UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For Period Ended September 30, 1998
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period from ___________to__________
Commission file number 0-26850
First Defiance Financial Corp.
------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-1803915
- ------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification) Number)
601 Clinton Street, Defiance, Ohio 43512
- ---------------------------------- ----------
(Address or principal executive office) (Zip Code)
Registrant's telephone number, including area code: (419) 782-5015
--------------
Indicate by check mark whether the registrant (1) has filed all documents and
reports required to be filed by Sections 13 or 15(d) of the Securities Exchange
Act of 1934 subsequent to the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Applicable Only to Issuers Involved in Bankruptcy
Proceedings During the Preceding Five Years
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the court. Yes [ ] No [ ]
Applicable Only to Corporate Issuers
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date. Common Stock, $.01 Par Value --
8,184,229 shares outstanding at November 13, 1998.
FIRST DEFIANCE FINANCIAL CORP.
INDEX
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - September 30, 1998 and December 31, 1997
Consolidated Condensed Statements of Income Three
months ended September 30, 1998 and 1997;
Nine months ended September 30, 1998 and 1997
Consolidated Condensed Statement of Changes in
Stockholders' Equity - Nine months ended
September 30, 1998
Consolidated Condensed Statements of Cash Flows
- Nine months ended September 30, 1998 and 1997
Notes to Consolidated Condensed Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION:
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except for share data)
September 30, December 31,
1998 1997
-------- --------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions ............................ $ 7,649 $ 8,149
Interest-bearing deposits .............................. -- 848
-------- --------
7,649 8,997
Securities:
Available-for-sale, carried at fair value .............. 55,464 82,436
Held-to-maturity, carried at amortized cost
(approximate fair value $15,312 and $21,370
at September 30, 1998 and December 31,
1997, respectively) ................................ 15,078 20,953
-------- --------
70,542 103,389
Loans held for sale (at lower of cost or fair value,
approximate fair value $133,724 and $89 at September
30, 1998 and December 31, 1997, respectively) .......... 133,665 88
Loans receivable, net ....................................... 445,798 441,823
Accrued interest receivable ................................. 4,628 3,480
Federal Home Loan Bank stock ................................ 5,195 3,764
Office properties and equipment ............................. 18,837 16,799
Deferred federal income taxes ............................... -- 415
Real estate, mobile homes and other
assets held for sale ................................... 1,085 541
Mortgage servicing rights ................................... 73,096 188
Goodwill .................................................... 11,141
Other assets ................................................ 10,142 214
-------- --------
$781,778 $579,698
======== ========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except for share data)
September 30, December 31,
1998 1997
--------- ---------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits ......................................... $ 414,976 $ 395,322
Advances from Federal Home Loan Bank ............. 51,937 71,665
Warehouse and term notes payable ................. 191,112 --
Deferred taxes ................................... 5,099 --
Other liabilities ................................ 13,730 5,826
--------- ---------
Total liabilities ................................ 676,854 472,813
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; 8,169,067 and
8,527,683 shares outstanding at September 30,
1998 and December 31, 1997, respectively .... 82 85
Additional paid-in capital ....................... 62,660 65,726
Stock acquired by ESOP ........................... (4,089) (4,534)
Stock acquired by Management
Recognition Plan ............................ (959) (1,387)
Net unrealized gains (losses) on available-for-
sale securities, net of income taxes of $146
and ($25) at September 30, 1998 and
December 31, 1997, respectively ............. 283 (50)
Retained earnings - substantially restricted ..... 46,947 47,045
--------- ---------
Total stockholders' equity ....................... 104,924 106,885
--------- ---------
Total liabilities and stockholders' equity ....... $ 781,778 $ 579,698
========= =========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
Interest income:
Mortgage and other loans ................ $11,830 $ 9,464 $31,477 $27,716
Investment securities ................... 1,144 1,796 4,149 4,855
Deposits with banks ..................... 2 36 14 80
------- ------- ------- -------
Total interest income ......................... 12,976 11,296 35,640 32,651
Interest expense:
Deposits ................................. 4,645 4,559 13,825 13,392
Federal Home Loan Bank
advances ............................... 1,129 1,030 3,064 2,347
Warehouse and term notes payable ......... 2,211 -- 2,211 --
------- ------- ------- -------
Total interest expense ........................ 7,985 5,589 19,100 15,739
------- ------- ------- -------
Net interest income ........................... 4,991 5,707 16,540 16,912
Provision for loan losses ..................... 1,039 514 1,727 1,160
------- ------- ------- -------
Net interest income after provision
for loan losses .......................... 3,952 5,193 14,813 15,752
Non-interest expense .......................... 10,247 3,487 17,570 10,119
Non-interest income ........................... 8,875 446 9,945 1,139
------- ------- ------- -------
Income before income taxes .................... 2,580 2,152 7,188 6,772
Income taxes .................................. 919 769 2,474 2,310
------- ------- ------- -------
Net income .................................... $ 1,661 $ 1,383 $ 4,714 $ 4,462
======= ======= ======= =======
Earnings per share: (Note 4)
Basic .................................... $ .22 $ .17 $ .62 $ .52
======= ======= ======= =======
Diluted .................................. $ .21 $ .16 $ .60 $ .50
======= ======= ======= =======
Dividends declared per share (Note 3) ......... $ .09 $ .08 $ .27 $ .24
======= ======= ======= =======
Average number of shares
Outstanding: (Note 4)
Basic ........................... 7,513 8,357 7,542 8,511
======= ======= ======= =======
Diluted ......................... 7,786 8,724 7,874 8,843
======= ======= ======= =======
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
Stock Acquired By
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
Balance at December 31, 1997 ................. $ 85 $ 65,726 $ (4,534) $ (1,387)
Comprehensive income:
Net income
Other comprehensive income, net of tax
ESOP shares released ................ 330 445
Amortization of deferred compensation
of Management Recognition Plan 428
Change in unrealized gains (losses)
net of income taxes of $171
Total comprehensive income
Stock issued under Option Plan ............... 1 446
Purchase of common stock for
treasury ................................. (4) (3,842)
Dividends declared (Note 3)
-------- -------- -------- --------
Balance at September 30, 1998 ................ $ 82 $ 62,660 $ (4,089) $ (959)
======== ======== ======== ========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
Net Unrealized
Losses on Total
Available-for- Retained Stockholders'
Sale Securities Earnings Equity
--------------- -------- ------
Balance at December 31, 1997 ...................... $ (50) $ 47,045 $106,885
Comprehensive income:
Net income ................................... 4,714 4,714
Other comprehensive income, net of tax:
ESOP shares released ..................... 775
Amortization of deferred compensation
of Management Recognition Plan ...... 428
Change in unrealized gains (losses)
net of income taxes of $171 ......... 333 333
--------
Total comprehensive income ........................ 6,250
--------
Stock issued under Option Plan .................... 447
Purchase of common stock for
treasury ...................................... (2,752) (6,598)
Dividends declared (Note 3) ....................... (2,060) (2,060)
Balance at June 30, 1998 .......................... $ (283) $ 46,947 $104,924
======== ======== ========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
Nine Months
Ended September 30,
------------------------
1998 1997
--------- ---------
Operating Activities
Net income ................................................. $ 4,714 $ 4,462
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ............................. 1,727 1,160
Provision for depreciation, amortization of premiums
and accretion of discounts on securities .......... 901 529
Amortization of mortgage servicing rights .... 2,685 1
Amortization of goodwill and other acquisition costs .. 534 --
Gain on sale or call of available-for-sale securities . -- (76)
Gain on sale of loans ................................. (2,455) (117)
Amortization of Management Recognition Plan
deferred compensation ............................. 428 580
Release of ESOP Shares ................................ 775 769
Gain on disposal of equipment ......................... (2) (3)
Deferred federal income tax provision (credit) ........ 400 (209)
Proceeds from sale of loans ........................... 566,492 5,959
Origination of mortgage servicing rights, net ......... (549) (48)
Origination of loans held for sale .................... (528,742) (5,585)
Increase in interest receivable and other assets ...... (1,524) (868)
Increase in other liabilities ......................... 2,386 1,472
--------- ---------
Net cash provided by operating activities .................. 47,770 8,026
Investing Activities
Proceeds from maturities of held-to-maturity securities .... 5,830 3,372
Proceeds from maturities of available-for-sale securities .. 34,000 6,172
Proceeds from sales of available-for-sale securities ....... 312 17,052
Proceeds from sales of real estate, mobile homes, and
other assets held for sale ............................ 1,268 1,104
Proceeds from sales of equipment ........................... 16 3
Acquisition of mortgage servicing rights ................... (9,239) --
Acquisition of The Leader Mortgage Co., net of cash received (30,057) --
Purchases of available-for-sale securities ................. (6,468) (34,293)
Purchases of Federal Home Loan Bank stock .................. (1,431) (664)
Purchases of office properties and equipment ............... (2,059) (4,148)
Net increase in loans receivable ........................... (46,299) (20,277)
--------- ---------
Net cash used in investing activities ...................... (54,127) (31,679)
FIRST DEFIANCE FINANCIAL CORP
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
Nine Months Ended
September 30,
-----------------------
1998 1997
-------- --------
Financing Activities
Net increase in deposits ................................... 19,654 1,472
Repayment of Federal Home Loan Bank long-term advances ..... (878) (905)
Repayment of term notes payable ............................ (917)
Proceeds from Federal Home Loan Bank long-term advances .... 25,000 --
Proceeds from term notes payable ........................... 2,000 --
Net increase in warehouse loans ............................ 12,243 --
Net (decrease) increase in Federal Home Loan Bank
short-term advances ................................... (43,850) 32,615
Purchase of common stock for treasury ...................... (6,598) (7,614)
Cash dividends paid ........................................ (2,092) (2,114)
Proceeds from exercise of stock options .................... 447 26
-------- --------
Net cash provided by financing activities .................. 5,009 23,480
-------- --------
Decrease in cash and cash equivalents ...................... (1,348) (173)
Cash and cash equivalents at beginning of period ........... 8,997 4,752
-------- --------
Cash and cash equivalents at end of period ................. $ 7,649 $ 4,579
======== ========
Supplemental cash flow information:
Interest paid .............................................. $19,718 $ 15,014
======== ========
Income taxes paid .......................................... $ 1,983 $ 1,946
======== ========
Transfers from loans to real estate, mobile homes
and other assets held for sale ........................ $ 1,198 $ 1,197
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities ......... $ (171) $ 97
======== ========
Noncash investing activities:
Decrease in net unrealized loss on
available-for-sale securities ......................... $ 504 $ 288
======== ========
Noncash financing activities:
Cash dividends declared but not paid ....................... $ 688 $ 668
======== ========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 1998)
- --------------------------------------------------------------------------------
1. Principles of Consolidation
The consolidated condensed financial statements include the accounts of
First Defiance Financial Corp. ("First Defiance" or "the Company"), its
wholly owned savings and loan, First Federal Savings and Loan ("First
Federal"), and First Federal's wholly owned mortgage banking company, The
Leader Mortgage Co. ("The Leader"). In the opinion of management, all
significant intercompany accounts and transactions have been eliminated in
consolidation.
2. Basis of Presentation
The consolidated condensed statement of financial condition at December 31,
1997 has been derived from the audited financial statements at that date,
which were included in First Defiance's Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of
September 30, 1998 and for the three and nine month periods ending
September 30, 1998 and 1997 have been prepared by First Defiance without
audit and do not include information or footnotes necessary for the
complete presentation of financial condition, results of operations, and
cash flows in conformity with generally accepted accounting principles. It
is suggested that these consolidated condensed financial statements be read
in conjunction with the financial statements and notes thereto included in
First Defiance's annual report for the year ended December 31, 1997.
However, in the opinion of management, all adjustments, consisting of only
normal recurring items, necessary for the fair presentation of the
financial statements have been made. The results of operations for the
three and nine month periods ended September 30, 1998 are not necessarily
indicative of the results that may be expected for the entire year.
3. Dividends on Common Stock
As of September 30, 1998, First Defiance had declared a quarterly cash
dividend of $.09 per share for the second quarter of 1998, payable October
23, 1998.
4. Earnings Per Share
Basic earnings per share as disclosed under Financial Accounting Standard
("FAS") No. 128 has been calculated by dividing net income by the weighted
average number of shares of common stock outstanding for the three month
and nine month periods ended September 30, 1998 and 1997. First Defiance
accounts for the shares issued to its Employee Stock Ownership Plan
("ESOP") in accordance with Statement of Position 93-6 of the American
Institute of Certified Public Accountants ("AICPA"). As a result, shares
controlled by the ESOP are not considered in the weighted average number of
shares of common stock outstanding until the shares are committed for
allocation to an employee's individual account. In the calculation of
diluted earnings per share for the three and nine month periods ended
September 30, 1998 and 1997, the effect of shares issuable under stock
option plans and unvested shares under the Management Recognition Plan have
been accounted for using the Treasury Stock method.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 1998)
- --------------------------------------------------------------------------------
The following table sets forth the computation of basic and diluted earning
per share:
Three Months Ended Nine Months Ended
September 30 September 30
--------------- ---------------
1998 1997 1998 1997
---- ---- ---- ----
Numerator for basic and diluted
earnings per share - net income $ 1,661 $ 1,383 $ 4,714 $ 4,462
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 7,513 8,357 7,542 8,511
Effect of dilutive securities:
Stock options 185 275 234 241
Unvested Management Recognition
Plan stock 88 92 98 91
------ ------- ---- ------
Dilutive potential common shares 273 367 332 332
----- ----- ----- -----
Denominator for diluted earnings
per share - adjusted weighted
average shares and dilutive
potential common shares 7,786 8,724 7,874 8,843
====== ====== -===== ======
Basic earnings per share $ .22 $ .17 $ .62 $ .52
===== ===== ===== =====
Diluted earnings per share $ .21 $ .16 $ .60 $ .50
===== ===== ===== =====
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 1998)
- --------------------------------------------------------------------------------
5. Mortgage Servicing Rights
The activity in Mortgage Servicing Rights ("MSRs") is summarized as
follows:
Nine Months Year Ended
Ended December 31,
September 30, 1998 1997
------------------ ----
(in thousands)
Balance at beginning of period ..... $ 188 $ 121
Purchase of The Leader ............. 65,805 --
Purchased .......................... 9,239 --
Originated, net .................... 549 69
Amortization ....................... (2,685) (2)
-------- --------
Balance at end of period ........... $ 73,096 $ 188
======== ========
Accumulated amortization of mortgage servicing rights aggregates
approximately $2,732,000 and $4,000 at September 30, 1998 and December 31,
1997, respectively.
The Company's servicing portfolio (excluding subserviced loans) is
comprised of the following as of September 30, 1998 (dollars in thousands):
Number Principal
Of Loans Balance
Outstanding
---------- ----------
(unaudited)
GNMA ............... 55,633 $3,236,660
FNMA ............... 11,281 702,196
FHLMC .............. 2,447 85,316
Other VA, FHA and
Conventional loans 12,009 708,031
---------- ----------
81,370 $4,732,203
========== ==========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 1998)
- --------------------------------------------------------------------------------
6. New Accounting Pronouncement
The Company has adopted FAS No. 130, "Reporting Comprehensive Income". This
statement establishes standards for the reporting and presentation of
comprehensive income and its components in a full set of financial
statements. Comprehensive income encompasses all changes in shareholders'
equity (except those arising from transactions with shareholders) and
includes net income, net unrealized gains or losses on available-for-sale
securities, and reductions in the Management Recognition Plan ("MRP") and
Employee Stock Ownership Plan ("ESOP") suspense accounts. As this new
standard only requires additional information in the financial statements,
it does not affect the Company's financial position or results of
operations. Comprehensive income for the three-month periods ended
September 30, 1998 and 1997 was $2,286,000 and $2,007,000, respectively.
Comprehensive income for the nine-month periods ended September 30, 1998
and 1997 was $6,250,000 and $6,002,000, respectively
The FASB has released Statement No. 133, "Accounting for Derivative and
Similar Financial Instruments and for Hedging Activities". This statement
establishes accounting and reporting standards for derivative financial
instruments and it requires all derivatives to be measured at fair value
and to be recognized as either assets or liabilities in the statement of
financial position. The standard becomes effective for First Defiance for
the first quarter of the year 2000 and is not expected to have a material
impact on the Company's financial statements.
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments
of an Enterprise and Related Information, which is required for years
beginning after December 15, 1997. The new rules change the manner in which
operating segments are defined and reported externally to be consistent
with the basis on which they are reported and evaluated internally. This
statement will not have a significant on the Company.
7. Acquisition of The Leader Mortgage Company
On July 1, 1998, the Company completed the acquisition of The Leader
Mortgage Co., in a cash transaction. At the date of acquisition, The Leader
had assets of $197.3 million and equity of $14.0 million. The cash price of
$34.9 million exceeded the fair value of net assets acquired by
approximately $11.3 million, which was recorded as goodwill and will be
amortized over twenty years. This transaction has been recorded as a
purchase and, accordingly, the consolidated statements of income includes
the results of The Leader's operations since the date of the acquisition.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 1998)
- --------------------------------------------------------------------------------
Pro forma revenues, net income, basic and diluted earnings per share for
the nine month periods ended September 30, 1998 and 1997 had the purchase
business combination been completed as of the first days of 1998 and 1997
were as follows:
(Amounts in thousands)
1998 1997
Revenues $64,387 $61,051
Net income 5,043 $ 3,362
Basic net income per share $ .67 $ .40
Diluted net income per share $ .64 $ .38
The Company expects to achieve operating cost savings primarily through the
utilization of lower cost sources of funding, the use of The Leaders
custodial escrow balances to reduce First Federal's cost of funds,
consolidation of back office functions, and the elimination of redundant
expenses. The operating cost savings are expected to be achieved in various
amounts at various times during the years subsequent to the acquisition of
The Leader and not ratably over, or at the beginning or end of, such
periods. No adjustment has been reflected in the unaudited pro forma
disclosures for the nine-month periods ended September 30, 1998 and 1997.
8. Subsequent Events
On November 2, 1998, the Company announced that it had signed a definitive
agreement to acquire the Insurance Center of Defiance, Inc., an insurance
agency that does business in the Defiance, Ohio area under the name of the
Stauffer Mendenhall Agency. The Stauffer Mendenhall Agency offers property
and casualty and life insurance products. The transaction is expected to
close in the fourth quarter of 1998.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
First Defiance is a holding company which conducts business through its wholly
owned subsidiary, First Federal Savings and Loan, Defiance Ohio ("First
Federal") and First Federal's wholly owned subsidiary, The Leader Mortgage
Company ("The Leader"). First Federal is primarily engaged in attracting
deposits from the general public through its offices and using those and other
available sources of funds to originate loans primarily in the five counties in
which its offices are located and in contiguous Putnam County. The Company's
traditional banking activities include originating and servicing residential,
commercial and consumer loans and providing a broad range of depository
services. The Leader is a mortgage banking company which specializes in
servicing mortgage loans under first-time home-buyer programs sponsored by
various state, county and municipal governmental entities. The Company's
mortgage banking activities consist primarily of originating or purchasing
residential mortgage loans for either direct resale into secondary markets or to
be securitized under various Government National Mortgage Association ("GNMA")
bonds.
First Defiance also invests in U.S. Treasury and federal government agency
obligations, money market mutual funds which are comprised of U.S. Treasury
obligations, obligations of the State of Ohio and its political subdivisions,
mortgage-backed securities which are issued by federal agencies, and to a lesser
extent, collateralized mortgage obligations ("CMOs") and real estate mortgage
investment conduits ("REMICs"). Management determines the appropriate
classification of all such securities at the time of purchase in accordance with
FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities.
Securities are classified as held-to-maturity when First Federal has the
positive intent and ability to hold the security to maturity. Held-to-maturity
securities are stated at amortized cost. Securities not classified as
held-to-maturity are classified as available-for-sale and are stated at fair
value. The available-for-sale portfolio consists of U.S. Treasury securities and
obligations of U.S. Government corporations and agencies ($28.8 million),
corporate bonds ($10.2 million), certain municipal obligations ($3.7 million),
adjustable-rate mortgage backed security mutual funds ($8.8 million), and CMOs
and REMICs ($4.0 million). In accordance with FASB Statement No. 115, unrealized
holding gains and losses on available-for-sale securities are reported in a
separate component of stockholders' equity and are not reported in earnings
until realized. Net unrealized holding gains on available-for-sale securities
were $429,000 at September 30, 1998, $283,000 after considering the related
deferred tax benefit. For the nine months ended September 30, 1998, net
unrealized gains increased by $504,000 ($333,000 after tax).
The profitability of First Defiance is primarily dependent on net interest
income generated by First Federal Savings and Loan and non-interest income
generated primarily by The Leader and to a lesser extent by First Federal. Net
interest income is the difference between interest and dividend income on
interest-earning assets, principally loans and securities, and interest expense
on interest-bearing deposits, Federal Home Loan Bank advances, and other
borrowings. The Company's non-interest income includes gain on sales of loans,
servicing income from servicing mortgage loans, as well as loan admininstration
fees. First Defianc's earnings also depend on the provision for loan losses and
its non-interest expense.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Changes in Financial Condition
At September 30, 1998, First Defiance's total assets, deposits and stockholders'
equity amounted to $781.8 million, $415.0 million and $104.9 million,
respectively, compared to $579.7 million, $395.3 million and $106.9 million,
respectively, at December 31, 1997.
Net loans receivable have increased from $441.8 million at December 31, 1997 to
$445.8 million at September 30, 1998. This increase was funded primarily with
maturing or redeemed securities. Loans held for sale increased from $88,000 at
December 31, 1997 to $133.7 million at September 30, 1998. This increase was
primarily the result of the acquisition of The Leader. The Leader's operations
are funded through various short and long-term financing arrangements, the total
of which were $191.1 million at September 30, 1998.
Securities decreased from $103.4 million at December 31, 1997 to $70.5 million
at September 30, 1998 as a result of U.S. Government Agency securities being
called prior to maturity. Proceeds from those calls were used to fund loan
growth and pay down advances from the Federal Home Loan Bank ("FHLB") rather
than being reinvested at current rates. As a result, FHLB advances decreased
from $71.7 million at December 31, 1997 to $51.9 million at September 30, 1998.
First Defiance has completed six 5% stock repurchases between May 1996 and
September 30, 1998. As of September 30, 1998, First Defiance had repurchased
426,384 shares of its own stock during 1998 for a total cost of $6.6 million, an
average of $15.47 per share.
Forward-Looking Information
Certain statements contained in this quarterly report that are not historical
facts, including but not limited to statements that can be identified by the use
of forward-looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," or "continue" or the negative thereof or other variations thereon or
comparable terminology are "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21B of the
Securities Act of 1934, as amended. Actual results could differ materially from
those indicated in such statements due to risks, uncertainties and changes with
respect to a variety of market and other factors.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Average Balances, Net Interest Income and Yields Earned and Rates Paid
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in thousands of dollars and rates, and the net interest margin. Dividends
received are included as interest income. The table does not reflect any effect
of income taxes. All average balances are based upon daily balances.
Three Months Ended September 30,
---------------------------------------------------------------
1998 1997
----------------------------- --------------------------
(dollars in thousands)
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $593,399 $11,830 7.97% $431,441 $9,464 8.77%
Securities 73,851 1,146 6.21 110,651 1,832 6.62
Dividends on FHLB stock 5,103 93 7.29 3,536 65 7.35
-------- ------ -------- --------
Total interest-earning assets 672,353 13,069 7.78 545,628 11,361 8.33
Non-interest-earning assets 123,662 26,467
--------- --------
Total assets $796,015 $572,095
======== ========
Interest-bearing liabilities:
Deposits $405,615 $4,645 4.58% $383,025 $4,559 4.76%
FHLB advances and other 79,820 1,129 5.66 69,234 1,030 5.95
Warehouse and term notes 191,345 2,211 4.62
------- ------ -------- ------
Total interest-bearing liabilities 676,780 7,985 4.72 452,259 5,589 4.94
------ ---- ------ ----
Non-interest-bearing liabilities 15,133 4,591
-------- --------
Total liabilities 691,913 456,850
Stockholders' equity 104,102 115,245
-------- ---------
Total liabilities and stock-
holders' equity $796,015 $572,095
======== ========
Net interest income; interest
rate spread $5,084 3.06% $5,772 3.39%
====== ===== ====== =====
Net interest margin (2) 3.02% 4.23%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 99% 121%
=== ====
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Nine Months Ended September 30,
---------------------------------------------------------------
1998 1997
----------------------------- --------------------------
(dollars in thousands)
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $499,279 $31,477 8.41% $425,211 $27,716 8.69%
Securities 87,616 4,163 6.34 102,287 4,935 6.43
Dividends on FHLB stock 4,233 230 7.24 3,241 175 7.20
--------- ------ -------- --------
Total interest-earning assets 591,128 35,870 8.09 530,739 32,826 8.25
Non-interest-earning assets 60,069 24,886
-------- --------
Total assets $651,197 $555,625
======== ========
Interest-bearing liabilities:
Deposits $403,081 $13,825 4.57% $380,605 $13,392 4.69%
FHLB advances and other 71,107 3,064 5.75 53,671 2,347 5.83
Warehouse and term notes 63,782 2,211 4.62
--------- -------- -------- -------
Total interest-bearing liabilities 537,970 19,100 4.73 434,276 15,739 4.83
-------- ---- ------- ----
Non-interest-bearing liabilities 8,981 4,357
-------- --------
Total liabilities 546,951 438,633
Stockholders' equity 104,246 116,992
-------- -------
Total liabilities and stock-
holders' equity $651,197 $555,625
======== ========
Net interest income; interest
rate spread $16,770 3.36% $17,087 3.41%
======= ===== ======= =====
Net interest margin (2) 3.78% 4.29%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 110% 122%
==== ====
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Results of Operations
Three Months Ended September 30, 1998 compared to Three Months Ended September
30, 1997
- --------------------------------------------------------------------------------
The acquisition of The Leader Mortgage Company on July 1, 1998 has had a
fundamental impact on the consolidated operating results of First Defiance
Financial Corp. making period-to-period comparisons less meaningful.
On a consolidated basis, First Defiance had net income of $1.7 million for the
three months ended September 30, 1998 compared to $1.4 million for the same
period in 1997. On a per share basis, basic and diluted earnings per share were
$.22 and $.21 respectively for the 1998 third quarter compared to $.17 and $.16
basic and diluted per share earnings for the 1997 third quarter. The sources of
that income have changed dramatically with the acquisition of The Leader and
First Defiance on a consolidated basis has effectively exchanged a certain level
of net interest margin for an increase in fee income. The Leader's business is
mortgage banking and their revenues are generated primarily as a result of the
origination, sale and servicing of mortgage loans, all of which are reported as
non-interest income. Results for the 1998 third quarter therefore reflect a
reduction in net interest of $716,000, which is attributable to a number of
factors discussed below. Those factors include the fact that the Leader purchase
was financed principally by taking out Federal Home Loan Bank advances, some of
which have been paid off as a result of subsequent sales of interest earning
assets. Non-interest income, which includes the majority of The Leader's
revenues, have increased by $8.4 million in the quarter ended September 30, 1998
compared to the same quarter in 1997. For the same periods, non-interest expense
has increased by $6.8 million.
In addition to the inclusion of The Leader for the first time, non-interest
income for the quarter ended September 30, 1998 also included a $785,000 gain
from the sale of seasoned mortgage loans and a $240,000 gain from the sale of a
majority of First Federal's mobile home loan portfolio.
Net Interest Income. Net interest income before provision for loan losses
decreased to $5.0 million for the three-month period ending September 30, 1998
from $5.7 million for the same period in 1997. The Company's net interest margin
decreased to 3.02% for the quarter ended September 30, 1998 from 4.23% for the
quarter ended September 30, 1997. The Company's interest rate spread (the
difference between yield on average interest-earning assets and the interest
rate on average interest-bearing liabilities) for the 1998 third quarter was
3.06%, which was 33 basis points lower than the 1997 third quarter level of
3.39%.
The decreases in net interest income, net interest margin, and interest rate
spread were primarily the result of the following: (1) a 55 basis point decrease
in the average yield on interest-earning assets from 8.33% for the quarter ended
September 30, 1997 to 7.78% for the comparable period in 1998, (2) a $224.5
million increase in the average balance of interest-bearing liabilities from
$452.3 million as of September 30, 1997 to $676.8 million as of September 30,
1998, and (3) a decrease in the ratio of average interest-earning assets to
average interest-bearing liabilities from 121% to 99% for the quarters ended
September 30, 1997 and 1998, respectively.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
The decrease in the yield on average interest-earning assets was the result of
the overall market decrease in interest rates generally, the addition of The
Leader's portfolio of FHA and VA loans, which are typically at lower rates than
conventional loans, and changes in the composition of the Company's loan
portfolio due to two large loan sales. On July 1, 1998, the Company sold $21
million of its mobile home loan portfolio. Despite the higher yield on mobile
home loans, the sale was a strategic response to the high cost of servicing the
mobile home loans as well has the high credit risk associated with these types
of loans. In September 1998, the Company sold $30.7 million of seasoned
long-term fixed-rate mortgage loans. The sale was in response to the Company's
review of its interest rate risk profile and the belief that, in the current low
rate environment, the probability of those loans prepaying had significantly
increased. The effects of these items on the average yield was offset somewhat
by the growth of the commercial loan portfolio, which has a higher yield than
the residential real estate loan portfolio. Part of the funds received from the
sale of fixed-rate mortgage loans was used to fund commercial loan originations.
Commercial loans increased to $54.0 million as of September 30, 1998 compared to
$28.5 million as of September 30, 1997.
The increases in the average balance of interest-bearing liabilities was the
result of the acquisition of The Leader, which was partially offset by the loan
sales discussed above. The Leader acquisition included $179.8 in assumed debt
relating to the warehouse facility and term notes payable which The Leader uses
to fund its mortgage-banking activities. The increase in liabilities resulting
from the acquisition of The Leader was offset somewhat by a decline in Federal
Home Loan Bank advances which were repaid with a portion of the funds from the
mobile home loan and mortgage loan sales.
The decrease in the average interest-earning assets to average interest-bearing
liabilities ratio from 121% for the three-months ended September 30, 1997 to 99%
for the same period in 1998 contributed to the decline in net interest margin.
Because of the acquisition of The Leader, First Defiance has a lower percentage
of interest earning assets over which to cover interest expenses, which tends to
reduce net interest margin. The Company's average interest-bearing liabilities
increased $191.3 million while average interest-earning assets only increased
$132.1 million for the three-month period ended September 30, 1998. This is due
to the fact that one of the largest assets on The Leader's balance sheet,
mortgage servicing rights ($72.6 million at September 30, 1998), is a
non-interest-earning asset.
The downward pressures on net interest income, net interest margin, and interest
rate spread were partially offset by a $126.8 million increase in the Company's
average interest-earning assets to $672.4 million at September 30, 1998 from
$545.6 million at September 30, 1997 and a 22 basis point decrease in the
average cost of interest-bearing liabilities from 4.94% for the three months
ended September 30, 1997 to 4.72% for the same period in 1998.
The increase in average interest-earning assets is attributable to the
acquisition of The Leader, whose assets include a sizable portfolio of loans
receivable. On July 1, 1998, The Leader's loan portfolio had a book value of
$131.5 million.
The decrease in the cost of average interest-bearing liabilities was primarily
the result of a decline in interest rates generally, the effect of which was
partially offset by the increase in the volume of interest-bearing liabilities
attributable to The Leader acquisition.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Provision for Loan Losses. The provision for loan losses increased to $1,039,000
during the 1998 third quarter from $514,000 for the same period in 1997.
Provisions for loan losses are charged to earnings to bring the total allowance
for loan losses to the level deemed appropriate by management based on
historical experience, the volume and type of lending conducted by First
Defiance, industry standards, the amount of non-performing assets and loan
charge-off activity, general economic conditions, particularly as they relate to
First Defiance's market area, and other factors related to the collectibility of
First Defiance's loan portfolio. The increase in the provision reflects a
$153,000 write-down in the value of repossessed mobile homes (included in
repossessed assets on the balance sheet), additional reserves of $225,000
against the remaining mobile home portfolio and a provision for $183,000 for
loans held for sale by The Leader. The Leader's loans available for sale include
loans that are delinquent and have been purchased out of a mortgage backed
security pool. The credit risk of these loans is limited due to the fact that
they are generally backed by government guarantees.
Non-performing assets, which include loans 90 days or more past due, loans
deemed impaired, and repossessed assets, totaled $10.0 million at September 30,
1998, which is 1.28% of total assets. Non-performing loans and repossessed
assets increased $7.2 million and $660,000, respectively, due to the addition of
The Leader's mortgage banking operations. The increase in non-performing loans
at The Leader represents loans held in a foreclosure warehouse line, which are
generally backed by government guarantees.
The allowance for loan losses at September 30, 1998 was $4.4 million compared to
$2.6 million at September 30, 1998 and $2.7 million at December 31, 1997. The
Leader acquisition accounted for $1.2 million of the increase in the allowance
from September 30, 1997 to 1998. For the quarter ended September 30, 1998, First
Defiance charged off $779,000 of loans against its allowance and realized
recoveries of $54,000 from loans previously charged off. During the same quarter
in 1997, First Defiance charged off $443,000 in loans and realized recoveries of
$68,000.
Non-Interest Income. Non-interest income increased substantially in the third
quarter of 1998, from $446,000 for the quarter ended September 30, 1997 to $8.9
million for the same period in 1998. The addition of The Leader made a
fundamental change in the operations of the Company. The Leader contributed $7.1
million of the $8.4 million increase in non-interest income growth from the
third quarter of 1997 to the third quarter of 1998.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$253,000 for the quarter ended September 30, 1997 to $6.5 million for the same
period in 1998. The increase of $6.2 million from the quarter ended September
30, 1997 to 1998 was the result of growth in service fees on sold loans,
origination fees, and late charge of $4.5 million, $777,000, and $541,000,
respectively, due to the addition of The Leader; and a $161,000 increase in
deposit fees at First Federal (from $188,000 for the quarter ended September 30,
1997 to $349,000 for the same period in 1998).
Gain on Sale of Loans. Gain on sale of loans increased from $49,000 for the
quarter ended September 30, 1997 to $2.2 million for the same period of 1998.
This was the result of two large loan sales at First Federal along with gains on
sales recorded by The Leader in their normal course of business. The $21 million
mobile home and the $30.7 million mortgage loan sales previously mentioned
resulted in gains of $240,000 and $785,000, respectively. In addition, The
Leader recognized $939,000 in gain on sale of loans for the third quarter of
1998.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, gains on sale of securities, and other
miscellaneous charges, increased to $156,000 for the quarter ended September 30,
1998 from $145,000 for the same period in 1997.
Non-Interest Expense. Total non-interest expense increased $6.7 million from
$3.5 million for the quarter ended September 30, 1997 to $10.2 million for the
same period in 1998. The acquisition of The Leader resulted in approximately
$6.1 million of this increase.
Compensation and Benefits. Compensation and benefits increased $2.1 million from
$2.0 million for the quarter ended September 30, 1997 to $4.1 million for the
same period in 1998. The addition of The Leader was responsible for $2.0 million
of this increase. Decreases in Management Recognition Plan and Employee Stock
Ownership Plan expenses ($295,000 combined for the quarter ended September 30,
1998 compared to $481,000 for the same period in 1997) were offset by increases
in overall staffing related to the Paulding and Hicksville branches (which
opened in October 1997 and February 1998, respectively) and the Findlay
commercial loan production office (which opened in August 1998) resulting in a
net $123,000 increase in the Company's compensation expense (excluding The
Leader) from $2.0 million for the quarter ended September 30, 1997 to $2.1
million for the same period in 1998.
Occupancy. Occupancy expense increased to $925,000 for the three-month period
ended September 30, 1998 from $340,000 for the three months ended September 30,
1997. The Leader accounted for $268,000 of this increase. The remainder of the
increase was due to increased depreciation brought about by the addition of two
new branches along with continued upgrades to all of the Company's computer
hardware and software.
Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing
rights (MSRs) increased to $2.7 million for the quarter ended September 30, 1998
from $1,000 for the same period in 1997. The entire $2.7 million increase was as
a result of the acquisition of The Leader. MSRs represent the value of future
cash flows to be generated from the servicing of mortgage loans. The value of
MSRs are amortized as the related mortgage loans are paid down.
Amortization of Goodwill and Other Acquisition Related Costs. As a result of the
purchase of The Leader, $534,000 in amortization of goodwill and other
acquisition related costs was recognized in the third quarter of 1998.
Other Non-Interest Expenses. Other non-interest expenses (including state
franchise tax, data processing, deposit premiums, and loan servicing) increased
to $2.2 million for the quarter ended September 30, 1998 from $1.2 million for
the same period in 1997. $832,000 of the increase was the result of The Leader's
normal operating activities for the third quarter. The remaining increase was
primarily due to increased data processing costs resulting from the
implementation of several new applications and increased state franchise taxes
at the holding company level.
First Defiance has computed federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 35.6% for the
quarter ended September 30, 1998 compared to 35.7% for the same period in 1997.
As a result of the above factors, net income for the quarter ended September 30,
1998 was $1,661,000 compared to $1,383,000 for the comparable period in 1997. On
a per share basis, basic and diluted earnings per share for the three months
ended September 30, 1998 was $.22 and $.21 respectively compared to $.17 and
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
$.16 for the same period in 1997. The increase in earnings per share is
attributable to the increased net income along with a decrease in the average
shares outstanding as a result of stock buy backs completed since the beginning
of 1997. Average shares outstanding for the basic and diluted calculations were
7,513,000 and 7,786,000, respectively, for the quarter ended September 30, 1998
compared to 8,357,000 and 8,786,000, respectively, for the quarter ended
September 30, 1997.
First Defiance's board of directors declared a dividend of $.09 per common share
as of September 30, 1998. The dividend amounted to $735,216, including dividends
on unallocated ESOP shares. It was paid on October 23, 1998. Dividends are
subject to determination and declaration by the board of directors, which will
take into account First Defiance's financial condition and results of
operations, economic conditions, industry standards and regulatory restrictions
which affect First Defiance's ability to pay dividends.
Nine Months Ended September 30, 1998 compared to Nine Months Ended September 30,
1997
- --------------------------------------------------------------------------------
The acquisition of The Leader also has significantly impacted the results for
the nine months ended September 30, 1998 compared to the same period in 1997.
Net income for the 1998 period was $4.7 million, or $.60 per diluted share
compared to $4.5 million or $.50 per diluted share for the same period in 1997.
Net interest income decreased to $16.5 million for the 1998 nine-month period
compared to the same period in 1997 while non-interest income increased to $9.9
million from $1.1 million and non-interest expense increased to $17.6 million
from $10.1 million.
Net Interest Income. Net interest income before provision for loan losses
decreased to $16.5 million for the nine-month period ending September 30, 1998
compared to $16.9 for the same period in 1997. The Company's year-to-date net
interest margin through September 30, 1998 decreased to 3.78% compared to 4.29%
for the same period in 1997. Interest rate spread slightly decreased for the
nine-month period ended September 30, 1998 to 3.36% from 3.41% for the
nine-month period ended September 30, 1997.
The decreases in net interest income, net interest margin, and interest rate
spread were the result of the following: A 16 basis point decrease in the
average yield on interest-earning assets from 8.25% for the nine-months ended
September 30, 1997 to 8.09% for the comparable period in 1998, a $103.7 million
increase in the average interest-bearing liabilities from $434.3 million as of
September 30, 1997 to $538.0 million as of September 30, 1998, and a decrease in
average interest-earning assets to average interest-bearing liabilities from
122% to 110% for the year-to-date periods ended September 30, 1997 and 1998 ,
respectively.
These downward pressures to net interest income, net interest margin, and
interest rate spread were partially offset by a $60.4 million increase in the
Company's average interest earning assets to $591.1 million as of September 30,
1998 from $530.7 million as of September 30, 1997 and a 10 basis point decrease
in the average cost of interest bearing liabilities from 4.83% for the
nine-months ended September 30, 1997 to 4.73% for the same period in 1998. As
was discussed in the results of operations for the three-months ended September
30, 1998, the change to the Company's net interest margin profile was caused
primarily by the acquisition of The Leader. In addition, the sale of seasoned
mortgage and mobile home loans along with the overall market decrease in
interest rates factored into the declines in net interest income, net interest
margin, and interest rate spread.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Provision for Loan Losses. The provision for loan losses increased to $1.7
million for the nine-months ended September 30, 1998 compared to $1.2 million
for the same period in 1997. The loan loss provision reflects the acquisition of
The Leader along with continued growth in the higher risk consumer and
commercial portfolios and increased year-to-date net charge-offs of 1998
compared to 1997. First Defiance charged off $1.4 million of loans against its
allowance for loan losses for the nine-month period ended September 30, 1998 and
realized recoveries of $165,000 from loans previously charged off. During the
same period in 1997, First Defiance charged off $1.0 million in loans and
realized recoveries of $152,000.
Non-Interest Income. Non-interest income increased $8.8 million for the
nine-month period ended September 30, 1998 from $1.1 million to $9.9 million for
the 1997 and 1998 periods, respectively. The Leader contributed $7.1 million of
this increase.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$723,000 for the nine-month period ended September 30, 1997 to $7.1 million for
the same period in 1998. The growth was due to service fees on loans sold,
origination fees, and late charge income related to The Leader acquisition and
increased deposit fee income at First Federal.
Gain on Sale of Loans. Gain on sale of loans increased from $117,000 for the
nine-months ended September 30, 1997 to $2.5 million for the same period in
1998. This was the result of gains on sales recorded by The Leader in their
normal course of business and two large loan sales in the third quarter of 1998
(resulting in a gain on sale of approximately $1.0 million).
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, gains on sale of securities, and other
miscellaneous charges, increased to $369,000 for the nine-months ended September
30, 1998 from $299,000 for the same period in 1997.
Non-Interest Expense. Total non-interest expense increased $7.5 million from
$10.1 million for the nine-month period ended September 30, 1997 to $17.6 for
the same period in 1998. The acquisition of The Leader brought on $6.1 million
of the increase. Compensation and Benefits. Compensation and benefits increased
$2.3 million from $5.5 million for the year-to-date period ended September 30,
1997 to $7.8 million for the same period in 1998. Decreases in Management
Recognition Plan and Employee Stock Ownership Plan expenses ($882,000 combined
for the nine-months ended September 30, 1998 compared to $1.3 million for the
same period in 1997) were offset by increases due to The Leader's staff,
additions of the Paudling and Hicksville branches, and the start up of the
Findlay commercial loan production office.
Occupancy. Occupancy expense increased to $1.6 million for the nine-month period
ended September 30, 1998 from $1.0 for the same period in 1997. This increase
related to the acquisition of The Leader and increased depreciation brought
about by the addition of two new branches along with continued upgrades to all
of the Company's computer hardware and software to support future growth.
Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing
rights increased to $2.7 million for the nine-month period ended September 30,
1998 from $2,000 for the same period in 1997. The entire increase was the result
of the acquisition of The Leader.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Amortization of Goodwill and Other Acquisition Costs. As a result of the
purchase of The Leader, $534,000 in amortization of goodwill and other
acquisition costs was recognized during the nine-month period ended September
30, 1998.
Other Non-Interest Expenses. Other non-interest expenses (including state
franchise tax, data processing, deposit premiums, and loan servicing) increased
to $4.9 million for the nine-month period ended September 30, 1998 compared to
$3.6 million for the same period in 1997. The increase was due to the
acquisition of The Leader along with increased data processing, state franchise
tax expenses, and mobile home loan servicing costs.
As a result of the above factors, net income for the nine-month period ended
September 30, 1998 increased slightly to $4.7 million from $4.5 million for the
nine-months ended September 30, 1997. However, due to the reduction in the
average shares outstanding related to the stock repurchase programs, on a per
share basis, basic and diluted earnings per share for the nine-month period
ended September 30, 1998 increased dramatically to $.62 and $.60 respectively
compared to $.52 and $.50 for the same period in 1997. Average shares
outstanding for the basic and diluted calculations were 7,542,000 and 7,874,000
respectively for the nine-months ended September 30, 1998 compared to 8,511,000
and 8,843,000 respectively for the same period in 1997.
Through the nine-months ended September 30, 1998, First Defiance has declared
dividends totaling $.27 per share.
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
Government, federal agency and other investments having maturities of five years
or less. Current OTS regulations require that a savings association 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, of
which short-term liquid assets must consist of not less than 1%. Monetary
penalties may be imposed for failure to meet applicable liquidity requirements.
First Federal's liquidity substantially exceeded applicable liquidity
requirements throughout the three and nine-month periods ended September 30,
1998.
First Defiance generated $47,770,000 of cash from operating activities during
the first nine months of 1998. The Company's cash from operating activities
results from net income for the period, adjusted for various non-cash items,
including the provision for loan losses, depreciation and amortization, ESOP
expense related to release of shares, and changes in loans available for sale,
interest receivable and other assets, and other liabilities. The primary
investing activity of First Defiance is the origination of loans (both for sale
in the secondary market and to be held in portfolio), which is funded with cash
provided by operations, proceeds from the amortization and prepayments of
existing loans, the sale of loans, proceeds from the sale or maturity of
securities, borrowings from the FHLB, and customer deposits. In the 1998 third
quarter, First Defiance invested $30.0 million, net of cash received, to acquire
the stock of The Leader Mortgage Company
At September 30, 1998, First Defiance had $8.76 million in outstanding mortgage
loan commitments and loans in process to be funded generally within the next six
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
months and an additional $65.38 million committed under existing consumer and
commercial lines of credit and standby letters of credit. At that date, the
total amount of certificates of deposit that are scheduled to mature by
September 30, 1999 is $223.1 million. First Defiance believes that it has
adequate resources to fund commitments as they arise and that it can adjust the
rate on savings certificates to retain deposits in changing interest rate
environments. If First Defiance requires funds beyond its internal funding
capabilities, advances from the FHLB of Cincinnati are available as an
additional source of borrowings. In addition, at September 30, 1998 First
Defiance has $8.79 million in outstanding commitments to sell mortgage loans.
Currently First Defiance invests in on-balance sheet derivative securities as
part of the overall asset and liability management process. Such derivative
securities include agency step-up, REMIC and CMO investments. Such investments
are not classified as high risk at September 30, 1998 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.
First Federal is required to maintain specified amounts of capital pursuant to
regulations promulgated by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
The following table sets forth First Federal's compliance with each of the
capital requirements at September 30, 1998.
Tangible Core Risk-Based
Capital Capital Capital (1)(2)
--------- --------- ---------
(Dollars in Thousands)
Regulatory capital ................ $ 73,516 $ 73,516 $ 76,145
Minimum required regulatory
capital ........................ 11,579 30,611 43,712
--------- --------- ---------
Excess regulatory capital ......... $ 61,967 $ 42,905 $ 32,433
========= ========= =========
Regulatory capital as a
percentage of assets (3) ....... 9.6% 9.6% 13.9%
Minimum capital required as
a percentage of assets ......... 1.5% 4.0% 8.0%
--------- --------- ---------
Excess regulatory capital as a
percentage in excess of
requirement .................... 8.1% 5.6% 5.9%
========= ========= =========
(1) Does not reflect the interest-rate risk component in the risk-based capital
requirement, discussed above.
(2) Reflects fully phased-in deductions from total capital.
(3) Tangible and core capital are computed as a percentage of adjusted total
assets of $765.3 million. Risk-based capital is computed as a percentage of
total risk-weighted assets of $546.4 million.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
Year 2000 Readiness
All companies, including First Federal and The Leader, currently face many risks
associated with the ability of computer systems to properly recognize calendar
dates beginning in the Year 2000. This potential problem could cause systems
which utilize date sensitive information to either not function at all, or to
provide incorrect data or information. First Federal and The Leader have
developed separate action plans to address the Year 2000 problems.
First Federal outsources the majority of its data processing needs to BISYS,
Inc. Platform applications maintained by BISYS include savings, DDAs, mortgage
loans, consumer loans and commercial loans. BISYS has represented to its
customers that these applications have been updated to properly process
transactions that reflect dates in the year 2000. Management is in the process
of testing all applications for various dates to assure that transactions will
process accurately. The first testing cycle is expected to be completed in
January 1999. While BISYS has indicated that all programs have been
appropriately remediated, there are no guarantees that all transactions will
process accurately.
First Federal processes its general ledger on a system that is integrated with
the BISYS platform applications. The vendor has indicated that the current
version of the general ledger system, which also includes accounting for
accounts payable, fixed assets, and the investment portfolio, is Year 2000
compliant. Testing of these general ledger applications for critical dates will
be performed by management in conjunction with other testing and should be
completed by January 1999.
First Federal's in-house computing environment consists of a series of Local
Area Network ("LAN") based systems that interface with the BISYS applications.
All hardware associated with these systems has been tested and is Year 2000
compliant. First Federal replaced approximately 12 personal computers that were
not compliant.
The Company receives information from a variety of outside sources and
management is working with the providers of this information to minimize its
exposure to non-compliant sources of data. The interchange of data with such
providers including the Federal Reserve, ACH providers, ATM networks, and others
is being tested to assure accurate Year 2000 processing.
Because its data processing functions are outsourced, the cost of Year 2000
remediation has not been material to First Federal. The cost of personal
computers that needed to be replaced was less than $50,000 and has been
capitalized. BISYS also is assessing a fee to cover the cost of the test bank
that was established to allow for appropriate testing. The cost of the test bank
and other incremental costs associated with year 2000 compliance will be less
than $100,000 in 1998.
While First Federal outsources the majority of its applications, The Leader
processes its critical applications on an in-house system. All of The Leader's
hardware and software, both internally developed and purchased from third party
vendors has been evaluated. All hardware has been upgraded to comply with Year
2000 requirements. The Company's most mission critical systems, the loan
servicing system and the wholesale bond system, have been modified to properly
process dates in the Year 2000. The wholesale bond system is Year 2000 compliant
and operational. The loan servicing system is currently running in a parallel
test mode.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Continued
The Leader is also dependent on a variety of third parties that provide software
or interface information with The Leader's system. Management has obtained
status reports from all vendors. Approximately 70% of those vendors indicated
they are Year 2000 ready and to the extent possible compliance has been tested
by The Leader. Management anticipates that testing for the remaining vendors
will be completed by the end of the first quarter 1999. Certain of the
applications provided by these vendors, including FNMA and HUD, are mission
critical.
The cost of Year 2000 compliance by The Leader is approximately $500,000
including hardware and software upgrades, programming costs, and retention
bonuses to incent key staff members to complete the Year 2000 project.
Approximately 60% of that cost has been expended to date with the majority of
those costs being equipment upgrades. The portion of these costs associated with
hardware acquisitions is being capitalized while most of the internal
programming costs are being expensed.
In addition to the critical systems noted above, both First Federal and The
Leader have certain non-information technology systems that may contain imbedded
technology that is date dependent. Examples of such systems include security
systems, heating and cooling systems, telephone systems, sprinkler systems, and
elevators. To the extent possible, both First Federal and The Leader have
attempted to assess the risks associated with these systems. Management is not
aware of any such systems that will prevent either company from operating beyond
the year 2000.
While both First Federal and The Leader believe that all critical systems will
be year 2000 compliant, contingency plans are in place to replace those systems
in early 1999 if the risk of non-compliance is deemed to be probable. Such
contingency plans include replacing existing systems with purchased software or
alternative outsourcing solutions.
Management believes it has provided its best estimate of both the costs of Year
2000 compliance and deadlines by which it will be Year 2000 compliant. However
those estimates are based on numerous assumptions of future events. There are no
guarantees that the estimates provided will be achieved and actual results could
differ materially from those anticipated.
Readiness for the Year 2000 is also a concern for First Defiance's customers,
particularly its commercial lending customers. Management is in process of
assessing the status of Year 2000 readiness for all commercial lending
customers. The ability to be Year 2000 compliant is one consideration taken into
account during the loan underwriting process. As of September 30, 1998,
management has not identified any commercial customers who will clearly not be
Year 2000 compliant. However, a substantial portion of the assessment process
has not yet been completed.
Item 3. Qualitative and Quantitave Disclosure About Market Risk
As discussed in detail in the 1997 Annual Report on Form 10-K, First Defiance's
ability to maximize net income is dependent on management's ability to plan and
control net interest income through management of the pricing and mix of assets
and liabilities. Because a large portion of assets and liabilities of First
Defiance are monetary in nature, changes in interest rates and monetary or
fiscal policy affect its financial condition and can have significant impact on
the net income of the Company. First Defiance and The Leader do not use off
balance sheet derivatives to enhance its risk management, nor does it engage in
trading activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis
through simulation analysis which measures the impact changes in interest rates
can have on net interest income. The simulation technique analyses the effect of
a presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, nonmaturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise or fall 100 basis points over a 12 month period, using
September 1998 amounts as a base case, First Defiance's net interest income
would be impacted by less than the board mandated 5% guidelines.
The simulation used by First Defiance does not yet take into account the impact
on the value of mortgage servicing rights, which can be negatively impacted by
declining interest rates. However, because loans serviced by The Leader
generally have lower than market interest rates, the impact of declining
interest rates is not as great as the impact on a mortgage banker that services
primarily conventional loans.
FIRST FEDERAL SAVINGS AND LOAN
DEFIANCE, OHIO
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
First Defiance is not engaged in any legal proceedings of a material
nature.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
a. On July 16, 1998 First Defiance filed a current report on Form
8-K, dated July 16, 1998, reporting, pursuant to Item 5 of such
form, that First Defiance completed the acquisition of The Leader
Mortgage Company effective July 1, 1998.
b. On September 14, 1998 First Defiance filed a current report on
Form 8-K/A dated September 14, 1998, reporting, pursuant to Item
2 of such form, the Acquisition of The Leader Mortgage Company
and filing certain financial statements of business acquired and
certain pro-forma financial information pursuant to Item 7 of
such form.
c. On November 2, 1998 First Defiance filed a current report on Form
8-K, dated November 2, 1998, reporting, pursuant to Item 5 of
such form, that First Defiance had reached an agreement to
acquire the stock of the Insurance Center of Defiance, Inc. Also,
pursuant to Item 5 of such form, First Defiance reported its
intention to repurchase up to 15% of its outstanding shares, or
1,226,704 shares, commencing no earlier than November 5, 1998.
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: November 13, 1998 p By: /s/ Don C. Van Brackel
----------------- -------------------------
Don C. Van Brackel
Chairman, President and
Chief Executive Officer
Date: November 13, 1998 By: /s/ John C. Wahl
----------------- -------------------
John C. Wahl
Senior Vice President, Chief
Financial Officer and
Treasurer