must be made only to provide
funds for residential housing finance.
For additional information regarding First Defiance's FHLB advances and
other debt see Notes 12 and 13 to the financial statements.
- 17 -
Employees
First Defiance had 345 employees at December 31, 2003. None of these
employees are represented by a collective bargaining agent, and First Defiance
believes that it enjoys good relations with its personnel.
Competition
Competition in originating loans arises mainly from other savings
associations, commercial banks, and mortgage companies. The distinction among
market participants is based primarily on price and, to a lesser extent, the
quality of customer service and name recognition. The Company competes for loans
by offering competitive interest rates and product types and by seeking to
provide a higher level of personal service to mortgage brokers and borrowers
than is furnished by competitors. However, First Federal does have a significant
market share of the lending markets in which it conducts operations.
Management believes that First Federal's most direct competition for
deposits comes from local financial institutions. The distinction among market
participants is based on price and the quality of customer service and name
recognition. First Federal's cost of funds fluctuates with general market
interest rates. During certain interest rate environments, additional
significant competition for deposits may be expected from corporate and
governmental debt securities, as well as from money market mutual funds. First
Federal competes for conventional deposits by emphasizing quality of service,
extensive product lines and competitive pricing.
- 18 -
REGULATION
General. First Defiance and First Federal are subject to regulation,
examination and oversight by the OTS. Because the FDIC insures First Federal's
deposits, First Federal is also subject to examination and regulation by the
FDIC. First Defiance and First Federal must file periodic reports with the OTS
and examinations are conducted periodically by the OTS and the FDIC to determine
whether First Federal is in compliance with various regulatory requirements and
is operating in a safe and sound manner. First Federal is subject to various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending disclosure, equal credit opportunity, and, in the case
of First Federal, fair credit reporting and community reinvestment. Failure to
abide by federal laws and regulations governing community reinvestment could
limit the ability of First Federal to open a new branch or engage in a merger
transaction. Community reinvestment regulations evaluate how well and to what
extent First Federal lends and invests in its designated service area, with
particular emphasis on low-to-moderate income communities and borrowers in such
areas.
First Defiance is also subject to various Ohio laws which restrict
takeover bids, tender offers and control-share acquisitions involving public
companies which have significant ties to Ohio.
Regulatory Capital Requirements. First Federal is required by OTS
regulations to meet certain minimum capital requirements. Current capital
requirements call for tangible capital of 1.5% of adjusted total assets, core
capital of 4.0% of adjusted total assets, except for associations with the
highest examination rating and acceptable levels of risk, and risk-based capital
of 8% of risk-weighted assets.
The following table sets forth the amount and percentage level of
regulatory capital of First Federal at December 31, 2003, and the amount by
which it exceeds the minimum capital requirements. Tangible and core capital are
reflected as a percentage of adjusted total assets. Total (or risk-based)
capital, which consists of core and supplementary capital, is reflected as a
percentage of risk-weighted assets. Assets are weighted at percentage levels
ranging from 0% to 100% depending on their relative risk.
At December 31, 2003
Amount Percent
------------------------
(In Thousands)
Tangible capital $ 94,144 9.30%
Requirement 15,181 1.50
------------------------
Excess $ 78,963 7.80%
========================
Core capital $ 94,144 9.30%
Requirement 40,483 4.00
------------------------
Excess $ 68,125 5.30%
========================
Total risk-based capital $102,976 13.58%
Risk-based requirement 60,680 8.00
------------------------
Excess $ 42,296 5.58%
========================
- 19 -
First Federal's capital at December 31, 2003, meets the standards for a
well-capitalized institution.
Transactions with Insiders and Affiliates. Loans to executive officers,
directors and principal shareholders and their related interests must conform to
the lending limits. Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of board of directors of the association with any "interested" director
not participating. All loans to directors, executive officers and principal
shareholders must be made on terms substantially the same as offered in
comparable transactions with the general public or as offered to all employees
in a company-wide benefit program. Loans to executive officers are subject to
additional restrictions. In addition, all related party transactions must be
approved by the Company's audit committee pursuant to Nasdaq Rule 4350(h),
including loans made by financial institutions in the ordinary course of
business. All transactions between savings associations and their affiliates
must comport with Sections 23A and 23B of the Federal Reserve Act (FRA) and the
Federal Reserve Board's Regulation W. An affiliate of a savings association is
any company or entity that controls, is controlled by or is under common control
with the savings association. First Defiance is an affiliate of First Federal.
Holding Company Regulation. First Defiance is a unitary thrift holding
company and is subject to OTS regulations, examination, supervision and
reporting requirements. Federal law generally prohibits a thrift holding company
from controlling any other savings association or thrift holding company,
without prior approval of the OTS, or from acquiring or retaining more than 5%
of the voting shares of a savings association or holding company thereof, which
is not a subsidiary. If First Defiance were to acquire control of another
savings institution, other than through a merger or other business combination
with First Federal, First Defiance would become a multiple thrift holding
company and its activities would thereafter be limited generally to those
activities authorized by the FRB as permissible for bank holding companies.
- 20 -
Item 2. Properties
At December 31, 2003, First Federal conducted its business from its main
office at 601 Clinton Street, Defiance, Ohio, and seventeen other full service
banking centers and one loan production office in northwestern Ohio. First
Insurance conducted its business from leased office space at 419 5th Street,
Suite 1200, Defiance, Ohio.
First Defiance maintains its headquarters in the main office of First
Federal at 601 Clinton Street, Defiance, Ohio.
The following table sets forth certain information with respect to the
office and other properties of the Company at December 31, 2003. See Note 10 to
the Consolidated Financial Statements.
Leased/ Net Book Value
Description/address Owned of Property Deposits
----------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Main Office, First Federal
601 Clinton Street, Defiance, OH Owned $ 5,689 $ 220,850
Branch Offices, First Federal
204 E. High Street, Bryan, OH Owned 1,023 93,007
211 S. Fulton Street, Wauseon, OH Owned 723 43,669
625 Scott Street, Napoleon, OH Owned 1,485 66,395
1050 East Main Street, Montpelier, OH Owned 540 24,886
926 East High Street, Bryan, OH Owned 101 8,086
1333 Woodlawn, Napoleon, OH Owned 52 16,170
825 N. Clinton Street, Defiance, OH Owned 369 11,598
190 Stadium Dr., Defiance, OH Leased 35 7,372
905 N. Williams St., Paulding, OH Owned 1,031 22,401
201 E. High St., Hicksville, OH Owned 539 9,369
3900 N. Main St., Findlay, OH Owned 1,350 28,963
11694 N. Countyline St., Fostoria, OH Owned 863 13,438
1226 W. Wooster, Bowling Green, OH Owned 1,302 25,658
301 S. Main St., Findlay, OH Owned 1,049 35,600
405 E. Main St., Ottawa, OH Owned 448 63,375
124 E. Main St., McComb, OH Owned 275 21,200
7591 Patriot Dr., Findlay, OH Owned 1,402 141
1690 Woodlands Dr., Maumee, OH Leased N/A N/A
First Insurance & Investments
419 5th Street, Site 1200, Defiance, OH Leased N/A N/A
-------------------------------
$ 18,276 $ 728,996
===============================
- 21 -
Item 3. Legal Proceedings
First Defiance is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition of First Defiance.
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to a vote of securities holders during the
fourth quarter of 2003.
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The Company's common stock trades on The Nasdaq Stock Market under the
symbol "FDEF." As of March 5, 2004, the Company had 1,615 shareholders of
record. The table below shows the reported high and low sales prices of the
common stock and cash dividends declared per share of common stock during the
periods indicated in 2003 and 2002.
Year Ending
------------------------------------------------------------------------------
December 31, 2003 December 31, 2002
------------------------------------ -------------------------------------
High Low Dividend High Low Dividend
------------------------------------ -------------------------------------
Quarter Ended:
March 31 $ 20.67 $ 18.21 $ .15 $ 17.25 $ 15.12 $ .13
June 30 20.70 18.50 .15 21.44 16.97 .13
September 30 26.80 19.28 .15 21.13 16.96 .13
December 31 30.65 24.00 .20 19.70 15.78 .15
The OTS imposes various restrictions or requirements on the ability of
associations to make capital distributions. Capital distributions include,
without limitation, payments of cash dividends, repurchases and certain other
acquisitions by an association of its shares and payments to stockholders of
another association in an acquisition of such other association.
An application must be submitted and approval from the OTS must be
obtained by a subsidiary of a savings and loan holding company (i) if the
proposed distribution would cause total distributions for the calendar year to
exceed net income for that year to date plus the savings association's retained
net income for the preceding two years; (ii) if the savings association will not
be at least adequately capitalized following the capital distribution; or (iii)
if the proposed distribution would violate a prohibition contained in any
applicable statute, regulation or agreement between the savings association and
the OTS (or the FDIC), or a condition imposed on the savings association in an
OTS-approved application or notice. If a savings association subsidiary of a
holding company is not required to file an application, it must file a notice of
the proposed capital distribution with the OTS. First Federal paid $5.0 million
in dividends to First Defiance during 2003.
- 22 -
Item 6. Selected Financial Data
The following table sets forth certain summary consolidated financial data
at or for the periods indicated. Results of operations associated with The
Leader, including certain inter-company financing transactions, are reflected as
discontinued operations for all periods presented. Continuing operations reflect
the results of First Federal, First Insurance and First Defiance holding company
expenses for all periods presented. This information should be read in
conjunction with the Consolidated Financial Statements and notes thereto
included herein. See "Item 8. Financial Statements and Supplementary Data."
At or For Years ended December 31,
---------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------------------------------------------------------------------
(Dollars in Thousands, except per share data)
Selected Consolidated Financial Data:
Total assets $1,040,599 $ 884,245 $1,132,648 $1,072,194 $ 987,994
Assets of continuing operations 1,040,599 884,245 644,194 664,468 580,649
Loans held-to maturity, net 735,255 561,041 499,141 529,963 449,784
Loans held-for-sale 5,872 15,336 672 -- --
Allowance for loan losses 8,844 7,496 6,548 6,330 6,504
Non-performing assets 2,949 2,731 2,526 1,490 1,258
Securities available-for-sale 168,259 209,604 48,453 52,850 53,712
Securities held-to maturity 2,776 3,921 5,818 7,697 9,895
Mortgage servicing rights 3,431 2,090 1,821 1,131 996
Deposits and borrowers' escrow balances 729,227 599,889 615,238 529,067 493,560
FHLB advances 164,522 149,096 196,302 223,258 265,410
Stockholders' equity 124,269 120,110 111,021 99,473 89,416
Selected Consolidated Operating Results:
Interest income from continuing
operations $ 49,936 $ 46,141 $ 46,545 $ 46,941 $ 40,882
Interest expense from continuing
operations 20,855 22,044 25,602 27,202 21,292
Net interest income from continuing
operations 29,081 24,097 20,943 19,739 19,590
Provision for loan losses 1,719 1,451 994 635 155
Non-interest income 18,788 12,921 10,220 6,676 4,881
Non-interest expense 28,378 26,161 22,948 20,178 17,965
Income before income taxes 17,772 9,406 7,221 5,602 6,351
Income taxes 5,690 2,986 2,423 1,734 2,072
Income from continuing operations 12,082 6,420 4,798 3,868 4,279
Discontinued operations, net of tax -- 8,853 8,818 7,094 4,344
Cumulative effect of change in method of
accounting for goodwill -- (194) -- -- --
Net income 12,082 15,079 13,616 10,962 8,623
Basic earnings per share from continuing
operations 2.00 1.01 0.74 0.61 0.66
Basic earnings per share 2.00 2.37 2.11 1.74 1.33
Diluted earnings per share from
continuing operations 1.91 0.97 0.72 0.60 0.64
Diluted earnings per share 1.91 2.28 2.05 1.71 1.29
- 23 -
At or for Years ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
------------------------------------------------------------------
(Dollars in Thousands, except per share data)
Selected Financial Ratios and Other Data (from continuing operations):
Performance Ratios:
Return on average assets 1.24% 0.77% 0.69% 0.60% 0.73%
Return on average equity 9.97% 5.39% 4.61% 4.13% 4.72%
Interest rate spread(1) 3.13% 2.92% 3.25% 3.11% 3.56%
Net interest margin(1) 3.42% 3.38% 3.68% 3.57% 3.92%
Ratio of operating expense to
Average total assets 2.91% 3.16% 3.31% 3.11%% 3.06%
Quality Ratios:
Non-performing assets to total assets
at end of period(2) 0.28% 0.31% 0.39% 0.22% 0.22%
Allowance for loan losses to
non-performing assets(2) 299.90% 274.48% 259.22% 424.83% 517.01%
Allowance for loan losses to total
loans receivable 1.19% 1.30% 1.31% 1.19% 1.45%
Capital Ratios(3):
Equity to total assets at end of period 11.94% 13.58% 17.23% 14.97% 15.40%
Tangible equity to tangible assets
at end of period 10.17% 13.23% 16.75% 14.46% 14.80%
Average equity to average assets 12.43% 14.36% 15.03% 14.45% 15.43%
Book value per share $ 19.64 $ 18.73 $ 16.20 $ 14.49 $ 13.12
Tangible book value per share $ 16.39 $ 18.17 $ 15.65 $ 13.92 $ 12.52
Ratio of average interest-earning assets
to average interest-bearing
liabilities 112.25% 115.57% 110.21% 110.02% 109.45%
Stock Price and Dividend Information:
High $ 30.65 $ 21.44 $ 18.00 $ 12.50 $ 14.50
Low 18.21 15.12 10.69 7.63 9.875
Close 25.90 18.90 15.20 10.88 10.50
Cash dividends declared per share 0.65 0.54 .49 .45 0.41
Dividend payout ratio(4) 32.50% 22.78% 23.22% 25.86% 30.83%
(1) Interest rate spread represents the difference between the weighted
average yield on interest-earnings assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earnings assets. Interest
income on tax-exempt securities and loans has been adjusted to a
tax-equivalent basis using the statutory federal income tax rate of 35%.
(2) Non-performing assets consist of non-accrual loans that are contractually
past due 90 days or more; loans that are deemed impaired under the
criteria of FASB Statement No. 114; and real estate, mobile homes and
other assets acquired by foreclosure or deed-in-lieu thereof.
(3) Capital ratios are based on assets of continuing operations.
(4) Dividends payout ratio was calculated using basic earnings per share.
- 24 -
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
First Defiance is a unitary thrift holding company which conducts business
through its subsidiaries, First Federal and First Insurance.
First Federal is a federally chartered savings bank that provides
financial services to communities based in northwest Ohio where it operates 19
full service banking center, including a center in Maumee, Ohio that opened on
February 26, 2004. Prior to opening the Maumee banking center, First Federal
operated a commercial loan production office in Maumee. 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.
During 2003, First Defiance acquired $166.7 million of deposits, $79.0
million of loans, and three banking center offices located in Findlay, Ottawa
and McComb Ohio (the "RFC acquisition"). First Defiance successfully completed
the RFC acquisition on June 6, 2003 and their results reflect the acquisition
from that date forward. For more details on the RFC acquisition, see Note 3 -
Acquisition of Banking Center Offices in the Notes to Consolidated Financial
Statements.
Effective April 1, 2002, First Defiance sold its Leader Mortgage
subsidiary to U.S. Bank Home Mortgage, a unit of U.S. Bank, and recognized an
after-tax gain of $7.7 million, or $1.16 per share from the sale. That gain, as
well as all operating results associated with the Leader, has been reported as
discontinued operations for all periods presented.
Financial Condition
Total assets at December 31, 2003 were $1.04 billion compared to $884.2
million at December 31, 2002. The increase is primarily due to the RFC
acquisition.
Net loans receivable increased by $174.3 million or 31.1% to $735.3
million at December 31, 2003 from $561.0 million at December 31, 2002. Excluding
the loans acquired in the RFC acquisition, First Defiance's total loans
increased by $95.3 million or 17.0% from December 31, 2002 to December 31, 2003.
A portion of that loan growth was funded with assets from the Company's
investment securities portfolio, which dropped from $213.5 million at December
31, 2002 to $171.0 million at December 31, 2003. Loans held for sale declined
from $15.3 million at December 31, 2002 to $5.9 million at December 31, 2003, a
function in lower mortgage refinance activity at the end of 2003 compared to the
end of 2002. Also, goodwill and other intangibles increased to $20.5 million at
December 31, 2003 from $3.6 million at
- 25 -
December 31, 2002, the result of recording $16.9 million in goodwill and other
intangibles in conjunction with the RFC acquisition. Also premises and equipment
increased from $20.0 million at December 31, 2002 to $23.8 million at December
31, 2003.
The increase in loans receivable was primarily in the non-residential real
estate loan, home equity and improvement loan, single-family residential real
estate loan and commercial loan categories. Non-residential real estate loans
increased by $115.7 million, or 59.2%, to $311.1 million at December 31, 2003
from $195.4 million at December 31, 2002. Of that increase, $35.4 million
related to the RFC acquisition. Home equity and improvement loans increased by
$20.1 million, or 40.3%, to $70.0 million at December 31, 2003 from $49.9
million at December 31, 2002 (only $1.8 million of home equity and improvement
loans were acquired in the RFC acquisition). Single-family residential loans
increased by $19.8 million, or 13.8% to $162.1 million at December 31, 2003 from
$142.4 million at December 31, 2002 ($21.4 million of loans were acquired in the
RFC acquisition). Commercial loan balances increased by $16.6 million, or 16.0%
to $120.7 million at December 31, 2003 from $104.1 million at December 31, 2002
($16.8 million in commercial loans were acquired in the RFC acquisition).
The decline in the Company's investment portfolio is due to a combination
of significant amortization of mortgage related securities due to the interest
rate environment and management taking advantage of the rate environment by
selling investments and realizing gains during 2003. The runoff of the portfolio
was used to fund the Company's significant loan growth. The remaining $171.0
million portfolio has an average duration of 3.48 years.
The Company's total deposits increased to $729.0 million at December 31,
2003 from $599.6 million at December 31, 2002, an increase of 21.6%. This growth
is a result of the acquisition of $166.7 million of deposits as part of the RFC
acquisition. Excluding the deposits acquired as part of the RFC acquisition,
deposits have actually dropped by $37.3 million between the end of 2002 and the
end of 2003. However, $30.6 million of that decline is the result of brokered
certificates of deposit maturing during 2003. Such CDs were not renewed. Of that
reduction in brokered CDs, $15.6 million were acquired as part of the RFC
acquisition and the balance of $15.0 million had been acquired in prior years by
First Defiance.
In addition to deposit growth, First Defiance had an increase in
securities sold under repurchase agreements, a product that is offered to
commercial deposit customers. The balance of that product increased from $4.3
million at December 31, 2002 to $12.3 million at December 31, 2004.
First Defiance also had an increase in its FHLB advance balances, which
increased from $149.1 million at December 31, 2002 to $164.5 million at December
31, 2003. The increase in advances, which included both long-term advances with
call options dependent on the LIBOR rate and short-term overnight advances, was
used to fund growth in the Company's loan balances and for income enhancement
strategies.
- 26 -
Average Balances, Interest Rates and Yields
The following table presents for the periods indicated the total dollar
amounts 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 dollars and rates, and the net interest margin. The table does
not reflect the effect of income taxes:
Year Ended December 31,
------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------------------------------------------------------------------------
Average Interest Yield/ Average Interest Yield/ Average Interest Yield/ Rate
Balance (1) Rate(2) Balance (1) Rate(2) Balance (1) (2)
------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-Earning Assets:
Loans receivable $ 667,165 $ 41,233 6.18% $525,855 $ 37,095 7.05% $ 520,917 $42,866 8.23%
Securities 186,631 9,186 4.92% 168,329 9,027 5.36% 57,770 3,672 6.36%
Interest-earning deposits 22,082 280 1.27% 44,285 720 1.63% 10,685 271 2.54%
Dividends on FHLB stock 17,552 695 3.96% 22,889 904 3.95% 15,669 1,055 6.73%
------------------------------------------------------------------------------------------------
Total interest-earning assets 893,430 51,394 5.75% 761,357 47,746 6.27% 605,041 47,864 7.91%
Non-interest-earning assets 81,617 185,140 493,998
---------- -------- ----------
Total Assets $ 975,047 $946,497 $1,099,039
========== ======== ==========
Interest-Bearing Liabilities:
Interest-bearing deposits $ 633,034 $ 13,435 2.12% $547,533 $ 16,508 3.01% $ 459,270 $20,931 4.56%
FHLB advances 155,301 7,343 4.73% 103,552 5,276 5.10% 70,868 3,609 5.09%
Other borrowings 7,570 77 1.02% 7,685 260 3.38% 18,875 1,062 5.63%
------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 795,905 20,855 2.62% 658,769 22,044 3.35% 549,014 25,602 4.66%
Non-interest bearing
demand deposits 47,505 -- 33,089 -- 31,684 --
-------------------- --------------------- -------------------
Total including non-
interest- bearing
demand deposits 843,410 20,855 2.47% 691,858 22,044 3.19% 580,697 25,602 4.41%
Other non-interest
liabilities 10,403 135,567 414,240
---------- -------- ----------
Total Liabilities 853,813 827,425 994,937
Stockholders' equity 121,234 119,072 104,102
---------- -------- ----------
Total liabilities and
stockholders' equity $ 975,047 $946,497 $1,099,039
========== ======== ==========
Net interest income; interest
rate spread(3) $ 30,539 3.13% $ 25,702 2.92% $22,262 3.25%
================ =============== ==================
Net interest margin(4) 3.42% 3.38% 3.68%
===== ===== =====
Average interest-earning
assets to average interest-
bearing liabilities 112.3% 115.6% 110.2%
===== ===== =====
(1) Interest on certain tax exempt loans (amounting to $61,000, $445,000 and
$143,000 in 2003, 2002 and 2001 respectively) and tax-exempt securities
($1.4 million, $947,000 and $380,000 in 2003, 2002 and 2001) is not
taxable for Federal income tax purposes. The average balance of such loans
was $870,000, $6.7 million and $2.4 million in 2003, 2002 and 2001 while
the average balance of such securities was $30.5 million, $21.1 million
and $7.8 million in 2003, 2002 and 2001 respectively. 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) At December 31, 2003, the yields earned and rates paid were as follows:
loans receivable, 5.77%; securities, 5.30%; FHLB stock, 4.00%; total
interest-earning assets, 5.65%; deposits, 1.78%; FHLB advances, 4.37%;
other borrowings, 0.85%; total interest-bearing liabilities, 2.23%; and
interest rate spread, 3.43%.
(3) Interest rate spread is the difference in the yield on interest-earning
assets and the cost of interest-bearing liabilities.
(4) Net interest margin is net interest income divided by average
interest-earning assets.
- 27 -
Rate/Volume Analysis
The following table describes the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected First Defiance's interest income and expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior year rate), (ii) change in rate
(change in rate multiplied by prior year volume), and (iii) total change in rate
and volume. The combined effect of changes in both rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
Year Ended December 31,
------------------------------------------------------------------------------------------------------------
2003 vs. 2002 2002 vs. 2001 2001 vs. 2000
------------------------------------------------------------------------------------------------------------
Increase Increase Increase Increase Increase Increase
(decrease) (decrease) Total (decrease) (decrease) Total (decrease) (decrease) Total
due to due to increase due to due to increase due to due to increase
rate volume (decrease) rate volume (decrease) rate volume (decrease)
------------------------------------------------------------------------------------------------------------
(in thousands)
Interest-Earning
Assets
Loans $ (5,830) $ 9,968 $ 4,138 $ (6,177) $ 406 $ (5,771) $ (1,565) $ 1,811 $ 246
Securities (823) 982 159 (1,672) 7,027 5,355 (206) (250) (456)
Interest-earning
deposits (78) (361) (439) (403) 852 449 (64) (27) (91)
FHLB stock 2 (211) (209) (637) 486 (151) (99) 81 (18)
----------------------------------------------------------------------------------------------------------
Total interest-
earning assets $ (6,729) $ 10,378 $ 3,649 $ (8,890) $ 8,772 $ (118) $ (1,933) $ 1,614 $ (319)
==========================================================================================================
Interest-Bearing
Liabilities
Deposits $ (5,651) $ 2,578 $ (3,073) $ (8,446) $ 4,023 $ (4,423) $ (1,555) $ 1,077 $ (478)
FHLB advances (570) 2,637 2,067 3 1,664 1,667 (522) (929) (1,451)
Term notes (179) (4) (183) (172) (630) (802) (362) 691 329
----------------------------------------------------------------------------------------------------------
Total interest-
bearing liabilities $ (6,400) $ 5,211 $ (1,189) $ (8,615) $ 5,057 $ (3,558) $ (2,439) $ 839 $ (1,600)
==========================================================================================================
Increase in net
interest income $ 4,838 $ 3,440 $ 1,281
======== ======== ========
Results of Operations
General -- First Defiance reported net income of $12.1 million for the
year ended December 31, 2003 compared to $15.1 million and $13.6 million for the
years ended December 31, 2002 and 2001 respectively. Results for 2002 and 2001
included $8.9 million and $8.8 million respectively of discontinued operations
related to the operating results of and gain on sale from the Company's former
Leader Mortgage Company subsidiary, which was sold to US Bancorp on April 1,
2002. See Note 4 to the consolidated financial statements. Income from
continuing operations was $6.2 million and $4.8 million for the years ended
December 31, 2002 and 2001 respectively. Excluding the cumulative effect
adjustment for a change in accounting for goodwill, First Defiance has income
from continuing operations of $6.4 million for the year ended December 31, 2002.
On a diluted per share basis, First Defiance earned $1.91 in 2003, $2.28
in 2002 and $2.05 in 2001. Diluted per share income from continuing operations
was $1.91 in 2003, $0.94 in
- 28 -
2002 ($.97 before cumulative effect adjustment for change in accounting for
goodwill) and $0.72 in 2001.
Net interest income was $29.1 million for the year ended December 31, 2003
compared to $24.1 million and $20.9 million for the years ended December 31,
2002 and 2001 respectively. The tax-equivalent net interest margin was 3.42%,
3.38% and 3.68% for the years ended December 31, 2003, 2002 and 2001
respectively. The increase in the margin between 2002 and 2003 is due to an
improved interest rate spread, which increased from 2.92% in 2002 to 3.13% in
2003, a result the cost of interest-bearing liabilities dropping 0.73% (73 basis
points) compared to the yield on interest-earning assets, which fell by just
0.52% (52 basis points). The margin between 2002 and 2003 also improved because
of growth in non-interest bearing deposits between the two periods. The decline
in net interest margin from 2001 to 2002 was due to significant growth in
lower-yielding interest-earning assets resulting from the sale of the Leader.
The proceeds from the sale were invested primarily in investment securities,
which lowered the average yield on total interest-earning assets. The average
balance of investment securities was $168.3 million in 2002 compared to just
$57.8 million in 2001. The yield on those securities was 5.36% in 2002 compared
to 6.36% in 2001.
The 52 basis point decline in the yield on interest-earning assets is due
to an 87 basis point decline in the yield on the Company's loan portfolio from
7.05% in 2002 to 6.18% in 2003. The drop in loan yields was slightly offset by
an improved mix of loans, securities and interest-earning deposits in 2003
compared to 2002. The overall decline in rates for both assets and liabilities
in 2003 compared to 2002 was due to the low rate environment that existed
throughout the entire twelve-month period in 2003, the result of cuts by the
Federal Reserve to its Federal Funds rate during the year.
In 2002 compared to 2001, the yield on interest earning assets declined by
164 basis points, to 6.27% from 7.91% while the cost of interest-bearing
liabilities declined by 131 basis points to 3.35% from 4.66%. A portion of the
decline in the yield on assets was due to the mix change caused by the growth in
the investment securities portfolio as well as a $33.6 million increase in the
average balance of interest-earning deposits that First Defiance maintained in
other banks. The decline in rates for both assets and liabilities was due to the
low level of interest rates throughout 2002 compared to 2001, the results of
cuts by the Federal Reserve to its Federal Funds rate implemented throughout
2001. The cost of brokered certificates of deposit and a portion of the cost of
FHLB advances were used to finance operations of the Leader throughout 2001 and
the first quarter of 2002. The cost associated with those brokered certificates
of deposit and advances was included in discontinued operations.
The provision for loan losses for the year ended December 31, 2003 was
$1.7 million compared to $1.5 million in 2002 and $1.0 million in 2001.
For the year ended December 31, 2003, non-interest income was $18.8
million compared to $12.9 million for 2002 and $10.2 million for 2001.
Non-interest expense for the year ended December 31, 2003 was $28.4 million
compared to $26.2 million for 2002 and $22.9 million for 2001.
- 29 -
Net Interest Income - First Defiance's net interest income is determined
by its interest rate spread (i.e. the difference between the yields on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Total interest income increased by $3.8 million, or 8.2% to $49.9 million
for the year ended December 31, 2003 from $46.1 million for the year ended
December 31, 2002. The increase in income was due to an increase in the average
balance of loans receivable, to $667.2 million for the twelve months of 2003
compared to $525.9 million for 2002. During the same period, the average balance
of investment securities increased to $186.6 million from $168.3 million but
that increase was offset by a decline in the average balance of funds held in
interest-bearing accounts at other financial institutions, which dropped to
$22.1 million for 2003 compared to $44.3 million for 2002. While the average
balance of total interest-earning assets including FHLB stock increased by
$132.1 million in 2003 compared to 2002, the yield on those total assets fell to
5.75% in 2003 from 6.27% in 2002.
The average balance of non-residential real estate loans, multi-family
real estate loans, non-owner occupied residential mortgage loans and commercial
loans increased by $143.2 million, or 42.7% in 2003, to $478.8 million for the
year ended December 31, 2003 from $335.6 million for 2002. The increase in these
portfolios is the result of First Defiance's June 2003 acquisition of branches
in Findlay, Ottawa and McComb, Ohio from RFC Banking Company. The growth was
also a result of continued strong growth in this type of lending throughout
First Defiance's market area. The Company also had an increase in the average
balance of home equity and improvement loans, which averaged $59.3 million in
2003, up 36.8% from 2002's average balance of $43.4 million. The average balance
of the Company's residential mortgage loan portfolio decreased, to $106.9
million for 2003 compared to $116.6 million for 2002. A total of $21.4 million
of residential mortgage loans were recorded in June 2003 as a result of the
acquisition of the three banking offices. The Company's average balance of
consumer loans also remained steady in 2003, at the same $39.0 million level as
in 2002. A total of $3.6 million in consumer loans was acquired as part of the
RFC acquisition.
Interest income from the investment portfolio increased slightly for 2003,
to $9.2 million from $9.0 million in 2002. The increase is due to a higher
average balance in the portfolio in 2003, at $186.6 million for the full year,
compared to $168.3 million for 2002. The higher average balance for 2003 is
actually due to the low average balance in the investment portfolio during the
first quarter of 2002 (just $53.5 million) prior to the receipt of proceeds from
the sale of the Leader. Overall the balance in the portfolio declined from
$213.5 million at the end of 2002 to $171.0 million at the end of 2003. The
yield on the investment portfolio was 4.92% for 2003, a 44 basis point drop from
the 5.36% yield in 2002. First Defiance also had a significant decline in the
balance of interest-earning deposits maintained at other banks, which averaged
$22.1 million, a 50% drop from the $44.3 million average balance carried during
2002. Those deposits were used to fund loan growth and national CD run-off. The
yield on those interest-bearing deposits, which is closely tied to the Federal
Funds rate, declined to 1.27% for 2003 compared to 1.63% in 2002.
- 30 -
In 2002, total interest income declined slightly, to $46.1 million from
$46.5 million in 2001. Income from loans decreased to $36.9 million in 2002
($37.1 million on a tax-equivalent basis) compared to $42.8 million in 2001
($42.9 million on a tax-equivalent basis). That decline was the result of a 118
basis point drop in the average yield on the loan portfolio as rates dropped
dramatically in 2002 compared to 2001 following numerous Federal Reserve rate
cuts in 2001. The decline in interest income from the loan portfolio was offset
by a $5.1 million increase in interest earnings from the investment portfolio in
2002 compared to 2001 ($5.4 million increase on a tax-equivalent basis), the
result of the average portfolio balance increasing to $168.3 million in 2002
from just $57.8 million in 2001. That increase was due to the receipt of
proceeds from the sale of Leader. Earnings on interest-bearing deposits held at
other financial institutions also increased significantly in 2002 as a result of
the receipt of the proceeds from the sale of Leader. The average balance of
those deposits was $44.3 million in 2002 compared to just $10.7 million in 2001.
The yield on those balances, which is generally tied to the Fed Funds rate, was
1.63% in 2002 and 2.54% in 2001.
Interest expense decreased by $1.2 million, or 5.4%, to $20.9 million in
2003 compared to $22.0 million in 2002. Interest expense on interest-bearing
deposits was $3.1 million lower in 2003 compared to 2002 despite an $85.5
million increase in the average balance of such deposits. The average cost of
interest-bearing deposits dropped to 2.12% in 2003 from 3.01% in 2002. The drop
in the interest rates paid on deposits occurred in both core deposit accounts,
which include money market accounts and interest-bearing checking accounts, and
in certificates of deposit. The average cost of savings and interest-bearing
checking accounts dropped from 1.51% in 2002 to 0.67% in 2002 while the average
cost of CDs declined from 3.89% to 3.06% between the same time periods. The
decline in interest expense on deposits was partially offset by an increase in
expense on FHLB advances, which increased to $7.3 million in 2003 from $5.3
million in 2002. Part of the increase is due to the fact that the interest
expense on approximately $148.5 million of FHLB advances was allocated to
discontinued operations during the first quarter of 2002 as those advances were
used to fund operations of the Leader. At the completion of the sale of Leader,
$25 million of those advances were prepaid and the remaining advances were
maintained to fund operations of First Federal.
In 2002, interest expense declined by $3.6 million, or 13.9%, to $22.0
million compared to $25.6 million for 2001. The decline is due to a 131 basis
point drop in total interest-bearing liabilities, to 3.35% in 2002 from 4.66% in
2001. Deposit balances were up significantly in 2002 compared to 2001 ($547.5
million compared to $459.3 million) while costs were lower by 155 basis points
(3.01% compared to 4.56%). FHLB advances included in continuing operations were
higher in 2002 compared to 2001 ($103.6 million compared to $70.9 million) while
other borrowings (which were primarily securities sold under repurchase
agreements in 2002 and borrowings from another bank in 2001) declined in 2002
compared to 2001 ($7.7 million compared to $18.9 million).
As a result of the foregoing, First Defiance's net interest income was
$29.1 million for the year ended December 31, 2003 compared to $24.1 million for
the year ended December 31, 2002 and $20.9 million for the year ended December
31, 2001. Net interest margin from continuing operations calculated on a
tax-equivalent basis was 3.42% for 2003 compared to 3.38% in 2002 and 3.68% in
2001. In addition to the factors cited above, net interest margin is
- 31 -
also favorably impacted by an increase in non-interest bearing deposits, which
increased to an average balance of $47.5 million in 2003 from an average of
$33.1 million in 2002 and $31.7 million in 2001.
Provision for Loan Losses - First Defiance's provision for loan losses was
$1.7 million for the year ended December 31, 2003 compared to $1.4 million and
$1.0 million for the years ended December 31, 2002 and 2001 respectively.
Provisions for loan losses are charged to earnings to bring the total
allowance for loan losses to a level deemed appropriate by management to absorb
probable losses in the loan portfolio. Factors considered by management include
identifiable risk in the portfolios; historical experience; the volume and type
of lending conducted by First Defiance; the amount of non-performing assets,
including loans which meet the FASB Statement No. 114 definition of impaired;
the amount of assets graded by management as substandard, doubtful, or loss;
general economic conditions, particularly as they relate to First Defiance's
market areas; and other factors related to the collectibility of First
Defiance's loan portfolio.
Continued growth in the non-residential loan and commercial loan
portfolios at First Defiance, which have an inherently higher level of risk than
other types of loans, as well as ongoing concerns about economic conditions both
nationally and within the northwest Ohio market areas has caused the provision
for loan losses to increase in 2003 from 2002 and 2001 levels. The allowance for
loan losses totaled $8.8 million at December 31, 2003 compared to $7.5 million
at December 31, 2002 and $6.5 million at December 31, 2001. While the allowance
for loan losses grew by 18.0% from December 31, 2002 to December 31, 2003, the
loan balances before the allowance increased by 28.4% between those same
periods. Total loan charge-offs were $725,000 in 2003 compared to $720,000 and
$1.0 million in 2002 and 2001 respectively while recoveries in those same years
were $354,000, $217,000 and $257,000 respectively. As a percentage of average
loans, net charge-offs were 0.06% for the year ended December 31, 2003 compared
to 0.10% and 0.15% for 2002 and 2001 respectively. Management does not believe
there has been any deterioration in the overall quality of its loan portfolio
during 2003.
The percentage of the allowance for loan losses to total loans declined to
1.18% at December 31, 2003 compared with 1.32% at December 31, 2002 because the
overall quality of the loan portfolio increased in 2003 and because in
conjunction with the RFC acquisition, management recorded a discount of $2.9
million to offset expected credit losses in the acquired portfolio. Given that
discount, no allowance for loan losses was required for the $63.2 million of
loans remaining in that portfolio at December 31, 2003. As of December 31, 2003,
management believes the remaining discount of $2.5 million will be adequate to
cover any future losses in that portfolio.
- 32 -
First Defiance's non-performing assets at December 31, 2003 were $2.9
million compared to $2.7 million at December 31, 2002 and $2.5 million at
December 31, 2001. Non-performing assets include loans that are 90 days past due
and all real estate owned and other foreclosed assets. Non-performing assets at
December 31, 2003 and 2002 by category were as follows:
December 31
2003 2002
-----------------
(In thousands)
Non-performing loans:
Single-family residential $ 471 $ 404
Non-residential and multi-family residential real estate 1,092 1,217
Commercial 949 879
Consumer finance 33 25
-----------------
Total non-performing loans 2,545 2,525
Real estate owned and repossessed assets 404 206
-----------------
Total non-performing assets $2,949 $2,731
=================
Non-performing loans in the single-family residential, non-residential and
multi-family residential real estate and commercial loan categories represent
0.28%, 0.32% and 0.79% of the total loans in those categories respectively at
December 31, 2003 compared to 0.26%, 0.53% and 0.84% respectively for the same
categories at December 31, 2002. Non-performing assets increased by
approximately 8% between December 31, 2002 and December 31, 2003 while loans
increased by approximately 30% between those same periods. Management believes
that the allowance for loan losses is adequate to cover any potential losses
from non-performing assets.
Non-interest Income - Non-interest income increased by $5.9 million to
$18.8 million for the year ended December 31, 2003 from $12.9 million in 2002
and $10.2 million in 2001. Of that increase, $2.6 million is attributable to
higher gains from sales of mortgage loans, which totaled $7.2 million in 2003
compared to $4.6 million in 2002. The higher level of gains is due to high
mortgage origination volume through First Federal's branch network during most
of 2003 in response to historically low mortgage interest rates. In 2003 First
Defiance originated a total of $291.5 million of mortgage loans compared to
$241.1 million in 2002, an increase of 20.9%. The 56.5% increase in gain on sale
income is due not only to the increased volume, but also to more efficient
management of the mortgage pipeline, which resulted in better pricing on the
loans sold.
First Defiance also realized $1.6 million in securities gains during 2003
compared to just $21,000 of gains in 2002 as management took advantage of high
bond prices resulting from the low interest rate environment and locked in gains
in the portfolio. Also in 2003, the Company realized a full year of earnings on
its investment in bank owned life insurance (BOLI), which is included in
non-interest income. BOLI earnings, which are exempt from income tax, totaled
$809,000 compared to $144,000 recognized in 2002 following the October 2002
purchase of that product.
- 33 -
Loan and deposit fees at First Defiance increased to $4.5 million in 2003
from $3.8 million in 2002, an increase of 18.9%. Also, insurance and investment
sales commissions recognized in 2003 were $3.7 million compared to $3.3 million
in 2002, an increase of 12.1%.
In 2001 First Defiance realized $3.1 million in gains from mortgage loan
sales, $3.1 million in loan and deposit service fees and $3.0 million from
commission income.
Non-interest Expense -- Total non-interest expense for 2003 was $28.4
million compared to $26.2 million for the year ended December 31, 2002 and $23.0
million for the year ended December 31, 2001. The $2.2 million increase from
2002 to 2003 is attributable primarily to increases in compensation and
benefits, which increased by $2.0 million, to $16.1 million for 2003 from $14.1
million for 2002. Amortization of mortgage servicing rights also increased
significantly in 2003, to $2.0 million compared to $1.4 million in 2002. Those
increases were offset by a recovery of previously recorded impairment of
mortgage servicing rights of $717,000 in 2003 compared to an impairment charge
of $517,000 in 2002, a net change of more than $1.2 million. The 14.2% increase
in wages and benefits is attributable to added staff as a result of the
acquisition of the three branches from RFC Banking Company in June 2003; the
addition of several commercial lenders beginning in mid-2002 and continuing
through late 2003; the addition of staff in the Company's central operations
departments in response to the increased workload resulting from a growing
branch network and a growing loan portfolio; normal wage increases for existing
staff which averaged between 3% and 4%; and a 6% increase in the Company's total
group health insurance cost.
First Defiance services a growing portfolio of mortgage loans for others,
comprised of loans originated in its banking offices which are subsequently sold
in the secondary market. At December 31, 2003, First Defiance serviced a total
of 5,387 loans for others with a principal balance of $433.1 million. The total
servicing portfolio at December 31, 2002 was 4,296 loans with balances of $324.9
million. The mortgage servicing rights associated with those loans had a net
value of $3.4 million as of December 31, 2003 after subtracting a $606,000
reserve for impairment, compared to $2.1 million as of December 31, 2002 after
subtracting $1.4 million of impairment. First Defiance recognized a recovery of
impairment reserves in 2003 totaling $717,000 compared to impairment expense of
$517,000 in 2002. The impairment recovery in 2003 is the result of values
increasing for mortgage servicing rights late in the year in response to
increased mortgage loan rates. Those values dropped sharply in 2002 when
mortgage rates initially fell. Amortization of mortgage servicing rights also
increased significantly in 2003, to $2.0 million from $1.4 million in 2002, a
direct result of the high volume of mortgage refinancing in 2003.
The increase in non-interest expense from 2001 to 2002 was primarily in
compensation and benefits, which increased by $2.0 million and in amortization
and impairment of mortgage servicing rights, which increased by $735,000.
Income Taxes - Income taxes amounted to $5.7 million in 2003 compared to
$3.0 million and $2.4 million of income taxes from continuing operations in 2002
and 2001 respectively. The effective tax rates for those years were 32.0%, 31.7%
and 33.6% respectively. The tax rate is lower than the statutory 35% tax rate
for the Company because of investments in
- 34 -
tax-exempt securities and in BOLI. The earnings on such investments are not
subject to federal income tax.
Discontinued Operations - First Defiance's 2002 results included income
from discontinued operations of $8.9 million, or $1.34 per diluted share. The
amount included $7.7 million related to the after-tax gain on the sale of the
Leader, $2.0 million of income earned by Leader during the three months the
subsidiary was operated by First Defiance, and $844,000 of other expenses
associated with discontinued operations. For 2001 the operating results of
Leader have been reported as discontinued operations. For both 2002 and 2001,
interest expense recorded at First Federal which was associated solely with
financing activities of the Leader, primarily interest on brokered CDs and a
portion of the Company's FHLB advances, has been reported as part of
discontinued operations. Total discontinued operations for 2001 were $8.8
million or $1.33 per share.
Change in Accounting for Goodwill - Effective January 1, 2002, First
Defiance adopted FASB Statement No. 142, Goodwill and Other Intangible Assets.
As required under the standard, management evaluated goodwill recorded at its
First Insurance & Investments subsidiary 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 required, that amount was
reflected in the income statement as the cumulative effect of a change in
accounting principle. As a result of Statement No. 142, First Defiance is no
longer required to recognize goodwill amortization as an expense. Such
amortization totaled $314,000 in 2001. Management is required to evaluate
goodwill on an annual basis to determine if the recorded value is impaired.
During 2002, First Defiance paid additional consideration of $200,000 to settle
a contingent payout clause under an agreement entered into in 1998 when First
Insurance was acquired. Because the settlement was reached after January 1,
2002, the goodwill created by the settlement was deemed to be impaired in 2002
and was recorded as part of non-interest expense in 2002. Goodwill was evaluated
at the end of 2002 and at the end of 2003 and no additional impairment charges
were required. See Footnote 21 to the Consolidated Financial Statements.
Concentrations of Credit Risk
Financial institutions such as First Defiance generate income primarily
through lending and investing activities. The risk of loss from lending and
investing activities includes the possibility that losses may occur from the
failure of another party to perform according to the terms of the loan or
investment agreement. This possibility is known as credit risk.
Lending or investing activities that concentrate assets in a way that
exposes the Company to a material loss from any single occurrence or group of
occurrences increases credit risk. Diversifying loans and investments to prevent
concentrations of risks is one manner a financial institution can reduce
potential losses due to credit risk. Examples of asset concentrations would
include multiple loans made to a single borrower and loans of inappropriate size
relative to the total capitalization of the institution. Management believes
adherence to its loan and investment policies allows it to control its exposure
to concentrations of credit risk at acceptable levels. First Defiance's loan
portfolio is concentrated geographically in its northwest Ohio market area.
There are no industry concentrations that exceed 10% of the Company's loan
portfolio.
- 35 -
Liquidity and Capital Resources
The Company's primary source of liquidity is its core deposit base, raised
through First Federal's branch network, along with unused wholesale sources of
funding and its capital base. These funds, along with investment securities,
provide the ability to meet the needs of depositors while funding new loan
demand and existing commitments.
Cash generated from operating activities was $21.5 million in 2003 and
cash used in operating activities was $75.3 million and $80.1 million in 2002
and 2001 respectively. Excluding the gain from the sale of discontinued
operations and net changes in assets and liabilities of discontinued operations,
First Defiance used $17.9 million in 2002 and generated cash from operations of
$18.9 million in 2001. The adjustments to reconcile net income to cash provided
by or used in operations during the periods presented consist primarily of
proceeds from the sale of loans (less the origination of loans held for sale),
the provision for loan losses, depreciation expense, the origination,
amortization and impairment of mortgage servicing rights, ESOP expense related
to the release of ESOP shares in accordance with AICPA SOP 93-6 and increases
and decreases in other assets and liabilities.
In a typical year, the primary investing activity of First Defiance is
lending, which is funded with cash provided from operating and financing
activities, as well as proceeds from payment on existing loans and proceeds from
maturities of investment securities. In addition to the ordinary investing
activities, in 2003, First Defiance completed the RFC acquisition, which
increased cash from investing activities by $70.1 million as deposits acquired
exceeded the purchase price plus loans acquired. In 2002, First Defiance
realized proceeds from the sale of The Leader of $371.8 million. In considering
other investing activities, during 2003 $64.9 million and $22.2 million was
realized from the maturity of investment securities and sale of investment
securities respectively while $97.4 million was used to fund loan growth and
$48.9 million was used to purchase available for sale securities. During 2002, a
total of $194.8 million was used to purchase available for sale securities,
$39.5 million in proceeds were received from the maturing of available for sale
securities and $64.0 million was used to fund loan growth. In 2001 only $5.1
million was invested in investment securities, $6.4 million in proceeds were
received from the maturing of available for sale securities and the reduction in
the loan portfolio provided $29.3 million in cash.
Principal financing activities include the gathering of deposits, the
utilization of FHLB advances, the sale of securities under agreements to
repurchase such securities and borrowings from other banks. In addition, First
Defiance also purchased common stock for its treasury. For the year ended
December 31, 2003, deposits declined by $37.3 million, primarily do to the
Company not replacing $32.0 million of maturing brokered certificates of deposit
which were no longer needed. First Defiance also had a $15.3 million decline in
deposits in 2002 due to the maturing of $64.3 million of brokered CDs. Cash
generated from increased deposit balances was $86.2 million in 2001. Also in
2003, First Defiance borrowed $9 million from the FHLB under long-term advance
agreements and an additional $8 million was borrowed on short-term advances. In
2002, the Company repaid $62.2 million of existing advances from the FHLB,
borrowed $15 million of new advances from the FHLB and repaid $18.2 million of
borrowings from other banks. Also, the Company repurchased $4.4 million and
$10.3 million of common
- 36 -
stock for treasury in 2003 and 2002 respectively. For additional information
about cash flows from First Defiance's operating, investing and financing
activities, see the Consolidated Statements of Cash Flows included in the
Consolidated Financial Statements.
At December 31, 2003, First Defiance had the following commitments to fund
deposit, advance and borrowing obligations:
Maturity Dates by Period at December 31, 2003
----------------------------------------------------------------------------
Less than After 5
Contractual Obligations Total 1 year 1-3 years 4-5 years years
- ----------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Savings, checking and demand accounts $320,132 $320,132 $ -- $ -- $ --
Certificates of deposit 408,864 301,468 90,725 15,659 1,012
FHLB overnight advances 11,000 11,000 -- -- --
FHLB fixed advances including interest(1) 208,885 8,851 16,573 24,960 158,501
Securities sold under repurchase agreements 12,267 12,267 -- -- --
Lease obligations 2,234 213 349 312 1,360
----------------------------------------------------------------------------
Total contractual cash obligations $963,382 $653,931 $107,647 $ 40,931 $160,873
============================================================================
(1) Includes principal payments of $153,522 and interest payments of $55,363
At December 31, 2003, First Defiance had the following commitments to fund
loan or line of credit obligations:
Amount of Commitment Expiration by Period
Total -----------------------------------------------------------
Amounts Less than After 5
Commitments Committed 1 year 1-3 years 4-5 years years
- ----------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Mortgage loans in process $ 6,079 $ 6,079 $ -- $ -- $ --
Commercial loans in process 20,195 20,195 -- -- --
Single-family mortgage loan
originations 720 720 -- -- --
Nonmortgage loan originations 27,237 27,237 -- -- --
Consumer lines of credit 56,823 3,803 3,661 4,430 44,929
Commercial lines of credit 65,815 61,933 3,737 145 --
-----------------------------------------------------------------------------
Total commitments $176,869 $119,967 $ 7,398 $ 4,575 $ 44,929
=============================================================================
In addition to the above commitments, at December31, 2003 First Defiance
had commitments to sell $2.0 million of loans held for sale to Freddie Mac.
To meet its obligations, management can adjust the rate of savings
certificates to retain deposits in changing interest rate environments; it can
sell or securitize mortgage and non-mortgage loans; and it can turn to other
sources of financing including FHLB advances, the Federal Reserve Bank, bank
lines and brokered certificates of deposit. At December 31, 2003 First Defiance
had $42.4 million capacity under its agreements with the FHLB and other banks.
- 37 -
Stockholders equity increased by $4.2 million, or 3.5% at December 31,
2003 compared to December 31, 2002. Net income for 2003 was $12.1 million, of
which $3.9 million was returned to shareholders in the form of declared
dividends ($.65 per share). The decrease in the unrealized gains on available
for sale securities decreased equity by $2.4 million. The vesting of Management
Recognition Plan shares and the release of ESOP shares increased equity by
$50,000 and $1.1 million respectively. Stock option exercises increased equity
by approximately $1.7 million. The purchase of 220,521 shares of First Defiance
common stock for treasury at an average price of $19.98 per share reduced equity
by $4.4 million. The book value of First Defiance's common stock was $19.64 per
share at December 31, 2003 compared to $18.73 per share at December 31, 2002.
The tangible book value (excluding goodwill and core deposit intangibles) per
share was $16.39 and $18.17 per share at December 31, 2003 and 2002. The decline
in tangible book value in 2003 is the result of goodwill acquired as part of the
RFC acquisition.
First Defiance is subject to various capital requirements of the Office of
Thrift Supervision. At December 31, 2003, First Federal had capital ratios that
exceeded the standard to be considered "well capitalized". For additional
information about First Federal's capital requirements, see Note 15 to the
Consolidated Financial Statements.
Pro Forma Income Statement
Management does not believe that the reported income from continuing
operations for the year ended December 31, 2002 accurately represented the true
financial picture of First Defiance because continuing operations for the first
three months of 2002 and for all prior periods did not reflect the reinvestment
of any of the net proceeds realized from the sale of The Leader.
The following 2002 pro-forma income statement attempts to present what
First Defiance's results from continuing operations would have been for 2002 had
the sale of The Leader occurred as of January 1, 2002 and the proceeds invested
for the period from January 1, 2002 to April 1, 2002. Management has estimated
that additional assets added to the balance sheet as a result of the sale would
have been reinvested to yield a weighted average rate of 4.44% for the first
quarter of 2002. Also, to the extent possible, management has assumed that
proceeds from the sale were used to prepay advances. Dollars are in thousands
(except per share amounts).
- 38 -
Continuing Pro Forma
Operations As Pro Forma Continuing
Reported Adjustments Operations
----------------------------------------------
Interest income $ 46,141 3,043(1) $ 49,184
Interest expense 22,044 2,516(2) 24,560
--------- ---------
Net interest income 24,097 24,624
Provision for loan losses 1,451 1,451
--------- ---------
Net interest income after provision 22,646 23,173
Non-interest income 12,921 12,921
Non-interest expense 26,161 26,161
--------- ---------
Income before income taxes 9,406 9,933
Income taxes 2,986 185(3) 3,171
--------- ---------
Net income from continuing operations $ 6,420 $ 6,762
========= =========
Net income per diluted share from continuing
operations $ 0.97 $ 1.02
========= =========
(1) Assumed $120 million invested at 5.65%, $154 million invested at 3.5% for
three months.
(2) Add back $799,000 of interest on brokered CDs classified as discontinued,
add back $2.2 million of interest on FHLB advances classified as
discontinued, subtract $326,000 interest on advances to be paid off,
subtract $157,000 interest on bank debt to be paid off.
(3) Income tax on $527,000 increase in net interest income at 35%
Critical Accounting Policies
First Defiance has established various accounting policies which govern
the application of accounting principles generally accepted in the United States
in the preparation of its financial statements. The significant accounting
policies of First Defiance are described in the footnotes to the consolidated
financial statements. Certain accounting policies involve significant judgments
and assumptions by management, which have a material impact on the carrying
value of certain assets and liabilities; management considers such accounting
policies to be critical accounting policies. The judgments and assumptions used
by management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of the
judgments and assumptions made by management, actual results could differ from
these judgments and estimates, which could have a material impact on the
carrying value of assets and liabilities and the results of operations of First
Defiance.
Allowance for Loan Losses: First Defiance believes the allowance for loan
losses is a critical accounting policy that requires the most significant
judgments and estimates used in preparation of its consolidated financial
statements. In determining the appropriate estimate for the allowance for loan
losses, management considers a number of factors relative to both specific
credits in the loan portfolio and macro-economic factors relative to the economy
of the United States as a whole and the economy of the northwest Ohio region in
which the Company does business.
Factors relative to specific credits that are considered include a
customer's payment history, a customer's recent financial performance, an
assessment of the value of collateral held,
- 39 -
knowledge of the customer's character, the financial strength and commitment of
any guarantors, the existence of any customer or industry concentrations,
changes in a customer's competitive environment, and any other issues that may
impact a customer's ability to meet his obligations.
Economic factors that are considered include levels of unemployment and
inflation, specific plant or business closings in the Company's market area, the
impact of strikes or other work stoppages, the impact of weather or
environmental conditions, especially relative to agricultural borrowers and
other matters than may have an impact on the economy as a whole.
In addition to the identification of specific customer's who may be
potential credit problems, management considers its historical losses, the
results of independent loan reviews, an assessment of the adherence to
underwriting standards, the loss experience being reported by other financial
institutions operating in the Company's market area, and other factors in
providing reserves against loan balances that have not been specifically
classified. While management believes its allowance for loan losses is
conservatively determined based on the above factors, it does not believe the
allowances to be excessive or unnecessary. Refer to the section entitled
Allowance for Loan Losses and Note 2, Statement of Accounting Policies for a
further description of the Company's estimation process and methodology related
to the allowance for loan losses.
Valuation of Mortgage Servicing Rights: First Defiance believes the
valuations of mortgage servicing rights is a critical accounting policy that
requires significant estimates in preparation of its consolidated financial
statements. First Defiance recognizes as separate assets the value of mortgage
servicing rights, which are acquired through loan origination activities. First
Defiance does not purchase any mortgage servicing rights.
Key assumptions made by management relative to the valuation of mortgage
servicing rights include the stratification policy used in valuing servicing,
assumptions relative to future prepayments of mortgages, the potential value of
any escrow deposits maintained or ancillary income received as a result of the
servicing activity and discount rates used to value the present value of a
future cash flow stream. The value of mortgage servicing rights is especially
vulnerable in a falling interest rate environment. Refer also to the section
entitled Mortgage Servicing Rights and Note 2, Statement of Accounting Policies,
and Note 9, Mortgage Banking, for a further description of First Defiance's
valuation process, methodology and assumptions along with sensitivity analyses.
SFAS 91 - Deferral of Fees: First Defiance believes that SFAS No. 91 -
Deferral of Fees is a critical accounting policy that utilizes estimates in its
preparation of its consolidated financial statements. First Defiance accounts
for loan origination and commitment fees and certain direct loan origination
costs by deferring the net fees, or net costs, and amortizing them as an
adjustment of the related loan's yield. While the amount of fees to be deferred
is generally apparent in the origination of a loan, the amount of costs,
especially indirect or allocated costs to defer is a judgment that management
makes based various time studies and cost accounting assumptions. Refer to Note
2, Statement of Accounting Policies, for a description of First Defiance's
process and methodology.
- 40 -
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Asset/Liability Management
A significant portion of the Company's revenues and net income is derived
from net interest income and, accordingly, the Company strives to manage its
interest-earning assets and interest-bearing liabilities to generate an
appropriate contribution from net interest income. Asset and liability
management seeks to control the volatility of the Company's performance due to
changes in interest rates. The Company attempts to achieve an appropriate
relationship between rate sensitive assets and rate sensitive liabilities. First
Defiance does not presently use off balance sheet derivatives to enhance its
risk management.
First Defiance monitors interest rate risk on a monthly basis through
simulation analysis that measures the impact changes in interest rates can have
on net interest 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, non-maturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise 100 basis points over a 12 month period, First
Defiance's net interest income would increase by just 0.75% over the base case
scenario. Were interest rates to fall by 100 basis points during the same
12-month period, the simulation indicates that net interest income would
decrease by only 1.44%. It should be noted that other areas of First Defiance's
income statement, such as gains from sales of mortgage loans and amortization of
mortgage servicing rights are also impacted by fluctuations in interest rates
but are not considered in the simulation of net interest income.
First Defiance has increased its lending activities in the non-residential
real estate and commercial loan areas. While such loans carry higher credit risk
than residential mortgage lending, they tend to be more rate sensitive than
residential mortgage loans. The balance of First Defiance's non-residential and
multi-family real estate loan portfolio increased to $341.4 million, which is
split between $62.6 million of fixed-rate loans and $278.8 million of
adjustable-rate loans at December 31, 2003. The commercial loan portfolio
increased to $120.7 million, which is split between $46.6 million of fixed-rate
loans and $74.1 million of adjustable-rate loans at December 31, 2003. Certain
of the loans classified as adjustable have fixed rates for an initial term that
may be as long as five years. The maturities on fixed-rate loans are generally
less than 7 years. First Defiance also has significant balances of consumer
loans ($40.3 million at December 31, 2003) which tend to have a shorter duration
than residential mortgage loans, and home equity and improvement loans ($70.0
million at December 31, 2003) which fluctuate with changes in the prime lending
rate. Also, to limit its interest rate risk, First Federal sells approximately
90% of its fixed-rate mortgage originations into the secondary market.
- 41 -
In addition to the simulation analysis, First Federal also prepares an
"economic value of equity" ("EVE") analysis. This analysis calculates the net
present value of First Federal's assets and liabilities in rate shock
environments that range from -100 basis points to +200 basis points. The results
of this analysis are reflected in the following table. (In prior years, the rate
shock considered a -200 basis point rate shock. However with the low relative
level of rates, as of December 31, 2003 a -200 basis rate decline is not
meaningful).
December 31, 2003
- -----------------------------------------------------------------------------------------------------------------
Economic Value of Equity as % of
Economic Value of Equity Present Value of Assets
---------------------------------------------------------------------------------
Change in Rates $ Amount $ Change % Change Ratio Change
(Dollars in Thousands)
- -----------------------------------------------------------------------------------------------------------------
+ 200 bp 139,339 1,414 1.03% 13.65% 59 bp
+ 100 bp 139,209 1,288 0.93% 13.41% 35 bp
0 bp 137,921 -- -- 13.06% --
-100 bp 135,814 (2,107) (1.53%) 12.66% (40) bp
Based on the above analysis, in the event of a 200 basis point increase in
interest rates as of December 31, 2003, First Federal would experience a 1.03%
increase in its economic value of equity. If rates would fall by 100 basis
points its economic value of equity would decline by 1.53%. During periods of
rising rates, the value of monetary assets declines. Conversely, during periods
of falling rates, the value of monetary assets increases. It should be noted
that the amount of change in value of specific assets and liabilities due to
changes in rates is not the same in a rising rate environment as in a falling
rate environment. Based on the EVE analysis, the change in the economic value of
equity in both rising and falling rate environments is generally negligible
because both its assets and liabilities have relatively short durations and the
durations are fairly closely matched. The average duration of its assets at
December 31, 2003 was 1.67 years while the average duration of its liabilities
was 2.09 years.
In evaluating First Federal's exposure to interest rate risk, certain
shortcomings inherent in the each of the methods of analysis presented must be
considered. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market rates
while interest rates on other types of financial instruments may lag behind
current changes in market rates. Furthermore, in the event of changes in rates,
prepayments and early withdrawal levels could differ significantly from the
assumptions in calculating the table and the results therefore may differ from
those presented.
- 42 -
Forward Looking Information
Forward looking statements in this report are made in reliance upon the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The statements in this report which are not historical fact are forward looking
statements and they include, among other statements, projections about growth in
the Financial Condition section, comments about the adequacy of the allowance
for loan losses and projections about interest rate simulations included in the
Asset/Liability Management section. Actual results may differ from expectations
contained in such forward looking information as a result of factors including
but not limited to the interest rate environment, economic policy or conditions,
federal and state banking and tax regulations, and competitive factors in the
marketplace. Each of these factors could affect estimates, assumptions,
uncertainties and risks considered in the development of forward looking
information and could cause actual results to differ materially from
management's expectation regarding future performance.
- 43 -
Item 8 Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition................................45
Consolidated Statements of Income.............................................47
Consolidated Statements of Stockholders' Equity...............................48
Consolidated Statements of Cash Flows.........................................49
Notes to Consolidated Financial Statements....................................51
Report of Independent Auditors................................................99
- 44 -
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
December 31
2003 2002
--------------------------
(In Thousands)
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions $ 28,020 $ 17,263
Interest-bearing deposits 9,763 11,395
--------------------------
37,783 28,658
Securities:
Available-for-sale, carried at fair value 168,259 209,604
Held-to-maturity, carried at amortized cost
(fair value $2,938 and $4,129 at
December 31, 2003 and 2002, respectively) 2,776 3,921
--------------------------
171,035 213,525
Loans receivable, net of allowance of $8,844
and $7,496 at December 31, 2003 and 2002,
respectively 735,255 561,041
Loans held for sale 5,872 15,336
Mortgage servicing rights 3,431 2,090
Accrued interest receivable 4,742 4,533
Federal Home Loan Bank stock and other
interest-earning assets 17,766 18,302
Bank Owned Life Insurance 17,952 15,144
Premises and equipment 23,846 19,958
Real estate and other assets held for sale 404 206
Goodwill 20,544 3,636
Other assets 1,969 1,816
--------------------------
Total assets $1,040,599 $ 884,245
==========================
-45-
December 31
2003 2002
-----------------------------
(In Thousands)
Liabilities and stockholders' equity
Liabilities:
Deposits $ 728,996 $ 599,573
Advances from the Federal Home Loan Bank 164,522 149,096
Short term borrowings and other interest-bearing liabilities 12,267 4,308
Advance payments by borrowers 231 316
Deferred taxes 1,859 2,299
Other liabilities 8,455 8,543
-----------------------------
Total liabilities 916,330 764,135
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; 6,328 and 6,412
shares outstanding, respectively 63 64
Additional paid-in capital 51,144 50,702
Stock acquired by ESOP (1,904) (2,387)
Deferred compensation (11) (30)
Accumulated other comprehensive income,
net of tax of $2,163 and $3,477, respectively 4,017 6,455
Retained earnings 70,960 65,306
-----------------------------
Total stockholders' equity 124,269 120,110
-----------------------------
Total liabilities and stockholders' equity $ 1,040,599 $ 884,245
=============================
See accompanying notes.
-46-
First Defiance Financial Corp.
Consolidated Statements of Income
Years ended December 31
2003 2002 2001
--------------------------------------
(In Thousands, except per share amount)
Interest income:
Loans $ 41,165 $ 36,871 $ 42,794
Investment securities 8,491 8,550 3,480
Interest-bearing deposits 280 720 271
--------------------------------------
Total interest income 49,936 46,141 46,545
Interest expense:
Deposits 13,435 16,508 20,931
Federal Home Loan Bank advances and other 7,343 5,276 3,609
Notes payable 77 260 1,062
--------------------------------------
Total interest expense 20,855 22,044 25,602
--------------------------------------
Net interest income 29,081 24,097 20,943
Provision for loan losses 1,719 1,451 994
--------------------------------------
Net interest income after provision for loan losses 27,362 22,646 19,949
Non-interest income:
Service fees and other charges 4,480 3,767 3,065
Insurance commissions 3,712 3,266 2,961
Dividends on FHLB stock 695 904 1,055
Gain on sale of loans 7,173 4,565 3,061
Gain (loss) on sale of securities 1,575 21 (137)
Trust income 161 117 110
Income from Bank Owned Life Insurance 809 144 --
Other noninterest income 183 137 105
--------------------------------------
Total noninterest income 18,788 12,921 10,220
Non-interest expense:
Compensation and benefits 16,120 14,104 12,142
Occupancy 3,040 2,802 2,728
SAIF Deposit insurance premiums 183 123 124
State Franchise tax 1,118 1,351 1,306
Data processing 1,841 1,457 1,402
Amortization of mortgage servicing rights 1,998 1,439 392
Impairment (recovery) of mortgage servicing rights (746) 517 829
Amortization and impairment of goodwill and other intangibles 70 200 314
Other noninterest expense 4,754 4,168 3,711
--------------------------------------
Total noninterest expense 28,378 26,161 22,948
--------------------------------------
Income before income taxes 17,772 9,406 7,221
Federal income taxes 5,690 2,986 2,423
--------------------------------------
Income from continuing operations 12,082 6,420 4,798
Discontinued operations, net of tax -- 8,853 8,818
--------------------------------------
Income before cumulative effect of a change in accounting principle 12,082 15,273 13,616
Cumulative effect of change in method of accounting for goodwill -- (194) --
--------------------------------------
Net income $ 12,082 $ 15,079 $ 13,616
======================================
Earnings per share:
Basic
From continuing operations $ 2.00 $ 1.01 $ 0.74
Discontinued operations, net of tax -- $ 1.39 $ 1.37
Cumulative effect of change in method of accounting for goodwill -- ($ 0.03) --
Net income $ 2.00 $ 2.37 $ 2.11
Diluted
From continuing operations $ 1.91 $ 0.97 $ 0.72
Discontinued operations, net of tax -- $ 1.34 $ 1.33
Cumulative effect of change in method of accounting for goodwill -- ($ 0.03) --
Net income $ 1.91 $ 2.28 $ 2.05
Dividends declared per share $ 0.65 $ 0.54 $ 0.49
See accompanying notes.
-47-
First Defiance Financial Corp.
Consolidated Statements of Stockholders' Equity
(In Thousands)
Stock Acquired By
-------------------- Accumulated
Management Other
Common Stock Additional Recogni- Comprehen- Total
---------------- Paid-In tion sive Retained Stockholders'
Shares Amount Capital ESOP Plan Income Earnings Equity
----------------------------------------------------------------------------------------
Balance at January 1, 2001 6,864 $ 69 $ 53,512 $ (3,238) $ (204) $ 47 $ 49,287 $ 99,473
Comprehensive income:
Net income -- -- -- -- -- -- 13,616 13,616
Change in net unrealized gains and
losses on available-for-sale
securities, net of income taxes
of $461 -- -- -- -- -- 716 -- 716
---------
Total comprehensive income 14,332
ESOP shares released -- -- 173 425 -- -- -- 598
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $63 -- -- 63 -- 122 -- -- 185
Shares issued under stock option plan,
net of income tax benefit of $94 41 -- 360 -- -- -- -- 360
Acquisition of common stock for treasury (51) -- (383) -- -- -- (365) (748)
Dividends declared -- -- -- -- -- -- (3,179) (3,179)
-------------------------------------------------------------------------------------
Balance at December 31, 2001 6,854 69 53,725 (2,813) (82) 763 59,359 111,021
Comprehensive income:
Net income -- -- -- -- -- -- 15,079 15,079
Change in net unrealized gains and
losses on available-for-sale
securities, net of income taxes
of $3,075 -- -- -- -- -- 5,692 -- 5,692
---------
Total comprehensive income 20,771
ESOP shares released -- -- 357 426 -- -- -- 783
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $36 -- -- 36 -- 52 -- -- 88
Shares issued under stock option plan,
net of income tax benefit of $290 108 1 1,170 -- -- -- -- 1,171
Acquisition of common stock for treasury (550) (6) (4,586) -- -- -- (5,683) (10,275)
Dividends declared -- -- -- -- -- -- (3,449) (3,449)
-------------------------------------------------------------------------------------
Balance at December 31, 2002 6,412 64 50,702 (2,387) (30) 6,455 65,306 120,110
Comprehensive income:
Net income -- -- -- -- -- -- 12,082 12,082
Change in net unrealized gains and
losses on available-for-sale
securities, net of income taxes
of $(1,314) (a) -- -- -- -- -- (2,438) -- (2,438)
---------
Total comprehensive income 9,644
ESOP shares released 596 483 -- -- -- -- -- 1,079
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $31 -- -- 31 -- 19 -- -- 50
Shares issued under stock option plan,
net of income tax benefit of $236 137 1 1,730 -- -- -- -- 1,731
Acquisition of common stock for treasury (221) (2) (1,915) -- -- -- (2,489) (4,406)
Dividends declared -- -- -- -- -- -- (3,939) (3,939)
-------------------------------------------------------------------------------------
Balance at December 31, 2003 6,328 $ 63 $ 51,144 $ (1,904) $ (11) $ 4,017 $ 70,960 $ 124,269
=====================================================================================
(a) Net of reclassification adjustments. Reclassification adjustments
represent net unrealized gains (losses) as of December 31 of the prior
year on securities available for sale that were sold during the current
year. The reclassification adjustments was $1,393,000 ($905,000 after tax)
in 2003.
See accompanying notes.
-48-
First Defiance Financial Corp.
Consolidated Statements of Cash Flows
Years ended December 31
2003 2002 2001
-----------------------------------------
(In Thousands)
Operating activities
Net income $ 12,082 $ 15,079 $ 13,616
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,719 1,451 994
Provision for depreciation 1,645 1,605 1,603
Net securities amortization 988 695 33
Amortization of mortgage servicing rights 1,998 1,439 392
Net impairment (recovery) of mortgage servicing rights (746) 517 829
Amortization of goodwill -- -- 314
Amortization of core deposit intangible 70 -- --
Net impairment of goodwill -- 438 --
Gain on sale of loans (7,173) (4,565) (3,061)
Gain on sale of discontinued operations -- (16,912) --
Amortization of Management Recognition Plan
deferred compensation 50 88 185
Release of ESOP shares 1,079 783 598
(Gains) losses on sales of securities (1,575) (21) 137
Deferred federal income tax (credit) 874 (437) 207
Proceeds from sale of loans 310,310 197,249 190,352
Origination of mortgage servicing rights (2,593) (2,225) (1,911)
Origination of loans held for sale (293,673) (207,348) (187,862)
(Decrease) increase in interest receivable and other assets (2,727) (17,998) 634
Decrease in assets held for sale -- 12 1,006
Decrease in liabilities held for sale -- -- (186)
Increase in assets of discontinued operations -- (40,479) (80,728)
Decrease in liabilities of discontinued operations -- -- (18,240)
(Decrease) increase in accrued interest and other liabilities (782) (4,638) 1,016
-----------------------------------------
Net cash provided by operating activities 21,546 (75,267) (80,072)
Investing activities
Proceeds from maturities of held-to-maturity securities 1,125 1,623 2,089
Proceeds from maturities of available-for-sale securities 64,852 39,523 6,395
Proceeds from sale of available-for-sale securities 22,233 2,459 3,919
Proceeds from sale of real estate and other assets held for sale 338 597 296
Proceeds from sale of office properties and equipment -- -- 27
Proceeds from sale of discontinued operations 1,228 371,772 --
Purchases of available-for-sale securities (48,885) (194,766) (5,120)
Purchases of Federal Home Loan Bank stock (692) (767) (1,055)
Purchases of office properties and equipment (3,506) (1,500) (1,652)
Acquisition of banking center offices 70,132 -- --
Net (increase) decrease in loans receivable (97,376) (64,018) 29,336
-----------------------------------------
Net cash provided by investing activities $ 9,449 $ 154,923 $ 34,235
-49-
First Defiance Financial Corp.
Consolidated Statements of Cash Flows (continued)
Years ended December 31
2003 2002 2001
-----------------------------------------
Financing activities
Net (decrease) increase in deposits (37,343) (15,349) 86,172
Repayment of Federal Home Loan Bank long-term advances (1,574) (25,206) (454)
Repayment of term notes payable (10) (39) (36)
Net increase (decrease) in Federal Home Loan Bank
short-term advances 8,000 (37,000) (116,500)
Net increase (decrease) in short-term line of credit -- (18,250) 6,250
Proceeds from Federal Home Loan Bank long-term advances 9,000 15,000 90,000
Increase in securities sold under repurchase agreements 6,671 4,299 --
Purchase of common stock for treasury (4,406) (10,275) (748)
Cash dividends paid (3,939) (3,449) (3,109)
Proceeds from exercise of stock options 1,731 1,171 360
-----------------------------------------
Net cash (used in) provided by financing activities (21,870) (89,098) 61,935
-----------------------------------------
Increase (decrease) in cash and cash equivalents 9,125 (9,442) 16,098
Cash and cash equivalents at beginning of period 28,658 38,100 22,002
-----------------------------------------
Cash and cash equivalents at end of period $ 37,783 $ 28,658 $ 38,100
=========================================
Supplemental cash flow information
Interest paid $ 21,047 $ 21,337 $ 25,694
=========================================
Income taxes paid $ 5,063 $ 14,260 $ 8,520
=========================================
Transfers from loans to real estate
and other assets held for sale $ 536 $ 667 $ 391
=========================================
Noncash operating activities
Change in deferred taxes on net unrealized gains or
losses on available-for-sale securities $ (1,314) $ 3,075 $ (461)
=========================================
Noncash investing activities
Increase (decrease) in net unrealized gain or (loss) on
available-for-sale securities $ (3,752) $ 8,784 $ 1,177
=========================================
Noncash financing activities
Cash dividends declared but not paid $ 1,220 $ 920 $ 848
=========================================
See accompanying notes.
-50-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
December 31, 2003
1. Basis of Presentation
First Defiance Financial Corp. (First Defiance) is a holding company that
conducts business through its two wholly owned subsidiaries, First Federal Bank
of the Midwest, Defiance Ohio (First Federal) and First Insurance & Investments
(First Insurance). All significant intercompany transactions and balances are
eliminated in consolidation.
First Federal is primarily engaged in attracting deposits from the general
public through its offices and using those and other available sources of funds
to originate loans primarily in the counties in which its offices are located.
First Federal's traditional banking activities include originating and servicing
residential, commercial and consumer loans and providing a broad range of
depository and trust services. First Federal is subject to the regulations of
certain federal agencies and undergoes periodic examinations by those regulatory
authorities. First Federal's wholly owned mortgage banking company, The Leader
Mortgage Company, LLC, was sold to US Bancorp in a transaction that was
completed on April 1, 2002.
First Insurance & Investments is an insurance agency that does business in the
Defiance, Ohio area offering property and casualty, group health, and life
insurance and investment and annuity products.
2. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates. Significant areas where First Defiance uses
estimates are the determination of the allowance for loan losses and the
valuation of mortgage servicing rights and goodwill.
Earnings Per Share
Earnings per share are based on the weighted average number of shares of common
stock outstanding during the period. Basic earnings per share exclude any
dilutive effects of options and unvested stock grants.
-51-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Cash and Cash Equivalents
Cash and cash equivalents include amounts due from banks and overnight
investments with the Federal Home Loan Bank (FHLB). Cash and amounts due from
depository institutions includes required balances at the FHLB and Federal
Reserve of approximately $713,000 and $1.8 million, respectively, at December
31, 2003.
Investment Securities
Management determines the appropriate classification of debt securities at the
time of purchase and evaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest
income using the interest method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity until realized. Realized gains and
losses, and unrealized losses judged to be other-than-temporary are included in
gains (losses) on sale of securities. The cost of mutual funds sold is based on
the average cost method. The cost of all other securities sold is based on the
specific identification method.
Currently, First Defiance invests in derivative securities as part of the
overall asset and liability management process. Such derivative securities are
disclosed in Note 6 and include agency step-up, REMIC and CMO investments. Such
investments are not classified by management as high risk at December 31, 2003
and do not present risk significantly different than other mortgage-backed or
agency securities.
Investments Required by Regulations
As a member of the FHLB System, First Federal is required to own stock of the
FHLB of Cincinnati in an amount principally equal to .15% of total assets plus
an amount of at least 2% but no more than 4% of its non-grandfathered mission
asset activity (as defined in the FHLB's regulations). First Federal is
permitted to own stock in excess of the minimum requirement.
-52-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
FHLB stock is a restricted equity security that does not have a readily
determinable fair value and is carried at cost.
Loans Receivable
Loans are reported at the principal amount outstanding, net of unearned income.
Unearned income, which includes deferred fees net of deferred incremental loan
origination costs, is amortized to interest income generally over the
contractual life of the loan using the interest method.
Mortgage loans originated and intended for sale in the secondary market are
classified as loans held for sale and are carried at the lower of cost or
estimated fair value in the aggregate.
Interest receivable is accrued on loans and credited to income as earned. The
accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received. The accrual of interest on these loans is generally resumed after a
pattern of repayment has been established.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the loan portfolio and is based
on the size and current risk characteristics of the loan portfolio, an
assessment of individual problem loans, actual loss experience, current economic
events in specific industries and geographical areas, and other pertinent
factors including regulatory guidance and general economic conditions.
Determination of the allowance is inherently subjective as it requires
significant estimates, including the amounts and timing of expected future cash
flows on impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience and consideration of economic trends, all of which
may be susceptible to significant change. Loan losses are charged off against
the allowance when in management's estimation it is unlikely that the loan will
be collected, while recoveries of amounts previously charged off are credited to
the allowance. A provision for loan losses is charged to operations based on
management's periodic evaluation of the factors previously mentioned, as well as
other pertinent factors.
The determination of whether a loan is considered past due or delinquent is
based on the contractual payment terms.
-53-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Marketing Costs
Marketing costs totaled $524,000, $504,000, and $463,000 in 2003, 2002, and
2001, respectively, and are expensed as incurred.
Mortgage Servicing Rights
The total cost of loans originated or purchased is allocated between loans and
servicing rights based on the relative fair values of each at the time of sale.
The servicing rights capitalized are amortized in proportion to and over the
period of estimated servicing income.
Mortgage servicing rights are periodically evaluated for impairment. For
purposes of measuring impairment, mortgage servicing rights are stratified based
on predominant risk characteristics of the underlying serviced loans. These risk
characteristics include loan type (fixed or adjustable rate) and interest rate.
Impairment represents the excess of amortized cost of an individual mortgage
servicing rights stratum over its fair value, and is recognized through a
valuation allowance.
Fair values for individual stratum are based on the present value of estimated
future cash flows using a discount rate commensurate with the risks involved.
Estimates of fair value include assumptions about prepayment, default and
interest rates, and other factors which are subject to change over time. Changes
in these underlying assumptions could cause the fair value of mortgage servicing
rights, and the related valuation allowance, to change significantly in the
future.
Real Estate and Other Assets Held for Sale
Assets held for sale are comprised of properties acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. These properties are
carried at the lower of cost or fair value, less estimated costs to dispose, at
the time of foreclosure or insubstance foreclosure. Loan losses arising from the
acquisition of such property are charged against the allowance for loan losses.
-54-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and
amortization computed principally by the straight-line method over the following
estimated useful lives:
Buildings and improvements 20 to 50 years
Furniture, fixtures and equipment 3 to 15 years
Long-lived assets to be held and those to be disposed of and certain intangibles
are evaluated for impairment using the guidance provided by SFAS No. 144,
Accounting for Long-Lived Assets to be Disposed of, relative to accounting for
long-lived assets and accounting for long-lived assets to be disposed of either
through sale, abandonment, exchange or a distribution to owners.
Income Taxes
Deferred income taxes reflect the temporary tax consequences on future years of
differences between the tax basis and financial statement amounts of assets and
liabilities at each year-end.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
An effective tax rate of 35% is used to determine after-tax components of other
comprehensive income included in the statements of stockholders' equity.
Business Combinations
Business combinations, which have been accounted for under the purchase method
of accounting, include the results of operations of the acquired business from
the date of acquisition. Net assets of companies acquired are recorded at their
estimated fair value as of the date of acquisition.
-55-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Goodwill and Other Intangibles
Core deposit intangibles are a measure of the value of checking and savings
deposits acquired in business combinations accounted for under the purchase
method. Core deposit intangibles are amortized on an accelerated basis over the
estimated lives of the existing deposit relationships acquired, but not
exceeding 10 years. Goodwill is the excess of the purchase price over the fair
value of the assets and liabilities of companies acquired through business
combinations accounted for under the purchase method. Goodwill is evaluated at
the business unit level, which for First Defiance is First Federal Bank and
First Insurance. At December 31, 2003 goodwill totaled $16.1 million and core
deposit intangibles were $703,000 at First Federal and goodwill totaled $3.7
million at First Insurance. Core deposit intangibles are amortized over the life
of the related deposits, not to exceed ten years. Amortization expense in 2003
was $70,000. Goodwill is not subject to amortization but its value is assessed
annually to determine if there is any impairment of value.
Effective January 1, 2002, First Defiance adopted Statement of Financial
Accounting Standard (SFAS) No 142, Goodwill and Other Intangible Assets, under
which goodwill is no longer amortized, but is subject to an annual impairment
test. Separable intangible assets that are not deemed to have an indefinite life
continue to be amortized over their useful lives. The Company completes annual
testing for impairment of goodwill. If an impairment loss is determined in the
future, the loss will be reflected as an expense in the statement of operations
in the period in which the impairment was determined. The impact on the
statement of income from the adoption of SFAS No. 142 in included in Note 21.
Stock Options
At December 31, 2003, the Company had three stock-based compensations plans,
which are more fully described in Note 18. 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
Corporation's employee stock options equals the market price of the underlying
stock on the date of the grant, no compensation expense is recognized.
-56-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (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-based compensation plans
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 which was originally developed for use in estimating the
fair value of traded options, which have different characteristics from the
Company's employee stock options. The model is also sensitive to changes in
assumptions, which can materially affect the fair value estimate. The following
weighted-average assumptions were used to determine the fair value of options
granted on First Defiance common stock:
December 31
2003 2002 2001
-----------------------------------------
Risk free interest rate 5.65% 5.74% 5.70%
Dividend yield 2.97% 2.93% 3.01%
Volatility factors of expected
market price of stock 0.266% 0.269% 0.268%
Weighted average expected life 8.71 years 8.62 years 8.65 years
Weighted average grant date fair
value of options granted $ 3.53 $ 3.44 $ 3.38
-57-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Based upon the above assumptions, pro forma net income and earnings per share
are computed as follows:
Years ended December 31
2003 2002 2001
--------------------------------------
Net income from continuing operations,
as reported $ 12,082 $ 6,420 $ 4,798
Stock-based compensation using the
fair value method, net of tax (186) (197) (210)
--------------------------------------
Pro forma net income from
continuing operations $ 11,896 $ 6,223 $ 4,588
======================================
Pro forma earnings per share:
Basic $ 1.97 $ 0.97 $ 0.71
======================================
Diluted $ 1.88 $ 0.94 $ 0.69
======================================
The pro forma effects for 2003, 2002 and 2001 are not likely to be
representative of the pro forma effects for future years.
Accounting for Derivative Instruments and Hedging Activities
First Defiance's accounting policies for derivative instruments and hedging
activities reflect the provisions of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. All derivative instruments,
which are comprised of interest rate locks issued to customers and commitment to
sell mortgage loans in the secondary market, are carried at fair value on the
balance sheet. When the special hedge accounting criteria are met, offsetting
changes in fair value or cash flows of both the derivative and the hedged asset
or liability are deferred and recognized in earnings in the same period;
however, any changes in fair value or cash flow that represent the ineffective
portion of a hedge are recognized in earnings and cannot be deferred. For
derivative instruments not accounted for as hedges, changes in fair value are
recognized in earnings as they occur.
-58-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Recent Accounting Pronouncements
Medicare Prescription Law
In December 2003, the FASB issued guidance that requires disclosure that
acknowledges the issuance of this new law and the fact that it may affect a
company's accumulated postretirement benefit obligation and net postretirement
benefit cost. The required disclosure for First Defiance is presented in Note
14.
Other-than-Temporary Impairment
In November 2003, the EITF finalized EITF No. 03-01, The Meaning of Other than
Temporary Impairment and its Application to Certain Investments, which requires
certain disclosures for impaired securities accounted for under SFAS No. 115,
Accounting for Certain Investment in Debt and Equity Securities, for which an
other-than-temporary impairment has not been recognized. The required disclosure
for First Defiance is presented in Note 6.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, which
establishes standards for issuers to classify and measure certain financial
instruments with characteristics of both liabilities and equity. SFAS No. 150
requires that certain financial instruments that would previously have been
classified as equity to be classified as liabilities. The guidance was effective
for financial instruments entered into or modified after May 31, 2003 and
otherwise became effective for First Defiance on July 1, 2003. The application
of SFAS No. 150 did not have any material effect on the Company's financial
condition or results of operations.
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.
-59-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
The standard is effective for the Company beginning January 1, 2003, and its
adoption did not have any material effect 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 was effective for exit or
disposal activities that initiated after December 31, 2002, with early
application encouraged. The Company 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.
FIN No. 45, which is applicable to public and non-public entities, will
significantly change 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 current practice for most entities. In addition, guarantors will be
required to make significant new disclosures, even if the likelihood of the
guarantor making payments under the guarantee is remote, which represents
another change from current general practice.
FIN No. 45's disclosure requirements were effective for financial statements of
interim or annual periods ending after December 15, 2002, while the initial
recognition and initial measurement provisions were applicable on a prospective
basis to guarantees issued or modified after December 31, 2002.
-60-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
The Company has included FIN No. 45's required disclosures in Note 7. FIN No. 45
recognition and measurement provisions had no material impact on the Company's
results of operations, financial position or liquidity when 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. In December 2003, the FASB
issued modifications to FIN No. 46 to provide additional scope exceptions,
address certain implementation issues and promote a more consistent application
of the provisions. Revised FIN No. 46 supercedes FIN No. 46 and will be adopted
by the Company in the first quarter of 2004. As of December 31, 2003, the
Company was not party to any VIEs. The provisions of FIN No. 46, as revised, are
not expected to have any material impact on results of operation or financial
position.
Accounting for Certain Loans or Debt Securities Acquired in a Transfer
In December 2003, the AICPA issued a Statement of Position that addresses the
accounting for differences between contractual cash flows and cash flows
expected to be collected from an investor's initial investment in loans or debt
securities (structured as loans) acquired in a transfer if those differences are
attributable, at least in part, to credit quality. As required by this
pronouncement, the Company will adopt this guidance for loans acquired after
December 31, 2004. Adoption of this guidance is not expected to have any
material effect on the Company's financial condition or results of operations.
-61-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
3. Acquisition of Banking Center Offices
On February 22, 2003, First Defiance entered into a purchase and assumption
agreement with RFC Banking Company and its parent Rurban Financial Corp. to
acquire banking center offices located in Findlay, Ottawa and McComb, Ohio and
related deposit liabilities, certain loans and other assets associated with the
business of those branches.
On June 6, 2003, First Defiance completed the purchase of the banking center
offices and the reported results include the operations of these acquired
banking centers assets and liabilities from that acquisition date and
thereafter. Total deposits acquired through the acquisition were $166.7 million.
Additionally, loan balances acquired by First Defiance in the transaction were
approximately $79 million, which included $35.4 million of non-residential real
estate loans, $16.8 million of commercial loans, $3.6 million of consumer loans,
$1.8 million of home equity loans and $21.4 million of residential mortgages.
Other assets acquired included $2.0 million of premises and equipment and
$443,000 of interest receivable and other assets. Cash received, net of the
premium paid, was $70.1 million. Total consideration for the acquisition was
10.5% of acquired non-brokered deposits plus an agreed upon amount for all
furnishings and equipment.
As of the final closing, First Defiance paid a net premium of $12.5 million and
recorded fair value increases (reductions) on acquired loans of ($1.2) million
and acquired deposits of $2.3 million to record them at fair value and recorded
transaction costs and other adjustments of approximately $900,000. These items
resulted in total intangibles of $16.9 million including goodwill of $16.1
million and a core deposit intangible of $772,000. The core deposit is being
amortized over 10 years and goodwill was recorded in accordance with SFAS No.
142 and accordingly is not subject to amortization. All intangible assets
acquired as part of this acquisition are deductible for Federal income tax
purposes over 15 years.
-62-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
4. Discontinued Operations
On April 1, 2002, First Defiance competed the sale of The Leader Mortgage
Company, LLC to US Bancorp. Discontinued operations as reported include the
operating results of The Leader for the periods owned, the gain realized by the
Company from the sale of The Leader, net of all expenses of the sale, and the
cost to the Company for early payment of certain FHLB advances and other
expenses. The components of discontinued operations for 2002 and 2001 were as
follows (in thousands):
2002 2001
-----------------------
Operations of The Leader $ 4,316 $ 15,343
Net interest income (expense) allocated
to discontinued operations (1,250) (1,365)
Gain from sale of The Leader 16,959 --
Cost to terminate financing and other expenses
associated with discontinued operations (1,225) --
-----------------------
Income from discontinued operations 18,800 13,978
before income tax
Income tax on discontinued operations 9,947 5,160
-----------------------
Income from discontinued operations $ 8,853 $ 8,818
=======================
Net interest income or expense is allocated to discontinued operations, in
accordance with EITF 87-24, based on interest earned by First Federal on
intercompany loans to The Leader less interest expense, primarily brokered CDs
and a portion of FHLB advances utilized to fund those intercompany loans. In
2002 and 2001, First Federal had a negative spread in its borrowing relationship
with The Leader.
The gain from the sale of The Leader was based on the net proceeds from the
sale, after expenses, less the book value of First Defiance's investment in The
Leader. The Leader's net book value included goodwill of $9.6 million.
-63-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
5. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
2003 2002 2001
----------------------------------------
(In Thousands, except per share amounts)
Numerator for basic and diluted earnings
per share-income from continuing
operations $12,082 $ 6,420 $ 4,798
=====================================
Denominator:
Denominator for basic earnings per
share-weighted-average shares 6,036 6,359 6,464
Effect of dilutive securities:
Employee stock options 277 236 149
Unvested Management Recognition
Plan stock 6 14 33
-------------------------------------
Dilutive potential common shares 283 250 182
-------------------------------------
Denominator for diluted earnings per
share-adjusted weighted-average shares 6,319 6,609 6,646
=====================================
Basic earnings per share from
continuing operations $ 2.00 $ 1.01 $ 0.74
=====================================
Diluted earnings per share from
continuing operations $ 1.91 $ 0.97 $ 0.72
=====================================
-64-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
6. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities:
December 31, 2003
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------
(In Thousands)
Available-for-sale securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and agencies $ 72,907 $ 3,980 $ 12 $ 76,875
Corporate bonds 7,210 506 -- 7,716
Mortgage-backed securities 19,621 169 38 19,752
REMICs 8,994 22 54 8,962
Collateralized mortgage obligations 14,687 53 21 14,719
Trust preferred stock 7,238 84 -- 7,322
Equity securities 69 9 -- 78
Obligations of state and political
subdivisions 31,352 1,504 21 32,835
--------------------------------------------------------
Totals $162,078 $ 6,327 $ 146 $168,259
========================================================
Held-to-maturity securities:
FHLMC certificates $ 603 $ 25 $ 1 $ 627
FNMA certificates 1,174 16 6 1,184
GNMA certificates 409 11 -- 420
Obligations of states and political subdivisions 590 117 -- 707
--------------------------------------------------------
Totals $ 2,776 $ 169 $ 7 $ 2,938
========================================================
-65-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
6. Investment Securities (continued)
December 31, 2002
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------
(In Thousands)
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 2,109 -- 54 2,055
funds
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 states and political subdivisions 590 131 -- 721
--------------------------------------------------------
Totals $ 3,921 $ 217 $ 9 $ 4,129
========================================================
The amortized cost and fair value of securities at December 31, 2003 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Mutual funds are not
due at a single maturity date. For purposes of the maturity table,
mortgage-backed securities, which are not due at a single maturity date, have
been allocated over maturity groupings based on the weighted-average contractual
maturities of the underlying collateral. The mortgage-backed securities may
mature earlier than their weighted-average contractual maturities because of
principal prepayments.
-66-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
6. Investment Securities (continued)
Available-for-Sale Held-to-Maturity
------------------------ -------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------------------------------------------------------
(In Thousands)
Due in one year or less $ 12,448 $ 12,656 $ 69 $ 73
Due after one year through
five years 41,112 43,834 290 337
Due after five years through
ten years 52,314 55,240 292 366
Due after ten years 56,135 56,451 2,125 2,162
--------------------------------------------------------
162,009 168,181 2,776 2,938
Equity securities 69 78 -- --
--------------------------------------------------------
Totals $162,078 $168,259 $ 2,776 $ 2,938
========================================================
Investment securities with carrying amounts of $105.2 million and $78.8 million
at December 31, 2003 and 2002, respectively, were pledged as collateral on
public deposits, securities sold under repurchase agreements and FHLB advances
and for other purposes required or permitted by law.
-67-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
6. Investment Securities (continued)
The following table summarizes First Defiance's securities that were in an
unrealized loss position at December 31, 2003:
Duration of Unrealized Loss Position
-----------------------------------------------------
Less than 12 Months 12 Month or Longer Total
---------------------- ----------------------- -----------------------
Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loses
-----------------------------------------------------------------------------------
(In Thousands)
Available-for-sale securities:
U.S. Treasury securities and
obligations of U.S.
Government corporations
and agencies $ $ $ 1,349 $ (12) $ 1,349 $ (12)
Mortgage-backed securities 11,171 (38) 11,171 (38)
Collateralized mortgage
obligations 13,164 (75) 13,164 (75)
Obligations of state and
political subdivisions 4,144 (21) 4,144 (21)
Held to maturity securities:
Mortgage-backed securities 374 (7) 374 (7)
-----------------------------------------------------------------------------------
Total temporarily impaired
securities $ -- $ -- $ 30,202 $ (153) $ 30,202 $ (153)
===================================================================================
The above securities all have fixed interest rates and defined maturities. Their
fair value is sensitive to movements in market interest rates. First Defiance
has the ability and intent to hold these investments for a time necessary to
recover the amortized cost without impacting its liquidity position.
-68-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
7. Commitments and Contingent Liabilities
Loan Commitments
Loan commitments are made to accommodate the financial needs of the First
Federal's customers; however, there are no long-term, fixed-rate loan
commitments that result in market risk. Standby letters of credit commit the
Company to make payments on behalf of customers when certain specified future
events occur. They primarily are issued to facilitate customers' trade
transactions.
Both arrangements 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
loans and unused lines of credit) and standby letters of credit outstanding on
December 31 was as follows (in thousands):
2003 2002
------------------------
Commercial $113,247 $103,984
Real estate 6,799 17,537
Consumer 56,823 41,555
Standby letters of credit 3,550 2,997
------------------------
Total $180,419 $166,073
========================
Lease Agreements
The Company has entered into lease agreements covering First Insurance's main
office, one banking center location and the land on which one banking center was
constructed and numerous stand-alone Automated Teller Machine sites with varying
terms and options to renew.
-69-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
7. Commitments and Contingent Liabilities (continued)
Lease Agreements (continued)
Future minimum commitments under non-cancelable operating leases are as follows
(in thousands):
2004 $ 213
2005 183
2006 166
2007 156
2008 156
Thereafter 1,360
Rentals under operating leases and data processing costs amounted to $195,000,
$169,000 and $131,000 in 2003, 2002 and 2001, respectively.
8. Loans Receivable
December 31
2003 2002
------------------------
(In Thousands)
Loans receivable consist of the following at December 31:
Real estate loans:
Secured by single family residential $162,111 $142,355
Secured by multi-family residential 30,322 32,324
Secured by non-residential real estate 311,101 195,431
Construction 16,830 15,357
------------------------
520,364 385,467
Other loans:
Automobile 31,043 30,229
Commercial 120,677 104,070
Home equity and improvement 70,038 49,890
Other 9,214 7,349
------------------------
230,972 191,538
------------------------
Total loans 751,336 577,005
Deduct:
Undisbursed loan funds 6,079 7,256
Net deferred loan origination fees and costs 1,158 1,212
Allowance for loan losses 8,844 7,496
------------------------
Totals $735,255 $561,041
========================
-70-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
8. Loans Receivable (continued)
Changes in the allowance for loan losses were as follows:
Years ended December 31
2003 2002 2001
----------------------------------
(In Thousands)
Allowance at beginning of year $7,496 $6,548 $6,330
Provision for credit losses 1,719 1,451 994
Charge-offs 725 720 1,033
Recoveries 354 217 257
----------------------------------
Net charge-offs 371 503 776
----------------------------------
Ending allowance $8,844 $7,496 $6,548
==================================
Unpaid balances of loans with contractual payments delinquent 90 days or more
totaled $2.5 million at December 31, 2003 and $2.5 million at December 31, 2002.
First Federal does not anticipate any significant losses in the collection of
these delinquent loans in excess of the allowance for loan losses.
Impaired loans having recorded investments of $563,000 at December 31, 2003 and
$593,000 at December 31, 2002 have been recognized in conformity with FASB
Statement No. 114, as amended by FASB Statement No. 118. The average recorded
investment in impaired loans during 2003 and 2002 was $892,000 and $697,000,
respectively. The total allowance for loan losses related to these loans was
$297,000 and $359,000 at December 31, 2003 and 2002. There was $29,000 of
interest received and recorded in income during 2003 on impaired loans including
interest received and recorded in income prior to such impaired loan
designation. There was $46,000 recorded in 2002 and $40,000 recorded in 2001.
Loans having carrying values of $536,000 and $667,000 were transferred to real
estate and other assets held for sale in 2003 and 2002, respectively.
-71-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
8. Loans Receivable (continued)
First Defiance is not committed to lend additional funds to debtors whose loans
have been modified.
Interest income on loans is as follows:
Years ended December 31
2003 2002 2001
-------------------------------------
(In Thousands)
Commercial and non-residential
real-estate loans $28,145 $22,099 $21,251
Mortgage loans 7,144 9,088 14,656
Other loans 5,876 5,684 6,887
-------------------------------------
Totals $41,165 $36,871 $42,794
=====================================
There are no industry concentrations (exceeding 10% of gross loans) in First
Federal's non-residential real estate and commercial loan portfolios. The
Company's loans receivable are primarily to borrowers in the Northwest Ohio,
Northeast Indiana or Southeast Michigan areas.
-72-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
9. Mortgage Banking
The unpaid principal balance of residential mortgage loans serviced for third
parties was $433.1 million at December 31, 2003 compared to $324.9 million at
December 31, 2002.
Years ended December 31
2003 2002 2001
---------------------------------------
(In Thousands)
Mortgage servicing assets:
Balance at beginning of period $ 3,442 $ 2,656 $ 1,137
Loans sold, servicing retained 2,593 2,225 1,911
Amortization (1,998) (1,439) (392)
---------------------------------------
Carrying value before valuation 4,037 3,442 2,656
allowance at end of period
Valuation allowance:
Balance at beginning of period (1,352) (835) (6)
Impairment recovery (charges) 746 (517) (829)
---------------------------------------
Balance at end of period (606) (1,352) (835)
---------------------------------------
Net carrying value of MSRs at end of period $ 3,431 $ 2,090 $ 1,821
=======================================
Fair value of MSRs at end of period $ 3,573 $ 2,116 $ 1,821
=======================================
The Company's servicing portfolio is comprised of the following:
December 31
2003 2002
---------------------------- ----------------------------
Number of Principal Number of Principal
Loans Outstanding Loans Outstanding
------------------------------------------------------------
(Dollars in Thousands)
Fannie Mae 682 $ 43,247 1,432 $ 106,070
Freddie Mac 4,705 389,886 2,864 218,854
------------------------------------------------------------
Totals 5,387 $ 433,133 4,296 $ 324,924
============================================================
Significant assumptions at December 31, 2003 used in determining the value of
MSRs include a weighted average prepayment rate of 302 PSA and a weighted
average discount rate of 8.75%.
-73-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
9. Mortgage Banking (continued)
A sensitivity analysis of the current fair value to immediate 10% and 20%
adverse changes in those assumptions as of December 31, 2003 is presented below.
These sensitivities are hypothetical. Changes in fair value based on a 10%
variation in assumptions generally cannot be extrapolated because the
relationship of the change in the assumption to the change in fair value may not
be linear. Also, the effect of a variation in a particular assumption on the
fair value of the MSR is calculated independently without changing any other
assumption. In reality, changes in one factor may result in changes in another
(for example, changes in mortgage interest rates, which drive changes in
prepayment rate estimates, could result in changes in the discount rates), which
might magnify or counteract the sensitivities.
10% Adverse 20% Adverse
Change Change
---------------------------
(Dollars in Thousands)
Assumption:
Decline in fair value from increase
in prepayment rate $ 170 $ 326
Declines in fair value from increase
in discount rate 98 190
10. Premises and Equipment
Premises and equipment are summarized as follows:
December 31
2003 2002
----------------------
(In Thousands)
Cost:
Land $ 3,348 $ 3,125
Buildings 18,221 16,640
Leasehold improvements 467 466
Furniture, fixtures and equipment 11,091 9,914
Construction in process 2,625 71
----------------------
35,752 30,216
Less allowances for depreciation and amortization 11,906 10,258
----------------------
$23,846 $19,958
======================
There was $10,000 of interest capitalized in 2003 and $14,000 in 2002.
-74-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
11. Deposits
The following schedule sets forth interest expense by type of savings deposit:
Years ended December 31
2003 2002 2001
-------------------------------------
(In Thousands)
Checking and money market accounts $ 1,466 $ 2,702 $ 3,871
Savings accounts 169 366 569
Certificates of deposit 11,810 13,454 16,491
-------------------------------------
13,445 16,522 20,931
Less interest capitalized 10 14 --
-------------------------------------
Totals $13,435 $16,508 $20,931
=====================================
Interest paid on brokered or national certificates of deposit in the amount of
$799,000 in 2002, and $4.2 million in 2001 were reclassified to discontinued
operations as they were used to fund operations of The Leader.
At December 31, 2003, accrued interest payable amounted to $536,000, which was
comprised of $520,000 and $16,000 for certificates of deposit and checking and
money market accounts respectively.
A summary of deposit balances is as follows:
December 31
2003 2002
-------------------------
(In Thousands)
Savings accounts $ 51,767 $ 39,363
Checking accounts 119,674 85,254
Money market demand accounts 148,691 129,036
Certificates of deposit 408,864 345,920
-------------------------
$728,996 $599,573
=========================
-75-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
11. Deposits (continued)
Scheduled maturities of certificates of deposit are as follows:
December 31,
2003
--------------
(In Thousands)
2004 $ 301,468
2005 67,074
2006 23,651
2007 11,095
2008 4,564
2009 and thereafter 1,012
--------------
Total $ 408,864
==============
At December 31, 2003 and 2002, deposits of $178.8 million and $139.3 million,
respectively, were in excess of the $100,000 Federal Deposit Insurance
Corporation insurance limit. At December 31, 2003 and 2002, $44.6 million and
$22.9 million, respectively, in investment securities were pledged as collateral
against public deposits for certificates in excess of $100,000. In addition,
First Federal has a $7,000,000 depository bond with the State of Ohio, which can
be pledged as collateral against public deposits for certificates in excess of
$100,000.
12. Advances from Federal Home Loan Bank
First Federal has the ability to borrow funds from the FHLB. First Federal
pledges its single-family residential mortgage loan portfolio, certain
investment securities and certain multi-family or non-residential real estate
loans as security for these advances. Advances secured by investment securities
must have collateral to exceed borrowing by 105%. Advances secured by
residential mortgages must have collateral to exceed borrowings by 125%.
Advances secured by multi-family or non-residential real estate loans securities
must have 300% collateral. The total level of borrowing is also limited to 50%
of total assets. Total loans pledged to the FHLB at December 31, 2003 were
$364.0 million. First Federal has a maximum potential to acquire advances of
approximately $196.8 million from the FHLB.
-76-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
12. Advances from Federal Home Loan Bank (continued)
As of December 31, 2003, the FHLB has made a series of advances totaling $120.0
million to First Defiance that have fixed maturity dates but are callable at the
option of the FHLB on a specified date and quarterly thereafter. The terms of
these advances are as follows (in thousands):
Balance Interest Rate Call Date Maturity Date
-------------------------------------------------------------------------
$ 15,000 5.44% 01/26/04 10/23/13
10,000 5.84% 03/01/04 09/01/10
20,000 4.61% 01/20/04 10/21/13
10,000 4.71% 02/07/04 11/07/13
15,000 4.52% 01/10/04 01/10/11
10,000 4.76% 01/10/04 01/10/11
10,000 4.93% 02/02/04 02/02/11
20,000 4.07% 03/08/04 03/08/11
10,000 5.14% 03/08/04 03/08/11
The rates on certain of the above advances were renegotiated with the FHLB
during 2003 in exchange for extending the maturity date.
The FHLB has made advances totaling $17.0 million to First Defiance that have
fixed maturity dates but which are callable after the call date only when
three-month LIBOR rates exceed the agreed upon strike rate in the advance
contract. The terms of these advances are as follows (in thousands):
Interest Maturity
Balance Rate Call Date Date LIBOR "Strike" Rate
-------------------------------------------------------------------------
$ 7,000 3.54% 01/15/04 10/15/12 8.0%
5,000 3.85% 02/02/04 11/06/12 8.0%
5,000 3.48% 02/25/04 02/25/13 7.5%
When called, First Defiance has the option of paying off these advances, or
converting them to variable rate advances priced at the three month LIBOR rate.
-77-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
12. Advances from Federal Home Loan Bank (continued)
First Defiance has an additional $16.5 million outstanding on a series of fixed
rate long-term advances. Of this amount, $1.1 million is a fixed rate advance
under the FHLB Affordable Housing Program in 1995. The total FHLB long-term
advances including all convertible advances bear a weighted average interest
rate of 4.60 % at December 31, 2003.
Future minimum payments by fiscal year are as follows (in thousands):
2004 $ 8,851
2005 8,764
2006 7,809
2007 7,809
2008 17,151
Thereafter 158,501
--------------
Total minimum payments 208,885
Less amounts representing interest 55,363
--------------
Totals $ 153,522
==============
First Defiance also utilizes short-term advances from the FHLB to meet cash flow
needs and for short-term investment purposes. There were $11.0 million in
short-term advances outstanding at December 31, 2003 and $3.0 million at
December 31, 2002. First Defiance borrows short-term advances under a variety of
programs at FHLB. At December 31, 2003, $11.0 million was outstanding under
First Defiance's Cash Management Advance line of credit. The total available
under the Cash Management line is $15.0 million. In addition, First Defiance has
$50.0 million available under a REPO Advance line of credit. Amounts are
generally borrowed under the Cash Management and REPO lines on an overnight
basis. Other advances may be borrowed under the FHLB's short-term fixed or LIBOR
based programs. Information concerning short-term advances is summarized as
follows:
Years ended December 31
2003 2002
-----------------------
(In Thousands, except percentages)
Average balance during the year $ 2,296 $17,118
Maximum month-end balance during the year 14,250 90,500
Average interest rate during the year 1.31% 2.08%
-78-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
13. Notes Payable and Other Short-term Borrowings
Total short term borrowings, revolving and term debt is summarized as follows:
December 31
2003 2002
----------------------
(In Thousands)
Securities sold under agreement to repurchase (rate of 0.85%
at December 31, 2003) $12,267 $ 4,298
Term note payable to bank, secured by business assets, interest
at 7.5% per annum, maturing March 1, 2003 -- 10
----------------------
Total borrowed money $12,267 $ 4,308
======================
First Defiance also has a $10 million revolving line of credit facility with a
financial institution. The facility is unsecured and has an interest rate of fed
funds rate plus 0.45%. There were no amounts outstanding on the line at December
31, 2003 or 2002. The maximum borrowed at any point in time in 2003 under the
line was $7.4 million and the average balance outstanding for the year was
$67,000.
14. Postretirement Benefits
First Defiance sponsors a defined benefit postretirement plan that is intended
to supplement Medicare coverage for certain retirees who meet minimum age
requirements. First Federal employees who retired prior to April 1, 1997 who
completed 20 years of service after age 40 receive full medical coverage at no
cost. Such coverage continues for surviving spouses of those participants for
one year, after which coverage may be continued provided the spouse pays 50% of
the average cost. First Federal employees retiring after April 1, 1997 are
provided medical benefits at a cost based on their combined age and years of
service at retirement. Surviving spouses are also eligible for continued
coverage after the retiree is deceased at a subsidy level that is 10% less than
what the retiree is eligible for. First Federal employees retiring before July
1, 1997 receive dental and vision care in addition to medical coverage. First
Federal employees who retire after July 1, 1997 are not eligible for dental or
vision care, but those retirees and their spouses each receive up to $200
annually in a medical spending account. Funds in that account may be used for
payment of uninsured medical expenses. First Federal employees who were born
after December 31, 1950 are not eligible for the medical coverage described
above at retirement. Rather, a medical spending account of up to $10,000 (based
on the participant's age and years of service) will be established to reimburse
medical expenses for those individuals. First Insurance employees who were born
before December 31, 1950 can continue coverage until they reach age 65, or in
lieu of continuing coverage, can elect the medical spending account option,
subject to eligibility requirements. Employees hired or acquired after January
1, 2003 are eligible only for the medical spending account option.
-79-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. Postretirement Benefits (continued)
The plan is not currently funded. The following table summarizes benefit
obligation and plan asset activity for the plan measured as of December 31 each
year:
December 31
2003 2002
-----------------------
(In Thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $ 1,303 $ 1,047
Service cost 36 31
Interest cost 83 76
Participant contribution 31 26
Plan amendments (269) --
Actuarial losses 485 229
Benefits paid (116) (106)
-----------------------
Benefit obligation at end of year 1,553 1,303
Change in fair value of plan assets:
Balance at beginning of measurement period -- --
Employer contribution 85 80
Participant contribution 31 26
Benefits paid (116) (106)
-----------------------
Balance at end of measurement period -- --
-----------------------
Funded status (1,553) (1,303)
Unrecognized prior service cost (benefit) (222) 52
Unrecognized net loss 804 328
-----------------------
Accrued postretirement benefit obligation
included in accrued interest and other
expenses in consolidated statement of
financial condition $ (971) $ (923)
=======================
-80-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. Postretirement Benefits (continued)
Net periodic postretirement benefit cost includes the following components:
Years ended December 31
2003 2002 2001
----------------------------
(In Thousands)
Service cost-benefits attributable to service
during the period $ 36 $ 31 $ 22
Interest cost on accumulated postretirement
benefit obligation 83 76 45
Net amortization and deferral 14 8 29
----------------------------
Net periodic postretirement benefit cost $133 $115 $ 96
============================
The following assumptions were used in determining the components of the
postretirement benefit obligation:
2003 2002
------------------------
Weighted average discount rates:
Used to determine benefit obligations
at December 31 6.00% 6.50%
Used to determine net periodic postretirement
benefit cost for years ended December 31 6.50% 7.00%
Assumed health care cost trend rates at December 31:
Health care cost trend rate assumed for
next year 8.50% 9.00%
Rate to which the cost trend rate is assumed
to decline (the ultimate trend rate) 4.00% 4.50%
-81-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. Postretirement Benefits (continued)
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage-point change in assumed
health care cost trend rates would have the following effect (in thousands):
One- One-
Percentage- Percentage-
Point Point
Increase Decrease
-------------------------------
Effect on total of service and interest cost $ 21 $ (17)
Effect on postretirement benefit obligation 207 (173)
Prescription drug coverage was recently added to Medicare under the Medicare
Prescription Drug Improvement and Modernization Act of 2003 (the Act). As a
result, the accumulated postretirement benefit obligation (APBO) at the end of
2003 reflects a reduction of approximately 15%. The net postretirement benefit
cost for 2003 was not affected since the legislation was signed on December 8,
2003 and was not in effect for most of the year. The decrease in the gross
liability for active participants is attributed to past and future years of
employment and decreases the APBO and service cost. The decrease in APBO will
not be immediately recognized; instead such change will be treated as being due
to a plan amendment and amortized starting in 2004. Net per capita claims cost
and the costs borne by retirees have been assumed to decrease in 2006 due to
this legislation but no other assumptions were affected. The Company has assumed
that it will opt for coverage under Medicare Part D rather than the Federal
subsidy approach. As specific authoritative guidance for matters related to the
Act are pending, guidance when issued, could require First Defiance to change
previously reported information.
-82-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
15. Regulatory Matters
First Defiance and First Federal are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the consolidated financial statements. Under capital
guidelines and the regulatory framework for prompt corrective action, First
Federal must meet specific capital guidelines that involve quantitative measures
of First Federal's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. First Federal's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require First Federal to maintain minimum amounts and ratios of Tier I and total
capital to risk-weighted assets and of Tier I capital to average assets. As of
December 31, 2003 and 2002, First Federal meets all capital adequacy
requirements to which it is subject.
The most recent notification from the Office of Thrift Supervision (OTS)
categorized First Federal as well capitalized under the regulatory framework.
The following schedule presents First Federal's regulatory capital ratios:
Required for Capital Required to be
Actual Adequacy Purposes Well Capitalized
---------------------- ----------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
----------------------------------------------------------------------------------
As of December 31, 2003:
Tangible Capital $ 94,144 9.30% $ 15,181 1.50% N/A N/A
Tier 1 (Core) Capital 94,144 9.30% 40,483 4.00% $ 50,603 5.00%
Tier 1 Capital to
risk-weighted assets 94,144 12.41% 30,340 4.00% 45,510 6.00%
Risk-Based Capital 102,976 13.58% 60,680 8.00% 75,850 10.00%
As of December 31, 2002:
Tangible Capital $ 102,880 11.84% $ 13,033 1.5% N/A N/A
Tier 1 (Core) Capital 102,880 11.84% 34,755 4.0% $ 13,033 5.00%
Tier 1 Capital to
risk-weighted assets 102,880 17.15% 24,000 4.0% 36,000 6.00%
Risk-Based Capital 110,349 18.39% 48,000 8.0% 60,000 10.00%
-83-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
16. Income Taxes
The components of income tax expense for continuing operations (credit) are as
follows:
Years ended December 31
2003 2002 2001
---------------------------------------
(In Thousands)
Current:
Federal $ 4,783 $ 3,399 $ 2,164
State and local 33 24 3
Deferred (credit) 874 (437) 256
---------------------------------------
$ 5,690 $ 2,986 $ 2,423
=======================================
The provision for income taxes differs from that computed at the statutory
corporate tax rate as follows:
Years ended December 31
2003 2002 2001
---------------------------------------
(In Thousands)
Tax expense at statutory rate $ 6,220 $ 3,292 $ 2,572
Increases (decreases) in taxes from:
Goodwill amortization and impairment -- 70 55
State income tax--net of federal tax benefit 21 15 2
Tax exempt interest income (517) (487) (183)
Bank owned life insurance (283) (50) --
Other 249 146 (23)
---------------------------------------
Totals $ 5,690 $ 2,986 $ 2,423
=======================================
Deferred federal income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
-84-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
16. Income Taxes (continued)
Significant components of First Defiance's deferred federal income tax assets
and liabilities are as follows:
December 31
2003 2002
-----------------------
(In Thousands)
Deferred federal income tax assets:
Allowance for loan losses $ 3,082 $ 2,532
Postretirement benefit costs 340 317
Deferred compensation and management
recognition plans 310 296
State income tax 9 6
Accrued disposition costs 125 490
Mortgage servicing right -- 156
Other 190 145
-----------------------
Total deferred federal income tax assets 4,056 3,942
Deferred federal income tax liabilities:
Net unrealized gains on available-for-sale securities 2,163 3,477
FHLB stock dividends 2,303 2,061
Deferred loan origination fees and costs (net) 23 221
Fixed assets 724 473
Mortgage servicing rights 421 --
Goodwill 281 9
-----------------------
Total deferred federal income tax liabilities 5,915 6,241
-----------------------
Net deferred federal income tax liability $(1,859) $(2,299)
=======================
The realization of the Company's deferred tax assets is dependent upon the
Company's ability to generate taxable income in future periods and the reversal
of deferred tax liabilities during the same period. The Company has evaluated
the available evidence supporting the realization of its deferred tax assets and
determined it is more likely than not that the assets will be realized and thus
no valuation allowance was required at December 31, 2003.
-85-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
16. Income Taxes (continued)
Retained earnings at December 31, 2003 include financial statement tax bad debt
reserves of $9.52 million for which no tax has been provided. The reserves do
not have to be recaptured for tax purposes unless retained earnings of First
Federal fall below $9.52 million.
17. Employee Benefit Plans
Employees of First Defiance are eligible to participate in the First Defiance
Financial Corp. 401(k) Employee Savings Plan (First Defiance 401(k)) if they
meet certain age and service requirements. Under the First Defiance 401(k),
First Defiance matches 50% of the participants' contributions, to a maximum of
3% of compensation. The First Defiance 401(k) also provides for a discretionary
First Defiance contribution in addition to the First Defiance matching
contribution. For the year ended December 31, 2003, First Defiance's matching
contribution was $258,000 and there was no discretionary company contribution.
For the year ended December 31, 2002, First Defiance's matching contribution
included in continuing operations was $213,000 and there was no discretionary
company contribution. For the year ended December 31, 2001, First Defiance's
matching contribution included in continuing operations was $188,000 and the
discretionary contribution was $162,000.
First Defiance also has established an Employee Stock Ownership Plan (ESOP)
covering all employees of First Defiance age 21 or older who have at least one
year of credited service. Contributions to the ESOP are made by First Defiance
and are determined by First Defiance's Board of Directors at their discretion.
The contributions may be made in the form of cash or First Defiance common
stock. The annual contributions may not be greater than the amount deductible
for federal income tax purposes and cannot cause First Federal to violate
regulatory capital requirements.
To fund the plan, the ESOP borrowed funds from First Defiance for the purpose of
purchasing shares of First Defiance common stock. The ESOP acquired a total of
863,596 shares in 1993 and 1995. The loan outstanding at December 31, 2003 was
$2,756,000. Principal and interest payments on the loan are due in equal
quarterly installments through June of 2008. The loan is collateralized by the
shares of First Defiance's common stock and is repaid by the ESOP with funds
from the Company's contributions to the ESOP, dividends on unallocated shares
and earnings on ESOP assets.
-86-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
17. Employee Benefit Plans (continued)
As principal and interest payments on the loan are paid, shares are released
from collateral and committed for allocation to active employees, based on the
proportion of debt service paid in the year. Shares held by the ESOP which have
not been released for allocation are reported as stock acquired by the ESOP plan
in the statement of financial condition. As shares are released, First Defiance
records compensation expense equal to the average fair value of the shares over
the period in which the shares were earned. Also, the shares released for
allocation are included in the average shares outstanding for earnings per share
computations. Dividends on allocated shares are recorded as a reduction of
retained earnings and dividends on unallocated shares are recorded as additional
ESOP expense. ESOP compensation expense was $802,000, $691,000 and $523,000 for
2003, 2002 and 2001, respectively. As of December 31, 2003, 645,804 ESOP shares
have been released for allocation of which 633,607 were allocated to
participants. The 217,792 unreleased shares have a fair value of $5.6 million at
December 31, 2003. A total of $391,000 and $343,000 of dividends in 2003 and
2002, respectively, were used for debt service.
Employees of The Leader participated in the ESOP. Upon the closing of the sale
of The Leader, all account balances of employees of The Leader vested and these
benefits were distributed to the former Leader participants based on their
benefit election. A total of 47,946 shares were allocated to these employees.
The shareholders of First Defiance approved and established Management
Recognition Plans (MRP) in 1993 and 1996 to provide directors, officers and
employees with a proprietary interest in First Defiance as incentive to
contribute to its success. Cash was contributed to the MRP in the form of
deferred compensation amounting to $800,000 in 1993 and $2,817,452 in 1996. The
$800,000 contributed in 1993 was used to purchase 172,722 shares of First
Defiance common stock. All shares acquired in 1993 were granted on July 19,
1993. A total of 258,921 of the shares acquired in 1996 have been granted as of
December 31, 2003, not including 47,032 shares forfeited by participants who
terminated before their shares vested. The shares vest at a rate of 20% per year
over five years. First Defiance is amortizing the deferred compensation and
recording additions to stockholder's equity as the shares vest. Compensation
expense attributable to the MRP amounted to $20,000, $52,000 and $121,000 in
2003, 2002 and 2001, respectively.
-87-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
18. Stock Option Plans
First Defiance has established incentive stock option plans for its directors
and its employees and has reserved 1,376,485 shares of common stock for issuance
under the plans. A total of 1,116,204 shares are reserved for employees and
260,281 shares are reserved for directors. As of December 31, 2003, 726,733
options (674,501 for employees and 52,232 for directors) have been granted and
remain outstanding at option prices based on the market value of the underlying
shares on the date the options were granted. There are 91,436 options granted
under the 1993 plan that are currently exercisable, 424,547 options granted
under the 1996 plan that vest at 20% per year beginning in 1997 of which 400,691
are fully vested and currently exercisable and 210,750 options granted under the
2001 plan which vest at 20% per year beginning in 2002, of which 62,300 are
fully vested and currently exercisable. All options expire ten years from date
of grant. Vested options of retirees expire on the earlier of the scheduled
expiration date or five years after the retirement date for the 1993 and 2001
plans and on the earlier of the scheduled expiration date or twelve months after
the retirement date for the 1996 plan.
FASB Statement No. 123, Accounting for Stock-Based Compensation defines a fair
value-based method of accounting for stock-based employee compensation plans.
Under the fair value-based method, compensation cost is measured at the grant
date based upon the value of the award and is recognized over the service
period. While the standard encourages entities to adopt this method of
accounting for employee stock compensation plans, it also allows an entity to
continue to measure compensation costs for its plans as prescribed in APB
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. First
Defiance has elected to continue to apply APB 25.
The pro forma results of operations included in Note 2 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 assumptions outlined in Note 2.
-88-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
18. Stock Option Plans (continued)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
First Defiance's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The following table summarizes stock option activity for 2003, 2002 and 2001:
Weighted
Option Average
Outstanding Option Prices
--------------------------------
Outstanding at January 1, 2001 787,888 $ 10.83
Granted 234,600 13.99
Exercised (41,106) 6.48
Expired or canceled (5,600) 12.24
-------------------------------
Balance at December 31, 2001 975,782 11.76
Granted 9,000 18.50
Exercised or cashed out (172,873) 10.31
Expired or canceled (4,589) 17.15
-------------------------------
Balance at December 31, 2002 807,320 12.12
Granted 57,000 20.47
Exercised (136,537) 10.95
Expired or canceled (1,050) 15.32
-------------------------------
Balance at December 31, 2003 726,733 $ 12.99
===============================
As of December 31, 2003 and 2002, 68,003 and 123,953 shares, respectively, were
available for grant under the Company's stock option plans. Upon the sale of The
Leader in 2002, certain option holders were paid cash for the value of their
vested options in lieu of issuing shares. These 65,000 options are not available
for future grants.
-89-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
18. Stock Option Plans (continued)
Information about stock options outstanding is as follows:
Weighted
Average
Weighted Remaining Weighted
Average Contractual Average
Range of Exercise Life Exercise
Exercise Prices Outstanding Price (in years) Exercisable Price
---------------------------------------------------------------------------------------------------
$8.25 - $12.99 339,553 $ 10.59 2.60 331,397 $ 10.58
$13.00 - $17.99 324,430 14.09 5.91 221,830 14.13
$18.00 - $22.99 55,250 19.43 9.18 1,200 18.50
$23.00 - $27.70 7,500 26.62 9.79 -- --
---------------------------------------------------------------------------
Total 726,733 $ 12.99 4.65 554,427 $ 12.02
===========================================================================
19. Parent Company and Regulatory Restrictions
Dividends paid by First Federal to First Defiance are subject to various legal
and regulatory restrictions. Because First Federal paid $40.0 million in
dividends to First Defiance in 2002 and 2003, it can initiate dividend payments
in 2004 only equal to or less than the 2004 net profits, as defined by statutes,
without prior regulatory approval. First Federal can apply to the OTS to pay a
dividend in excess of 2004 net profits.
-90-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
19. Parent Company and Regulatory Restrictions (continued)
Condensed parent company financial statements, which include transactions with
subsidiaries, follow:
December 31
Statements of Financial Condition 2003 2002
------------------------
(In Thousands)
Assets
Cash and cash equivalents $ 2,066 $ 2,899
Investment securities, available for
sale, carried at fair value 1,078 1,060
Investment in subsidiaries 119,318 113,358
Loan receivable from First Defiance
Employee Stock Ownership Plan 2,817 3,281
Other assets 10 8
------------------------
Total assets $125,289 $120,606
========================
Liabilities and stockholders' equity:
Accrued liabilities $ 1,020 $ 496
Stockholders' equity 124,269 120,110
------------------------
Total liabilities and stockholders' equity $125,289 $120,606
========================
Years ended December 31
Statements of Income 2003 2002 2001
------------------------------------------
(In Thousands)
Interest on loan to ESOP $ 257 $ 295 $ 330
Interest expense on notes payable (4) (164) (953)
Other income 42 7 2
Noninterest expense (568) (593) (638)
------------------------------------------
Loss before income taxes and equity in earnings of
subsidiaries (273) (455) (1,259)
Income tax (credit) (75) (138) (440)
------------------------------------------
Loss before equity in earnings of subsidiaries (198) (317) (819)
Equity in earnings of subsidiaries 12,280 15,396 14,435
------------------------------------------
Net income $ 12,082 $ 15,079 $ 13,616
==========================================
-91-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
19. Parent Company and Regulatory Restrictions (continued)
Years ended December 31
Statements of Cash Flows 2003 2002 2001
------------------------------------------
(In Thousands)
Operating activities:
Net income $ 12,082 $ 15,079 $ 13,616
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in earnings of subsidiaries (12,280) (15,396) (14,435)
Dividends received from subsidiary 5,000 35,000 --
Change in other assets and liabilities 515 (362) (136)
------------------------------------------
Net cash provided by (used in) operating activities 5,317 34,321 (955)
Investing activities:
Purchase First Insurance and Investment -- (200) --
Principal payments received on ESOP loan 464 425 302
Purchase of available-for-sale securities -- (1,000) --
------------------------------------------
Net cash provided by (used in) investing activities 464 (775) 302
Financing activities:
Net increase (decrease) in short-term line of credit -- (18,250) 3,250
Stock options exercised 1,731 1,171 360
Purchase of common stock for treasury (4,406) (10,275) (748)
Cash dividends paid (3,939) (3,449) (3,109)
------------------------------------------
Net cash used in financing activities (6,614) (30,803) (247)
------------------------------------------
Net (decrease) increase in cash and cash equivalents (833) 2,743 (900)
Cash and cash equivalents at beginning of year 2,899 156 1,056
------------------------------------------
Cash and cash equivalents at end of year $ 2,066 $ 2,899 $ 156
==========================================
Non cash operating activities--change in deferred
taxes on net unrealized (losses) gains on
available-for-sale securities $ 6 $ 7 $ 6
==========================================
Non cash investing activities--change in net unrealized
gain (loss) on available-for-sale securities $ 18 $ (27) $ (19)
==========================================
Non cash financing activities--cash dividends
declared but not paid $ 1,220 $ 920 $ 848
==========================================
-92-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
20. Fair Value Statement of Consolidated Financial Condition
The following is a comparative condensed consolidated statement of financial
condition based on carrying and estimated fair values of financial instruments
as of December 31, 2003 and 2002. FASB Statement No. 107, Disclosures about Fair
Value of Financial Instruments excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
First Defiance Financial Corp.
Much of the information used to arrive at "fair value" is highly subjective and
judgmental in nature and therefore the results may not be precise. Subjective
factors include, among other things, estimated cash flows, risk characteristics
and interest rates, all of which are subject to change. With the exception of
investment securities, the Company's financial instruments are not readily
marketable and market prices do not exist. Since negotiated prices for the
instruments, which are not readily marketable depend greatly on the motivation
of the buyer and seller, the amounts that will actually be realized or paid per
settlement or maturity of these instruments could be significantly different.
The carrying amount of cash and cash equivalents, warehouse and term notes
payable and advance payments by borrowers for taxes and insurance, as a result
of their short-term nature, is considered to be equal to fair value.
For investment securities, fair value has been based or current market
quotations. If market prices are not available, fair value has been estimated
based upon the quoted price of similar instruments.
The fair value of loans which reprice within 90 days is equal to their carrying
amount. For other loans, the estimated fair value is calculated based on
discounted cash flow analysis, using interest rates currently being offered for
loans with similar terms. The fair value of loans have not been adjusted for
credit risk.
SFAS No. 107 requires that the fair value of demand, savings, NOW and certain
money market accounts be equal to their carrying amount. The Company believes
that the fair value of these deposits is greater than that prescribed by SFAS
No. 107.
For deposits with fixed maturities, fair value is estimated based on interest
rates currently being offered on deposits with similar characteristics and
maturities.
-93-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
20. Fair Value Statement of Consolidated Financial Condition (continued)
FHLB advances with maturities greater than 90 days are valued based on
discounted cash flow analysis, using interest rates currently being quoted for
similar characteristics and maturities.
The cost or value of any call or put options are based on the estimated cost to
settle the option at December 31, 2003.
December 31, 2003 December 31, 2002
------------------------------- -------------------------------
Carrying Estimated Carrying Estimated
Value Fair Values Value Fair Values
----------------------------------------------------------------------
(In Thousands)
Assets:
Cash and cash equivalents $ 37,783 $ 37,783 $ 28,658 $ 28,658
Investment securities 171,035 171,197 213,525 213,733
Loans, net 741,126 756,373 576,377 588,858
----------------------------------------------------------------------
949,944 $ 965,353 818,560 $ 831,249
============= =============
Other assets 90,655 65,685
------------- -------------
Total assets $ 1,040,599 $ 884,245
============= =============
Liabilities and stockholders' equity:
Deposits $ 729,996 $ 734,488 $ 599,573 $ 603,775
Advances from Federal Home
Loan Bank 164,522 176,304 149,096 157,165
Short term borrowings and other interest
bearing liabilities 12,267 12,267 4,308 4,308
Advance payments by borrowers
for taxes and insurance 231 231 316 316
----------------------------------------------------------------------
907,016 $ 923,290 753,293 $ 765,564
============= =============
Other liabilities 9,314 10,842
------------- -------------
Total liabilities 916,330 764,135
Stockholders' equity 124,269 120,110
------------- -------------
Total liabilities and
stockholders' equity $ 1,040,599 $ 884,245
============= =============
-94-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
21. Change in Accounting Method
On January 1, 2002, First Defiance adopted SFAS 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 a cumulative effect of an accounting change in the 2002 statement
of income.
Results from continuing operations for December 31, 2001 include goodwill
amortization expense of $314,000. Had FAS No. 142 been in effect for those
periods, the Company would have reported income from continuing operations of
$5.1 million for 2001. This amount was determined as follows:
2003 2002 2001
---------------------------------------------
(In Thousands, except for per
share amounts)
Reported income from continuing operations $ 12,082 $ 6,420 $ 4,798
Add back goodwill amortization -- -- 314
Deduct tax benefit from deductible goodwill -- -- (55)
---------------------------------------------
Adjusted income from continuing operations $ 12,082 $ 6,420 $ 5,057
=============================================
Basic earnings per share:
Reported income from continuing operations $ 2.00 $ 1.01 $ 0.74
Add back goodwill amortization -- -- 0.05
Deduct tax benefit from deductible goodwill -- -- (0.01)
---------------------------------------------
Adjusted income from continuing operations $ 2.00 $ 1.01 $ 0.78
=============================================
Diluted earnings per share:
Reported income from continuing operations $ 1.91 $ 0.97 $ 0.72
Add back goodwill amortization -- -- 0.05
Deduct tax benefit from deductible goodwill -- -- (0.01)
---------------------------------------------
Adjusted income from continuing operations $ 1.91 $ 0.97 $ 0.76
=============================================
-95-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
22. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly consolidated results of operations,
which reflects the classification of The Leader as a discontinued operation:
Three Months ended
------------------------------------------------------
March 31 June 30 September 30 December 31
-------------------------------------------------------
(In Thousands, except per share amounts)
2003
Interest income $11,791 $12,162 $13,028 $12,955
Interest expense 5,357 5,320 5,198 4,980
----------------------------------------------------
Net interest income 6,434 6,842 7,830 7,975
Provision for loan losses 335 353 497 534
----------------------------------------------------
Net interest income after provision for 6,099 6,489 7,333 7,441
loan losses
Gain on sale of securities 631 288 -- 656
Non-interest income 4,160 5,049 4,825 3,179
Non-interest expense 7,015 7,701 6,776 6,886
----------------------------------------------------
Income before income taxes 3,875 4,125 5,382 4,390
Income taxes 1,157 1,246 1,715 1,572
----------------------------------------------------
Net income $ 2,718 $ 2,879 $ 3,667 $ 2,818
====================================================
Earnings per share:
Basic $ 0.45 $ 0.48 $ 0.61 $ 0.47
Diluted $ 0.43 $ 0.46 $ 0.58 $ 0.44
Average shares outstanding:
Basic 6,074 6,013 6,002 6,038
Diluted 6,330 6,254 6,293 6,380
-96-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
22. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three Months ended
----------------------------------------------------------
March 31 June 30 September 30 December 31
----------------------------------------------------------
(In Thousands, except per share amounts)
2002
Interest income $ 9,729 $ 11,914 $ 12,201 $ 12,297
Interest expense 4,201 6,189 5,952 5,701
---------------------------------------------------------
Net interest income 5,528 5,725 6,249 6,596
Provision for loan losses 582 156 386 328
---------------------------------------------------------
Net interest income after provision for 4,946 5,569 5,863 6,268
loan losses
Gain (loss) on sale of securities (15) -- 36 --
Non-interest income 2,440 2,737 3,235 4,518
Non-interest expense 5,993 6,313 7,184 6,702
---------------------------------------------------------
Income before income taxes 1,378 1,993 1,950 4,084
Income taxes 491 607 568 1,319
---------------------------------------------------------
Income from continuing 887 1,386 1,382 2,765
operations
Discontinued operations,
net of tax 2,015 7,332 -- (494)
---------------------------------------------------------
Income before cumulative 2,902 8,718 1,382 2,271
effect of change in
accounting principal
Cumulative effect of change
in accounting for goodwill (194) -- -- --
---------------------------------------------------------
Net income $ 2,708 $ 8,718 $ 1,382 $ 2,271
=========================================================
-97-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
22. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three Months ended
-------------------------------------------------------------
March 31 June 30 September 30 December 31
-------------------------------------------------------------
2002 (In Thousands, except per share amounts)
Earnings per share:
Basic:
From continuing operations $ 0.14 $ 0.22 $ 0.22 $ 0.45
Discontinued operations,
net of tax 0.31 1.14 -- (0.08)
Cumulative effect of change in
method of accounting for goodwill (0.03) -- -- --
-------------------------------------------------------------
Net income $ 0.42 $ 1.36 $ 0.22 $ 0.37
=============================================================
Diluted:
From continuing operations $ 0.14 $ 0.21 $ 0.21 $ 0.43
Discontinued operations,
net of tax 0.30 1.09 -- (0.08)
Cumulative effect of change in
method of accounting for goodwill (0.03) -- -- --
-------------------------------------------------------------
Net income $ 0.41 $ 1.30 $ 0.21 $ 0.35
=============================================================
Average shares outstanding:
Basic 6,442 6,418 6,400 6,216
Diluted 6,663 6,689 6,652 6,471
-98-
Report of Independent Auditors
The Board of Directors
First Defiance Financial Corp.
We have audited the accompanying consolidated statements of financial condition
of First Defiance Financial Corp. and subsidiaries as of December 31, 2003 and
2002, and the related consolidated statements of income, changes in
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Defiance
Financial Corp. and subsidiaries at December 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States.
As discussed in Note 21 to the consolidated financial statements, in 2002 the
Company changed its method of accounting for goodwill.
/s/ Ernst & Young LLP
Cleveland, Ohio
March 8, 2004
-99-
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not Applicable
Item 9a. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed
to ensure that information required to be disclosed in the Company's Exchange
Act reports is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to the Registrant's management, including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure based closely on the definition of
"disclosure controls and procedures" in Exchange Act Rules 13a-15(e) and
15d-15(e). In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
As of the end of the period covered by this report, the Registrant carried
out an evaluation, under the supervision and with the participation of the
Registrant's management, including the Registrant's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Registrant's disclosure controls and procedures. Based on the foregoing, the
Registrant's Chief Executive Officer and Chief Financial Officer concluded that
the Registrant's disclosure controls and procedures were effective, in all
material respects, to ensure that information required to be disclosed in the
reports the Registrant files and submits under the Exchange Act is recorded,
processed, summarized and reported as and when required.
The Registrant also conducted an evaluation of internal control over
financial reporting to determine whether any changes occurred during the quarter
ended December 31, 2003, that have materially affected, or are reasonably likely
to materially affect, the Registrant's internal control over financial
reporting. Based on this evaluation, there has been no such change during the
quarter that ended December 31, 2003.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference from pages 6
through 12 of the definitive proxy statement dated March 15, 2004.
- 100 -
Item 11. Executive Compensation
The information required herein is incorporated by reference from the
Directors' Compensation section on page 12, the Executive Compensation section
on page 13, the Report of the Compensation Committee on page 14, the Stock
Options section on page 15, the Employment Agreements section on page 16, and
the Performance Graph on page 17 of the definitive proxy statement dated March
15, 2004.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required herein is incorporated by reference from the
Beneficial Ownership section beginning on page 3 of the definitive proxy
statement dated March 15, 2004.
First Defiance maintains the 1993 Stock Incentive Plan, the 1993
Directors' Stock Option plan, the 1996 Stock Option Plan, the 2001 Stock Option
and Incentive Plan (collectively, the "Plans") and the 1996 Management
Recognition Plan and Trust ("MRP") under which it may issue equity securities to
its directors, officers and employees in exchange for goods and services. All of
the Plans and the MRP were approved by the shareholders of First Defiance.
The following table shows, as of December 31, 2003, the number of common
shares issuable upon the exercise of outstanding stock options, the weighted
average exercise price of those stock options, and the number of common shares
remaining for future issuance under the Plans and the MRP, excluding shares
issuable upon exercise of outstanding stock options.
Equity Compensation Plan Information
- ------------------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities to be Weighted-average future issuance under equity
issued upon exercise price of compensation plans
exercise of outstanding outstanding options, (excluding securities
Plan Category options, warrants and rights warrants and rights reflected in column (a))
- ------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------
1993 Stock Incentive Plan 91,436 $11.83 -0-
1996 Stock Option Plan 424,547 $13.72 676
2001 Stock Option and
Incentive Plan 210,750 $15.43 66,550
1996 Management
Recognition Plan and Trust N/A N/A 155
- 101 -
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from the
Indebtedness of Management section on page 18 of the definitive proxy statement
dated March 15, 2004.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference
under the caption "INDEPENDENT PUBLIC ACCOUNTANTS" on page 18 of the definitive
proxy statement dated March 15, 2004.
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
The following consolidated financial statements are filed as a part
of this document under "Item 8. Financial Statements and
Supplementary Data."
Consolidated Statements of Financial Condition as of December 31,
2003 and 2002
Consolidated Statements of Income for the years ended December 31,
2003, 2002 and 2001
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December
31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
Independent Auditor's Report
(a) (2) Financial Statement Schedules
All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are included in the
Notes to Consolidated Financial Statements incorporated herein by
reference and therefore have been omitted.
- 102 -
(a) (3) Exhibits
The following exhibits are either filed as a part of this report or
are incorporated herein by reference to documents previously filed
as indicated below:
Exhibit
Number Description
- ------------------------------------------------------------------------------------------------------
3.1 Articles of Incorporation (1)
3.2 Code of Regulations (1)
3.2 Bylaws (1)
10.1 1996 Stock Option Plan (2)
10.2 1996 Management Recognition Plan and Trust (2)
10.3 2001 Stock Option and Incentive Plan (3)
10.4 1993 Stock Incentive Plan (1)
10.5 1993 Directors' Stock Option Plan (1)
10.6 Employment Agreement with William J. Small (4)
10.7 Employment Agreement with James L. Rohrs (2)
10.8 Employment Agreement with John C. Wahl (2)
10.9 Employment Agreement with Gregory R. Allen (5)
13 Annual Report to Shareholders and Notice of Annual
Meeting of Shareholders and Proxy Statement (6)
14 Code of Ethics (6)
21 List of Subsidiaries of the Company (6)
23 Consent of Ernst & Young LLP, Independent Auditors (6)
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the (6)
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the (6)
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the (6)
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the (6)
Sarbanes-Oxley Act of 2002
(1) Incorporated herein by reference to the like numbered exhibit in the
Registrant's Form S-1 (File No. 33-93354).
(2) Incorporated herein by reference to like numbered exhibit in Registrant's
2001 Form 10-K
(3) Incorporated herein by reference to Appendix B to the 2001 Proxy Statement
(4) Incorporated herein by reference to like numbered exhibit in Registrant's
2000 Form 10-K
(5) Incorporated herein by reference to like numbered exhibit in Registrant's
2002 Form 10-K
(6) Included herein
- 103 -
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on January 21, 2004 which included a
copy of the Company's earnings release for the year ended December 31,
2003.
- 104 -
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST DEFIANCE FINANCIAL CORP.
March 15, 2004 By: /s/ John C. Wahl
--------------------------------------------
John C. Wahl, Exec.V.P, Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 15, 2004.
Signature Title
- ------------------------------- ------------------------------------
/s/ William J. Small Chairman of the Board, President and
- ------------------------------- Chief Executive Officer
William J. Small
/s/ John C. Wahl Executive Vice President and
- ------------------------------- Chief Financial Officer
John C. Wahl
/s/ James L. Rohrs Director, Executive Vice President
- -------------------------------
James L. Rohrs
/s/ Don C. Van Brackel Director, Vice Chairman
- -------------------------------
Don C. Van Brackel
/s/ Stephen L. Boomer Director
- -------------------------------
Stephen L. Boomer
/s/ Dr. Douglas A. Burgei Director
- -------------------------------
Dr. Douglas A. Burgei
/s/ Peter A. Diehl Director
- -------------------------------
Peter A. Diehl
/s/ Dr. John U. Fauster, III Director
- -------------------------------
Dr. John U. Fauster, III
/s/ Gerald W. Monnin Director
- -------------------------------
Gerald W. Monnin
/s/ Thomas A. Voigt Director
- -------------------------------
Thomas A. Voigt
- 105 -