Exhibit 13
Annual Report to Shareholders
and Notice of Annual Meeting of Shareholders
and Proxy Statement
A Foundation for Growth
1997 Annual Report
First Defiance Financial Corp.
Table of Contents
Financial Highlights.......................1
Letter from the President................2-4
Financial Highlights....................2
Foundation for Growth...................3
Where do we go from here?...............4
Locations..................................5
Selected Consolidated
Financial Information....................6-7
Management's Discussion and
Analysis of Financial Condition
and Results of Operations...............8-13
Report of Independent Auditors............14
Audited Consolidated
Financial Statements...................15-36
Consolidated Statements
of Financial Condition.................15
Consolidated Statements
of Income..............................16
Consolidated Statements of
Changes in Stockholder's Equity........17
Consolidated Statements
of Cash Flows.......................18-19
Notes to Consolidated
Financial Statements................20-36
Stock Information.........................36
Executive Officers
(pictured from left to right)
Patricia A. Cooper [GRAPHIC-PHOTO OF EXECUTIVE
Senior Vice President OFFICERS LISTED]
William J. Small
Senior Vice President and
President, First Federal Savings and Loan
Don C. Van Brackel
Chairman, President and Chief Executive Officer
John C. Wahl
Senior Vice President,
Chief Financial Officer and Corporate Treasurer
John W. Boesling
Senior Vice President and Corporate Secretary
Jeffrey D. Vereecke
Senior Vice President
First Defiance Financial Corp.
Financial Highlights
Years ended December 31
($ in thousands, except per share data) 1997 1996 1995
- -------------------------------------------------------------------------------------------
At Period End:
Assets $579,698 $543,411 $525,550
Loans, net 441,911 415,925 385,203
Deposits 395,322 382,525 381,779
Stockholders' equity 106,885 116,565 133,506
Book value per share 12.53 12.31 12.16
Stockholders' equity to total assets 18.44% 21.45% 25.40%
Average Balances:
Assets $560,709 $528,863 $489,628
Loans 428,550 399,949 367,773
Deposits 382,574 381,444 376,864
Stockholders' equity 115,231 127,280 89,873
Summary of Operating Results:
Net interest income $22,471 $21,798 $18,276
Provision for loan losses 1,613 1,020 374
Non-interest income 1,627 1,327 1,035
Non-interest expense* 14,093 13,497 10,560
Net income* 5,407 5,775 5,521
Basic earnings per share* 0.65 0.60 0.54
Diluted earnings per share* 0.62 0.59 0.53
Return on average equity* 4.69% 4.54% 6.14%
Return on average assets* 0.96% 1.09% 1.13%
* 1996 operating results exclude the effect of a one-time $2.461 million
charge to recapitalize the Savings Association Insurance Fund Net of tax
the charge was $1.624 million, or $.17 per share (both basic and diluted).
Net income for 1996 including the charge was $4.151 million, basic and
diluted EPS were $.43 and $.42, respectively, return on average equity was
3.26% and return on average assets was .78%.
[GRAPHIC-PICUTRE OF COLUMNS]
Dear Shareholder:
Much was accomplished at First Defiance Financial Corp. during 1997:
We achieved our highest level of earnings per share since becoming a public
company in 1993.
We completed major renovations at our four main office facilities.
We enhanced our distribution channel
by opening a new branch facility in Paulding, Ohio in September and followed
that with the opening of a branch in Hicksville, Ohio in early 1998.
We upgraded our computer systems to improve our efficiency and customer service
efforts.
We made some key additions to our
management team to allow us to more effectively implement our strategic plan.
We grew our commercial and consumer loan portfolios substantially without
adversely affecting asset quality.
From an earnings per share standpoint, 1997 was a record year. Our basic
earnings per share for 1997 was $.65 per share, an increase from the 1996 level
of $.60 per share, after adding back the one-time SAIF charge. The increase in
earnings per share was achieved despite a decrease in net income in 1997
compared to 1996 (after adding back the SAIF assessment) because of a 1.2
million reduction in the average shares outstanding. The reduction in
outstanding shares is the result of five successful stock repurchase programs
completed between May 1996 and November 1997. We have recently completed our
sixth stock repurchase during the first quarter of 1998.
Our net income for 1997 was $5.4 million, compared to $5.8 million in 1996
(after adding back the SAIF assessment). Net interest income for the year
increased by over $600,000, but our provision for loan losses increased by
essentially the same amount. Our non-interest income increased by $300,000 but
our non-interest expense increased by $600,000, primarily to pay for
improvements to our facilities and computer systems as well as personnel costs
of new branches and central operations additions.
In highlighting these accomplishments, I need to stress that we are in no way
satisfied with our financial performance in 1997. For the year ended December
31, 1997, our return on average equity was 4.69%, compared to 4.54% in 1996 when
you exclude the effect of the SAIF assessment. Return on average assets was .96%
for 1997 compared to 1.09% in 1996. We realize that it is management's job to
improve shareholder value and that shareholder value is best improved by higher
levels of profitability and return on equity.
[GRAPHIC-COLUMNS DEPICTING EARNING PER SHARE]
However, in order to achieve our long-range strategic goals, certain
improvements needed to be made to our infrastructure. Those changes included
improvements to our physical plants, upgrades to our computer systems, expansion
of our product offerings and distribution channels, and upgrading the capability
of our central office staff to support growth. Many of these very positive
changes had a negative impact on earnings in 1997.
2
A Foundation for Growth
We believe the improvements we made to our facilities and to our systems during
1997 will allow us to better compete in the rapidly consolidating financial
services industry. The renovations of our offices in Defiance, Napoleon, Bryan
and Wauseon actually began in late 1995 and were completed during the first
quarter of 1997. These facilities were originally designed for traditional
savings and loan associations. We had space for loan officers who processed only
mortgage loans and for tellers who opened only passbook savings accounts and
certificates of deposits. Over the years, space became a premium as we added
many services, including a variety of non-mortgage loan products, as well as
individual retirement accounts and checking accounts. Our renovated facilities
allow us to serve our customers in a setting that strengthens quality customer
service.
[GRAPHIC-PHOTO OF BANK CUSTOMERS AT COUNTER]
As outdated as our offices were, on a relative basis, our data processing
platform was even more outdated. We spent considerable time and money during
1997 upgrading our PC networks, our communications links, our reporting systems,
and our tellering platform. These efforts should allow for both more efficient
processing of transactions, and for the production of better management reports.
We are continuing to improve our systems and in the spring of 1998 we will
implement check imaging for our 12,000 checking accounts. We also are working
closely with our third party data processors to assure that all systems are Year
2000 compliant.
We understand that to achieve our strategic growth initiatives, we will need to
grow both by increasing our market share in those areas we now serve and by
expanding into new areas. We are very excited about the prospects in the two new
markets we have recently entered with de novo branches, Paulding and Hicksville,
Ohio. Both of these communities are adjacent to markets we already serve but
provide us with an opportunity to cost effectively expand our customer base to
the south and to the west. The Paulding office opened in September and has
significantly exceeded our expectations for both deposit and loan growth through
its first three months of operations. The Hicksville office opened on February
6, 1998 and has experienced a brisk traffic flow during its short life thus far.
In both of these locations, we hired managers and staff who are from those
communities and who have been able to make a maximum impact in a short period of
time.
[GRAPHIC-PHOTO OF BANK CUSTOMER AND SERVICE PERSON]
3
Also in 1997 we increased our support staff in our central operations
departments. We hired a full-time marketing manager and restructured our loan
departments to support growth in commercial and consumer lending. While these
efforts cost us earnings in 1997, we are confident they will pay off in the
future.
[GRAPHIC-PHOTO]
Where do we
go from here?
While we are proud of our heritage as a
savings and loan, in reality, our operations
do not resemble those of a traditional thrift
institution.
I believe that during 1998, we'll continue to shed our thrift identity and
implement the initiatives that will make us a more competitive provider of a
wide array of financial services.
From a strategic standpoint, we need growth, especially in the commercial and
consumer lending areas. And, we have all the products in place to compete in
those areas - our suite of commercial business products is as good as any in the
market. In the consumer arena, we have been very successful in making car loans
through a network of auto dealers in northwest Ohio. We hope to expand to other
areas of consumer credit in 1998. Finally, we will continue to be a dominant
mortgage lender in the markets we serve, not only with our traditional first
mortgage products, but with some very successful home equity loan programs as
well.
[GRAPHIC-PHOTO]
We also will continue to focus our attention on sound capital management. If it
remains prudent, and if our regulators allow, we will continue to repurchase our
own stock. We also will continue to actively pursue opportunities to better
leverage our balance sheet.
We believe we have put the foundation for growth in place to successfully meet
the challenges in 1998 and beyond.
I would like to thank our employees for their hard work and dedication to First
Defiance, our thousands of customers for their continued loyalty, and you our
shareholders for your patience and your continued interest in First Defiance
Financial Corp.
Yours truly,
/S/Don C. Van Brackel
- ---------------------
Don C. Van Brackel
Chairman, President and CEO
4
Office Locations
- --------------------------------------------------------------------------------
First Defiance Financial
Corp. Headquarters
601 Clinton St.
Defiance, OH 43512
www.fdef.com
419-782-5015
[GRAPHIC-MAPS OF OHIO SHOWING LOCATIONS]
Bryan Downtown
204 East High Street
Bryan, Ohio 43506
419-636-3118
Bryan East
926 East High Street
Bryan, Ohio 43506
419-636-5653
Defiance Downtown
601 Clinton Street
Defiance, OH 43512
419-782-5015
Defiance North
825 North Clinton Street
Defiance, OH 43512
419-782-6626
Defiance Super K-Mart
190 Stadium Drive
Defiance, OH 43512
419-782-5252
Hicksville
201 East High Street
Hicksville, OH 43526
419-542-5626
Montpelier
1050 East Main Street
Montpelier, OH 43543
419-485-5591
Napoleon Downtown
625 Scott Street
Napoleon, OH 43545
419-592-3060
Napoleon Woodlawn
1333 Woodlawn Avenue
Napoleon, OH 43545
419-599-2727
Paulding
905 North Williams Street
Paulding, OH 45879
419-399-9748
Wauseon
211 South Fulton Street
Wauseon, OH 43567
419-335-7911
www.first-fed.com
5
First Defiance Financial Corp. and Subsidiary
Selected Consolidated Financial Information
($ in thousands, except per share data)
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Selected Consolidated Financial Condition Data: At December 31
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $579,698 $543,411 $525,550 $471,461 $467,400
Loans receivable held-to-maturity 441,824 415,366 381,444 354,937 333,664
Loans receivable held-for-sale 88 559 3,759 - -
Allowance for loan losses 2,686 2,217 1,817 1,733 1,662
Non-performing assets 1,906 2,239 945 865 1,015
Securities available-for-sale 82,436 77,407 93,041 65,604 77,069
Securities held-to-maturity 20,953 25,937 26,073 30,632 39,351
Deposits 395,322 382,525 381,779 375,690 376,281
FHLB advances 71,665 40,821 6,842 23,741 21,509
Stockholders' equity 106,885 116,565 133,506 68,396 65,681
- ---------------------------------------------------------------------------------------------------------------------------
Selected Consolidated Operating Results: Years ended December 31
- ---------------------------------------------------------------------------------------------------------------------------
Total interest income $ 43,858 $ 41,257 $ 38,565 $ 35,260 $ 36,461
Total interest expense 21,387 19,459 20,289 16,928 18,413
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Net interest income 22,471 21,798 18,276 18,332 18,048
Provision for loan losses 1,613 1,020 374 465 975
- ---------------------------------------------------------------------------------------------------------------------------
Net interest income after provision for loan losses 20,858 20,778 17,902 17,867 17,073
Non-interest income 1,627 1,327 1,035 1,001 1,043
Non-interest expense 1 14,093 15,957 10,560 9,930 8,631
- ---------------------------------------------------------------------------------------------------------------------------
Income before income taxes 8,392 6,148 8,377 8,938 9,485
Income taxes 2,985 1,997 2,856 2,985 3,052
- ---------------------------------------------------------------------------------------------------------------------------
Net income 1 $ 5,407 $ 4,151 $ 5,521 $ 5,953 $ 6,433
- ---------------------------------------------------------------------------------------------------------------------------
Basic earnings per share 1,2 $ 0.65 $ 0.43 $ 0.54 $ 0.58 $ 0.31
- ---------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share 1,2 $ 0.62 $ 0.43 $ 0.53 $ 0.58 $ 0.31
- ---------------------------------------------------------------------------------------------------------------------------
Cash dividends declared per share 2 $ 0.33 $ 0.29 $ 0.28 $ 0.28 $ 0.13
- ---------------------------------------------------------------------------------------------------------------------------
[GRAPHIC-COLUMNS SHOWING NET INTEREST INCOME]
[GRAPHIC-PIE CHARTS DEPICTING ASSETS BY CATEGORIES]
6
1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
- ---------------------------------------------------------------------------------------------------------------------------
Performance Ratios:
Return on average assets 1 0.96% 0.78% 1.13% 1.28% 1.40%
Return on average equity 1 4.69% 3.26% 6.14% 8.87% 12.30%
Interest rate spread 3 3.39% 3.22% 3.01% 3.50% 3.59%
Net interest margin 3 4.24% 4.31% 3.87% 4.06% 4.06%
Ratio of operating expense to average total assets 1 2.51% 3.02% 2.16% 2.13% 1.88%
Dividend payout ratio 4 50.77% 67.44% 51.85% 48.28% 41.94%
Quality Ratios:
Non-performing assets to total assets at end of period 5 0.33% 0.41% 0.24% 0.28% 0.25%
Allowance for loan losses to non-performing assets 5 140.92% 99.02% 192.28% 200.35% 163.74%
Provision for loan losses to total loans receivable 0.60% 0.52% 0.47% 0.48% 0.49%
Capital Ratios:
Equity to total assets at end of period 18.44% 21.45% 25.40% 14.51% 14.05%
Average equity to average assets 20.55% 24.07% 18.36% 14.40% 11.41%
Book value per share $ 12.53 $12.31 $12.16 $6.23 $5.99
Ratio of average interest-earning assets to average
interest-bearing liabilities 121% 129% 120% 115% 111%
1 Non-interest expense for 1996 includes a one-time charge of $2.461 million
to recapitalize the Savings Association Insurance Fund (SAIF). Without the
SAIF charge, net income for 1996 would have been $5.775 million, or $.60
basic earnings share ($.59 on a diluted basis), return on average assets
would have been 1.09%, return on equity would have been 4.54% and the ratio
of operating expense to average total assets would have been 2.55%.
2 Per share amounts for 1993-1994 have been restated to reflect the
reorganization described in Note 1 to the Consolidated Financial
Statements. Earnings per share for 1993 are based on the weighted average
number of shares outstanding (as adjusted) and net income from July 19,
1993, the date of the Mutual Holding Company Reorganization, through
December 31, 1993. See Note 1 to the Consolidated Financial Statements.
Earnings per share for 1993-1996 have been restated for FASB Statement 128
as described in Note 3 to the Consolidated Financial Statements.
3 Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earning assets.
4 Dividend payout ratio was calculated using basic earnings per share.
5 Non-performing assets consist of non-accrual loans that are contractually
past due 90 days or more, loans that are deemed impaired under the criteria
of FASB Statement No. 114, and real estate, mobile homes and other assets
acquired by foreclosure or deed-in-lieu thereof.
[GRAPHIC-COLUMNS SHOWING EQUITY TO TOTAL ASSETS]
{GRAPHIC-COLUMNS SHOWING NON-PERFORMING ASSETS TO TOTAL ASSETS] 7
Management's Discussion and Analysis
Management's Discussion and Analysis of
Financial Condition and Results of Operations
First Defiance Financial Corp. ("First Defiance" or "the Company"), through its
wholly owned subsidiary First Federal Savings and Loan ("First Federal")
provides financial services to communities based in the northwest corner of
Ohio. First Federal operates 11 full-service branches, including branches in
Paulding, Ohio and Hicksville, Ohio which opened in September, 1997 and
February, 1998 respectively.
Forward Looking Statements
The statements in this Annual Report which are not historical fact are forward
looking statements. Forward-looking information should not be construed as
guarantees of future performance. Actual results may differ from expectations
contained in such forward looking information as a result of factors including
but not limited to the interest rate environment, economic policy or conditions,
federal and state banking and tax regulations and competitive factors in the
marketplace. Each of these factors could affect estimates, assumptions,
uncertainties and risks considered in the development of forward looking
information and could cause actual results to differ materially from
management's expectations regarding future performance.
Financial Condition
First Defiance increased average interest earning assets by $24.6 million in
1997 from 1996. This growth was achieved through a $28.6 million, or 7.1%,
increase in the average loan portfolio for the year ended December 31, 1997
compared to 1996. The growth in the loan portfolio was funded primarily through
increases in Federal Home Loan Bank (FHLB) advances, whose average balance
increased by $42.3 million, and through maturities of investments held in the
investment securities portfolio. The average outstanding balance in the
investment portfolio decreased by $4.4 million for the year ended December 31,
1997 compared to the year ended December 31, 1996. However, without the
implementation of several leveraged growth strategies implemented during 1997,
the average balance in the investment portfolio would have been an additional
$28.9 million lower. FHLB advances were utilized to fund the leverage growth
strategies and also to fund $14.5 million in purchases of treasury stock during
1997. The average balance of deposits outstanding for 1997 was $382.6 million,
only a slight increase from the $381.4 million average balance outstanding for
1996.
First Defiance also had a substantial increase in its properties and equipment
during 1997 as the balance in those accounts increased from $12.3 million at
December 31, 1996 to $16.8 million at December 31, 1997. The increase is due to
the completion of renovations to the Company's facilities in Wauseon, Napoleon,
Bryan and at the headquarters in Defiance during the first half of 1997. The
total cost of those renovations capitalized during 1997 was $10.6 million,
including $7.6 million that was in construction in process at December 31, 1996.
Premises and equipment also includes $1.2 million in construction in process at
the end of 1997, of which approximately $1 million is for the permanent branch
facility in Paulding, Ohio, which is scheduled to be completed in April, 1998
and the new branch in Hicksville, Ohio which opened in February, 1998. The
branch renovations increased occupancy costs by approximately $366,000 in 1997
compared to 1996. It is estimated that occupancy costs will increase by
approximately $450,000 in 1998.
Asset/Liability Management
First Defiance's ability to maximize net income is largely dependent upon
management's ability to plan and control net interest income through management
of the pricing and mix of assets and liabilities. Due to the fact that the
majority of assets and liabilities of a financial institution are monetary in
nature, changes in interest rates and monetary or fiscal policy affect its
financial condition and have potentially the greatest 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 any trading activities.
First Defiance monitors interest rate risk on a monthly basis through simulation
analysis which measures the impact changes in interest rates can have on net
interest income. The simulation technique analyzes the effect of a presumed 100
basis point shift in interest rates (which is consistent with management's
estimate of the range of potential interest rate fluctuations) and takes into
account prepayment speeds on amortizing financial instruments, loan and deposit
volumes and rates, nonmaturity deposit assumptions and capital requirements. The
results of the simulation indicate that in an environment where interest rates
rise 100 basis points over a 12 month period, using 1998 projected amounts as a
base case, First Defiance's net interest income would decline by 3.0%. Were
interest rates to fall by 100 basis points during that same 12 month period, the
simulation indicates that net interest income would increase by 3.4% over the
projected 1998 base case.
8
The following table shows First Defiance's cumulative gap over the next two
years. The interest rate gaps reported in the table result when assets are
funded with liabilities having different repricing intervals. The traditional
gap approach shows the Company to be liability sensitive to rate changes at
December 31, 1997. During 1997, net interest income increased by $880,000 as a
result of changing interest rates. The interest rate gaps are managed and
frequently change as adjustments are made to interest rate forecasts, market
outlooks, and balance sheet cash flows. First Defiance's gap position at the end
of any period may not be reflective of interest rate views in subsequent
periods, and the Company's active management dictates that longer-term economic
views are balanced against short-term interest rate changes.
Interest Rate Sensitivity Analysis
December 31,1997 Over Over Over
(Dollars in thousands) Less than 3 through 6 6 Months 1 through 2 Over
3 Months Months through 1 Year Years 2 Years Total
- --------------------------------------------------------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------------------------------------------------------
Loans, gross $ 60,938 $ 32,448 $ 77,542 $ 38,119 $ 235,463 $ 444,510
Securities 2,800 2,784 5,282 43,476 49,047 103,389
FHLB Stock 3,764 3,764
- --------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive assets 63,738 35,232 82,824 81,595 288,274 551,663
Other assets 28,035 28,035
- --------------------------------------------------------------------------------------------------------------------------------
Total assets $ 63,738 $ 35,232 $ 82,824 $ 81,595 $ 316,309 $ 579,698
- --------------------------------------------------------------------------------------------------------------------------------
Liabilities
- --------------------------------------------------------------------------------------------------------------------------------
Savings, NOW accounts, checking
and money market deposit accounts 70,046 46,698 116,744
Certificates of deposit 59,778 47,236 76,733 78,495 16,336 278,578
FHLB advances 67,305 172 353 746 3,089 71,665
- --------------------------------------------------------------------------------------------------------------------------------
Total rate sensitive liabilities 197,129 47,408 77,086 79,241 66,123 466,987
Other liabilities 5,826 5,826
Stockholders' equity 106,885 106,885
- --------------------------------------------------------------------------------------------------------------------------------
Total liabilites and stockholders' equity $ 197,129 $ 47,408 $ 77,086 $ 79,241 $ 178,834 $ 579,698
- --------------------------------------------------------------------------------------------------------------------------------
Interest rate sensitivity gap $(133,391) $ (12,176) $ 5,738 $ 2,354 $ 222,151 $ 84,676
- --------------------------------------------------------------------------------------------------------------------------------
Cumulative interest rate sensitivity gap $(133,391) $(145,567) $(139,829) $ (137,475) $ 84,676
- --------------------------------------------------------------------------------------------------------------------------------
Percentage of cumulative gap to
total rate sensitive assets (24.18)% (26.39)% (25.35)% (24.92)% 15.35%
- --------------------------------------------------------------------------------------------------------------------------------
In addition to the simulation analysis and the interest rate gap table, First
Defiance also utilizes the "market value of portfolio equity" ("NPV")
methodology adopted by the OTS. Under the NPV methodology, interest rate risk
exposure ("IRR") is assessed by reviewing the estimated changes in First
Federal's Net Interest Income ("NII") and NPV which would hypothetically occur
if interest rates simultaneously rise or fall along the yield curve. Projected
values of NII and NPV at both higher and lower regulatory defined rate scenarios
are compared to base case values (no change in rates) to determine the
sensitivity to changing interest rates. For 1997, the results of such
projections were within limits set by the Company's board of directors.
First Defiance's lending strategy is designed to increase the rate sensitivity
of its loan portfolio. The focus of growth in First Defiance's loan portfolio is
in the consumer and commercial areas, which by their nature have less exposure
to interest rate fluctuations. The balances of First Defiance's auto loans
increased from $62.1 million at December 31, 1996 to $69.1 million at December
31, 1997 and commercial loans increased from $26.7 million to $30.0 million
during that same time period. First Defiance also has increased the outstanding
balance on its home equity lines of credit, which are granted at up to 100% of
collateral value at competitive rates. The total outstanding home equity loans
at December 31, 1997 were $16.9 million compared to $13.6 million at December
31, 1996.
9
First Defiance originates a substantial amount of fixed and adjustable rate
mortgage loans. Loans originated with a maturity of 20 years or more are
generally sold in the secondary market while loans originated with a maturity
less than 20 years are generally retained in the portfolio. A total of $8.2
million in loans were sold during 1997 and at December 31, 1997, First Defiance
serviced a total of $17.8 million in loans for others, compared to $11.3 million
at December 31, 1996.
Management utilizes the investment portfolio to help enhance overall net
interest margin and to maintain liquidity. At December 31, 1997, First
Defiance's available for sale investment portfolio was comprised of U.S.
Treasury and Agency securities ($58.9 million fair value), corporate bonds
($10.1 million fair value), mutual funds which invest primarily in adjustable
rate mortgage backed securities ($8.8 million fair value), REMICs and CMOs ($4.1
million fair value) and municipal obligations ($550,000 fair value). The Company
also has certain securities, primarily mortgage-backed securities and municipal
obligations, which havebeen classified as held-to-maturity. The total carrying
amount of those securities is $21.0 million at December 31, 1997.
First Defiance's sources of funding include deposits received through its branch
network, loan repayments, investment security maturities and repayments,
national/brokered certificates of deposit obtained through brokers or directly
from other institutions, and advances from the FHLB. Deposits are priced
according to management's asset/liability objectives, alternate funding sources
and competition. Based on an assessment of the current interest rate
environment, management has focused its efforts on competitively pricing
primarily shorter-term deposits. As a result, 67.5% of First Defiance's $278.6
million in certificates of deposit at December 31, 1997 will mature during 1998.
The asset/liability committee regularly assesses which source of funding is the
most appropriate given pending needs.
During 1997, First Defiance expanded both the uses of national/brokered
certificates of deposit and FHLB advances. The Company had no national or
brokered certificates of deposit at December 31, 1996 and had a total of $7.1
million at December 31, 1997. The company issues brokered or national
certificates if the rates are appropriate in relation to other sources of
funding. FHLB advances increased to $71.7 million at December 31, 1997 from
$40.8 million at December 31, 1996. In addition to being a source of funding for
the lending operations of First Defiance, FHLB advances are used specifically
for leveraged growth strategies and to fund the repurchase of shares of Company
stock as part of First Defiance's capital management.
Concentration of Credit Risk
Financial institutions such as First Defiance generate income primarily through
lending and investing activities. The risk of loss from lending and investing
activities includes the possibility that losses may occur from the failure of
another party to perform according to the terms of the loan or investment
agreement. This possibility of loss is known as credit risk.
Credit risk is increased by lending or investing in activities that concentrate
a financial institution's assets in a way that exposes the institution to a
material loss from any single occurrence or group of related occurrences.
Diversifying loans and investments to prevent concentrations of risks is one
manner a financial institution can reduce potential losses due to credit risk.
Examples of asset concentrations would include geographic concentrations, loans
or investments of a single type, loans or investments in a single industry,
multiple loans made to a single borrower, and loans of inappropriate size
relative to the total capitalization of the institution. Management believes
adherence to its loan and investment policies allows it to control its credit
risk at acceptable levels.
Liquidity and Capital Resources
First Federal is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of United States
Treasury, federal agency and other investments having maturities of five years
or less. Current OTS regulations require that a savings institution maintain
liquid assets of not less than 4% of its average daily balance of net
withdrawable deposit accounts and borrowings payable in one year or less. First
Federal's liquidity substantially exceeded applicable requirements throughout
1997 and at December 31, 1997.
Cash was generated by First Defiance's operating activities during the years
ended December 31, 1997, 1996 and 1995, primarily as a result of net income. The
adjustments to reconcile net income to cash provided by operations during the
periods presented consisted primarily of proceeds from the sale of loans (less
the origination of loans held for sale), the provision for loan losses,
depreciation and amortization expense, ESOP expense related to the release of
ESOP shares in accordance with AICPA SOP 93-6 and increases and decreases in
other assets and liabilities. The primary investing activity of First Defiance
is lending, which is funded with cash provided from operations and financing
activities, as well as proceeds from payments on existing loans and proceeds
from maturities of securities and, in 1995, from proceeds from a public stock
offering. For additional information about cash flows from First Defiance's
operating, investing and financing activities, see the Consolidated Statements
of Cash Flows included in the Consolidated Financial Statements.
10
At December 31, 1997, First Defiance had an aggregate of $37.2 million in
unfunded commitments to originate loans (including unused portions of lines of
credit and letters of credit) and no commitments to purchase securities. At the
same date, the total amount of certificates of deposit that are scheduled to
mature by December 31, 1998 was $188.2 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, national/brokered certificates of deposit and advances from FHLB
are available.
Stockholders' equity decreased by $9.7 million, or 8.3%, at December 31, 1997
compared to December 31, 1996 due to the repurchase of 966,519 shares of First
Defiance stock (10.2% of shares outstanding at the beginning of the year). Those
shares were repurchased for an average cost of $15.05 per share and as a result,
stockholders' equity was reduced by $14.5 million. First Defiance made similar
purchases of 1,518,688 shares of common stock during 1996.
The equity reduction caused by the repurchase of First Defiance shares was
offset to a lesser degree by earnings retention, the vesting or issuance of
shares under the Company's Management Recognition ("MRP") and Employee Stock
Ownership ("ESOP") plans, unrealized securities gains, and the issuance of stock
under stock option programs. Net income for 1997 was $5.4 million, of which $2.8
million was returned to shareholders in the form of declared dividends (51.7% of
net income, $.33 per share). The vesting of MRP shares and release of ESOP
shares increased equity by $898,000 and $847,000 respectively. Unrealized gains
on available for sale securities, net of tax, increased equity by $347,000.
Stock option exercises increased equity by approximately $161,000. The book
value of First Defiance's common stock increased to $12.53 at December 31, 1997
from $12.31 at December 31, 1996.
First Federal is subject to the various capital requirements of the Office of
Thrift Supervision. At December 31, 1997, First Federal's capital ratios well
exceeded the minimum regulatory requirements. For additional information about
First Federal's capital requirements, see Note 13 to the Consolidated Financial
Statements.
Results of Operations
General - First Defiance reported net income of $5.4 million for the year ended
December 31, 1997 compared to $4.2 million and $5.5 million respectively for the
years ended December 31, 1996 and December 31, 1995 respectively. The 1996 net
income was adversely impacted by a one-time assessment of $2.5 million to
recapitalize the Savings Association Insurance Fund ("SAIF"). The after-tax
impact of the SAIF charge was a reduction in net income in 1996 by $1.6 million.
Without the SAIF charge, First Defiance's net income for 1996 would have been
$5.8 million. On a diluted per share basis, First Defiance's net income was
$.62, $.42 and $.53 respectively for the years ended December 31, 1997, 1996 and
1995 ($.59 for 1996 after adding back the SAIF assessment). Earnings per share
increased in 1997 despite the reduction in net income because of a 1.1 million
reduction in the number of average shares outstanding. The reduction in average
shares outstanding is the result of the repurchase of almost 2.5 million shares
in six separate stock buy-backs conducted between May, 1996 and December, 1997.
Net interest income after the provision for loan losses was $20.9 million for
the year ended December 31, 1997, compared to $20.8 million and $17.9 million
for the years ended December 31, 1996 and 1995 respectively. Net interest margin
was 4.24%, 4.31% and 3.87% for the years ending December 31, 1997, 1996 and 1995
respectively. The yield on interest earning assets was 8.24% for 1997, a slight
increase from 8.12% for the year ended December 31, 1996 and 8.13% for 1995. The
Company's cost of funds for the year ended December 31, 1997 was 4.85% compared
to 4.90% for the year ended December 31, 1996 and 5.12% for the year ended
December 31, 1995. As a result, the interest rate spread increased to 3.39% for
the year ended December 31, 1997 compared to 3.22% for 1996 and 3.01% for 1995.
Non-interest income for the year ended December 31, 1997 was $1.6 million, a
22.6% increase from the $1.3 million level for the year ended December 31, 1996.
The 1996 amount was a 28.2% increase from the 1995 level of $1.0 million.
Non-interest expense for the year ended December 31, 1997 was $14.1 million
compared to $16.0 million for the year ended December 31, 1996. However, the
1996 amount includes the $2.5 million SAIF assessment. Without the SAIF
assessment, non-interest expense for 1996 would have been $13.5 million.
Non-interest expense for the year ended December 31, 1995 was $10.6 million.
Net Interest Income - First Defiance's net interest income is determined by its
interest rate spread (i.e., the difference between the yields on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Total interest income increased by $2.6 million, or 6.3%, from $41.3 million for
the year ended December 31, 1996 to $43.9 million for the year ended December
31, 1997. The increase was due to a $28.6 million increase in the average
balance of loans outstanding for 1997 when compared to 1996. The yield on those
loans increased
11
slightly, to 8.70% in 1997 from 8.66% in 1996. The 1996 interest income was an
increase of $2.7 million, or 7.0%, from 1995. Total interest income for the year
ended December 31, 1995 was $38.6 million. That increase was due to a $32.2
million increase in the average balance of loans outstanding in 1996 compared to
1995. The yield on loans for 1995 was 8.70%. Earnings from the investment
portfolio have been constant at $6.6 million for each of the years ending
December 31, 1997, 1996 and 1995. For 1997, the yield on the investment
portfolio increased approximately 20 basis points, to 6.35% from 6.15% for 1996
and 6.18% for 1995. However, the average balance of the portfolio declined to
$103.3 million for the year ended December 31, 1997 from $107.7 million for 1996
and $106.1 million for 1995.
Interest expense in 1997 increased to $21.4 million from $19.5 million for the
year ended December 31, 1996. The increase was due to an increase in interest
expense on FHLB advances, which was $3.4 million for the year ended December 31,
1997 compared to $880,000 for the same period in 1996. This increase was due to
a significant increase in the average balance of FHLB advances outstanding
during the year ended December 31, 1997 compared to 1996. Average FHLB advances
during 1997 were $58.1 million, compared to $15.9 million in 1996. The average
cost of those advances also increased to 5.84% for the year ended December 31,
1997 compared to 5.56% for the year ended December 31, 1996. The cost of deposit
liabilities actually decreased to $18.0 million for the year ended December 31,
1997 compared to $18.6 million for the same period in 1996. The decline in
deposit cost was due to a 17 basis point decrease in the average cost of those
funds as the average balance of deposits outstanding was essentially flat when
comparing 1997 to 1996. Interest expense for the year ended December 31, 1996
compared to the year ended December 31, 1995 declined by $830,000. The decrease
was due primarily to a decline in the average outstanding balance of FHLB
advances, which were $19.0 million for 1995, as well a 13 basis point decline in
the average rate paid on deposits in 1996 compared to 1995. Also, interest
expense in 1995 included an interest penalty of approximately $125,000 incurred
to pay off a high rate fixed-rate advance in December 1995.
As a result of the foregoing, First Defiance's net interest income was $22.5
million for the year ended December 31, 1997 compared to $21.8 million for the
year ended December 31, 1996 and $18.3 million for the year ended December 31,
1995.
Provision for Loan Losses - First Defiance's provision for loan losses was $1.6
million for the year ended December 31, 1997 compared to $1.0 million and
$374,000 for 1996 and 1995, respectively. Provisions for loan losses are charged
to earnings to bring the total allowance for loan losses to a level that is
deemed appropriate by management. Factors considered by management include
historical experience, the volume and type of lending conducted by First
Defiance, industry standards, the amount of non-performing assets, including
loans which meet the "FASB" Statement No. 114's definition of impaired, general
economic conditions, particularly as they relate to First Defiance's market
area, and other factors related to the collectability of First Defiance's loan
portfolio.
The increase in the provision for loan losses, both from 1995 to 1996 and from
1996 to 1997, can be attributed to the overall growth of the loan portfolio and
the continued emphasis on higher-yielding consumer and commercial lending, which
have inherently greater credit risk than mortgage lending. Also, the level of
charge-offs has increased substantially, especially during 1997. Total
charge-offs, net of recoveries were $1.1 million for the year ending December
31, 1997 compared to $620,000 in 1996 and $293,000 in 1995.
At December 31, 1997, non-performing assets, which include loans 90 days past
due and repossessed assets, were $1.9 million. That amount includes one loan
($537,000) considered impaired as defined by FASB Statement No. 114. The total
allowance for loan losses at December 31, 1997 was $2.7 million. At December 31,
1996, $1.6 million in loans were considered impaired and other non-performing
assets totaled an additional $678,000. The loan loss reserve at December 31,
1996 was $2.2 million.
Non-interest Income - First Defiance's non-interest income was $1.6 million for
the year ended December 31, 1997, compared to $1.3 million for 1996 and $1.0
million for 1995. Service fees and other charges increased by $211,000 or 25.6%
in 1997 compared to 1996. NSF income, late fees on loans, income from the sale
of credit life insurance products and ATM surcharge fees all contributed to
those increases. The Company had similar increases from 1995 to 1996, when
service fee income increased by $153,000 primarily due to increases in NSF
charges.
Non-interest income also includes gains on sales of mortgage loans and service
fees related to the servicing of those loans. For 1997, those amounts totaled
$183,000 compared to $221,000 for 1996 and $2,000 for 1995. First Defiance did
not become a Freddie Mac seller/servicer until December 1995. Non-interest
income also includes $103,000 of gains from the disposal of available-for-sale
securities for 1997 compared to $26,000 of similar gains in 1996 and $75,000 in
losses in 1995. Also, non-interest income for 1995 included a gain on disposal
of investment properties of $110,000.
Non-interest Expense - Total non-interest expense for 1997 was $14.1 million
compared to $16.0 million for the year ended December 31, 1996 ($13.5 million
excluding the SAIF assessment) and $10.6 million for the year ended December 31,
1995. The increase from 1996 to 1997 was due primarily to a $1.0 million
increase in compensation and benefits expense and a $596,000 increase in
occupancy costs. Compensation expense increased by $288,000 because of an
increase in the value of shares released by the Company's ESOP plan for
allocation to participants. Compensation costs also increased by approximately
$518,000 due to increased compensation costs related to increases in staffing,
both at the Company headquarters and at the branches. During 1997, First
Defiance hired a full-time marketing director and realigned duties in the
lending area in order to improve customer service. Also, staffing for the
Paulding branch, which opened in September 1997
12
was hired beginning in June 1997 in order to prepare for the opening of that
facility and the staffing for the Hicksville Branch, which opened in February
1998 was hired and trained beginning in October 1997. Total full-time equivalent
employees at December 31, 1997 was 155 compared to 138 at December 31, 1996.
Occupancy costs increased in 1997 compared to 1996 because of the completion of
major renovations at the Defiance headquarters and at large branches in Bryan,
Napoleon and Wauseon. The total increase in depreciation expense as a result of
those renovations was $366,000. Also, in addition to the building renovations,
First Defiance made substantial improvements to its computer hardware, network
equipment and communications links during 1997. The total of those technology
expenditures was $699,000 and the increased depreciation expense resulting from
those improvements was $95,000.
The increases in compensation and occupancy costs in 1997 were offset by
substantial decreases in SAIF deposit insurance premiums and Ohio franchise
taxes. SAIF premiums, excluding the special 1996 SAIF assessment, decreased to
$194,000 for 1997 compared to $872,000 in 1996. The decrease in premiums
resulted from the reduction in the annual assessment from approximately 23 basis
points per $100 of insured deposits to 6.4 basis points per $100 of insured
deposits. Ohio franchise tax for 1997 was $1.1 million compared to $1.7 million
for the year ended December 31, 1996. The reduction in state franchise taxes
were the result of a tax planning strategy which decreased franchise taxes for
both First Federal and the holding company but increased Ohio income taxes at
the holding company level.
The increase in non-interest expense from 1995 to 1996 was primarily due to a
$1.6 million increase in compensation and benefits, a $695,000 increase in Ohio
franchise taxes, a $123,000 increase in data processing costs, and a $462,000
increase in non-interest expense - other. The increase in compensation costs was
due to an increase in salaries and wages of $665,000, a 21% increase from 1995.
This increase was due to the expansion of staffing, both at headquarters and in
the branches, inflationary wage increases and merit increases. Compensation
costs also increased by $577,000 in 1996 over 1995 due to the amortization of
the additional shares acquired by the Management Recognition Plan in 1996 and by
$161,000 due to increases in ESOP expense because of increases in the price of
First Defiance's common stock. Also, expense for the pension plan increased by
$126,000 from 1995 to 1996. Ohio franchise taxes are calculated based on
beginning of year equity and increased in 1996 because of the proceeds from the
September 1995 stock offering. Data processing costs increased due to the
upgrade of systems and the addition of several new applications in 1996.
Non-interest expense - other increased in 1996 over 1995 because of an increase
in charitable contributions and the outsourcing of appraisal fees. The increase
in appraisal fees in 1996 was offset by an increase in fees charged to loan
customers.
Income Taxes - Income tax amounted to $3.0 million in 1997 compared to $2.0
million in 1996 and $2.9 million in 1995. The effective tax rates for the three
years were 35.6%, 32.5% and 34.1% respectively. The increase in the tax rate for
1997 compared to the other years is due primarily to the inclusion in 1997 of a
provision for Ohio income taxes, which are assessed at the holding company level
and were not material in 1996. See Note 14 to the Consolidated Financial
Statements.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in
accordance with generally accepted accounting principles, which require the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative purchasing power of money
over time due to inflation. Unlike most industrial companies, substantially all
of the assets and liabilities of a financial institution are monetary in nature.
As a result, interest rates have a more significant impact on a financial
institution's performance than effects of general levels of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as
the prices of goods and services as measured by the consumer price index.
Technology Risk
In order to limit its technology risk, First Defiance has outsourced the
majority of its computer processing tasks to a variety of third-party vendors.
An ongoing assessment of technology risk includes an assessment of third party
vendors readiness for processing in the year 2000. Management has identified all
third party vendors and has requested certification as to the vendors'
compliance with processing in the year 2000. Management is coordinating with the
Company's primary data processing provider, BISYS, Inc. to perform testing of
all significant applications during the third and fourth quarters of 1998. BISYS
has represented to the Company that all appropriate programming changes will be
completed and that all testing will be performed and certified before the end of
1998.
Management has reviewed all existing hardware and software that is maintained by
the Company. Certain older personal computers which are not Year 2000 compliant
will be replaced during 1998. Management also is developing a contingency plan
which will be implemented should its primary third party vendors fail to be Year
2000 compliant. However, based on representations from third party vendors,
management believes those vendors will be compliant by the end of 1998.
Because all major data processing is outsourced, management does not believe the
cost of being Year 2000 compliant will be material to the financial statements
of the Company.
13
Report of Independent Auditors
To the Stockholders and the Board of Directors
First Defiance Financial Corp.
We have audited the consolidated statements of financial condition of First
Defiance Financial Corp. as of December 31, 1997 and 1996, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Defiance
Financial Corp. at December 31, 1997 and 1996, and the consolidated results of
its operations and cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/Ernst & Young LLP
--------------------
Ernst & Young LLP
Toledo, Ohio
January 16, 1998
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
December 31
1997 1996
- --------------------------------------------------------------------------------------------
Assets
- --------------------------------------------------------------------------------------------
Cash and cash equivalents:
Cash and amounts due from depository institutions $ 8,149,392 $ 3,102,385
Interest-bearing deposits 848,078 1,649,801
- --------------------------------------------------------------------------------------------
8,997,470 4,752,186
Investment securities:
Available-for-sale, carried at fair value 82,435,528 77,407,019
Held-to-maturity, carried at amortized cost
(approximate fair value $21,370,123 and
$26,324,936 at December 31, 1997 and
1996, respectively) 20,953,120 25,936,547
- --------------------------------------------------------------------------------------------
103,388,648 103,343,566
Loans held for sale
(approximate fair value $89,062 and $563,642
at December 31, 1997 and 1996, respectively) 87,500 558,550
Loans receivable, net of allowance
of $2,686,472 and $2,217,022 at
December 31, 1997 and 1996, respectively 441,823,805 415,366,199
Accrued interest receivable 3,479,496 3,061,133
Federal Home Loan Bank stock 3,764,300 3,033,300
Premises and equipment 16,798,904 12,254,660
Deferred federal income taxes 415,000 550,000
Real estate, mobile homes and other
assets held for sale 540,760 266,521
Other assets 402,560 224,606
- --------------------------------------------------------------------------------------------
Total assets $579,698,443 $543,410,721
- --------------------------------------------------------------------------------------------
Liabilities and stockholders' equity
- --------------------------------------------------------------------------------------------
Deposits $395,322,084 $382,525,366
Advances from the Federal Home Loan Bank 71,664,669 40,820,664
Accrued expenses and other liabilities 5,165,604 2,886,535
Advance payments by borrowers
for taxes and insurance 661,255 613,494
- --------------------------------------------------------------------------------------------
Total liabilities 472,813,612 426,846,059
Stockholders' equity:
Preferred stock, no par value per share:
5,000,000 shares authorized; no shares issued Common stock, $.01 par value
per share:
20,000,000 shares authorized; 8,527,686 and
9,470,880 shares outstanding, respectively 85,277 94,709
Additional paid-in capital 65,726,285 73,670,607
Stock acquired by ESOP (4,533,819) (5,092,569)
Stock acquired by Management Recognition Plan (1,387,934) (2,172,987)
Net unrealized losses on available-for-sale securities,
net of tax of $25,000 and $203,000, respectively (49,961) (397,056)
Retained earnings--substantially restricted 47,044,983 50,461,958
- --------------------------------------------------------------------------------------------
Total stockholders' equity 106,884,831 116,564,662
- --------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $579,698,443 $543,410,721
- --------------------------------------------------------------------------------------------
See accompanying notes.
15
First Defiance Financial Corp.
Consolidated Statements of Income
Years ended December 31
1997 1996 1995
- -----------------------------------------------------------------------------------------------
Interest income:
Mortgage and other loans $37,302,078 $34,635,111 $32,002,983
Investment securities 6,458,038 6,429,590 5,915,313
Deposits with banks 98,013 192,200 646,405
- -----------------------------------------------------------------------------------------------
Total interest income 43,858,129 41,256,901 38,564,701
Interest expense:
Deposits 17,992,359 18,579,237 18,857,219
Federal Home Loan Bank
advances and other 3,394,457 879,565 1,431,751
- -----------------------------------------------------------------------------------------------
Total interest expense 21,386,816 19,458,802 20,288,970
- -----------------------------------------------------------------------------------------------
Net interest income 22,471,313 21,798,099 18,275,731
Provision for loan losses 1,613,310 1,019,813 373,741
- -----------------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 20,858,003 20,778,286 17,901,990
Non-interest income:
Service fees and other charges 1,035,630 824,239 671,602
Dividends on Federal Home Loan Bank stock 242,401 206,941 190,861
Net gain (loss) on sale of
available-for-sale securities 103,130 25,527 (75,158)
Other 246,279 270,684 248,018
- -----------------------------------------------------------------------------------------------
1,627,440 1,327,391 1,035,323
Non-interest expense:
Compensation and benefits 7,904,833 6,899,701 5,329,669
Occupancy 1,241,104 645,166 600,413
SAIF deposit insurance premiums 193,745 871,611 858,765
SAIF special assessment - 2,460,977 -
State franchise tax 1,101,230 1,721,329 1,025,947
Data processing 780,300 721,132 598,556
Mobile home loan servicing 456,904 433,331 404,313
Other 2,415,136 2,204,388 1,742,315
- -----------------------------------------------------------------------------------------------
14,093,252 15,957,635 10,559,978
- -----------------------------------------------------------------------------------------------
Income before income taxes 8,392,191 6,148,042 8,377,335
Income taxes 2,985,000 1,997,000 2,856,000
- -----------------------------------------------------------------------------------------------
Net income $ 5,407,191 $ 4,151,042 $ 5,521,335
- -----------------------------------------------------------------------------------------------
Earnings per share:
Basic $ .65 $ .43 $ .54
- -----------------------------------------------------------------------------------------------
Diluted $ .62 $ .42 $ .53
- -----------------------------------------------------------------------------------------------
Dividends declared per share $ .33 $ .29 $ .28
- -----------------------------------------------------------------------------------------------
Average number of shares outstanding:
Basic 8,360,149 9,610,153 10,286,992
- -----------------------------------------------------------------------------------------------
Diluted 8,706,131 9,771,544 10,375,258
- -----------------------------------------------------------------------------------------------
See accompanying notes.
16
First Defiance Financial Corp.
Consolidated Statements of Changes in Stockholders' Equity For the years ended
December 31, 1997, 1996 and 1995
Stock Acquired By
- ------------------------------------------------------------------------------------------------------------------------------------
Additional Management
Common Stock Paid-In Recognition
- ------------------------------------------------------------------------------------------------------------------------------------
Shares Amount Capital ESOP Plan
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at January 1, 1995 10,976,211 $109,762 $20,068,511 $(1,000,000) $(262,095)
Amortization of deferred compensation
of Management Recognition Plan 164,838
ESOP shares released 102,601 479,166
Shares issued under stock option plan 539 5 2,495
Organization of First Defiance Financial Corp.:
Cancellation of shares held by First
Federal Mutual Holding Company (6,476,914) (64,769) 64,769
Proceeds from issuance of 6,476,914
shares of First Defiance Financial Corp.
common stock on September 29, 1995,
net of 135 fractional shares acquired, and
net of stock offering costs of $1,684,468 6,476,779 64,768 63,019,904 (5,181,530)
First Federal Mutual Holding
Company Equity 200,000
Change in net unrealized gains (losses), net
of income taxes of $1,206,000
Dividends declared
Net income
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 10,976,615 109,766 83,458,280 (5,702,364) (97,257)
Amortization of deferred compensation of
Management Recognition Plan 741,722
ESOP shares released 133,381 609,795
Shares issued under stock option plan 12,953 130 59,843
Acquisition of common stock for
Management Recognition Plan (2,817,452)
Acquisition of common stock for treasury (1,518,688) (15,187) (9,980,897)
Change in net unrealized gains (losses),
net of income taxes of $125,000
Dividends declared
Net income
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 9,470,880 94,709 73,670,607 (5,092,569) (2,172,987)
Amortization of deferred compensation
of Management Recognition Plan 113,000 785,053
ESOP shares released 287,972 558,750
Shares issued under stock option plan 23,325 233 160,570
Acquisition of common stock for treasury (966,519) (9,665) (8,505,864)
Change in net unrealized gains (losses), net
of income taxes of $178,000
Dividends declared
Net income
- ------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 8,527,686 $85,277 $65,726,285 $(4,533,819) $(1,387,934)
- ------------------------------------------------------------------------------------------------------------------------------
See accompanying notes.
Net Unrealized
Gain
(Losses) on Total
Available-For- Retained Stockholders'
Sale Securities Earnings Equity
Balance at January 1, 1995 $(2,493,010) $51,973,285 $68,396,453
Amortization of deferred compensation
of Management Recognition Plan 164,838
ESOP shares released 581,767
Shares issued under stock option plan 2,500
Organization of First Defiance Financial Corp.:
Cancellation of shares held by First
Federal Mutual Holding Company
Proceeds from issuance of 6,476,914
shares of First Defiance Financial Corp.
common stock on September 29, 1995,
net of 135 fractional shares acquired, and
net of stock offering costs of $1,684,468 57,903,142
First Federal Mutual Holding
Company Equity 200,000
Change in net unrealized gains (losses), net
of income taxes of $1,206,000 2,341,373 2,341,373
Dividends declared (1,604,919) (1,604,919)
Net income 5,521,335 5,521,335
- ------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 (151,637) 55,889,701 133,506,489
Amortization of deferred compensation of
Management Recognition Plan 741,722
ESOP shares released 743,176
Shares issued under stock option plan 59,973
Acquisition of common stock for
Management Recognition Plan (2,817,452)
Acquisition of common stock for treasury (6,819,103) (16,815,187)
Change in net unrealized gains (losses),
net of income taxes of $125,000 (245,419) (245,419)
Dividends declared (2,759,682) (2,759,682)
Net income 4,151,042 4,151,042
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 (397,056) 50,461,958 116,564,662
Amortization of deferred compensation
of Management Recognition Plan 898,053
ESOP shares released 846,722
Shares issued under stock option plan 160,803
Acquisition of common stock for treasury (6,031,107) (14,546,636)
Change in net unrealized gains (losses), net
of income taxes of $178,000 347,095 347,095
Dividends declared (2,793,059) (2,793,059)
Net income 5,407,191 5,407,191
- -------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $(49,961) $47,044,983 $106,884,831
- -------------------------------------------------------------------------------------------------------------------
17
First Defiance Financial Corp.
Consolidated Statements of Cash Flows
Years ended December 31
1997 1996 1995
- ----------------------------------------------------------------------------------------------
Operating activities
- ----------------------------------------------------------------------------------------------
Net income $ 5,407,191 $ 4,151,042 $ 5,521,335
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 1,613,310 1,019,813 373,741
Provision for depreciation 736,183 256,713 239,164
Amortization of deferred compensation
of Management Recognition Plan 785,053 741,722 164,838
Release of ESOP shares 846,722 743,176 381,767
(Gain) loss on sale of office
properties and equipment (3,149) 44,575 7,275
Gain on sale of investment properties - - (110,881)
(Gain) loss on sale of securities (103,130) (25,527) 75,158
Gain on sale of loans (116,223) (209,458) (1,658)
Amortization of premiums and accretion
of discounts on available-for-sale and
held-to-maturity securities 40,558 9,704 33,309
Tax benefit of stock plans in equity 161,000 - -
Deferred federal income taxes (credit) (43,000) (203,000) 176,000
Increase in interest receivable and
other assets (596,317) (246,593) (369,012)
Proceeds from sale of loans 8,358,029 13,541,259 87,599
Originations of loans held for sale (7,770,756) (10,131,779) (3,847,829)
Increase in accrued interest
and other expenses 2,316,415 89,540 126,261
- ----------------------------------------------------------------------------------------------
Net cash provided by operating activities 11,631,886 9,781,187 2,857,067
Investing activities
- ----------------------------------------------------------------------------------------------
Proceeds from maturities of
available-for-sale securities 13,231,326 19,613,796 5,604,170
Proceeds from sale of
available-for-sale securities 22,220,275 27,247,132 2,921,719
Purchases of available-for-sale securities (39,838,154) (36,747,804) (32,500,000)
Proceeds from maturities of
held-to-maturity securities 4,929,138 5,302,174 4,535,734
Proceeds from sale of real estate, mobile
homes and other assets held for sale 1,519,073 1,336,585 1,043,797
Proceeds from sale of Federal Home
Loan Bank stock - - 209,700
Proceeds from sale of office properties
and equipment and investment properties 3,149 1,600 315,675
Purchases of Federal Home Loan Bank stock (731,000) (203,300) (186,500)
Purchases of premises and equipment (5,280,427) (6,273,024) (3,616,879)
Net increase in mortgage and other loans (29,864,228) (36,371,949) (27,928,124)
- ----------------------------------------------------------------------------------------------
Net cash used in investing activities (33,810,848) (26,094,790) (49,600,708)
18
First Defiance Financial Corp.
Consolidated Statements of Cash Flows (continued)
Years ended December 31
1997 1996 1995
- ----------------------------------------------------------------------------------------------------------
Financing activities
- ----------------------------------------------------------------------------------------------------------
Net increase in deposits and advance payments
by borrowers for taxes and insurance 12,796,718 746,227 6,288,692
Net increase (decrease) in Federal Home
Loan Bank short-term advances 31,804,058 35,220,000 (11,000,000)
Proceeds from Federal Home Loan Bank
long-term advances - - 1,364,000
Repayment of Federal Home Loan Bank
long-term advances (960,053) (1,241,774) (7,262,204)
Loan to ESOP - - (5,981,530)
Purchase of common stock for treasury (14,546,636) (16,815,187) -
Contribution to Management Recognition
Plan for purchase of common stock - (2,817,451) -
Cash dividends paid (2,782,644) (2,771,179) (1,178,625)
Proceeds from exercise of stock options 112,803 59,972 2,500
Net proceeds from issuance of common stock - - 63,084,672
- ----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 26,424,246 12,380,608 45,317,505
- ----------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 4,245,284 (3,932,995) (1,426,136)
Cash and cash equivalents
at beginning of period 4,752,186 8,685,181 10,111,317
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 8,997,470 $ 4,752,186 $ 8,685,181
- ----------------------------------------------------------------------------------------------------------
Supplemental cash flow information
- ----------------------------------------------------------------------------------------------------------
Interest paid $20,194,478 $19,652,287 $ 20,473,789
- ----------------------------------------------------------------------------------------------------------
Income taxes paid $ 2,738,977 $ 2,364,000 $ 2,612,434
- ----------------------------------------------------------------------------------------------------------
Transfers from loans to real estate, mobile
homes and other assets held for sale $ 1,793,312 $ 1,430,202 $ 1,047,107
- ----------------------------------------------------------------------------------------------------------
Noncash operating activities
- ----------------------------------------------------------------------------------------------------------
Change in deferred taxes on net unrealized
gains or losses on available-for-sale securities $ 178,000 $ (125,000) $ (1,206,000)
- ----------------------------------------------------------------------------------------------------------
Noncash investing activities
- ----------------------------------------------------------------------------------------------------------
Change in net unrealized gain (loss) on
available-for-sale securities $ 525,095 $ (370,419) $ 3,547,373
- ----------------------------------------------------------------------------------------------------------
Land acquired with notes payable - - $ 236,400
- ----------------------------------------------------------------------------------------------------------
Land formerly included in investment properties - - $ 186,842
- ----------------------------------------------------------------------------------------------------------
Noncash financing activities
- ----------------------------------------------------------------------------------------------------------
Cash dividends declared but not paid $ 720,248 $ 757,675 $ 720,928
- ----------------------------------------------------------------------------------------------------------
Repayment of ESOP obligation
guaranteed by First Federal - - $ 1,000,000
- ----------------------------------------------------------------------------------------------------------
Transfer of equity of Mutual Holding Company - - $ 200,000
- ----------------------------------------------------------------------------------------------------------
See accompanying notes.
19
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
December 31, 1997
1. Basis of Presentation and Reorganization
The consolidated financial statements include the accounts of First Defiance
Financial Corp. ("First Defiance" or "the Company") and First Federal Savings
and Loan ("First Federal"), its wholly-owned subsidiary. First Federal operates
eleven branches in northwestern Ohio as a federally chartered savings and loan.
First Federal focuses primarily on single family residential mortgage lending,
consumer and business loans to customers. First Federal is subject to the
regulations of certain federal agencies and undergoes periodic examinations by
those regulatory authorities. All significant intercompany transactions and
balances are eliminated in consolidation.
On September 29, 1995, First Federal and First Federal Mutual Holding Company
("the Mutual Holding Company") completed a second step conversion ("the
Reorganization"). As part of the Reorganization, First Defiance was formed as a
first-tier wholly-owned subsidiary of First Federal. The Mutual Holding Company
was converted to an interim federal stock savings association and simultaneously
merged with and into First Federal, at which point the Mutual Holding Company
ceased to exist and 3,000,000 shares or 59% of the outstanding First Federal
common stock held by the Mutual Holding Company was cancelled. A second interim
savings and loan association ("Interim") formed by First Defiance solely for the
Reorganization was then merged with and into First Federal. As a result of the
merger of Interim with and into First Federal, First Federal became a
wholly-owned subsidiary of First Defiance. Pursuant to an exchange ratio of
2.1590231 shares for each share of First Federal stock, which assured that the
public shareholders of First Federal maintained their 41.0% ownership of First
Defiance, the 2,184,500 outstanding shares of First Federal were exchanged for
approximately 4,500,000 shares of First Defiance. Concurrent with the
Reorganization, First Defiance sold 6,476,914 additional shares to members of
the Mutual Holding Company, employees of First Federal and the public at a price
of $10.00 per share. Reorganization and stock offering costs of approximately
$1,685,000 resulted in net proceeds from the offering of approximately
$63,085,000.
Each depositor of First Federal as of the effective date of the Conversion will
have upon liquidation of First Federal a right to his pro rata interest in a
liquidation account established for the benefit of such depositors. Records are
maintained to ensure such rights receive statutory priority as required by OTS
regulations. The reorganization was accounted for as a change in corporate form
with the historic basis of accounting for First Federal unchanged.
2. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. Most significantly, First Defiance uses estimates in determining the
value of the allowance for loan losses.
Earnings Per Share
Earnings per share are based on the weighted average number of shares of common
stock. In 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 128, "Earnings per Share". Statement 128 replaced the calculation
of primary and fully diluted earnings per share with basic and diluted earnings
per share. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of options and unvested stock grants. Diluted earnings per
share is very similar to the previously reported fully diluted earnings per
share. All earnings per share amounts for all periods have been presented, and
where appropriate, restated to conform to the Statement 128 requirements.
Cash and Cash Equivalents
Cash and cash equivalents include amounts due from banks and overnight
investments with the Federal Home Loan Bank ("FHLB").
20
Investment Securities
Management determines the appropriate classification of debt securities at the
time of purchase and evaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest
income using the interest method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity until realized.
Realized gains and losses, and declines in value judged to be
other-than-temporary are included in gains (losses) on sale of securities. The
cost of mutual funds sold is based on the average cost method. The cost of all
other securities sold is based on the specific identification method.
Currently, First Defiance invests in on-balance sheet derivative securities as
part of the overall asset and liability management process. Such derivative
securities are disclosed in Note 3 and include agency step-up, REMIC and CMO
investments. Such investments are not classified as high risk at December 31,
1997 and do not present risk significantly different than other mortgage-backed
or agency securities. First Defiance does not invest in off-balance sheet
derivative securities.
Investments Required by Regulations
As a member of the FHLB System, First Federal is required to own stock of the
FHLB of Cincinnati in an amount principally equal to at least 1% of its net home
mortgage loans, subject to periodic redemption at par if the stock owned is over
the minimum requirement. FHLB stock is a restricted equity security that does
not have a readily determinable fair value and is carried at cost.
Loans Receivable
Investment in real estate mortgage loans consists principally of long-term
conventional loans collateralized by first mortgages on single-family
residences, other residential property, and commercial and industrial property.
Such loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal adjusted for any charge-offs, the allowance for loan
losses, and any deferred fees or costs on originated loans.
Mortgage loans originated and intended for the secondary market are carried at
the lower of cost or estimated market value in the aggregate.
Nonrefundable fees and related costs associated with originating or acquiring
real estate mortgage and other loans are capitalized and recognized as an
adjustment of the yield of the related loan.
Interest receivable is accrued on loans and credited to income as earned. The
accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is fully reserved.
Interest income is subsequently recognized only to the extent cash payments are
received.
Management's determination of the adequacy of the allowance for loan losses is
based on an evaluation of the portfolio, past loan loss experience, current
economic conditions, volume, growth and composition of the loan portfolio, and
other relevant factors. The allowance is increased by provisions for loan losses
charged against earnings and decreased by charge-offs (net of recoveries).
Loan Servicing Rights
In June 1996, the FASB issued Statement 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." This
Statement supersedes certain provisions of Statement 65, "Accounting for Certain
Mortgage Banking Activities," and Statement 122, "Accounting for Mortgage
Servicing Rights." Statement 125 requires that servicing assets and other
retained interests in transferred assets be measured by allocating the previous
carrying amount between the assets sold and retained interests based on their
relative fair values at the date of the transfer. It also requires that
servicing assets be subsequently measured by (a) amortization in proportion to
and over the period of estimated net servicing income and (b) assessment for
asset impairment based on the fair value. The adoption of Statement 125 has had
no significant impact on the results of operations.
21
Notes to Consolidated Financial Statements
2. Statement of Accounting Policies (continued)
Real Estate, Mobile Homes and Other Assets Held for Sale
Assets held for sale are comprised of properties acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. These properties are
carried at the lower of cost or fair value at time of foreclosure or insubstance
foreclosure. Loan losses arising from the acquisition of such property are
charged against the allowance for loan losses.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and
amortization computed principally by the straight-line method over the following
estimated useful lives:
Buildings and improvements 20 to 50 years
Furniture, fixtures and equipment 5 to 15 years
Income Taxes
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
Accounting Pronouncements
The FASB issued Statement 130, "Reporting Comprehensive Income," in 1997. First
Defiance will adopt the provisions of Statement 130 in 1998. Statement 130
requires that comprehensive income, which includes net income and other
comprehensive income consisting of minimum pension liability adjustments and
unrealized gains and losses on certain security investments, be reported as a
total in the financial statements. Adoption of Statement 130 will have no effect
on First Defiance's consolidated results of operations, financial position or
cash flows.
3. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
1997 1996 1995
- ---------------------------------------------------------------------------------------------
Numerator for basic and diluted earnings
per share - net income $5,407,191 $4,151,042 $ 5,521,335
- ---------------------------------------------------------------------------------------------
Denominator:
Denominator for basic earnings per
share - weighted-average shares 8,360,149 9,610,153 10,286,992
Effect of dilutive securities:
Employee stock options 251,992 136,810 88,266
Unvested Management Recognition Plan stock 93,990 24,580 -
- ---------------------------------------------------------------------------------------------
Dilutive potential common shares 345,982 161,390 88,266
- ---------------------------------------------------------------------------------------------
Denominator for diluted earnings per share -
adjusted weighted-average shares and
assumed conversions 8,706,131 9,771,544 10,375,258
- ---------------------------------------------------------------------------------------------
Basic earnings per share $.65 $.43 $.54
- ---------------------------------------------------------------------------------------------
Diluted earnings per share $.62 $.42 $.53
- ---------------------------------------------------------------------------------------------
In accordance with Statement 128, unreleased shares held by the Employee Stock
Ownership Plan (ESOP) (504,451, 583,665 and 658,942 shares at December 31, 1997,
1996 and 1995, respectively) and unvested shares held for the 1996 Management
Recognition Plan (MRP) (214,145 and 259,076 shares at December 31, 1997 and
1996, respectively) have been excluded from basic average shares outstanding.
Such shares are included in basic average shares outstanding as they are
released for allocation (ESOP) or become vested (MRP). Unvested MRP shares and
stock options are included in diluted average shares outstanding based upon the
treasury stock method.
For additional disclosures regarding the employee stock options and the
management recognition plan stock, see notes 16 and 15, respectively.
22
While the number of outstanding shares has been restated for all periods to
reflect the 1995 Reorganization, earnings on the proceeds from the
Reorganization are reflected only in the fourth quarter of 1995 and thereafter.
Had the Reorganization occurred at January 1, 1995 and assuming the net proceeds
were used to repay advances and invested in medium-term investment securities,
pro-forma net income (unaudited) would have been $6,327,000 for the year ended
December 31, 1995. Pro-forma basic and diluted earnings per share (unaudited)
would have been $.62 and $.61, respectively.
4. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities:
December 31,1997 Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- -----------------------------------------------------------------------------------------------------------
Available-for-Sale Securities
- -----------------------------------------------------------------------------------------------------------
U. S. Treasury securities and obligations of U. S.
Government corporations and agencies $ 58,850,967 $151,534 $152,253 $ 58,850,248
Corporate bonds 10,094,368 19,387 292 10,113,463
Adjustable rate mortgage-backed
security mutual funds 8,981,303 144,763 8,836,540
REMIC 2,963,184 24,196 16,838 2,970,542
Collateralized mortgage obligations 1,075,667 38,787 1,114,454
Obligations of state and
political subdivisions 545,000 5,281 550,281
- -----------------------------------------------------------------------------------------------------------
Totals $ 82,510,489 $239,185 $314,146 $ 82,435,528
- -----------------------------------------------------------------------------------------------------------
Held-to-Maturity Securities
- -----------------------------------------------------------------------------------------------------------
FHLMC certificates $ 8,797,603 $197,421 $ 26,345 $ 8,968,679
FNMA certificates 8,310,283 95,405 119,096 8,286,592
GNMA certificates 2,607,298 96,665 865 2,703,098
Obligations of states and
political subdivisions 1,237,936 173,868 50 1,411,754
- -----------------------------------------------------------------------------------------------------------
Totals $ 20,953,120 $563,359 $ 146,356 $ 21,370,123
- -----------------------------------------------------------------------------------------------------------
December 31, 1996
Available-for-Sale Securities
- -----------------------------------------------------------------------------------------------------------
U. S. Treasury securities and obligations of U. S.
Government corporations and agencies $ 44,762,114 $ 13,681 $ 541,513 $ 44,234,282
Fixed income mutual funds 18,856,749 56,918 18,913,667
Adjustable rate mortgage-backed
security mutual funds 11,255,372 7,083 159,752 11,102,703
Money market mutual funds 750,000 750,000
REMIC 1,160,983 19,812 1,141,171
Collateralized mortgage obligations 1,097,593 34,507 1,132,100
Other 124,264 8,832 133,096
- -----------------------------------------------------------------------------------------------------------
Totals $ 78,007,075 $121,021 $ 721,077 $ 77,407,019
- -----------------------------------------------------------------------------------------------------------
Held-to-Maturity Securities
- -----------------------------------------------------------------------------------------------------------
FHLMC certificates $ 11,795,121 $261,891 $ 48,933 $12,008,079
FNMA certificates 9,628,002 104,518 177,919 9,554,601
GNMA certificates 3,089,882 90,538 2,922 3,177,498
Obligations of states and
political subdivisions 1,423,542 161,316 100 1,584,758
- -----------------------------------------------------------------------------------------------------------
Totals $ 25,936,547 $618,263 $ 229,874 $26,324,936
- -----------------------------------------------------------------------------------------------------------
23
Notes to Consolidated Financial Statements
4. Investment Securities (continued)
During the years ended December 31, 1997, 1996 and 1995, available-for-sale
securities with fair values of $22.2, $27.2 and $2.9 million, respectively, were
sold with realized gains (losses) of $103,130 $25,527 and ($75,158),
respectively. The amortized cost and fair value of securities at December 31,
1997 by contractual maturity are shown below. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties. Mutual funds
are not due at a single maturity date. For purposes of the maturity table,
mortgage-backed securities, which are not due at a single maturity date, have
been allocated over maturity groupings based on the weighted-average contractual
maturities of underlying collateral. The mortgage-backed securities may mature
earlier than their weighted-average contractual maturities because of principal
prepayments.
Available-for-Sale Held-to-Maturity
- -------------------------------------------------------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
- -------------------------------------------------------------------------------------------------
Due in one year or less $ 19,868,008 $ 19,801,028 $ 1,207,225 $ 1,208,476
Due after one year through five years 32,162,793 32,169,083 3,251,023 3,356,327
Due after five years through ten years 17,479,176 17,590,131 1,155,537 1,240,711
Due after ten years 4,019,209 4,038,746 15,339,335 15,564,609
- -------------------------------------------------------------------------------------------------
73,529,186 73,598,988 20,953,120 21,370,123
Adjustable rate mortgage-backed
security mutual funds 8,981,303 8,836,540 - -
- -------------------------------------------------------------------------------------------------
Totals $82,510,489 $82,435,528 $20,953,120 $21,370,123
- -------------------------------------------------------------------------------------------------
5. Loan Commitments and Delinquencies
Loan commitments are made to accommodate the financial needs of First Defiance's
customers. The associated credit risk is essentially the same as that involved
in extending loans to customers and are subject to First Defiance's normal
credit policies. Collateral such as mortgages on property and equipment,
receivables and inventory is obtained based on management's credit assessment of
the customer. At December 31, 1997, First Defiance's outstanding commitments to
fund long-term mortgage loans amounted to approximately $8,643,000 which were
comprised of approximately 74% fixed rate and 26% adjustable rate loans with
rates ranging from 6.375% to 11.5%. First Defiance's maximum exposure to credit
loss for loan commitments (unfunded loans, unused lines of credit and letters of
credit) was $37,204,200 at December 31, 1997.
Unpaid balances of mortgage and installment loans with contractual payments
delinquent 90 days or more totaled $1,365,000 at December 31, 1997 and $411,000
at December 31, 1996. First Federal does not anticipate any significant losses
in the collection of these delinquent loans in excess of the allowance for loan
losses.
Impairment of loans having recorded investments of $537,000 at December 31, 1997
and $1.6 million at December 31, 1996 has been recognized in conformity with FAS
Statement No. 114, as amended by FAS Statement No. 118. The average recorded
investment in impaired loans during 1997 and 1996 was $1.3 and $1.45 million,
respectively. The total allowance for loan losses related to these loans was
$327,000 and $804,000 at December 31, 1997 and 1996, respectively.
Loans having carrying values of $1.8 million and $1.4 million were transferred
to real estate, mobile homes and other assets held for sale in 1997 and 1996,
respectively.
First Defiance is not committed to lend additional funds to debtors whose loans
have been modified.
24
6. Loans Receivable
December 31
1997 1996
- --------------------------------------------------------------------------------------------
Loans receivable consist of the following at December 31:
Mortgage loans:
Secured by one-to-four-family residences $255,339,585 $241,227,635
Secured by other properties 26,526,267 28,438,585
Construction loans 10,148,331 11,412,465
Other mortgage loans 2,995,888 2,084,060
- --------------------------------------------------------------------------------------------
295,010,071 283,162,745
Other loans:
Automobile 69,130,753 62,089,625
Mobile home 25,423,509 25,198,701
Commercial 29,758,228 26,674,342
Home equity and improvement 16,940,115 13,570,255
Other 11,980,094 11,929,499
- --------------------------------------------------------------------------------------------
153,232,699 139,462,422
- --------------------------------------------------------------------------------------------
Total mortgage and other loans 448,242,770 422,625,167
Deduct:
Undisbursed loan funds 3,087,228 4,473,780
Net deferred loan origination fees and costs 645,265 568,166
Allowance for loan losses 2,686,472 2,217,022
- --------------------------------------------------------------------------------------------
Totals $441,823,805 $415,366,199
- --------------------------------------------------------------------------------------------
Changes in the allowance for mortgage and other loan losses were as follows:
Years ended December 31
1997 1996 1995
- ------------------------------------------------------------------------------------------------
Balance at beginning of year $ 2,217,022 $1,816,944 $1,733,411
Charge-offs (1,341,359) (775,399) (344,563)
Recoveries 197,499 155,664 51,355
- ------------------------------------------------------------------------------------------------
Net charge-offs (1,143,860) (619,735) (293,208)
Provision charged to income 1,613,310 1,019,813 376,741
- ------------------------------------------------------------------------------------------------
Balance at end of year $ 2,686,472 $2,217,022 $1,816,944
- ------------------------------------------------------------------------------------------------
Interest income on mortgage and other loans for the years ended December 31, is
as follows:
1997 1996 1995
- ------------------------------------------------------------------------------------------------
Mortgage loans $23,259,455 $22,272,502 $21,039,898
Other loans 14,042,623 12,362,609 10,963,085
- ------------------------------------------------------------------------------------------------
Totals $37,302,078 $34,635,111 $32,002,983
- ------------------------------------------------------------------------------------------------
7. Mortgage Banking
Mortgage loans serviced for others are not included in the accompanying
consolidated statements of financial condition. The unpaid principal balances of
mortgage loans serviced for others was approximately $17.8 million and $11.3
million at December 31, 1997 and 1996, respectively. Custodial escrow balances
maintained in connection with the foregoing loan servicing, and included in
demand deposits, were approximately $76,000 and $46,000 at December 31, 1997 and
1996, respectively.
In accordance with Statement No. 125, mortgage servicing rights of $98,651 and
$123,201 were capitalized during the years ended December 31, 1997 and 1996. The
book value of mortgage servicing rights was approximately $188,000 and $121,000
at December 31, 1997 and 1996. Amortization of mortgage servicing rights was
$17,347 and $1,456 in the years ended December 31, 1997 and 1996, respectively.
As of December 31, 1997, a valuation allowance of approximately $14,700 was
recorded to reflect changes in the market value of mortgage servicing rights
recorded.
25
Notes to Consolidated Financial Statements
7. Mortgage Banking (continued)
The components of mortgage banking income (included in other non-interest
income) are as follows:
Years ended December 31
1997 1996 1995
- ---------------------------------------------------------------------------------------------
Gain on sale of loans $116,223 $209,458 $1,658
Loan servicing fee income, net of amortization 67,254 11,406 -
- ---------------------------------------------------------------------------------------------
$183,477 $220,864 $1,658
- ---------------------------------------------------------------------------------------------
8. Premises and Equipment
Premises and equipment are summarized as follows:
December 31
1997 1996
- -------------------------------------------------------------------------------
Cost:
Land $ 1,890,427 $ 1,850,427
Buildings 11,436,832 3,604,775
Leasehold improvements 235,714 235,714
Furniture, fixtures and equipment 5,579,868 1,833,311
Construction in process 1,174,195 7,616,060
- -------------------------------------------------------------------------------
20,317,036 15,140,287
Less allowances for depreciation and amortization 3,518,132 2,885,627
- -------------------------------------------------------------------------------
$16,798,904 $12,254,660
- -------------------------------------------------------------------------------
Interest capitalized on construction projects amounted to approximately $83,515
and $214,587 for the years ended December 31, 1997 and 1996, respectively.
9. Deposits
The following schedule sets forth interest expense for the years ended December
31 by type of savings deposit:
1997 1996 1995
- ------------------------------------------------------------------------------------------------
Demand, N.O.W. and money market accounts $ 1,400,170 $ 1,119,239 $ 1,226,354
Savings accounts 1,624,915 2,036,287 2,138,660
Certificates 15,050,789 15,638,298 15,512,741
- ------------------------------------------------------------------------------------------------
18,075,874 18,793,824 18,877,755
Less interest capitalized (83,515) (214,587) (20,536)
- ------------------------------------------------------------------------------------------------
Totals $17,992,359 $18,579,237 $18,857,219
- ------------------------------------------------------------------------------------------------
A summary of deposit balances is as follows:
December 31
1997 1996
- --------------------------------------------------------------------------------
Savings accounts $ 59,403,817 $ 68,865,453
Demand and N.O.W. accounts 32,414,463 32,184,313
Money Market demand accounts 24,926,328 15,875,015
Certificates of deposit 278,577,476 265,600,585
- --------------------------------------------------------------------------------
Totals $395,322,084 $382,525,366
- --------------------------------------------------------------------------------
At December 31, 1997, scheduled maturities of certificates of deposit are as
follows (in thousands):
1998 $188,168
1999 79,645
2000 7,686
2001 1,309
2002 456
2003 and thereafter 1,314
- --------------------------------------------------------------------------------
Total $278,578
- --------------------------------------------------------------------------------
26
At December 31, 1997 and 1996 deposits of $33.0 and $24.6 million, respectively,
were in excess of the $100,000 Federal Deposit Insurance Corporation limit. At
December 31, 1997, $1 million in U. S. Government Agency securities were pledged
as collateral against public deposits for certificates in excess of $100,000.
On September 30, 1996, the Deposit Insurance Funds Act of 1996 (the Act) was
enacted. The Act provided for a special assessment to be calculated for
depository institutions on deposit, accrued interest and escrow data from the
base date of March 31, 1995. The assessment of $2,460,977 was assessed at
September 30, 1996 and was subsequently paid when due to the Federal Deposit
Insurance Corporation in November 1996.
10. Advances from Federal Home Loan Bank
First Federal has the ability to borrow funds from the FHLB. First Federal
pledges its single-family residential mortgage loan portfolio as security for
these advances. At December 31, 1997, the total available for collateral
amounted to approximately $254.0 million. Collateral must exceed borrowings by
150%. The total level of borrowing is also limited to 25% of total assets. This
would give First Federal a maximum potential to acquire advances of
approximately $144.9 million from the FHLB.
The FHLB made a series of fixed rate long-term advances to First Defiance during
1992 and a long-term fixed rate advance under the FHLB Affordable Housing
Program in 1995. The total FHLB long-term advances bear a weighted average
interest rate of 6.57% at December 31, 1997. Future minimum payments by fiscal
year are as follows:
1998 $ 961,838
1999 961,838
2000 961,838
2001 961,838
2002 299,777
Thereafter 1,676,098
- --------------------------------------------------------------------------------
Total minimum payments 5,823,227
Less amounts representing interest 1,293,558
- --------------------------------------------------------------------------------
Totals $4,529,669
- --------------------------------------------------------------------------------
First Defiance also utilizes short-term advances from the FHLB to meet cash flow
needs and for short-term investment purposes. There were $67.2 million in
short-term advances outstanding at December 31, 1997 ($35.2 at December 31,
1996). First Defiance borrows funds under a variety of programs at FHLB. At
December 31, 1997, $30 million was outstanding under First Defiance's REPO
Advance line of credit. The total available under the REPO line is $30 million.
Amounts are generally borrowed under the REPO line on an overnight basis. An
additional $13.8 million was borrowed under the FHLB's Cash Management Advance
("CMA") program at a variable rate. Amounts borrowed under the CMA program
mature within 90 days. The $23.4 million of other advances are borrowed under
the FHLB's short-term fixed or LIBOR based programs. Information concerning
short-term advances is summarized as follows:
1997 1996
- --------------------------------------------------------------------------------
Average balance during the year $53,039,497 $ 8,309,801
Maximum month-end balance during the year 70,135,000 35,220,000
Average interest rate during the year 5.77% 5.59%
11. Postretirement Benefits
The Company sponsors a defined benefit postretirement plan that is intended to
supplement Medicare coverage for certain retirees who meet minimum years of
service requirements. Persons who retired prior to April 1, 1997 who completed
20 years of service after age 40 receive full medical coverage at no cost. Such
coverage continues for surviving spouses of those participants for one year,
after which coverage may be continued provided the spouse pays 50% of the
average cost. Persons retiring after April 1, 1997 will be provided medical
benefits at a cost based on their combined age and years of service at
retirement. An employee whose combined age and years of service at retirement is
at least 90 years is eligible to receive coverage that is 80% paid by the
Company. The percentage paid by the Company decreases as the combined sum of age
and years of service declines, to a
27
Notes to Consolidated Financial Statements
11. Postretirement Benefits (continued)
maximum of 35% for age and years of service totalling 75 years. No coverage is
provided to retirees whose age and service combined totals less than 75 years.
Surviving spouses are also eligible for continued coverage after the retiree is
deceased at a subsidy level that is 10% less than what the retiree is eligible
for. Persons retiring before July 1, 1997 received dental and vision care in
addition to medical coverage. Persons who retire after July 1, 1997 are not
eligible for dental or vision care, but those retirees and their spouses each
receive up to $200 in a medical spending account. Funds in that account may be
used for payment of uninsured medical expenses. All retiree medical plans are
intended to be secondary to Medicare to the extent permitted by law. Premiums
charged to retirees who are not Medicare eligible are based on the Company's
COBRA rate.
The plan is not currently funded. The following table sets forth the amount
recorded in the Company's consolidated statements of financial condition at
December 31:
1997 1996
- --------------------------------------------------------------------------------
Accumulated postretirement benefit obligation:
Retirees $329,517 $270,191
Active employees fully eligible for benefits 30,198 274,329
Other active plan participants 427,108 190,264
- --------------------------------------------------------------------------------
786,823 734,784
Unrecognized prior service cost (58,657) -
Unrecognized net gain (loss) 20,003 (44,155)
- --------------------------------------------------------------------------------
Accrued postretirement benefit obligation
included in accrued interest and other expenses
in consolidated statement of financial condition $748,169 $690,629
- --------------------------------------------------------------------------------
Net periodic postretirement benefit cost includes the following components:
Years ended December 31
1997 1996 1995
- ---------------------------------------------------------------------------------------------
Service cost-benefits attributable to
service during the period $39,905 $43,902 $21,980
Interest cost on accumulated postretirement
benefit obligation 51,443 47,200 35,283
Net amortization and deferral 3,910 - (8,807)
- ---------------------------------------------------------------------------------------------
Net periodic postretirement benefit cost $95,258 $91,102 $48,456
- ---------------------------------------------------------------------------------------------
For measurement purposes, an 8.5% annual rate of increase in the per capita cost
of covered health care benefits was assumed for 1997 and 1996; the rate was
assumed to decrease gradually to 5.5% for the year 2001 and remain at that level
thereafter. The health care cost trend rate assumption has a significant effect
on the amounts reported. To illustrate, increasing the assumed health care cost
trend rate by 1 percentage point for each year would increase the accumulated
postretirement benefit obligation as of December 31, 1997 by $144,900 and the
aggregate of the service and interest cost for the year then ended by $20,000.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.25% for 1997, 1996 and 1995.
12. Pension Plan
The Company has a defined benefit pension plan covering substantially all of its
employees. The benefits are based on years of service and the employee's
compensation during the last five years of employment. The Company's policy is
to fund pension costs as accrued and to amortize past service costs over
approximately twenty years.
28
During 1997, the Company amended the plan to eliminate all benefits for future
service in connection with a termination of the plan and distribution of plan
assets which will occur in 1998. Such actions have decreased the actuarially
determined present value of projected plan benefits in 1997 by approximately
$2.5 million and all accumulated plan benefits have become fully vested. The
effect in 1998 of the final settlement of plan obligations is not anticipated to
be material.
Net periodic pension cost includes the following components:
Years ended December 31
1997 1996 1995
- -----------------------------------------------------------------------------------------------
Service cost-benefits earned during the period $354,032 $311,459 $225,175
Interest cost on projected benefit obligation 290,956 244,186 234,485
Actual (return) loss on plan assets (6,460) 66,041 (142,619)
Net amortization and deferral 10,205 (53,727) 124,958
- -----------------------------------------------------------------------------------------------
Net periodic pension cost $648,733 $567,959 $441,999
- -----------------------------------------------------------------------------------------------
Weighted average discount rate 6% 5.75% 7%
Rate of increase in future compensation levels - 4% 4%
Expected long-term rate of return on plan assets 5% 5.5% 5.5%
The following table sets forth the plan's funded status and amounts recognized
in the Company's consolidated statements of financial condition.
December 31
1997 1996
- --------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested
benefits of $1,835,624 and $2,733,744 $1,835,624 $3,026,043
- --------------------------------------------------------------------------------
Projected benefit obligation for
service rendered to date $1,835,624 $4,849,273
Plan assets (insurance contracts and money
market certificates) at fair value (1,450,904) (2,284,964)
- --------------------------------------------------------------------------------
Projected benefit obligation in excess of
plan assets 384,720 2,564,309
Unrecognized net loss from experience different
than that assumed and effects of changes
in assumptions (775,933) (2,350,987)
Unrecognized net obligation at transition (108,020) (125,662)
Adjustment required to recognize
minimum liability 883,953 653,419
- --------------------------------------------------------------------------------
Accrued pension liability recorded in accrued
interest and other expenses in statement
of financial condition $ 384,720 $ 741,079
- --------------------------------------------------------------------------------
13. Regulatory Matters
First Defiance is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on First Defiance's financial statements. Under capital
guidelines and the regulatory framework for prompt corrective action, First
Federal must meet specific capital guidelines that involve quantitative measures
of First Federal's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. First Federal's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require First Federal to maintain minimum amounts and ratios of Tier I and total
capital to risk-weighted assets and of Tier I capital to average assets. As of
December 31, 1997 and 1996, First Federal meets all capital adequacy
requirements to which it is subject.
The most recent notification from the Office of Thrift Supervision categorized
First Federal as well capitalized under the regulatory framework. To be
categorized as well capitalized, First Federal must maintain minimum Tangible,
Core and Risk-Based Capital ratios as set forth in the table below. There are no
conditions or events since that notification that management believes have
changed First Federal's ranking.
29
Notes to Consolidated Financial Statements
13. Regulatory Matters (continued)
The following schedule presents First Federal's regulatory capital ratios as of
December 31, 1997 and 1996 (dollars in thousands):
Regulatory Capital Standards
- -------------------------------------------------------------------------------------------
Actual Required
Amount Ratio Amount Ratio
- -------------------------------------------------------------------------------------------
As of December 31, 1997:
Tangible Capital $80,284 13.65% $ 8,821 1.5%
Core Capital 80,284 13.65 17,642 3.0
Risk-Based Capital 82,473 21.55 30,613 8.0
As of December 31, 1996:
Tangible Capital $74,942 13.97% $ 8,049 1.5%
Core Capital 74,942 13.97 16,098 3.0
Risk-Based Capital 76,617 22.43 27,332 8.0
14. Income Taxes
The components of income tax expense are as follows:
Years ended December 31
1997 1996 1995
- -------------------------------------------------------------------------------------------------
Current:
Federal $2,812,000 $2,200,000 $2,680,000
State 216,000 - -
Deferred (credit) (43,000) (203,000) 176,000
- -------------------------------------------------------------------------------------------------
$2,985,000 $1,997,000 $2,856,000
- -------------------------------------------------------------------------------------------------
The provision for income taxes differs from that computed at the statutory
corporate tax rate as follows:
Years ended December 31
1997 1996 1995
- -------------------------------------------------------------------------------------------------
Tax expense at statutory rate $2,853,000 $2,090,000 $2,848,000
Increases (decreases) in taxes from:
State income tax - net of federal tax benefit 143,000 - -
Tax exempt interest income (36,000) (39,000) (41,000)
Other 25,000 (54,000) 49,000
- -------------------------------------------------------------------------------------------------
Totals $2,985,000 $1,997,000 $2,856,000
- -------------------------------------------------------------------------------------------------
Deferred federal income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of First Defiance's deferred federal income tax assets and
liabilities as of December 31, 1997 and 1996 are as follows:
December 31
1997 1996
- --------------------------------------------------------------------------------
Deferred federal income tax assets:
Net unrealized losses on
available-for-sale securities $ 25,000 $ 203,000
Allowance for loan losses 321,000 218,000
Pension costs 131,000 16,000
Postretirement benefit costs 261,000 233,000
Deferred compensation and
management recognition plans 493,000 403,000
State income tax 73,000 -
Other 80,000 89,000
- --------------------------------------------------------------------------------
Total deferred federal income tax assets 1,384,000 1,162,000
Deferred federal income tax liabilities:
FHLB stock dividends 614,000 532,000
Deferred loan origination fees and costs (net) 222,000 80,000
Other 133,000 -
- --------------------------------------------------------------------------------
Total deferred federal income tax liabilities 969,000 612,000
- --------------------------------------------------------------------------------
Net deferred federal income tax assets $ 415,000 $ 550,000
- --------------------------------------------------------------------------------
30
No valuation allowance was required at December 31, 1997 or 1996.
Retained earnings at December 31, 1996 include financial statement tax bad debt
reserves of $10.6 million. The Small Business Job Protection Act of 1996 passed
on August 20, 1996 eliminated the special bad debt deduction previously granted
solely to thrifts. This results in the recapture of past taxes for permanent
deductions arising from the "applicable excess reserve," which is the total
amount of First Federal's reserve over its base year reserve as of December 31,
1987. The recapture tax was to be paid in six equal annual installments
beginning after December 31, 1996. However, deferral of those payments was
permitted for up to two years, contingent upon satisfying a specified mortgage
origination test for 1996 and 1997 (which was met). At December 31, 1997, First
Federal had $1.037 million in excess of the base year reserves. Deferred taxes
have been provided related to this item. No provision is required to be made for
the $9.52 million of base year reserves.
15. Employee Stock Ownership and Management Recognition Plans
The Company has established an Employee Stock Ownership Plan ("ESOP") covering
all employees age 21 or older who have at least one year of credited service.
The ESOP will be funded by First Defiance's contributions made in cash or common
stock. Benefits may be paid either in shares of common stock or in cash. The
Company accounts for its ESOP in accordance with Statement of Position 93-6
"Employers' Accounting for Employee Stock Ownership Plans" of the Accounting
Standards Division of the American Institute of Certified Public Accountants.
In conjunction with First Federal's initial offering of common stock in 1993,
the ESOP borrowed $1,600,000 from an unaffiliated lender to purchase 160,000
shares of First Federal common stock (exchanged for 345,443 shares of First
Defiance stock in 1995). The remaining loan was paid in connection with the
Reorganization. Also in conjunction with the Reorganization, the ESOP acquired
an additional 518,153 shares of common stock of the Company.
First Defiance makes contributions to the ESOP in amounts sufficient to pay
obligations maturing under the loan made to the ESOP. As principal and interest
on the loan is paid, shares are released from collateral and committed for
allocation to active employees, based on the proportion of debt service paid in
the year. Shares held by the ESOP which have not been released for allocation
are reported as stock acquired by the ESOP plan in the statement of financial
condition. As shares are released, First Defiance reports compensation expense
equal to the average fair value of the shares over the period in which the
shares were earned. Also, the shares released for allocation are included in
average shares outstanding for earnings per share computations. Dividends on
allocated shares are recorded as a reduction of retained earnings and dividends
on unallocated shares are recorded as additional ESOP expense. ESOP compensation
expense was $1,025,000, $735,000 and $582,000 for 1997, 1996 and 1995,
respectively. As of December 31, 1997, 353,062 ESOP shares have been released
for allocation of which 338,668 were allocated to participants. The 510,534
unreleased shares have a fair value of $8.2 million at December 31, 1997.
The Shareholders of First Defiance approved and established Management
Recognition Plans ("MRP") in 1993 and 1996 to provide directors, officers and
employees with a proprietary interest in First Defiance as incentive to
contribute to its success. Cash was contributed to the MRP in the form of
prepaid compensation amounting to $800,000 in 1993 and $2,817,452 in 1996. The
$800,000 contributed in 1993 was used to purchase 80,000 shares of First Federal
common stock (exchanged for 172,722 shares of First Defiance common stock in
1995). The $2,817,452 contributed in 1996 was used to purchase 259,076 shares of
First Defiance common stock. At the discretion of a committee appointed by the
Board of Directors, all 172,722 shares acquired in 1993 were granted on July 19,
1993. Also at the committee's discretion, 228,551 of the shares acquired in 1996
have been granted as of December 31, 1997, not including 27,773 shares forfeited
by participants who terminated before their shares vested. The shares vest at a
rate of 20% per year over 5 years. First Defiance is amortizing the prepaid
compensation and recording additions to stockholder's equity as the shares vest.
Compensation expense attributable to the MRP amounted to $785,053, $741,722 and
$164,838 in 1997, 1996 and 1995, respectively.
16. Stock Option Plans
First Defiance has established incentive stock option plans for its directors
and its employees and has reserved 1,033,485 shares of common stock for issuance
under the plans. A total of 731,235 shares are reserved for employees and
302,250 shares are reserved for directors. As of December 31, 1997, 870,140
options (621,128 for employees and 249,012 for directors) have been granted and
remain outstanding at option prices based on the market value of the underlying
shares on the date the
31
Notes to Consolidated Financial Statements
16. Stock Option Plans (continued)
options were granted. The 385,994 options granted under the 1993 plan are
currently exercisable while the 484,146 options granted under the 1996 plan vest
at 20% per year beginning in 1997.
All options expire ten years from date of grant.
Statement 123, "Accounting for Stock-Based Compensation" defines a fair
value-based method of accounting for stock-based employee compensation plans.
Under the fair value-based method, compensation costs is measured at the grant
date based upon the value of the award and is recognized over the service
period. While the standard encourages entities to adopt this method of
accounting for employee stock compensation plans, it also allows an entity to
continue to measure compensation costs for its plans as prescribed in APB
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." First
Defiance has elected to continue to apply APB 25.
The following pro forma information regarding net income and earnings per share
assumes the adoption of Statement No. 123 for stock options. The estimated fair
value of the option is 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 for 1997 and 1996:
1997 1996
- --------------------------------------------------------------------------------
Risk free interest rate 6.23% 6.62%
Dividend yield 2.68% 2.66%
Volatility factors of expected market price of stock 0.319% 0.341%
Weighted average expected life 7.5 years 7.35 years
Based upon the above assumptions, pro forma net income and earnings per share
for the years ended December 31, 1997 and 1996 are as follows:
1997 1996
- --------------------------------------------------------------------------------
Pro forma net income $5,015,000 $3,783,000
- --------------------------------------------------------------------------------
Pro forma earnings per share:
Basic $.60 $.39
- --------------------------------------------------------------------------------
Diluted $.58 $.39
- --------------------------------------------------------------------------------
No options were granted in 1995, thus pro forma disclosures are not required.
The pro forma effects for 1997 and 1996 are not likely to be representative of
the pro forma effects for future years.
Because Statement No. 123 is applicable only to options granted subsequent to
December 31, 1994, options granted prior to December 31, 1994 do not have fair
value pro forma information provided.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
First Defiance's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
32
The following table summarizes stock option activity for 1997 and 1996:
1997 1996
- -------------------------------------------------------------------------------------------------
Range of Range of
Option Option Option Option
Shares Prices Shares Prices
- -------------------------------------------------------------------------------------------------
Outstanding at January 1 894,339 $4.63 to $10.6875 325,456 $4.63 to $6.95
Granted 75,961 $12.625 to $13.00 582,836 $10.375 to $10.6875
Exercised (23,325) $4.63 to $10.6875 (12,953) 4.63
Expired or cancelled (76,835) 10.50 (1,000) 10.50
- -------------------------------------------------------------------------------------------------
Outstanding at December 31 870,140 $4.63 to $13.00 894,339 $4.63 to $10.6875
- -------------------------------------------------------------------------------------------------
Exercisable to:
2004 289,978 $4.63 to $6.95 312,503 $4.63 to $6.95
2006 504,201 $10.375 to $10.6875 581,836 $10.375 to $10.6875
2007 75,961 $12.625 to $13.00 - -
- -------------------------------------------------------------------------------------------------
870,140 $4.63 to $13.00 894,339 $4.63 to $10.6875
- -------------------------------------------------------------------------------------------------
Available for future grant at
December 3l 163,345 162,471
- -------------------------------------------------------------------------------------------------
17. Condensed Financial Statements of First Defiance Financial Corp.
(Parent Only)
First Defiance Financial Corp. was organized in June 1995 and began operations
on September 29, 1995. The Company's balance sheet as of December 31, 1997 and
1996 and related statements of income and cash flows for the years ended
December 31, 1997 and 1996 and from inception to December 31, 1995 are as
follows:
December 31
Balance Sheets 1997 1996
- --------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 670,950 $ 344,476
Investment securities available-for-sale - 6,927,616
Investment in First Federal Savings and Loan 80,321,687 74,558,462
Subordinated debt receivable from
First Federal Savings and Loan 30,000,000 30,000,000
Loan receivable from First Federal
Employee Stock Ownership Plan 4,972,143 5,438,254
Other assets 205,591 36,442
- --------------------------------------------------------------------------------
Total assets $ 116,170,371 $ 117,305,250
- --------------------------------------------------------------------------------
Liabilities and Stockholders' Equity
Accrued liabilities $ 9,285,540 $ 740,588
Stockholders' equity 106,884,831 116,564,662
- --------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 116,170,371 $ 117,305,250
- --------------------------------------------------------------------------------
Sept. 29, 1995
Year ended December 31 to December 31,
Statements of Income 1997 1996 1995
- -----------------------------------------------------------------------------------------------
Interest income $ 191,036 $ 955,190 $ 96,675
Interest on subordinated debt 2,475,000 - -
Interest on loan to ESOP 454,450 499,044 131,654
Gain on sale of investments 58,600 25,527 -
Non-interest expense (289,451) (582,384) (72,814)
- -----------------------------------------------------------------------------------------------
Income before income taxes and
equity in earnings of subsidiary 2,889,635 897,377 155,515
Income tax expense 1,124,000 363,000 20,000
- -----------------------------------------------------------------------------------------------
Income before equity in earnings of subsidiary 1,765,635 534,377 135,515
Equity in earnings of First
Federal Savings and Loan 3,641,556 3,616,665 1,732,273
- -----------------------------------------------------------------------------------------------
Net income $ 5,407,191 $ 4,151,042 $ 1,867,788
- -----------------------------------------------------------------------------------------------
33
Notes to Consolidated Financial Statements
17. Condensed Financial Statement of First Defiance Financial Corp.
(Parent Only) (continued)
Sept. 29, 1995
Year ended December 31 to December 31,
1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Statements of Cash Flows
Operating Activities
Net income $ 5,407,191 $ 4,151,042 $ 1,867,788
Adjustments to reconcile net income to
net cash provided by operating activities:
Gain on sale of securities (58,600) (25,527) -
Tax benefit of stock option plan
included in equity 48,000 - -
Deferred federal income taxes (credit) 10,000 (37,000) -
Equity in earnings of First Federal Savings and Loan (3,641,556) (3,616,665) (1,732,273)
Dividends received from subsidiary - 30,000,000 25,560,806
Change in other assets and liabilities 8,324,388 74,028 (59,315)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 10,089,423 30,545,878 25,637,006
Investing activities
Loan to subsidiary - (30,000,000) -
Proceeds from sale of available-for-sale securities 7,051,480 27,247,132 -
Investment in subsidiary - - (57,103,142)
Loan to ESOP - - (5,981,530)
Principal payments received on ESOP loan 466,111 458,954 84,322
Purchase of available-for-sale securities (112,063) (8,602,422) (25,500,000)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 7,405,528 (10,896,336) (88,500,350)
Financing activities
Proceeds from sale of common stock - - 63,084,672
Stock options exercised 160,803 59,972 -
Purchase of common stock for treasury (14,546,636) (16,815,187) -
Cash dividends paid (2,782,644) (2,771,179) -
- ---------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (17,168,477) (19,526,394) 63,084,672
- ---------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 326,474 123,148 221,328
Cash equivalents at beginning of year 344,476 221,328 -
- ---------------------------------------------------------------------------------------------------------------------------
Cash equivalents at end of year $ 670,950 $ 344,476 $ 221,328
- ---------------------------------------------------------------------------------------------------------------------------
Noncash financing activities
Cash dividends declared but not paid $ 720,248 $ 757,675 $ 720,928
- ---------------------------------------------------------------------------------------------------------------------------
18. Fair Value Statement of Consolidated Financial Condition
The following is a comparative condensed consolidated statement of financial
condition based on carrying and estimated fair values of financial instruments
as of December 31, 1997 and 1996 (dollars in thousands). In cases where quoted
market prices are not available, fair values are based on estimates using
present value or other valuation techniques. Those techniques are significantly
affected by the assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases, could not
be realized in immediate settlement of the instrument. Statement of Financial
Accounting Standards No. 107, "Disclosures about Fair Value of Financial
Instruments" excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of First Defiance
Financial Corp.
December 31, 1997 December 31, 1996
- ---------------------------------------------------------------------------------------------
Carrying Estimated Carrying Estimated
Value Fair Values Value Fair Values
- ---------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 8,997 $ 8,997 $ 4,752 $ 4,752
Investment securities 103,389 103,806 103,344 103,732
Loans, net 441,911 443,232 415,925 417,977
- ---------------------------------------------------------------------------------------------
554,297 $ 556,035 524,021 $526,461
Other assets 25,401 19,390
Total assets $579,698 $ 543,411
Liabilities and
stockholders' equity
Deposits $395,322 $ 395,451 $ 382,525 $383,273
Advances from Federal
Home Loan Bank 71,665 71,665 40,821 41,000
- ---------------------------------------------------------------------------------------------
466,987 $467,116 423,346 424,273
Other liabilities 5,826 3,500
472,813 426,846
Stockholders' equity 106,885 116,565
Total liabilities and
stockholders' equity $579,698 $543,411
19. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly consolidated results of operations
for 1997 and 1996 (amounts in thousands, except per share data):
Three months ended
1997 March 31 June 30 September 30 December 31
- -----------------------------------------------------------------------------------------------
Interest income $10,601 $10,754 $11,296 $11,207
Interest expense 4,966 5,184 5,589 5,648
- -----------------------------------------------------------------------------------------------
Net interest income 5,635 5,570 5,707 5,559
Provision for loan losses 365 282 514 452
- -----------------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 5,270 5,288 5,193 5,107
Gain on sale of securities 7 6 63 27
Non-interest income 329 351 383 461
Non-interest expense 3,254 3,378 3,487 3,974
- -----------------------------------------------------------------------------------------------
Income before income taxes 2,352 2,267 2,152 1,621
Income taxes 795 746 769 675
- -----------------------------------------------------------------------------------------------
Net income $ 1,557 $ 1,521 $ 1,383 $ 946
- -----------------------------------------------------------------------------------------------
Earnings per share:
Basic $ 0.18 $ 0.18 $ 0.17 $ 0.12
- -----------------------------------------------------------------------------------------------
Diluted $ 0.17 $ 0.17 $ 0.16 $ 0.11
- -----------------------------------------------------------------------------------------------
Average shares outstanding:
Basic 8,597 8,622 8,357 7,946
- -----------------------------------------------------------------------------------------------
Diluted 8,911 8,937 8,724 8,334
- -----------------------------------------------------------------------------------------------
35
Notes to Consolidated Financial Statements
19. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three months ended
1996 March 31 June 30 September 30 December 31
- -----------------------------------------------------------------------------------------------
Interest income $10,237 $10,254 $10,263 $10,503
Interest expense 4,895 4,778 4,782 5,004
- -----------------------------------------------------------------------------------------------
Net interest income 5,342 5,476 5,481 5,499
Provision for loan losses 163 181 264 412
- -----------------------------------------------------------------------------------------------
Net interest income after provision
for loan losses 5,179 5,295 5,217 5,087
Gain on sale of securities - - - 26
Non-interest income 308 284 366 343
Non-interest expense 3,201 3,113 5,963 3,680
- -----------------------------------------------------------------------------------------------
Income (loss) before income taxes 2,286 2,466 (380) 1,776
Income taxes 751 791 (145) 600
- -----------------------------------------------------------------------------------------------
Net income $ 1,535 $ 1,675 $ (235) $ 1,176
- -----------------------------------------------------------------------------------------------
Earnings per share:
Basic $ 0.15 $ 0.17 $ (0.03) $ 0.13
- -----------------------------------------------------------------------------------------------
Diluted $ 0.15 $ 0.17 $ (0.02) $ 0.13
- -----------------------------------------------------------------------------------------------
Average shares outstanding:
Basic 10,323 9,875 9,392 8,875
- -----------------------------------------------------------------------------------------------
Diluted 10,447 10,003 9,544 9,117
- -----------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Stock Information
- --------------------------------------------------------------------------------
First Defiance's Common Stock is traded on the National Association of
Securities Dealers Automated Quotation ("NASDAQ") National Market System under
the symbol "FDEF". The range of high and low sales prices and closing stock date
for First Defiance's Common Stock, along with information on declared cash
dividends is as follows:
1997 1996
- ----------------------------------------------------------------------------------------------
High Low High Low
- ----------------------------------------------------------------------------------------------
Quarter Ended
March 31 $14.625 $11.75 $10.8125 $10.125
June 30 14.75 12.375 11.00 10.375
September 30 16.00 14.25 11.00 9.875
December 31 16.25 14.75 12.50 10.625
Dividend Declared per
Share of Common Stock 1997 1996
- ----------------------------------------------------------------------------------------------
March $0.08 $0.07
June 0.08 0.07
September 0.08 0.07
December 0.09 0.08
- ----------------------------------------------------------------------------------------------
As of March 6, 1998 there were approximately 1,915 registered holders of Common
Stock.
Dividends are subject to determination and declaration by the Board of
Directors, which will take into account First Defiance's financial condition,
results of operations, tax considerations, industry standards, economic
conditions, and regulatory restrictions which affect the payment of dividends
and other factors. The Board of Directors of First Defiance has adopted, subject
to the considerations described above, a cash dividend policy at a rate of 36
cents per share, per annum, payable quarterly.
In addition to certain federal income tax considerations, regulations of the OTS
impose limitations on the payment of dividends and other capital distributions
by savings associations. Under such regulations, a savings association that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its fully phased-in capital
requirement is generally permitted without OTS approval (but subsequent to 30
day notice to the OTS of the planned dividend) to make capital distributions
during a calendar year in the amount of up to 100% of its net earnings to date
during the year plus an amount equal to one-half of the amount by which its
total capital to assets ratio exceeded its fully phased-in capital to assets
ratio at the beginning of the year.
36
Board of Directors of First Defiance Financial Corp. and First Federal Savings
and Loan
Don C. Van Brackel
Chairman, President and Chief
Executive Officer
First Defiance Financial Corp. 1,2
Edwin S. Charles
Vice Chairman, Retired CEO of
First Federal Savings and
Loan 2,3,4
James M. Zachrich
Retired Manufacturer 5,6,7
Dr. John U. Fauster, III
Dentist 5,6,7
Dr. Marvin J. Ludwig
President Emeritus of
The Defiance College 3,6,7
Stephen L. Boomer
President, Co-owner of
Arps Dairy, Defiance OH 3,4,6
Dr. Douglas A. Burgei
Veterinarian 2,4,5
Thomas A. Voigt
Vice President, General Manager, Bryan Publishing Company,
Bryan, OH 3,5,7
Gerald W. Monnin
President, CEO Northwest
Controls, Defiance, OH 3,4,5
1 Permanent member of
Executive committee. Other
board members serve on
Executive committee on a
rotating basis
2 Investment Committee
3 MRP-Stock Option Committee
4 Governance Committee
5 Long Range Planning
Committee
6 Audit Committee
7 Compensation Committee
Officers of First Defiance Financial Corp.
Don C. Van Brackel
Chairman, President and Chief Executive Officer
William J. Small
Senior Vice President and President First Federal Savings and Loan
John C. Wahl
Senior Vice President, Chief Financial Officer and Corporate Treasurer
John W. Boesling
Senior Vice President and
Corporate Secretary
Patricia A. Cooper
Senior Vice President
Jeffrey D. Vereecke
Senior Vice President
Dennis E. Rose, Jr.
Controller
Officers of First Federal
Savings and Loan
Executive Officers
Don C. Van Brackel
Chairman and Chief
Executive Officer
William J. Small
President and Chief
Operating Officer
John C. Wahl
Senior Vice President,
Chief Financial Officer and
Corporate Treasurer
John W. Boesling
Senior Vice President and
Corporate Secretary
Patricia A. Cooper
Senior Vice President
Jeffrey D. Vereecke
Senior Vice President
Vice Presidents
Jack E. Brace
Patrick S. Rothgery
David R. Schultz
Gary W. Spencer
John D. Starner
Frederick Warncke
Thomas F. Weber
J. Kevin Yarnell
Controller
Dennis E. Rose, Jr.
Assistant Vice Presidents
Cynthia S. Castor
Brian A. Eitniear
Gregory L. Troyer
Robin L. Trudel
Assistant Secretaries
James M. Crow
Jeffrey A. Hench
Assistant Treasurer
Kathryn L. Hoover
Internal Auditor
Bruce C. Fackler
Compliance Officer
Gary L. Verhoff
Human Resource Manager
Rachel L. Ulrich
Marketing Director
Robert G. McCullough
General Counsel
Vorys, Sater, Seymour and Pease
Suite 2100 Atrium Two
221 E. Fourth St.
Cincinnati, OH 45201
Transfer Agent
and Registrar
Registrar & Transfer Company
10 Commerce Dr.
Cranford, NJ 07016
Independent Auditor
Ernst & Young LLP
One Seagate
Toledo, OH 43604
Major Market Makers
Keefe, Bruyette & Woods, Inc.
Friedman, Billings, and Ramsey Co.
Sandler O'Neill & Partners L.P.
Tucker Anthony Incorporated
Herzog, Heine, Geduld, Inc.
Everen Securities
Howe Barnes Investments Inc.
ABN AMRO Chicago Corp.
Ryan Beck & Co., Inc.
Annual meeting
April 21, 1998, 1:00 p.m.
at the office of First Federal
Savings and Loan
601 Clinton Street
Defiance, Ohio 43512
Form 10-K
A copy of First Defiance's Annual
Report on Form 10-K, as filed
with the Securities and Exchange
Commission, is available without
charge to all stockholders of record
by writing to:
John C. Wahl
Senior Vice President and
Chief Financial Officer
First Defiance Financial Corp.
601 Clinton Street
Defiance, Ohio 43512
Long-time directors Edwin S.
Charles and James M. Zachrich
will retire from the boards of
First Defiance Financial Corp.
and First Federal Savings and
Loan effective with the 1998
annual meeting.
Ed Charles joined the First
Federal board in 1959 and
served as its president and
managing officer from 1972 until
1978, as president until 1988
and as chairman of the board and
CEO from 1988 until 1994. He has
been vice chairman since 1994. Jim
Zachrich served as an outside
director beginning in 1975.