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, 2003
OR
|_| Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Transition Period from __________to__________
Commission file number 0-26850
First Defiance Financial Corp.
(Exact name of registrant as specified in its charter)
Ohio 34-1803915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification) Number)
601 Clinton Street, Defiance, Ohio 43512
(Address or principal executive office) (Zip Code)
Registrant's telephone number, including area code: (419) 782-5015
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date. Common Stock, $.01 Par Value -
6,306,990 shares outstanding at November 4, 2003
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number
-----------
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - September 30, 2003 and December 31, 2002 2
Consolidated Condensed Statements of Income -
Three and nine months ended September 30, 2003 and 2002 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Nine months ended September 30, 2003 5
Consolidated Condensed Statements of Cash Flows
- Nine months ended September 30, 2003 and 2002 7
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 21
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 35
Item 4. Controls and Procedures 35
PART II.-OTHER INFORMATION:
Item 1. Legal Proceedings 36
Item 2. Changes in Securities 36
Item 3. Defaults upon Senior Securities 36
Item 4. Submission of Matters to a Vote of Security Holders 36
Item 5. Other Information 36
Item 6. Exhibits and Reports on Form 8-K 36
Signatures 38
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
September 30, 2003 December 31, 2002
------------------ -----------------
Assets
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 20,153 $ 17,263
Interest-bearing deposits 25,322 11,395
---------- --------
45,475 28,658
Securities:
Available-for-sale, carried at fair value 175,018 209,604
Held-to-maturity, carried at amortized cost
(approximate fair value $3,127 and $4,129
at September 30, 2003 and December 31,
2002 respectively) 2,953 3,921
---------- --------
177,971 213,525
Loans held for sale 11,594 15,336
Loans receivable, net 710,300 561,041
Accrued interest receivable 5,038 4,533
Federal Home Loan Bank stock and other
interest-earning assets 17,589 18,302
Bank owned life insurance 15,760 15,144
Office properties and equipment 23,104 19,958
Real estate and other assets held for sale 324 206
Goodwill 20,548 3,636
Mortgage servicing rights 3,041 2,090
Other assets 2,198 1,816
---------- --------
Total assets $1,032,942 $884,245
========== ========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
September 30, 2003 December 31, 2002
------------------ -----------------
Liabilities and stockholders' equity
Liabilities:
Non-interest-bearing deposits $ 52,190 $ 43,936
Interest-bearing deposits 683,217 555,637
----------- ---------
Total deposits 735,407 599,573
Advances from Federal Home Loan Bank 153,967 149,096
Short-term borrowings and other interest-bearing liabilities 9,726 4,308
Advance payments by borrowers for taxes and insurance 153 316
Deferred taxes 1,957 2,299
Other liabilities 8,553 8,543
----------- ---------
Total liabilities 909,763 764,135
Stockholders' equity:
Preferred stock, no par value per share:
5,000 shares authorized; no shares
issued -- --
Common stock, $.01 par value per share:
20,000 shares authorized; 6,295
and 6,412 shares outstanding, respectively 63 64
Additional paid-in capital 50,367 50,702
Stock acquired by ESOP (1,962) (2,387)
Deferred compensation (16) (30)
Accumulated other comprehensive income,
net of income taxes of $2,864
and $3,477, respectively 5,322 6,455
Retained earnings 69,405 65,306
----------- ---------
Total stockholders' equity 123,179 120,110
----------- ---------
Total liabilities and stockholders' equity $ 1,032,942 $ 884,245
=========== =========
See accompanying notes
3
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
- --------------------------------------------------------------------------------
Three Months ended Nine Months ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Interest Income
Loans $ 10,934 $ 9,281 $ 30,246 $ 27,322
Investment securities 1,987 2,728 6,519 5,903
Interest-bearing deposits 107 192 216 619
-------- ------- -------- --------
Total interest income 13,028 12,201 36,981 33,844
Interest Expense
Deposits 3,330 4,227 10,275 12,616
FHLB advances and other 1,868 1,702 5,553 3,476
-------- ------- -------- --------
Total interest expense 5,198 5,952 15,875 16,342
-------- ------- -------- --------
Net interest income 7,830 6,249 21,106 17,502
Provision for loan losses 497 386 1,185 1,124
-------- ------- -------- --------
Net interest income after provision for loan losses 7,333 5,863 19,921 16,378
Non-interest Income
Service fees and other charges 1,204 968 3,353 2,721
Insurance commission income 924 810 2,817 2,520
Dividends on stock and other interest income 176 234 518 700
Gain on sale of loans 2,274 1,179 6,590 2,254
Gain on sale of securities -- 36 919 21
Trust income 46 32 116 86
Income from Bank Owned Life Insurance 211 -- 616 --
Other non-interest income 4 12 23 131
-------- ------- -------- --------
Total non-interest income 4,839 3,271 14,952 8,433
Non-interest Expense
Compensation and benefits 4,281 3,630 11,965 10,428
Occupancy 758 671 2,227 2,084
SAIF deposit insurance premiums 30 32 85 97
State franchise tax 272 351 838 996
Data processing 498 362 1,357 1,053
Amortization of mortgage servicing rights 546 512 1,825 777
Impairment (recovery) of mortgage servicing rights (987) 521 (381) 785
Amortization and impairment of goodwill and other intangibles 31 -- 39 200
Other non-interest expense 1,347 1,105 3,537 3,069
-------- ------- -------- --------
Total non-interest expense 6,776 7,184 21,492 19,489
-------- ------- -------- --------
Income from continuing operations before income taxes 5,396 1,950 13,381 5,322
Federal income taxes 1,715 568 4,118 1,667
-------- ------- -------- --------
Income from continuing operations 3,681 1,382 9,263 3,655
Discontinued operations, net of tax -- -- -- 9,347
-------- ------- -------- --------
Income before cumulative effect of a change in accounting principle 3,681 1,382 9,263 13,002
Cumulative effect of change in method of accounting for goodwill,
net of tax -- -- -- (194)
-------- ------- -------- --------
Net income $ 3,681 $ 1,382 $ 9,263 $ 12,808
======== ======= ======== ========
Earnings per share (Note 5)
Basic:
From continuing operations $ 0.61 $ 0.22 $ 1.54 $ 0.57
Discontinued operations, net of tax -- -- -- 1.46
Cumulative effect of change in method of accounting for goodwill -- -- -- (0.03)
-------- ------- -------- --------
Net income $ 0.61 $ .22 $ 1.54 $ 1.78
======== ======= ======== ========
Diluted:
From continuing operations $ 0.58 $ 0.21 $ 1.47 $ 0.55
Discontinued operations, net of tax -- -- -- 1.40
Cumulative effect of change in method of accounting for goodwill -- -- -- (0.03)
-------- ------- -------- --------
Net income $ 0.58 $ .21 $ 1.47 $ 1.92
======== ======= ======== ========
Dividends declared per share (Note 4) $ 0.15 $ 0.13 $ 0.45 $ 0.39
======== ======= ======== ========
Average shares outstanding (Note 5)
Basic 6,002 6,400 6,033 6,416
======== ======= ======== ========
Diluted 6,293 6,652 6,296 6,665
======== ======= ======== ========
See accompanying notes
4
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2003
--------------------------------------------------------------
Stock Acquired By
-----------------
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
----- ------- ---- ----
Balance at January 1 $ 64 $50,702 $(2,387) $ (30)
Comprehensive income:
Net income
Change in unrealized gains
net of income taxes of $613
Total comprehensive income
ESOP shares released 514 425
Amortization of deferred compensation
of Management Recognition Plan 14
Shares issued under stock option plan 1 1,036
Purchase of common stock for
treasury (2) (1,885)
Dividends declared (Note 5)
--------------------------------------------------------------
Balance at September 30 $ 63 $50,367 $(1,962) $ (16)
==============================================================
See accompanying notes
5
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2003 2002
--------------------------------------------------- -------
Net Unrealized
gains (losses) on Total Total
available-for- Retained Stockholders' Stockholder's
sale securities Earnings Equity Equity
--------------- -------- ------ ------
Balance at January 1 $6,455 $65,306 $120,110 $ 111,021
Comprehensive income:
Net income 9,263 9,263 11,426
Change in unrealized gains (losses)
net of income taxes of $613 (1,133) (1,133) 2,411
-------- ----------
Total comprehensive income 8,130 13,837
ESOP shares released 939 561
Amortization of deferred compensation
of Management Recognition Plan 14 26
Shares issued under stock option plan 1,037 677
Purchase of common stock for
treasury (2,449) (4,336) (2,239)
Dividends declared (Note 5) (2,715) (2,715) (1,695)
----------------------------------------- ----------
Balance at September 30 $5,322 $69,405 $123,179 $ 122,188
========================================= ==========
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Nine Months
Ended September 30,
2003 2002
-------------------------
Operating Activities
Net income $ 9,263 $ 12,808
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,185 1,124
Provision for depreciation 1,218 1,176
Net securities amortization 721 496
Amortization of mortgage servicing rights 1,825 777
Net impairment of mortgage servicing rights (381) 785
Amortization of core deposit intangible 39 --
Net impairment of goodwill -- 438
Gain on sale of loans (6,590) (2,254)
Gain on sale of discontinued operations -- (16,912)
Amortization of Management Recognition Plan
deferred compensation 14 39
Release of ESOP Shares 939 784
Gains on sales of securities (919) (21)
Deferred federal income tax (credit) 269 (313)
Proceeds from sale of loans 268,773 107,092
Origination of mortgage servicing rights, net (2,395) (1,421)
Origination of loans held for sale (258,441) (113,086)
Increase in interest receivable and other assets (1,060) (5,411)
Increase in other liabilities (657) 361
Decrease in assets held for sale -- 6,304
Decrease in liabilities held for sale -- (6,292)
Increase in assets of discontinued operations -- (5,418)
Decrease in liabilities of discontinued operations -- (35,166)
--------- ---------
Net cash provided by operating activities 13,803 (54,110)
Investing Activities
Proceeds from maturities of held-to-maturity securities 951 1,197
Proceeds from maturities of available-for-sale securities 59,844 18,313
Proceeds from sale of available-for-sale securities 9,958 2,459
Proceeds from sales of real estate and
other assets held for sale 317 439
Proceeds from sale of discontinued operations 1,228 367,921
Purchases of available-for-sale securities (36,745) (172,674)
Purchases of Federal Home Loan Bank stock (515) (576)
Purchases of office properties and equipment (2,337) (1,421)
Acquisition of Banking Center Offices (Note 10) 70,132 --
Net (increase) decrease in loans receivable (71,786) (39,946)
--------- ---------
Net cash provided by investing activities 31,047 175,712
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
2003 2002
-------- ---------
Financing Activities
Net decrease in deposits (31,010) (24,220)
Repayment of Federal Home Loan Bank long-term advances (1,129) (25,118)
Repayment of term notes payable (10) (29)
Net decrease in Federal Home Loan Bank short-term advances (3,000) (40,000)
Net decrease in short-term line of credit -- (18,250)
Proceeds from Federal Home Loan Bank long term advances 9,000 --
Increase in securities sold under repurchase agreements 4,130 779
Purchase of common stock for treasury (4,336) (3,727)
Cash dividends paid (2,715) (2,530)
Proceeds from exercise of stock options 1,037 763
-------- ---------
Net cash used in financing activities (28,033) (112,332)
-------- ---------
Increase in cash and cash equivalents 16,817 9,270
Cash and cash equivalents at beginning of period 28,658 38,100
-------- ---------
Cash and cash equivalents at end of period $ 45,475 $ 47,370
======== =========
Supplemental cash flow information:
Interest paid $ 15,363 $ 16,889
======== =========
Income taxes paid $ 3,868 $ 9,451
======== =========
Transfers from loans to real estate
and other assets held for sale $ 435 $ 674
======== =========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ (613) $ (3,110)
======== =========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ (1,744) $ 8,840
======== =========
Noncash financing activities:
Cash dividends declared but not paid $ 901 $ 835
======== =========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
1. Principles of Consolidation
The consolidated condensed financial statements include the accounts of
First Defiance Financial Corp. ("First Defiance" or "the Company"), its
two wholly owned subsidiaries, First Federal Bank of the Midwest ("First
Federal") and First Insurance and Investments, Inc. ("First Insurance"),
and, prior to April 1, 2002, First Federal's wholly owned mortgage banking
company, The Leader Mortgage Company, LLC ("The Leader"). Operations of
The Leader were sold to US Bancorp in a transaction that was completed on
April 1, 2002. In the opinion of management, all significant intercompany
accounts and transactions have been eliminated in consolidation.
2. Basis of Presentation
The consolidated condensed statement of financial condition at December
31, 2002 has been derived from the audited financial statements at that
date, which were included in First Defiance's Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of
September 30, 2003 and for the three and nine-month periods ending
September 30, 2003 and 2002 have been prepared by First Defiance without
audit and do not include information or footnotes necessary for the
complete presentation of financial condition, results of operations, and
cash flows in conformity with accounting principles generally accepted in
the United States. For the purposes of these statements, operations of The
Leader are presented as results of discontinued operations. These
consolidated condensed financial statements should be read in conjunction
with the financial statements and notes thereto included in First
Defiance's 2002 Annual Report on Form 10-K for the year ended December 31,
2002. However, in the opinion of management, all adjustments, consisting
of only normal recurring items, necessary for the fair presentation of the
financial statements have been made. The results for the nine-month period
ended September 30, 2003 are not necessarily indicative of the results
that may be expected for the entire year.
Stock Compensation
At September 30, 2003, the Company had three stock-based compensation
plans, which are more fully described in Note 18 in the financial
statements included in First Defiance's 2002 Annual Report on Form 10-K.
The Company accounts for those plans under recognition and measurement
principles of Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees and related interpretations. Under APB No.
25, because the exercise price of the Company's employee stock options
equals the market price of the underlying stock on the date of the grant,
no compensation expense is recognized.
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Pro forma information regarding net income and earnings per share is
required by Statement of Financial Accounting Standard (SFAS) No. 123,
Accounting for Stock-Based Compensation and has been determined as if
First Defiance had accounted for its employee stock options under the fair
value method of that Statement. Under the fair-value based method,
compensation cost is measured at the grant date based upon the value of
the award and recognized over the service period. For purposes of the pro
forma disclosures, the estimated fair value of the option is amortized to
expense over the options' vesting period.
The following pro forma results of operations use a fair value method of
accounting for stock options in accordance with SFAS No. 123. The
estimated fair value of the options are amortized to expense over the
option and vesting period. The fair value was estimated at the date of
grant using a Black-Scholes option pricing model with the following
weighted-average assumptions:
September 30,
2003 2002
--------------------------------
Risk free interest rate 5.66% 5.74%
Dividend yield 2.97% 2.93%
Volatility factors of expected market price
of stock 0.267% 0.269%
Weighted average expected life 8.70 years 8.62 years
Weighted average grant date fair value
of options granted $3.52 $3.44
Based on the above assumptions, pro forma net income and earnings per
share are computed as follows (in thousands, except per share amounts):
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
-------------------------------------------------
Income from continuing operations $ 3,681 $ 1,382 $ 9,263 $ 3,655
Stock-based compensation using the
fair value method, net of tax (43) (51) (144) (151)
-------------------------------------------------
Pro forma net income from continuing
operations $ 3,638 $ 1,331 $ 9,119 $ 3,504
=================================================
Pro forma earnings per share:
Basic $ 0.61 $ 0.21 $ 1.51 $ 0.55
=================================================
Diluted $ 0.58 $ 0.20 $ 1.45 $ 0.53
=================================================
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Accounting Pronouncements adopted in 2003
Asset Retirement Obligations
In August 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143
requires an entity to record a liability for an obligation associated with
the retirement of an asset at the time the liability is incurred by
capitalizing the cost as part of the carrying value of the related asset
and depreciating it over the remaining useful life of that asset.
The standard was effective for the Company beginning January 1, 2003, and
its adoption did not have a material impact on the Company's results of
operations, financial position or liquidity.
Accounting for Costs Associated with Exit or Disposal Activities
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities, was issued in June 2002 and replaces Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring)." The provisions of SFAS No.
146 address the accounting and reporting for one-time employee termination
benefits, certain contract termination costs and other costs associated
with exit or disposal activities such as facility closings or
consolidations and employee relocations. SFAS No. 146 is effective for
exit or disposal activities that are initiated after December 31, 2002,
with early application encouraged.
The Company has adopted SFAS No. 146 prospectively as of January 1, 2003
and it did not have a material impact on the Company's results of
operations, financial position, or liquidity.
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others
On November 25, 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (FIN No. 45) which expands on the
accounting guidance of Statements No. 5, 57 and 107 and incorporates
without change the provisions of FASB Interpretation No. 34, which is
being superseded.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
FIN No. 45, significantly changes current practice in the accounting for,
and disclosure of, guarantees. Each guarantee meeting the characteristics
described in FIN No. 45 is to be recognized and initially measured at fair
value, which will be a change from prior practice. In addition, guarantors
must make significant new disclosures, even if the likelihood of the
guarantor making payments under the guarantee is remote, which represents
another change from prior general practice.
FIN No. 45's disclosure requirements were effective for financial
statements of interim or annual periods ending after December 15, 2002,
while the initial recognition and initial measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002.
The Company has included FIN No. 45's required disclosures in Note 7. FIN
No. 45 recognition and measurement provisions did not have a material
impact on the Company's results of operations, financial position or
liquidity once adopted by the Company on January 1, 2003.
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46),
"Consolidation of Variable Interest Entities". The objective of this
interpretation is to provide guidance on how to identify a variable
interest entity (VIE) and determine when the assets, liabilities,
non-controlling interests and results of operations of a VIE need to be
included in a company's consolidated financial statements. A company that
holds variable interests in an entity will need to consolidate the entity
if the company's interest in the VIE is such that the company will absorb
a majority of the VIE's expected loss and/or receive a majority of the
entity's expected residual returns, if they occur. FIN No. 46 also
requires additional disclosures by primary beneficiaries and other
significant variable interest holders. The provisions of this
interpretation initially became effective upon issuance, however, in
October 2003, the FAST issued an interpretation that defers the effective
date of FIN No. 46 for VIEs held by public companies in all entities that
were acquired prior to February 1, 2003. The deferral will require that
public companies adopt the provisions of FIN No. 46 in the period that
ends on or after December 31, 2003. As of September 30, 2003, the Company
was not party to any VIEs. The Company continues to assess the impact, if
any, the interpretation will have on results of operations, financial
position, or liquidity, as it applies to other areas within the Company.
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Accounting Pronouncement Adopted in 2002
On January 1, 2002, First Defiance adopted SFAS No. 142, Goodwill and
Other Intangible Assets. As required by FAS No. 142, goodwill is no longer
amortized into the income statement over an estimated life but rather is
tested at least annually for impairment based on specific guidance
included in FAS No. 142. Based on an impairment test performed as of
January 1, 2002, the Company determined that a portion of previously
recorded goodwill related to its First Insurance business unit was
impaired. The amount of impairment as of January 1, 2002, which was
$238,000 or $194,000 after tax, is reflected in the financial statements
as an adjustment for the cumulative effect of an accounting change. During
the quarter ended March 31, 2002, management reached a settlement with the
former shareholders of one of the agencies acquired to form First
Insurance related to an earn-out provision of the original purchase
agreement. The payment of $200,000 was recorded as additional goodwill for
First Insurance and was considered impaired. This $200,000 impairment
adjustment is reported as an operating cost by First Defiance in the 2002
first quarter. Since the first quarter of 2002, no further amount of
goodwill has been deemed to be impaired. The balance of goodwill recorded
at First Insurance totals $3.7 million at September 30, 2003. The balance
of goodwill, acquired as part of the 2003 branch acquisition (see Note
10), at First Federal totals $16.8 million at September 30, 2003.
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
3. Discontinued Operations
On April 1, 2002, First Defiance completed the sale of The Leader to US
Bancorp. Discontinued operations as reported for the nine months ended
September 30, 2002 include the operating results of The Leader for that
period. Net interest income is allocated to discontinued operations in
accordance with Emerging Issues Task Force (EITF) 87-24, based on interest
earned by First Federal on intercompany loans to The Leader less interest
expense, primarily interest on brokered certificates of deposit and a
portion of FHLB advances utilized to fund those intercompany loans. For
the first nine months of 2002, First Federal had a negative spread in its
borrowing relationship with The Leader. The components of discontinued
operations for the nine-month period ended September 30, 2002
are as follows (in thousands):
Nine months ended
September 30, 2002
------------------
Operations of The Leader $ 4,316
Net interest expense allocated to discontinued
operations (1,250)
Gain from sale of The Leader 16,959
Cost to terminate financing and other expenses
associated with discontinued operations (465)
---------------
Income from discontinued operations
before income taxes 19,560
Income tax on discontinued operations 10,213
---------------
Income from discontinued operations $ 9,347
===============
4. Dividends on Common Stock
As of September 30, 2003, First Defiance had declared a quarterly cash
dividend of $.15 per share for the third quarter of 2003, payable October
24, 2003.
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
5. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been
calculated by dividing net income by the weighted average number of shares
of common stock outstanding for the three and nine-month periods ended
September 30, 2003 and 2002. First Defiance accounts for the shares issued
to its Employee Stock Ownership Plan ("ESOP") in accordance with Statement
of Position 93-6 of the American Institute of Certified Public Accountants
("AICPA"). As a result, shares controlled by the ESOP are not considered
in the weighted average number of shares of common stock outstanding until
the shares are committed for allocation to an employee's individual
account. In the calculation of diluted earnings per share for the three
and nine-months ended September 30, 2003 and 2002, the effect of shares
issuable under stock option plans and unvested shares under the Management
Recognition Plan have been accounted for using the Treasury Stock method.
The following table sets forth the computation of basic and diluted
earning per share (in thousands except per share data):
Three Months Ended Nine Months Ended
September 30 September 30
2003 2002 2003 2002
------------------------------------------
Numerator for basic and diluted earnings per share -
income from continuing operations $3,681 $1,382 $9,263 $3,655
Denominator:
Denominator for basic earnings per share -
weighted average shares 6,002 6,400 6,033 6,389
Effect of dilutive securities:
Employee stock options 288 242 256 154
Unvested management recognition plan stock 3 10 7 38
------------------------------------------
Dilutive potential common shares 291 252 263 192
------------------------------------------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 6,293 6,652 6,296 6,581
==========================================
Basic earnings per share from continuing operations $ 0.61 $ 0.22 $ 1.54 $ 0.57
==========================================
Diluted earnings per share from continuing operations $ 0.58 $ 0.21 $ 1.47 $ 0.55
==========================================
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
6. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities (in thousands):
September 30, 2003
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
----------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 70,934 $5,019 $ 6 $ 75,947
Corporate bonds 16,491 1,283 -- 17,774
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 61 2,048
Mortgage-backed securities 21,055 216 6 21,265
Collateralized mortgage obligations 7,647 83 2 7,728
REMICs 9,618 45 15 9,648
Trust preferred stock 7,238 111 3 7,346
Equity securities 69 4 -- 73
Obligations of state and political
subdivisions 31,669 1,573 53 33,189
--------------------------------------------
Totals $166,830 $8,334 $146 $175,018
============================================
Held-to-Maturity Securities:
FHLMC certificates $ 676 $ 25 $ 1 $ 700
FNMA certificates 1,245 18 6 1,257
GNMA certificates 442 13 -- 455
Obligations of state and political
subdivisions 590 125 -- 715
--------------------------------------------
Totals $ 2,953 $ 181 $ 7 $ 3,127
============================================
16
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
6. Investment Securities (continued)
December 31, 2002
-----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
-----------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 95,462 $ 6,373 $ 2 $101,833
Corporate bonds 25,720 1,733 -- 27,453
Adjustable rate mortgage-backed security
mutual funds 2,109 -- 54 2,055
Adjustable rate mortgage-backed securities 15,169 269 -- 15,438
REMICs 12,636 232 -- 12,868
Collateralized mortgage obligations 11,380 201 42 11,539
Trust preferred stock 7,238 53 55 7,236
Equity securities 69 -- 2 67
Obligations of state and political
subdivisions 29,890 1,283 58 31,115
---------------------------------------------
Totals $199,673 $10,144 $213 $209,604
=============================================
Held-to-Maturity Securities:
FHLMC certificates $ 1,004 $ 32 $ 3 $ 1,033
FNMA certificates 1,691 29 6 1,714
GNMA certificates 636 25 -- 661
Obligations of state and political
subdivisions 590 131 -- 721
---------------------------------------------
Totals $ 3,921 $ 217 $ 9 $ 4,129
=============================================
17
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
7. Commitments, Guarantees and Contingent Liabilities
Loan commitments are made to accommodate the financial needs of First
Defiance's customers; however, there are no long-term, fixed-rate loan
commitments that result in market risk. Standby letters of credit obligate
the Company to pay a third party beneficiary when a customer fails to
repay an outstanding loan or debt instrument, or fails to perform some
contractual non-financial obligation. Standby letters of credit are issued
to address customers' financing needs and to facilitate customers' trade
transactions. In accordance with FASB Interpretation No. 45, "Guarantor's
Guarantees of Indebtedness of Others," certain guarantees issued or
modified on or after January 1, 2003, require the recognition of a
liability on First Defiance's balance sheet for the "stand ready"
obligation with such guarantees.
If amounts are drawn under standby letters of credit, such amounts are
treated as loans. Both loan commitments and standby letters of credit have
credit risk, essentially the same as that involved in extending loans to
customers, and are subject to the Company's normal credit policies.
Collateral (e.g., securities, receivables, inventory and equipment) is
obtained based on management's credit assessment of the customer.
The Company's maximum obligation to extend credit for loan commitments
(unfunded loan and unused lines of credit) and standby letters of credit
was as follows:
September 30, December 31,
2003 2002
-----------------------------
(In Thousands)
Commercial $ 98,414 $103,984
Real Estate 10,826 17,537
Consumer 54,026 41,555
Standby Letters of Credit 4,490 2,997
-------- --------
Total $180,679 $166,073
======== ========
The remaining weighted average life for outstanding standby letters of
credit was less than one year at September 30, 2003. The Company had no
standby letters of credit with a life longer than one year.
18
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
8. Loans
Loans receivable and held for sale consist of the following (in
thousands):
September 30, December 31
2003 2002
--------------------------
Real Estate:
One-to-four family residential $165,914 $157,691
Construction 16,457 15,357
Non-residential and multi-family 321,602 227,754
----------------------
503,973 400,802
Other Loans:
Commercial 130,001 104,070
Consumer finance 40,532 37,579
Home equity and improvement 63,853 49,889
----------------------
234,386 191,538
----------------------
Total real estate and other loans 738,359 592,340
Deduct:
Loans in process 6,713 7,255
Net deferred loan origination fees and costs 1,175 1,212
Allowance for loan loss 8,577 7,496
----------------------
Totals $721,894 $576,377
======================
Changes in the allowance for loan losses were as follows (in $000s):
Three Months ended Nine Months ended
September 30 September 30
2003 2002 2003 2002
------------------------------------------------
Balance at beginning of period $8,106 $7,028 $7,496 $6,548
Provision for loan losses 497 386 1,185 1,124
Charge-offs:
One-to-four family residential real estate -- 18 18 82
Non-residential and multi-family real estate -- 110 162 184
Commercial 52 20 115 20
Consumer finance 45 64 133 304
------------------------------------------------
Total charge-offs 97 212 428 590
Recoveries 71 54 324 174
------------------------------------------------
Net charge-offs 26 158 104 416
------------------------------------------------
Ending allowance $8,577 $7,256 $8,577 $7,256
================================================
19
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2003 and 2002)
- --------------------------------------------------------------------------------
9. Deposits
A summary of deposit balances is as follows (in thousands):
September 30, December 31,
2003 2002
----------------------------
Non-interest-bearing checking accounts $ 52,190 $ 43,936
Interest-bearing checking accounts 63,966 41,318
Savings accounts 51,532 39,363
Money market demand accounts 151,675 129,036
Certificates of deposit 416,044 345,920
------------------------
$735,407 $599,573
========================
10. Banking Center Acquisition
On June 6, 2003, First Defiance completed the acquisition of three banking
centers from RFC Banking Company, a subsidiary of Rurban Financial Corp.
The banking centers are located in Findlay, Ottawa, and McComb, Ohio.
Under the terms of the agreement, First Defiance paid a purchase price
equal to 10.5% of all non-brokered deposit accounts plus an agreed upon
amount for all furnishings and equipment of those branches. In addition,
First Defiance acquired certain loans of those banking centers. As a
result of the acquisition, First Defiance acquired deposits of $166.5
million, including $32.8 million of brokered certificates of deposit, net
loans of $80.6 million, and premises, furnishings and equipment of $2.0
million. In addition, First Defiance also recorded intangible assets
resulting from the acquisition of $16.7 million, including goodwill of
$15.9 million and core deposit intangibles of $772,000. The core deposit
intangible will be amortized over approximately 10 years.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General
First Defiance Financial Corp. ("First Defiance" of "the Company") is a holding
company which conducts business through its two wholly owned subsidiaries, First
Federal Bank of the Midwest ("First Federal") and First Insurance and
Investments, Inc. ("First Insurance"). First Federal is a federally chartered
savings bank that provides financial services to communities based in northwest
Ohio where it operates 17 full service branches and one commercial loan
production office. First Federal provides a broad range of financial services
including checking accounts, savings accounts, certificates of deposit, real
estate mortgage loans, commercial loans, consumer loans, home equity loans and
trust services. First Insurance sells a variety of property and casualty, group
health and life, and individual health and life insurance products and
investment and annuity products. Insurance products are sold through First
Insurance's office in Defiance, Ohio while investment and annuity products are
sold through registered investment representatives located at two First Federal
banking center locations.
Effective April 1, 2002, The Leader Mortgage Company, LLC ("The Leader"), a
mortgage banking subsidiary of First Federal, was sold to US Bancorp. The
operating results the Leader and the associated gains from the sale are reported
as discontinued operations for the nine month period ended September 30, 2002.
First Defiance invests in U.S. Treasury and federal government agency
obligations, obligations of municipal and other political subdivisions,
mortgage-backed securities which are issued by federal agencies, corporate
bonds, and collateralized mortgage obligations ("CMOs") and real estate mortgage
investment conduits ("REMICs"). Management determines the appropriate
classification of all such securities at the time of purchase in accordance with
FAS Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities.
Securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the security to maturity. Held-to-maturity
securities are stated at amortized cost and had a recorded value of $3.1 million
at September 30, 2003. Securities not classified as held-to-maturity are
classified as available-for-sale, which are stated at fair value and had a
recorded value of $175.0 million at September 30, 2003. The available-for-sale
portfolio consists of U.S. Treasury securities and obligations of U.S.
Government corporations and agencies ($75.9 million), corporate bonds ($17.8
million), certain municipal obligations ($33.2 million), CMOs and REMICs ($17.4
million), mortgage backed securities ($21.3 million), preferred stock and other
equity investments ($7.4 million) and adjustable-rate mortgage backed security
mutual funds ($2.0 million). In accordance with SFAS No. 115, unrealized holding
gains and losses deemed temporary on available-for-sale securities are reported
in a separate component of stockholders' equity and are not reported in earnings
until realized. Net unrealized holding gains on available-for-sale securities
were $8.2 million at September 30, 2003, or $6.4 million after considering the
related deferred tax liability.
21
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
The profitability of First Defiance is primarily dependent on its net interest
income and non-interest income. Net interest income is the difference between
interest income on interest-earning assets, principally loans and securities,
and interest expense on interest bearing deposits, Federal Home Loan Bank
advances, and other borrowings. The Company's non-interest income includes
deposit and loan servicing fees, gains on sales of mortgage loans, and insurance
commissions. First Defiance's earnings also depend on the provision for loan
losses and non-interest expenses, such as employee compensation and benefits,
occupancy and equipment expense, deposit insurance premiums, amortization and
impairment of mortgage servicing rights and miscellaneous other expenses, as
well as federal income tax expense.
Forward-Looking Information
Certain statements contained in this quarterly report that are not historical
facts, including but not limited to statements that can be identified by the use
of forward-looking terminology such as "may", "will", "expect", "anticipate", or
"continue" or the negative thereof or other variations thereon or comparable
terminology are "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21B of the Securities Act
of 1934, as amended. Actual results could differ materially from those indicated
in such statements due to risks, uncertainties and changes with respect to a
variety of market and other factors.
Banking Center Acquisition
On June 6, 2003, First Defiance completed the acquisition of three banking
centers from RFC Banking Company, a subsidiary of Rurban Financial Corp. The
banking centers are located in Findlay, Ottawa, and McComb, Ohio. Under the
terms of the purchase and assumption agreement, First Defiance paid a purchase
price equal to 10.5% of all non-brokered deposit accounts plus an agreed upon
amount for all furnishings and equipment of those branches. In addition, First
Defiance acquired certain loans of those banking centers. As a result of the
acquisition, First Defiance acquired deposits of $166.7 million, including $32.8
million of brokered certificates of deposit, net loans of $79.1 million, and
premises, furnishings and equipment of $2.0 million. In addition, First Defiance
also recorded intangible assets resulting from the acquisition of $16.9 million,
including goodwill of $16.1 million and core deposit intangibles of $772,000.
The core deposit intangible will be amortized over approximately 10 years.
Changes in Financial Condition
At September 30, 2003, First Defiance's total assets, deposits and stockholders'
equity amounted to $1.03 billion, $735.4 million and $123.2 million,
respectively, compared to $884.2 million, $599.6 million and $120.1 million,
respectively, at December 31, 2002.
Net loans receivable increased to $710.3 million at September 30, 2003 from
$561.0 million at December 31, 2002 due in part to the $79.1 of loans acquired
as part of the RFC banking center acquisition. The increase in loans receivable
occurred primarily in non-residential and multi-family real estate loans, which
increased by $93.8 million to $321.6 million at September 30, 2003. In addition,
commercial loans increased by $25.9 million to $130.0 million at September 30,
2003. Also, home equity and improvement loans, increased by $14.0 million to
$63.9 at September 30, 2003. One-to-four family residential loans increased by
$8.2 million to $165.9 million at September 30, 2003 because of residential
mortgage loans that were acquired as part of the banking center
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
acquisition. Without the acquisition, residential mortgage loans declined
because of the substantial refinancing activity, most of which is sold into the
secondary market. Also, consumer loans increased by $3.0 million to $40.5
million at September 30, 2003.
The investment securities portfolio decreased to $178.0 million at September 30,
2003 from $213.5 million at December 31, 2002. The decrease in the balance in
the investment portfolio is the result of redeploying funds from securities as
they mature or get called to fund loan growth and to fund the run-off of
brokered certificates of deposit. At September 30, 2003 there were approximately
$25.3 million of interest-bearing deposits held at other financial institutions.
These funds, which resulted from acquiring more deposits in the banking center
acquisition than loans, will be redeployed into loans, higher earning
investments as interest rates rise, or will be used to liquidate $38.3 million
of brokered CDs, $20.5 million of which are scheduled to mature over the next 12
months which management does not currently intend to renew.
Deposits increased from $599.6 million at December 31, 2002 to $735.4 million as
of September 30, 2003. As a result of the banking center acquisition and other
deposit growth initiatives, money market demand accounts have increased by $22.7
million, to $151.7 million at September 30, 2003 from $129.0 million at December
31, 2002, and checking accounts, both interest and non-interest bearing, have
increased by $30.8 million, to $116.1 million at September 30, 2003 from $85.3
million at December 31, 2002. While the Company has focused on increasing its
lower cost core deposits, and has been less aggressive in retaining higher cost
certificates of deposit during 2003, those balances still increased by $70.1
million to $416.0 million at September 30, 2003, from $345.9 million at December
31, 2002. Those balances increased because the Company acquired $107.2 million
of CDs as part of the acquisition of the banking centers from RFC Bank.
Additionally, FHLB advances increased to $154.0 million at September 30, 2003
from $149.1 million at December 31, 2002. These borrowings were used to fund
loan growth and investment strategies and were part of management's strategy to
take advantage of the historically low rate environment to lock in long-term
funding. Short-term borrowings increased to $9.7 million at September 30, 2003
from $4.3 million at December 31, 2002. This is a result of an increase in the
balance of securities sold under repurchase agreements, an alternative source of
funding for the Company, which fluctuates, based on customer demand.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Average Balances, Net Interest Income and Yields Earned and Rates Paid
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in thousands of dollars and rates, and the net interest margin. Dividends
received on FHLB stock are included as interest income. The table reports
interest income from tax-exempt loans and investment on a tax-equivalent basis.
All average balances are based upon daily balances. The average balance sheet
and income statement for the 2002 nine month period have been adjusted to
allocate interest expense associated with financing The Leader's operations to
discontinued operations. The average balance of FHLB advances for this yield
analysis does not include those advances, which were used to finance The
Leader's operations. The interest-bearing liabilities reflect only those funds
attributable to First Defiance's continuing operations.
Three Months Ended September 30,
--------------------------------------------------------------------------
2003 2002
---------------------------------- ---------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
----------- ---------- ------- --------- ----------- -------
Interest-earning assets:
Loans receivable $ 713,402 $ 10,989 6.11% $ 535,149 $ 9,343 6.93%
Securities 177,730 2,165 4.83 216,845 2,870 5.25
Interest-earning deposits 36,884 107 1.15 42,200 192 1.81
FHLB stock and other 17,415 176 4.01 21,730 234 4.27
----------- ---------- --------- --------
Total interest-earning assets 945,431 13,437 5.64 815,924 12,639 6.15
Non-interest-earning assets
(including assets of discontinued
operations) 92,757 56,884
----------- ---------
Total assets $ 1,038,188 $ 872,808
=========== =========
Interest-bearing liabilities:
Deposits $ 691,280 $ 3,330 1.91% $ 561,660 $ 4,227 2.99%
FHLB advances and other 154,116 1,843 4.74 131,913 1,702 5.12
Notes payable 9,898 25 1.00 2,466 23 3.70
----------- ---------- --------- --------
Total interest-bearing liabilities 855,294 5,198 2.41 696,039 5,952 3.39
Non-interest bearing deposits 52,013 -- -- 32,120 -- --
----------- ---------- --------- --------
Total including non-interest bearing
demand deposits 907,307 5,198 2.27 728,159 5,952 3.24
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 10,345 21,158
----------- ---------
Total liabilities 917,652 749,317
Stockholders' equity 120,536 123,491
----------- ---------
Total liabilities and stock-
holders' equity $ 1,038,188 $ 872,808
=========== =========
Net interest income; interest
rate spread $ 8,239 3.23% $ 6,687 2.75%
========== ==== ======== ====
Net interest margin (3) 3.46% 3.25%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 111% 117%
=== ===
- ----------
(1) Interest on certain tax exempt loans and securities is not taxable for
Federal income tax purposes. In order to compare the tax-exempt yields on
these assets to taxable yields, the interest earned on these assets is
adjusted to a pre-tax equivalent amount based on the marginal corporate
federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Nine Months Ended September 30,
--------------------------------------------------------------------------------
2003 2002
----------------------------------- -------------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
---------- ----------- ------- ---------- ----------- -------
Interest-earning assets:
Loans receivable $ 645,665 $ 30,418 6.30% $ 514,353 $ 27,485 7.14%
Securities 191,274 7,040 4.92 152,902 6,222 5.44
Interest-earning deposits 22,816 216 1.27 50,715 619 1.63
FHLB stock and other 17,540 518 3.95 24,206 700 3.87
---------- --------- ---------- ---------
Total interest-earning assets 877,295 38,192 5.82 742,176 35,026 6.31
Non-interest-earning assets
(including assets of discontinued
operations) 76,639 227,173
--------- ---------
Total assets $ 953,934 $ 969,349
========= ========
Interest-bearing liabilities (4):
Deposits $ 616,617 $ 10,275 2.23% $ 544,206 $ 12,616 3.10%
FHLB advances and other 155,112 5,553 4.79 90,361 3,476 5.14
Notes payable 5,711 47 1.10 8,775 250 3.81
---------- --------- ---------- ---------
Total interest-bearing liabilities 777,440 15,875 2.73 643,342 16,342 3.40
Non-interest bearing deposits 45,619 -- 31,272 --
---------- --------- ---------- ---------
Total including non-interest bearing
demand deposits 823,059 15,875 2.58 674,614 16,342 3.24
Other non-interest-bearing liabilities
(including liabilities of
discontinued operations) 10,319 176,488
---------- ----------
Total liabilities 833,378 851,102
Stockholders' equity 120,556 118,247
---------- ----------
Total liabilities and stock-
holders' equity $ 953,934 $ 969,349
========== ==========
Net interest income; interest
rate spread $ 22,317 3.09% $ 18,684 2.91%
========= ==== ========= ====
Net interest margin (3) 3.40% 3.37%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 113% 115%
==== ====
- ----------
(1) Interest on certain tax exempt loans and securities is not taxable for
Federal income tax purposes. In order to compare the tax-exempt yields on
these assets to taxable yields, the interest earned on these assets is
adjusted to a pre-tax equivalent amount based on the marginal corporate
federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
(4) This analysis does not reflect borrowings to fund discontinued operations.
Results of Operations
On April 1, 2002, First Defiance completed the sale of The Leader to US Bancorp.
As a result of this sale, management has included the operating results for The
Leader in discontinued operations for all prior periods presented. See Note 3 to
the Consolidated Condensed Financial Statements filed with this Form 10-Q.
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Three Months Ended September 30, 2003 compared to Three Months Ended September
30, 2002
On a consolidated basis, First Defiance had net income of $3.7 million or $.58
per share for the three months ended September 30, 2003 compared to $1.4 million
or $0.21 per share in 2002. Results for the 2003 third quarter were favorably
impacted by a $987,000 recovery in its reserve for mortgage servicing rights
("MSR") impairment ($642,000 or $.10 per share after tax). During the 2002 third
quarter, First Defiance increased its reserve for impairment by $521,000
($339,000 or $.05 per share after tax). See non-interest expense discussion for
additional discussion regarding the impairment recovery.
Net Interest Income. Net interest income for the quarter ended September 30,
2003 was $7.8 million compared to $6.2 million from continuing operations for
the same period in 2002. Net interest margin for the 2003 second quarter was
3.46% compared to 3.25% for the same period in 2002. On a tax-equivalent basis,
net interest income for the quarter ended September 30, 2003 was $8.2 million
compared to $6.7 million from continuing operations for the same period in 2002.
Total interest income increased by $827,000 to $13.0 million for the three
months ended September 30, 2003 from $12.2 million from continuing operations
for the three months ended September 30, 2002. On a tax equivalent basis, total
interest income increased by $798,000 to $13.4 million for the three months
ended September 30, 2003 from $12.6 million for the three months ended September
30, 2002. Interest on loans increased $1.6 million to $10.9 million in the
second quarter of 2003 from $9.3 million in the second quarter of 2002. The
increase in interest from loans was due to a $178.3 million increase in average
loan balances between the third quarter of 2002 and the third quarter of 2003.
Much of the benefit of increased loan volumes has been offset by declining
portfolio yields. The yield on First Defiance's loan portfolio declined from
6.93% for the three months ended September 30, 2002 to 6.11% for the same period
in 2003 because of falling interest rates over that time period. The Company
also has experienced a change in the mix of its loan portfolio as commercial
loans and non-residential real estate loans were $451.6 million at September 30,
2003, up from $331.8 million at December 31, 2002. During that same time,
one-to-four family residential loans, excluding loans held for sale, increased
from $157.7 million to $165.9 million. However, that number includes loans
acquired as part of the banking center acquisition. Excluding the loans acquired
in the acquisition, the portfolio of one- to four-family residential loan
mortgages declined as a result of increased mortgage loan refinance activity.
The Company sells most of its new mortgage loan originations into the secondary
market.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, decreased $848,000 to $2.5 million for the three
months ended September 30, 2003 compared to $3.3 million for the same period in
2002. The decrease is due to a combination of declining yields in the investment
portfolio and declining balances in both the investment portfolio and interest
bearing deposits as a result of utilizing those balances to fund loan growth.
The rate decline is due both to the historically low rate environment in the
2003 third-quarter along with managements' decision to invest primarily in
shorter-term investments in anticipation of continued loan growth and other
requirements. The average balance of securities for the 2003
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
third quarter decreased to $177.7 million from $216.8 million for the same
period in 2002. The tax equivalent yield on those securities dropped 42 basis
points, from 5.25% for the three months ended September 30, 2002 to 4.83% for
the three months ended September 30, 2003. The average balance on interest
bearing deposits decreased $5.3 million to $36.9 million from $42.2 million. To
compare the tax-exempt asset yields to taxable yields, amounts are adjusted to
pretax equivalents based using a marginal corporate Federal tax rate of 35%. The
tax-equivalent adjustments to net interest income for the 2003 and 2002 third
quarters were $233,000 and $204,000 respectively.
Total interest expense decreased by $754,000, to $5.2 million for the third
quarter of 2003 compared to $6.0 million from continuing operations for the same
period in 2002. Interest expense on interest bearing deposits decreased by
$897,000 to $3.3 million for the quarter ended September 30, 2003 from $4.2
million for the quarter ended September 30, 2002. This happened despite growth
in deposits because of the change in the mix of deposits from higher costing
certificates of deposit to checking and money market deposit accounts. The
average cost of interest-bearing deposits decreased from 2.99% for the third
quarter of 2002 to 1.91% for the third quarter of 2003. Interest expense on FHLB
advances increased $141,000 to $1.8 million for the third quarter of 2003
compared to the same period in 2002. The increase is due to the increase of
average balances of FHLB advances, which increased to $154.1 million in the
third quarter of 2003, up from $131.9 million for the quarter ended September
30, 2002.
Provision for Loan Losses. The provision for loan losses was $497,000 in the
third quarter of 2003 compared to $386,000 for the third quarter of 2002. Net
charge-offs for the 2003 third quarter were $26,000, compared to $158,000 for
the same period in 2002. Provisions for loan losses are charged to earnings to
bring the total allowance for loan losses to the level deemed appropriate by
management based on historical experience, the volume and type of lending
conducted by First Defiance, industry standards, the amount of non-performing
assets and loan charge-off activity, general economic conditions, particularly
as they relate to First Defiance's market area, and other factors related to the
collectibility of First Defiance's loan portfolio. The increase in the loan loss
provision over the prior year was required to maintain the allowance at an
appropriate level considering the continued growth in the Company's commercial
loan and non-residential real estate loan portfolios. Management believes the
balance of the allowance for loan losses is appropriate.
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Non-performing assets and asset quality ratios for First Defiance were as
follows (in $000's):
September 30, December 31,
2003 2002
-------------------------------
Non-accrual loans $ 2,975 $ 2,525
Loans over 90 days past due and still accruing -- --
-----------------------------
Total non-performing loans $ 2,975 $ 2,525
Real estate owned (REO) 324 206
-----------------------------
Total non-performing assets $ 3,299 $ 2,731
=============================
Allowance for loans losses as a percentage of total loans 1.19% 1.32%
Allowance for loan losses as a percentage of non-
performing assets 259.99% 274.48%
Allowance for loan losses as a percentage of non-
performing loans 288.30% 296.87%
Total non-performing assets as a percentage of total assets 0.32% 0.31%
Total non-performing loans as a percentage of total loans 0.41% 0.44%
Of the $3.0 million in non-accrual loans, $2.4 million were commercial loans or
non-residential real estate loans and $494,000 were residential mortgage loans.
The allowance for loan losses at September 30, 2003 was $8.6 million compared to
$7.3 million at September 30, 2002 and $7.5 million at December 31, 2002. For
the quarter ended September 30, 2003, First Defiance charged off $97,000 of
loans against its allowance and realized recoveries of $71,000 from loans
previously charged off. During the same quarter in 2002, First Defiance charged
off $212,000 in loans and realized recoveries of $54,000.
In addition to the existing allowance for loan losses, management also evaluated
the expected collectibility of the loans acquired as part of the banking center
acquisition. In conjunction with that evaluation, those balances were discounted
by approximately $2.9 million in recording the acquisition to reflect potential
credit losses. That $2.9 million discount is in addition to First Federal's $8.6
million allowance for loan losses. $11,000 was charged against that discount
during the 2003 third quarter.
Non-Interest Income. Non-interest income increased $1.5 million to $4.8 million
for the quarter ended September 30, 2003 from $3.3 million for the same period
in 2002. Individual components of non-interest income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased
$1.1 million to $2.3 million for the three months ended September 30, 2003 from
$1.2 million during the 2002 third quarter. The increase is due to high mortgage
loan origination activity in the low interest rate environment. While the
Company exited the mortgage banking business at the national level with the sale
of The Leader, the origination and servicing of mortgage loans continues to be a
core activity of First Federal in its local market areas.
Service Fees. Loan and deposit fees increased $236,000 to $1.2 million for the
quarter ended September 30, 2003 from $968,000 for the quarter ended September
30, 2002. Increases occurred primarily in loan servicing fees on mortgage loans
serviced for others and checking NSF fees.
28
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $114,000 to $924,000 in the third quarter of 2003
from $810,000 in the same period of 2002. Increases occurred in the property and
casualty lines as well as income from the sale of securities and annuities.
Bank Owned Life Insurance. Income from bank owned life insurance was $211,000 in
the quarter ended September 30, 2003. The Company made an initial $15 million
investment in BOLI during the 2002 fourth quarter.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, decreased to
$226,000 for the quarter ended September 30, 2003 from $278,000 for the same
period in 2002.
Non-Interest Expense. Total non-interest expense decreased $408,000 to $6.8
million for the quarter ended September 30, 2003 from $7.2 million for the same
period in 2002. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $651,000 to $4.3
million for the quarter ended September 30, 2003 from $3.6 million for the same
period in 2002. The increase was the result of the addition of the three new
banking offices in June of 2003, as well as other staffing increases necessary
to support the Company's significant growth. Compensation and benefits also
increased due to cost of living and merit increases for existing employees which
averaged approximately 4%, and higher level of sales commissions at First
Insurance due to higher commission premium income.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of
mortgage servicing rights ("MSR's") totaled $546,000 in the 2003 third quarter
compared to $512,000 in the 2002 third quarter, the result of continuing
significant refinancing activity in the First Federal loan servicing portfolio.
Also, the Company recognized a favorable adjustment of $987,000 for the recovery
of previously recorded impairment reserves against the value of its MSR
portfolio during the 2003 third quarter, the result of an increase in the market
value of MSRs caused by increases in market rates for mortgage loans since June
30, 2003. There was a $521,000 unfavorable adjustment for impairment recognized
in the third quarter of 2002. First Defiance has total remaining impairment
reserves of $942,000 recorded against assets with a book value before reserves
of $4.5 million at September 30, 2003. That portfolio represents approximately
5,265 loans serviced for others with unpaid balances of approximately $424
million.
Amortization/Impairment of Goodwill and Other Intangibles. First Defiance is no
longer required to recognize goodwill amortization as an expense but must test
for and recognize any impairment in goodwill. There was no goodwill impairment
in 2003 or 2002. In conjunction with the branch acquisition, First Defiance
recognized a core deposit intangible of $772,000, which is subject to
amortization. Amortization expense for the 2003 third quarter was $31,000.
29
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $2.9 million for the quarter ended September 30, 2003 from $2.5 million for
the same period in 2002.
First Defiance computes federal income tax expense in accordance with SFAS
Statement No. 109 which resulted in an effective tax rate of 31.78% for the
quarter ended September 30, 2003 compared to 29.13% for the same period in 2002.
The effective tax rate is less than the statutory rate as a result of investing
approximately $33.8 million in municipal securities, and $15.8 million of bank
owned life insurance which are both exempt from federal tax. At September 30,
2002, First Defiance had $27.4 million invested in tax-exempt securities and no
investment in bank owned life insurance. The year over year increase in the
effective tax rate is due to taxable income increasing at a faster rate than
tax-exempt income.
As a result of the above factors, income for the quarter ended September 30,
2003 was $3.7 million compared to income from continuing operations of $1.4
million for the comparable period in 2002. On a per share basis, basic and
diluted earnings per share for the three months ended September 30, 2003 were
each $0.61 and $.58, respectively, compared to basic and diluted earnings per
share from continuing operations of $0.22 and $0.21, respectively, for the
quarter ended September 30, 2002.
Nine Months Ended September 30, 2003 compared to Nine Months Ended September 30,
2002
On a consolidated basis, First Defiance had net income of $9.3 million or $1.47
per share for the nine months ended September 30, 2003 compared to $12.8 million
or $1.92 per share in 2002. The 2002 net income included earnings from
discontinued operations of $9.3 million or $1.40 per share. Income from
continuing operations for the first nine months of 2002 was $3.7 million or
$0.55 per share.
Net Interest Income. Net interest income for the nine months ended September 30,
2003 was $21.1 million compared to $17.5 million from continuing operations for
the same period in 2002. Net interest margin for the 2003 first three quarters
was 3.40% compared to 3.37% for the same period in 2002. On a tax equivalent
basis, net interest income for the nine months ended September 30, 2003 was
$22.3 million compared to $18.7 million from continuing operations for the same
period in 2002.
Total interest income increased by $3.2 million to $37.0 million for the nine
months ended September 30, 2003 from $33.8 million from continuing operations
for the nine months ended September 30, 2002. On a tax equivalent basis, total
interest income increased by $3.2 million to $38.2 million for the nine months
ended September 30, 2003 from $35.0 million for the nine months ended September
30, 2002. Interest on loans increased $2.9 million to $30.2 million in the first
nine months of 2003 from $27.3 million in the first nine months of 2002. The
increase in interest from loans was due to a $131.3 million increase in average
loan balances between the first nine months of 2002 and the first nine months of
2003.
Much of the benefit of increased loan volumes has been offset by declining
portfolio yields. The yield on First Defiance's loan portfolio declined from
7.14% for the nine months ended September
30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
30, 2002 to 6.30% for the same period in 2003 because of falling interest rates
over that time period.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, increased $415,000 to $7.3 million for the nine
months ended September 30, 2003 compared to $6.8 million for the same period in
2002. The increase is due to an increase in the average balance of securities
outstanding, which increased to $191.3 million from $152.9 million for the same
period in 2002. This increase is due primarily to the receipt of net proceeds
related to the sale of The Leader. The tax equivalent yield on those securities
dropped 52 basis points from 5.44% for the nine months ended September 30, 2002
to 4.92% for the nine months ended September 30, 2003. The average balance on
interest bearing deposits decreased $27.9 million to $22.8 million for the
period ending September 30, 2003 from $50.7 million for the same period in 2002.
Total interest expense decreased by $467,000 to $15.9 million for the first nine
months of 2003 compared to $16.3 million from continuing operations for the same
period in 2002. Interest expense on FHLB advances increased $2.1 million to $5.6
million for the first nine months of 2003 compared to the same period in 2002.
The increase is due primarily to the increase of average balances of FHLB
advances. FHLB advances increased $64.8 million to $155.1 million for the nine
months ended September 30, 2003 from $90.4 million for the nine months ended
September 30, 2002. The average balance sheet and income statement for 2002 were
adjusted to allocate interest expense associated with financing The Leader's
operations to discontinued operations. For 2003, all FHLB advances are included
in operations as they were used to fund purchases of investment securities and
loan growth. Interest expense on interest bearing deposits decreased by $2.3
million to $10.3 million for the nine months ended September 30, 2003 from $12.6
million for the nine months ended September 30, 2002. This happened despite
growth in deposits because of the change in the mix of deposits from higher
costing certificates of deposit to checking and money market deposit accounts.
The average cost of funds decreased from 3.24% for the nine months ended
September 30, 2002 to 2.58% for the same period in 2003. The average balances of
interest-bearing liabilities increased $134.1 million from $643.3 million in the
first nine months of 2002 to $777.4 million in the first nine months of 2003.
Provision for Loan Losses. The provision for loan losses was $1.2 million for
the first nine months of 2003 compared to $1.1 million for the first nine months
of 2002. Net charge-offs for the first three quarters of 2003 were $104,000,
compared to $416,000 for the same period in 2002.
Non-Interest Income. Non-interest income increased $6.6 million in the first
nine months of 2003, to $15.0 million for the nine months ended September 30,
2003 from $8.4 million for the same period in 2002. Individual components of
non-interest income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased
$4.3 million to $6.6 million for the period ended September 30, 2003 from $2.3
million during the first nine months of 2002.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $919,000 for the nine months ending September 30, 2003 compared
to $21,000 in the first nine months of 2002. The realization of gains in the
investment portfolio was part of a strategy by management to shorten
31
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
the duration of assets in the investment portfolio to position the company to
benefit from rising rates and to take advantage of a portion of the gains in the
portfolio while they exist. In addition the Company realized securities gains in
the second quarter of 2003 due to the early call of an investment security with
a significant unamortized discount.
Service Fees. Loan and deposit fees increased $632,000 to $3.4 million for the
nine months ended September 30, 2003 from $2.7 million for the nine months ended
September 30, 2002. Increases occurred primarily in loan servicing fees on
mortgage loans serviced for others, debit card interchange fees, and checking
NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $297,000 to $2.8 million in the first nine months of
2003 from $2.5 million in the same period of 2002. Increases occurred in the
property and casualty lines as well as income from the sale of securities and
annuities.
Bank Owned Life Insurance. Income from bank owned life insurance was $616,000
for the nine months ended September 30, 2003. The Company made an initial $15
million investment in BOLI during the 2002 fourth quarter.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, decreased to
$657,000 for the nine months ended September 30, 2003 from $917,000 for the same
period in 2002.
Non-Interest Expense. Total non-interest expense increased $2.0 million to $21.5
million for the nine months ended September 30, 2003 from $19.5 million for the
same period in 2002. Significant individual components of the increase are as
follows:
Amortization and Impairment of Mortgage Servicing Rights. Amortization of MSRs
totaled $1.8 million in the first nine months of 2003 compared to $777,000 in
the 2002 first three quarters, the result of significant refinancing activity in
the First Federal loan-servicing portfolio. Also, the Company recognized a
favorable $381,000 adjustment for recovery in impairment reserves on the value
of its MSR portfolio during the first nine months of 2003. This is the result of
an increase in the market value of its MSRs due to recent increases in market
mortgage interest rates and decreased prepayment speeds on mortgage loans in
general. There was a $785,000 unfavorable adjustment for impairment reserves
recognized in the first nine months of 2002.
Compensation and Benefits. Compensation and benefits increased $1.5 million to
$11.9 million for the nine months ended September 30, 2003 from $10.4 million
for the same period in 2002.
Amortization/Impairment of Goodwill and Other Intangibles. First Defiance is no
longer required to recognize goodwill amortization as an expense but must test
for and recognize any impairment in goodwill. There was no goodwill impairment
in 2003. During the first nine months of 2002, management evaluated goodwill
recorded at First Insurance for the purpose of measuring impairment and
determined that such goodwill was impaired by $238,000 ($194,000 or $0.03 per
share after tax) as of January 1, 2002. As permitted, this amount is reflected
in the income statement as the cumulative effect of a change in accounting
principle. In addition to the $238,000
32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
of impaired goodwill, First Defiance paid additional consideration of $200,000
to settle a contingent payout clause under its agreement to acquire First
Insurance. The impairment of the goodwill created by that settlement was
recorded as an operating expense during the 2002 first half. Such impairment
totaled $200,000 in the first nine months of 2002. In conjunction with the
banking center acquisition, First Defiance recognized a core deposit intangible
of $772,000, which is subject to amortization. Amortization expense for the nine
months ending September 30, 2003 was $39,000.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $8.0 million for the nine months ended September 30, 2003 from $7.3 million
for the nine months ended September 30, 2002.
The effective federal income tax rate utilized for the nine months ended
September 30, 2003 was 30.8% compared to 31.3% for the nine months ended
September 30, 2002.
As a result of the above factors, income for the nine months ended September 30,
2003 was $9.3 million compared to income from continuing operations of $3.7
million for the comparable period in 2002. On a per share basis, basic and
diluted earnings per share for the nine months ended September 30, 2003 were
$1.54 and $1.47 respectively, compared to basic and diluted earnings per share
from continuing operations of $0.57 and $0.55, respectively, for the nine months
ended September 30, 2002.
Discontinued Operations. Discontinued operations for 2002, which represents net
income earned by The Leader's operations during the first quarter of 2002 plus
the gain from the sale of The Leader, were $9.3 million or $1.40 per share.
Liquidity and Capital Resources
As a regulated financial institution, First Federal is required to maintain
appropriate levels of "liquid" assets to meet short-term funding requirements.
First Defiance generated $13.1 million of cash from operating activities during
the third quarter of 2003. The Company's cash from operating activities resulted
from net income for the period, adjusted for various non-cash items, including
the provision for loan losses, depreciation and amortization of mortgage
servicing rights, ESOP expense related to release of shares, and changes in
loans available for sale, interest receivable and other assets, and other
liabilities. The primary investing activity of First Defiance is the origination
of loans (both for sale in the secondary market and to be held in portfolio),
which is funded with cash provided by operations, proceeds from the amortization
and prepayments of existing loans, the sale of loans, proceeds from the sale or
maturity of securities, borrowings from the FHLB, and customer deposits.
At September 30, 2003, First Defiance had $57.2 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $110.6 million committed under existing consumer and
commercial lines of credit and standby letters of credit. Also as of September
30, 2003, the total amount of certificates of deposit that are scheduled to
mature by September 30, 2004 is $300.2 million. First Defiance believes that it
has adequate
33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
resources to fund commitments as they arise and that it can adjust the rate on
savings certificates to retain deposits in changing interest rate environments.
If First Defiance requires funds beyond its internal funding capabilities,
advances from the FHLB of Cincinnati and other financial institutions are
available.
First Defiance utilizes forward purchase and forward sale agreements to meet the
needs of its customers and manage its exposure to fluctuations in the fair value
of mortgage loans held for sale and its pipeline. These forward purchase and
forward sale agreements are considered to be derivatives as defined by FAS 133,
Accounting for Derivatives and Hedging Instruments. The change in value in the
forward purchase and forward sale agreements is approximately equal to the
change in value in the loans held for sale and the effect of this accounting
treatment is not material to the financial statements. At September 30, 2003,
First Defiance had commitments to sell $5.6 million of loans held-for-sale.
First Defiance also invests in on-balance sheet derivative securities as part of
the overall asset and liability management process. Such derivative securities
include REMIC and CMO investments. Securities totaling $1.4 million do not pass
the FFIEC high-risk security test as of September 30, 2003. The weighted average
life of these securities exceeds the test limits in an instantaneous rate
increase scenario of 200 and 300 basis points. The company feels that at this
time the return being realized on those securities justifies continuing to hold
them in the portfolio. The remaining $16.0 million of these securities are not
classified as high risk at September 30, 2003 and do not present risk
significantly different than other mortgage-backed or agency securities.
First Federal is required to maintain specified amounts of capital pursuant to
regulations promulgated by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
The following table sets forth First Federal's compliance with each of the
capital requirements at September 30, 2003.
Core Capital Risk-Based Capital
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
----------- ----------- ----------- -----------
Regulatory capital $ 91,124 $91,124 $ 99,666 $ 99,666
Minimum required regulatory capital 40,126 50,158 59,738 74,673
-------- ------- -------- ---------
Excess regulatory capital $ 50,998 $40,966 $ 39,928 $ 24,993
======== ======= ======== =========
Regulatory capital as a percentage of assets (1) 9.1% 9.1% 13.4% 13.4%
Minimum capital required as a percentage of assets 4.0% 5.0% 8.0% 10.0%
-------- ------- -------- ---------
Excess regulatory capital as a percentage of assets 5.1% 4.1% 5.4% 3.4%
======== ======= ======== =========
(1) Core capital is computed as a percentage of adjusted total assets of
$1,003.2 million. Risk-based capital is computed as a percentage of total
risk-weighted assets of $746.7 million.
34
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
FDIC Insurance
The deposits of First Federal are currently insured by the Savings Association
Insurance Fund ("SAIF") which is administered by the FDIC. The FDIC also
administers the Bank Insurance Fund ("BIF") which generally provides insurance
to commercial bank depositors. Both the SAIF and BIF are required by law to
maintain a reserve ratio of 1.25% of insured deposits. First Federal's annual
deposit insurance premiums for 2003 are approximately $0.016 per $100 of
deposits.
Item 3. Qualitative and Quantitative Disclosure About Market Risk
As discussed in detail in the 2002 Annual Report on Form 10-K, First Defiance's
ability to maximize net income is dependent on management's ability to plan and
control net interest income through management of the pricing and mix of assets
and liabilities. Because a large portion of assets and liabilities of First
Defiance are monetary in nature, changes in interest rates and monetary or
fiscal policy affect its financial condition and can have significant impact on
the net income of the Company. First Defiance does not use off balance sheet
derivatives to enhance its risk management, nor does it engage in trading
activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis
through simulation analysis which measures the impact changes in interest rates
can have on net income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, nonmaturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise or fall 100 basis points over a 12 month period, using
September 2003 amounts as a base case, First Defiance's net interest income
would be impacted by less than the board mandated guidelines of 10%.
Item 4. Controls and Procedures
As of September 30, 2003, we performed an evaluation under the supervision and
with the participation of our management, including the CEO and CFO, of the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c)). Based on that
evaluation, our management, including the CEO and CFO, concluded that our
disclosure controls and procedures were effective as of September 30, 2003 to
provide reasonable assurance that material information relating to the Company
would be made known to them by others within the Company, particularly during
the period in which the Form 10-Q was being prepared. There have been no
significant changes in our internal controls or in other factors that could
significantly affect internal controls subsequent to our most recent evaluation
of these controls, nor any significant deficiencies or material weaknesses in
such controls requiring corrective actions. As a result, no corrective actions
were required or taken.
35
FIRST DEFIANCE FINANCIAL CORP.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
First Defiance is not engaged in any legal proceedings of a material
nature.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1 - Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 - Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 - Certification of the Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, As Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 - Certification of the Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, As Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
36
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on October 21, 2003 which included a
copy of the Company's earnings release for the quarter ended September 30,
2003.
37
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 11, 2003 By: /s/ William J. Small
-----------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: November 11, 2003 By: /s/ John C. Wahl
-----------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
38