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, 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 -
6,960,268 shares outstanding at November 10, 1999.
FIRST DEFIANCE FINANCIAL CORP.
INDEX
PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements (Unaudited):
Consolidated Condensed Statements of Financial
Condition - September 30, 1999 and December 31, 1998
Consolidated Condensed Statements of Income Three
months ended September 30, 1999 and 1998;
Nine months ended September 30, 1999 and 1998
Consolidated Condensed Statement of Changes in
Stockholders' Equity - Nine months ended
September 30, 1999
Consolidated Condensed Statements of Cash Flows
- Nine months ended September 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)
September 30, 1999 December 31, 1998
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions ..................... $ 3,644 $ 16,137
Interest-bearing deposits ....................... 6,367 4,369
-------- --------
10,011 20,506
Securities:
Available-for-sale, carried at fair value ....... 46,610 47,554
Held-to-maturity, carried at amortized cost
(approximate fair value $10,594 and $13,753
at September 30, 1999 and December 31,
1998, respectively) ......................... 10,544 13,541
-------- --------
57,154 61,095
Loans held for sale (at lower of cost or fair value,
approximate fair value
$234,401 and $120,097 at September 30,
1999 and December 31,1998, respectively) ..... 234,401 119,910
Loans receivable, net ................................ 464,876 448,574
Mortgage servicing rights ............................ 88,011 76,452
Accrued interest receivable .......................... 3,990 3,605
Federal Home Loan Bank stock ......................... 13,259 10,826
Office properties and equipment ...................... 21,442 19,057
Real estate, mobile homes and other
assets held for sale ............................ 3,308 1,517
Goodwill, net ........................................ 14,862 13,333
Other assets ......................................... 20,762 10,524
-------- --------
Total assets ......................................... $932,076 $785,399
======== ========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(UNAUDITED)
(Amounts in Thousands, except for share data)
September 30, 1999 December 31, 1998
------------------ -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Deposits ................................................. $ 462,681 $ 433,979
Advances from Federal Home Loan Bank ..................... 235,783 168,142
Advance payments by borrowers for taxes and insurance .... 75,040 77,334
Mortgage warehouse and other notes payable ............... 56,097 368
Deferred taxes ........................................... 2,434 2,847
Other liabilities ........................................ 9,755 9,019
--------- ---------
Total liabilities ........................................ 841,790 691,689
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; 6,990,000 and 7,575,000
shares outstanding at
September 30, 1999
and December 31,1998, respectively .................. 70 76
Additional paid-in capital ............................... 54,250 58,681
Stock acquired by ESOP ................................... (3,664) (4,089)
Deferred compensation .................................... (539) (843)
Accumulated other comprehensive income (loss),
net of income taxes of $310 and
($83) at September 30, 1999 and
December 31, 1998, respectively ..................... (602) 162
Retained earnings ........................................ 40,771 39,723
--------- ---------
Total stockholders' equity ............................... 90,286 93,710
--------- ---------
Total liabilities and stockholders' equity ............... $ 932,076 $ 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 Nine Months Ended
September 30, September 30,
------------- -------------
1999 1998 1999 1998
------- ------- ------- -------
Interest income:
Loans ............................. $12,885 $11,830 $36,375 $31,477
Investment securities ............. 783 1,144 2,357 4,149
Other ............................. 33 2 96 14
------- ------- ------- -------
Total interest income ................... 13,701 12,976 38,828 35,640
Interest expense:
Deposits ........................... 4,964 4,645 14,495 13,825
Federal Home Loan Bank
advances ......................... 2,706 1,129 6,796 3,064
Notes payable ...................... 600 2,211 858 2,211
------- ------- ------- -------
Total interest expense .................. 8,270 7,985 22,149 19,100
------- ------- ------- -------
Net interest income ..................... 5,431 4,991 16,679 16,540
Provision for loan losses ............... 429 1,039 1,140 1,727
------- ------- ------- -------
Net interest income after provision
for loan losses .................... 5,002 3,952 15,539 14,813
Non-interest expense .................... 12,034 10,247 34,709 17,570
Non-interest income ..................... 10,263 8,875 29,073 9,945
------- ------- ------- -------
Income before income taxes .............. 3,231 2,580 9,903 7,188
Income taxes ............................ 1,139 919 3,502 2,474
------- ------- ------- -------
Net income .............................. $ 2,092 $ 1,661 $ 6,401 $ 4,714
======= ======= ======= =======
Earnings per share: (Note 4)
Basic .............................. $ .33 $ .22 $ .98 $ .62
======= ======= ======= =======
Diluted ............................ $ .32 $ .21 $ .95 $ .60
======= ======= ======= =======
Dividends declared per share (Note 3) ... $ .10 $ .09 $ .30 $ .27
======= ======= ======= =======
Average number of shares
Outstanding: (Note 4)
Basic ..................... 6,447 7,513 6,561 7,542
======= ======= ======= =======
Diluted ................... 6,627 7,786 6,768 7,874
======= ======= ======= =======
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 $392
($18) for 1999 and 1998, respectively
Total comprehensive income
ESOP shares released 197 425
Amortization of deferred compensation
of Management Recognition Plan 304
Shares issued under stock option plan 276
Purchase of common stock for
treasury (6) (4,904)
Dividends declared (Note 3)
Balance at September 30 $ 70 $54,250 $(3,664) $(539)
=== ======= ======= =======
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 6,401 6,401 4,714
Change in unrealized gains (losses)
net of income taxes of $392 and
($171) for 1999 and 1998, respectively (764) (764) 333
------- ------
Total comprehensive income 5,637 5,047
ESOP shares released 622 775
Amortization of deferred compensation
of Management Recognition Plan 304 428
Shares issued under stock option plan 276 447
Purchase of common stock for
treasury (3,369) (8,279) (6,598)
Dividends declared (Note 3) (1,984) (1,984) (2,060)
----- ------- ------- --------
Balance at September 30 $(602) $40,771 $90,286 $104,924
===== ======= ======= ========
See accompanying notes
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
Nine Months Ended
September 30,
----------- -----------
Operating Activities
Net income $ 6,401 $ 4,714
Adjustments to reconcile net income to net cash
Provision for loan losses 1,140 1,727
Provision for depreciation 1,308 913
Net securities amortization 94 (12)
Amortization of mortgage servicing rights 9,378 2,685
Amortization of goodwill 464 141
Gain on sale of loans (4,878) (2,455)
Gain on sale of mortgage servicing rights (479) --
Amortization of Management Recognition Plan
deferred compensation 304 428
Release of ESOP Shares 622 775
Loss (gain) on disposal of office properties and equipment 3 (2)
Loss on sale of securities 1 --
Deferred federal income tax (credit) provision (21) 400
Proceeds from sale of loans 1,139,094 566,492
Proceeds from sale of mortgage servicing rights 2,610 --
Servicing rights on loans sold with servicing retained (23,068) (9,788)
Origination of loans held for sale (1,250,014) (528,742)
Increase in interest receivable and other assets (4,423) (1,131)
Net repurchase of loans serviced for others (10,806) (1,376)
Increase in other liabilities 478 2,386
----------- -----------
Net cash (used in) provided by operating activities (131,792) 37,155
Investing Activities
Proceeds from maturities of held-to-maturity securities 2,953 5,830
Proceeds from maturities of available-for-sale securities 16,895 34,000
Proceeds from sales of available-for-sale securities 2,000 312
Proceeds from sales of real estate, mobile homes, and
other assets held for sale 1,242 1,268
Proceeds from sales of office properties and equipment 8 16
Purchases of available-for-sale securities (19,158) (6,468)
Purchases of Federal Home Loan Bank stock (2,433) (1,431)
Purchases of office properties and equipment (3,601) (2,059)
Adjustment of acquisition of Insurance Center (126) --
Acquisition of Insurance and Risk Management Co. office (1,918)
Acquisition of Moreland Greens, net of cash received 217 --
Acquisition of The Leader Mortgage Co., net of cash received .. -- (30,057)
Net increase in loans receivable (8,362) (44,923)
----------- -----------
Net cash used in investing activities (12,283) (43,512)
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
Nine Months Ended
September 30,
1999 1998
--------- ---------
Financing Activities
Net increase in deposits and advance payments by borrowers
for taxes and insurance 26,408 19,654
Repayment of Federal Home Loan Bank long-term advances (964) (878)
Proceeds from Federal Home Loan Bank long-term advances -- 25,000
Repayment of term notes payable (79) (917)
Proceeds from term notes payable 2,000
Proceeds from federal funds purchased 2,000
Increase in mortgage warehouse and other notes payable 49,655 12,243
Net increase (decrease) in Federal Home Loan Bank
short-term advances 66,605 (43,850)
Purchase of common stock for treasury (8,279) (6,598)
Cash dividends paid (2,042) (2,092)
Proceeds from exercise of stock options 276 447
--------- ---------
Net cash provided by financing activities 133,580 5,009
--------- ---------
Decrease in cash and cash equivalents (10,495) (1,348)
Cash and cash equivalents at beginning of period 20,506 8,997
--------- ---------
Cash and cash equivalents at end of period $ 10,011 $ 7,649
========= =========
Supplemental cash flow information:
Interest paid $ 21,969 $ 19,718
========= =========
Income taxes paid $ 4,925 $ 1,946
========= =========
Transfers from loans to real estate, mobile homes
and other assets held for sale $ 2,108 $ 1,140
========= =========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ 392 $ (171)
========= =========
Noncash investing activities:
(Decrease) increase in net unrealized gain or loss on
available-for-sale securities $ (1,156) $ 504
========= =========
Exchange of debt for equity position in Moreland Greens $ 3,701 $ --
========= =========
Noncash financing activities:
Cash dividends declared but not paid $ 652 $ 688
========= =========
See accompanying notes.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 1999)
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
September 30, 1999 and for the three-month and nine-month periods ending
September 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 nine-month periods ended September 30,
1999 are not necessarily indicative of the results that may be expected for
the entire year.
3. Dividends on Common Stock
As of September 30, 1999, First Defiance had declared a quarterly cash
dividend of $.10 per share for the third quarter of 1999, payable October
22, 1999.
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 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 nine-month periods ended September 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 nine-months
ended September 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.
The following table sets forth the computation of basic and diluted earning
per share (in thousands except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
------ ------ ------ ------
Numerator for basic and diluted
earnings per share - net income $2,092 $1,661 $6,401 $4,714
====== ====== ====== ======
Denominator:
Denominator for basic earnings per
share - weighted average shares 6,447 7,513 6,561 7,542
Effect of dilutive securities:
Employee stock options 105 185 121 234
Unvested Management Recognition
Plan stock 75 88 86 98
------ ------ ------ ------
Dilutive potential common shares 180 273 207 332
====== ====== ====== ======
Denominator for diluted earnings
per share - adjusted weighted average
shares and assumed conversions 6,627 7,786 6,768 7,874
====== ====== ====== ======
Basic earnings per share $ .33 $ .22 $ .98 $ .62
====== ====== ====== ======
Diluted earnings per share $ .32 $ .21 $ .95 $ .60
====== ====== ====== ======
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 1999)
5. Mortgage Servicing Rights
The activity in Mortgage Servicing Rights ("MSRs") is summarized as follows
(in thousands):
Nine Months
Ended Year Ended
September 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 23,068 12,428
Amortization (9,378) (5,385)
-------- -------
Balance at end of period $88,011 $76,452
======== =======
Accumulated amortization of mortgage servicing rights aggregated
approximately $14.2 million and $5.4 million at September 30, 1999 and
December 31, 1998, respectively.
The Company's servicing portfolio (excluding sub-serviced loans) is
comprised of the following as of September 30, 1999 (dollars in thousands):
Principal
Number Balance
of Loans Outstanding
------ -----------
GNMA 60,692 $3,833,832
FNMA 11,067 685,539
FHLMC 2,477 102,346
Other VA, FHA and
Conventional loans 15,438 905,184
------ -----------
89,674 $5,526,901
======= ==========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 1999)
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
nine-months ended September 30, 1999 and the three-months ended September
30, 1998, as there was no mortgage banking segment for the six-months ended
June 30, 1998.
Three-Months Ended September 30, 1999
(In Thousands)
Parent Retail Mortgage
Consolidated and Other Banking Banking
------------ --------- ------- -------
Total interest income $ 13,701 $ (3,739) $ 13,869 $ 3,571
Total interest expense 8,270 (4,037) 9,173 3,134
--------- --------- --------- ---------
Net interest income 5,431 298 4,696 437
Provision for loan losses 429 -- 105 324
--------- --------- --------- ---------
Net interest income after
Provision 5,002 298 4,591 113
Non-interest income 10,263 214 923 9,126
Non-interest expense 12,034 314 4,213 7,507
--------- --------- --------- ---------
Income before income taxes 3,231 198 1,301 1,732
Income taxes 1,139 93 406 640
--------- --------- --------- ---------
Net income $ 2,092 $ 105 $ 895 $ 1,092
========= ========= ========= =========
Total assets $ 932,076 $(286,301) $ 830,694 $ 387,683
========= ========= ========= =========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 1999)
6. Line of Business Reporting - Continued
Nine-Months Ended September 30, 1999
(In Thousands)
Parent Retail Mortgage
Consolidated and Other Banking Banking
------------ --------- ------- -------
Total interest income $ 38,828 $ (9,576) $ 39,706 $ 8,698
Total interest expense 22,149 (10,675) 25,759 7,065
--------- --------- --------- ---------
Net interest income 16,679 1,099 13,947 1,633
Provision for loan losses 1,140 -- (11) 1,151
--------- --------- --------- ---------
Net interest income after
Provision 15,539 1,099 13,958 482
Non-interest income 29,073 532 3,008 25,533
Non-interest expense 34,709 894 12,061 21,754
--------- --------- --------- ---------
Income before income taxes 9,903 737 4,905 4,261
Income taxes 3,502 341 1,559 1,602
--------- --------- --------- ---------
Net income $ 6,401 $ 396 $ 3,346 $ 2,659
========= ========= ========= =========
Total assets $ 932,076 $(286,301) $ 830,694 $ 387,683
========= ========= ========= =========
Three-Months Ended September 30, 1998
(In Thousands)
Parent Retail Mortgage
Consolidated and Other Banking Banking
------------ --------- ------- -------
Total interest income $ 12,976 $ (39) $ 10,694 $ 2,321
Total interest expense 7,985 (433) 6,167 2,251
--------- --------- --------- ---------
Net interest income 4,991 394 4,527 70
Provision for loan losses 1,039 -- 856 183
--------- --------- --------- ---------
Net interest income after
Provision 3,952 394 3,671 (113)
Non-interest income 8,875 (36) 1,794 7,117
Non-interest expense 10,247 79 4,087 6,081
--------- --------- --------- ---------
Income before income taxes 2,580 279 1,378 923
Income taxes 919 109 448 362
--------- --------- --------- ---------
Net income $ 1,661 $ 170 $ 930 $ 561
========= ========= ========= =========
Total assets $ 781,778 $ (44,209) $ 582,588 $ 243,399
========= ========= ========= =========
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements (continued)
(Unaudited at September 30, 1999)
7. Acquisitions
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.
On September 1, 1999, the Insurance Center completed the asset acquisition
of the Defiance office of Insurance and Risk Management in a cash
transaction valued at $1.9 million. The acquisition has been accounted for
as a purchase.
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.
Comparability of the nine-months ended September 30, 1999 and 1998 is
affected substantially by the acquisition of The Leader, as the results of
operations for the 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 markets in which its offices are located.
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 First Insurance and Investments. First
Insurance and Investments offers property and casualty, group health, 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 $10.5
million at September 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 $46.6 million at September 30, 1999. The available-for-sale
portfolio consists of U.S. Treasury securities and obligations of U.S.
Government corporations and agencies ($12.1 million), corporate bonds ($11.1
million), certain municipal obligations ($5.4 million), adjustable-rate mortgage
backed security mutual funds ($8.7 million), CMOs and REMICs ($7.1 million),
preferred stock ($1.9 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 $911,000 at
September 30, 1999, $602,000 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 servicing fees, 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 September 30, 1999, First Defiance's total assets, deposits (including
customer's escrow deposits) and stockholders' equity amounted to $932.1 million,
$537.7 million and $90.3 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
$464.8 million at September 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
$234.4 million at September 30, 1999. This increase was the result of increased
loan production at The Leader.
Deposits increased from $434.0 million at December 31, 1998 to $462.7 million as
of September 30, 1999. This increase was primarily the result of obtaining
brokered certificates of deposit, which in conjunction with Federal Home Loan
Bank ("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
$235.8 million at September 30, 1999.
First Defiance has continued to repurchase shares of its stock. As of September
30, 1999, First Defiance has repurchased 635,143 shares of its own stock during
1999 at a total cost of $8.3 million, an average of $13.03 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.
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,
1999 1998
----------------------------- -------------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $674,680 $12,885 7.64% $593,399 $11,830 7.97%
Securities 57,287 816 5.70 73,851 1,146 6.21
FHLB stock 14,699 268 7.29 5,103 93 7.29
-------- ------- -------- -------
Total interest-earning assets 746,666 13,969 7.48 672,353 13,069 7.78
Non-interest-earning assets 149,550 123,662
--------- --------
Total assets $896,216 $796,015
======== ========
Interest-bearing liabilities:
Deposits $470,494 $4,964 4.22% $405,615 $4,645 4.58%
FHLB advances and other 211,624 2,706 5.11 79,820 1,129 5.66
Warehouse and term notes payable 40,086 600 5.99 191,345 2,211 4.62
---------- ------- --------- -------
Total interest-bearing liabilities 722,204 8,270 4.58 676,780 7,985 4.72
------ ---- ------- ----
Non-interest-bearing liabilities 83,611 15,133
-------- ---------
Total liabilities 805,815 691,913
Stockholders' equity 90,401 104,102
-------- ---------
Total liabilities and stock-
holders' equity $896,216 $796,015
======== ========
Net interest income; interest
rate spread $5,699 2.90% $5,084 3.06%
====== ===== ====== =====
Net interest margin (2) 3.05% 3.02%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 103% 99%
==== ===
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
Nine Months Ended September 30,
1999 1998
-------------------------------- -----------------------------
Average Yield Average Yield
Balance Interest Rate(1) Balance Interest Rate(1)
------- -------- ------- ------- -------- -------
Interest-earning assets:
Loans receivable $634,028 $36,375 7.65% $499,279 $31,477 8.41%
Securities 56,076 2,453 5.83 87,616 4,163 6.34
FHLB stock 12,566 686 7.28 4,233 230 7.24
-------- ------- -------- -------
Total interest-earning assets 702,670 39,514 7.50 591,128 35,870 8.09
Non-interest-earning assets 139,315 60,069
--------- --------
Total assets $841,985 $651,197
======== ========
Interest-bearing liabilities:
Deposits $467,774 $14,495 4.13% $403,081 $13,825 4.57%
FHLB advances and other 182,570 6,796 4.96 71,107 3,064 5.75
Notes payable 19,089 858 5.99 63,782 2,211 4.62
--------- ------- -------- -------
Total interest-bearing liabilities 669,433 22,149 4.41 537,970 19,100 4.73
------- ---- ------- ----
Non-interest-bearing liabilities 81,853 8,981
-------- ---------
Total liabilities 751,286 546,951
Stockholders' equity 90,699 104,246
-------- --------
Total liabilities and stock-
holders' equity $841,985 $651,197
======== ========
Net interest income; interest
rate spread $17,365 3.09% $16,770 3.36%
======= ===== ======= =====
Net interest margin (2) 3.30% 4.78%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 105% 110%
=== ===
(1) Annualized
(2) Net interest margin is net interest income divided by average
interest-earning assets.
Results of Operations
Three Months Ended September 30, 1999 compared to Three Months Ended September
30, 1998
Results for the quarter ended September 30, 1999 represent the first period in
which The Leader's operating results are included in the comparable period of
1998, as the acquisition was completed on July 1, 1998.
On a consolidated basis, First Defiance had net income of $2.1 million for the
three months ended September 30, 1999 compared to $1.7 million for the same
period in 1998. On a per share basis, basic and diluted earnings per share were
$.33 and $.32, respectively, for the 1999 third quarter compared to $.22 and
$.21 basic and diluted per share earnings for the 1998 third quarter. Cash
earnings for the third quarter of 1999 were $2.3 million or $.34 per diluted
share compared to $1.8 million or $.23 per diluted share for the same period in
1998. Cash earnings are calculated by excluding the net income impact of
amortization of goodwill.
Net Interest Income. Net interest income before provision for loan losses
increased to $5,431,000 for the three-month period ending September 30, 1999
from $4,991,000 for the same period in 1998. The Company's net interest margin
increased to 3.05% for the quarter ended September 30, 1999 as compared to 3.02%
for the quarter ended September 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 third
quarter was 2.90%, which was 16 basis points lower than the 1998 third quarter
level of 3.06%.
The improvements to net interest income and net interest margin for the
three-month period ended September 30, 1999 compared to the same period in 1998
were a result of capitalizing on internal funding sources. In the fourth quarter
of 1998, The Leader's warehouse funding and term debt arrangements with other
banks (which had an average funding cost of 7.01% for the three-month period
ended September 30, 1998 before the interest credit received by The Leader for
maintaining escrow deposits at the banks providing the financing) were replaced
with Federal Home Loan Bank Debt (with an average funding cost of 5.66% for the
three-month period ended September 30, 1998). In connection with replacing the
existing term debt arrangements, in the fourth quarter of 1998, The Leader
transferred the customer escrow deposits to First Federal. These funds had an
average balance of $71.6 million during the third quarter of 1999 with no
associated interest cost. This transfer of funds improved First Defiance's net
interest margin while slightly reducing the interest rate spread.
The positive impacts to net interest margin were partially offset by the growth
in the average balance of The Leader's loans available-for-sale from $132.1
million for the three-months ended September 30, 1998 to $197.5 million for the
same period in 1999. This growth negatively impacts net interest margin, as the
yield on this portfolio, which is comprised of low-coupon loans originated under
first-time home-buyer programs, is approximately 6.50%, which reduces the yield
on interest earning assets.
Total interest income increased by $725,000, or 5.6%, from $13.0 million for the
three months ended September 30, 1998 to $13.7 million for the three months
ended September 30, 1999. The increase was due to a $81.3 million increase in
the average balance of loans outstanding for the third quarter of 1999 when
compared to the same period in of 1998. The yield on those loans declined to
7.64% in 1999 versus 7.97% in 1998. This increase in the average balance of
loans outstanding was primarily attributable to the $65.4 million increase in
The Leader's loans available-for-sale from September 30, 1998 to September
30,1999. Interest income was also favorably impacted by the increase in the
average balance in commercial loans, which was $119.6 million for the
three-months ended September 30, 1999, compared to $37.3 million for the
three-months ended September 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 $816,000 for the
three months ended September 30, 1999 compared to $1.1 million for the same
period in 1998. The decline in 1999 was due to a decrease in the average balance
of securities from $73.9 million for the three-month period ended September 30,
1998 to $57.3 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 September 30, 1999 was
5.70% compared to 6.21% for the same period in 1998.
Interest expense increased by $285,000, or 3.6%, to $8.3 million for the third
quarter of 1999 compared to $8.0 million for the same period in 1998. The
increase is primarily due to an increase in FHLB advances and brokered
certificates of deposit used to fund the increase in The Leader's loans
available-for-sale. The average financing required to fund The Leader's
operations for the three months ended September 30, 1999 was approximately
$191.9 million, net of the $71.6 million average balance in The Leader's
customer's escrow deposits at First Federal. In comparison, the average
financing required to fund The Leader's operations for the three-months ended
September 30, 1998 was $131.3 million, net of The Leader's customer's escrow
deposits of $60.1 million and compensating cash balances of $20.6 million. This
increase in The Leader's funding requirements, together with the increase in
commercial loans and the refinancing of The Leader's existing bank debt in the
fourth quarter of 1998, resulted in a $131.8 million increase in FHLB advances
from $79.8 million for the three-months ended September 30, 1998 to $211.6 for
the same period in 1999. The average cost of these advances decreased from 5.66%
for the three-months ended September 30, 1998 to 5.11% for the same period in
1999. Also, due to the increase in the available-for-sale loan portfolio in the
third quarter of 1999, additional financing was obtained from banks and other
sources. This financing had a weighed average cost of 5.99% during the
three-months ended September 30, 1999.
Interest expense also increased because of an increase in the average balance of
deposits outstanding, which increased to $470.5 million for the three-months
ended September 30, 1999 compared to $405.6 million for the three-months ended
September 30, 1998. This increase in deposits was primarily the result of the
increase in brokered certificates to $50.3 million for the three-month period
ended September 30, 1999 from $7.9 million for the same period in 1998 which
were used as an additional funding source for The Leader's operations. The
average cost of deposits declined by 36 basis points in the third quarter of
1999, to 4.22% from 4.58% for the same period in 1998.
Provision for Loan Losses. The provision for loan losses decreased during the
1999 third quarter to $429,000 compared to $1,039,000 for the same period in
1998. The third quarter of 1998 provision included a $378,000 write down of
First Federal's mobile home loan portfolio. This portfolio was subsequently sold
in the second quarter of 1999, requiring no additional charge to 1999 earnings.
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.
Non-performing assets, which include loans 90 days or more past due, loans
deemed impaired, and repossessed assets totaled $4.5 million at September 30,
1999, which is .48% of total assets. Non-performing loans and repossessed assets
reported do not include $15.6 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
September 30, 1999 was $8.1 million compared to $4.2 million at September 30,
1998 and $9.8 million at December 31, 1998. 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 September 30, 1999, First Defiance charged off $566,000 of
loans against its allowance and realized recoveries of $52,000 from loans
previously charged off. These charge offs include the indirect auto originations
discussed above, which was fully reserved during the fourth quarter of 1998.
During the same quarter in 1998, First Defiance charged off $779,000 in loans
and realized recoveries of $54,000.
Non-Interest Income. Non-interest income increased $1.4 million or 15.6% in the
third quarter of 1999, from $8.9 million for the quarter ended September 30,
1998 to $10.3 million for the same period in 1999.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$6.5 for the quarter ended September 30, 1998 to $7.6 million for the same
period in 1999. Of this increase, $837,000 was due to increased servicing fees
at The Leader due to an increase in the number of loans serviced for others.
Gain on Sale of Loans. Gain on sale of loans decreased from $2.2 for the quarter
ended September 30, 1998 to $1.7 million for the same period of 1999. The Leader
recognized gains on sale of loans of $1.6 million for the third quarter of 1999,
while First Federal recognized $123,000 in the same period. The $2.2 million
gain on sale in the third quarter of 1998 was the result of two large portfolio
sales at First Federal along with $939,000 in gains on sale of loans from the
normal course of The Leader's business. First Federal sold $21.0 million and
$30.7 million in mobile and mortgage loans, respectively, included in their loan
portfolio.
These sales resulted in total gains of $1.0 million.
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 $707,000 for the quarter
ended September 30, 1999 from $323,000 for the same period in 1998. The
acquisition of the Insurance Center accounted for $289,000 of the increase over
the third quarter of 1998.
Non-Interest Expense. Total non-interest expense increased $1.8 million from
$10.2 million for the quarter ended September 30, 1998 to $12.0 million for the
same period in 1999. The Leader's operations accounted for $1.4 million of the
increase in non-interest expense from the three-months ended September 30, 1998
to the same period in 1999.
Compensation and Benefits. Compensation and benefits increased $1.1 million from
$4.0 million for the quarter ended September 30, 1998 to $5.1 million for the
same period in 1999. The Leader's compensation and benefits increased $698,000
due to increased staffing requirements related to significant growth in the
servicing portfolio. First Federal's compensation and benefits increased
$171,000 due to increases in overall staffing related to its Findlay branch
which opened in February 1999 and other general staffing level increases at
First Federal. The acquisition of the Insurance Center resulted in an additional
$210,000 increase in the Company's compensation expense.
Occupancy. Occupancy expense increased to $1.1 million for the three-month
period ended September 30, 1999 from $771,000 for the three-months ended
September 30, 1998. The Leader accounted for $174,000 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 $3.0 million for the quarter ended September 30, 1999
from $2.9 million for the same period in 1998.
Amortization of Goodwill and Other Acquisition Related Costs. As a result of the
purchases of The Leader and the Insurance Center, $586,000 and $534,000 in
amortization of goodwill and other acquisition related costs was recognized in
the third quarter of 1999 and 1998, respectively.
Other Non-Interest Expenses. Other non-interest expenses (including state
franchise tax, data processing, deposit premiums, and loan servicing) increased
to $2.3 million for the quarter ended September 30, 1999 from $2.2 million for
the same period in 1998.
First Defiance has computed federal income tax expense in accordance with FASB
Statement No. 109 which resulted in an effective tax rate of 35.3% for the
quarter ended September 30, 1999 compared to 35.6% for the same period in 1998.
As a result of the above factors, net income for the quarter ended September 30,
1999 was $2,092,000 compared to $1,661,000 for the comparable period in 1998. On
a per share basis, basic and diluted earnings per share for the three-months
ended September 30, 1999 was $.33 and $.32 respectively compared to $.22 and
$.21, respectively, for the same period in 1998. 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 6,447,000 and
6,627,000, respectively, for the quarter ended September 30, 1999 compared to
7,513,000 and 7,786,000, respectively, for the quarter ended September 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 September 30, 1999, 176,854 shares
have been purchased under this program.
First Defiance's board of directors declared a dividend of $.10 per common share
as of September 30, 1999. The dividend amounted to $698,958, including dividends
on unallocated ESOP shares. It was paid on October 22, 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.
Nine Months Ended September 30, 1999 compared to Nine Months Ended September 30,
1998
The acquisition of The Leader significantly impacted the results for the nine
months ended September 30, 1999 compared to the same period in 1998, as the
first six months of 1998 do not include the results of The Leader's operations.
Net income for the 1999 period was $6.4 million, or $.95 per diluted share
compared to $4.7 million or $.60 per diluted share for the same period in 1998.
For the year-to-date periods ended September 30, 1999 and 1998 cash earnings and
diluted per share cash earnings were $7.0 million or $1.03 per share and $4.9
million or $.62 per share, respectively. Net interest income increased to $16.7
million for the 1999 nine-month period compared to $16.5 million for the same
period in 1998 while non-interest income increased to $29.1 million from $9.9
million and non-interest expense increased to $34.7 million from $17.6 million.
Net Interest Income. Net interest income before provision for loan losses
increased to $16.7 million for the nine-month period ending September 30, 1999
compared to $16.5 million for the same period in 1998. The Company's
year-to-date net interest margin through September 30, 1999 decreased to 3.30%
compared to 4.78% for the same period in 1998. Interest rate spread also
decreased to 3.09% for the nine-month period ended September 30, 1999 from 3.36%
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 $80.8
million for the nine months ended September 30, 1999. Mortgage servicing rights
are a non-interest earning asset.
Interest rate spread decreased because of a 76 basis point decrease in the
average yield on interest earning assets, from 8.41% for the nine-months ended
September 30, 1998 to 7.65% for the comparable period in 1999. This declining
rate is due to the inclusion of The Leader's available for sale loans, which
averaged $163.8 million for the nine-month period ended September 30, 1999. The
average yield on those available for sale loans was 6.24% for the year-to-date
period ended September 30, 1999.
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
$99.4 million for the first nine months of 1999 compared to only $33.7 million
for the same period in 1998. Also, the average cost of interest bearing
liabilities declined to 4.41% for the nine-months ended September 30, 1999
compared to 4.73% for the same period in 1998. During that period the average
cost of deposits fell to 4.13% from 4.57% while the average cost of FHLB
advances fell to 4.96% from 5.75%
Provision for Loan Losses. The provision for loan losses decreased to $1.1
million for the nine-months ended September 30, 1999 compared to $1.7 million
for the same period in 1998. First Defiance charged off $2.9 million of loans
against its allowance for loan losses for the nine-month period ended September
30, 1999 and realized recoveries of $218,000 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 $1.4 million in loans and realized
recoveries of $165,000.
Non-Interest Income. Non-interest income increased $19.2 million for the
nine-month period ended September 30, 1999 from $9.9 million to $29.1 million
for the 1998 and 1999 periods, respectively. The Leader contributed $18.7
million of this increase.
Loan and Deposit Servicing Fees. Loan and deposit servicing fees increased from
$7.1 million for the nine-month period ended September 30, 1998 to $21.4 million
for the same period in 1999. The growth was due to service fees on sold 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 $2.5 million for the
nine-months ended September 30, 1998 to $4.9 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.
Gain on Sale of Loan Servicing. Results for the nine-months ended September 30,
1999 included a $479,000 gain realized on the sale of non-core servicing rights
at The Leader. 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 $2.3 million for the first nine months of
1999 from $369,000 for the same period in 1998.
Non-Interest Expense. Total non-interest expense increased $17.1 million from
$17.6 million for the nine-month period ended September 30, 1998 to $34.7 for
the same period in 1999. The results of operations of The Leader contributed
$15.7 million of the increase.
Compensation and Benefits. Compensation and benefits increased $6.3 million from
$7.8 million for the year-to-date period ended September 30, 1998 to $14.1
million for the same period in 1999. Decreases in Management Recognition Plan
and Employee Stock Ownership Plan expenses ($672,000 combined for the
nine-months ended September 30, 1999 compared to $882,000 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 $2.9 million for the nine-month period
ended September 30, 1999 from $1.6 million 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 $9.4 million for the nine-month period ended September 30,
1999 from $2.9 million for the same period in 1998.
Amortization of Goodwill and Other Acquisition Costs. $1.7 million and $534,000
in amortization of goodwill and other acquisition costs was recognized as of the
nine-month period ended September 30, 1999 and 1998, respectively, 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 $6.6 million for the nine-month period ended September 30, 1999 compared to
$4.9 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 nine-month period ended
September 30, 1999 increased to $6.4 million from $4.7 million for the
nine-months ended September 30, 1998. On a per share basis, basic and diluted
earnings per share for the nine-months ended September 30, 1999 was $.98 and
$.95 respectively compared to $.62 and $.60, respectively, for the same period
in 1998. As stated above, the 1999 year-to-date results 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 6,561,000 and 6,768,000 respectively for the
nine-months ended September 30, 1999 compared to 7,542,000 and 7,874,000
respectively for the same period in 1998.
Through September 30, 1999, First Defiance has declared dividends totaling $.30
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 September 30, 1999.
First Defiance utilized $131.8 million in cash for operating activities during
the first nine 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 September 30, 1999, First Defiance had $22.4 million in outstanding mortgage
loan commitments and loans in process to be funded generally within the next six
months and an additional $57.5 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, 2000 is $265.4 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 utilized funding from banks and other sources. As
of September 30, 1999, First Defiance has available a $50 million warehouse line
of credit under which it can borrow utilizing mortgages available for sale as
collateral and a $60 million repurchase line-of-credit under which it can borrow
utilizing mortgage loans which are in process of being securitized. 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 September 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.
Because The Leader's mortgage loan production is primarily comprised of loans
originated under first-time homebuyer programs, it has not had to hedge its
mortgage loan pipeline. This is due to the fact that trustees under the
first-time homebuyer programs are obligated to purchase the underlying mortgage
backed securities at par, regardless of increases or decreases in interest
rates.
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, 1999.
Tangible Core Risk-Based
Capital Capital Capital (1)(2)
------- ------- --------------
(Dollars in Thousands)
Regulatory capital $ 49,641 $ 49,641 $ 61,007
Minimum required regulatory
capital 13,521 36,057 53,495
--------- --------- ---------
Excess regulatory capital $ 36,120 $ 13,584 $ 7,512
========= ========= =========
Regulatory capital as a
percentage of assets (3) 5.5% 5.5% 9.1%
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% 1.1%
========= ========= =========
- ---------------
(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 $901.4 million. Risk-based capital is computed as a percentage of
total risk-weighted assets of $668.7 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 $0.059 per $100
of deposits.
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 the 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
mission critical systems, including the loan servicing system and the wholesale
bond system, have been modified to process dates in the Year 2000 and are fully
operational.
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. Most of that total 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 needed to be replaced was the phone system at The
Leader, which also included the Interactive Voice Response Unit and the Voice
Mail components. The system was replaced in October 1999 and is now year 2000
compliant. The 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 have been resolved, it cannot guarantee that all such issues have been
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 developed
contingency/recovery plans aimed at ensuring the continuity of critical
functions. As part of this process, management 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 have been developed, including
the use of electronic spreadsheets, resetting system dates, and manual
workarounds. The Company has completed its contingency planning, including a
major part of the testing. Efforts for the remainder of the year will focus on
rehearsing contingency planning scenarios with the appropriate staff.
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.
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
September 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 September 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: November 10, 1999 By: /s/ William J. Small
----------------- --------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: November 10, 1999 By: /s/ John C. Wahl
----------------- ----------------
John C. Wahl
Executive Vice President, Chief
Financial Officer and
Treasurer