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, 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 -
6,292,763 shares outstanding at November 8, 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 - September 30, 2004 and December 31, 2003 2
Consolidated Condensed Statements of Income -
Three and nine months ended September 30, 2004 and 2003 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity - Nine months ended September 30, 2004 5
Consolidated Condensed Statements of Cash Flows
- Nine months ended September 30, 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 23
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 38
Item 4. Controls and Procedures 38
PART II-OTHER INFORMATION:
Item 1. Legal Proceedings 39
Item 2. Changes in Securities 39
Item 3. Defaults upon Senior Securities 39
Item 4. Submission of Matters to a Vote of Security Holders 39
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 40
Signatures 41
1
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(Amounts in Thousands)
- ----------------------------------------------------------------------------------------------
September 30, 2004 December 31, 2003
------------------ -----------------
(unaudited)
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 20,544 $ 28,020
Interest-bearing deposits 627 9,763
---------- ----------
21,171 37,783
Securities:
Available-for-sale, carried at fair value 141,655 168,259
Held-to-maturity, carried at amortized cost
(approximate fair value $2,565 and $2,938
at September 30, 2004 and December 31,
2003 respectively) 2,427 2,776
---------- ----------
144,082 171,035
Loans held for sale 6,812 5,872
Loans receivable, net of allowance for loan losses of
$9,712 and $8,844 respectively 844,546 735,255
Accrued interest receivable 5,155 4,742
Federal Home Loan Bank stock and other
interest-earning assets 13,235 17,766
Bank owned life insurance 18,532 17,952
Office properties and equipment 24,056 23,846
Real estate and other assets held for sale 61 404
Goodwill and other intangibles 18,961 20,544
Mortgage servicing rights 3,516 3,431
Other assets 2,243 1,969
---------- ----------
Total assets $1,102,370 $1,040,599
========== ==========
See accompanying notes.
2
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(Amounts in Thousands)
- --------------------------------------------------------------------------------
September 30, 2004 December31, 2003
------------------ ----------------
(unaudited)
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 55,321 $ 52,323
Interest-bearing deposits 723,935 676,673
----------- -----------
Total deposits 779,256 728,996
Advances from Federal Home Loan Bank 173,670 164,522
Short-term borrowings and other
interest-bearing liabilities 12,052 12,267
Advance payments by borrowers for
taxes and insurance 179 231
Deferred taxes 1,074 1,859
Other liabilities 10,716 8,455
----------- -----------
Total liabilities 976,947 916,330
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; 6,286
and 6,328 shares outstanding, respectively 63 63
Additional paid-in capital 51,593 51,144
Stock acquired by ESOP (1,478) (1,904)
Deferred compensation (6) (11)
Accumulated other comprehensive income,
net of income taxes of $1,596
and $2,163, respectively 2,963 4,017
Retained earnings 72,288 70,960
----------- -----------
Total stockholders' equity 125,423 124,269
----------- -----------
Total liabilities and stockholders' equity $ 1,102,370 $ 1,040,599
=========== ===========
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,
2004 2003 2004 2003
------- -------- ------- --------
Interest Income
Loans $12,205 $ 10,934 $34,412 $ 30,246
Investment securities 1,633 1,987 5,225 6,519
Interest-bearing deposits 1 107 37 216
------- -------- ------- --------
Total interest income 13,839 13,028 39,674 36,981
Interest Expense
Deposits 3,384 3,330 9,453 10,275
FHLB advances and other 1,843 1,843 5,418 5,553
Notes payable and warehouse loans 31 25 75 47
------- -------- ------- --------
Total interest expense 5,258 5,198 14,946 15,875
------- -------- ------- --------
Net interest income 8,581 7,830 24,728 21,106
Provision for loan losses 376 497 1,244 1,185
------- -------- ------- --------
Net interest income after provision for loan losses 8,205 7,333 23,484 19,921
Non-interest Income
Service fees and other charges 1,372 1,204 3,950 3,353
Insurance and investment sales commission income 906 924 3,192 2,817
Dividends on stock 140 176 471 518
Gain on sale of loans 518 2,274 1,910 6,590
Gain on sale of securities 302 -- 694 919
Trust income 69 46 167 116
Income from Bank Owned Life Insurance 194 211 579 616
Other non-interest income 49 4 140 23
------- -------- ------- --------
Total non-interest income 3,550 4,839 11,103 14,952
Non-interest Expense
Compensation and benefits 4,274 4,281 13,062 11,965
Occupancy 798 758 2,452 2,227
SAIF deposit insurance premiums (rebates) 26 30 12 85
State franchise tax 155 272 467 838
Data processing 595 498 1,717 1,357
Amortization of mortgage servicing rights 141 546 547 1,825
Impairment (recovery) of mortgage servicing rights 321 (987) 34 (381)
Amortization and impairment of goodwill and other intangibles 28 31 82 39
Settlement of contingent liability 1,927 -- 1,927 --
Other non-interest expense 1,204 1,347 3,767 3,537
------- -------- ------- --------
Total non-interest expense 9,469 6,776 24,067 21,492
------- -------- ------- --------
Income before income taxes 2,286 5,396 10,520 13,381
Federal income taxes 606 1,715 3,203 4,118
------- -------- ------- --------
Net Income $ 1,680 $ 3,681 $ 7,317 $ 9,263
======= ======== ======= ========
Earnings per share (Note 6)
Basic $ 0.28 $ 0.61 $ 1.20 $ 1.54
======= ======== ======= ========
Diluted $ 0.27 $ 0.58 $ 1.15 $ 1.47
======= ======== ======= ========
Dividends declared per share (Note 5) $ 0.20 $ 0.15 $ 0.60 $ 0.45
======= ======== ======= ========
Average shares outstanding (Note 6)
Basic 6,076 6,002 6,103 6,033
======= ======== ======= ========
Diluted 6,332 6,293 6,380 6,296
======= ======== ======= ========
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 $566
Total comprehensive income
ESOP shares released 845 426
Amortization of deferred compensation
of Management Recognition Plan 5
Shares issued under stock option plan 1 1,302
Purchase of common stock for
treasury (1) (1,698)
Dividends declared (Note 5)
-----------------------------------------------------------
Balance at September 30 $ 63 $ 51,593 $ (1,478) $ (6)
===========================================================
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 7,317 7,317 9,263
Change in unrealized gains (losses),
net of income taxes of $566 (1,054) (1,054) (1,133)
--------- ----------
Total comprehensive income 6,263 8,130
ESOP shares released 1,271 939
Amortization of deferred compensation
of Management Recognition Plan 5 14
Shares issued under stock option plan 1,303 1,037
Purchase of common stock for
treasury (2,321) (4,020) (4,336)
Dividends declared (Note 5) (3,668) (3,668) (2,715)
-------------------------------------------- ----------
Balance at September 30 $ 2,963 $ 72,288 $ 125,423 $ 123,179
============================================ ==========
See accompanying notes
6
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
- ------------------------------------------------------------------------------------------
Nine Months
Ended September 30,
2004 2003
--------- ---------
Operating Activities
Net income $ 7,317 $ 9,263
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,244 1,185
Loss on sale of office properties and equipment 2 --
Provision for depreciation 1,335 1,218
Net securities amortization 301 721
Amortization of mortgage servicing rights 547 1,825
Net impairment (recovery) of mortgage servicing rights 34 (381)
Amortization of core deposit intangible 82 39
Gain on sale of loans (1,910) (6,590)
Amortization of Management Recognition Plan
deferred compensation 5 14
Release of ESOP Shares 1,271 939
Gains on sales of securities (694) (919)
Deferred federal income tax expense (credit) (219) 269
Proceeds from sale of loans 81,698 268,773
Origination of mortgage servicing rights, net (666) (2,395)
Origination of loans held for sale (80,728) (258,441)
Decrease in interest receivable and other assets (1,267) (1,060)
Increase (decrease) in other liabilities 2,189 (657)
--------- ---------
Net cash provided by operating activities 10,541 13,803
Investing Activities
Proceeds from maturities of held-to-maturity securities 343 951
Proceeds from maturities of available-for-sale securities 36,279 59,844
Proceeds from sale of available-for-sale securities 10,595 9,958
Proceeds from sales of real estate and
other assets held for sale 978 317
Proceeds from sale of discontinued operations -- 1,228
Proceeds from sale of Federal Home Loan Bank stock 5,000 --
Purchases of available-for-sale securities (21,491) (36,745)
Purchases of Federal Home Loan Bank stock (469) (515)
Purchases of office properties and equipment (1,547) (2,337)
Acquisition of branch offices -- 70,132
Net increase in loans receivable (109,935) (71,786)
--------- ---------
Net cash (used in) provided by investing activities (80,247) 31,047
7
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
- ---------------------------------------------------------------------------------------------------
Nine Months
Ended September 30,
2004 2003
-------- --------
Financing Activities
Net increase (decrease) in deposits 50,546 (31,010)
Repayment of Federal Home Loan Bank long-term advances (1,352) (1,129)
Repayment of term notes payable -- (10)
Net increase (decrease) in Federal Home Loan Bank
short-term advances 10,500 (3,000)
Proceeds from Federal Home Loan Bank long term advances -- 9,000
Net (decrease) increase in securities sold under repurchase agreements (215) 4,130
Purchase of common stock for treasury (4,020) (4,336)
Cash dividends paid (3,668) (2,715)
Proceeds from exercise of stock options 1,303 1,037
-------- --------
Net cash provided by (used in) financing activities 53,094 (28,033)
-------- --------
(Decrease) increase in cash and cash equivalents (16,612) 16,817
Cash and cash equivalents at beginning of period 37,783 28,658
-------- --------
Cash and cash equivalents at end of period $ 21,171 $ 45,475
======== ========
Supplemental cash flow information:
Interest paid $ 14,875 $ 15,363
======== ========
Income taxes paid $ 2,772 $ 3,868
======== ========
Transfers from loans to real estate
and other assets held for sale $ 635 $ 435
======== ========
Noncash operating activities:
Change in deferred taxes established on net unrealized
gain or loss on available-for-sale securities $ 566 $ (613)
======== ========
Noncash investing activities:
Decrease in net unrealized gain or loss on
available-for-sale securities $ (1,620) $ (1,744)
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 1,211 $ 901
======== ========
See accompanying notes.
8
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 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") and 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 September 30,
2004 and for the three and nine-month periods ending September 30, 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 U.S.
generally accounting principles. 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
nine-month period ended September 30, 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
September 30, 2004 goodwill totaled $19.0 million, a reduction from the $20.5
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. Also, in the 2004 third quarter, management
determined that certain market value adjustments were posted incorrectly when
the RFC branches were acquired in 2003, resulting in a $338,000 overstatement of
goodwill and deposits. That item was corrected in the 2004 third quarter,
resulting in a further goodwill reduction. Neither of those adjustments had any
effect on reported net income.
9
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
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 September 30, 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.
10
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
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
2004 2003
---------------------------------------
Risk free interest rate 5.54% 5.66%
Dividend yield 2.99% 2.97%
Volatility factors of expected market price
of stock 0.261% 0.267%
Weighted average expected life 8.90 years 8.70 years
Weighted average grant date fair value
of options granted $3.77 $3.52
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,
2004 2003 2004 2003
-------------------------------------------------
Net income $ 1,680 $ 3,681 $ 7,317 $ 9,263
Stock-based compensation using the
fair value method, net of tax (62) (43) (166) (144)
-------------------------------------------------
Pro forma net income from
continuing operations $ 1,618 $ 3,638 $ 7,151 $ 9,119
=================================================
Pro forma earnings per share:
Basic $ 0.27 $ 0.61 $ 1.17 $ 1.51
=================================================
Diluted $ 0.26 $ 0.58 $ 1.12 $ 1.45
=================================================
Medicare Prescription Law
In May 2004, the FASB issued revised 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
11.
11
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Recent Accounting Pronouncements
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 September 30, 2004.
Other Than Temporary ImpairmentsIn March 2004, the Emerging Issues Task Force
("EITF"), revised EITF No. 03-01, "The Meaning of Other than Temporary
Impairment and its Application to Certain Investments." In the revised guidance,
the EITF reached a consensus regarding the model to be used in determining
whether an investment is other than temporarily impaired, and the required
disclosures about unrealized losses on available for sale debt and equity
securities. The other than temporary impairment evaluation guidance was
effective for First Defiance on July 1, 2004. However, in September 2004 the
FASB issued FSP 03-1-1, Effective Date of Paragraphs 10-20 of eitf 03-1, The
Meaning of Other Than Temporary Impairment, delaying the effective date for the
recognition and measurement guidance of EITF 03-1, as contained in paragraphs
10-20, until certain implementation issues are addressed and a final FSP
providing implementation guidance is issued. The final FSP is expected to be
issued in December 2004. Management is currently evaluating the effect of this
guidance on First Defiance's financial condition and results of operations.
12
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Recent Accounting Pronouncements (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. Acquisitions
On August 4, 2004, First Defiance entered into an Agreement and Plan of Merger
with ComBanc, Inc. (ComBanc), a $205 million bank holding company headquartered
in Delphos, Ohio. Under the terms of the agreement, First Defiance will acquire
ComBanc and its wholly owned subsidiary, The Commercial Bank of Delphos Ohio
(the Commercial Bank). First Defiance has agreed to purchase the outstanding
shares of ComBanc for $17.20 per share for a transaction valued at $38.0
million. The shareholders of ComBanc have the right to select payment of the
purchase price in either cash or shares of First Defiance common stock, subject
to an aggregate consideration mix of 50% cash and 50% common stock. Following
the merger, which is contingent on receipt of regulatory and ComBanc shareholder
approvals, the Commercial Bank will be merged with and into First Federal Bank.
Management anticipates the transaction to close in the first quarter of 2005.
On October 13, 2004, First Defiance announced an agreement to acquire The Genoa
Savings and Loan Company (Genoa Savings), headquartered in Genoa, Ohio. The
purchase price for Genoa Savings is $11.0 million and will be paid in cash.
Following the merger, which is contingent on Genoa shareholder and regulatory
approvals, Genoa Savings will be merged with and into First Federal Bank. The
transaction is expected to close early in the second quarter of 2005.
13
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
4. Settlement of Contingent Liabilities
During the 2004 third quarter First Defiance resolved a contingent liability
related to the 2002 sale of its Leader Mortgage subsidiary. After considering
contingency reserves previously recorded by First Defiance, the settlement
resulted in a pre-tax charge of $1.9 million which was recorded in the 2004
third quarter. After tax the charge amounted to $1.25 million or $0.20 per
share. When it sold Leader Mortgage in 2002, First Defiance recognized an
after-tax gain of $7.7 million or $1.16 per share.
5. Dividends on Common Stock
As of September 30, 2004, First Defiance had declared a quarterly cash dividend
of $.20 per share for the third quarter of 2004, payable October 22, 2004.
6. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been calculated by
dividing net income by the weighted average number of shares of common stock
outstanding for the three and nine-month periods ended September 30, 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 and nine-months ended September 30, 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.
14
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
6. Earnings Per Share (continued)
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
2004 2003 2004 2003
------------------------------------------
Numerator for basic and diluted earnings per
share - Net income $1,680 $3,681 $7,317 $9,263
Denominator:
Denominator for basic earnings per share -
weighted average shares 6,076 6,002 6,103 6,033
Effect of dilutive securities:
Employee stock options 255 288 275 256
Unvested management recognition plan stock 1 3 2 7
------------------------------------------
Dilutive potential common shares 256 291 277 263
------------------------------------------
Denominator for diluted earnings per share -
adjusted weighted average shares and assumed
conversions 6,332 6,293 6,380 6,296
==========================================
Basic earnings per share $ 0.28 $ 0.61 $ 1.20 $ 1.54
==========================================
Diluted earnings per share $ 0.27 $ 0.58 $ 1.15 $ 1.47
==========================================
15
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
7. Investment Securities
The following is a summary of available-for-sale and held-to-maturity securities
(in thousands):
September 30, 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 $ 44,592 $2,202 $ 17 $ 46,777
Corporate bonds 6,172 385 -- 6,557
Mortgage-backed securities 17,641 180 15 17,806
REMICs 6,416 2 23 6,395
Collateralized mortgage obligations 19,974 150 59 20,065
Trust preferred stock 7,228 58 -- 7,286
Equity securities 69 -- 3 66
Obligations of state and political
subdivisions 35,002 1,703 2 36,703
---------------------------------------------
Totals $137,094 $4,680 $119 $141,655
=============================================
Held-to-Maturity Securities:
FHLMC certificates $ 472 $ 23 $ -- $ 495
FNMA certificates 1,046 17 2 1,061
GNMA certificates 319 3 1 321
Obligations of state and political
subdivisions 590 98 -- 688
---------------------------------------------
Totals $ 2,427 $ 141 $ 3 $ 2,565
=============================================
Management has determined that unrealized losses on securities classified as
available-for-sale are deemed temporary as the Company has the intent and
ability to hold such securities until loss are recovered or until maturity.
16
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
7. 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
=============================================
17
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
7. Investment Securities (continued)
The following table presents the age of gross unrealized losses and fair value
by investment category at September 30, 2004 (in $000s):
Less than 12 Months 12 Months or More Total
----------------------------------------------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
----------------------------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities
and Obligations of U.S.
Government corporations
and agencies $ 2,982 $ 17 $ -- $ -- $ 2,982 $ 17
Mortgage-backed securities 3,479 5 804 10 4,283 15
REMICs 5,650 23 -- -- 5,650 23
Collateralized mortgage
obligations 7,248 59 -- -- 7,248 59
Equity securities 66 3 -- -- 66 3
Obligations of state and
Political subdivisions -- -- 177 2 177 2
--------------------------------------------------------------------
Total $19,425 $ 107 $ 981 $ 12 $20,406 $ 119
====================================================================
Held-to-Maturity Securities:
FNMA certificates $ -- $ -- $ 174 $ 2 $ 174 $ 2
GNMA certificates 30 1 -- -- 30 1
--------------------------------------------------------------------
Total $ 30 $ 1 $ 174 $ 2 $ 204 $ 3
====================================================================
18
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
8. Loans
Loans receivable and held for sale consist of the following (in thousands):
September 30, December 31
2004 2003
--------------------------
Real Estate:
One-to-four family residential $186,688 $167,983
Construction 16,816 16,830
Non-residential and multi-family 392,610 341,423
----------------------
596,114 526,236
Other Loans:
Commercial 141,264 120,677
Consumer finance 45,267 40,257
Home equity and improvement 87,755 70,038
----------------------
274,286 230,972
----------------------
Total real estate and other loans 870,400 757,208
Deduct:
Loans in process 8,155 6,079
Net deferred loan origination fees and costs 1,175 1,158
Allowance for loan loss 9,712 8,844
----------------------
Totals $851,358 $741,127
======================
Changes in the allowance for loan losses were as follows (in $000s):
Three Months ended Nine Months ended
September 30 September 30
2004 2003 2004 2003
------------------------------------------
Balance at beginning of period $9,537 $8,106 $8,844 $7,496
Provision for loan losses 376 497 1,245 1,185
Charge-offs:
One-to-four family residential real estate -- -- 52 18
Non-residential and multi-family real estate 25 -- 34 162
Commercial 144 52 283 115
Consumer finance 78 45 149 133
------------------------------------------
Total charge-offs 247 97 518 428
Recoveries 46 71 141 324
------------------------------------------
Net charge-offs 201 26 377 104
------------------------------------------
Ending allowance $9,712 $8,577 $9,712 $8,577
==========================================
19
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
9. Deposits
A summary of deposit balances is as follows (in thousands):
September 30, December 31,
2004 2003
-------- --------
Non-interest-bearing checking accounts $ 55,321 $ 52,323
Interest-bearing checking accounts 68,513 67,351
Savings accounts 53,143 51,767
Money market demand accounts 171,011 148,691
Certificates of deposit 431,268 408,864
-------- --------
$779,256 $728,996
======== ========
10. 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 because First Federal enters into a forward sales
commitment at the same time it makes the commitment for a fixed rate loan that
it is going to be put in the held-for-sale category. At September 30,2004 First
Defiance had commitments to sell $7.8 million of loans held-for-sale. 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.
20
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
10. Commitments, Guarantees and Contingent Liabilities (continued)
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,
2004 2003
----------------------------
(In Thousands)
Commercial $123,478 $113,247
Real Estate 9,256 6,799
Consumer 65,458 56,823
Standby Letters of Credit 5,119 3,550
----------------------------
Total $203,311 $180,419
============================
The remaining weighted average life for outstanding standby letters of credit
was less than one year at September 30, 2004. The Company had $80,000 of standby
letters of credit with a life longer than one year.
11. 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 and nine-month periods ended September 30, 2004 and 2003:
Three Months ended Nine Months ended
September 30 September 30
2004 2003 2004 2003
----------------------------------------------
(In Thousands)
Service cost-benefits attributable to service
during the period $ 12 $ 9 $ 36 $ 27
Interest cost on accumulated postretirement
benefit obligation 24 21 72 63
Net amortization and deferral 6 3 18 9
----------------------------------------------
Net periodic postretirement benefit cost $ 42 $ 33 $ 126 $ 99
==============================================
21
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2004 and 2003)
- --------------------------------------------------------------------------------
11. Postretirement Benefits (continued)
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 not yet determined whether its
current plan is actuarially equivalent to Medicare Part D under the Act. Until
such determination is made, the Company has assumed that it will opt for
coverage under Medicare Part D rather than the Federal subsidy approach.
22
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.
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
and investment sales 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.
Changes in Financial Condition
- ------------------------------
At September 30, 2004, First Defiance's total assets, deposits and stockholders'
equity amounted to $1.1 billion, $779.3 million and $125.4 million,
respectively, compared to $1.04 billion, $729.0 million and $124.3 million,
respectively, at December 31, 2003.
Net loans receivable increased to $851.4 million at September 30, 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 $51.2 million to $392.6 million, commercial loans, which increased by $20.6
million to $141.3 million, one-to-four family residential loans, which increased
by $18.7 million to $186.7 million, home equity and improvement loans, which
increased by $17.7 million to $87.8 million and consumer loans, which increased
by $5.0 million to $45.3 million.
23
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
The investment securities portfolio decreased to $144.1 million at September 30,
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.
Deposits increased $50.3 million from $729.0 million at December 31, 2003 to
$779.3 million as of September 30, 2004. This increase resulted from an increase
in money market deposit accounts which increased $22.3 million to $171.0
million, non-interest checking accounts, which increased $3.0 million to $55.3
million, savings accounts, which increased $1.4 million to $53.1 million, and
interest bearing checking accounts, which increased $1.2 million to $68.5
million. Certificates of deposit balances increased $22.4 million to $431.3
million with $37.1 million of the increase resulting from an increase in
brokered certificates of deposit balances. Management uses brokered CDs as an
alternative source of funding.
Additionally, FHLB advances increased to $173.7 million at September 30, 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
slightly to $12.1 million at September 30, 2004 from $12.3 million at December
31, 2003. These borrowings are primarily securities sold under repurchase
agreements.
Stockholders' equity increased from $124.3 million at December 31, 2003 to
$125.4 million at September 30, 2004. The increase is a result of the $7.3
million of net income, the release of ESOP shares which increased equity by $1.3
million and the exercise of stock options by First Defiance employees which also
increased equity by $1.3 million. Those increases were offset by a decrease in
unrealized gains on available for sale securities (net of tax) of $1.1 million,
$3.7 million of dividends declared and $4.0 million from the repurchase of
158,905 shares of First Defiance stock for treasury at an average price of
$25.30 per share.
24
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 September 30,
---------------------------------------------------------------------
2004 2003
-------------------------------- ---------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 832,116 $ 12,209 5.84% $ 713,402 $ 10,989 6.11%
Securities 147,358 1,839 4.96 177,730 2,165 4.83
Interest-earning deposits 835 1 0.48 36,884 107 1.15
FHLB stock and other 13,097 140 4.25 17,415 176 4.01
----------- -------- ----------- --------
Total interest-earning assets 993,406 14,189 5.68 945,431 13,437 5.64
Non-interest-earning assets 93,799 92,757
----------- -----------
Total assets $ 1,087,205 $ 1,038,188
=========== ===========
Interest-bearing liabilities:
Deposits $ 712,814 $ 3,384 1.89% $ 691,280 $ 3,330 1.91%
FHLB advances and other 172,620 1,843 4.25 154,116 1,843 4.74
Notes payable 10,317 31 1.20 9,898 25 1.00
----------- -------- ----------- --------
Total interest-bearing liabilities 895,751 5,258 2.34 855,294 5,198 2.41
Non-interest bearing deposits 55,641 -- 52,013 --
----------- -------- ----------- --------
Total including non-interest bearing
demand deposits 951,392 5,258 2.20 907,307 5,198 2.27
Other non-interest-bearing liabilities 10,013 10,345
----------- -----------
Total liabilities 961,405 917,652
Stockholders' equity 125,800 120,536
----------- -----------
Total liabilities and stock-
holders' equity $ 1,087,205 $ 1,038,188
=========== ===========
Net interest income; interest
rate spread $ 8,931 3.34% $ 8,239 3.23%
======== ==== ======== ====
Net interest margin (3) 3.58% 3.46%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities 111% 111%
==== ====
- ----------
(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%. First Defiance believes this measure to be
the preferred industry measurement of net interest income and provides
relevant comparison between taxable and non-taxable amounts.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Nine Months Ended September 30,
------------------------------------------------------------------
2004 2003
------------------------------ ------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $ 789,513 $ 34,424 5.82% $ 645,665 $ 30,418 6.30%
Securities 155,864 5,801 4.97 191,274 7,040 4.92
Interest-earning deposits 3,086 37 1.60 22,816 216 1.27
FHLB stock and other 15,374 471 4.09 17,540 518 3.95
----------- -------- ----------- --------
Total interest-earning assets 963,837 40,733 5.65 877,295 38,192 5.82
Non-interest-earning assets 92,242 76,639
----------- -----------
Total assets $ 1,058,079 $ 953,934
=========== ===========
Interest-bearing liabilities:
Deposits $ 691,100 $9,453 1.83% $ 616,617 $ 10,275 2.23%
FHLB advances and other 167,177 5,418 4.33 155,112 5,553 4.79
Notes payable 10,241 75 .98 5,711 47 1.10
----------- -------- ----------- --------
Total interest-bearing liabilities 868,518 14,946 2.30 777,440 15,875 2.73
Non-interest bearing deposits 54,515 -- 45,619 --
----------- -------- ----------- --------
Total including non-interest bearing
demand deposits 923,033 14,946 2.16 823,059 15,875 2.58
Other non-interest-bearing liabilities 9,186 10,319
----------- -----------
Total liabilities 932,219 833,378
Stockholders' equity 125,860 120,556
----------- -----------
Total liabilities and stock-
holders' equity $ 1,058,079 $ 953,934
=========== ===========
Net interest income; interest
rate spread $ 25,787 3.35% $ 22,317 3.09%
======== ===== ======== ====
Net interest margin (3) 3.57% 3.40%
===== ====
Average interest-earning assets
to average interest-bearing
liabilities 111% 113%
===== ====
- ----------
(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%. First Defiance believes this measure to be
the preferred industry measurement of net interest income and provides
relevant comparison between taxable and non-taxable amounts.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
26
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Results of Operations
- ---------------------
Three Months Ended September 30, 2004 compared to Three Months Ended September
- --------------------------------------------------------------------------------
30, 2003
- --------
First Defiance had net income of $1.7 million or $.27 per share for the three
months ended September 30, 2004 compared to $3.7 million or $0.58 per share for
the same period in 2003.
Net Interest Income. Net interest income for the quarter ended September 30,
2004 was $8.6 million compared to $7.8 million for the same period in 2003. Net
interest margin for the 2004 first quarter was 3.58% compared to 3.46% for the
same period in 2003. On a tax-equivalent basis, net interest income for the
quarter ended September 30, 2004 was $8.9 million compared to $8.2 million for
the same period in 2003.
Total interest income increased by $811,000 to $13.8 million for the three
months ended September 30, 2004 from $13.0 million for the three months ended
September 30, 2003. On a tax equivalent basis, total interest income increased
by $752,000 to $14.2 million for the three months ended September 30, 2004 from
$13.4 million for the three months ended September 30, 2003. Interest on loans
increased $1.3 million to $12.2 million in the third quarter of 2004 from $10.9
million in the third quarter of 2003. The increase in interest from loans was
due to a $118.7 million increase in average loan balances between the third
quarter of 2003 and the third quarter of 2004. The increase is due primarily to
growth of the Company's commercial and commercial real estate loan portfolios
over the past twelve months. The Company also has had growth in its mortgage,
home equity and consumer loan portfolios in the last year as well.
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
6.11% for the three months ended September 30, 2003 to 5.84% for the same period
in 2004 The rate reduction is primarily a result of a change in the mix of its
loan portfolio as commercial loans and non-residential real estate loans were
$533.9 million at September 30, 2004, up from $462.1 million at December 31,
2003 and $451.6 million at September 30, 2003. During that same time one-to-four
family residential loans, excluding loans held for sale, increased just $17.8
million to $196.7 million from $178.9 million (one-to-four family residential
loans were $170.8 million at September 30, 2003). The Company sells most of its
new mortgage loan originations into the secondary market. Although interest
rates have increased over the last year, especially the prime interest rate
which has increased by 0.75%, first Defiance has not experienced a significant
impact of the rate increase because of a concentration of 3-year and 5-year
adjustable loans which have not adjusted. Also, a large amount of loans that are
prime based are subject to interest rate floors that were higher than the
current loan rates.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, decreased $432,000 to $1.8 million for the three
months ended September 30, 2004 compared to $2.3 million for the same period in
2003. The decrease is due to the decline in the average balance by $66.4 million
from $214.6 million at September 30, 2003 to $148.2 million at September 30,
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%. First
27
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Defiance believes this measure to be the preferred industry measurement of net
interest income and provides relevant comparison between taxable and non-taxable
amounts. The tax-equivalent adjustments to net interest income for 2004 and 2003
were $210,000 and $108,000 respectively.
The tax-equivalent yield on the investment portfolio was 4.96% for the three
months ended September 30, 2004, up from 4.83% for the third quarter of 2003.
Total interest expense increased by $60,000 to $5.3 million for the third
quarter of 2004 compared to $5.2 million for the same period in 2003. Interest
expense on interest bearing deposits increased by $54,000 to $3.4 million for
the quarter ended September 30, 2004 from $3.3 million for the quarter ended
September 30, 2003. The average balance of interest bearing deposits increased
by $21.5 million, from $691.3 million for the quarter ended September 30, 2003,
to $712.8 million for the quarter ended September 30, 2004. The average cost of
funds decreased from 2.27% for the third quarter of 2003 to 2.20% for the third
quarter of 2004. The average balances of interest-bearing liabilities increased
$40.5 million from $855.3 million in the third quarter of 2003 to $895.8 million
in the third quarter of 2004.
Provision for Loan Losses. The provision for loan losses was $376,000 in the
third quarter of 2004 compared to $497,000 for the third quarter of 2003.
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. The growth in the allowance for loan losses is
consistent with the growth in loan balances outstanding. While the balance of
net charge-offs continues to be low, the allowance for loan losses as a
percentage of total loans declined to 1.13% at September 30, 2004 from 1.18% at
December 31, 2003 and 1.17% at September 30, 2003.
28
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,
2004 2003
--------------------------------
Non-accrual loans $ 1,945 $ 2,545
Loans over 90 days past due and still accruing -- --
-----------------------------
Total non-performing loans $ 1,945 $ 2,545
Real estate owned (REO) 61 404
-----------------------------
Total non-performing assets $ 2,006 $ 2,949
=============================
Allowance for loans losses as a percentage
of total loans 1.13% 1.18%
Allowance for loan losses as a percentage
of non-performing assets 484.15% 299.90%
Allowance for loan losses as a percentage
of non-performing loans 499.33% 347.50%
Total non-performing assets as a percentage
of total assets 0.18% 0.28%
Total non-performing loans as a percentage
of total loans 0.23% 0.34%
Of the $1.9 million in non-accrual loans, $1.4 million were commercial loans or
non-residential real estate loans and $489,000 were residential mortgage loans.
The allowance for loan losses at September 30, 2004 was $9.7 million compared to
$8.6 million at both September 30, 2003 and $8.8 million at December 31, 2003.
For the quarter ended September 30, 2004, First Defiance charged off $247,000 of
loans against its allowance and realized recoveries of $46,000 from loans
previously charged off. During the same quarter in 2003, First Defiance charged
off $97,000 in loans and realized recoveries of $71,000.
Non-Interest Income. Non-interest income decreased $1.3 million in the third
quarter of 2004, to $3.6 million for the quarter ended September 30, 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
$1.8 million to $518,000 for the three months ended September 30, 2004 from $2.3
million during the 2003 third 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 nine months of 2004 as interest rates increased
from their record low levels of mid-2003. The origination and servicing of
mortgage loans is a core activity of First Federal in its local market areas.
Gain on Sale of Securities. Gains realized from the sale of investment
securities were $302,000 in the third quarter of 2004. There were no gains from
the sale of investment securities in the third quarter of 2003.
Service Fees. Loan and deposit fees increased $168,000 to $1.4 million for the
quarter ended September 30, 2004 from $1.2 million for the quarter ended
September 30, 2003. Increases occurred primarily in loan servicing fees on sold
loans, debit card interchange fees, and checking NSF fees.
29
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 was essentially flat, decreasing $18,000 to $906,000 in the
third quarter of 2004 from $924,000 in the same period of 2003. Part of the
reason for the decline was a change by First Insurance and Investments in the
investment broker/dealer utilized to process trades during the third quarter.
This change resulted in a temporary reduction in the amount of investment
transactions during the time of the conversion.
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, increased to $452,000 for the quarter ended September 30,
2004 from $437,000 for the same period in 2003.
Non-Interest Expense. Total non-interest expense increased $2.7 million to $9.5
million for the quarter ended September 30, 2004 from $6.8 million for the same
period in 2003. Significant individual components of the increase are as
follows:
Settlement of Contingent Liability. Income for the 2004 third quarter was
negatively impacted by a one-time $1.9 million charge recorded during the
quarter to settle certain contingent liabilities related to the 2002 sale of the
Leader Mortgage Company subsidiary. After tax, the charge amounted to $1.25
million or $0.20 per share. First Defiance recognized an after-tax gain from the
sale of Leader Mortgage of $7.7 million or $1.16 per share in 2002.
Compensation and Benefits. Compensation and benefits remained essentially flat
at $4.3 million for both the quarter ended September 30, 2004 and for the same
period in 2003.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of
mortgage servicing rights ("MSR's") totaled $141,000 in the 2004 third quarter
compared to $546,000 in the 2003 third 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 $321,000
adjustment for impairment in the value of its MSR portfolio during the 2004
third quarter, the result of the decrease in the market value of MSRs in the
face of falling interest rates during the 2004 third quarter. There was a
$987,000 favorable adjustment to recognize a recovery of previously recorded
impairment reserves in the third quarter of 2003. First Defiance has a total
impairment reserve of $640,000 recorded against an asset with a book value
before reserves of $4.2 million at September 30, 2004. That portfolio represents
approximately 5,522 loans with unpaid balances of approximately $456 million.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, and deposit insurance premiums) decreased
to $2.8 million for the quarter ended September 30, 2004 from $2.9 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 26.51% for the
quarter ended September 30, 2004 compared to 31.78% for the same period in 2003.
The effective tax rate is lower than the Company's statutory 35% rate because it
has approximately $35.6 million invested in municipal securities, and $18.5
million of bank owned life insurance which are both exempt from federal tax. The
Company also adjusted its
30
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
tax accrual accounts following the filing of its 2003 Federal tax return during
the 2004 third quarter. These adjustments had a favorable impact on its
effective tax rate.
As a result of the above factors, income for the quarter ended September 30,
2004 was $1.7 million compared to income of $3.7 million for the comparable
period in 2003. On a per share basis, basic and diluted earnings per share for
the three months ended September 30, 2004 were each $0.28 and $.27,
respectively, compared to basic and diluted earnings per share of $0.61 and
$0.58, respectively, for the quarter ended September 30, 2003. The recognition
of the expense for the settlement of contingent liabilities reduced income in
the 2004 third quarter by $0.20 per share and the impact of recognizing
impairment reserves in the 2004 third quarter compared to an impairment recovery
in the 2003 third quarter resulted in a $0.13 per share swing in earnings per
share between the two quarterly periods
Nine Months Ended September 30, 2004 compared to Nine Months Ended September 30,
- --------------------------------------------------------------------------------
2003
- ----
On a consolidated basis, First Defiance had net income of $7.3 million or $1.15
per share for the nine months ended September 30, 2004 compared to $9.3 million
or $1.47 per share in 2003.
Net Interest Income. Net interest income for the nine months ended September 30,
2004 was $24.7 million compared to $21.1 million for the same period in 2003.
Net interest margin for the first three quarters of 2004 was 3.57% compared to
3.40% for the same period in 2003. On a tax equivalent basis, net interest
income for the nine months ended September 30, 2004 was $25.8 million compared
to $22.3 million for the same period in 2003.
Total interest income increased by $2.7 million to $39.7 million for the nine
months ended September 30, 2004 from $37.0 million for the nine months ended
September 30, 2003. On a tax equivalent basis, total interest income increased
by $2.5 million to $40.7 million for the nine months ended September 30, 2004
from $38.2 million for the nine months ended September 30, 2003. Interest on
loans increased $4.0 million to $34.4 million in the first three quarters of
2004 from $30.4 million in the first three quarters of 2003. The increase in
interest from loans was due to a $143.8 million increase in average loan
balances between the first three quarters of 2003 and the first three quarters
of 2004. That increase is the result of the acquisition of three branch offices
in June 2003, which added $79.1 million in loans, and due to continued portfolio
growth throughout the First Defiance market, especially in the commercial and
non-residential real estate loan categories
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
6.30% for the nine months ended September 30, 2003 to 5.82% for the same period
in 2004 because of falling interest rates over that time period.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, decreased $1.4 million to $5.8 million for the nine
months ended September 30, 2004 compared to $7.2 million for the same period in
2003. The decrease was due to the $35.4 million decline in average balances of
investments, to $155.9 million for the first three quarters of 2004 compared to
$191.3 million for the first three quarters of 2003.
Total interest expense declined by $929,000 to $15.0 million for the first three
quarters of 2004 compared to $15.9 million for the same period in 2003. Interest
expense on FHLB advances decreased
31
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
$135,000 to $5.4 million for the first nine months of 2004 compared to the same
period in 2003. This happened despite an increase of $12.1 million in the
average balance of FHLB advances in 2004 compared to 2003. In the third quarter
of 2003, the Company was able to re-negotiate the interest rate downward on $45
million of FHLB advances contributing to the 46 basis point decline in the
average cost of those borrowings from 4.79% for the first three quarters of 2003
compared to 4.33% for the first three quarters of 2004. Interest expense on
interest-bearing deposits decreased by $822,000 to $9.5 million for the nine
months ended September 30, 2004 from $10.3 million for the nine months ended
September 30, 2003. This decrease occurred despite growth in deposits because of
the change in the mix of deposits from higher costing certificates of deposit to
checking and money market accounts, as well as, decreasing market interest rates
during the time period. The average cost of funds decreased from 2.23% for the
nine months ended September 30, 2003 to 1.83% for the same period in 2004. The
average balances of interest-bearing liabilities increased $91.1 million from
$777.4 million in the first three quarters of 2003 to $868.5 million in the
first three quarters of 2004.
Provision for Loan Losses. The provision for loan losses was $1.24 million for
the first three quarters of 2004 compared to $1.19 million for the first three
quarters of 2003. This increase is a result of the significant loan growth that
has occurred during the first three quarters of 2004. Net charge-offs for the
2004 first three quarters were $377,000, compared to $105,000 for the same
period in 2003.
Non-Interest Income. Non-interest income decreased $3.8 million in the first
three quarters of 2004, to $11.1 million for the nine months ended September 30,
2004 from $14.9 million for the same period in 2003. Individual components on
non-interest income are as follows:
Gain on Sale of Loans. Gains realized from the sale of mortgage loans decreased
$4.7 million to $1.9 million for the nine months ended September 30, 2004 from
$6.6 million during the first three quarters of 2003.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $694,000 for the nine months ended September 30, 2004 compared to
$919,000 in the first three quarters of 2003.
Service Fees. Loan and deposit fees increased $597,000 to $4.0 million for the
nine months ended September 30, 2004 from $3.4 million for the nine months ended
September 30, 2003. Increases occurred primarily in loan servicing fees on
mortgage loans serviced for others, checking NSF fees and debit card interchange
fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $375,000 to $3.2 million in the first three quarters
of 2004 from $2.8 million in the same period of 2003. Increases occurred
primarily in the sale of investment and annuity products.
Bank Owned Life Insurance. Income from bank owned life insurance ("BOLI")
decreased $37,000 to $579,000 in the first three quarters of 2004 compared to
$616,000 for the nine months ended September 30, 2003. This was a result of
decreasing market interest rates over the last 12 months. First Defiance's BOLI
investment is in general account contracts, whose rates generally lag the
overall market.
32
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock and other miscellaneous charges, increased to
$778,000 for the nine months ended September 30, 2004 from $657,000 for the same
period in 2003.
Non-Interest Expense. Total non-interest expense increased $2.6 million to $24.1
million for the nine months ended September 30, 2004 from $21.5 million for the
same period in 2003. Significant individual components of the increase are as
follows:
Settlement of Contingent Liability. Income for the first nine months of 2004 was
negatively impacted by the one-time $1.9 million charge recorded to settle
certain contingent liabilities related to the 2002 sale of its Leader Mortgage
Company subsidiary. The charge amounted to $1.25 million or $0.20 per share
after tax.
Amortization and Impairment of Mortgage Servicing Rights. Amortization of MSRs
totaled $547,000 in the first three quarters of 2004 compared to $1.8 million in
the 2003 first three quarters, the result of a significant decline in the level
of refinancing activity in the First Federal loan servicing portfolio. Also, the
Company recognized a net negative adjustment of $34,000 related to impairment of
the value of MSRs. That net adjustment is due to recent decreases in market
interest rates and anticipated increased prepayment speeds on mortgage loans in
general. There was a net positive adjustment of $381,000 to impairment reserves
recorded in the first nine months of 2003.
Compensation and Benefits. Compensation and benefits increased $1.1 million to
$13.1 million for the nine months ended September 30, 2004 from $12.0 million
for the same period in 2003. The increase resulted from the additional staffing
added with the June 2003 branch acquisition and the opening of de novo branches
in December 2003 and February 2004.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, amortization of intangibles and deposit
insurance premiums) increased to $8.5 million for the nine months ended
September 30, 2004 from $8.1 million for the nine months ended September 30,
2003.
The effective federal income tax rate utilized for the nine months ended
September 30, 2004 was 30.5% compared to 30.8% for the nine months ended
September 30, 2003.
As a result of the above factors, income for the nine months ended September 30,
2004 was $7.3 million compared to $9.3 million for the comparable period in
2003. On a per share basis, basic and diluted earnings per share for the nine
months ended September 30, 2004 were $1.20 and $1.15 respectively, compared to
basic and diluted earnings per share of $1.54 and $1.47, respectively, for the
nine months ended September 30, 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.
33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
First Defiance generated $1.6 million of cash from operating activities during
the third quarter of 2004 and $10.5 million for the 2004 year-to-date period.
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, 2004, First Defiance had $72.0 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $131.3 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 $7.8 million of loans held-for-sale. Also
as of September 30, 2004, the total amount of certificates of deposit that are
scheduled to mature by September 30, 2005 is $224.8 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, other sources of funding are available including
the brokered Certificate of Deposit market, the FHLB, and other financial
institutions.
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 September 30, 2004, all of these
securities pass the FFIEC high risk security test, are not classified as high
risk, and do not present risk significantly different than other mortgage-backed
or agency securities.
34
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, 2004.
Core Capital Risk-Based Capital
---------------------------------------------------------------
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
---------------------------------------------------------------
Regulatory capital $ 98,770 $ 98,770 $ 108,473 $ 108,473
Minimum required regulatory capital 43,070 53,837 68,429 85,536
-------------------------------------------------------------
Excess regulatory capital $ 55,700 $ 44,933 $ 40,044 $ 22,937
=============================================================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
=============================================================
Regulatory capital as a percentage of assets (1) 9.2% 9.2% 12.7% 12.7%
Minimum capital required as a percentage
of assets 4.0% 5.0% 8.0% 10.0%
-------------------------------------------------------------
Excess regulatory capital as a percentage
of assets 5.2% 4.2% 4.7% 2.7%
=============================================================
(1) Core capital is computed as a percentage of adjusted total assets of $1.08
billion. Risk-based capital is computed as a percentage of total
risk-weighted assets of $855.4 million.
35
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
Pending Acquisition
On August 4, 2004, First Defiance entered into an Agreement and Plan of Merger
with ComBanc, Inc. Under the terms of the agreement, First Defiance will acquire
ComBanc and its wholly owned subsidiary, The Commercial Bank of Delphos Ohio.
First Defiance has agreed to purchase the outstanding shares of ComBanc for
$17.20 per share for a transaction valued at $38.0 million. The shareholders of
ComBanc have the right to select payment of the purchase price in either cash or
shares of First Defiance common stock, subject to an aggregate consideration mix
of 50% cash and 50% common stock. Management expects one-time costs, including
acquisition-related and restructuring charges, will not exceed $1.75 million on
a pre-tax basis over the integration period. The cash portion of the acquisition
will be financed from existing sources of liquidity.
Upon completion of the acquisition, on a pro forma basis using September 30,
2004 data, First Defiance will have $1.306 billion in total assets, $965.1
million in loans, $950.5 million in total deposits, and $144.4 million in
shareholders' equity. The acquisition is expected to result in approximately
$16.7 million in additional goodwill and other intangibles. Management expects
the transaction, which is subject to regulatory and ComBanc shareholder
approval, to close in the first quarter of 2005.
Subsequent Event
On October 13, 2004, First Defiance entered into an Agreement and Plan of Merger
with The Genoa Savings and Loan Company. Under the terms of the agreement, First
Defiance will acquire Genoa Savings. First Defiance has agreed to purchase the
outstanding shares of Genoa Savings for $30.22 per share in cash for a
transaction valued at $11.0 million. Management expects one-time costs,
including acquisition-related and restructuring charges will not exceed $2.35
million on a pre-tax basis over the integration period. Management believes the
financing of the acquisition can come from existing sources of liquidity.
Upon completion of the acquisition and the previously announced ComBanc
acquisition, on a pro forma basis using September 30, 2004 data, First Defiance
will have $1.395 billion in total assets, $1.036 billion in loans, $1.038
billion in total deposits and $144.4 million in shareholders equity. The Genoa
acquisition is expected to result in approximately $6.0 million in additional
goodwill and other intangibles. Management expects the transaction, which is
subject to regulatory and Genoa Savings shareholder approval, to close early in
the second quarter of 2005.
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
36
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations - Continued
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 third 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.
37
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
June 2004 amounts as a base case, First Defiance's net interest income would
increase by approximately $300,000 in a rising rate environment and decline by
approximately $800,000 in a declining rate environment. Both scenarios result in
changes that are within 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.
38
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
- --------------------------------------------------------------------------------------------------------------------
Total Number of Maximum Number of
Total Number of Shares Purchased as Shares that May Yet
Shares Part of Publicly Be Purchased Under
Purchased Average Price Paid Announced Plans or the Plans or
Period Per Share Programs Programs (a)
- --------------------------------------------------------------------------------------------------------------------
July 1, 2004 -
July 31, 2004 227 $22.73 227 517,909
- --------------------------------------------------------------------------------------------------------------------
August 1, 2004 -
August 31, 2004 3,660 $25.35 3,660 514,249
- --------------------------------------------------------------------------------------------------------------------
September 1, 2004 -
September 30, 2004 32,170 $26.13 32,170 482,079
- --------------------------------------------------------------------------------------------------------------------
Total for 2004
Third Quarter 36,057 $26.03 36,057 482,079
- --------------------------------------------------------------------------------------------------------------------
Year to Date
Total (b) 158,905 $25.30 158,905 482,079
- --------------------------------------------------------------------------------------------------------------------
(a) On July 18, 2003, the registrant announced that its Board of Directors had
authorized management to repurchase up to 10% of the Registrant's common stock
through the open market or in any private transaction. The authorization, which
is for 639,828 shares, does not have an expiration date.
(b) Year-to-date totals include 1,156 shares purchased to complete a previously
announced share repurchase authorization and 157,749 shares purchased under the
authorization announced on July 18, 2003.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Non applicable
Item 5. Other Information
Not applicable.
39
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
(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 15, 2004 which described the
settlement of contingent liabilities related to the 2002 sale of the
Company's Leader Mortgage Company subsidiary. The filing included a copy
of the Company's press release dated October 14, 2004.
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on October 15, 2004 which included a
copy of the Agreement and Plan of Merger dated as of October 13, 2004 by
and among First Defiance Financial Corp., First Federal Bank of the
Midwest and The Genoa Savings and Loan Company. The filing also included a
copy of the Company's press release dated October 13, 2004.
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission on October 20, 2004 which included a
copy of the Company's earnings release for the quarter ended September 30,
2004.
40
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: November 9, 2004 By: /s/ William J. Small
---------------- -------------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: November 9, 2004 By: /s/ John C. Wahl
---------------- -------------------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer
41