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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period Ended September 30, 2009 |
OR
¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from to |
Commission file number 0-26850
First Defiance Financial Corp.
(Exact name of registrant as specified in its charter)
Ohio | 34-1803915 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
601 Clinton Street, Defiance, Ohio | 43512 | |
(Address or principal executive office) | (Zip Code) |
Registrant’s telephone number, including area code: (419) 782-5015
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by 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 whether the registrant submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer x | |
Non-accelerated filer ¨ | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value – 8,117,520 shares outstanding at November 9, 2009.
Table of Contents
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number | ||||
PART I.-FINANCIAL INFORMATION | ||||
Item 1. | ||||
Consolidated Condensed Statements of Financial Condition – September 30, 2009 and December 31, 2008 | 2 | |||
4 | ||||
5 | ||||
Consolidated Condensed Statements of Cash Flows - Nine months ended September 30, 2009 and 2008 | 6 | |||
7 | ||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 38 | ||
Item 3. | 62 | |||
Item 4. | 62 | |||
PART II-OTHER INFORMATION: | ||||
Item 1. | 63 | |||
Item 1A. | 63 | |||
Item 2. | 68 | |||
Item 3. | 68 | |||
Item 4. | 69 | |||
Item 5. | 69 | |||
Item 6. | 69 | |||
70 |
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PART 1-FINANCIAL INFORMATION
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except share and per share data)
September 30, 2009 | December 31, 2008 | |||||
Assets | ||||||
Cash and cash equivalents: | ||||||
Cash and amounts due from depository institutions | $ | 30,207 | $ | 40,980 | ||
Interest-bearing deposits | 47,109 | 5,172 | ||||
77,316 | 46,152 | |||||
Securities: | ||||||
Available-for-sale, carried at fair value | 126,985 | 117,575 | ||||
Held-to-maturity, carried at amortized cost (fair value $1,729 and $917 at September 30, 2009 and December 31, 2008, respectively) | 1,697 | 886 | ||||
128,682 | 118,461 | |||||
Loans held for sale | 24,340 | 10,960 | ||||
Loans receivable, net of allowance of $31,248 at September 30, 2009 and $24,592 at December 31, 2008, respectively | 1,592,379 | 1,592,643 | ||||
Accrued interest receivable | 8,110 | 7,293 | ||||
Federal Home Loan Bank stock | 21,376 | 21,376 | ||||
Bank owned life insurance | 30,585 | 28,747 | ||||
Premises and equipment | 46,372 | 47,756 | ||||
Real estate and other assets held for sale | 9,352 | 7,000 | ||||
Goodwill | 56,585 | 56,585 | ||||
Core deposit and other intangibles | 7,242 | 8,344 | ||||
Mortgage servicing rights | 8,350 | 6,611 | ||||
Deferred taxes | 1,305 | 336 | ||||
Other assets | 6,604 | 5,136 | ||||
Total assets | $ | 2,018,598 | $ | 1,957,400 | ||
(continued)
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FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except share and per share data)
September 30, 2009 | December 31, 2008 | |||||||
Liabilities and stockholders’ equity | ||||||||
Liabilities: | ||||||||
Deposits | $ | 1,543,085 | $ | 1,469,912 | ||||
Advances from the Federal Home Loan Bank | 146,937 | 156,067 | ||||||
Securities sold under repurchase agreements | 43,280 | 49,454 | ||||||
Subordinated debentures | 36,083 | 36,083 | ||||||
Advance payments by borrowers | 492 | 652 | ||||||
Other liabilities | 14,192 | 16,073 | ||||||
Total liabilities | 1,784,069 | 1,728,241 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $.01 par value per share: 37,000 shares authorized and issued with a liquidation preference of $37,000,000, net of discount | 36,252 | 36,133 | ||||||
Preferred stock, $.01 par value per share: | ||||||||
4,963,000 shares authorized; no shares issued | — | — | ||||||
Common stock, $.01 par value per share: | ||||||||
25,000,000 shares authorized; 12,739,496 and 12,739,496 shares issued and 8,117,520 and 8,117,120 shares outstanding, respectively | 127 | 127 | ||||||
Common stock warrant | 878 | 878 | ||||||
Additional paid-in capital | 140,622 | 140,449 | ||||||
Accumulated other comprehensive income (loss), net of tax of $240 and ($1,025), respectively | 446 | (1,904 | ) | |||||
Retained earnings | 128,835 | 126,114 | ||||||
Treasury stock, at cost, 4,621,976 and 4,622,376 shares respectively | (72,631 | ) | (72,638 | ) | ||||
Total stockholders’ equity | 234,529 | 229,159 | ||||||
Total liabilities and stockholders’ equity | $ | 2,018,598 | $ | 1,957,400 | ||||
See accompanying notes
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FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Interest Income | ||||||||||||||||
Loans | $ | 23,766 | $ | 24,902 | $ | 70,229 | $ | 72,220 | ||||||||
Investment securities: | ||||||||||||||||
Taxable | 949 | 1,078 | 3,028 | 3,365 | ||||||||||||
Non-taxable | 473 | 357 | 1,360 | 1,017 | ||||||||||||
Interest-bearing deposits | 41 | 5 | 89 | 119 | ||||||||||||
FHLB stock dividends | 258 | 301 | 726 | 797 | ||||||||||||
Total interest income | 25,487 | 26,643 | 75,432 | 77,518 | ||||||||||||
Interest Expense | ||||||||||||||||
Deposits | 6,163 | 7,658 | 20,206 | 23,851 | ||||||||||||
FHLB advances and other | 1,267 | 1,603 | 3,865 | 4,803 | ||||||||||||
Subordinated debentures | 344 | 461 | 1,139 | 1,445 | ||||||||||||
Notes payable | 140 | 555 | 433 | 1,217 | ||||||||||||
Total interest expense | 7,914 | 10,277 | 25,643 | 31,316 | ||||||||||||
Net interest income | 17,573 | 16,366 | 49,789 | 46,202 | ||||||||||||
Provision for loan losses | 8,051 | 4,907 | 14,762 | 8,761 | ||||||||||||
Net interest income after provision for loan losses | 9,522 | 11,459 | 35,027 | 37,441 | ||||||||||||
Non-interest Income | ||||||||||||||||
Service fees and other charges | 3,577 | 3,717 | 9,989 | 9,756 | ||||||||||||
Insurance commission income | 1,129 | 1,179 | 3,945 | 4,381 | ||||||||||||
Mortgage banking income | 980 | 1,011 | 7,677 | 3,627 | ||||||||||||
Gain on sale of non-mortgage loans | 151 | 134 | 251 | 177 | ||||||||||||
Gain on sale or call of securities | 154 | — | 279 | 19 | ||||||||||||
Impairment on available-for-sale securities (includes total losses of $350 and $1.9 million for the three and nine months ended September 30, 2009, plus $644 and $677 recognized from other comprehensive income, respectively, pre-tax) | (994 | ) | (2,051 | ) | (2,541 | ) | (2,583 | ) | ||||||||
Trust income | 101 | 114 | 306 | 343 | ||||||||||||
Income from Bank Owned Life Insurance | 201 | 224 | 338 | 751 | ||||||||||||
Other non-interest income | 257 | (188 | ) | 475 | (166 | ) | ||||||||||
Total non-interest income | 5,556 | 4,140 | 20,719 | 16,305 | ||||||||||||
Non-interest Expense | ||||||||||||||||
Compensation and benefits | 6,551 | 7,980 | 21,501 | 22,421 | ||||||||||||
Occupancy | 1,860 | 1,949 | 5,901 | 5,562 | ||||||||||||
FDIC insurance premium | 649 | 327 | 2,713 | 792 | ||||||||||||
State franchise tax | 571 | 533 | 1,668 | 1,540 | ||||||||||||
Data processing | 1,100 | 1,221 | 3,330 | 3,384 | ||||||||||||
Acquisition related charges | — | 20 | — | 1,032 | ||||||||||||
Amortization of intangibles | 355 | 424 | 1,101 | 1,035 | ||||||||||||
Other non-interest expense | 3,700 | 2,779 | 9,701 | 8,458 | ||||||||||||
Total non-interest expense | 14,786 | 15,233 | 45,915 | 44,224 | ||||||||||||
Income before income taxes | 292 | 366 | 9,831 | 9,522 | ||||||||||||
Federal income taxes | (37 | ) | 44 | 3,193 | 3,046 | |||||||||||
Net Income | $ | 329 | $ | 322 | $ | 6,638 | $ | 6,476 | ||||||||
Dividends accrued on preferred shares | $ | (473 | ) | $ | — | $ | (1,403 | ) | $ | — | ||||||
Accretion on preferred shares | $ | (40 | ) | $ | — | $ | (118 | ) | $ | — | ||||||
Net income (loss) applicable to common shares | $ | (184 | ) | $ | 322 | $ | 5,117 | $ | 6,476 | |||||||
Earnings per common share (Note 8) | ||||||||||||||||
Basic | $ | (0.02 | ) | $ | 0.04 | $ | 0.63 | $ | 0.83 | |||||||
Diluted | $ | (0.02 | ) | $ | 0.04 | $ | 0.63 | $ | 0.83 | |||||||
Dividends declared per share (Note 7) | $ | 0.04 | $ | 0.26 | $ | 0.295 | $ | 0.78 | ||||||||
Average shares outstanding (Note 8) | ||||||||||||||||
Basic | 8,117 | 8,113 | 8,117 | 7,813 | ||||||||||||
Diluted | 8,117 | 8,123 | 8,172 | 7,842 |
See accompanying notes
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FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Changes in Stockholders’ Equity
(UNAUDITED)
(Amounts in Thousands)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Balance at beginning of period | $ | 232,683 | $ | 193,800 | $ | 229,159 | $ | 165,954 | ||||||||
Comprehensive income: | ||||||||||||||||
Net income | 329 | 322 | 6,638 | 6,476 | ||||||||||||
Other comprehensive income (loss) (Note 3) | 2,259 | (2,400 | ) | 2,350 | (4,518 | ) | ||||||||||
Total comprehensive income | 2,588 | (2,078 | ) | 8,988 | 1,958 | |||||||||||
ESOP shares released | — | — | — | 551 | ||||||||||||
Stock option expense | 55 | 65 | 175 | 181 | ||||||||||||
Tax benefit of employee plans | — | — | — | 72 | ||||||||||||
Shares issued under stock option plans | — | — | 5 | 768 | ||||||||||||
Treasury shares repurchased | — | (10 | ) | — | (635 | ) | ||||||||||
Acquisition of Pavilion Bancorp | — | — | — | 27,128 | ||||||||||||
Preferred stock dividends accrued | (473 | ) | — | (1,403 | ) | — | ||||||||||
Common cash dividends declared (Note 7) | (324 | ) | (2,101 | ) | (2,395 | ) | (6,301 | ) | ||||||||
Balance at end of period | $ | 234,529 | $ | 189,676 | $ | 234,529 | $ | 189,676 | ||||||||
See Accompanying Notes
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FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
Nine Months Ended September 30, | ||||||||
2009 | 2008 | |||||||
Operating Activities | ||||||||
Net income | $ | 6,638 | $ | 6,476 | ||||
Items not requiring (providing) cash | ||||||||
Provision for loan losses | 14,762 | 8,761 | ||||||
Depreciation | 2,876 | 2,858 | ||||||
Amortization of mortgage servicing rights, net of impairment | 1,708 | 1,020 | ||||||
Amortization of intangible assets | 1,102 | 1,035 | ||||||
Amortization of mark to market adjustments | 582 | 423 | ||||||
Amortization of premiums and discounts in securities | (400 | ) | (122 | ) | ||||
Deferred federal income tax | (2,235 | ) | (1,351 | ) | ||||
Proceeds from the sale of loans held for sale | 427,095 | 153,491 | ||||||
Originations of loans held for sale | (436,646 | ) | (155,547 | ) | ||||
Gain from sale of loans | (7,527 | ) | (2,985 | ) | ||||
Loss on sales or write-down of securities, net | 2,262 | 2,564 | ||||||
Loss on sale of fixed assets | 6 | — | ||||||
Loss on sale or write-down of foreclosed assets | 1,226 | 303 | ||||||
Stock option expense | 175 | 181 | ||||||
Income from bank-owned life insurance | (338 | ) | (751 | ) | ||||
FHLB stock dividends | — | (754 | ) | |||||
Release of ESOP shares | — | 551 | ||||||
Changes in | ||||||||
Interest receivable | (817 | ) | 26 | |||||
Other assets | (1,468 | ) | 1,264 | |||||
Other liabilities | (944 | ) | (4,345 | ) | ||||
Net cash provided by (used in) operating activities | 8,057 | 13,098 | ||||||
Investing Activities | ||||||||
Proceeds from maturities of held-to-maturity securities | 89 | 139 | ||||||
Proceeds from maturities and pay-downs of available-for-sale securities | 18,036 | 25,048 | ||||||
Proceeds from sale of real estate and other assets held for sale | 3,330 | 2,739 | ||||||
Proceeds from the sale of available-for-sale securities | 6,383 | — | ||||||
Net cash paid for acquisition of Pavilion Bancorp, Inc. | — | (23,902 | ) | |||||
Proceeds from sale of non-mortgage loans | 6,103 | 10,707 | ||||||
Purchases of available-for-sale securities | (32,075 | ) | (25,970 | ) | ||||
Purchases of held-to-maturity securities | (900 | ) | — | |||||
Purchases of bank-owned life insurance | (1,500 | ) | — | |||||
Purchases of office properties and equipment, net | (1,498 | ) | (3,240 | ) | ||||
Net increase in loans receivable | (28,030 | ) | (88,327 | ) | ||||
Net cash used in investing activities | (30,062 | ) | (102,806 | ) | ||||
Financing Activities | ||||||||
Net increase in deposits and advance payments by borrowers | 73,203 | 8,726 | ||||||
Repayment of Federal Home Loan Bank long-term advances | (30 | ) | (6,399 | ) | ||||
Net increase (decrease) in Federal Home Loan Bank short-term advances | (9,100 | ) | 15,300 | |||||
Proceeds from Federal Home Loan Bank long-term advances | — | 19,000 | ||||||
Increase (decrease) in securities sold under repurchase agreements | (6,174 | ) | 16,737 | |||||
Net increase in short-term borrowings | — | 11,200 | ||||||
Purchase of common stock for treasury | — | (635 | ) | |||||
Cash dividends paid on common stock | (3,450 | ) | (6,026 | ) | ||||
Cash dividends paid on preferred stock | (1,285 | ) | — | |||||
Proceeds from exercise of stock options | 5 | 768 | ||||||
Excess tax benefits from exercise of stock options | — | 72 | ||||||
Net cash provided by (used in) financing activities | 53,169 | 58,743 | ||||||
Increase (decrease) in cash and cash equivalents | 31,164 | (30,965 | ) | |||||
Cash and cash equivalents at beginning of period | 46,152 | 65,553 | ||||||
Cash and cash equivalents at end of period | $ | 77,316 | $ | 34,588 | ||||
Supplemental cash flow information: | ||||||||
Interest paid | $ | 26,322 | $ | 32,125 | ||||
Income taxes paid | $ | 6,600 | $ | 6,682 | ||||
Transfers from loans to other real estate owned and other assets held for sale | $ | 6,908 | $ | 3,648 | ||||
See accompanying notes.
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FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2009 and 2008)
1. Basis of Presentation
First Defiance Financial Corp. (“First Defiance” or the “Company”) is a unitary thrift holding company that conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal”) and First Insurance and 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, trust and wealth management services. First Insurance is an insurance agency that does business in the Defiance and Bowling Green, Ohio areas offering property and casualty, and group health and life insurance products.
The consolidated condensed statement of financial condition at December 31, 2008 has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of September 30, 2009 and for the three and nine month periods ended September 30, 2009 and 2008 have been prepared by First Defiance without audit and do not include information or footnotes necessary for the complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance’s 2008 Annual Report on Form 10-K for the year ended December 31, 2008. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results for the three and nine month periods ended September 30, 2009 are not necessarily indicative of the results that may be expected for the entire year.
2.Significant 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 valuation of certain investment securities, the determination of the allowance for loan losses, the valuation of mortgage servicing rights and goodwill, the determination of unrecognized income tax benefits, and the determination of post-retirement benefits.
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Earnings Per Common Share
Basic earnings per common share is net income applicable to common shares divided by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options, warrants and stock grants. Unreleased shares held by the Company’s Employee Stock Ownership Plan (“ESOP”) are not included in average shares for purposes of calculating earnings per share. As shares are released for allocation, they are included in the average shares outstanding. All shares under the ESOP plan were allocated as of December 31, 2008.
Comprehensive Income
Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income includes unrealized gains and losses on available for sale investment securities and the net unrecognized actuarial losses and unrecognized prior service costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items included in other comprehensive income (loss) are reported net of tax.
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 other comprehensive income (loss) until realized. Realized gains and losses are included in gains (losses) on securities. Realized gains and losses on securities sold are recognized on the trade date based on the specific identification method.
Interest income includes amortization of purchase premiums and discounts. Securities with unrealized losses are reviewed quarterly to determine if impairment is other–than-temporary. In performing this review, management considers the length of time and extent that fair value has been less than cost, the financial condition of the issuer, the impact of changes in market interest rates on market value and the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. If the fair value of a security is less than amortized cost and the impairment is determined to be other-than-temporary, it is reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of impairment related to other factors is recognized in other comprehensive income (loss).
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Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses 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 general economic conditions and the regulatory environment. 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. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.
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 loss is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors in order to maintain the allowance for loan losses at the level deemed adequate by management.
The determination of whether a loan is considered past due or delinquent is based on the contractual payment terms. A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Goodwill and Other Intangibles
Goodwill results from business acquisitions and represents the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. Identified purchased intangibles, which consist of core deposit intangibles, customer relationship intangibles and non-compete agreements, are recorded at cost or estimated fair value and amortized over their estimated lives, which range from five years for non-compete agreements to 10 to 20 years for core deposit and customer relationship intangibles.
Stock Compensation Plans
Compensation cost is recognized for stock options issued to employees and directors, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.
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Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
Mortgage Banking Derivatives
Commitments to fund mortgage loans (interest rate locks) to be sold in the secondary market and forward commitments for the future delivery of these mortgage loans to the secondary market are accounted for as derivatives not qualifying for hedge accounting. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date of commitments. Changes in the fair values of these derivatives are included in mortgage banking income.
Operating Segments
Management considers the following factors in determining the need to disclose separate operating segments: 1) The nature of products and services, which are all financial in nature. 2) The type and class of customer for the products and services; in First Defiance’s case retail customers for retail bank and insurance products and commercial customers for commercial loan, deposit, life, health and property and casualty insurance needs. 3) The methods used to distribute products or provide services; such services are delivered through banking and insurance offices and through bank and insurance customer contact representatives. Retail and commercial customers are frequently targets for both banking and insurance products. 4) The nature of the regulatory environment; both banking and insurance entities are subject to various regulatory bodies and a number of specific regulations.
Quantitative thresholds as stated in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280,Segment Reporting are monitored. For the nine months ended September 30, 2009, the reported revenue for First Insurance was 5.5% of total revenue for First Defiance. Total revenue includes net interest income (before provision for loan losses) plus non-interest income. Net income for First Insurance for the nine months ended September 30, 2009 was 6.3% of consolidated net income. Total assets of First Insurance at September 30, 2009 were 0.4% of total assets. First Insurance does not meet any of the quantitative thresholds of FASB ASC Topic 280. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.
Income Taxes
The Company’s effective tax rate differs from the statutory 35% federal tax rate primarily because of the volatility of income tax expense attributable to the change in income before income taxes and the impact of the Company’s tax exempt income on obligations of state and political subdivisions. In accordance with FASB ASC Topic 740, Subtopic 270, Section 25, income tax expense should be recorded using the Company’s best estimate of the effective tax
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rate for a full year. With the other-than-temporary impairment charge recorded for the Company’s trust preferred collateralized debt obligations and the higher than anticipated provisions for loan losses being necessary, the Company’s pre-tax income is lower than expected. This has been mostly offset by the large increase in mortgage banking income. As a result, the Company’s tax exempt income had a larger impact than originally estimated and resulted in a lower than expected tax rate for the third quarter ended September 30, 2009.
Reclassifications
Some items in the prior financial statements were reclassified to conform to the current presentation.
New Accounting Standards
Statements of Financial Accounting Standards
In May 2009, FASB issued SFAS No. 165, “Subsequent Events,”which was primarily codified into FASB ASC Topic 855 “Subsequent Events.” FASB ASC Topic 855 requires entities to disclose the date through which they have evaluated subsequent events and whether the date corresponds with the release date of their financial statements. FASB ASC Topic 855 is effective for interim and annual periods ending after June 15, 2009. FASB ASC Topic 855 did not have an impact on the Company’s financial statements.
In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles,” which was primarily codified into FASB ASC Topic 105 “Generally Accepted Accounting Standards.” FASB ASC Topic 105 provides for the FASB Accounting Standards Codification to be the official source of authoritative, nongovernmental U.S. generally accepted accounting principles (“GAAP”). The provisions of FASB ASC Topic 105 are effective for interim and annual periods ending after September 15, 2009 and, accordingly, are effective for the Company for the current reporting period. The adoption of this pronouncement did not have an impact on the Company’s financial condition of results of operations, but will impact our financial reporting process by eliminating all references to pre-codification standards. On the effective date of this Statement, the FASB ASC superseded all then-existing non-SEC accounting and reporting standards, and all other non-grandfathered non-SEC accounting literature not included in the FASB ASC became non-authoritative.
Financial Accounting Standards Board Staff Positions and Interpretations
In September 2006,FASB issued FSP SFAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,”which was primarily codified into FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” FASB ASC Topic 820 affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. FASB ASC Topic 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence.
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FASB ASC Topic 820 is effective for the Company for interim and annual reporting periods ending after June 15, 2009, applied prospectively; early adoption is permitted for periods ending after March 15, 2009. The Company elected to early adopt FASB ASC Topic 820 for the period ending March 31, 2009 and it did not have a significant impact on the Company’s financial statements.
In April 2009, FASB issued FSP SFAS 115-2 and SFAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,”which was primarily codified into ASC Topic 320, “Investments – Debt and Equity Securities.” FASB ASC Topic 320 (i) changes existing guidance for determining whether an impairment is other than temporary to debt securities and (ii) replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under FASB ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. FASB ASC Topic 320 is effective for the Company for interim and annual reporting periods ending after June 15, 2009; early adoption is permitted for periods ending after March 15, 2009. The Company adopted the Topic effective January 1, 2009. No amounts were reversed for non-credit portion of cumulative other-than-temporary impairment (“OTTI”) charges from previous periods. As a result of implementing the new Topic, the amount of OTTI recognized in the first, second and third quarters of 2009 was $672,000, $875,000 and $994,000, respectively. Had the Standard not been issued, the amount of OTTI that would have been recognized for the first, second and third quarters of 2009 would have been $2,211,000, $1,101,000 and $920,000.
In April 2009, FASB issued FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,”which was primarily codified into ASC Topic 825, “Financial Instruments.” FASB ASC Topic 825 amends previous FASB ASC Topic 825 guidance to require an entity to provide disclosures about fair value of financial instruments in interim as well as annual financial. Under FASB ASC Topic 825, a publicly traded company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In addition, entities must disclose, in the body or in the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for annual reporting periods, the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by FASB ASC Topic 825. FASB ASC Topic 825 is effective for the Company for interim and annual reporting periods ending after June 15, 2009; early adoption is permitted for periods ending after March 15, 2009. The Company elected to early adopt FASB ASC Topic 825 for the period ending March 31, 2009 and the new interim disclosures are included within Note 4.
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3. Comprehensive Income
Comprehensive income consists of net income and other comprehensive income (loss) (“OCI”). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale and the net unrecognized actuarial losses and unrecognized prior services costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items reported in other comprehensive income (loss) are reported net of tax. Following is a summary of other comprehensive income (loss) for the three and nine months ended September 30, 2009 and 2008:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(In thousands) | ||||||||||||||||
Net income | $ | 329 | $ | 322 | $ | 6,638 | $ | 6,476 | ||||||||
Change in securities available-for-sale: | ||||||||||||||||
Other-than-temporary impairment on available-for-sale securities | (350 | ) | (2,051 | ) | (1,864 | ) | (2,583 | ) | ||||||||
Other-than-temporary impairment on available-for-sale securities associated with credit losses realized in income | 994 | 2,051 | 2,541 | 2,583 | ||||||||||||
Other-than-temporary impairment on available-for-sale securities recorded in OCI | 644 | — | 677 | — | ||||||||||||
Unrealized holding gains (losses) on available-for-sale securities arising during the period | 2,983 | (3,488 | ) | 3,217 | (6,969 | ) | ||||||||||
Reclassification adjustment for (gains) losses realized in income | (154 | ) | — | (279 | ) | 19 | ||||||||||
Net unrealized gains (losses) | 2,829 | (3,488 | ) | 2,938 | (6,950 | ) | ||||||||||
Income tax effect | (1,214 | ) | 1,088 | (1,265 | ) | 2,432 | ||||||||||
Total other comprehensive income (loss) | 2,259 | (2,400 | ) | 2,350 | (4,518 | ) | ||||||||||
Comprehensive income | $ | 2,588 | $ | (2,078 | ) | $ | 8,988 | $ | 1,958 | |||||||
The following table summarizes the changes within each classification of accumulated comprehensive income for the nine months ended September 30, 2009 and 2008:
Unrealized gains (losses) on available for sale securities | Postretirement Benefit | Accumulated other comprehensive income (loss),net | ||||||||||
(In thousands) | ||||||||||||
Balance at December 31, 2008 | $ | (1,100 | ) | $ | (804 | ) | $ | (1,904 | ) | |||
Other comprehensive income (loss), net | 2,350 | — | 2,350 | |||||||||
Balance at September 30, 2009 | $ | 1,250 | $ | (804 | ) | $ | 446 | |||||
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Unrealized gains (losses) on available for sale securities | Postretirement Benefit | Accumulated other comprehensive income (loss), net | ||||||||||
(In thousands) | ||||||||||||
Balance at December 31, 2007 | $ | 364 | $ | (779 | ) | $ | (415 | ) | ||||
Other comprehensive income (loss), net | (4,518 | ) | — | (4,518 | ) | |||||||
Balance at September 30, 2008 | $ | (4,154 | ) | $ | (779 | ) | $ | (4,933 | ) | |||
4. Fair Value
FASB ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
FASB ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on the best information available. In that regard, FASB ASC Topic 820 established a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
• | Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. |
• | Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other that quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by a correlation or other means. |
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• | Level 3: Unobservable inputs for determining fair value of assets and liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. |
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Available for sale securities. Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service which uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include other federal agency securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities and municipal securities. The Company classifies its pooled trust preferred collateralized debt obligations as Level 3. The portfolio consists of collateralized debt obligations backed by pools of trust preferred securities issued by financial institutions and insurance companies. Based on the lack of observable market data, the Company estimated fair values based on the observable data available and reasonable unobservable market data. The Company estimated fair value based on a discounted cash flow model which used appropriately adjusted discount rates reflecting credit and liquidity risks. The Company used an independent third party which is described further in Note 9.
Impaired loans. Impaired loans are reported at the fair value of the underlying collateral, if repayment is expected solely from collateral. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in impaired loans being valued using Level 3 inputs.
Mortgage servicing rights. Mortgage servicing rights are reported at fair value utilizing Level 2 inputs. MSRs are valued by a third party consultant using a proprietary cash flow valuation model.
Mortgage banking derivative. The fair value of mortgage banking derivatives are based on derivative valuation models using market data inputs as of the valuation date (Level 2).
Real estate held for sale. Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell.
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The following table summarizes the financial assets measured at fair value on a recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Assets and Liabilities Measured on a Recurring Basis
September 30, 2009 | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||||
(In Thousands) | ||||||||||||||
Available for sale securities: | ||||||||||||||
U.S. Treasury securities and obligations of U.S. Government corporations and agencies | $ | — | $ | 13,429 | $ | — | $ | 13,429 | ||||||
Mortgage-backed securities | — | 32,034 | — | 32,034 | ||||||||||
REMICs | — | 3,952 | — | 3,952 | ||||||||||
Collateralized mortgage obligations | — | 30,499 | — | 30,499 | ||||||||||
Trust preferred stock | — | — | 1,877 | 1,877 | ||||||||||
Preferred stock | 137 | — | — | 137 | ||||||||||
Obligations of state and political subdivisions | — | 45,057 | — | 45,057 | ||||||||||
Mortgage banking derivative – asset | — | 994 | — | 994 | ||||||||||
Mortgage banking derivative – liability | — | (418 | ) | — | (418 | ) | ||||||||
December 31, 2008 | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||||
(In Thousands) | ||||||||||||||
Available for sale securities: | ||||||||||||||
U.S. Treasury securities and obligations of U.S. Government corporations and agencies | $ | — | $ | 14,685 | $ | — | $ | 14,685 | ||||||
Mortgage-backed securities | — | 35,366 | — | 35,366 | ||||||||||
REMICs | — | 4,159 | — | 4,159 | ||||||||||
Collateralized mortgage obligations | — | 22,430 | — | 22,430 | ||||||||||
Trust preferred stock | — | — | 3,873 | 3,873 | ||||||||||
Preferred stock | 49 | — | — | 49 | ||||||||||
Obligations of state and political subdivisions | — | 37,013 | — | 37,013 | ||||||||||
Mortgage banking derivative – asset | — | 1,264 | — | 1,264 | ||||||||||
Mortgage banking derivative – liability | — | (166 | ) | — | (166 | ) |
The table below presents a reconciliation and income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2009:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands) | ||||
Beginning balance, July 1, 2009 | $ | 2,161 | ||
Total gains or losses (realized/unrealized) | ||||
Included in earnings | (994 | ) | ||
Included in other comprehensive income (presented gross of taxes) | 709 | |||
Purchases, issuances, and settlements | 1 | |||
Transfers in and/or out of Level 3 | — | |||
Ending balance, September 30, 2009 | $ | 1,877 | ||
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Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands) | ||||
Beginning balance, January 1, 2009 | $ | 3,873 | ||
Total gains or losses (realized/unrealized) | ||||
Included in earnings | (2,541 | ) | ||
Included in other comprehensive income (presented gross of taxes) | 547 | |||
Purchases, issuances, and settlements | (2 | ) | ||
Transfers in and/or out of Level 3 | — | |||
Ending balance, September 30, 2009 | $ | 1,877 | ||
The following table summarizes the financial assets measured at fair value on a non-recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Assets and Liabilities Measured on a Non-Recurring Basis
September 30, 2009 | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||
(In Thousands) | ||||||||||||
Impaired loans | $ | — | $ | — | $ | 19,280 | $ | 19,280 | ||||
Mortgage servicing rights | — | 8,350 | — | 8,350 | ||||||||
Real estate held for sale | — | — | 2,437 | 2,437 | ||||||||
December 31, 2008 | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||
(In Thousands) | ||||||||||||
Impaired loans | $ | — | $ | — | $ | 14,782 | $ | 14,782 | ||||
Mortgage servicing rights | — | 6,611 | — | 6,611 | ||||||||
Real estate held for sale | — | — | 90 | 90 |
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $19,280,000, with a valuation allowance of $7,797,000 at September 30, 2009. A provision expense of $3,411,000 and $6,035,000 for the three and nine months ended September 30, 2009 was included in earnings.
Mortgage servicing rights which are carried at lower of cost or fair value had a fair value of $8,350,000 at September 30, 2009, resulting in a valuation allowance of $1,874,000. A charge of $772,000 for the three months ended September 30, 2009 and a recovery of $917,000 for the nine months ended September 30, 2009 was included in earnings.
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Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell. The change in fair value of real estate held for sale was $438,000 and $1,101,000 for the three and nine months ended September 30, 2009 which was recorded directly as an adjustment to current earnings through non-interest expense.
In accordance with FASB ASC Topic 825, the following table is a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of September 30, 2009 and December 31, 2008. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.
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 on 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 allowance for loan losses is considered to be a reasonable adjustment for credit risk.
FASB ASC Topic 825 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 may be greater or less than that prescribed by FASB ASC Topic 825.
The carrying value of Subordinated Debentures and deposits with fixed maturities is estimated based on interest rates currently being offered on instruments with similar characteristics and maturities. 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 is based on the estimated cost to settle the option at September 30, 2009.
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September 30, 2009 | December 31, 2008 | |||||||||||
Carrying Value | Estimated Fair Values | Carrying Value | Estimated Fair Values | |||||||||
(In Thousands) | ||||||||||||
Assets: | ||||||||||||
Cash and cash equivalents | $ | 77,316 | $ | 77,316 | $ | 46,152 | $ | 46,152 | ||||
Investment securities | 128,682 | 128,714 | 118,461 | 118,492 | ||||||||
Loans, net, including loans held for sale | 1,616,719 | 1,613,583 | 1,603,603 | 1,619,409 | ||||||||
1,822,717 | $ | 1,819,613 | 1,768,216 | $ | 1,784,053 | |||||||
Other assets | 195,881 | 189,184 | ||||||||||
Total assets | $ | 2,018,598 | $ | 1,957,400 | ||||||||
Liabilities and stockholders’ equity: | ||||||||||||
Deposits | $ | 1,543,085 | $ | 1,547,617 | $ | 1,469,912 | $ | 1,476,135 | ||||
Advances from Federal Home Loan Bank | 146,937 | 153,556 | 156,067 | 162,776 | ||||||||
Securities sold under repurchase agreements | 43,280 | 43,280 | 49,454 | 49,454 | ||||||||
Subordinated debentures | 36,083 | 28,069 | 36,083 | 26,299 | ||||||||
Advance payments by borrowers for taxes and insurance | 492 | 492 | 652 | 652 | ||||||||
1,769,877 | $ | 1,773,014 | 1,712,168 | $ | 1,715,316 | |||||||
Other liabilities | 14,192 | 16,073 | ||||||||||
Total liabilities | 1,784,069 | 1,728,241 | ||||||||||
Stockholders’ equity | 234,529 | 229,159 | ||||||||||
Total liabilities and stockholders’ equity | $ | 2,018,598 | $ | 1,957,400 | ||||||||
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5. Stock Compensation Plans
First Defiance has established incentive stock option plans for its directors and employees and has reserved 1,727,485 shares of common stock for issuance under the plans. As of September 30, 2009, 475,900 options (453,900 for employees and 22,000 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.
The Company can issue incentive stock options and nonqualified stock options under their incentive stock plans. Generally, one-fifth of the options awarded become exercisable on each of the first five anniversaries of the date of grant. The option period expires ten years from the date of grant and the exercise price is the market price at the date of grant.
Following is activity under the plans:
Nine Months Ended September 30, 2009 | |||||||||
Options Outstanding | Weighted Average Exercise Price | Aggregate Intrinsic Value | |||||||
Options outstanding, beginning of period | 439,800 | $ | 20.58 | ||||||
Forfeited or cancelled | (27,850 | ) | 14.06 | ||||||
Exercised | (400 | ) | 11.75 | ||||||
Granted | 64,350 | 9.43 | |||||||
Options outstanding, end of period | 475,900 | $ | 19.46 | $ | 427,000 | ||||
Vested or expected to vest at period end | 450,553 | $ | 19.55 | ||||||
Exercisable at period end | 284,800 | $ | 20.83 | $ | 81,000 | ||||
Proceeds, related tax benefits realized from options exercised and intrinsic value of options exercised were as follows:
Nine Months Ended September 30, | ||||||
2009 | 2008 | |||||
Cash received from option exercises | $ | 5,000 | $ | 768,000 | ||
Tax benefit realized from option exercises | — | 72,000 | ||||
Intrinsic value of options exercised | 1,000 | 290,000 |
As of September 30, 2009, there was $490,000 of total unrecognized compensation costs related to unvested stock options granted under the Company Stock Option Plans. The cost is expected to be recognized over a weighted-average period of 2.95 years.
As of September 30, 2009 there were 90,350 shares available for grant under the Company’s stock option plans.
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The fair value of stock options granted during the nine months ended September 30, 2009 and 2008 was determined at the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:
Nine Months Ended September 30, | ||||||
2009 | 2008 | |||||
Expected average risk-free rate | 3.38 | % | 4.26 | % | ||
Expected average life | 6.41 | years | 6.46 | years | ||
Expected volatility | 26.10 | % | 22.50 | % | ||
Expected dividend yield | 3.62 | % | 6.08 | % |
The weighted-average fair value of options granted for the nine months ended September 30, 2009 and 2008 were $1.87 and $1.98, respectively.
6. Acquisitions
On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc., which was headquartered in Adrian, Michigan. Each Pavilion shareholder received 1.4209 shares of First Defiance common stock and $37.50 in cash for each share of Pavilion stock. In connection with this transaction, 1,036,861 shares of First Defiance common stock were issued at a value of $27.1 million. The common shares issued were valued at $26.117 per share, representing the average of the closing bid and ask price as of the date of announcement plus two days prior and two days subsequent to the announcement. The total cost of the transaction, including legal and investment banking fees, was $55.5 million. The assets and liabilities of Pavilion were recorded on the balance sheet at their fair value as of the acquisition date. The results of Pavilion’s operations have been included in the First Defiance’s consolidated statement of income from the date of acquisition.
The following tables summarize the estimated fair values of the net assets acquired and the computation of the purchase price and goodwill related to the Pavilion acquisition.
Acquisition Date | |||
March 14, 2008 | |||
(In Thousands) | |||
Assets | |||
Cash and cash equivalents | $ | 4,514 | |
Investment securities | 9,136 | ||
Loans, net of allowance for loan losses | 232,499 | ||
Premises and equipment | 6,992 | ||
Federal Home Loan Bank stock | 2,036 | ||
Goodwill and other intangibles | 26,016 | ||
Other assets | 6,801 | ||
Total Assets | 287,994 | ||
Liabilities | |||
Deposits | 209,385 | ||
Borrowings | 18,403 | ||
Other liabilities | 4,658 | ||
Total Liabilities | 232,446 | ||
Net assets acquired | $ | 55,548 | |
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6.Acquisitions (continued)
Acquisition Date March 14, 2008 | ||||
(In Thousands) | ||||
Purchase price | $ | 55,548 | ||
Pavilion’s carrying value of net assets acquired | (28,138 | ) | ||
Excess purchase price over Pavilion’s carrying Value of net assets acquired | 27,410 | |||
Purchase accounting adjustments | ||||
Portfolio loans | (6,632 | ) | ||
Premises and equipment | 2,579 | |||
Mortgage servicing rights | (1,010 | ) | ||
Deposits | 1,021 | |||
Deferred tax liabilities | 2,648 | |||
Total net tangible assets | (1,394 | ) | ||
Core deposit and other intangibles | (6,251 | ) | ||
Goodwill | $ | 19,765 | ||
During the nine months ended September 30, 2008, First Defiance recognized $1,032,000 of acquisition related charges, of which, $198,000 related to retention bonuses and $171,000 related to termination of certain contracts. The remaining $663,000 includes items related to professional services, start-up costs of system conversions, supplies and other non-recurring costs associated with the completion of the acquisition and the transition of operations.
7. Dividends on Common Stock
As of September 30, 2009, First Defiance had declared a quarterly cash dividend of $.04 per common share for the third quarter of 2009, payable on October 23, 2009. The Company’s primary source of funds for the payment of dividends is distributions from First Federal, which require prior approval of the Office of Thrift Supervision (“OTS”), the primary regulator for both the Company and First Federal. The OTS has advised the Company that the OTS is not likely to approve any dividends in the foreseeable future. The OTS has also advised the Company that it should not pay dividends utilizing borrowings or other sources of funds that the Company may have access to. The Company expects to have further discussions with the OTS regarding these issues, but the payment of dividends in the fourth quarter of 2009 is uncertain.
As a result of the Company’s participation in the Capital Purchase Program, First Defiance is prohibited, without prior approval from the U.S. Treasury, from paying a quarterly dividend of more than $0.26 per share until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party.
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8. Earnings Per Share
Basic earnings per share as disclosed under FASB ASC Topic 260 has been calculated by dividing net income applicable to common shares by the weighted average number of shares of common stock outstanding for the three and nine month periods ended September 30, 2009 and 2008. First Defiance accounts for the shares issued to its ESOP in accordance with FASB ASC Topic 718, Subtopic 40. As a result, shares controlled by the ESOP are not considered in the weighted average number of shares of common stock outstanding until the shares are committed for allocation to an employee’s individual account. In the calculation of diluted earnings per share for the three and nine month periods ended September 30, 2009 and 2008, the effect of shares issuable under stock option plans and unvested shares under the Management Recognition Plan have been accounted for using the Treasury Stock method.
The following table sets forth the computation of basic and diluted earnings per common share (in thousands except per share data):
Three months ended September 30, | Nine months ended September 30, | ||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||
Numerator for basic and diluted earnings per common share – Net income applicable to common shares | $ | (184 | ) | $ | 322 | $ | 5,117 | $ | 6,476 | ||||
Denominator: | |||||||||||||
Denominator for basic earnings per common share – weighted average common shares | 8,117 | 8,113 | 8,117 | 7,813 | |||||||||
Effect of warrants | — | — | 54 | — | |||||||||
Effect of employee stock options | — | 10 | 1 | 29 | |||||||||
Denominator for diluted earnings per common share share | 8,117 | 8,123 | 8,172 | 7,842 | |||||||||
Basic earnings per common share | $ | (0.02 | ) | $ | 0.04 | $ | 0.63 | $ | 0.83 | ||||
Diluted earnings per common share | $ | (0.02 | ) | $ | 0.04 | $ | 0.63 | $ | 0.83 | ||||
There were 475,900 and 412,800 shares under option granted to employees excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and nine months ended September 30, 2009, respectively. Shares under option of 333,000 and 305,413 were excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and nine months ended September 30, 2008, respectively. Additionally, the 550,595 shares issuable related to the warrant issued to the U.S. Treasury pursuant to the Capital Purchase Program were anti-dilutive and excluded from the diluted earnings per share calculation for the three months ended September 30, 2009. Shares under option and the warrant were anti-dilutive either due to the Company’s weighted average stock price being less than the exercise price plus unearned compensation for the particular instrument or due to the Company’s net income applicable to common shares being a loss.
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9. Investment Securities
The following is a summary of available-for-sale and held-to-maturity securities (in thousands):
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||
At September 30, 2009 | |||||||||||||
Available-for-Sale Securities: | |||||||||||||
U.S. Treasury securities and obligations of U.S. Government corporations and agencies | $ | 13,077 | $ | 353 | $ | (1 | ) | $ | 13,429 | ||||
Mortgage-backed securities | 30,562 | 1,472 | — | 32,034 | |||||||||
REMICs | 3,770 | 182 | — | 3,952 | |||||||||
Collateralized mortgage obligations | 29,684 | 918 | (103 | ) | 30,499 | ||||||||
Trust preferred stock and preferred stock | 5,495 | 8 | (3,489 | ) | 2,014 | ||||||||
Obligations of state and political subdivisions | 42,474 | 2,597 | (14 | ) | 45,057 | ||||||||
Totals | $ | 125,062 | $ | 5,530 | $ | (3,607 | ) | $ | 126,985 | ||||
Held-to-Maturity Securities: | |||||||||||||
FHLMC certificates | $ | 130 | $ | 6 | $ | — | $ | 136 | |||||
FNMA certificates | 316 | 2 | (1 | ) | 317 | ||||||||
GNMA certificates | 111 | 3 | — | 114 | |||||||||
Obligations of state and political subdivisions | 1,140 | 22 | — | 1,162 | |||||||||
Totals | $ | 1,697 | $ | 33 | $ | (1 | ) | $ | 1,729 | ||||
At December 31, 2008 | |||||||||||||
Available-for-Sale Securities: | |||||||||||||
U.S. Treasury securities and obligations of U.S. Government corporations and agencies | $ | 14,180 | $ | 505 | $ | — | $ | 14,685 | |||||
Mortgage-backed securities | 34,232 | 1,137 | (3 | ) | 35,366 | ||||||||
REMICs | 4,041 | 118 | — | 4,159 | |||||||||
Collateralized mortgage obligations | 22,196 | 486 | (252 | ) | 22,430 | ||||||||
Trust preferred stock and preferred stock | 8,038 | — | (4,116 | ) | 3,922 | ||||||||
Obligations of state and political subdivisions | 36,581 | 754 | (322 | ) | 37,013 | ||||||||
Totals | $ | 119,268 | $ | 3,000 | $ | (4,693 | ) | $ | 117,575 | ||||
Held-to-Maturity Securities: | |||||||||||||
FHLMC certificates | $ | 141 | $ | 5 | $ | — | $ | 146 | |||||
FNMA certificates | 378 | 1 | (2 | ) | 377 | ||||||||
GNMA certificates | 127 | 1 | — | 128 | |||||||||
Obligations of state and political subdivisions | 240 | 26 | — | 266 | |||||||||
Totals | $ | 886 | $ | 33 | $ | (2 | ) | $ | 917 | ||||
The amortized cost and fair value of securities at September 30, 2009 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. For purposes of the maturity table, mortgage-backed securities (“MBS”), collateralized mortgage obligations (“CMO”) and REMICs, which are not due at a single maturity date, have not been allocated over the maturity groupings. The MBS, CMO and REMIC securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.
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Available-for-Sale | Held-to-Maturity | |||||||||||
Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||
(In Thousands) | ||||||||||||
Due in one year or less | $ | 2,670 | $ | 2,726 | $ | 960 | $ | 961 | ||||
Due after one year through five years | 12,628 | 13,024 | 180 | 201 | ||||||||
Due after five years through ten years | 7,675 | 8,015 | — | — | ||||||||
Due after ten years | 38,073 | 36,735 | — | — | ||||||||
MBS/CMO/REMIC | 64,016 | 66,485 | 557 | 567 | ||||||||
$ | 125,062 | $ | 126,985 | $ | 1,697 | $ | 1,729 | |||||
Investment securities with a carrying amount of $115.9 million at September 30, 2009 were pledged as collateral on public deposits, securities sold under repurchase agreements and FHLB advances and for other purposes required or permitted by law.
As of September 30, 2009, the Company’s investment portfolio consisted of 281 securities, 28 of which were in an unrealized loss position.
The following table summarizes First Defiance’s securities that were in an unrealized loss position at September 30, 2009:
Duration of Unrealized Loss Position | |||||||||||||||||||||
Less than 12 Months | 12 Month or Longer | Total | |||||||||||||||||||
Fair Value | Gross Unrealized Loss | Fair Value | Gross Unrealized Loss | Fair Value | Unrealized Losses | ||||||||||||||||
(In Thousands) | |||||||||||||||||||||
At September 30, 2009 | |||||||||||||||||||||
Available-for-sale securities: | |||||||||||||||||||||
U.S. treasury securities and obligations of U.S. government corporations and agencies | $ | 1,004 | $ | (1 | ) | $ | — | $ | — | $ | 1,004 | $ | (1 | ) | |||||||
Collateralized mortgage obligations and REMICs | 1,979 | (54 | ) | 656 | (49 | ) | 2,635 | (103 | ) | ||||||||||||
Trust preferred stock and preferred stock | — | — | 1,942 | (3,489 | ) | 1,942 | (3,489 | ) | |||||||||||||
Obligations of state and political subdivisions | — | — | 1,256 | (14 | ) | 1,256 | (14 | ) | |||||||||||||
Held to maturity securities: | |||||||||||||||||||||
Mortgage-backed securities | 125 | — | 139 | (1 | ) | 264 | (1 | ) | |||||||||||||
Total temporarily impaired securities | $ | 3,108 | $ | (55 | ) | $ | 3,993 | $ | (3,553 | ) | $ | 7,101 | $ | (3,608 | ) | ||||||
With the exception of Trust Preferred Stock, the above securities all have fixed interest rates, and all securities have defined maturities. Their fair value is sensitive to movements in the market interest rates. First Defiance does not intend to sell and does not believe it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis.
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Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequent when economic or market conditions warrant such an evaluation. The investment portfolio is evaluated for OTTI by segregating the portfolio into two general segments. Investment securities classified as available for sale or held-to-maturity are generally evaluated for OTTI under FASB ASC Topic 320. Certain collateralized debt obligations are evaluated for OTTI under FASB ASC Topic 325,Investment – Other.
When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected compared to the book value of the security and is recognized in earnings. The amount of OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.
The Company held twelve trust preferred collateralized debt obligations (“CDOs”) at September 30, 2009. Management’s analysis for the first six months of 2009 deemed that the value of eight of the CDOs were other-than-temporarily impaired, three of which were written off in full.
During the third quarter 2009, management determined that additional OTTI had arose on four of the previously impaired investments along with identifying a new OTTI on an additional CDO. These securities had other-than-temporary impairment losses of $(350,000), of which $(994,000) was recorded as an expense and $644,000 was recorded as an adjustment to other comprehensive income for the three months ended September 30, 2009. For the nine months ended September 30, 2009, nine CDOs were other-than-temporarily impaired. These securities had OTTI losses of $(1,864,000), of which $(2,541,000) was recorded as an expense and $677,000 was recorded as an adjustment to other comprehensive income. To date, four CDOs have been written down to zero. As required under FASB ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. Life-to date, the Company has a total of nine securities that are other-than-temporarily impaired at September 30, 2009 and remain classified as available for sale.
Given the conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, the Company’s CDOs will be classified within Level 3 of the fair value hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.
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The Company’s CDO valuations were prepared by an independent third party. Their approach to determining fair value involved several steps: 1) Detailed credit and structural evaluation of each piece of collateral in the CDO; 2) Collateral performance projections for each piece of collateral in the CDO (default, recovery and prepayment/amortization probabilities) and 3) Discounted cash flow modeling.
Trust Preferred CDOs Discount Rate Methodology
First Defiance uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific CDO instruments. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for trust preferred CDOs, however, First Defiance looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that nevertheless exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific CDOs. Importantly, as part of the analysis described above, First Defiance considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.
Fundamental to this evaluation is an assessment of the likelihood of CDO coverage test failures that would have the effect of diverting cash flow away from the relevant CDO bond for some period of time. Generally speaking, the Company adjusts indicative credit spreads upwards in the case of CDOs that have relatively weaker collateral and/or less cushion with respect to overcollateralization and interest coverage test ratios and downwards if the reverse is true. This aspect of the Company’s discount rate methodology is important because there is frequently a great difference in the risks present in CDO instruments that are otherwise very similar (i.e. CDOs with the same basic type of collateral, the same manager, the same vintage, etc., may exhibit vastly different performance characteristics). With respect to this last point, First Defiance notes that given today’s credit environment, characterized by high default and deferral rates, it is typically the case that deal-specific credit performance (determined on the basis of the credit characteristics of remaining collateral) is the best indicator of what a willing market participant would pay for an instrument.
The Company uses the same methodology for all of its CDOs and believes its valuation methodology is appropriate for all of its CDOs in accordance with FASB ASC Topic 320 as well as other related guidance.
The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already defaulted, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% for insurance companies. Although there is a possibility that the deferring collateral will become current at some point in the future, First Defiance has conservatively assumed that it will continue to defer and gradually will default.
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The following table details the nine securities with other-than-temporary impairment, their lowest credit rating at September 30, 2009 and the related credit losses recognized in earnings for the three month periods ended March 31, 2009, June 30, 2009 and September 30, 2009 (In Thousands):
Preferred Term VI | TPREF Funding II | Alesco VIII | Alesco Preferred Funding XII | Alesco Preferred Funding XVI | Alesco Preferred Term Sec XVII | Trapeza CDO I | Alesco Preferred Funding VIII | Alesco Preferred Funding IX | ||||||||||||||||||||||
Rated Caa1 | Rated Caa3 | Rated Ca | Rated Ca | Rated Ca | Rated Ca | Rated Ca | Not Rated | Not Rated | Total | |||||||||||||||||||||
Amount of OTTI related to credit loss at January 1, 2009 | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | $ | 488 | $ | 428 | $ | 440 | $ | 1,356 | ||||||||||
Addition – Qtr 1 | 15 | 1 | 212 | — | 25 | — | 369 | 25 | 25 | 672 | ||||||||||||||||||||
Amount of OTTI related to credit loss at March 31, 2009 | $ | 15 | $ | 1 | $ | 212 | $ | — | $ | 25 | $ | — | $ | 857 | $ | 453 | $ | 465 | $ | 2,028 | ||||||||||
Addition – Qtr 2 | — | 123 | 625 | — | 84 | 43 | — | — | — | 875 | ||||||||||||||||||||
Amount of OTTI related to credit loss at June 30, 2009 | $ | 15 | $ | 124 | $ | 837 | $ | — | $ | 109 | $ | 43 | $ | 857 | $ | 453 | $ | 465 | $ | 2,903 | ||||||||||
Addition – Qtr 3 | — | 119 | 163 | 34 | 135 | 543 | — | — | — | 994 | ||||||||||||||||||||
Amount of OTTI related to credit loss at September 30, 2009 | $ | 15 | $ | 243 | $ | 1,000 | $ | 34 | $ | 244 | $ | 586 | $ | 857 | $ | 453 | $ | 465 | $ | 3,897 | ||||||||||
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The following table provides additional information related to First Defiance’s trust preferred securities as of September 30, 2009 (dollars in thousands):
Deal | Class | Book Value | Fair Value | Unrealized Loss | Realized Losses 2009 | Lowest Rating | Current Number of Banks and Insurance Companies | Actual Deferrals and Defaults as a % of Current Collateral | Expected Deferrals and Defaults as a % of Remaining Performing Collateral | Excess Subordination as a % of Current Performing Collateral | |||||||||||||||||||
Preferred Term VI | Mezz | $ | 243 | $ | 170 | $ | (73 | ) | $ | (15 | ) | Caa1 | 5 | 54.40 | % | 0.75 | % | — | % | ||||||||||
TPREF Funding II | B | 751 | 295 | (456 | ) | (243 | ) | Caa3 | 23 | 28.04 | % | 23.27 | % | — | |||||||||||||||
Alesco VIII* | D-1 | 0 | 0 | — | (1,000 | ) | Ca | * | * | * | * | ||||||||||||||||||
Alesco Preferred Funding XVI | C | 171 | 30 | (141 | ) | (244 | ) | Ca | 38 | 25.85 | % | 26.71 | % | — | |||||||||||||||
Alesco Preferred Term Sec XVII | C-1 | 414 | 29 | (385 | ) | (586 | ) | Ca | 40 | 25.57 | % | 28.74 | % | — | |||||||||||||||
I-Preferred Term Sec I | B-1 | 1,000 | 504 | (496 | ) | — | B+ | 15 | 9.04 | % | 18.07 | % | 24.20 | % | |||||||||||||||
Dekania II CDO | C-1 | 989 | 480 | (509 | ) | — | BB+ | 38 | — | 15.46 | % | 28.99 | % | ||||||||||||||||
Alesco Preferred Funding XII | C-1 | 822 | 200 | (622 | ) | (34 | ) | Ca | 71 | 19.47 | % | 21.47 | % | — | |||||||||||||||
Preferred Term Sec XXVII | C-1 | 952 | 169 | (783 | ) | — | Ca | 37 | 20.02 | % | 21.75 | % | 0.03 | % | |||||||||||||||
Trapeza CDO I* | D | 0 | 0 | — | (369 | ) | Ca | * | * | * | * | ||||||||||||||||||
Alesco Preferred Funding VIII* | D-1 | 0 | 0 | — | (25 | ) | Not Rated | * | * | * | * | ||||||||||||||||||
Alesco Preferred Funding IX* | I/O | 0 | 0 | — | (25 | ) | Not Rated | * | * | * | * | ||||||||||||||||||
Total | $ | 5,342 | $ | 1,877 | $ | (3,465 | ) | $ | (2,541 | ) | |||||||||||||||||||
* | These securities have been written down to a book value of zero and have no underlying collateral support. |
The increase in OTTI in the third quarter of 2009 was the result of a significant deterioration in the performance of the underlying collateral. Specifically, depreciation was driven by both realized credit events (i.e. defaults and deferrals) and weakening credit fundamentals in some of the performing collateral, which led to an increased probability of default going forward. Coupled together, this collateral decay resulted in an increase in the Company’s assumed average lifetime default rate from 32.3% at the end of the second quarter 2009 to a rate of 34.5% at the end of the third quarter 2009.
Sales and write-downs of available for sale securities were as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(In thousands) | (In thousands) | |||||||||||||||
Proceeds | $ | 2,779 | $ | — | $ | 6,383 | $ | — | ||||||||
Gross realized gains | 154 | — | 279 | — | ||||||||||||
Gross realized losses | — | — | — | — | ||||||||||||
Other-than-temporary impairment charges | (994 | ) | (2,051 | ) | (2,541 | ) | (2,583 | ) |
Gross gains from calls of securities available for sale during the first nine months of 2008 were $19,000.
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10. Loans
Loans receivable consist of the following (in $000s):
September 30, 2009 | December 31, 2008 | |||||
Real Estate: | ||||||
Residential | $ | 233,958 | $ | 251,807 | ||
Construction | 53,605 | 72,938 | ||||
Commercial real estate | 802,434 | 755,740 | ||||
1,089,997 | 1,080,485 | |||||
Other Loans: | ||||||
Commercial | 371,881 | 356,574 | ||||
Consumer finance | 36,416 | 41,012 | ||||
Home equity and improvement | 150,379 | 161,106 | ||||
558,676 | 558,692 | |||||
Total real estate and other loans | 1,648,673 | 1,639,177 | ||||
Deduct: | ||||||
Loans in process | 23,957 | 20,892 | ||||
Net deferred loan origination fees and costs | 1,089 | 1,050 | ||||
Allowance for loan loss | 31,248 | 24,592 | ||||
Totals | $ | 1,592,379 | $ | 1,592,643 | ||
Changes in the allowance for loan losses were as follows (in $000s):
Three Months ended September 30, | Nine Months ended September 30, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
Balance at beginning of period | $ | 25,840 | $ | 20,578 | $ | 24,592 | $ | 13,890 | ||||
Provision for loan losses | 8,051 | 4,907 | 14,762 | 8,761 | ||||||||
Reserve acquired from Pavilion | — | 121 | — | 4,258 | ||||||||
Charge-offs: | ||||||||||||
Residential | 744 | 478 | 1,397 | 816 | ||||||||
Commercial real estate | 1,152 | 1,495 | 3,887 | 2,277 | ||||||||
Commercial | 658 | — | 2,310 | 220 | ||||||||
Home equity and improvement | 196 | 216 | 627 | 306 | ||||||||
Consumer finance | 39 | 73 | 245 | 156 | ||||||||
Total charge-offs | 2,789 | 2,262 | 8,466 | 3,775 | ||||||||
Recoveries | 146 | 101 | 360 | 311 | ||||||||
Net charge-offs | 2,643 | 2,161 | 8,106 | 3,464 | ||||||||
Ending allowance | $ | 31,248 | $ | 23,445 | $ | 31,248 | $ | 23,445 | ||||
The following table presents the aggregate amounts of non-performing assets, comprised of non-performing loans and real estate owned on the dates indicated:
September 30, 2009 | December 31, 2008 | |||||
(in thousands) | ||||||
Non-accrual loans | $ | 35,490 | $ | 28,017 | ||
Loans over 90 days past due and still accruing | — | — | ||||
Troubled debt restructuring, still accruing | 4,574 | 6,250 | ||||
Total non-performing loans | 40,064 | $ | 34,267 | |||
Real estate owned (REO) | 9,352 | 7,000 | ||||
Total non-performing assets | $ | 49,416 | $ | 41,267 | ||
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Impaired loans were as follows as of September 30, 2009 (in thousands):
Period-end impaired loans with no allowance for loan losses allocated | $ | 16,787 | |
Period-end impaired loans with allowance for loan losses allocated | 27,077 | ||
Total | $ | 43,864 | |
Amount of the allowance allocated to impaired loans | $ | 7,797 |
Impaired loans were as follows as of December 31, 2008 (in thousands):
Period-end impaired loans with no allowance for loan losses allocated | $ | 6,734 | |
Period-end impaired loans with allowance for loan losses allocated | 20,812 | ||
Total | $ | 27,546 | |
Amount of the allowance allocated to impaired loans | $ | 6,030 |
Three Months Ended September 30, 2009 | Nine Months Ended September 30, 2009 | |||||
(in thousands) | ||||||
Average of impaired loans during the period | $ | 39,945 | $ | 33,869 | ||
Interest income recognized during the period | 219 | 549 | ||||
Cash-basis interest income recognized | 219 | 518 |
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11. Mortgage Banking
Net revenues from the sales and servicing of mortgage loans consisted of the following:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(in thousands) | ||||||||||||||||
Gain from sale of mortgage loans | $ | 1,541 | $ | 624 | $ | 7,276 | $ | 2,808 | ||||||||
Mortgage loans servicing revenue (expense): | ||||||||||||||||
Mortgage loans servicing revenue | 725 | 691 | 2,109 | 1,839 | ||||||||||||
Amortization of mortgage servicing rights | (514 | ) | (268 | ) | (2,625 | ) | (1,008 | ) | ||||||||
Mortgage servicing rights valuation adjustments | (772 | ) | (36 | ) | 917 | (12 | ) | |||||||||
(561 | ) | 387 | 401 | 819 | ||||||||||||
Net revenue from sale and servicing of mortgage loans | $ | 980 | $ | 1,011 | $ | 7,677 | $ | 3,627 | ||||||||
The unpaid principal balance of residential mortgage loans serviced for third parties was $1.2 billion for September 30, 2009 and $1.1 billion for September 30, 2008.
Activity for capitalized mortgage servicing rights and the related valuation allowance follows for the nine months ended September 30, 2009 and for the year ended December 31, 2008:
September 30, 2009 | December 31, 2008 | |||||||
(in thousands) | ||||||||
Mortgage servicing assets: | ||||||||
Balance at beginning of period | $ | 9,403 | $ | 6,089 | ||||
Loans sold, servicing retained | 3,447 | 1,450 | ||||||
Fair value of servicing assets acquired from Pavilion | — | 3,130 | ||||||
Amortization | (2,625 | ) | (1,266 | ) | ||||
Carrying value before valuation allowance at end of period | 10,225 | 9,403 | ||||||
Valuation allowance: | ||||||||
Balance at beginning of period | (2,792 | ) | (116 | ) | ||||
Impairment recovery (charges) | 917 | (2,676 | ) | |||||
Balance at end of period | (1,875 | ) | (2,792 | ) | ||||
Net carrying value of MSRs at end of period | $ | 8,350 | $ | 6,611 | ||||
Fair value of MSRs at end of period | $ | 8,350 | $ | 6,611 | ||||
Amortization of mortgage servicing rights is computed based on payments and payoffs of the related mortgage loans serviced. Estimates of future amortization expense are not easily estimable.
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12. Deposits
A summary of deposit balances is as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||
Non-interest-bearing checking accounts | $ | 174,145 | $ | 176,063 | ||
Interest-bearing checking and money market accounts | 477,566 | 374,488 | ||||
Savings accounts | 132,333 | 132,146 | ||||
Retail certificates of deposit less than $100,000 | 544,957 | 578,244 | ||||
Retail certificates of deposit greater than $100,000 | 166,787 | 170,485 | ||||
Brokered or national certificates of deposit | 47,297 | 38,486 | ||||
$ | 1,543,085 | $ | 1,469,912 | |||
13. Borrowings
First Defiance’s debt, Federal Home Loan Bank (“FHLB”) advances and junior subordinated debentures owed to unconsolidated subsidiary trusts are comprised of the following:
September 30, 2009 | December 31, 2008 | |||||
(in thousands) | ||||||
FHLB Advances: | ||||||
Overnight borrowings | $ | — | $ | 9,100 | ||
Single maturity fixed rate advances | 35,000 | 10,000 | ||||
Single maturity LIBOR based advances | 20,000 | 45,000 | ||||
Putable advances | 64,000 | 64,000 | ||||
Strike-rate advances | 27,000 | 27,000 | ||||
Amortizable mortgage advances | 937 | 967 | ||||
Total | $ | 146,937 | $ | 156,067 | ||
Junior subordinated debentures owed to unconsolidated subsidiary trusts | $ | 36,083 | $ | 36,083 | ||
The putable advances can be put back to the Company at the option of the FHLB on a quarterly basis. $14.0 million of the putable advances with a weighted average rate of 2.69% are not yet callable by the FHLB. The call dates for these advances range from January 14, 2010 to February 11, 2011 and the maturity dates range from February 11, 2013 to March 12, 2018. The FHLB has the option to call the remaining $50.0 million of putable advances with a weighted average rate of 5.01%. The maturity dates of these advances range from September 1, 2010 to January 14, 2015. The strike-rate advances are putable at the option of the FHLB only when the three month LIBOR rates exceed the agreed upon strike-rate in the advance contract which ranges from 7.5% to 8.0%. The three month LIBOR rate at September 30, 2009 was 0.29%. The weighted average rate of the strike-rate advances is 4.18% and the maturity dates range from March 8, 2011 to February 25, 2013.
In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (Trust Affiliate II) that issued $15 million of Guaranteed Capital Trust Securities (Trust Preferred Securities). In connection with this transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) to Trust Affiliate II. The Company formed Trust Affiliate II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a fixed rate equal to 6.441% for the first five years and a floating interest rate based on three-month LIBOR plus 1.50% points, repricing quarterly, thereafter.
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The Company also sponsored an affiliated trust, First Defiance Statutory Trust I (Trust Affiliate I), that issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Junior Debentures held by Trust Affiliate I are the sole assets of the trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.38%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate I was 1.68% and 3.38% on September 30, 2009 and December 31, 2008 respectively.
The Trust Preferred Securities issued by Trust Affiliates I and II are subject to mandatory redemption, in whole or part, upon repayment of the Subordinated Debentures. The Company has entered into agreements that fully and unconditionally guarantee the Trust Preferred Securities subject to the terms of the guarantees. The Trust Preferred Securities and Subordinated Debentures issued by Trust Affiliate I mature on December 15, 2035 but may be redeemed by the issuer at par after October 28, 2010. The Trust Preferred Securities issued by Trust Affiliate II mature on June 15, 2037, but may be redeemed at the Company’s option at any time on or after June 15, 2012, or at any time upon certain events.
A summary of all junior debentures issued by the Company to affiliates follows. These amounts represent the par value of the obligations owed to these affiliates, including the Company’s equity interest in the trusts. Junior subordinated debentures owed to the following affiliates were as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||
First Defiance Statutory Trust I due December 2035 | $ | 20,619 | $ | 20,619 | ||
First Defiance Statutory Trust II due June 2037 | 15,464 | 15,464 | ||||
Total junior subordinated debentures owed to unconsolidated subsidiary Trusts | $ | 36,083 | $ | 36,083 | ||
Interest on both issues of trust preferred securities may be deferred for a period of up to five years at the option of the issuer.
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14. Commitments, Guarantees and Contingent Liabilities
Loan commitments are made to accommodate the financial needs of 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 as of the periods stated below were as follows (in thousands):
September 30, 2009 | December 31, 2008 | |||||||||||
Fixed Rate | Variable Rate | Fixed Rate | Variable Rate | |||||||||
Commitments to make loans | $ | 49,240 | $ | 76,857 | $ | 22,710 | $ | 70,114 | ||||
Unused lines of credit | 35,422 | 206,301 | 44,535 | 211,291 | ||||||||
Standby letters of credit | 270 | 20,195 | 67 | 18,860 | ||||||||
Total | $ | 84,932 | $ | 303,353 | $ | 67,312 | $ | 300,265 | ||||
Commitments to make loans are generally made for periods of 60 days or less.
In addition to the above commitments, First Defiance had commitments to sell $44.1 million and $72.9 million of loans to Freddie Mac, Fannie Mae, Federal Home Loan Bank of Cincinnati or BB&T Mortgage at September 30, 2009 and December 31, 2008, respectively.
15. 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. A description of employees or former employees eligible for coverage is included in Footnote 16 in the financial statements included in First Defiance’s 2008 Annual Report on Form 10-K.
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Net periodic postretirement benefit costs include the following components for the three and nine-month periods ended September 30, 2009 and 2008:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
(In Thousands) | ||||||||||||
Service cost-benefits attributable to service during the period | $ | 15 | $ | 13 | $ | 45 | $ | 39 | ||||
Interest cost on accumulated post-retirement benefit obligation | 41 | 37 | 124 | 110 | ||||||||
Net amortization and deferral | 14 | 15 | 42 | 46 | ||||||||
Net periodic postretirement benefit cost | $ | 70 | $ | 65 | $ | 211 | $ | 195 | ||||
16. Income Taxes
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for the years before 2005.
17. Derivative Financial Instruments
The Company adopted SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment to FASB Statement No. 133,” on January 1, 2009 which was codified into FASB ASC Topic 815, “Derivatives and Hedging,” and has included here the expanded disclosures required by that statement.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts (“forward contracts”) and rate lock loan commitments. The fair value of the Company’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.
The table below provides data about the carrying values of derivative instruments:
September 30, 2009 | December 31, 2008 | |||||||||||||||||||
Assets | (Liabilities) | Assets | (Liabilities) | |||||||||||||||||
Carrying Value | Carrying Value | Derivative Net Carrying Value | Carrying Value | Carrying Value | Derivative Net Carrying Value | |||||||||||||||
(In Thousands) | ||||||||||||||||||||
Derivatives not designated as hedging instruments | ||||||||||||||||||||
Mortgage Banking Derivatives | $ | 994 | $ | (418 | ) | $ | 576 | $ | 1,264 | $ | (166 | ) | $ | 1,098 | ||||||
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The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||
(in thousands) | |||||||||||||
Derivatives not designated as hedging instruments | |||||||||||||
Mortgage Banking Derivatives – Gain (Loss) | $ | 37 | $ | — | $ | (522 | ) | $ | — | ||||
18. Subsequent Events
The Company evaluated subsequent events up to and through November 9, 2009, which is the date the financial statements were issued. As a result of that evaluation, no subsequent events were identified that required recognition or disclosure in the financial statements.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
First Defiance Financial Corp. (“First Defiance” or “the Company”) is a unitary thrift holding company that conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal”) and First Insurance and Investments, Inc. (“First Insurance”). First Federal is a federally chartered savings bank that provides financial services through 35 full-service branches in communities based in northwest Ohio, northeast Indiana, and southeastern Michigan. On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc. (“Pavilion”), which added eight banking centers in southeast Michigan, expanding the Company’s reach to markets adjacent to its existing branch network. 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 offices in Defiance and Bowling Green, Ohio while investment and annuity products are sold through registered investment representatives located at certain First Federal banking center locations.
First Defiance invests in U.S. Treasury and federal government agency obligations, obligations of municipal and other political subdivisions, mortgage-backed securities which are issued by federal agencies, corporate bonds, and collateralized mortgage obligations (“CMOs”) and real estate mortgage investment conduits (“REMICs”). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB ASC Topic 320.
Securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the security to maturity. Held-to-maturity securities are stated at amortized cost and had a recorded value of $1,697,000 at September 30, 2009. Securities not classified as held-to-maturity are classified as available-for-sale, which are stated at fair value and had a recorded value of $127.0 million at September 30, 2009. The available-for-sale portfolio consists of obligations of U.S. Government corporations and agencies ($13.4 million), certain municipal obligations ($45.1 million), CMOs and REMICs ($34.5 million), mortgage backed securities ($32.0 million) and trust preferred stock ($2.0 million).
In accordance with ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income.
In order to properly assess the collateral dependent loans included in its loan portfolio, the Company has established policies regarding the monitoring of the collateral underlying such loans. The Company requires an appraisal that is less than one year old for all new collateral dependent real estate loans, and all renewed collateral dependent real estate loans where new money is extended. The appraisal process is handled by the Credit Department, which selects the appraiser and orders the appraisal. First Defiance’s loan policy prohibits the account officer from talking or communicating with the appraiser to insure that the appraiser is not influenced by the account officer in any way in making their determination of value.
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First Federal generally does not require updated appraisals for performing loans unless new money is requested by the borrower.
When a collateral dependent loan is downgraded to classified status, First Federal reviews the most current appraisal on file and if necessary, based on First Federal’s assessment of the appraisal, such as age, market, etc, First Federal will discount this amount to a more appropriate current value based on inputs from lenders and realtors. This amount may then be discounted further by First Federal’s estimation of the carrying and selling costs. Finally, First Federal assesses whether there is any collateral short fall, considering guarantor support, and determines if a reserve is necessary.
When a collateral dependent loan moves to non-performing status, First Federal generally gets a new third party appraisal and adjusts the reserve as necessary based upon the new appraisal and an estimate of costs to liquidate the collateral. All properties that are moved into the Other Real Estate Owned “OREO”) category are supported by current appraisals, and the OREO is carried at the appraised value less First Federal’s estimate of the liquidation costs.
First Federal does not adjust any appraisals upward without written documentation of this valuation change from the appraiser. When setting reserves on classified loans, appraisal values may be discounted downward based upon First Federal’s experience with liquidating similar properties.
All collateral dependent loans over 90 days past due and or on non-accrual as well as all Troubled Debt Restructured collateral dependent loans are classified as non-performing loans. Non-performing status automatically occurs in the month in which the 90 day delinquency occurs. For Troubled Debt Restructured collateral dependent loans, the loans are put into non-performing status in the month in which the restructure occurs.
As stated above, once a collateral dependent loan is identified as non-performing, First Federal generally gets an appraisal. Troubled Debt Restructure collateral dependent loans receive an appraisal as part of the restructure credit decision.
Appraisals are received within approximately 60 days after they are requested. The First Federal Loan Loss Reserve Committee reviews each new appraisal and makes any necessary adjustment to the reserve at its meeting prior to the end of each quarter.
Any partially charged-off collateral dependent loans are considered non-performing, and as such, would need to show an extended period of time with satisfactory payment performance as well as cash flow coverage capability supported by current financial statements before First Federal will consider an upgrade to performing status. If the loan maintains a rate at restructuring that is lower than the market rate for similar credits, the loan will remain classified as a Troubled Debt Restructuring until such time as it is paid off or restructured at prevailing rates and terms. First Federal may consider moving the loan to an accruing status after six months of satisfactory payment performance.
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For loans where First Federal determines that an updated appraisal is not necessary, other means are used to verify the value of the real state, such as recent sales of similar properties on which First Federal had loans as well as calls to appraisers, brokers, realtors, and investors. First Federal monitors and tracks its reserves quarterly to determine accuracy. Based on these results, changes may occur in the processes used. The recent analysis indicates that First Federal is within its target range of the ultimate losses on liquidated loans being on average within 10% of the specific reserves established for these loans.
Loan modifications constitute a Troubled Debt Restructuring if First Federal for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that it would not otherwise consider. For loans that are considered Troubled Debt Restructurings, First Federal either computes the present value of expected future cash flows discounted at the original loan’s effective interest rate or, as a practical expedient, we may measure impairment based on the observable market price of the loan or the fair value of the collateral even though Troubled Debt Restructurings are not expected to be deemed collateral dependent. The difference between the carrying value and fair value of the loan is recorded as a valuation allowance.
The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, FHLB advances, and other borrowings. The Company’s non-interest income is mainly derived from service fees and other charges, mortgage banking income, and insurance commissions. First Defiance’s earnings also depend on the provision for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense.
Participation in the U.S. Treasury Capital Purchase Program
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (“EESA”), which creates the Troubled Asset Relief Program (“TARP”) and provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. The Capital Purchase Program (“CPP”) was announced by the U.S. Treasury on October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will purchase up to $250 billion of senior preferred shares on standardized terms from qualifying financial institutions. The purpose of the CPP is to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.
The CPP is voluntary and requires a participating institution to comply with a number of restrictions and provisions, including standards for executive compensation and corporate governance and limitations on share repurchases and the declaration and payment of dividends on common shares. The standard terms of the CPP require that a participating financial institution limit the payment of dividends to the most recent quarterly amount prior to October 14, 2008, which is $0.26 per share in the case of First Defiance. This dividend limitation will remain in effect until such time that the preferred shares are no longer outstanding.
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Eligible financial institutions could generally apply to issue senior preferred shares to the U.S. Treasury in aggregate amounts between 1% to 3% of the institution’s risk-weighted assets. In the case of First Defiance, an application was approved by the U.S. Treasury and on December 5, 2008, First Defiance issued $37.0 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (“Senior Preferred Shares”). The Senior Preferred Shares constitute Tier 1 capital and rank senior to First Defiance’s common shares. The Senior Preferred Shares pay cumulative dividends at a rate of 5% per annum for the first five years and will reset to a rate of 9% per annum after five years.
As part of its participation in the CPP, First Defiance also issued a warrant to the U.S. Treasury to purchase 550,595 common shares having an exercise price of $10.08 per share. The initial exercise price for the warrant and the market price for determining the number of common shares subject to the warrant was determined by reference to the market price of the common shares on the date of the investment by the U.S. treasury in the Senior Preferred Shares (calculated on a 20-day trailing average). The warrant has a term of 10 years.
Forward-Looking Information
Certain statements contained in this quarterly report are not historical facts, including but not limited to statements that can be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “anticipate”, or “continue” or the negative thereof or other variations thereon or comparable terminology are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21B of the Securities Act of 1934, as amended. Actual results could differ materially from those indicated in such statements due to risks, uncertainties and changes with respect to a variety of market and other factors.
Changes in Financial Condition
At September 30, 2009, First Defiance’s total assets, deposits and stockholders’ equity amounted to $2.02 billion, $1.54 billion and $234.5 million, respectively, compared to $1.96 billion, $1.47 billion and $229.2 million, respectively, at December 31, 2008.
Net loans receivable (excluding loans held for sale) remained flat at $1.59 billion at September 30, 2009 compared to December 31, 2008. The variances in loans receivable between December 31, 2008 and September 30, 2009 included decreases in residential real estate loans (down $17.8 million), home equity and improvement loans (down $10.7 million), construction loans (down $19.3 million), and consumer loans (down $4.6 million) while commercial loans increased $15.3 million and commercial real estate loans increased $46.7 million.
The investment securities portfolio increased $10.2 million to $128.7 million at September 30, 2009 from $118.5 million at December 31, 2008. The increase is the result of $33.0 million of securities being purchased during the first nine months of 2009 partially offset by $5.9 million of securities being matured or called in the period, principal pay downs of $12.2 million in CMOs and mortgage-backed securities, and $6.1 million of securities being sold. There was an unrealized gain in the investment portfolio of $1.9 million at September 30, 2009 compared to an unrealized loss of $1.7 million at December 31, 2008.
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Deposits increased from $1.47 billion at December 31, 2008 to $1.54 billion as of September 30, 2009. Of the $73.2 million increase, interest-bearing demand deposits and money market accounts increased $103.1 million to $477.6 million and broker/national certificates of deposit increased $8.8 million to $47.3 million. These increases were slightly offset by a decline in retail time deposits of $37.0 million to $711.7 million and non-interest-bearing demand deposits decreased $1.9 million to $174.1 million. Savings accounts remained relatively flat at $132.3 million as of September 30, 2009 when compared to December 31, 2008.
FHLB advances decreased $9.1 million to $146.9 million at September 30, 2009 from $156.1 million at December 31, 2008. The decrease is attributable to a $9.1 million decrease in overnight advances due in large part from the growth in deposits.
Stockholders’ equity increased from $229.2 million at December 31, 2008 to $234.5 million at September 30, 2009. The increase is primarily the result of recording net income of $6.6 million and a $2.3 million unrealized gain on available-for-sale securities partially offset by $2.4 million of cash dividends declared on common stock and $1.4 million of accrued dividends on preferred stock.
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Average Balances, Net Interest Income and Yields Earned and Rates Paid
The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in thousands of dollars and rates, and the net interest margin. The table reports interest income from tax-exempt loans and investment on a tax-equivalent basis. All average balances are based upon daily balances.
Three Months Ended September 30, | ||||||||||||||||||
2009 | 2008 | |||||||||||||||||
Average Balance | Interest(1) | Yield/ Rate(2) | Average Balance | Interest(1) | Yield/ Rate(2) | |||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans receivable | $ | 1,613,529 | $ | 23,812 | 5.85 | % | $ | 1,585,489 | $ | 24,934 | 6.26 | % | ||||||
Securities | 130,673 | 1,685 | 5.08 | 118,502 | 1,636 | 5.31 | ||||||||||||
Interest-earning deposits | 60,822 | 41 | 0.27 | 2,231 | 5 | 0.89 | ||||||||||||
FHLB stock and other | 21,376 | 258 | 4.79 | 21,121 | 301 | 5.67 | ||||||||||||
Total interest-earning assets | 1,826,400 | 25,796 | 5.60 | 1,727,343 | 26,876 | 6.18 | ||||||||||||
Non-interest-earning assets | 203,570 | 201,644 | ||||||||||||||||
Total assets | $ | 2,029,970 | $ | 1,928,987 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Deposits | $ | 1,374,441 | $ | 6,163 | 1.78 | % | $ | 1,268,016 | $ | 7,658 | 2.40 | % | ||||||
FHLB advances and other | 146,941 | 1,267 | 3.42 | 174,343 | 1,603 | 3.66 | ||||||||||||
Subordinated debentures | 36,228 | 344 | 3.77 | 36,228 | 461 | 5.06 | ||||||||||||
Notes payable | 44,685 | 140 | 1.24 | 64,368 | 555 | 3.43 | ||||||||||||
Total interest-bearing liabilities | 1,602,295 | 7,914 | 1.96 | 1,542,955 | 10,277 | 2.65 | ||||||||||||
Non-interest bearing deposits | 175,928 | — | 169,257 | — | ||||||||||||||
Total including non-interest bearing demand deposits | 1,778,223 | 7,914 | 1.77 | 1,712,212 | 10,277 | 2.39 | ||||||||||||
Other non-interest-bearing liabilities | 17,506 | 22,323 | ||||||||||||||||
Total liabilities | 1,795,729 | 1,734,535 | ||||||||||||||||
Stockholders’ equity | 234,241 | 194,452 | ||||||||||||||||
Total liabilities and stock- holders’ equity | $ | 2,029,970 | $ | 1,928,987 | ||||||||||||||
Net interest income; interest rate spread | $ | 17,882 | 3.64 | % | $ | 16,599 | 3.53 | % | ||||||||||
Net interest margin (3) | 3.88 | % | 3.81 | % | ||||||||||||||
Average interest-earning assets to average interest-bearing liabilities | 114 | % | 112 | % | ||||||||||||||
(1) | Interest on certain tax-exempt loans and securities is not taxable for Federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%. |
(2) | Annualized |
(3) | Net interest margin is net interest income divided by average interest-earning assets. |
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Nine Months Ended September 30, | ||||||||||||||||||
2009 | 2008 | |||||||||||||||||
Average Balance | Interest(1) | Yield/ Rate(2) | Average Balance | Interest(1) | Yield/ Rate(2) | |||||||||||||
Interest-earning assets: | ||||||||||||||||||
Loans receivable | $ | 1,600,878 | $ | 70,333 | 5.87 | % | $ | 1,485,455 | $ | 72,297 | 6.50 | % | ||||||
Securities | 126,883 | 5,145 | 5.36 | 118,908 | 4,959 | 5.50 | ||||||||||||
Interest-earning deposits | 63,093 | 89 | 0.19 | 6,311 | 119 | 2.52 | ||||||||||||
FHLB stock and other | 21,376 | 726 | 4.54 | 20,199 | 797 | 5.27 | ||||||||||||
Total interest-earning assets | 1,812,230 | 76,293 | 5.61 | 1,630,873 | 78,172 | 6.40 | ||||||||||||
Non-interest-earning assets | 202,008 | 193,324 | ||||||||||||||||
Total assets | $ | 2,014,238 | $ | 1,824,197 | ||||||||||||||
Interest-bearing liabilities: | ||||||||||||||||||
Deposits | $ | 1,366,645 | $ | 20,206 | 1.98 | % | $ | 1,210,631 | $ | 23,851 | 2.63 | % | ||||||
FHLB advances and other | 146,994 | 3,865 | 3.52 | 161,891 | 4,803 | 3.96 | ||||||||||||
Subordinated debentures | 36,241 | 1,139 | 4.19 | 36,245 | 1,445 | 5.33 | ||||||||||||
Notes payable | 42,446 | 433 | 1.36 | 48,018 | 1,217 | 3.39 | ||||||||||||
Total interest-bearing liabilities | 1,592,326 | 25,643 | 2.15 | 1,456,785 | 31,316 | 2.87 | ||||||||||||
Non-interest bearing deposits | 172,341 | — | 155,000 | — | ||||||||||||||
Total including non-interest bearing demand deposits | 1,764,667 | 25,643 | 1.94 | 1,611,785 | 31,316 | 2.60 | ||||||||||||
Other non-interest-bearing liabilities | 17,659 | 25,082 | ||||||||||||||||
Total liabilities | 1,782,326 | 1,636,867 | ||||||||||||||||
Stockholders’ equity | 231,912 | 187,330 | ||||||||||||||||
Total liabilities and stock-holders’ equity | $ | 2,014,238 | $ | 1,824,197 | ||||||||||||||
Net interest income; interest rate spread | $ | 50,650 | 3.46 | % | $ | 46,856 | 3.53 | % | ||||||||||
Net interest margin (3) | 3.73 | % | 3.83 | % | ||||||||||||||
Average interest-earning assets to average interest-bearing liabilities | 114 | % | 112 | % | ||||||||||||||
(1) | Interest on certain tax-exempt loans and securities is not taxable for Federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%. |
(2) | Annualized |
(3) | Net interest margin is net interest income divided by average interest-earning assets. |
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Results of Operations
Three Months Ended September 30, 2009 and 2008
On a consolidated basis, First Defiance’s net income for the quarter ended September 30, 2009 was $329,000 compared to income of $322,000 for the comparable period in 2008. Net income applicable to common shares was a loss of $(184,000) for the third quarter of 2009. On a per share basis, basic and diluted earnings per common share for the three months ended September 30, 2009 were both $(0.02), compared to basic and diluted earnings per common share of $0.04 for the quarter ended September 30, 2008.
Net Interest Income.
The Company’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. Net interest income is the Company’s largest source of revenue, representing 76.0% of total revenue during the third quarter of 2009. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The federal funds rate, which is the cost of immediately overnight funds and established by the Federal Reserve Board’s Open Market Committee, began 2008 at 4.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 0.25%. During the third quarter of 2009, the federal funds rate did not change ending the quarter at 0.25%. The federal funds rate drives the Company’s prime rate, which is used to price a substantial balance of loans in the commercial and home equity portfolios. The prime interest rate began 2008 at 7.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 3.25%. During the third quarter of 2009, the prime interest rate did not change ending the quarter at 3.25%. First Defiance effectively managed the impact of the change in the prime rate by reducing its deposit rates and by changing the mix of its interest-bearing liabilities.
Net interest income was $17.6 million for the third quarter of 2009 compared to $16.4 million in the third quarter of 2008. For the third quarter of 2009, total interest income was $25.5 million, a $1.2 million decrease from the third quarter of 2008. The decline in total interest income is the result of the decline in loan yields from period to period.
Interest expense was $7.9 million for the third quarter of 2009 compared to $10.3 million in the third quarter of 2008. The majority of the decrease in interest expense occurred in interest-bearing deposits, where despite average balances increasing $106.4 million to $1.37 billion for the third quarter of 2009, the cost of that funding decreased 0.62% between the 2008 and 2009 third quarters, to 1.78% from 2.40%.
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Net interest margin for the quarter ended September 30, 2009 was 3.88%, a 0.07% increase from the 2008 third quarter margin of 3.81%. The Company’s interest rate spread increased as well to 3.64% in the 2009 third quarter compared to 3.53% in the same 2008 quarterly period. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. In this low rate environment, management’s attention will be to focus on a disciplined pricing strategy to strengthen the net interest margin for the remainder of 2009.
Provision for Loan Losses.
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio in the normal course of business. The allowance for loan loss is made up of two basic components. The first component is the specific allowance in which the company sets aside reserves based on the analysis of individual credits. The second component is the general reserve. The general reserve is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolios based on quantitative and qualitative factors. Due to the uncertainty of risks in the loan portfolio, the Company’s judgment on the amount of the allowance necessary to adsorb loans losses is approximate. The table on page 51 presents the allocation of the specific and general components of the allowance by signification loan types.
In establishing specific reserves, First Federal analyzes all loans on its classified and special mention lists at least quarterly and makes judgments about the risk of loss based on the cash flow of the borrower, the value of any collateral, and the financial strength of any guarantor in determining the amount of impairment of individual loans and the specific reserve to be recorded.
For purpose of the general reserve analysis, the loan portfolio is stratified into ten different loan pools based on loan type and by market area to allocate historic loss experience. The loss experience factor applied to the non-impaired loan portfolio was based upon historical losses of the most recent four quarters.
The stratification of the loan portfolio resulted in a quantitative general allowance of $10.2 million at September 30, 2009 compared to $9.9 million at June 30, 2009. The increase in the quantitative allowance from second quarter 2009 to third quarter 2009 was due to the increase in the historical loss factors relating to commercial and commercial real estate loans.
In addition to the quantitative analysis, a qualitative analysis is performed each quarter to provide additional general reserves on the non-impaired loan portfolio for various factors that have a bearing on its loss content, including but not limited to the following.
• | Changes in international, national and local economic and business conditions and developments, including the condition of various market segments |
• | Changes in the nature and volume of the loan portfolio |
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• | Changes in the trends of the volume and severity of past due and classified loans; and changes in trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications |
• | The existence and effect of any concentrations of credit and changes in the level of such concentrations |
• | Changes in the value of underlying collateral for collateral dependent loans |
• | Changes in the political and regulatory environment |
• | Changes in lending policies and procedures, including underwriting standards, and collection, charge-off and recovery practices |
• | Changes in the experience, ability and depth of lending management and staff |
• | Changes in the quality and breadth of the loan review process |
The qualitative analysis for the third quarter of 2009 indicated a general reserve of $8.6 million at September 30, 2009 compared with $4.3 million at June 30, 2009. In light of the continued environment of high unemployment, declining real estate values and sustained economic weakness in the Midwest, management feels it is prudent to build our general loan loss reserves.Out of the fifteen counties that represent the footprint of the Company, only one County in Ohio, Ottawa, seen an improvement in its unemployment rate in 2009. The following are the unemployment rates for August 2009 and December 2008. August 2009 was the latest available information consistently provided for Ohio, Michigan and Indiana. The unemployment rates in August 2009 for the following counties in Ohio were; Allen 11.1%, Defiance 13.1%, Fulton 13.2%, Hancock 10.3%, Henry 12.0%, Lucas 12.4%, Ottawa 11.5%, Paulding 13.2%, Putnam 10.2%, Seneca 12.9%, Williams 15.9%, Wood 11.1%, compared to December 2008 in Allen 9.1%, Defiance 9.6%, Fulton 10.5%, Hancock 7.8%, Henry 10.6%, Lucas 10.1%, Ottawa 12.5%, Paulding 9.6%, Putnam 7.6%, Seneca 9.2%, Williams 11.0%, Wood 8.4%. The Company operates in two counties in Michigan, Hillsdale and Lenawee. The unemployment rate in Hillsdale County was 17.8% in August 2009 compared to 13.2% in December 2008 and the unemployment rate in Lenawee County was 16.5% in August 2009 compared to 12.4% in December 2008. The Company operates in one County in Indiana, Allen, which had an unemployment rate of 9.9% in August 2009 compared to 8.1% in December 2008.
The Company also received the results of a regularly scheduled examination completed on September 9, 2009 and incorporated the results of that examination in its consideration of the qualitative portion of the allowance. The inputs from the examination focused on the continued uncertainty surrounding collateral values as well as the overall directional trend of the allowance in relationship to non-performing loans and classified assets. In the aggregate, the impact to the qualitative reserve was $2.2 million.
As a result of the quantitative and qualitative analyses, the Company’s provision for loan losses for the quarter ended September 30, 2009 was $8.1 million, compared to $ 4.9 million for the quarter ended September 30, 2008. The large change this quarter was impacted by the overall increased unemployment rates in the Company’s markets, as discussed above, as well as high levels of non-performing loans, delinquencies and classified assets, particularly in the
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commercial and commercial real estate categories as indicated in the tables on pages 52 through 55. The provision was offset by net-charge offs of $1.5 million against specific reserves and $1.2 million against general reserves, resulting in an increase to the overall allowance for loan loss of $5.4 million in the third quarter. In management’s opinion, the overall allowance for loan and lease losses of $31.2 million as of September 30, 2009 is adequate.
Non-performing assets, which include non-accrual loans, accruing restructured loans and real estate owned, increased to $49.4 million at September 30, 2009 from $30.3 million at September 30, 2008 and from $41.3 million at December 31, 2008. Non-performing assets and asset quality ratios for First Defiance were as follows at September 30, 2009 and December 31, 2008:
September 30, 2009 | December 31, 2008 | |||||||
(in thousands) | ||||||||
Non-accrual loans | $ | 35,490 | $ | 28,017 | ||||
Restructured loans, accruing | 4,574 | 6,250 | ||||||
Total non-performing loans | $ | 40,064 | $ | 34,267 | ||||
Real estate owned (REO) | 9,352 | 7,000 | ||||||
Total non-performing assets | $ | 49,416 | $ | 41,267 | ||||
Allowance for loans losses as a percentage of total loans | 1.92 | % | 1.52 | % | ||||
Allowance for loan losses as a percentage of non-performing assets | 63.23 | % | 59.59 | % | ||||
Allowance for loan losses as a percentage of non-performing loans | 78.00 | % | 71.77 | % | ||||
Total non-performing assets as a percentage of total assets | 2.45 | % | 2.11 | % | ||||
Total non-performing loans as a percentage of total loans | 2.47 | % | 2.12 | % |
Of the $35.5 million in non-accrual loans, $6.1 million were 1-4 family residential loans, $28.8 million were commercial or commercial real estate loans and $0.6 million were home equity or consumer loans.
First Federal’s Asset Review Committee meets monthly to review the status of work-out strategies for all criticized relationships, which include all non-accrual loans. Based on such factors as anticipated collateral values in liquidation scenarios, cash flow projections, assessment of net worth of guarantors and all other factors which may mitigate risk of loss, the Asset Review Committee makes recommendations regarding required allowances and proposed charge-offs which are approved by the Senior Loan Committee (in the case of charge-offs) or the Loan Loss Reserve Committee (in the case of specific allowances). At September 30, 2009 the specific allowance for loan losses recorded against the $28.8 million of non-accrual commercial and commercial real estate loans totaled $6.1 million.
Charge-offs for the third quarter of 2009 were $2.8 million and recoveries of previously charged off loans totaled $146,000 for net charge-offs of $2.6 million. By comparison, $2.3 million of charge-offs were recorded in the 2008 third quarter and $101,000 of recoveries were realized for net charge-offs of $2.2 million. As a percentage of average loans, annualized net charge-offs were 0.66% for the third quarter of 2009 compared to 0.55% in the same period of 2008.
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Of the $2.8 million charge-offs in the third quarter 2009, $2.2 million were related specifically to eight credit relationships. Of the $1.2 million commercial real estate charge-offs, $989,000 or 86% related to those credit relationships. Of the $658,000 in commercial charge-offs, $627,000 or 95% related to those credit relationships.
The following table discloses charge-offs, recoveries and provision expense for the quarter ended September 30, 2009 by loan category ($ in thousands).
Quarter Ended September 30, 2009 | Commercial Real Estate | Commercial | Consumer | Residential | Home Equity and improvement | Total | ||||||||||||||||||
Allowance for loans individually evaluated | ||||||||||||||||||||||||
Beginning Specific Allocations | $ | 5,492 | $ | 2,205 | $ | 64 | $ | 2,495 | $ | 350 | $ | 10,606 | ||||||||||||
Charge-Offs | (1,030 | ) | (157 | ) | (6 | ) | (244 | ) | (47 | ) | (1,484 | ) | ||||||||||||
Recoveries | — | — | — | — | — | — | ||||||||||||||||||
Provisions | 1,687 | 542 | 39 | 737 | 284 | 3,289 | ||||||||||||||||||
Ending Specific Allocations | $ | 6,149 | $ | 2,590 | $ | 97 | $ | 2,988 | $ | 587 | $ | 12,411 | ||||||||||||
Allowance for loans collectively evaluated | ||||||||||||||||||||||||
Beginning General Allocations | $ | 7,425 | $ | 3,603 | $ | 608 | $ | 2,341 | $ | 1,257 | $ | 15,234 | ||||||||||||
Charge-Offs | (122 | ) | (501 | ) | (33 | ) | (500 | ) | (149 | ) | (1,305 | ) | ||||||||||||
Recoveries | 29 | 48 | 45 | 24 | — | 146 | ||||||||||||||||||
Provisions | 2,626 | 1,443 | (99 | ) | 655 | 137 | 4,762 | |||||||||||||||||
Ending General Allocations | $ | 9,958 | $ | 4,593 | $ | 521 | $ | 2,520 | $ | 1,245 | $ | 18,837 | ||||||||||||
Significant provisions for loan losses were recorded in the third quarter of 2009 on the following credits;
• | A relationship totaling $3.38 million in loans secured by all business assets of a trucking company including titled trucks and trailers. These loans were originated in July of 2006 in the lower region of Michigan. These loans were part of the March 2008 acquisition of Pavilion. In the third quarter of 2009, a $500,000 specific reserve was allocated to the allowance for this credit as a result of the company’s financial results received through June 2009. In receipt of this information, management decided to lower the value of collateral as a best estimate to the true value of the collateral. Currently, all account receivables are valued at 80%, inventory, which includes parts and supplies, are valued at 50%, and trucks, trailers and equipment is valued at 70%. |
• | A $907,000 individual mortgage loan secured by a home in the lower region of Michigan. This loan was part of the March 2008 acquisition of Pavilion. In the third quarter of 2009, a $453,000 specific reserve was allocated to the allowance for this credit based on a realtor’s opinion of value. |
• | A relationship of 6 loans to one borrower totaling $1.11 million secured by investment properties in northwest Ohio and Florida. These loans were originated between December 2003 and July 2008. Due to the falling market, the loans are under collateralized and, during the third quarter of 2009, a $400,000 specific reserve was allocated to the allowance for this credit for a total reserve on this relationship of |
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$600,000. The specific reserve was the result of the lender’s best estimate of value and then discounted using 80% of the lender’s estimate. A new appraisal has been ordered and will be reviewed when received and adjustments made accordingly if any are required. |
• | A relationship of 6 loans totaling $1.63 million secured by commercial rental real estate and all business assets of a medical practice. These loans were originated between July 2002 and September 2007. These loans were part of the Pavilion acquisition. Due to loss of tenants and the borrower’s inability to lease the real estate, during the third quarter of 2009, a $313,000 specific reserve was allocated to the allowance for this credit for a total reserve on this relationship of $597,000. The specific reserve was the result of management’s best estimate of the current value based on discussions with realtors as well as reviewing recent market transaction. The result is an overall discount of 47% of the last appraisal, done in October 2004. Management believes that is analysis is directionally consistent with collateral value declines in this market and weighted current information more heavily in determining the value. This is management’s best estimate with the current information. A new appraisal has been ordered and will be reviewed when received and adjustments, if any, will be made accordingly. |
• | A relationship of 3 loans totaling $3.56 million in loans, a majority of which is secured by equipment. The borrower’s main line of business is in commercial and residential cement/masonry, foundations and driveways in Southeastern Michigan. These loans were originated between September 2004 and March 2008. These loans were part of the Pavilion acquisition. Due to a slowing of the economy in the Michigan area, the borrower’s inability to produce sufficient cash flow, and the decline in collateral values, during the third quarter of 2009, a $250,000 specific reserve has been allocated to the allowance for this credit. Because of the continued deterioration in Southeastern Michigan, management’s best estimate was to reduce the collateral value of the equipment to 60%. This equipment was appraised by an independent third party in February 2009. |
• | A relationship of 4 loans totaling $1.29 million in loans secured by developed lots. These loans were originated between May 2004 and July 2006. Due to lack of lot sales and declining values, during the third quarter of 2009, a $250,000 specific reserve has been allocated to the allowance for this credit. The specific reserve was the result of lowering the estimated lot sales price from approximately $70,000 per lot to $40,000 per lot due to the non-existence of lot sales in the subdivision at the higher lot value and an indication of realtor’s value in the third quarter of approximately $40,000 on an as is basis. The value of the lots is management’s best estimate of the current value using best available current data. A new appraisal has been ordered on the subdivision. The new appraisal will be reviewed when received and adjustments, if any, will be made accordingly. |
The following table details net charge-offs and nonaccrual loans by loan type. For the three months ended and as of September 30, 2009, commercial real estate, which represented 48.7% of total loans, accounted for 42.5% of net charge-offs and 65.6% of nonaccrual loans, and commercial loans, which represented 22.6% of total loans, accounted for 23.1% of net charge-offs and 15.7% of nonaccrual loans. For the three months ended and as of September 30, 2008, Commercial real estate, which represented 45.9% of total loans, accounted for 66.4% of net charge-offs and 55.8% of nonaccrual loans, and commercial loans, which represented 21.7% of total loans, accounted for (0.74)% of net charge-offs and 14.5% of nonaccrual loans.
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For the Three Months Ended September 30, 2009 | As of September 30, 2009 | ||||||||||||
Net Charge-offs | % of Total Net Charge-offs | Nonaccrual Loans | % of Total Non- Accrual Loans | ||||||||||
(in thousands) | (in thousands) | ||||||||||||
Residential | $ | 720 | 27.24 | % | $ | 5,839 | 16.45 | % | |||||
Construction | — | 0.00 | % | 194 | 0.55 | % | |||||||
Commercial real estate | 1,123 | 42.49 | % | 23,279 | 65.59 | % | |||||||
Commercial | 610 | 23.08 | % | 5,564 | 15.68 | % | |||||||
Consumer finance | (6 | ) | (0.23 | )% | 49 | 0.14 | % | ||||||
Home equity and improvement | 196 | 7.42 | % | 565 | 1.59 | % | |||||||
Total loans, net on unearned income | $ | 2,643 | 100.00 | % | $ | 35,490 | 100.00 | % | |||||
For the Three Months Ended September 30, 2008 | As of September 30, 2008 | ||||||||||||
Net Charge-offs | % of Total Net Charge-offs | Nonaccrual Loans | % of Total Non- Accrual Loans | ||||||||||
(in thousands) | (in thousands) | ||||||||||||
Residential | $ | 475 | 21.98 | % | $ | 5,400 | 21.93 | % | |||||
Construction | (4 | ) | (0.19 | )% | 1,489 | 6.05 | % | ||||||
Commercial real estate | 1,435 | 66.40 | % | 13,749 | 55.82 | % | |||||||
Commercial | (16 | ) | (0.74 | )% | 3,575 | 14.51 | % | ||||||
Consumer finance | 55 | 2.55 | % | 150 | 0.61 | % | |||||||
Home equity and improvement | 216 | 10.00 | % | 267 | 1.08 | % | |||||||
Total loans, net on unearned income | $ | 2,161 | 100.00 | % | $ | 24,630 | 100.00 | % | |||||
Credit Quality Profile
The following table discloses the period end balances for the loan portfolio by payment status as of September 30, 2009, June 30, 2009 and December 31, 2008 and selected loan trends for the past five quarters.
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(dollars in thousands) | Total Balance | Current and Performing | 30 to 89 days past due | Non Accrual Loans | Troubled Debt Restructuring | Non Accrual % | > 30 Days Past Due and Non Accrual % | ||||||||||||||
September 30, 2009 | |||||||||||||||||||||
Residential | $ | 233,958 | $ | 221,077 | $ | 4,637 | $ | 5,839 | $ | 2,405 | 2.50 | % | 4.48 | % | |||||||
Construction | 53,605 | 53,340 | 71 | 194 | — | 0.36 | % | 0.49 | % | ||||||||||||
Commercial real estate | 802,434 | 765,469 | 11,570 | 23,279 | 2,116 | 2.90 | % | 4.34 | % | ||||||||||||
Commercial | 371,881 | 363,739 | 2,525 | 5,564 | 53 | 1.50 | % | 2.18 | % | ||||||||||||
Consumer finance | 36,416 | 35,913 | 454 | 49 | — | 0.13 | % | 1.38 | % | ||||||||||||
Home equity and improvement | 150,379 | 147,031 | 2,783 | 565 | — | 0.38 | % | 2.23 | % | ||||||||||||
Total loans | $ | 1,648,673 | $ | 1,586,569 | $ | 22,040 | $ | 35,490 | $ | 4,574 | 2.15 | % | 3.49 | % | |||||||
Total Number of Loans | 22,807 | 22,215 | 322 | 235 | 35 | ||||||||||||||||
June 30, 2009 | |||||||||||||||||||||
Residential | $ | 238,000 | $ | 223,846 | $ | 5,594 | $ | 5,541 | $ | 3,019 | 2.33 | % | 4.68 | % | |||||||
Construction | 44,670 | 44,416 | 194 | 60 | — | 0.13 | % | 0.57 | % | ||||||||||||
Commercial real estate | 768,636 | 727,983 | 13,212 | 25,672 | 1,769 | 3.34 | % | 5.06 | % | ||||||||||||
Commercial | 382,434 | 375,007 | 3,781 | 3,589 | 57 | 0.94 | % | 1.93 | % | ||||||||||||
Consumer finance | 38,074 | 37,595 | 440 | 39 | — | 0.10 | % | 1.26 | % | ||||||||||||
Home equity and improvement | 151,213 | 147,975 | 2,611 | 627 | — | 0.41 | % | 2.14 | % | ||||||||||||
Total loans | $ | 1,623,027 | $ | 1,556,822 | $ | 25,832 | $ | 35,528 | $ | 4,845 | 2.19 | % | 3.78 | % | |||||||
Total Number of Loans | 23,106 | 22,522 | 333 | 219 | 32 | ||||||||||||||||
December 31, 2008 | |||||||||||||||||||||
Residential | $ | 251,807 | $ | 241,446 | $ | 4,677 | $ | 4,584 | $ | 1,101 | 1.82 | % | 3.68 | % | |||||||
Construction | 72,938 | 72,814 | 52 | 72 | — | 0.10 | % | 0.17 | % | ||||||||||||
Commercial real estate | 755,740 | 728,150 | 5,403 | 19,979 | 2,205 | 2.64 | % | 3.36 | % | ||||||||||||
Commercial | 356,574 | 349,078 | 1,671 | 2,881 | 2,944 | 0.81 | % | 1.28 | % | ||||||||||||
Consumer finance | 41,012 | 40,428 | 559 | 69 | — | 0.17 | % | 1.42 | % | ||||||||||||
Home equity and improvement | 161,106 | 155,650 | 4,026 | 432 | — | 0.27 | % | 3.39 | % | ||||||||||||
Total loans | $ | 1,639,177 | $ | 1,587,566 | $ | 16,388 | $ | 28,017 | $ | 6,250 | 1.71 | % | 2.77 | % | |||||||
Total Number of Loans | 24,354 | 23,733 | 402 | 202 | 17 |
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The table below is the credit risk profile trend for the last five quarters using the Company’s internally assigned loan grades. This table was created using data required to be compliant with the Company’s reporting on the thrift financial report.
Commercial Real Estate | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 695,848 | $ | 650,573 | $ | 652,615 | $ | 655,421 | $ | 647,211 | |||||
Special Mention | 30,672 | 38,429 | 49,247 | 47,068 | 47,313 | ||||||||||
Substandard/Doubtful | 75,914 | 79,634 | 62,979 | 53,251 | 52,152 | ||||||||||
Total by Exposure | $ | 802,434 | $ | 768,636 | $ | 764,841 | $ | 755,740 | $ | 746,676 | |||||
Commercial | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 333,797 | $ | 338,026 | $ | 313,369 | $ | 318,949 | $ | 316,793 | |||||
Special Mention | 12,479 | 17,102 | 21,125 | 20,960 | 19,485 | ||||||||||
Substandard/Doubtful | 25,605 | 27,306 | 15,576 | 16,665 | 17,175 | ||||||||||
Total by Exposure | $ | 371,881 | $ | 382,434 | $ | 350,070 | $ | 356,574 | $ | 353,453 | |||||
Residential | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 212,140 | $ | 214,982 | $ | 217,765 | $ | 233,520 | $ | 231,915 | |||||
Special Mention | 3,769 | 4,585 | 6,052 | 4,433 | 6,812 | ||||||||||
Substandard/Doubtful | 18,049 | 18,433 | 17,302 | 13,854 | 11,517 | ||||||||||
Total by Exposure | $ | 233,958 | $ | 238,000 | $ | 241,119 | $ | 251,807 | $ | 250,244 | |||||
Construction | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 50,655 | $ | 40,985 | $ | 50,434 | $ | 72,813 | $ | 75,013 | |||||
Special Mention | 2,850 | 2,850 | 100 | — | — | ||||||||||
Substandard/Doubtful | 100 | 835 | — | 125 | 809 | ||||||||||
Total by Exposure | $ | 53,605 | $ | 44,670 | $ | 50,534 | $ | 72,938 | $ | 75,822 | |||||
Consumer Financing | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 36,132 | $ | 37,924 | $ | 38,589 | $ | 40,696 | $ | 41,772 | |||||
Special Mention | — | — | — | — | — | ||||||||||
Substandard/Doubtful | 284 | 150 | 87 | 316 | 192 | ||||||||||
Total by Exposure | $ | 36,416 | $ | 38,074 | $ | 38,676 | $ | 41,012 | $ | 41,964 | |||||
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Home Equity and Improvement | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 148,805 | $ | 149,839 | $ | 155,221 | $ | 160,268 | $ | 157,937 | |||||
Special Mention | — | — | — | — | — | ||||||||||
Substandard/Doubtful | 1,574 | 1,374 | 1,447 | 838 | 1,055 | ||||||||||
Total by Exposure | $ | 150,379 | $ | 151,213 | $ | 156,668 | $ | 161,106 | $ | 158,992 | |||||
Total | |||||||||||||||
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Grade | |||||||||||||||
Pass | $ | 1,477,377 | $ | 1,432,329 | $ | 1,427,993 | $ | 1,481,667 | $ | 1,470,641 | |||||
Special Mention | 49,770 | 62,966 | 76,524 | 72,461 | 73,610 | ||||||||||
Substandard/Doubtful | 121,526 | 127,732 | 97,391 | 85,049 | 82,900 | ||||||||||
Total by Exposure | $ | 1,648,673 | $ | 1,623,027 | $ | 1,601,908 | $ | 1,639,177 | $ | 1,627,151 | |||||
The following table sets forth the activity in First Defiance’s allowance for loan losses during the periods indicated.
For the Quarter Ended | |||||||||||||||
3rd 2009 | 2nd 2009 | 1st 2009 | 4th 2008 | 3rd 2008 | |||||||||||
(Dollars in Thousands) | |||||||||||||||
Allowance at beginning of period | $ | 25,840 | $ | 25,694 | $ | 24,592 | $ | 23,445 | $ | 20,578 | |||||
Provision for credit losses | 8,051 | 3,965 | 2,746 | 3,824 | 4,907 | ||||||||||
Acquired from Pavilion acquisition | — | — | — | — | 121 | ||||||||||
Charge-offs: | |||||||||||||||
Residential | 744 | 505 | 148 | 369 | 478 | ||||||||||
Commercial real estate | 1,152 | 2,066 | 669 | 1,480 | 1,495 | ||||||||||
Commercial | 658 | 950 | 702 | 593 | — | ||||||||||
Consumer finance | 39 | 83 | 123 | 224 | 73 | ||||||||||
Home equity and improvement | 196 | 301 | 130 | 57 | 216 | ||||||||||
Total charge-offs | 2,789 | 3,905 | 1,772 | 2,723 | 2,262 | ||||||||||
Recoveries | 146 | 86 | 128 | 46 | 101 | ||||||||||
Net charge-offs | 2,643 | 3,819 | 1,644 | 2,677 | 2,161 | ||||||||||
Ending allowance | $ | 31,248 | $ | 25,840 | $ | 25,694 | $ | 24,592 | $ | 23,445 | |||||
The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at the dates indicated.
September 30, 2009 | June 30, 2009 | March 31, 2009 | December 31, 2008 | September 30, 2008 | ||||||||||||||||||||||||||
Amount | Percent of total loans by category | Amount | Percent of total loans by category | Amount | Percent of total loans by category | Amount | Percent of total loans by category | Amount | Percent of total loans by category | |||||||||||||||||||||
Residential | $ | 5,395 | 14.2 | % | $ | 4,735 | 14.7 | % | $ | 4,364 | 15.0 | % | $ | 3,416 | 15.4 | % | $ | 3,542 | 15.4 | % | ||||||||||
Construction | 113 | 3.3 | 101 | 2.7 | 154 | 3.1 | 140 | 4.4 | 253 | 4.7 | ||||||||||||||||||||
Commercial real estate | 16,107 | 48.6 | 12,918 | 47.4 | 13,538 | 47.8 | 13,436 | 46.1 | 12,657 | 45.8 | ||||||||||||||||||||
Commercial | 7,183 | 22.6 | 5,808 | 23.6 | 5,613 | 21.9 | 6,351 | 21.8 | 5,741 | 21.7 | ||||||||||||||||||||
Consumer | 618 | 2.2 | 672 | 2.3 | 681 | 2.4 | 458 | 2.5 | 721 | 2.6 | ||||||||||||||||||||
Home equity and improvement | 1,832 | 9.1 | 1,606 | 9.3 | 1,344 | 9.8 | 791 | 9.8 | 531 | 9.8 | ||||||||||||||||||||
$ | 31,248 | 100.0 | % | $ | 25,840 | 100.0 | % | $ | 25,694 | 100.0 | % | $ | 24,592 | 100.0 | % | $ | 23,445 | 100.0 | % | |||||||||||
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Key Asset Quality Ratio Trends
3rd Qtr 2009 | 2nd Qtr 2009 | 1st Qtr 2009 | 4th Qtr 2008 | 3rd Qtr 2008 | |||||||||||
Allowance for loan losses / loans | 1.92 | % | 1.60 | % | 1.62 | % | 1.52 | % | 1.47 | % | |||||
Allowance for loan losses to net charge-offs | 1,182.29 | % | 676.62 | % | 1,562.90 | % | 918.64 | % | 1,084.91 | % | |||||
Allowance for loan losses / non-performing assets | 63.23 | % | 52.80 | % | 57.73 | % | 59.59 | % | 77.35 | % | |||||
Allowance for loan losses / non-performing loans | 78.00 | % | 64.00 | % | 70.06 | % | 71.77 | % | 91.82 | % | |||||
Non-performing assets / loans plus REO | 3.03 | % | 3.02 | % | 2.79 | % | 2.54 | % | 1.89 | % | |||||
Non-performing assets / total assets | 2.45 | % | 2.42 | % | 2.21 | % | 2.11 | % | 1.58 | % | |||||
Net charge-offs / average loans (annualized) | 0.66 | % | 0.96 | % | 0.41 | % | 0.67 | % | 0.55 | % |
Non-Interest Income.
Total non-interest income increased to $5.6 million in the third quarter of 2009, compared with $4.1 million in the same period in 2008.
Service Fees.Service fees and other charges decreased by $140,000 or 3.8% in the 2009 third quarter compared to the same period in 2008. The decrease can be attributed to customers retaining more cash reserves in their checking and saving accounts resulting in less NSF fee transactions.
First Defiance’s overdraft privilege program generally provides for the automatic payment of modest overdraft limits on all accounts deemed to be in good standing when the account is accessed using paper-based check processing, a teller withdrawal, a point-of-sale terminal, an ACH transaction, or an ATM. To be in good standing, an account must be brought to a positive balance within a 30-day period. Overdraft limits are established for all customers without discrimination using a risk assessment approach for each account classification. The approach includes a systematic review and evaluation of the normal deposit flows made to each account classification to establish reasonable and prudent negative balance limits that would be routinely repaid by normal, expected and reoccurring deposits. The risk assessment by portfolio approach assumes a minimal degree of undetermined credit risk associated with unidentified individual accounts that are overdrawn for 30 or more days. Accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence and the fee charged for an item that is paid is equal to the fee charged for a non-sufficient fund item that is returned.
Overdrawn balances, net of allowance for losses, are reflected as loans on First Defiance’s balance sheet. The fees charged for this service are established based both on the return of processing costs plus a profit, and on the level of fees charged by competitors in the Company’s market area for similar services. These fees are considered to be compensation for providing a service to the customer and therefore are deemed to be non-interest income rather than interest income. Fee income related to the overdraft privilege product, net of adjustments to the allowance for uncollectible overdrafts, was $2.3 million for the quarter ended September 30, 2009 compared to $2.3 million for the same period of 2008.
Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans decreased $31,000 to $980,000 for the third quarter of 2009 compared to $1.0 million for the same period of 2008. Gains realized from the sale of mortgage loans more than doubled in the
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third quarter of 2009 to $1.5 million from $624,000 in the third quarter of 2008. Mortgage loan servicing revenue increased $34,000 in the third quarter of 2009 compared to the third quarter of 2008. The increases in gains and servicing revenue were offset by expense increases of $246,000 for the amortization of mortgage servicing rights due to the higher refinance activity during the third quarter of 2009. The Company recorded a valuation adjustment charge of $772,000 in the third quarter of 2009 compared to a charge of $36,000 in the third quarter of 2008. The mortgage servicing rights valuation is a reflection of increased market prepayment speeds.
Loss on Sale or Write-Down of Securities. Non-interest income also includes investment securities gains or losses. In the third quarter of 2009, First Defiance recognized other-than-temporary impairment (“OTTI”) charges of $994,000 for certain impaired investment securities, where in management’s opinion, the value of the investment will not be recovered. The OTTI charge related to five Trust Preferred Collateralized Debt Obligation (“CDO”) investments with a remaining book value of $2.2 million. In the third quarter of 2008, First Defiance recognized a $1.9 million OTTI charge relating to the perpetual preferred securities issued by Fannie Mae and Freddie Mac. The OTTI was determined by management as a result of the action taken by the United States Treasury Department and the Federal Housing Finance Agency on September 7, 2008, which placed Fannie Mae and Freddie Mac into conservatorship. First Defiance invested $1.0 million each in preferred stock of Fannie Mae and Freddie Mac in January 2008 and as of September 30, 2008, had a combined market value of $151,000. First Defiance also recorded $150,000 of OTTI on its investment in the equity notes of two CDOs in the 2008 third quarter as a result of the default by the issuers of the securities. At September 30, 2008, the market value of those CDOs, which had a total original cost of $1.0 million, had been written down to $168,000. In the third quarter of 2009, nine available for sale securities were sold for a gain of $154,000 compared to no security sales in the same period of 2008.
Non-Interest Expense.
Non-interest expense decreased to $14.8 million for the third quarter of 2009 compared to $15.2 million for the same period in 2008. The 2008 third quarter amount includes $20,000 of non-recurring acquisition related charges associated with the March 14, 2008 acquisition of Pavilion Bancorp.
Compensation and Benefits. Compensation and benefits decreased to $6.6 million for the quarter ended September 30, 2009 from $8.0 million for the same period in 2008. The decrease is mainly attributable to reversals of variable compensation due to the overall performance of the company as well as a reduction in employees.
FDIC insurance premium. FDIC insurance expense increased to $649,000 in the third quarter of 2009 from $327,000 in the same period of 2008. This was the result of the FDIC rate increase in 2009 and higher insured deposits.
Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles and other) increased by $769,000 to $5.7 million for the quarter ended September 30, 2009 from $5.0 million for the same period in 2008. Increases between the 2009 and 2008 third quarters include an increase in credit, collection and OREO expenses of $777,000 for other real estate owned and repossessed assets. These costs were partially offset by a decrease in office supply expense (down $34,000) and country club memberships (down $22,000) as a direct result of management’s cost control initiative.
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The efficiency ratio, considering tax equivalent interest income and excluding securities gains and losses, for the third quarter of 2009 was 60.90% compared to 66.84% for the third quarter of 2008.
Income Taxes.
First Defiance computes federal income tax expense in accordance with ASC Topic 740, Subtopic 942, which resulted in an effective tax rate of (12.67)% for the quarter ended September 30, 2009 compared to 12.02% for the same period in 2008.
Nine Months Ended September 30, 2009 and 2008
On a consolidated basis, First Defiance recognized net income for the nine months ended September 30, 2009 of $6.6 million compared to income of $6.5 million for the comparable period in 2008. Net income applicable to common shares was $5.1 million for the nine months ended September 30, 2009. On a per share basis, basic and diluted earnings per common share for the nine months ended September 30, 2009 were $0.63 compared to basic and diluted earnings per common share of $0.83 for the nine months ended September 30, 2008.
Net Interest Income.
Net interest income was $49.8 million for the nine months ended September 30, 2009 compared to $46.2 million for the same period in 2008. For the nine month period ended September 30, 2009, total interest income was $75.4 million, a $2.1 million decrease from the same period in 2008. Despite average earning assets increasing $181.4 million in the first nine months of 2009, the average yield declined 79 basis points as a result of a lower rate environment. The amount of interest income recognized was also affected in the first nine months of 2009 by an increase in the balance of loans that were delinquent by more than 90 days. It is the Company’s policy to reverse interest accrued on loans when they become 90 days past due. As a result of the increase in these non-performing loans, interest income was reduced by $1.9 million in the first nine months of 2009 compared to $1.3 million for the same period in 2008.
Interest expense decreased by $5.7 million to $25.6 million for the nine months ended September 30, 2009 compared to $31.3 million for the same period in 2008. While the average balance of interest-bearing liabilities increased by $135.5 million between the first nine months of 2008 and 2009, the expense associated with the higher balance was more than offset by a decline in the average cost of interest-bearing deposits, including non-interest-bearing liabilities, for the nine months ending September 30, 2009, to 1.94%, a 66 basis point decrease from the 2.60% average cost in the first nine months of 2008.
Provision for Loan Losses.
The provision for loan losses was $14.8 million for the nine months ended September 30, 2009, compared to $8.8 million during the nine months ended September 30, 2008. The year
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over year increase was primarily the result of the deterioration of a number of large credits in the commercial loan portfolio along with a decline in the overall economy in the Company’s primary market area, and the resulting increase in loan delinquencies. Charge-offs for the first nine months of 2009 were $8.5 million and recoveries of previously charged off loans totaled $360,000 for net charge-offs of $8.1 million. By comparison, $3.8 million of charge-offs were recorded in the same period of 2008 and $311,000 of recoveries were realized for net charge-offs of $3.5 million.
Non-Interest Income.
Total non-interest income increased to $20.7 million for the nine months ended September 30, 2009 from $16.3 million recognized in the same period of 2008.
Service Fees.Service fees and other charges increased by $233,000 or 2.4% in the nine months ended September 30, 2009 compared to the same period in 2008.
Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans increased 111.7% to $7.7 million for the nine months ended September 30, 2009 from $3.6 million for the same period of 2008. Gains realized from the sale of mortgage loans increased $4.5 million to $7.3 million for the first nine months of 2009 from $2.8 million during the same period of 2008. Mortgage loan servicing revenue increased $270,000 in the first nine months of 2009 compared to the same period of 2008. These increases were offset by a $1.6 million increase in the amortization of mortgage servicing rights in the first nine months of 2009 when compared to 2008. The Company had a positive valuation adjustment of $917,000 in the first nine months of 2009 compared to a charge of $12,000 in the first nine months of 2008. The mortgage servicing rights valuation is a reflection of the increase in the fair value of certain sectors of the Company’s portfolio of mortgage servicing rights.
Insurance and Investment Sales Commission.Insurance and investment sales commission income decreased $436,000, to $3.9 million for the nine months ended September 30, 2009, from $4.4 million during the same period of 2008. This is the result of receiving less contingent commission income in the first nine months of 2009 compared to the first nine months of 2008. In 2009, $432,000 was received compared to $784,000 in 2008.
Loss on Securities.Non-interest income was reduced in the first nine months of 2009 by $2.3 million as First Defiance recognized $2.5 million of other-than-temporary impairment charges for certain impaired investment securities partially offset by the gain on sale of $279,000 from available for sale securities. In the first nine months of 2008, $2.6 million of other-than-temporary impairment charges were recorded on impaired investments partially offset by the $19,000 gain recorded from the call or maturity of securities.
Other Non-Interest Income. Other sources of non-interest income include gains from the sale of non-mortgage loans, trust income, earnings from bank-owned life insurance (“BOLI”) and other. In total, these categories increased by $265,000 in the first nine months of 2009 compared to 2008. The value of the life insurance assets used to fund the deferred compensation plan increased by $290,000 in the first nine months of 2009 and declined by $382,000 in the first nine months of 2008 resulting in a net increase in non-interest income related to this item of $672,000. This was offset by a related change in the deferred compensation liability, which is included in other non-interest expense. Also, earnings from the Company’s BOLI declined in the first nine months of 2009 due to a lower crediting rate on the Company’s investment.
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Non-Interest Expense.
Non-interest expense increased to $45.9 million for the first nine months of 2009 compared to $44.2 million for the same period in 2008. The year-to-date 2008 amount includes $1.0 million of non-recurring costs associated with the Pavilion acquisition. These costs included termination fees of certain contracts, costs to grant prior service credit to former Pavilion employees in the Company’s retiree medical plan and other non-recurring costs associated with the completion of the acquisition and the transition of operations. Also in the first nine months of 2008, $752,000 of loss was recognized related to a former investment advisor.
Compensation and Benefits. Compensation and benefits decreased to $21.5 million for the first nine months ended September 30, 2009 from $22.4 million for the same period in 2008. A significant part of this decrease relates to adjustments in performance based variable compensation and a reduction in medical claims of $353,000 for the first nine months of 2009 compared to the same period in 2008. Slightly offsetting these decreases is year-over-year annual pay increases.
Occupancy. Occupancy costs increased $339,000 in the first nine months of 2009. This increase can be attributable to operating costs of a full period of the Pavilion branches in 2009.
FDIC insurance premium. FDIC insurance expense increased to $2.7 million in the first nine months of 2009 from $792,000 in the same period of 2008. This was the result of the FDIC rate increase in 2009, higher insured deposits, a special FDIC assessment of $904,000, and full utilization early in 2008 first quarter of credits issued by the FDIC.
Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles and other) increased by $1.4 million to $15.8 million for the first nine months of 2009 from $14.4 million for the same period in 2008. Significant increases between the first nine months of 2009 and 2008 include an increase in the amortization of intangibles of $66,000 due to recording the core deposit and customer relationship intangible in conjunction with the Pavilion acquisition and an increase in credit, collection and OREO expenses of $1.9 million for other real estate owned and repossessed assets. These costs were partially offset by a decrease in office supply expense (down $74,000) and postage (down $111,000) as a direct result of management’s cost control initiative. Included in the 2008 results was $752,000 related to losses associated with the former investment advisor which were not covered by First Defiance’s fidelity bond.
The efficiency ratio, considering tax equivalent interest income and excluding securities gains and losses, for the first nine months of 2009 was 62.36% compared to 67.29% for the same period of 2008. Excluding the impact of the acquisition related costs, the efficiency ratio for the first nine months of 2008 was 65.72%.
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Liquidity
As a regulated financial institution, First Federal is required to maintain appropriate levels of “liquid” assets to meet short-term funding requirements.
First Defiance had $8.1 million of cash provided by operating activities during the first nine months of 2009. The Company’s cash used in operating activities resulted from the origination of loans held for sale mostly offset by the proceeds on the sale of loans.
At September 30, 2009, First Defiance had $126.1 million in outstanding loan commitments and loans in process to be funded generally within the next six months and an additional $262.2 million committed under existing consumer and commercial lines of credit and standby letters of credit. Also at that date, First Defiance had commitments to sell $44.1 million of loans held-for-sale. Also, the total amount of certificates of deposit that are scheduled to mature by September 30, 2010 is $420.8 million. First Defiance believes that it has adequate resources to fund commitments as they arise and that it can adjust the rate on savings certificates to retain deposits in changing interest rate environments. If First Defiance requires funds beyond its internal funding capabilities, advances from the FHLB of Cincinnati and other financial institutions are available.
Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to mange this risk, our Board of Directors has established an Liquidity Policy that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements. This policy designates our Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO reviews liquidity on a monthly basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by the Company’s Chief Financial Officer and Controller.
ALCO uses an economic value of equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of First Federal’s assets and liabilities in rate shock environments that range from -300 basis points to +300 basis points. The likelihood of a decrease in rates as of September 30, 2009 was considered to be remote given the current interest rate environment and therefore, was not included in this analysis. The results of this analysis are reflected in the following tables for the nine months ended September 30, 2009 and the year-ended December 31, 2008.
September 30, 2009 Economic Value of Equity | ||||||||
Change in Rates | $ Amount | $ Change | % Change | |||||
(Dollars in Thousands) | ||||||||
+ 300 bp | 257,317 | (12,816 | ) | (4.74 | )% | |||
+ 200 bp | 263,393 | (6,740 | ) | (2.50 | )% | |||
+ 100 bp | 267,610 | (2,523 | ) | (0.93 | )% | |||
0 bp | 270,133 | — | — |
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December 31, 2008 Economic Value of Equity | ||||||||
Change in Rates | $ Amount | $ Change | % Change | |||||
(Dollars in Thousands) | ||||||||
+ 300 bp | 250,485 | (29,300 | ) | (10.47 | )% | |||
+ 200 bp | 261,652 | (18,133 | ) | (6.48 | )% | |||
+ 100 bp | 271,860 | (7,925 | ) | (2.83 | )% | |||
0 bp | 279,785 | — | — |
Capital Resources
First Federal is required to maintain specified amounts of capital pursuant to regulations promulgated by the OTS. The capital standards generally require the maintenance of regulatory capital sufficient to meet a tangible capital requirement, a core capital requirement, and a risk-based capital requirement. The following table sets forth First Federal’s compliance with each of the capital requirements at September 30, 2009.
Core Capital | Risk-Based Capital | |||||||||||||||
Adequately Capitalized | Well Capitalized | Adequately Capitalized | Well Capitalized | |||||||||||||
Regulatory capital | $ | 207,137 | $ | 207,137 | $ | 229,685 | $ | 229,685 | ||||||||
Minimum required regulatory capital | 78,178 | 97,722 | 144,051 | 180,063 | ||||||||||||
Excess regulatory capital | $ | 128,959 | $ | 109,415 | $ | 85,634 | $ | 49,622 | ||||||||
Regulatory capital as a percentage of assets (1) | 10.60 | % | 10.60 | % | 12.76 | % | 12.76 | % | ||||||||
Minimum capital required as a percentage of assets | 4.00 | % | 5.00 | % | 8.00 | % | 10.00 | % | ||||||||
Excess regulatory capital as a percentage of assets | 6.60 | % | 5.60 | % | 4.76 | % | 2.76 | % | ||||||||
(1) | Core capital is computed as a percentage of adjusted total assets of $1.95 billion. Risk-based capital is computed as a percentage of total risk-weighted assets of $1.80 billion. |
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 included in the Company’s Annual Report on Form 10-K. 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. Those policies which are identified and discussed in detail in the Company’s Annual Report on Form 10-K include the Allowance for Loan Losses, Valuation of Securities, and the Valuation of Mortgage Servicing Rights. There have been no material changes in assumptions or judgments relative to those critical policies during the first nine months of 2009.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
As discussed in detail in the 2008 Annual Report on Form 10-K, First Defiance’s ability to maximize net income is dependent on management’s ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of First Defiance are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance does not use off-balance sheet derivatives to enhance its risk management, nor does it engage in trading activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis through simulation analysis which measures the impact changes in interest rates can have on net income. The simulation technique analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with management’s estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 100 basis points over a 12 month period, using September 30, 2009 amounts as a base case, First Defiance’s net interest income would be impacted by less than the board mandated guidelines of 10%.
Item 4. Controls and Procedures
Disclosure Controls are procedures designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this report, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. 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, not absolute, assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of September 30, 2009. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. No changes occurred in the Company’s internal controls over financial reporting during the quarter ended September 30, 2009 that materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.
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FIRST DEFIANCE FINANCIAL CORP.
PART II-OTHER INFORMATION
First Defiance is not engaged in any legal proceedings of a material nature.
An investment in the Company’s common stock is subject to risks inherent to the Company’s business. The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report. The risks and uncertainties described below are the not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.
If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the market price of the Company’s common stock could decline significantly, and you could lose all or part of your investment.
Economic conditions may adversely affect our operations and financial condition.
The Company conducts its banking and insurance business primarily in northwest Ohio, northeast Indiana and southeast Michigan. Unemployment rates for the counties within our geographic market area are above the median rate for the United States and above the median rates for the States of Ohio, Indiana, and Michigan. Real estate values have declined in our market area. High unemployment and declining real estate values have a negative impact on First Defiance’s earnings and financial condition because:
• | more borrowers are unable to make payments on their loans; |
• | the value of collateral securing loans has declined; and |
• | the overall quality of the loan portfolio has declined. |
General Economic Conditions: Dramatic declines in real estate values, along with high unemployment and underemployment, have disrupted the credit and capital markets over the last two years. As a result, many financial institutions have had to seek additional capital, to merge with larger and stronger institutions and, in some cases, to seek government assistance or bankruptcy protection. Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers, including to other financial institutions, because of concern about the stability of the financial markets and the strength of counterparties. It is difficult to predict how long these economic conditions will exist, which of our markets, products or other businesses will ultimately be affected, and whether management’s actions will effectively mitigate these external factors. The reduced availability of credit, the lack of confidence in the financial sector, decreased consumer confidence, increased volatility in the financial markets and reduced business activity could materially and adversely affect the Company’s business, financial condition and results of operations.
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As a result of the challenges presented by economic conditions, the Company faces the following risks:
• | Inability of borrowers to make timely repayments of their loans, or decreases in value of real estate collateral securing the payment of such loans resulting in significant credit losses, which could result in increased delinquencies, foreclosures and customer bankruptcies, any of which could have a material adverse effect on our operating results; |
• | Increased regulation of the financial services industry, including heightened legal standards and regulatory requirements or expectations. Compliance with such regulation will likely increase costs and may limit the Company’s ability to pursue business opportunities; |
• | Further disruptions in the capital markets or other events, including actions by rating agencies and deteriorating investor expectations, may result in an inability to borrow on favorable terms or at all from other financial institutions; |
• | Increased competition among financial services companies due to the consolidation of financial institutions and the conversion of certain investment banks to bank holding companies, which may adversely affect the Company’s ability to market our products and services; and |
• | Further increases in FDIC insurance premiums due to the market developments which have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. |
Declining Real Estate Values:.Approximately 76.4% of the loans in our portfolio are secured in whole or in part by real estate. As residential real estate prices have declined in the last two years, defaults and foreclosures have increased. Foreclosures and resolutions of nonperforming loans require significant personnel resources and involve other costs that may increase our operating expenses. Properties acquired through foreclosure or by deed in lieu of foreclosure are taking longer to sell in the current economy, which increases our expenses for maintaining and insuring real estate owned. If we are unable to sell properties at a price that will cover our expenses as well as the unpaid principal and interest on the loan, the resulting write-downs and losses adversely affect our net income.
Commercial real estate values are also experiencing declines. In addition, the owners of many income-producing properties are experiencing declines in their revenue, which may adversely affect their ability to repay their loans. Our commercial real estate loans typically have higher principal amounts than residential real estate loans, and many of our commercial real estate borrowers have more than one loan outstanding. As a result, an adverse development on one loan can expose us to greater risk of loss on other loans.
Volatile Capital Markets:The capital and credit markets have been experiencing volatility and disruption for more than a year. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers seemingly without regard to those issuers’ underlying financial strength. Continuing market disruption and volatility could have an adverse effect on the Company’s ability to access capital and on our business, financial condition and results of operations.
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The market price for First Defiance’s Common Shares has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future, including:
• | announcements of developments related to our business; |
• | fluctuations in our results of operations; |
• | sales of substantial amounts of our securities into the marketplace; |
• | general conditions in our markets or the worldwide economy; |
• | a shortfall in revenues or earnings compared to securities analysts’ expectations; |
• | changes in analysts’ recommendations or projections; and |
• | our announcement of new acquisitions or other projects. |
Changes in interest rates can adversely affect our profitability
The earnings and financial condition of First Defiance are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. Interest rates are highly sensitive to many factors, including:
• | The rate of inflation; |
• | Economic conditions; |
• | Federal monetary policies; and |
• | Stability of domestic and foreign markets. |
First Federal originates a significant amount of residential mortgage loans for sale and for our portfolio. The origination of residential mortgage loans is highly dependent on the local real estate market and the level of interest rates. Increasing interest rates tend to reduce the origination of loans for sale and consequently fee income, which we report as mortgage banking income. Conversely, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the value of mortgage servicing rights on the loans sold to be lower than originally anticipated. If this happens, the Company may be required to write down the value of our mortgage servicing rights faster than anticipated, which will increase expense and lower earnings. Accelerated repayments on loans and mortgage backed securities could result in the reinvestment of funds at lower rates than the loans or securities were paying. Increasing interest rates may also increase the risk of default on adjustable rate mortgage loans.
The issuance of Series A Preferred Shares and Warrants to the U. S. Government may adversely affect the holders of our Common Shares.
First Defiance issued 37,000 Series A Preferred Shares and a warrant to purchase 550,595 shares of First Defiance Common Shares to the U.S. Department of the Treasury under the Capital Purchase Program. The dividends accrued and the accretion on discount on the Series A Preferred Shares issued to the U.S. Treasury reduce the net income available to the holders of our Common Shares and our earnings per Common Share. Because the Series A Preferred Shares are cumulative, any dividends not declared or paid will accumulate and will be payable when the payment of dividends is resumed. If the Series A Preferred Shares are not redeemed within five years after their original date of issuance, the annual dividend rate on the Series A Preferred Shares will increase from 5.0% per annum to 9.0% per annum. If we are unable to redeem the Series A Preferred Shares by December 5, 2013, the increase
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in the annual dividend rate on the Series A Preferred Shares could have a material adverse effect on our earnings and could also adversely affect our ability to declare and pay dividends on our Common Shares. Series A Preferred Shares will also receive preferential treatment in the event of a liquidation, dissolution or winding up of First Defiance.
The Common Shares underlying the Warrant represent approximately 6.8% of the Common Shares outstanding as of September 30, 2009 (including the shares issuable upon exercise of the Warrant in our total outstanding Common Shares). If the Warrant is exercised, the interest of the existing holders of our Common Shares will be diluted. Although the Treasury Department has agreed not to vote any of the Common Shares acquired upon exercise of the Warrant, a transferee of the Warrant or of any Common Shares acquired upon exercise of the Warrant is not bound by this restriction. Finally, the terms of the Series A Preferred Shares allow the U.S. Treasury to impose additional restrictions, including those on dividends and to unilaterally amend the terms of the Series A Preferred Shares to comply with changes in applicable federal law.
If we fail to pay dividends on the Series A Preferred Shares for six quarterly dividend periods (whether or not consecutive), the Treasury Department will have the right to appoint two directors to our Board of Directors until all accrued but unpaid dividends have been paid. As long as the Series A Preferred Shares are outstanding, in addition to any other vote or consent of shareholders required by law or our Articles of Incorporation, as amended (the “Articles”), the vote or consent of holders owning at least 66 2/3% of the Series A Preferred Shares outstanding is required for:
• | any authorization or issuance of shares ranking senior to the Series A shares; |
• | any amendments to the rights of the Series A Preferred Shares that would adversely affect the rights, preferences, privileges or voting power of the Series A shares; or |
• | the consummation of any merger, share exchange or similar transaction unless the Series A shares remain outstanding, or if we are not the surviving entity in such transaction, are converted into or exchanged for preference securities of the surviving entity and the Series A shares remaining outstanding or such preference securities have the rights, preferences, privileges and voting power of the Series A shares. |
The holders of Series A Preferred Shares, including the U.S. Treasury, may have different interests from the holders of our common shares, and could vote to block transactions that may be in the best interests of the present holders of our common shares.
Regulatory restriction on dividends and our ability to repurchase shares may adversely affect our shareholders and the market price of our common shares.
As long as the Series A shares are outstanding and held by the Treasury Department, we cannot increase the dividend on our common shares above $.26 per share without prior approval from the Treasury Department. In addition to this restriction, the OTS has directed First Defiance to seek approval of the OTS before paying any dividends on our common shares.
As long as the Series A shares are outstanding and held by the Treasury Department, we cannot repurchase our common shares without the consent of the Treasury Department (other than repurchases in connection with the administration of any employee benefit plan in the ordinary course of business and consistent with past practice and certain other exemptions). Further, the OTS has directed First Defiance to seek approval of the OTS before repurchasing any common shares.
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Our principal source of funds to pay dividends on our common shares is distributions from First Federal, which require the prior approval of the OTS. The OTS has advised us that it is not likely to approve any distributions from First Federal for this purpose, to us in the foreseeable future. The OTS has also advised us that we should not pay dividends utilizing borrowings or other sources of funds that we may have access to. Our payment of dividends in the fourth quarter of 2009 is uncertain.
The Company’s ability to meet cash flow needs on a timely basis at a reasonable cost may adversely affect net income.
First Defiance’s principal sources of liquidity are local deposits and wholesale funding sources such as Federal Home Loan Bank (“FHLB”) advances, Federal Funds purchased, securities sold under repurchase agreements, and brokered or other out-of-market certificate of deposit purchases. Also, the Company maintains a portfolio of securities that can be used as a secondary source of liquidity. Other sources of liquidity that may be available if necessary include the sale or securitization of loans, the issuance of additional collateralized borrowings beyond those currently utilized with the FHLB, the issuance of debt securities and the issuance of preferred or common securities in public or private transactions, or borrowings from a commercial bank.
The inability of the Company to access the above listed sources of liquidity when needed could cause First Federal to be unable to meet customer needs, which could adversely impact its financial condition, results of operations, cash flow, or regulatory capital levels. The OTS has directed First Defiance to seek OTS approval before incurring any new debt.
Competition affects our earnings.
The Company’s continued profitability depends on its ability to continue to effectively compete to originate loans and attract and retain deposits. Competition for both loans and deposits is intense in the financial services industry. The Company competes in its market area by offering superior service and competitive rates and products. The type of institutions First Defiance competes with include large regional commercial banks, smaller community banks, savings institutions, mortgage banking firms, credit unions, finance companies, brokerage firms, insurance agencies and mutual funds. As a result of their size and ability to achieve economies of scale, certain of First Defiance’s competitors can offer a broader range of products and services than the Company can offer. To stay competitive in its market area, First Defiance may need to adjust the interest rates on its products to match rates of its competition, which could have a negative impact on net interest margin.
The increasing complexity of our operations presents varied risks that could affect our earnings and financial condition
First Defiance processes a large volume of transactions on a daily basis and is exposed to numerous types of risks related to internal processes, people and systems. These risks include, but are not limited to, the risk of fraud by persons inside or outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, breaches of data security and the Company’s internal control system and compliance with a complex array of consumer and safety and soundness regulations. The Company could also experience additional loss as a result of potential legal actions that could arise as a result of operational deficiencies or as a result of noncompliance with applicable laws and regulations.
The Company has established and maintains a system of internal controls that provide management with information on a timely basis and allows for the monitoring of compliance with operational standards. While not foolproof, these systems have been designed to manage operational risks at an appropriate, cost effective level. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. Losses from operational risks may occur, however, including losses from the effects of operational errors.
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First Defiance’s operations are also dependent on its existing infrastructure, including equipment and facilities. Extended disruption of vital infrastructure as a result of fire, power loss, natural disaster, telecommunications failures, computer hacking or viruses, terrorist activity or the domestic response to such activity, or other events outside of the control of management could have a material adverse impact on First Defiance’s business, results of operations, cash flows and financial condition. First Defiance has a business recovery plan but there are no assurances that such plan will work as intended or that it will prevent significant interruptions to operations.
Laws and regulations may affect our results of operations.
The earnings of financial institutions such as First Defiance and First Federal are affected by the policies of the regulatory authorities, including the Federal Reserve Board, which regulates the money supply, and the OTS, which regulates First Defiance and First Federal. Such policies and regulations may negatively impact the Company’s operating results or financial condition.
Among the methods employed by the Federal Reserve Board to regulate the money supply are open market operations in U.S. Government securities, changes in the discount rate on member bank borrowings, and changes in the reserve requirement against member bank deposits. These tools are utilized by the Federal Reserve in varying combinations to influence overall economic conditions and growth, and they have a significant impact on interest rates charged on loans and paid on deposits, which has a profound effect on the operating results of commercial and savings banks.
Under the Emergency Economic Stabilization Act of 2008 (the “EESA”), the U.S. Treasury established the Troubled Assets Relief Program, to provide up to $700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The American Recovery and Reinvestment Act (the “ARRA”) was subsequently enacted to provide a sweeping economic recovery package to stimulate the economy. The failure of these significant legislative measures to help stabilize the financial markets and improve current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit and the trading price of our common.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
First Defiance did not have any common stock repurchases during the third quarter of 2009, but has 93,124 shares that may be purchased under a plan announced by the Board of Directors on July 18, 2003. Participation in the Capital Purchase Program prohibits the Company from repurchasing any of its common shares without the prior approval of the U.S. Treasury until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party.
Item 3. Defaults upon Senior Securities
Not applicable.
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Item 4. | Submission of Matters to a Vote of Security Holders | |
Not applicable. | ||
Item 5. | Other Information | |
Not applicable. | ||
Item 6. | Exhibits |
Exhibit 31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act | |
Exhibit 31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act | |
Exhibit 32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act | |
Exhibit 32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act |
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FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.
First Defiance Financial Corp. (Registrant) | ||||
Date: November 9, 2009 | By: | /s/ William J. Small | ||
William J. Small | ||||
Chairman, President and Chief Executive Officer | ||||
Date: November 9, 2009 | By: | /s/ Donald P. Hileman | ||
Donald P. Hileman | ||||
Executive Vice President and Chief Financial Officer |
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