UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Quarterly Period Ended March 31, 2004
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 -
6,391,933 shares outstanding at May 7, 2004
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page
Number
------
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - March 31, 2004 and December 31, 2003 2
Consolidated Condensed Statements of Income -
Three months ended March 31, 2004 and 2003 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Three months ended March 31, 2004 5
Consolidated Condensed Statements of Cash Flows
- Three months ended March 31, 2004 and 2003 7
Notes to Consolidated Condensed Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 29
Item 4. Controls and Procedures 29
PART II.-OTHER INFORMATION:
Item 1. Legal Proceedings 30
Item 2. Changes in Securities 30
Item 3. Defaults upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 32
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
March 31, 2004 December 31, 2003
-------------- -----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 17,610 $ 28,020
Interest-bearing deposits 4,828 9,763
---------- ----------
22,438 37,783
Securities:
Available-for-sale, carried at fair value 155,379 168,259
Held-to-maturity, carried at amortized cost
(approximate fair value $2,828 and $2,937
at March 31, 2004 and December 31,
2003 respectively) 2,665 2,776
---------- ----------
158,044 171,035
Loans held for sale 8,214 5,872
Loans receivable, net 757,920 735,255
Accrued interest receivable 4,821 4,742
Federal Home Loan Bank stock and other
interest-earning assets 17,943 17,766
Bank owned life insurance 18,145 17,952
Office properties and equipment 24,131 23,846
Real estate and other assets held for sale 348 404
Goodwill and other intangibles 19,302 20,544
Mortgage servicing rights 3,199 3,431
Other assets 2,595 1,969
---------- ----------
Total assets $1,037,100 $1,040,599
========== ==========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
March 31, 2004 December 31, 2003
-------------- -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 52,091 $ 52,323
Interest-bearing deposits 669,977 676,673
----------- -----------
Total deposits 722,068 728,996
Advances from Federal Home Loan Bank 167,974 164,522
Short-term borrowings and other interest-bearing liabilities 8,290 12,267
Advance payments by borrowers for taxes and insurance 162 231
Deferred taxes 2,235 1,859
Other liabilities 9,141 8,455
----------- -----------
Total liabilities 909,870 916,330
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; 6,401
and 6,328 shares outstanding, respectively 64 63
Additional paid-in capital 52,380 51,144
Stock acquired by ESOP (1,691) (1,904)
Deferred compensation (9) (11)
Accumulated other comprehensive income,
net of income taxes of $2,519
and $2,163, respectively 4,691 4,017
Retained earnings 71,795 70,960
----------- -----------
Total stockholders' equity 127,230 124,269
----------- -----------
Total liabilities and stockholders' equity $ 1,037,100 $ 1,040,599
=========== ===========
See accompanying notes
3
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
- --------------------------------------------------------------------------------
For the Three Months Ended
March 31,
2004 2003
---- ----
Interest Income
Loans $ 10,928 $ 9,338
Investment securities 1,865 2,424
Interest-bearing deposits 32 29
-------- --------
Total interest income 12,825 11,791
Interest Expense
Deposits 2,998 3,534
FHLB advances and other 1,785 1,814
Notes payable 23 9
-------- --------
Total interest expense 4,806 5,357
-------- --------
Net interest income 8,019 6,434
Provision for loan losses 379 335
-------- --------
Net interest income after provision for loan losses 7,640 6,099
Non-interest Income
Service fees and other charges 1,252 985
Insurance commission income 1,062 926
Dividends on stock and other interest income 177 169
Gain on sale of loans 589 1,800
Gain/(loss) on sale of securities 98 631
Trust income 49 32
Income from Bank Owned Life Insurance 193 201
Other non-interest income 2 47
-------- --------
Total non-interest income 3,422 4,791
Non-interest Expense
Compensation and benefits 4,314 3,708
Occupancy 840 728
SAIF deposit insurance premiums (credit) (42) 24
State franchise tax 156 281
Data processing 543 432
Amortization and impairment of mortgage servicing rights 409 763
Amortization of goodwill and other intangibles 27 --
Other non-interest expense 1,217 1,079
-------- --------
Total non-interest expense 7,464 7,015
-------- --------
Income before income taxes 3,598 3,875
Federal income taxes 1,105 1,157
-------- --------
Net Income $ 2,493 $ 2,718
======== ========
Earnings per share (Note 4)
Basic $ 0.41 $ 0.45
======== ========
Diluted $ 0.39 $ 0.43
======== ========
Dividends declared per share (Note 3) $ 0.20 $ 0.15
======== ========
Average shares outstanding (Note 4)
Basic 6,113 6,074
======== ========
Diluted 6,427 6,330
======== ========
See accompanying notes
4
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2004
-------------------------------------------------------
Stock Acquired By
-----------------
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
----- ------- ---- ----
Balance at January 1 $ 63 $ 51,144 $ (1,904) $ (11)
Comprehensive income:
Net income
Change in unrealized gains (losses)
net of income taxes of ($362)
Total comprehensive income
ESOP shares released 446 213
Amortization of deferred compensation
of Management Recognition Plan 2
Shares issued under stock option plan 1 1,091
Purchase of common stock for
treasury (301)
Dividends declared (Note 3)
----------------------------------------------------
Balance at March 31 $ 64 $ 52,380 $ (1,691) $ (9)
====================================================
See accompanying notes
5
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
2004 2003
--------------------------------------------- -------------
Net Unrealized
gains (losses) on Total Total
available-for- Retained Stockholders' Stockholder's
sale securities Earnings Equity Equity
--------------- -------- ------ ------
Balance at January 1 $ 4,017 $ 70,960 $ 124,269 $ 120,110
Comprehensive income:
Net income 2,493 2,493 2,718
Change in unrealized gains (losses)
net of income taxes of $(362) 674 674 (387)
--------- ---------
Total comprehensive income 3,167 2,331
ESOP shares released 659 455
Amortization of deferred compensation
of Management Recognition Plan 2 5
Shares issued under stock option plan 1,092 516
Purchase of common stock for
treasury (420) (721) (2,356)
Dividends declared (Note 3) (1,238) (1,238) (914)
--------------------------------------- ---------
Balance at March 31 $ 4,691 $ 71,795 $ 127,230 $ 120,147
======================================= =========
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Three Months
Ended March 31,
2004 2003
---- ----
Operating Activities
Net income $ 2,494 $ 2,718
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 379 335
Provision for depreciation 447 396
Net securities amortization 166 289
Amortization of mortgage servicing rights 172 523
Net impairment of mortgage servicing rights 237 240
Amortization of core deposit intangible 27 --
Gain on sale of loans (589) (1,800)
Amortization of Management Recognition Plan
deferred compensation 2 5
Release of ESOP Shares 659 455
Gains on sales of securities (98) (631)
Deferred federal income tax credit 12 67
Proceeds from sale of loans 20,935 75,619
Origination of mortgage servicing rights, net (177) (709)
Origination of loans held for sale (22,688) (69,874)
Decrease in interest receivable and other assets (898) (1,717)
Increase in other liabilities 666 (432)
-------- --------
Net cash provided by operating activities 1,746 5,484
Investing Activities
Proceeds from maturities of held-to-maturity securities 109 387
Proceeds from maturities of available-for-sale securities 16,836 23,668
Proceeds from sale of available-for-sale securities -- 1,670
Proceeds from sales of real estate and
other assets held for sale 459 154
Proceeds from sale of discontinued operations -- 1,228
Purchases of available-for-sale securities (2,984) (12,657)
Purchases of Federal Home Loan Bank stock (177) (168)
Purchases of office properties and equipment (732) (898)
Net increase in loans receivable (22,212) (25,808)
-------- --------
Net cash used in investing activities (8,701) (12,424)
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2004 2003
---- ----
Financing Activities
Net (decrease) increase in deposits (6,997) 8,246
Repayment of Federal Home Loan Bank long-term advances (448) (249)
Repayment of term notes payable -- (10)
Net increase (decrease) in Federal Home Loan Bank
short-term advances 3,900 (1,700)
Proceeds from Federal Home Loan Bank long term advances -- 9,000
Decrease in securities sold under repurchase agreements (3,977) (2,301)
Purchase of common stock for treasury (722) (2,356)
Cash dividends paid (1,238) (914)
Proceeds from exercise of stock options 1,092 516
-------- --------
Net cash (used in) provided by financing activities (8,390) 10,232
-------- --------
(Decrease) increase in cash and cash equivalents (15,345) 3,292
Cash and cash equivalents at beginning of period 37,783 28,658
-------- --------
Cash and cash equivalents at end of period $ 22,438 $ 31,950
======== ========
Supplemental cash flow information:
Interest paid $ 4,748 $ 5,192
======== ========
Income taxes paid $ -- $ 400
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ (362) $ 350
======== ========
Transfers from loans to real estate
and other assets held for sale $ 403 $ 7
======== ========
Noncash investing activities:
Increase (decrease) in net unrealized gain or loss on
available-for-sale securities $ 1,038 $ (737)
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 1,238 $ 920
======== ========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
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"). 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, 2003
has been derived from the audited financial statements at that date, which were
included in First Defiance's Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of March 31,
2004 and for the three-month period ending March 31, 2004 and 2003 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 2003 Annual Report on Form 10-K for the
year ended December 31, 2003. However, in the opinion of management, all
adjustments, consisting of only normal recurring items, necessary for the fair
presentation of the financial statements have been made. The results for the
three-month period ended March 31, 2004 are not necessarily indicative of the
results that may be expected for the entire year.
Goodwill
Goodwill is the excess of the purchase price over the fair value of the assets
and liabilities of companies acquired through business combinations accounted
for under the purchase method. Goodwill is evaluated at the business unit level,
which for First Defiance are First Federal Bank and First Insurance. At March
31, 2004 goodwill totaled $18.6 million, a reduction from the $19.8 million
balance reported at December 31, 2003. The reduction in goodwill is the result
of management reassessing the required discount adjustment necessary for the
loan portfolio acquired in June 2003 from the RFC Banking Company. Based on
early pay-offs of several large classified loans, management reduced the
discount recorded in conjunction with the original purchase price allocation.
The offsetting adjustment was a $1.2 million reduction in goodwill recorded
during the 2004 first quarter.
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
Income Taxes
The Company's effective tax rate differs from the statutory 35% federal tax rate
primarily because of the existence of municipal securities and bank owned life
insurance, the earnings of which are exempt from federal income taxes.
Stock Compensation
At March 31, 2004, 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 2003 Annual Report on Form 10-K. The Company accounts for those
plans under recognition and measurement principles of Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations. Under APB No. 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of the grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, Accounting for Stock-Based Compensation and has been determined as
if First Defiance had accounted for its employee stock options under the fair
value method of that Statement. Under the fair-value based method, compensation
cost is measured at the grant date based upon the value of the award and
recognized over the service period. For purposes of the pro forma disclosures,
the estimated fair value of the option is amortized to expense over the options'
vesting period.
The following pro forma results of operations use a fair value method of
accounting for stock options in accordance with SFAS No. 123. The estimated fair
value of the options are amortized to expense over the option and vesting
period. The fair value was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions:
March 31
2004 2003
------------------------------
Risk free interest rate 5.65% 5.73%
Dividend yield 2.97% 2.96%
Volatility factors of expected market price
of stock 0.266% 0.269%
Weighted average expected life 8.71 years 8.63 years
Weighted average grant date fair value
of options granted $3.53 $3.45
Based on the above assumptions, pro forma net income and earnings per share are
computed as follows (in thousands, except per share amounts):
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Three months ended March 31
2004 2003
---------------------------
Net Income $ 2,493 $ 2,718
Stock-based compensation using the fair
value method, net of tax (45) (51)
---------------------------
Pro forma net income from continuing
operations $ 2,448 $ 2,667
===========================
Pro forma earnings per share:
Basic $ 0.40 $ 0.44
===========================
Diluted $ 0.38 $ 0.42
===========================
Recent Accounting Pronouncements
Medicare Prescription Law
In December 2003, the FASB issued guidance that requires disclosure that
acknowledges the issuance of this new law and the fact that it may affect a
company's accumulated postretirement benefit obligation and net postretirement
benefit cost. The required disclosure for First Defiance is presented in Note
14.
Consolidation of Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46),
Consolidation of Variable Interest Entities. The objective of this
interpretation is to provide guidance on how to identify a variable interest
entity (VIE) and determine when the assets, liabilities, non-controlling
interests and results of operations of a VIE need to be included in a company's
consolidated financial statements. A company that holds variable interests in an
entity will need to consolidate the entity if the company's interest in the VIE
is such that the company will absorb a majority of the VIE's expected loss
and/or receive a majority of the entity's expected residual returns, if they
occur. FIN No. 46 also requires additional disclosures by primary beneficiaries
and other significant variable interest holders. In December 2003, the FASB
issued modifications to FIN No. 46 to provide additional scope exceptions,
address certain implementation issues and promote a more consistent application
of the provisions. Revised FIN No. 46 superceded FIN No. 46 and was adopted by
the Company effective January 1, 2004. First Defiance is not a party to any VIEs
as of March 31, 2004.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Accounting for Certain Loans or Debt Securities Acquired in a Transfer
In December 2003, the AICPA issued a Statement of Position that addresses the
accounting for differences between contractual cash flows and cash flows
expected to be collected from an investor's initial investment in loans or debt
securities (structured as loans) acquired in a transfer if those differences are
attributable, at least in part, to credit quality. The implementation of this
guidance has been deferred to be effective after December 31, 2004. Adoption of
this guidance is not expected to have any material effect on the Company's
financial condition or results of operations.
3. Dividends on Common Stock
As of March 31, 2004, First Defiance had declared a quarterly cash dividend of
$.20 per share for the first quarter of 2004, payable April 23, 2004.
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
4. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been calculated by
dividing net income by the weighted average number of shares of common stock
outstanding for the three month period ended March 31, 2004 and 2003. First
Defiance accounts for the shares issued to its Employee Stock Ownership Plan
("ESOP") in accordance with Statement of Position 93-6 of the American Institute
of Certified Public Accountants ("AICPA"). As a result, shares controlled by the
ESOP are not considered in the weighted average number of shares of common stock
outstanding until the shares are committed for allocation to an employee's
individual account. In the calculation of diluted earnings per share for the
three months ended March 31, 2004 and 2003, the effect of shares issuable under
stock option plans and unvested shares under the Management Recognition Plan
have been accounted for using the Treasury Stock method.
The following table sets forth the computation of basic and diluted earning per
share (in thousands except per share data):
Three months ended March 31
2004 2003
Numerator for basic and diluted earnings per share -
Net income $ 2,493 $ 2,718
Denominator:
Denominator for basic earnings per share - weighted
average shares 6,113 6,074
Effect of dilutive securities:
Employee stock options 311 245
Unvested management recognition plan stock 3 11
-------------------------
Dilutive potential common shares 314 256
-------------------------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 6,427 6,330
=========================
Basic earnings per share from net income $ 0.41 $ 0.45
=========================
Diluted earnings per share from net income $ 0.39 $ 0.43
=========================
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
5. Investment Securities
The following is a summary of available-for-sale and held-to-maturity securities
(in thousands):
March 31, 2004
---------------------------------------------------
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 $ 61,698 $ 4,417 $ -- $ 66,115
Corporate bonds 6,200 582 -- 6,782
Mortgage-backed securities 18,441 285 5 18,721
REMICs 8,440 18 27 8,431
Collateralized mortgage obligations 14,858 230 -- 15,088
Trust preferred stock 7,238 71 -- 7,309
Equity securities 69 9 -- 78
Obligations of state and political
subdivisions 31,213 1,648 6 32,855
---------------------------------------------------
Totals $ 148,157 $ 7,260 $ 38 $ 155,379
===================================================
Held-to-Maturity Securities:
FHLMC certificates $ 581 $ 21 $ 1 $ 601
FNMA certificates 1,117 20 1 1,136
GNMA certificates 377 9 -- 386
Obligations of state and political
subdivisions 590 115 -- 705
---------------------------------------------------
Totals $ 2,665 $ 165 $ 2 $ 2,828
===================================================
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
5. Investment Securities (continued)
December 31, 2003
---------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
---------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 72,907 $ 3,980 $ 12 $ 76,875
Corporate bonds 7,210 506 -- 7,716
Mortgage-backed securities 19,621 169 38 19,752
REMICs 8,994 22 54 8,962
Collateralized mortgage obligations 14,687 53 21 14,719
Trust preferred stock 7,238 84 -- 7,322
Equity securities 69 9 -- 78
Obligations of state and political
subdivisions 31,352 1,504 21 32,835
---------------------------------------------------
Totals $ 162,078 $ 6,327 $ 146 $ 168,259
===================================================
Held-to-Maturity Securities:
FHLMC certificates $ 603 $ 25 $ 1 $ 627
FNMA certificates 1,174 16 6 1,184
GNMA certificates 409 11 -- 420
Obligations of state and political
subdivisions 590 117 -- 707
---------------------------------------------------
Totals $ 2,776 $ 169 $ 7 $ 2,938
===================================================
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
6. Loans
Loans receivable and held for sale consist of the following (in thousands):
March 31, December 31
2004 2003
------------------------
Real Estate:
One-to-four family residential $ 173,367 $ 167,983
Construction 15,272 16,830
Non-residential and multi-family 359,070 341,423
------------------------
547,709 526,236
Other Loans:
Commercial 119,442 120,677
Consumer finance 40,858 40,257
Home equity and improvement 74,800 70,038
------------------------
235,100 230,972
------------------------
Total real estate and other loans 782,809 757,208
Deduct:
Loans in process 6,406 6,079
Net deferred loan origination fees and costs 1,102 1,158
Allowance for loan loss 9,167 8,844
------------------------
Totals $ 766,134 $ 741,127
=======================
Changes in the allowance for loan losses were as follows (in $000s):
Three Months ended March 31
2004 2003
---------------------------
Balance at beginning of period $ 8,844 7,496
Provision for loan losses 379 335
Charge-offs:
One-to-four family residential real estate 52 --
Non-residential and multi-family real estate -- --
Commercial 14 25
Consumer finance 38 50
-----------------------
Total charge-offs 104 75
Recoveries 48 168
-----------------------
Net charge-offs 56 (93)
-----------------------
Ending allowance $ 9,167 $ 7,924
=======================
16
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
7. Deposits
A summary of deposit balances is as follows (in thousands):
March 31, December 31,
2004 2003
Non-interest-bearing checking accounts $ 52,091 $ 52,323
Interest-bearing checking accounts 67,666 67,351
Savings accounts 54,054 51,767
Money market demand accounts 148,527 148,691
Certificates of deposit 399,730 408,864
-----------------------
$ 722,068 $ 728,996
=======================
8. Commitments, Guarantees and Contingent Liabilities
Loan commitments are made to accommodate the financial needs of First Defiance's
customers; however, there are no long-term, fixed-rate loan commitments that
result in market risk. Standby letters of credit obligate the Company to pay a
third party beneficiary when a customer fails to repay an outstanding loan or
debt instrument, or fails to perform some contractual 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:
March 31, December 31,
2004 2003
-------------------------
(In Thousands)
Commercial $ 119,102 $ 113,247
Real Estate 11,406 6,799
Consumer 59,113 56,823
Standby Letters of Credit 4,481 3,550
-----------------------
Total $ 194,102 $ 180,419
=======================
17
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at March 31, 2004 and 2003)
- --------------------------------------------------------------------------------
8. Commitments, Guarantees and Contingent Liabilities (continued)
The remaining weighted average life for outstanding standby letters of credit
was less than one year at March 31, 2004. The Company had $94,000 of standby
letters of credit with a life longer than one year.
9. 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 14 in the financial statements included in
First Defiance's 2003 Annual Report on Form 10-K.
Net periodic postretirement benefit costs include the following components for
the three-month periods ended March 31, 2004 and 2003:
Three Months Ended March 31
2004 2003
----------------------------
(In Thousands)
Service cost-benefits attributable to service
during the period $ 12 $ 9
Interest cost on accumulated postretirement
benefit obligation 24 21
Net amortization and deferral 6 3
---------------------------
Net periodic postretirement benefit cost $ 42 $ 33
===========================
Prescription drug coverage was added to Medicare under the Medicare Prescription
Drug Improvement and Modernization Act of 2003 (the Act). As a result, net per
capita claims cost and the costs borne by retirees have been assumed to decrease
in 2006 due to this legislation. The enactment of the Act resulted in a decrease
to the accrued postretirement benefit obligation in 2003 which is being
amortized beginning in 2004. The Company has assumed that it will opt for
coverage under Medicare Part D rather than the Federal subsidy approach. As
specific authoritative guidance for matters related to the Act are pending,
guidance when issued could require First Defiance to change previously reported
information.
18
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 19 full service branches. 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 three 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
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 $2.7 million
at March 31, 2004. 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 $155.4 million at March 31, 2004. The available-for-sale portfolio consists
of U.S. Treasury securities and obligations of U.S. Government corporations and
agencies ($66.1 million), corporate bonds ($6.8 million), certain municipal
obligations ($32.9 million), CMOs and REMICs ($23.5 million), mortgage backed
securities ($18.7 million) and preferred stock and other equity investments
($7.3 million).
In accordance with FAS No. 115, unrealized holding gains and losses deemed
temporary on available-for-sale securities are reported in a separate component
of stockholders' equity and are not reported in earnings until realized. Net
unrealized holding gains on available-for-sale securities were $7.2 million at
March 31, 2004, or $4.7 million after considering the related deferred tax
liability.
The profitability of First Defiance is primarily dependent on its net interest
income and non-interest income. Net interest income is the difference between
interest income on interest-earning assets, principally loans and securities,
and interest expense on interest-bearing deposits, Federal Home Loan Bank
advances, and other borrowings. The Company's non-interest income includes
deposit and loan servicing fees, gains on sales of mortgage loans, and insurance
commissions. First Defiance's earnings also depend on the provision for loan
losses and non-interest expenses, such as employee compensation and benefits,
occupancy and equipment expense, deposit
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
insurance premiums, amortization and impairment of mortgage servicing rights and
miscellaneous other expenses, as well as federal income tax expense.
Forward-Looking Information
Certain statements contained in this quarterly report that are not historical
facts, including but not limited to statements that can be identified by the use
of forward-looking terminology such as "may", "will", "expect", "anticipate", or
"continue" or the negative thereof or other variations thereon or comparable
terminology are "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21B of the Securities Act
of 1934, as amended. Actual results could differ materially from those indicated
in such statements due to risks, uncertainties and changes with respect to a
variety of market and other factors.
Changes in Financial Condition
At March 31, 2004, First Defiance's total assets, deposits and stockholders'
equity amounted to $1.04 billion, $722.1 million and $127.2 million,
respectively, compared to $1.04 billion, $729.0 million and $124.3 million,
respectively, at December 31, 2003.
Net loans receivable increased to $766.1 million at March 31, 2004 from $741.1
million at December 31, 2003. The increase in loans receivable occurred
primarily in non-residential and multi-family real estate loans, which increased
by $17.6 million to $359.1 million, one-to-four family residential loans, which
increased by $5.4 million to $173.4 million, home equity and improvement loans,
which increased by $4.8 million to $74.8 million and consumer loans, which
increased by $601,000 to $40.9 million. The increase was partially offset by an
$1.2 million decline in commercial loans to $119.4 million.
The investment securities portfolio decreased to $158.0 million at March 31,
2004 from $171.0 million at December 31, 2003. The decrease in the balance in
the investment portfolio is the result of redeploying funds from securities as
they mature or get called to fund loan growth. At March 31, 2004 there were
approximately $4.8 million of interest-bearing deposits held at other financial
institutions. These funds will be redeployed into higher earning investments as
interest rates rise.
Deposits decreased from $729.0 million at December 31, 2003 to $722.0 million as
of March 31, 2004. This decline resulted from a $9.1 million decrease
certificate of deposit balances to $399.7 million. $2.6 million of the decline
resulted from a decrease in brokered certificates of deposit balances. There was
an increase in savings deposits of $2.3 million to $54.1 million as of March 31,
2004. The Company has focused on increasing its lower cost core deposits, and at
the same time has been less aggressive in retaining higher cost CDs during 2004.
Additionally, FHLB advances increased to $168.0 million at March 31, 2004 from
$164.5 million at December 31, 2003. These borrowings were used to fund loan
growth and short-term funding needs. Short-term borrowings decreased to $8.3
million at March 31, 2004 from $12.3 million at December 31, 2003. This is a
result of a decrease in the balance of securities sold under repurchase
agreements, which are a function of customer demand.
20
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Stockholders' equity increased from $124.3 million at December 31, 2003 to
$127.2 million at March 31, 2004. The increase is a result of the $2.5 million
of net income, an increase in unrealized gains on available for sale securities
(net of tax) of $674,000, the release of ESOP shares which increased equity by
$659,000 and $1.1 million from the exercise of stock options by First Defiance
employees. Those increases were partially offset by $1.2 million of dividends
declared and by $722,000 from the repurchase of shares for treasury.
During March 2004, First Defiance repurchased a total of 26,147
shares of stock at an average price of $27.60. The first 1,156 share purchased
completed a repurchase program approved by the Board of Directors in 2002. The
balance of those shares were purchased under a repurchase program authorized by
the Company's board of directors in 2003. The Company is authorized to purchase
an additional 614,468 shares under that program.
21
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.
Three Months Ended March 31,
----------------------------------------------------------------------
2004 2003
--------------------------------- ---------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 749,848 $ 10,932 5.86% $ 589,837 $ 9,398 6.46%
Securities 165,239 2,024 4.93 206,645 2,591 5.09
Interest-earning deposits 8,490 32 1.52 6,865 29 1.71
FHLB stock and other 17,768 177 4.01 17,960 169 3.82
---------- -------- ---------- --------
Total interest-earning assets 941,345 13,165 5.62 821,307 12,187 6.02
Non-interest-earning assets 95,226 63,231
---------- ----------
Total assets $1,036,571 $ 884,538
========== ==========
Interest-bearing liabilities:
Deposits $ 673,193 $ 2,998 1.79% $ 555,524 $ 3,534 2.58%
FHLB advances and other 163,242 1,785 4.40 156,561 1,814 4.70
Notes payable 10,741 23 .86 3,010 9 1.21
---------- -------- ---------- --------
Total interest-bearing liabilities 847,176 4,806 2.28 715,095 5,357 3.04
Non-interest bearing deposits 53,109 -- 38,339 --
---------- -------- ---------- --------
Total including non-interest bearing
demand deposits 900,285 4,806 2.15 753,434 5,357 2.88
Other non-interest-bearing liabilities 10,414 10,851
---------- ----------
Total liabilities 910,699 764,285
Stockholders' equity 125,872 120,253
---------- ----------
Total liabilities and stock-
holders' equity $1,036,571 $ 884,538
========== ==========
Net interest income; interest
rate spread $ 8,359 3.34% $ 6,830 2.98%
======== ====== ======== ======
Net interest margin (3) 3.57% 3.37%
====== ======
Average interest-earning assets
to average interest-bearing
liabilities 111% 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.
22
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Results of Operations
Three Months Ended March 31, 2004 compared to Three Months Ended March 31, 2003
On a consolidated basis, First Defiance had net income of $2.5 million or $.39
per share for the three months ended March 31, 2004 compared to $2.7 million or
$0.43 per share in 2003.
Net Interest Income. Net interest income for the quarter ended March 31, 2004
was $8.0 million compared to $6.4 million for the same period in 2003. Net
interest margin for the 2004 first quarter was 3.57% compared to 3.37% for the
same period in 2003. On a tax-equivalent basis, net interest income for the
quarter ended March 31, 2004 was $8.4 million compared to $6.8 million for the
same period in 2003.
Total interest income increased by $1.0 million to $12.8 million for the three
months ended March 31, 2004 from $11.8 million for the three months ended March
31, 2003. On a tax equivalent basis, total interest income increased by $978,000
to $13.2 million for the three months ended March 31, 2004 from $12.2 million
for the three months ended March 31, 2003. Interest on loans increased $1.6
million to $10.9 million in the first quarter of 2004 from $9.3 million in the
first quarter of 2003. The increase in interest from loans was due to a $160.0
million increase in average loan balances between the first quarter of 2003 and
the first quarter of 2004. A portion of the increase was attributable to the
$79.0 million of loans acquired in June 2003 as part of the acquisition of
banking center offices in Findlay, Ottawa and McComb Ohio from RFC Banking
Company. The balance of the increase is due to growth of the Company's
commercial and commercial real estate portfolios over the past twelve months
Some of the benefit of increased loan volumes has been offset by declining
portfolio yields. The yield on First Defiance's loan portfolio declined from
6.46% for the three months ended March 31, 2003 to 5.86% for the same period in
2004 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 $478.5 million at March 31, 2004, up
from $462.1 million at December 31, 2003 and $359.6 million at March 31, 2003.
During that same time one-to-four family residential loans, excluding loans held
for sale, increased only $1.5 million to $180.4 million from $178.9 million
(one-to-four family residential loans were $149.7 million at March 31, 2003).
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 $556,000 to $2.2 million for the three
months ended March 31, 2004 compared to $2.8 million for the same period in
2003. The decrease is due to the decline in the average balance by $40.0 million
from $231.5 million at March 31, 2003 to $191.5 million at March 31, 2004. 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 2004 and 2003 were
$163,000 and $227,000 respectively. The tax-equivalent yield on the investment
portfolio was 4.93% for the three months ended March 31, 2004, down from 5.09%
for the first three months of 2003.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Total interest expense decreased by $551,000 to $4.8 million for the first
quarter of 2004 compared to $5.4 million for the same period in 2003. Interest
expense on interest bearing deposits decreased by $536,000 to $3.0 million for
the quarter ended March 31, 2004 from $3.5 million for the quarter ended March
31, 2003. 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 2.88%
for the first quarter of 2003 to 2.15% for the first quarter of 2004. The
average balances of interest-bearing liabilities increased $132.1 million from
$715.1 million in the first quarter of 2003 to $847.2 million in the first
quarter of 2004.
Provision for Loan Losses. The provision for loan losses was $379,000 in the
first quarter of 2004 compared to $335,000 for the first quarter of 2003 despite
significant growth in loan balances. The lower provision was due in part to the
Company's very low loss experience in the 2004 first quarter, which showed net
charge-offs of $56,000. Provisions for loan losses are charged to earnings to
bring the total allowance for loan losses to the level deemed appropriate by
management based on the following factors: historical experience; the volume and
type of lending conducted by First Defiance; the amount of non-performing
assets, including loans which meet the FASB Statement No. 114 definition of
impaired; the amount of assets graded by management as substandard, doubtful, or
loss; industry standards; general economic conditions, particularly as they
relate to First Defiance's market area; and other factors related to the
collectibility of First Defiance's loan portfolio. Management believes the
balance of the allowance for loan losses is appropriate.
Non-performing assets and asset quality ratios for First Defiance were as
follows (in $000's):
March 31, December 31,
2004 2003
Non-accrual loans $ 2,375 $ 2,545
Loans over 90 days past due and still accruing -- --
-----------------------
Total non-performing loans $ 2,375 $ 2,545
Real estate owned (REO) 348 404
-----------------------
Total non-performing assets $ 2,723 $ 2,949
=======================
Allowance for loans losses as a percentage
of total loans 1.18% 1.18%
Allowance for loan losses as a percentage
of non-performing assets 336.65% 299.90%
Allowance for loan losses as a percentage
of non-performing loans 385.98% 347.50%
Total non-performing assets as a percentage
of total assets 0.26% 0.28%
Total non-performing loans as a percentage
of total loans 0.31% 0.34%
Of the $2.4 million in non-accrual loans, $1.8 million were commercial loans or
non-residential real estate loans and $545,000 were residential mortgage loans.
The allowance for loan losses at March 31, 2004 was $9.2 million compared to
$7.9 million at both March 31, 2003 and $8.8 million at December 31, 2003. For
the quarter ended March 31, 2004, First Defiance charged off
24
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
$104,000 of loans against its allowance and realized recoveries of $48,000 from
loans previously charged off. During the same quarter in 2003, First Defiance
charged off $75,000 in loans and realized recoveries of $168,000.
In conjunction with the acquisition of the banking centers in June 2003,
management recorded a discount of $2.9 million to offset expected credit losses
in the acquired portfolio. Subsequent to December 31, 2003, several large
classified loans in the acquired portfolio were paid off by the borrower,
resulting in a reduction in the required discount. During the 2004 first quarter
management adjusted the discount downward by $1.2 million to $1.6 million. The
offsetting adjustment was a $1.2 million reduction in the goodwill recorded in
conjunction with the acquisition.
Non-Interest Income. Non-interest income decreased $1.4 million in the first
quarter of 2004, to $3.4 million for the quarter ended March 31, 2004 from $4.8
million for the same period in 2003. Individual components of non-interest
income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans decreased
$1.2 million to $589,000 for the three months ended March 31, 2004 from $1.8
million during the 2003 first quarter. The decrease is due to a decline in
mortgage loan origination activity starting in the fourth quarter of 2003 and
continuing through the first two months of 2004 as interest rates increased from
their record low levels of mid-2003. The origination and servicing of mortgage
loans continues to be a core activity of First Federal in its local market
areas.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $98,000 in the first quarter of 2004. This was a decrease of
$533,000 from a gain of $631,000 in the first quarter of 2003. First Defiance
did not sell any securities during the 2004 first quarter. However, several
securities with call provisions that were purchased at discounts were called
during the first three months of 2004. The resulting write-off of unamortized
discounts is reflected as securities gains.
Service Fees. Loan and deposit fees increased $267,000 to $1.3 million for the
quarter ended March 31, 2004 from $985,000 for the quarter ended March 31, 2003.
Increases occurred primarily in loan servicing fees on sold loans, debit card
interchange fees, and checking NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $136,000 to $1.1 million in the first quarter of
2004 from $926,000 in the same period of 2003. Increases occurred in the
property and casualty lines as well as income from the sale of securities and
annuities.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, income from Bank Owned Life Insurance and other
miscellaneous charges, decreased to $421,000 for the quarter ended March 31,
2004 from $449,000 for the same period in 2003.
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Non-Interest Expense. Total non-interest expense increased $449,000 to $7.5
million for the quarter ended March 31, 2004 from $7.0 million for the same
period in 2003. Significant individual components of the increase are as
follows:
Compensation and Benefits. Compensation and benefits increased $606,000 to $4.3
million for the quarter ended March 31, 2004 from $3.7 million for the same
period in 2003. The increase was the result of an increase in staffing due to
the significant expansion in the Company's branch network. In addition to the
June 2003 acquisition of three banking centers, the Company opened a de novo
branch in Findlay, Ohio in December 2003 and in the Toledo suburb of Maumee,
Ohio in February 2004.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of
mortgage servicing rights ("MSR's") totaled $172,000 in the 2004 first quarter
compared to $523,000 in the 2003 first quarter, the result of a decline in the
significant refinancing activity in the First Federal loan servicing portfolio
that was taking place a year ago. Also, the Company recognized a $237,000
adjustment for impairment in the value of its MSR portfolio during the 2004
first quarter, the result of the decline in the market value of MSRs in the face
of falling interest rates late in March 2004. There was a $240,000 impairment
adjustment recognized in the first quarter of 2003. First Defiance has a total
impairment reserve of $843,000 recorded against an asset with a book value
before reserves of $4.0 million at March 31, 2004. That portfolio represents
approximately 5,430 loans with unpaid balances of approximately $436 million.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) increased
to $2.7 million for the quarter ended March 31, 2004 from $2.5 million for the
same period in 2003.
First Defiance computes federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 30.71% for the
quarter ended March 31, 2004 compared to 29.86% for the same period in 2003. The
effective tax rate is lower than the Company's statutory 35% rate because it has
approximately $31.8 million invested in municipal securities, and $18.1 million
of bank owned life insurance which are both exempt from federal tax.
As a result of the above factors, income for the quarter ended March 31, 2004
was $2.5 million compared to income of $2.7 million for the comparable period in
2003. On a per share basis, basic and diluted earnings per share for the three
months ended March 31, 2004 were each $0.41 and $.39, respectively, compared to
basic and diluted earnings per share from continuing operations of $0.45 and
$0.43, respectively, for the quarter ended March 31, 2003.
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 $1.7 million of cash from operating activities during
the first three months of 2004. 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
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
amortization of mortgage servicing rights, ESOP expense related to release of
shares, and changes in loans available for sale, interest receivable and other
assets, and other liabilities. The primary investing activity of First Defiance
is the origination of loans (both for sale in the secondary market and to be
held in portfolio), which is funded with cash provided by operations, proceeds
from the amortization and prepayments of existing loans, the sale of loans,
proceeds from the sale or maturity of securities, borrowings from the FHLB, and
customer deposits.
At March 31, 2004, First Defiance had $59.3 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $134.8 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 $21.5 million of loans held-for-sale.
Also as of March 31, 2004, the total amount of certificates of deposit that are
scheduled to mature by March 31, 2005 is $249.8 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.
First Defiance utilizes forward purchase and forward sale agreements to meet the
needs of its customers and manage its exposure to fluctuations in the fair value
of mortgage loans held for sale and its pipeline. These forward purchase and
forward sale agreements are considered to be derivatives as defined by FAS 133,
Accounting for Derivatives and Hedging Instruments. The change in value in the
forward purchase and forward sale agreements is approximately equal to the
change in value in the loans held for sale and the effect of this accounting
treatment is not material to the financial statements.
First Defiance also invests in on-balance sheet derivative securities as part of
the overall asset and liability management process. Such derivative securities
include REMIC and CMO investments. As of March 31, 2004, $834,000 of these
securities do not pass the FFIEC high risk security test. The weighted average
life of these securities exceeds the test limits in an instantaneous rate
increase scenario of 200 and 300 basis points. The company feels that at this
time the return being realized is worth this risk. The remaining $22.7 million
of these securities are not classified as high risk at March 31, 2004 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 March 31, 2004.
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Core Capital Risk-Based Capital
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
----------- ----------- ----------- -----------
Regulatory capital $ 98,468 $ 98,468 $ 107,415 $ 107,415
Minimum required regulatory capital 40,334 50,418 62,206 77,757
--------- --------- --------- ---------
Excess regulatory capital $ 58,134 $ 48,050 $ 45,209 $ 29,658
========= ========= ========= =========
Regulatory capital as a percentage of assets (1) 9.8% 9.8% 13.8% 13.8%
Minimum capital required as a percentage of
assets 4.0% 5.0% 8.0% 10.0%
--------- --------- --------- ---------
Excess regulatory capital as a percentage of
assets 5.8% 4.8% 5.8% 3.8%
========= ========= ========= =========
(1) Core capital is computed as a percentage of adjusted total assets of $1.0
billion. Risk-based capital is computed as a percentage of total
risk-weighted assets of $777.6 million.
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, the Valuation of Mortgage Servicing Rights and the Deferral of Fees
under SFAS 91. There have been no material changes in assumptions or judgments
relative to those critical policies during the first quarter of 2004.
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 2004 are approximately $0.015 per $100 of
deposits.
28
Item 3. Qualitative and Quantitative Disclosure About Market Risk
As discussed in detail in the 2003 Annual Report on Form 10-K, First Defiance's
ability to maximize net income is dependent on management's ability to plan and
control net interest income through management of the pricing and mix of assets
and liabilities. Because a large portion of assets and liabilities of First
Defiance are monetary in nature, changes in interest rates and monetary or
fiscal policy affect its financial condition and can have significant impact on
the net income of the Company. First Defiance does not use off balance sheet
derivatives to enhance its risk management, nor does it engage in trading
activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis
through simulation analysis which measures the impact changes in interest rates
can have on net income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, nonmaturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise or fall 100 basis points over a 12 month period, using
March 2004 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
Our management evaluated, with the participation of our Chief Executive Officer
and Chief Financial Officer, the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this report. Based
on such evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
regulations and are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules
13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred
during the most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
29
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
The information presented in changes in Financial Condition of
Management's Discussion and Analysis related to share report base
activity is incorporated herein by reference.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
At the annual meeting of shareholders held on April 20, 2004, in Defiance,
Ohio the shareholders elected three directors to three-year terms. The
following is a tabulation of all votes timely cast in person or by proxy
by shareholders of First Defiance for the annual meeting:
I. Nominees for Director with Three-year Terms Expiring in 2006:
NOMINEE FOR WITHHELD
Stephen L. Boomer 5,289,463 367,276
Peter A. Diehl 5,149,772 506,967
William J. Small 5,556,202 100,537
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) 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
30
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on April 21, 2004 which included a copy
of the Company's earnings release for the quarter ended March 31, 2004
31
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: May 10, 2004 By: /s/ William J. Small
---------------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: May 10, 2004 By: /s/ John C. Wahl
---------------------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
32