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 June 30, 1999
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.
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(Exact name of registrant as specified in its charter)
Ohio 34-1803915
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
601 Clinton Street, Defiance, Ohio 43512
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(Address or principal executive office) (Zip Code)
(419) 782-5015
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Registrant's telephone number, including area code:
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 -
7,068,738 shares outstanding at August 11, 1999.
FIRST DEFIANCE FINANCIAL CORP.
INDEX
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - June 30, 1999 and December 31, 1998
Consolidated Condensed Statements of Income
Three months ended June 30, 1999 and 1998;
Six months ended June 30, 1999 and 1998
Consolidated Condensed Statement of Changes in
Stockholders' Equity - Six months ended
June 30, 1999
Consolidated Condensed Statements of Cash Flows
- Six months ended June 30, 1999 and 1998
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)
June 30, 1999 December 31, 1998
------------- ----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions ................... $ -- $ 16,137
Interest-bearing deposits ....................... 4,463 4,369
-------- --------
4,463 20,506
Securities:
Available-for-sale, carried at fair value ....... 46,258 47,554
Held-to-maturity, carried at amortized cost
(approximate fair value $11,352 and $13,753
at June 30, 1999 and December 31,
1998, respectively) ....................... 11,272 13,541
-------- --------
57,530 61,095
Loans held for sale (at lower of cost or fair value,
approximate fair value $155,220 and $120,097 at
June 30, 1999 and December 31, 1998, respectively) 155,220 119,910
Loans receivable, net ................................. 468,036 448,574
Mortgage servicing rights ............................. 81,417 76,452
Accrued interest receivable ........................... 3,524 3,605
Federal Home Loan Bank stock .......................... 11,942 10,826
Office properties and equipment ....................... 26,360 19,057
Real estate, mobile homes and other
assets held for sale ............................ 2,499 1,517
Goodwill, net ......................................... 13,188 13,333
Other assets .......................................... 13,850 10,524
-------- --------
Total assets .......................................... $838,029 $785,399
======== ========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except for share data)
June 30, 1999 December 31, 1998
------------- -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits ............................................ $ 457,277 $ 433,979
Advances from Federal Home Loan Bank ................ 199,153 168,142
Advance payments by borrowers for taxes and insurance 72,393 77,334
Notes payable ....................................... 6,466 368
Deferred taxes ...................................... 1,984 2,847
Other liabilities ................................... 10,400 9,019
--------- ---------
Total liabilities ................................... 747,673 691,689
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; 7,111,000 and
7,575,000 shares outstanding
at June 30, 1999
and December 31, 1998, respectively ........... 71 76
Additional paid-in capital .......................... 55,063 58,681
Stock acquired by ESOP .............................. (3,770) (4,089)
Deferred compensation ............................... (644) (843)
Accumulated other comprehensive income (loss),
net of income taxes of $175 and
($83) at June 30, 1999 and
December 31, 1998, respectively ............... (341) 162
Retained earnings ................................... 39,977 39,723
--------- ---------
Total stockholders' equity .......................... 90,356 93,710
--------- ---------
Total liabilities and stockholders' equity .......... $ 838,029 $ 785,399
========= =========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
1999 1998 1999 1998
------- ------- ------- -------
Interest income:
Loans .............................. $11,869 $ 9,894 $23,491 $19,647
Investment securities .............. 760 1,425 1,574 3,005
Other .............................. 17 3 62 12
------- ------- ------- -------
Total interest income ...................... 12,646 11,322 25,127 22,664
Interest expense:
Deposits ............................. 4,849 4,625 9,531 9,180
Federal Home Loan Bank
advances ........................... 2,107 964 4,089 1,935
Notes payable ........................ 166 -- 258 --
------- ------- ------- -------
Total interest expense ..................... 7,122 5,589 13,878 11,115
------- ------- ------- -------
Net interest income ........................ 5,524 5,733 11,249 11,549
Provision for loan losses .................. 202 239 712 688
------- ------- ------- -------
Net interest income after provision
for loan losses ...................... 5,322 5,494 10,537 10,861
Non-interest expense ....................... 11,556 3,763 22,673 7,322
Non-interest income ........................ 9,846 585 18,838 1,069
------- ------- ------- -------
Income before income taxes ................. 3,612 2,316 6,702 4,608
Income taxes ............................... 1,241 771 2,373 1,555
------- ------- ------- -------
Net income ................................. $ 2,371 $ 1,545 $ 4,329 $ 3,053
======= ======= ======= =======
Earnings per share: (Note 4)
Basic ................................ $ .37 $ .21 $ .66 $ .40
======= ======= ======= =======
Diluted .............................. $ .35 $ .20 $ .63 $ .39
======= ======= ======= =======
Dividends declared per share (Note 3) ...... $ .10 $ .09 $ .20 $ .18
======= ======= ======= =======
Average number of shares
Outstanding: (Note 4)
Basic .................... 6,489 7,464 6,614 7,553
======= ======= ======= =======
Diluted .................. 6,670 7,814 6,835 7,917
======= ======= ======= =======
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
1999
----------------------------------------------------
Stock Acquired By
------------------------
Additional Management
Common Paid-in Recognition
Stock Capital ESOP Plan
-------- -------- -------- --------
Balance at January 1 .................... $ 76 $ 58,681 $ (4,089) $ (843)
Comprehensive income:
Net Income
Change in unrealized gains (losses)
net of income taxes of $258 and
($18) for 1999 and 1998,
respectively
Total comprehensive income
ESOP shares released .................... 162 319
Amortization of deferred compensation
of Management Recognition Plan ..... 199
Shares issued under stock option plan ... 257
Purchase of common stock for
treasury ........................... (5) (4,037)
Dividends declared (Note 3)
-------- -------- -------- --------
Balance at June 30 ...................... $ 71 $ 55,063 $ (3,770) $ (644)
======== ======== ======== ========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued)
(UNAUDITED)
(Amounts in Thousands)
1999 1998
--------------------------------------------------- -------------
Net Unrealized
gains (losses) on Total Total
available-for- Retained Stockholders' Stockholder's
sale securities Earnings Equity Equity
--------------- -------- ------ ------
Balance at January 1 .................................... $ 162 $ 39,723 $ 93,710 $106,885
Comprehensive income:
Net Income ........................................ 4,329 4,329 3,053
Change in unrealized gains (losses)
net of income taxes of $258 and
($18) for 1999 and 1998, respectively ..... (503) (503) 36
-------- --------
Total comprehensive income .............................. 3,826 3,089
ESOP shares released .................................... 481 599
Amortization of deferred compensation
of Management Recognition Plan .......................... 199 276
Shares issued under stock option plan ................... 257 393
Purchase of common stock for
treasury ........................................... (2,742) (6,784) (6,598)
Dividends declared (Note 3) ............................. (1,333) (1,333) (1,372)
-------- -------- -------- --------
Balance at June 30 ...................................... $ (341) $ 39,977 $ 90,356 $103,272
======== ======== ======== ========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
Six Months
Ended June 30,
1999 1998
--------- ----------
Operating Activities
Net income ..................................................... $ 4,329 $ 3,053
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses ................................ 712 688
Provision for depreciation ............................... 851 517
Net securities amortization .............................. 67 (11)
Amortization of mortgage servicing rights ................ 6,353 28
Amortization of goodwill ................................. 271 --
Gain on sale of loans .................................... (3,196) (263)
Gain on sale of mortgage servicing rights ................ (479) --
Amortization of Management Recognition Plan
deferred compensation .............................. 199 276
Release of ESOP Shares ................................... 481 599
Loss (gain) on disposal of office properties and equipment 3 (1)
Deferred federal income tax (credit) provision ........... (605) 163
Proceeds from sale of loans .............................. 676,360 15,107
Proceeds from sale of mortgage servicing rights .......... 2,610 --
Origination of mortgage servicing rights, net ............ (13,449) (190)
Origination of loans held for sale ....................... (709,781) (18,065)
Increase in interest receivable and other assets ......... (3,067) (832)
Net repurchase of loans serviced for others .............. (14,344) --
Increase in other liabilities ............................ 1,111 2,425
--------- ---------
Net cash (used in) provided by operating activities ............ (51,574) 3,494
Investing Activities
Proceeds from maturities of held-to-maturity securities ........ 2,232 4,274
Proceeds from maturities of available-for-sale securities ...... 16,729 22,167
Proceeds from sales of real estate, mobile homes, and
other assets held for sale ............................... 1,054 943
Proceeds from sales of office properties and equipment ......... 8 15
Purchases of available-for-sale securities ..................... (16,224) (6,316)
Purchases of Federal Home Loan Bank stock ...................... (1,116) (137)
Purchases of office properties and equipment ................... (2,117) (1,846)
Adjustment of acquisition of Insurance Center .................. (126) --
Acquisition of Moreland Greens, net of cash received ........... 243 --
Net increase in loans receivable ............................... (6,559) (21,961)
--------- ---------
Net used in by investing activities ............................ (5,876) (2,861)
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
Six Months Ended
June 30,
1999 1998
------- -------
Financing Activities
Net increase in deposits and advance payments by borrowers
for taxes and insurance ............................ 18,357 9,171
Repayment of Federal Home Loan Bank long-term advances ... (843) (725)
Proceeds from Federal Home Loan Bank long-term advances .. -- 25,000
Repayment of term notes payable .......................... (55) --
Net increase (decrease) in Federal Home Loan Bank
short-term advances ................................ 31,854 (29,800)
Purchase of common stock for treasury .................... (6,784) (6,598)
Cash dividends paid ...................................... (1,379) (1,405)
Proceeds from exercise of stock options .................. 257 393
-------- --------
Net cash provided by (used in) financing activities ...... 41,407 (3,964)
-------- --------
Decrease in cash and cash equivalents .................... (16,043) (3,331)
Cash and cash equivalents at beginning of period ......... 20,506 8,997
-------- --------
Cash and cash equivalents at end of period ............... $ 4,463 $ 5,666
======== ========
Supplemental cash flow information:
Interest paid ............................................ $ 13,981 $ 11,379
======== ========
Income taxes paid ........................................ $ 3,125 $ 1,354
======== ========
Transfers from loans to real estate, mobile homes
and other assets held for sale ..................... $ 1,793 $ 867
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities ...... $ (258) $ (18)
======== ========
Noncash investing activities:
(Decrease) increase in net unrealized gain or loss on
available-for-sale securities ...................... $ (761) $ 54
======== ========
Exchange of debt for equity position in Moreland Greens .. $ 3,701 $ --
======== ========
Noncash financing activities:
Cash dividends declared but not paid ..................... $ 664 $ 687
======== ========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at June 30, 1999)
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1. Principles of Consolidation
The consolidated condensed financial statements include the accounts of
First Defiance Financial Corp. ("First Defiance" or "the Company"), its
two wholly subsidiaries, First Federal Savings and Loan ("First Federal"),
and the Insurance Center of Defiance ("Insurance Center") 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, 1998 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 June
30, 1999 and for the three-month and six-month periods ending June 30,
1999 and 1998 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 1998 annual report on Form 10-K for the year ended
December 31, 1998. 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-month and six-month periods ended June 30, 1999
are not necessarily indicative of the results that may be expected for the
entire year.
3. Dividends on Common Stock
As of June 30, 1999, First Defiance had declared a quarterly cash dividend
of $.10 per share for the second quarter of 1999, payable July 23, 1999.
4. Earnings Per Share
Basic earnings per share as disclosed under Statement of 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 and six-month periods ended June 30, 1999 and
1998. 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 six-months
ended June 30, 1999 and 1998, 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 (continued)
(Unaudited at June 30, 1999)
- --------------------------------------------------------------------------------
The following table sets forth the computation of basic and diluted
earning per share (in thousands except per share data):
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1999 1998 1999 1998
------ ------ ------ ------
Numerator for basic and diluted
earnings per share - net income ........ $2,371 $1,545 $4,329 $3,053
====== ====== ====== ======
Denominator:
Denominator for basic earnings per
share - weighted average shares ..... 6,489 7,464 6,614 7,553
Effect of dilutive securities:
Employee stock options .............. 101 257 129 263
Unvested Management Recognition
Plan stock ..................... 80 93 92 101
------ ------ ------ ------
Dilutive potential common shares ....... 181 350 221 364
====== ====== ====== ======
Denominator for diluted earnings
per share - adjusted weighted average
shares and assumed conversions ...... 6,670 7,814 6,835 7,917
====== ====== ====== ======
Basic earnings per share .................. $ .37 $ .21 $ .66 $ .40
====== ====== ====== ======
Diluted earnings per share ................ $ .35 $ .20 $ .63 $ .39
====== ====== ====== ======
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at March 31, 1999)
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5. Mortgage Servicing Rights
The activity in Mortgage Servicing Rights ("MSRs") is summarized as
follows (in thousands):
Six Months
Ended Year Ended
June 30, December 31,
1999 1998
----- ----
Balance at beginning of period ............. $ 76,452 $ 188
Acquired in purchase of The Leader ......... -- 65,804
Purchases .................................. -- 3,417
Sale of servicing rights, net .............. (2,131) --
Loans sold servicing retained .............. 13,449 12,428
Amortization ............................... (6,353) (5,385)
-------- --------
Balance at end of period ................... $ 81,417 $ 76,452
======== ========
Accumulated amortization of mortgage servicing rights aggregated
approximately $11.1 million and $5.4 million at June 30, 1999 and December
31, 1998, respectively.
The Company's servicing portfolio (excluding subserviced loans) is
comprised of the following as of June 30, 1999 (dollars in thousands):
Principal
Number Balance
of Loans Outstanding
-------- -----------
GNMA 56,530 $3,525,775
FNMA 10,874 668,897
FHLMC 2,532 105,203
Other VA, FHA and
Conventional loans 14,088 822,969
------ -----------
84,024 $5,122,844
======= ==========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 1999)
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6. Line of Business Reporting
First Defiance operates two major lines of business. Retail banking, which
consists of the operations of First Federal, includes direct and indirect
lending, deposit-gathering, small business services and consumer finance.
Mortgage banking, which consists of the operations of The Leader, includes
buying and selling mortgages in the secondary market and the subsequent
servicing of these sold loans. The channels through which the product or
service is delivered identify the business units. The retail-banking unit
funds the mortgage-banking unit and an investment/funding unit within the
retail-banking unit centrally manages interest rate risk. Transactions
between business units are primarily conducted at fair value, resulting in
profits that are eliminated for reporting consolidated results of
operations.
The parent unit is comprised of the operations of the Insurance Center and
inter-segment income eliminations and unallocated expenses. Selected
segment information in the following table includes only the three and
six-months ended June 30, 1999, as there was only a retail banking segment
for the three and six-months ended June 30, 1998.
Three-Months Ended June 30, 1999
--------------------------------
(In Thousands)
Parent Retail Mortgage
Consolidated and Other Banking Banking
------------ --------- ------- -------
Total interest income .... $ 12,646 $ (3,239) $ 13,116 $ 2,769
Total interest expense ... 7,122 (3,554) 8,421 2,255
--------- --------- --------- ---------
Net interest income ...... 5,524 315 4,695 514
Provision for loan losses 202 -- (237) 439
--------- --------- --------- ---------
Net interest income after
Provision .......... 5,322 315 4,932 75
Non-interest income ...... 9,846 (839) 1,936 8,749
Non-interest expense ..... 11,556 362 3,926 7,268
--------- --------- --------- ---------
Income before income taxes 3,612 (886) 2,942 1,556
Income taxes ............. 1,241 62 618 561
--------- --------- --------- ---------
Net income ............... $ 2,371 $ (948) $ 2,324 $ 995
========= ========= ========= =========
Total assets ............. $ 838,029 $(320,051) $ 844,033 $ 314,047
========= ========= ========= =========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at June 30, 1999)
- --------------------------------------------------------------------------------
6. Line of Business Reporting - Continued
Six-Months Ended June 30, 1999
------------------------------
(In Thousands)
Parent Retail Mortgage
Consolidated and Other Banking Banking
------------ --------- ------- -------
Total interest income .... $ 25,127 $ (5,837) $ 25,837 $ 5,127
Total interest expense ... 13,878 (6,638) 16,586 3,930
--------- --------- --------- ---------
Net interest income ...... 11,249 801 9,251 1,197
Provision for loan losses 712 -- (116) 828
--------- --------- --------- ---------
Net interest income after
Provision .......... 10,537 801 9,367 369
Non-interest income ...... 18,838 (1,221) 3,652 16,407
Non-interest expense ..... 22,673 578 7,848 14,247
--------- --------- --------- ---------
Income before income taxes 6,702 (998) 5,171 2,529
Income taxes ............. 2,373 258 1,153 962
--------- --------- --------- ---------
Net income ............... $ 4,329 $ (1,256) $ 4,018 $ 1,567
========= ========= ========= =========
Total assets ............. $ 838,029 $(320,051) $ 844,033 $ 314,047
========= ========= ========= =========
7. Acquisitions
On July 1, 1998, First Federal completed the acquisition of The Leader, 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, including $2 million held in escrow for indemnifiable claims,
exceed fair value of net assets acquired by approximately $11.3 million,
which was recorded as goodwill.
On December 24, 1998, First Defiance completed the acquisition of the
Insurance Center in a stock transaction valued at $2.1 million. The
acquisition has been accounted for as a purchase. First Defiance could be
subject to additional contingent consideration of up to $400,000 if
certain earning criteria are met.
Comparability of the three and six-months ended June 30, 1999 and 1998 is
affected substantially by the acquisition of The Leader, as the results of
operations for the three and six-months ended June 30, 1998 do not include
any effects of this transaction.
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 two
wholly owned subsidiaries, First Federal Savings and Loan, Defiance Ohio ("First
Federal") and the Insurance Center of Defiance ("Insurance Center") 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 six 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. First Federal
is subject to the regulations of certain federal agencies and undergoes periodic
examinations by those regulatory authorities. 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. The Insurance Center is
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.
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 and had a recorded value of $11.3
million at June 30, 1999. Securities not classified as held-to-maturity are
classified as available-for-sale, which are stated at fair value and had a
recorded value of $46.2 million at June 30, 1999. The available-for-sale
portfolio consists of U.S. Treasury securities and obligations of U.S.
Government corporations and agencies ($11.2 million), corporate bonds ($11.2
million), certain municipal obligations ($5.5 million), adjustable-rate mortgage
backed security mutual funds ($8.7 million), CMOs and REMICs ($7.3 million),
preferred stock ($2.0 million), and corporate equities ($300,000). 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 losses on available-for-sale securities were $516,000 at June
30, 1999, $341,000 after considering the related deferred tax benefit.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
The profitability of First Defiance is primarily dependent on its net interest
income and non-interest income. Net interest income is the difference between
interest 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
loan administration fees, gains on sales of mortgage loans, and the recognition
of mortgage servicing rights generated by The Leader and First Federal. First
Defiance's earnings also depend on the provision for loan losses and its
non-interest expenses, such as employee compensation and benefits, occupancy and
equipment expense, deposit insurance premiums, and miscellaneous other expenses,
as well as federal income tax expense.
Changes in Financial Condition
- ------------------------------
At June 30, 1999, First Defiance's total assets, deposits (including customer's
escrow deposits) and stockholders' equity amounted to $838.0 million, $529.7
million and $90.4 million, respectively, compared to $785.4 million, $511.3
million and $93.7 million, respectively, at December 31, 1998.
Net loans receivable have increased from $448.6 million at December 31, 1998 to
$468.0 million at June 30, 1999. This increase was funded primarily with
maturing or redeemed securities and increases in Federal Home Loan Bank
advances. Loans held for sale increased from $119.9 at December 31, 1998 to
$155.2 million at June 30, 1999. This increase was primarily the result of the
operations of The Leader.
Securities decreased from $61.1 million at December 31, 1998 to $57.5 million at
June 30, 1999 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"). In addition,
deposits increased from $434.0 million at December 31, 1998 to $457.3 million as
of June 30, 1999. This increase was primarily the result of obtaining brokered
certificates of deposit, which in conjunction with FHLB advances were used to
fund increased mortgage banking activities at The Leader and increased loan
demand (primarily commercial loans) at First Federal. FHLB advances increased
from $168.1 million at December 31, 1998 to $199.2 million at June 30, 1999.
First Defiance has continued to repurchase shares of its stock. As of June 30,
1999, First Defiance has repurchased 509,907 shares of its own stock during 1999
at a total cost of $6.8 million, an average of $13.31 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", 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 June 30,
-------------------------------------------------------------------------
1999 1998
----------------------------------- ----------------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable ................. $633,800 $ 11,869 7.49% $458,935 $ 9,894 8.62%
Securities ....................... 55,431 777 5.61 90,115 1,428 6.34
FHLB stock ....................... 11,736 221 7.53 3,832 69 7.20
-------- -------- -------- --------
Total interest-earning assets .... 700,967 12,867 7.34 552,882 11,391 8.24
Non-interest-earning assets ......... 137,596 28,922
-------- --------
Total assets ..................... $838,563 $581,804
======== ========
Interest-bearing liabilities:
Deposits ......................... $475,717 $ 4,849 4.08% $405,870 $ 4,625 4.56%
FHLB advances and other .......... 172,372 2,107 4.89 66,703 964 5.78
Notes payable .................... 11,113 166 5.97 --
-------- -------- -------- --------
Total interest-bearing liabilities 659,202 7,122 4.32 472,573 5,589 4.73
Non-interest-bearing liabilities .... 88,117 6,030
-------- --------
Total liabilities ................ 747,319 478,603
Stockholders' equity ................ 91,244 103,201
======== ========
Total liabilities and stock-
holders' equity ............. $838,563 $581,804
======== ========
Net interest income; interest
rate spread ...................... $ 5,745 3.02% $ 5,802 3.51%
======== ==== ======== ====
Net interest margin (2) ............. 3.28% 4.20%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities ...................... 106% 117%
=== ====
(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
- --------------------------------------------------------------------------------
Six Months Ended June 30,
------------------------------------------------------------------------------
1999 1998
----------------------------------- -----------------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable ................. $613,702 $ 23,491 7.66% $452,218 $ 19,647 8.69%
Securities ....................... 55,471 1,636 5.90 94,499 3,017 6.39
FHLB stock ....................... 11,573 418 7.22 3,799 137 7.21
-------- -------- -------- --------
Total interest-earning assets .... 680,746 25,545 7.51 550,516 22,801 8.28
Non-interest-earning assets ......... 134,123 28,272
-------- --------
Total assets ..................... $814,869 $578,788
======== ========
Deposits ......................... $466,414 $ 9,531 4.09% $401,814 $ 9,181 4.57%
FHLB advances and other .......... 168,043 4,089 4.87 66,750 1,935 5.80
Notes payable .................... 8,591 258 6.01 -- --
-------- -------- -------- --------
Total interest-bearing liabilities 643,048 13,878 4.32 468,564 11,116 4.74
Non-interest-bearing liabilities .... 79,924 5,907
-------- --------
Total liabilities ................ 722,972 474,471
Stockholders' equity ................ 91,897 104,317
-------- --------
Total liabilities and stock-
holders' equity ............. $814,869 $578,788
======== ========
Net interest income; interest
rate spread ...................... $ 11,667 3.19% $ 11,685 3.54%
======== ==== ======== ====
Net interest margin (2) ............. 3.43% 4.25%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities ...................... 106% 117%
=== ====
(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 June 30, 1999 compared to Three Months Ended June 30, 1998
- -----------------------------------------------------------------------------
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 $2.4 million for the
three months ended June 30, 1999 compared to $1.5 million for the same period in
1998. On a per share basis, basic and diluted earnings per share were $.37 and
$.35, respectively, for the 1999 second quarter compared to $.21 and $.20 basic
and diluted per share earnings for the 1998 second quarter. The sources of that
income have changed dramatically with the acquisition of The Leader. 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 its 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.
Net Interest Income. Net interest income before provision for loan losses
decreased to $5,524,000 for the three-month period ending June 30, 1999 from
$5,733,000 for the same period in 1998. The Company's net interest margin
decreased to 3.28% for the quarter ended June 30, 1999 as compared to 4.20% for
the quarter ended June 30, 1998. 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 1999 second quarter was
3.02%, which was 49 basis points lower than the 1998 first quarter level of
3.51%. The decrease in net interest margin is due primarily to the acquisition
of The Leader and the financing required to fund its mortgage banking
operations. Included in those requirements is the cost of borrowings required to
finance the acquisition of mortgage servicing rights, the average balance of
mortgage servicing rights for the quarter ended June 30, 1999 totaled
approximately $79.0 million. This financing negatively impacts net interest
margin because mortgage servicing rights are a non-interest earning asset. Other
factors affecting net interest margin include an increase in Federal Home Loan
Bank borrowings to fund the acquisition of The Leader, the growth in The
Leader's held for sale portfolio, the below market rate of interest on loans
held in The Leader's held for sale portfolio, and repurchases of First
Defiance's stock. The average coupon rate on loans held for sale by The Leader
at June 30, 1999 was less than 6.5%.
Total interest income increased by $1.3 million, or 11.7%, from $11.3 million
for the three months ended June 30, 1998 to $12.6 million for the three months
ended June 30, 1999. The increase was due to a $174.9 million increase in the
average balance of loans outstanding for the second quarter of 1999 when
compared to the same period in of 1998. The yield on those loans declined to
7.49% in 1999 versus 8.62% in 1998. The increase in loans receivable was
primarily attributable to the acquisition of The Leader's loans available for
sale. Those loans averaged $163.3 million for the three months ended June 30,
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
1999. The inclusion of those loans also caused the reduced yield because of the
below market nature of loans originated under the first-time homebuyer programs.
Interest income was favorably impacted by the increase in the average balance in
commercial loans, which was $99.4 million as of June 30, 1999 compared to $33.6
million as of June 30, 1998. The increase in commercial loan balances occurred
after the hiring of three experienced commercial lenders and a commercial credit
analyst during the second half of 1998.
Interest earnings from the investment portfolio declined to $760,000 for the
three months ended June 30, 1999 compared to $1.4 million for the same period in
1998. The decline in 1999 was due to a decrease in the average balance of
securities from $90.1 million for the three-month period ended June 30, 1998 to
$55.4 million for the same period in 1999. The decline was primarily due to
agency securities with call provisions being called during the low rate
environment, particularly during the second half of 1998. The yield on the
average portfolio balance for the three months ended June 30, 1999 was 5.61%
compared to 6.34% for the same period in 1998.
Interest expense increased by $1.5 million, or 27.4%, to $7.1 million for the
second quarter of 1999 compared to $5.6 million for the same period in 1998. The
increase is primarily due to the financing requirements of The Leader's
operations. When it was acquired, The Leader had debt arrangements with a
consortium of banks that provided financing for its mortgage loan warehouse and
also for the acquisition of mortgage servicing rights. Those debt agreements
were replaced during December 1998 with financing from First Federal Savings and
Loan, which was funded through deposits (both retail and brokered) and FHLB
advances. The average balance in national and brokered certificates of deposit
increased to $54.2 million for the quarter ended June 30, 1999 from $8.6 million
for the same period in 1998. The average financing required to fund The Leader's
operations for the three months ended June 30, 1999 was approximately $163.3
million, net of the $76.6 million average balance in The Leader's customer's
escrow deposits at First Federal.
Interest expense also increased because of an increase in the average balance of
deposits outstanding, which increased to $475.7 million for the three months
ended June 30, 1999 compared to $405.9 million for the three months ended June
30, 1998. The average cost of those deposits declined by 48 basis points in the
second quarter of 1999, to 4.08% from 4.56% for the same period in 1999. The
average balance of FHLB advances increased to $172.4 million in for the three
months ended June 30, 1999 from $66.7 million for the comparable period in 1998.
The average cost of those advances declined to 4.89% from 5.78% for the three
months ended June 30, 1999 and 1998, respectively. The balance in FHLB advances
increased substantially in December 1998, as they were used as the primary
source of funding to replace The Leader's bank debt.
Provision for Loan Losses. The provision for loan losses decreased slightly
during the 1999 second quarter to $202,000 compared to $239,000 for the same
period in 1998. 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.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
Non-performing assets, which include loans 90 days or more past due, loans
deemed impaired, and repossessed assets totaled $4.1 million at June 30, 1999,
which is .49% of total assets. Non-performing loans and repossessed assets
reported do not include $20.9 million of mortgage loans 90 days or more past due
which have FHA insurance or VA guarantees. The risk of loss on these loans is
generally limited to the administrative cost of foreclosure actions, which is
provided for in the allowance for loan losses. The allowance for loan losses at
June 30, 1999 was $8.5 million compared to $2.9 million at June 30, 1998 and
$9.8 million at December 31, 1998. The Leader acquisition accounted for $1.5
million of the increase in the allowance from June 30, 1998 to June 30, 1999.
During the fourth quarter of 1998, First Federal recorded a $5.4 million
adjustment to the Company's allowance for loan losses. Of this adjustment $3.6
million resulted from internal and external reviews of the Company's consumer
loan portfolio, specifically indirect lending. For the quarter ended June 30,
1999, First Defiance charged off $1.1 million of loans against its allowance and
realized recoveries of $96,000 from loans previously charged off. These charge
offs include the indirect auto originations discussed above and the final
disposition of the mobile home portfolio, both of which were fully reserved
during the fourth quarter of 1998. During the same quarter in 1998, First
Defiance charged off $190,000 in loans and realized recoveries of $59,000.
Non-Interest Income. Non-interest income increased substantially in the second
quarter of 1999, from $585,000 for the quarter ended June 30, 1998 to $9.8
million for the same period in 1999. The addition of The Leader contributed $8.7
million of the $9.2 million increase in non-interest income from the second
quarter of 1998 to the second quarter of 1999.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$320,000 for the quarter ended June 30, 1998 to $7.0 million for the same period
in 1999. The increase of $6.7 million from the quarter ended June 30, 1998 to
1999 was primarily the result of growth in service fees on sold loans, late
charge income, and origination fees of $5.2 million, $753,000, and $615,000,
respectively, due to the addition of The Leader.
Gain on Sale of Loans. Gain on sale of loans increased from $143,000 for the
quarter ended June 30, 1998 to $1.6 million for the same period of 1999. The
Leader recognized gains on sale of loans of $1.4 million for the second quarter
of 1999, while First Federal recognized $235,000 in the same period.
Gain on Sale of Loan Servicing. The gain on sale of loan servicing for the
quarter ended June 30, 1999 was the result of a $479,000 gain realized on the
sale of non-core servicing rights. The servicing rights sold had a weighted
average coupon of 9.36% and an average delinquency of 13.64%. There were no
sales of loan servicing in the previous year. The Company does not anticipate
that it will be selling servicing in this manner on a regular basis.
Other Non-Interest Income. Other non-interest income, including dividends on
Federal Home Loan Bank stock, gains on sale of securities, insurance commission
income, and other miscellaneous charges, increased to $777,000 for the quarter
ended June 30, 1999 from $121,000 for the same period in 1998. The acquisition
of the Insurance Center accounted for $219,000 of the increase over the second
quarter of 1998.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
Non-Interest Expense. Total non-interest expense increased $7.8 million from
$3.8 million for the quarter ended June 30, 1998 to $11.6 million for the same
period in 1999. The acquisition of The Leader resulted in $7.3 million of this
increase.
Compensation and Benefits. Compensation and benefits increased $2.7 million from
$2.0 million for the quarter ended June 30, 1998 to $4.7 million for the same
period in 1999. The addition of The Leader was responsible of $2.4 million of
this increase. Increases in overall staffing related to the Findlay commercial
loan production office and the Findlay branch (which opened August 1998 and
February 1999, respectively) and the acquisition of the Insurance Center
resulted in an additional $329,000 increase in the Company's compensation
expense.
Occupancy. Occupancy expense increased to $1.0 million for the three-month
period ended June 30, 1999 from $430,000 for the three months ended June 30,
1998. The Leader accounted for $412,000 of this increase. The remainder of the
increase was due to increased depreciation brought about by the addition of one
new branch, the cost of both the Findlay loan office and the Findlay branch
which opened in February of 1999 and continued upgrades to all of the Company's
computer hardware and software to improve services provided as well as to assure
Year 2000 compliance.
Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing
rights (MSRs) increased to $3.1 million for the quarter ended June 30, 1999 from
$24,000 for the same period in 1998. The Leader accounted for $3.0 million of
this increase.
Amortization of Goodwill and Other Acquisition Related Costs. As a result of the
purchases of The Leader and the Insurance Center, $576,000 in amortization of
goodwill and other acquisition related costs was recognized in the second
quarter of 1999.
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 June 30, 1999 from $1.3 million for the
same period in 1998. $897,000 of the increase was the result of The Leader's
normal operating activities for the second quarter of 1999. 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 34.4% for the
quarter ended June 30, 1999 compared to 33.3% for the same period in 1998.
As a result of the above factors, net income for the quarter ended June 30, 1999
was $2,371,000 compared to $1,545,000 for the comparable period in 1998. On a
per share basis, basic and diluted earnings per share for the three months ended
June 30, 1999 was $.37 and $.35 respectively compared to $.21 and $.20,
respectively, for the same period in 1998. As stated above, the results for the
quarter were favorably impacted by the $479,000 gain realized on the sale of
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
certain non-core mortgage servicing rights. The after tax gain resulting from
the sale of the servicing was $316,000 or $.05 per basic and diluted share. 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 a five percent
stock buy back and a fifteen percent stock buy back completed since the
beginning of 1998. Average shares outstanding for the basic and diluted
calculations were 6,489,000 and 6,670,000, respectively, for the quarter ended
June 30, 1999 compared to 7,464,000 and 7,814,000, respectively, for the quarter
ended June 30, 1998. First Defiance's board of directors approved an additional
five percent stock buy back beginning April 26, 1999 under which First Defiance
will acquire an additional 358,000 shares of its stock. As of June 30, 1999,
51,618 shares have been purchased under this program.
First Defiance's board of directors declared a dividend of $.10 per common share
as of June 30, 1999. The dividend amounted to $716,418, including dividends on
unallocated ESOP shares. It was paid on July 23, 1999. 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.
Six Months Ended June 30, 1999 compared to Six Months Ended June 30, 1998
The acquisition of The Leader also significantly impacted the results for the
six months ended June 30, 1999 compared to the same period in 1998. Net income
for the 1999 period was $4.3 million, or $.63 per diluted share compared to $3.1
million or $.39 per diluted share for the same period in 1998. Net interest
income decreased to $11.2 million for the 1999 six-month period compared to
$11.5 million for the same period in 1998 while non-interest income increased to
$18.8 million from $1.1 million and non-interest expense increased to $22.7
million from $7.3 million. The acquisition of The Leader was completed effective
July 1, 1998 and the 1998 results as of June 30, 1998 therefore do not include
any activity related to the mortgage banking subsidiary.
Net Interest Income. Net interest income before provision for loan losses
decreased to $11.2 million for the six-month period ending June 30, 1999
compared to $11.5 million for the same period in 1998. The Company's
year-to-date net interest margin through June 30, 1999 decreased to 3.43%
compared to 4.25% for the same period in 1998. Interest rate spread also
decreased to 3.19% for the six-month period ended June 30, 1999 from 3.54% for
the same period in 1998.
The decrease in net interest income and net interest margin is the result of the
acquisition of The Leader and the need to fund its mortgage banking operations,
especially the financing of mortgage servicing rights, which averaged $78.2
million for the six months ended June 30, 1999. Mortgage servicing rights are a
non-interest earning asset.
Interest rate spread decreased because of a 77 basis point decrease in the
average yield on interest earning assets, from 8.28% for the six-months ended
June 30, 1998 to 7.51% for the comparable period in 1999. This declining rate is
due to the inclusion of The Leader's available for sale loans, which averaged
$146.9 million for the six-month period ended June 30, 1999. The average yield
on those available for sale loans was 6.02% for the year-to-date period ended
June 30, 1999.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
The downward pressure on net interest income due to the above factors was
partially offset by increases in the average commercial loan balance, which was
$89.1 million for the first half of 1999 compared to only $32.0 million for the
same period in 1998. Also, the average cost of interest bearing liabilities
declined to 4.32% for the six-months ended June 30, 1999 compared to 4.74% for
the first half of 1998. During that period the average cost of deposits fell to
4.09% from 4.57% while the average cost of FHLB advances fell to 4.87% from
5.80%
Provision for Loan Losses. The provision for loan losses increased to $712,000
for the six-months ended June 30, 1999 compared to $688,000 for the same period
in 1998. First Defiance charged off $1.9 million of loans against its allowance
for loan losses for the six-month period ended June 30, 1999 and realized
recoveries of $146,000 from loans previously charged off. These charge offs
include a substantial number of 1997 and 1998 indirect auto originations and the
final disposition of the mobile home portfolio, both of which were fully
reserved during the fourth quarter of 1998. During the same period in 1998,
First Defiance charged off $603,000 in loans and realized recoveries of
$111,000.
Non-Interest Income. Non-interest income increased $17.7 million for the
six-month period ended June 30, 1999 from $1.1 million to $18.8 million for the
1998 and 1999 periods, respectively. The Leader contributed $16.4 million of
this increase.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$594,000 for the six-month period ended June 30, 1998 to $13.8 million for the
same period in 1999. The growth was due to service fees on sole loans,
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 of sale of loans increased from $263,000 for the
six-months ended June 30, 1999 to $3.7 million for the same period in 1999. This
was the result of gains on sales recorded by The Leader in their normal course
of business and increased secondary market activity at First Federal.
Gain on Sale of Loan Servicing. Results for the six-months ended June 30, 1999
included a $479,000 gain realized on the sale of non-core servicing rights as
discussed in the results of operations for the quarter ended June 30, 1999.
There were no sales of loan servicing during 1998. The Company does not
anticipate that it will be selling servicing in this manner on a regular basis.
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 $1.4 million for the first half of 1999 from
$213,000 for the same period in 1998.
Non-Interest Expense. Total non-interest expense increased $15.4 million from
$7.3 million for the six-month period ended June 30, 1998 to $22.7 for the same
period in 1999. The acquisition of The Leader caused $14.3 million of the
increase.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
Compensation and Benefits. Compensation and benefits increased $5.2 million from
$3.8 million for the year-to-date period ended June 30, 1998 to $9.0 million for
the same period in 1999. Decreases in Management Recognition Plan and Employee
Stock Ownership Plan expenses ($455,000 combined for the six-months ended June
30, 1999 compared to $586,000 for the same period in 1998) were offset by
increases due to The Leader's staff and the start up of the Findlay commercial
loan production and branch offices.
Occupancy. Occupancy expense increased to $1.9 million for the six-month period
ended June 30, 1999 from $840,000 for the same period in 1998. This increase
related to the acquisition of The Leader and increased depreciation due to the
addition of the Findlay loan production and branch offices along with continued
upgrades to all of the Company's computer hardware and software to assure Year
2000 compliance.
Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing
rights increased to $6.4 million for the six-month period ended June 30, 1999
from $28,000 for the same period in 1998.
Amortization of Goodwill and Other Acquisition Costs. $1.2 in amortization of
goodwill and other acquisition costs was recognized as of the six-month period
ended June 30, 1999, due to the purchase of The Leader and the Insurance Center.
Other Non-Interest Expenses. Other non-interest expenses (including state
franchise tax, data processing, deposit premiums, and loan servicing) increased
to $4.3 million for the six-month period ended June 30, 1999 compared to $2.7
million for the same period in 1998. The increase was due to the acquisition of
The Leader along with increased data processing costs at First Federal.
As a result of the above factors, net income for the six-month period ended June
30, 1999 increased to $4.3 million from $3.1 million for the six-months ended
June 30, 1998. On a per share basis, basic and diluted earnings per share for
the six months ended June 30, 1999 was $.66 and $.63 respectively compared to
$.40 and $.39, respectively, for the same period in 1998. As stated above the
results for the quarter were favorably impacted by the $479,000 gain realized on
the sale of certain non-core mortgage servicing rights. The after tax gain
resulting from the sale of the servicing was $316,000 or $.05 per basic and
diluted share. Average shares outstanding for the basic and diluted calculations
were 6,614000 and 6,835,000 respectively for the six-months ended June 30, 1999
compared to7,553,000 and 7,917,000 respectively for the same period in 1997.
Through June 30, 1999, First Defiance has declared dividends totaling $.20 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 exceeded applicable liquidity requirements throughout
the three-month period ended June 30, 1999.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
First Defiance utilized $51.6 million in cash for operating activities during
the first six months of 1999. The primary reason for this negative cash flow was
the build up in the Company's held for sale loan portfolio as a result of
increased loan purchases, primarily related to first-time home-buyer programs at
The Leader. The Company's operating activities include net income for the
period, adjusted for various non-cash items, including the provision for loan
losses, depreciation and amortization, including amortization of mortgage
servicing rights, ESOP expense related to release of shares, and changes in
loans held for sale, interest receivable and other assets, and other
liabilities. The primary investing activity of First Defiance is the origination
of loans (both for sale in the secondary market and to be held in portfolio),
which is funded with cash provided by operations, proceeds from the amortization
and prepayments of existing loans, the sale of loans, proceeds from the sale or
maturity of securities, borrowings from the FHLB, and customer deposits.
At June 30, 1999, First Defiance had $28.8 million in outstanding mortgage loan
commitments and loans in process to be funded generally within the next six
months and an additional $43.3 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 June 30,
2000 is $237.4 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, additional
advances from the FHLB of Cincinnati are available. In addition, First Defiance
has a $50 million warehouse line of credit with a bank under which it can borrow
utilizing mortgages available for sale as collateral. The Company also has a
Fed-Funds line of credit with another bank under which it can borrow up to $10
million.
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 June 30, 1999 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.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
The following table sets forth First Federal's compliance with each of the
capital requirements at June 30, 1999.
Tangible Core Risk-Based
Capital Capital Capital (1)(2)
--------- --------- ---------
(Dollars in Thousands)
Regulatory capital ................ $ 44,465 $ 44,465 $ 61,063
Minimum required regulatory
capital ........................ 12,088 32,235 46,537
--------- --------- ---------
Excess regulatory capital ......... $ 32,377 $ 12,230 $ 14,526
========= ========= =========
Regulatory capital as a
percentage of assets (3) ....... 5.5% 5.5% 10.5%
Minimum capital required as
a percentage of assets ......... 1.5% 4.0% 8.0%
--------- --------- ---------
Excess regulatory capital as a
percentage in excess of
requirement .................... 4.0% 1.5% 2.5%
========= ========= =========
(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 $805.9 million. Risk-based capital is computed as a percentage of
total risk-weighted assets of $581.7 million.
FDIC Insurance
The Deposits of First Federal are currently insured by the Savings Association
Insurance Fund("SAIF") which is administered by the FDIC. The FDIC also
administers the Bank Insurance Fund ("BIF") which generally provides insurance
to commercial bank depositors. Both the SAIF and BIF are required by law to
attain and maintain a reserve ratio of 1.25% of insured deposits. First
Federal's deposit insurance premiums for 1999 are approximately $0.064 per $100
of deposits.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
Year 2000 Readiness
All companies, including First Defiance and its subsidiaries, 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 problem.
First Federal outsources the majority of its data processing needs to BISYS,
Inc. Applications maintained by BISYS include savings, checking, mortgage loans
and consumer 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, and First Federal has successfully tested all of
First Federal's BISYS applications for a variety of key dates in 1999, 2000 and
beyond.
First Federal processes its general ledger on a system that is integrated with
the BISYS applications. Testing of the general ledger interface was performed by
management during the 1999 first quarter in conjunction with other system
testing.
First Federal's in-house computing environment consists of a Wide Area Network
("WAN") system that links together its 12 branches and is interfaced with the
BISYS applications. All hardware associated with the WAN has been tested and is
Year 2000 compliant.
In addition to BISYS, First Federal is dependent on a number of other third
parties to provide various processing. Management has successfully tested the
interchange of data among and between these various third party providers that
include the Federal Reserve Bank of Cleveland, the Federal Home Loan Bank of
Cincinnati, the MAC ATM network, and various ACH providers.
Because its data processing functions are outsourced, the cost of Year 2000
remediation has not been material to First Federal. BISYS is assessing a fee of
less than $50,000 to cover the cost of the test bank established to provide for
the appropriate testing. Testing itself is being performed by individuals
responsible for the various applications and is being coordinated by First
Federal's internal auditor in coordination with First Federal's Sr. Vice
President of Operations. The cost of the individuals has not been quantified,
however the three primary individuals involved have devoted approximately 60% of
their time during the testing phase which was essentially completed during the
1999 first quarter. First Federal's total out of pocket expenses recognized in
conjunction with Year 2000 compliance are expected to be less than $100,000 in
1999.
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 upgraded and tested and management believes it is functioning
properly and will continue to function properly in the Year 2000. The Company's
most mission critical systems, the loan servicing system and the wholesale bond
system, have been modified to process dates in the Year 2000 and are fully
operational.
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. The Leader participated in a
Year 2000 readiness test in conjunction with the Mortgage Bankers of America. As
part of that test, The Leader successfully conducted data interchange testing
with Fannie Mae, Freddie Mac and GNMA.
The estimated total cost of Year 2000 compliance by The Leader is approximately
$650,000 including the cost of hardware and software upgrades, programming
costs, and retention bonuses to key staff members involved in the Year 2000
project. Approximately 80% of the cost has been expended to date with the
majority of those costs being equipment upgrades. The portion of the costs
associated with hardware acquisitions is being capitalized while internal
programming costs and retention payments are being expensed. Estimated Year 2000
expense for The Leader for 1999 is not anticipated to exceed $300,000.
In addition to the mission critical systems identified by both First Federal and
The Leader, both entities 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. The
only significant system that management has identified as needing to be replaced
is the phone system at The Leader, which also includes the Interactive Voice
Response Unit and the Voice Mail components. Management is in the process of
installing its replacement phone system. The estimated cost of the replacement
phone system is included in The Leader's estimate of $650,000 in total Year 2000
costs.
The Company is attempting to limit the potential impact of the Year 2000 by
monitoring the progress of its own Year 2000 projects and those of its critical
external relationships. While management believes that all critical Year 2000
issues will be resolved, it cannot guarantee that all such issues will be
resolved. Any critical unresolved Year 2000 issues could have a material adverse
effect on the Company's results of operations, liquidity or financial condition.
In addition to Year 2000 remediation efforts, the Company is developing
contingency/recovery plans aimed at ensuring the continuity of critical
functions. As part of this process, management has developed an assessment of
reasonably likely failure scenarios for its critical systems and has developed
plans that are designed to reduce the impact on the Company, and provide methods
of returning to normal operations, if one or more of those scenarios occur. A
variety of automated and manual fallback plans are under consideration,
including the use of electronic spreadsheets, resetting system dates, and manual
workarounds. The Company estimates that contingency planning (including testing)
will be completed by September 1999.
Readiness for the Year 2000 is also a concern for First Defiance's customers,
particularly its commercial lending customers. Management continues to assess
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. Also, to the extent possible, management is
considering the risk associated with not being Year 2000 compliant when
evaluating the adequacy of the allowance for loan losses for individual
commercial loan customers.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations -Continued
- --------------------------------------------------------------------------------
Statements made herein about the implementation of First Defiance's Year 2000
remediation, the costs expected to be associated with those efforts and the
results that First Defiance expects to achieve constitute forward looking
information. As noted above, there are many uncertainties involved in the year
2000 issue, including the extent to which First Defiance will be able to
successfully remediate systems and adequately provide for contingencies that may
arise, as well as the broader scope of the Year 2000 issues as it may affect
third parties that are not controlled by First Defiance. Accordingly, the costs
and results of First Defiance's Year 2000 program and the extent of any impact
on First Defiance's operations could vary materially from those stated herein.
Item 3. Qualitative and Quantitative Disclosure About Market Risk
- -----------------------------------------------------------------
As discussed in detail in the 1998 Annual Report in 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 monitory 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 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
June 30, 1999 amounts as a base case, First Defiance's net interest income would
be impacted by less than the board mandated guidelines of 10%.
The simulation model used by First Defiance measures the impact of rising and
falling interest rates on net interest income only. The Company also monitors
the potential change in the value of its mortgage-servicing portfolio given the
same 100 basis point shift in interest rates. At June 30, 1999, a 100 basis
point decrease in interest rate would not materially impact the valuation
reserve for mortgage servicing rights.
FIRST DEFIANCE FINANCIAL CORP.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
First Defiance is not engaged in any legal proceedings of a
material nature.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
Exhibit 27 - Financial Data Schedule
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: August 13, 1999 By: /s/ William J. Small
--------------- -----------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: August 13, 1999 By: /s/ John C. Wahl
--------------- -------------------
John C. Wahl
Executive Vice President, Chief
Financial Officer and
Treasurer