10-Q 1 0001.txt 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, 2000 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from ___________to__________ Commission file number 0-26850 First Defiance Financial Corp. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-1803915 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 601 Clinton Street, Defiance, Ohio 43512 -------------------------------------------------------------------------------- (Address or principal executive office) (Zip Code) (419) 782-5015 -------------------------------------------------------------------------------- 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 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 - 6,891,549 shares outstanding at August 11, 2000. FIRST DEFIANCE FINANCIAL CORP. INDEX Page Number PART I.-FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements (Unaudited): Consolidated Condensed Statements of Financial Condition - June 30, 2000 and December 31, 1999 1 Consolidated Condensed Statements of Income - Three months ended June 30, 2000 and 1999; Six months ended June 30, 2000 and 1999 3 Consolidated Condensed Statement of Changes in Stockholders' Equity - Six months ended June 30, 2000 4 Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2000 and 1999 6 Notes to Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures about Market Risk 29 PART II. OTHER INFORMATION: Item 1. Legal Proceedings 30 Item 2. Changes in Securities 30 Item 3. Defaults upon Senior Securities 30 Item 4. Submission of Matters to a Vote of Security Holders 30 Item 5. Other Information 30 Item 6. Exhibits and Reports on Form 8-K 30 Signatures 31 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, 2000 December 31, 1999 ------------- ----------------- ASSETS Cash and cash equivalents: Cash and amounts due from depository institutions $ 8,324 $ 13,102 Interest-bearing deposits 5,027 3,134 -------- -------- 13,351 16,236 Securities: Available-for-sale, carried at fair value 53,427 53,946 Trading, carried at fair value 240 29,805 Held-to-maturity, carried at amortized cost (approximate fair value $8,661 and $9,953 at June 30, 2000 and December 31, 1999, respectively) 8,658 9,895 -------- -------- 62,325 93,646 Loans held for sale (at lower of cost or fair value, approximate fair value $197,707 and $237,622 at June 30, 1999 and December 31,1998, respectively) 197,707 237,622 Loans receivable, net 511,384 465,321 Mortgage servicing rights 114,304 97,519 Accrued interest receivable 5,567 3,868 Federal Home Loan Bank stock 14,692 14,181 Office properties and equipment 21,427 21,311 Real estate, mobile homes and other assets held for sale 1,132 2,557 Goodwill, net 14,361 14,699 Other assets 23,512 21,034 -------- -------- Total assets $979,762 $987,994 ======== ========
See accompanying notes. 1
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (UNAUDITED) (Amounts in Thousands, except for share data) ------------------------------------------------------------------------------------------ June 30, 2000 December 31, 1999 ------------ ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 562,707 $ 502,969 Advances from Federal Home Loan Bank 220,967 265,410 Warehouse and term notes payable 16,156 53,504 Advance payments by borrowers for taxes and insurance 71,109 61,542 Deferred taxes 1,603 2,232 Other liabilities 13,746 12,921 --------- --------- Total liabilities 886,288 898,578 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; 6,891,000 and 6,814,000 shares outstanding at June 30, 2000 and December 31,1999, respectively 69 68 Additional paid-in capital 53,609 53,181 Stock acquired by ESOP (3,345) (3,664) Deferred compensation (329) (458) Accumulated other comprehensive income, net of income taxes of $(592) and $(565), respectively (1,151) (1,096) Retained earnings 44,621 41,385 --------- --------- Total stockholders' equity 93,474 89,416 --------- --------- Total liabilities and stockholders' equity $ 979,762 $ 987,994 ========= =========
See accompanying notes 2
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, --------- -------- 2000 1999 2000 1999 ------- ------- ------- ------- Interest income: Loans $14,206 $11,869 $28,514 $23,491 Investment securities 1,003 760 2,474 1,574 Other 150 17 201 62 ------- ------- ------- ------- Total interest income 15,359 12,646 31,189 25,127 Interest expense: Deposits 6,153 4,849 11,776 9,531 Federal Home Loan Bank advances 2,842 2,107 5,729 4,089 Notes payable 1,230 166 2,362 258 ------- ------- ------- ------- Total interest expense 10,225 7,122 19,867 13,878 ------- ------- ------- ------- Net interest income 5,134 5,524 11,322 11,249 Provision for loan losses 581 202 1,989 712 ------- ------- ------- ------- Net interest income after provision for loan losses 4,553 5,322 9,333 10,537 Non-interest income: Mortgage banking income 8,599 6,609 16,703 13,118 Gain on sale of loans 2,587 1,633 4,531 3,196 Other non-interest income 1,932 1,604 3,727 2,524 ------- ------- ------- ------- Total non-interest income 13,118 9,846 24,961 18,838 Non-interest expense 13,814 11,556 27,063 22,673 ------- ------- ------- ------- Income before income taxes 3,857 3,612 7,231 6,702 Income taxes 1,399 1,241 2,573 2,373 ------- ------- ------- ------- Net income $ 2,458 $ 2,371 $ 4,658 $ 4,329 ======= ======= ======= ======= Earnings per share: (Note 4) Basic $ .39 $ .37 $ .74 $ .66 ======= ======= ======= ======= Diluted $ .38 $ .35 $ .73 $ .63 ======= ======= ======= ======= Dividends declared per share (Note 3) $ .11 $ .10 $ .22 $ .20 ======= ======= ======= ======= Average number of shares Outstanding: (Note 4) Basic 6,305 6,489 6,272 6,614 ======= ======= ======= ======= Diluted 6,407 6,670 6,394 6,835 ======= ======= ======= =======
See accompanying notes 3
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (UNAUDITED) (Amounts in Thousands) ------------------------------------------------------------------------------------------------------------------- 2000 ------------------------- Stock Acquired By -------------------------- Additional Management Common Paid-in Recognition Stock Capital ESOP Plan ----- ------- ---- ---- Balance at January 1 $68 $53,181 $(3,664) $ (458) Comprehensive income: Net Income Change in unrealized gains (losses) net of income taxes of $27 and $258 for 2000 and 1999, respectively Total comprehensive income ESOP shares released 70 319 Amortization of deferred compensation of Management Recognition Plan 129 Shares issued under stock option plan 1 363 Purchase of common stock for treasury (5) Dividends declared (Note 3) ---- ------- ------- ----- Balance at June 30 $ 69 $53,609 $(3,345) $(329) ==== ======= ======= =====
See accompanying notes 4
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued) (UNAUDITED) (Amounts in Thousands) ------------------------------------------------------------------------------------------------------------------- 2000 1999 -------------------------------------- -------------- Net Unrealized gains (losses) on Total Total available-for- Retained Stockholders' Stockholder's sale securities Earnings Equity Equity --------------- -------- ------ ------ Balance at January 1 $(1,096) $41,385 $89,416 $93,710 Comprehensive income: Net Income 4,658 4,658 4,329 Change in unrealized gains (losses) net of income taxes of $27 and $258 for 2000 and 1999, respectively (55) (55) (503) ---- ------- Total comprehensive income 4,603 3,826 ESOP shares released 389 481 Amortization of deferred compensation of Management Recognition Plan 129 199 Shares issued under stock option plan 364 257 Purchase of common stock for treasury (4) (9) (6,784) Dividends declared (Note 3) (1,418) (1,418) (1,333) ------------------------------------------ ------- Balance at June 30 $(1,151) $44,621 $93,474 $90,356 ========================================== =======
See accompanying notes 5
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (UNAUDITED) (Amounts in Thousands) ------------------------------------------------------------------------------------------------------------------- Six Months Ended June 30, 2000 1999 ------------------- Net income $ 4,658 $ 4,329 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,989 712 Provision for depreciation 998 851 Net securities amortization 31 67 Amortization of mortgage servicing rights 7,243 6,353 Amortization of goodwill 338 271 Gain on sale of loans (4,531) (3,196) Gain on sale of mortgage servicing rights - (479) Amortization of Management Recognition Plan deferred compensation 129 199 Release of ESOP Shares 389 481 (Gain) loss on disposal of office properties and equipment (60) 3 Deferred federal income tax credit (602) (605) Proceeds from sale of loans 1,171,145 676,360 Proceeds from sale of mortgage servicing rights - 2,610 Origination of mortgage servicing rights, net (24,028) (13,449) Origination of loans held for sale (1,126,699) (709,781) Increase in interest receivable and other assets (4,177) (3,067) Net repurchase of loans serviced for others (6,151) (14,344) Increase in other liabilities 815 1,111 ---------- -------- Net cash provided by (used in) operating activities 21,487 (51,574) Investing Activities Proceeds from maturities of held-to-maturity securities 1,220 2,232 Proceeds from maturities of available-for-sale securities 2,817 16,729 Proceeds from sale of trading securities 29,563 - Proceeds from sales of real estate, mobile homes, and other assets held for sale 1,967 1,054 Proceeds from sales of office properties and equipment 323 8 Purchases of available-for-sale securities (2,392) (16,224) Purchases of Federal Home Loan Bank stock (511) (1,116) Purchases of office properties and equipment (1,377) (2,117) Adjustment of acquisition of First Insurance - (126) Acquisition of Moreland Greens, net of cash received - 243 Net increase in loans receivable (42,443) (6,559) ---------- -------- Net used in investing activities (10,833) (5,876)
6
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (Continued) (UNAUDITED) (Amounts in Thousands) ---------------------------------------------------------------------------------------- Six Months Ended June 30, 2000 1999 --------- --------- Financing Activities Net increase in deposits and advance payments by borrowers for taxes and insurance 69,305 18,357 Repayment of Federal Home Loan Bank long-term advances (100,443) (843) Repayment of term notes payable (305) (55) Net increase in Federal Home Loan Bank short-term advances 56,000 31,854 Proceeds from short term line of credit 10,000 -- Decrease in warehouse loans (47,043) -- Purchase of common stock for treasury (9) (6,784) Cash dividends paid (1,408) (1,379) Proceeds from exercise of stock options 364 257 --------- --------- Net cash (used in) provided by financing activities (13,539) 41,407 --------- --------- Decrease in cash and cash equivalents (2,885) (16,043) Cash and cash equivalents at beginning of period 16,236 20,506 --------- --------- Cash and cash equivalents at end of period $ 13,351 $ 4,463 ========= ========= Supplemental cash flow information: Interest paid $19,558 $ 13,981 ========= ========= Income taxes paid $ 3,200 $ 3,125 ========= ========= Transfers from loans to real estate, mobile homes and other assets held for sale $ 234 $ 1,793 ========= ========= Noncash operating activities: Change in deferred tax established on net unrealized gain or loss on available-for-sale securities $ 27 $ (258) ========= ========= Noncash investing activities: (Decrease) increase in net unrealized gain or loss on available-for-sale securities $ 55 $ (761) ========= ========= Exchange of debt for equity position in Moreland Greens $ -- $ 3,701 ========= ========= Noncash financing activities: Cash dividends declared but not paid $ 713 $ 664 ========= =========
See accompanying notes. 7 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2000 and 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 Bank of the Midwest ("First Federal"), and First Insurance and Investments ("First Insurance") and First Federal's wholly owned mortgage banking company, The Leader Mortgage Company LLC. ("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, 1999 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, 2000 and for the three-month and six-month periods ending June 30, 2000 and 1999 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 1999 annual report on Form 10-K for the year ended December 31, 1999. 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, 2000 are not necessarily indicative of the results that may be expected for the entire year. 3. Dividends on Common Stock As of June 30, 2000, First Defiance had declared a quarterly cash dividend of $.11 per share for the second quarter of 2000, payable July 28, 2000. 8 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000 and 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, 2000 and 1999. 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, 2000 and 1999, 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 earnings per share (in thousands except per share data):
Three Months Ended Six Months Ended June 30, June 30, ------------------ ---------------- 2000 1999 2000 1999 ------ ------ ------ ------ Numerator for basic and diluted earnings per share - net income $2,458 $2,371 $4,659 $4,329 ====== ====== ====== ====== Denominator: Denominator for basic earnings per share - weighted average shares 6,305 6,489 6,272 6,614 Effect of dilutive securities: Employee stock options 38 101 47 129 Unvested Management Recognition Plan stock 64 80 75 92 ------ ------ ------ ------ Dilutive potential common shares 102 181 122 221 ====== ====== ====== ====== Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 6,407 6,670 6,394 6,835 ====== ====== ====== ====== Basic earnings per share $ .39 $ .37 $ .74 $ .66 ====== ====== ====== ====== Diluted earnings per share $ .38 $ .35 $ .73 $ .63 ====== ====== ====== ======
9 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000) -------------------------------------------------------------------------------- 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, 2000 1999 -------- -------- Balance at beginning of period $ 97,519 $ 76,452 Purchases 24,028 35,909 Sale of servicing rights, net - (2,610) Loans sold servicing retained - 479 Amortization (7,243) (12,711) -------- -------- Balance at end of period $114,304 $ 97,519 ======== ========
Accumulated amortization of mortgage servicing rights aggregated approximately $24.7 million and $17.5 million at June 30, 2000 and December 31, 1999, respectively. The Company's servicing portfolio (excluding subserviced loans) is comprised of the following as of June 30, 2000 (dollars in thousands): Principal Number Balance of Loans Outstanding -------- ----------- GNMA 75,843 $5,040,308 FNMA 12,614 807,360 FHLMC 2,379 102,318 Other VA, FHA and Conventional loans 18,593 999,967 -------- ---------- 109,429 $6,949,953 ======== ========== 10 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000 and 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 First Insurance 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, 2000 and 1999.
Three-Months Ended June 30, 2000 -------------------------------- (In Thousands) Parent Retail Mortgage Consolidated and Other Banking Banking ------------ --------- ------- ------- Total interest income $ 15,359 $ (4,532) $ 15,741 $ 4,150 Total interest expense 10,225 (4,484) 10,527 4,182 -------- --------- -------- -------- Net interest income 5,134 (48) 5,214 (32) Provision for loan losses 581 - 75 506 -------- --------- -------- -------- Net interest income after Provision 4,553 (48) 5,139 (538) Non-interest income 13,118 629 1,066 11,423 Non-interest expense 13,814 720 4,332 8,762 -------- --------- -------- -------- Income before income taxes 3,857 (139) 1,873 2,123 Income taxes 1,399 (38) 614 823 -------- --------- -------- -------- Net income $ 2,458 $ (101) $ 1,259 $ 1,300 ======== ========= ======== ======== Total assets $979,762 $(352,625) $966,219 $366,168 ======== ========= ======== ========
11 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000 and 1999) -------------------------------------------------------------------------------- 6. Line of Business Reporting - Continued
Six-Months Ended June 30, 2000 ------------------------------ (In Thousands) Parent Retail Mortgage Consolidated and Other Banking Banking ------------ --------- ------- ------- Total interest income $ 31,189 $ (8,830) $ 30,645 $ 9,374 Total interest expense 19,867 (8,854) 20,246 8,475 -------- --------- -------- -------- Net interest income 11,322 24 10,399 899 Provision for loan losses 1,989 - 311 1,678 -------- --------- -------- -------- Net interest income after Provision 9,333 24 10,088 (779) Non-interest income 24,961 1,266 1,983 21,712 Non-interest expense 27,063 1,407 8,661 16,995 -------- --------- -------- -------- Income before income taxes 7,231 (117) 3,410 3,938 Income taxes 2,573 (9) 1,092 1,490 -------- --------- -------- -------- Net income $ 4,658 $ (108) $ 2,318 $ 2,448 ======== ========= ======== ======== Total assets $979,762 $(352,625) $966,219 $366,168 ======== ========= ======== ======== 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 9,846 156 941 8,749 Non-interest expense 11,556 362 3,926 7,268 -------- --------- -------- -------- Income before income taxes 3,612 109 1,947 1,556 Income taxes 1,241 62 618 561 -------- --------- -------- -------- Net income $ 2,371 $ 47 $ 1,329 $ 995 ======== ========= ======== ======== Total assets $838,029 $(320,051) $844,033 $314,047 ======== ========= ======== ========
12 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000 and 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 18,838 346 2,085 16,407 Non-interest expense 22,673 578 7,848 14,247 -------- --------- -------- -------- Income before income taxes 6,702 569 3,604 2,529 Income taxes 2,373 258 1,153 962 -------- --------- -------- -------- Net income $ 4,329 $ 311 $ 2,451 $ 1,567 ======== ========= ======== ======== Total assets $838,029 $(320,051) $844,033 $314,047 ======== ========= ======== ========
7. Acquisitions On December 24, 1998, First Defiance completed the acquisition of First Insurance 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 earnings criteria are met. On September 1, 1999, First Insurance 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, exceeded fair value of net assets acquired by approximately $11.3 million, which was recorded as goodwill. The goodwill is amortized over 15 years. On May 1, 1999, The Leader exchanged a debt position in a partnership that owned a Cleveland area apartment complex for a 100% ownership position. 13 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2000 and 1999) -------------------------------------------------------------------------------- 8. New Accounting Pronouncement The FASB has released Statement of Financial Accounting Standards ("FAS") No. 133, Accounting for Derivative and Similar Financial Instruments and for Hedging Activities, as amended by FAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133 and FAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities. These statement establish accounting and reporting standards for derivative financial instruments and require all derivatives to be measured at fair value and to be recognized as either assets or liabilities in the statement of financial position. These standards become effective for First Defiance for quarterly and annual reporting beginning January 1, 2001 and are not expected to have a material impact on the Company's financial statements. 14 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 Bank of the Midwest, Defiance Ohio ("First Federal") and First Insurance & Investments ("First Insurance") and First Federal's wholly owned subsidiary, The Leader Mortgage Company LLC ("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 seven 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 and trust 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. First Insurance is an insurance agency that does business in the Defiance, Ohio area. First Insurance 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 $8.7 million at June 30, 2000. Loans held-for-sale securitized in the normal course of The Leader's operations have been classified as trading securities, reported at fair market value. The Leader has committed to sell these securities at their carrying value. Securities not classified as held-to-maturity or trading are classified as available-for-sale, which are stated at fair value and had a recorded value of $53.4 million at June 30, 2000. The available-for-sale portfolio consists of U.S. Treasury securities and obligations of U.S. Government corporations and agencies ($18.2 million), corporate bonds ($12.7 million), certain municipal obligations ($5.3 million), adjustable-rate mortgage backed security mutual funds ($8.6 million), CMOs and REMICs ($6.6 million), preferred stock ($1.7 million), and corporate equities ($295,000). 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 $1.7 million at June 30, 2000, $1.2 million after considering the related deferred tax benefit. 15 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 mortgage loan servicing income, other 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, 2000, First Defiance's total assets, deposits (including customer's escrow deposits) and stockholders' equity amounted to $979.8 million, $633.8 million and $93.5 million, respectively, compared to $988.0 million, $564.5 million and $89.4 million, respectively, at December 31, 1999. Net loans receivable have increased to $511.4 million at June 30, 2000 from $465.3 million at December 31, 1999. During the same period, loans held-for-sale decreased to $197.7 million at June 30, 2000 from $237.6 million at December 31, 1999. The reduction in the held-for-sale loans is a result of efforts by management to reduce the time between loan purchases and settlements on securitizations, thereby reducing overall funding costs. Securities decreased to $62.3 million at June 30, 2000 from $93.6 million at December 31, 1999 as a result of a $29.6 million decrease in trading securities. Trading securities represent low coupon GNMA securities issued by the Company but not yet delivered to the bond trustee who is obligated to purchase the securities at par. This reduction in trading securities is related to management's efforts to securitize loans and deliver the securities to the trustees on a more timely basis, thereby reducing funding requirements. Proceeds from the sale of trading securities were used to fund loan growth and pay down advances from the Federal Home Loan Bank ("FHLB"). In addition, deposits increased to $562.7 million as of June 30, 2000 from $503.0 million at December 31, 1999. This increase was primarily the result a $31.2 million increase in brokered certificates of deposit, to $91.3 million as of June 30, 2000 from $60.1 million as of December 31, 1999, with the remainder of the increase due to acquiring additional retail deposits. As a result of the decline in the loans held-for-sale and increase in deposits, FHLB advances and warehouse and term notes payable decreased to $221.0 million and $16.2 million, respectively, as of June 30, 2000 from $265.4 million and $53.5 million, respectively, at December 31, 1999. 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. 16 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. See Results of Operations section for a discussion of the impact on the six-month period ended June 30, 2000 loan yields resulting from a change in the estimated income on loans 90 days or more past due which have FHA insurance or VA guarantees.
Three Months Ended June 30, --------------------------------------------------------------- (in thousands) 2000 1999 ----------------------------- --------------------------- Average Yield Average Yield Balance Interest Rate(1) Balance Interest Rate(1) ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans receivable $727,245 $14,206 7.81% $633,800 $11,869 7.49% Securities 64,562 1,153 7.14 55,431 777 5.61 FHLB stock 14,431 266 7.37 11,736 221 7.53 -------- -------- ------ Total interest-earning assets 806,238 15,625 7.75 700,967 12,867 7.34 Non-interest-earning assets 189,907 137,596 -------- -------- Total assets $996,145 $838,563 ======== ======== Interest-bearing liabilities: Deposits $530,179 $6,153 4.64% $475,717 $4,849 4.08% FHLB advances and other 203,530 2,842 5.59 172,372 2,107 4.89 Notes payable 82,990 1,230 5.93 11,113 166 5.97 --------- ------- -------- -------- Total interest-bearing liabilities 816,699 10,225 5.01 659,202 7,122 4.32 ------- ---- ------ ---- Non-interest-bearing liabilities 87,595 88,117 -------- -------- Total liabilities 904,294 747,319 Stockholders' equity 91,851 91,244 -------- --------- Total liabilities and stock- holders' equity $996,145 $838,563 ======== ======== Net interest income; interest rate spread $5,400 2.74% $5,745 3.02% ====== ===== ====== ===== Net interest margin (2) 2.68% 3.28% ===== ===== Average interest-earning assets to average interest-bearing liabilities 99% 106% ==== ====
(1) Annualized (2) Net interest margin is net interest income divided by average interest-earning assets. 17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued --------------------------------------------------------------------------------
Six Months Ended June 30, --------------------------------------------------------------- (in thousands) 2000 1999 ----------------------------- ---------------------------- Average Yield Average Yield Balance Interest Rate(1) Balance Interest Rate(1) ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans receivable $702,601 $28,514 8.12% $613,702 $23,491 7.66% Securities 74,578 2,675 7.17 55,471 1,636 5.90 FHLB stock 14,307 514 7.19 11,573 418 7.22 -------- ------- -------- ------- Total interest-earning assets 791,486 31,011 8.01 680,746 25,545 7.51 Non-interest-earning assets 182,870 134,123 -------- -------- Total assets $974,356 $814,869 ======== ======== Interest-bearing liabilities: Deposits $517,843 $11,776 4.55% $466,414 $9,531 4.09% FHLB advances and other 210,699 5,729 5.44 168,043 4,089 4.87 Notes payable 75,081 2,362 6.29 8,591 258 6.01 -------- ------- -------- ------- Total interest-bearing liabilities 803,623 19,867 4.94 643,048 13,878 4.32 ------- ---- ------- ---- Non-interest-bearing liabilities 79,782 79,924 -------- --------- Total liabilities 883,405 722,972 Stockholders' equity 90,951 91,897 -------- --------- Total liabilities and stock- holders' equity $974,356 $814,869 ======== ======== Net interest income; interest rate spread $11,836 3.07% $11,667 3.19% ======= ===== ======= ===== Net interest margin (2) 2.99% 3.43% ===== ===== Average interest-earning assets to average interest-bearing liabilities 98% 106% ==== ====
(1) Annualized (2) Net interest margin is net interest income divided by average interest-earning assets. Results of Operations --------------------- Three Months Ended June 30, 2000 compared to Three Months Ended June 30, 1999 ----------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $2.5 million for the three months ended June 30, 2000 compared to $2.4 million for the same period in 1999. On a per share basis, basic and diluted earnings per share were $.39 and $.38, respectively, for the 2000 second quarter compared to $.37 and $.35 basic and diluted per share earnings for the 1999 second quarter. The 1999 second quarter results included a $316,000 after tax gain ($.05 per share) realized on the sale of certain non-core mortgage servicing rights. Excluding the impact of that one-time gain, 2000 second quarter earnings per diluted share increased by 27% over the same period in 1999. Cash earnings for the second quarter of 2000 were $2.7 million or $.42 per diluted share compared to $2.6 million or $.37 per diluted share for the same period in 1999. 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 decreased to $5,134,000 for the three-month period ending June 30, 2000 from $5,524,000 for the same period in 1999. The Company's net interest margin decreased to 2.68% for the quarter ended June 30, 2000 as 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued ------------------------------------------------------------------------------- compared to 3.28% for the quarter ended June 30, 1999. 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 2000 second quarter was 2.74%, which was 28 basis points lower than the 1999 second quarter level of 3.02%. The reductions in net interest income and net interest margin results from the necessary funding to support the growth in average non-interest earning assets, primarily mortgage servicing rights, which increased from an average of $79.8 million for the second quarter of 1999 to $109.1 million for the same period in 2000. The increase in average mortgage servicing rights reflects the growth in loan production at The Leader and results in increases in both gain on sale of loans and mortgage banking income. Total interest income increased by $2.8 million, or 21.5%, from $12.6 million for the three months ended June 30, 1999 to $15.4 million for the three months ended June 30, 2000. The increase was primarily due to a $93.4 million increase in the average balance of loans outstanding for the second quarter of 2000 when compared to the same period in of 1999. The yield on those loans increased to 7.81% in 2000 versus 7.49% in 1999. The increase in loans receivable was attributable to increases in the average balance of loans held-for-sale at The Leader and commercial loans at First Federal. Loans held-for-sale increased from an average balance of $163.3 million for the second quarter of 1999 to $213.9 million for the same period in 2000. The recent increasing rate environment along with a planned expansion of The Leader's mortgage banking operations has resulted in the increase in the average balance in loans held-for-sale. For the 2000 second quarter, The Leader originated 8,930 loans with balances of $619.5 million compared to production of 5,532 loans with balances of $370.3 million during the same period of 1999. Commercial loans increased from an average balance of $99.4 million for the three-month period ended June 30, 1999 to $174.7 million for the same period in 2000. Interest earnings from the investment portfolio increased to $1.0 million for the three months ended June 30, 2000 compared to $760,000 for the same period in 1999. The increase in interest income was the result of a $9.2 million increase in the average balance on investment securities from $55.4 million for the second quarter of 1999 to $64.6 million for the same period in 2000. Additionally, due to the increasing rate environment of the last several quarters, the average yield on the investment portfolio increased from 5.61% for the three-month period ended June 30, 1999 to 7.14% for the same period in 2000. Interest expense increased by $3.1 million, or 43.6%, to $10.2 million for the second quarter of 2000 compared to $7.1 million for the same period in 1999. The increase is primarily due to funding the $102.3 million increase in average interest-earning assets combined with a $52.3 million increase in average non-interest earning assets, from $137.6 million for the first quarter of 1999 to $189.9 million for the same period in 2000. As previously noted, this increase in average non-interest earning assets was primarily the result in increases in mortgage servicing rights resulting from The Leader's increased production. Interest expense also increased because of an increase in the average balance of deposits outstanding and the average cost of those deposits. Average deposits increased to $530.2 million for the three months ended June 30, 2000 compared to $475.7 million for the three months ended 19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- June 30, 1999. The average cost of those deposits increased by 56 basis points in the second quarter of 2000, to 4.64% from 4.08% for the same period in 1999. The average balance of FHLB advances increased to $203.5 million for the three months ended June 30, 2000 from $172.4 million for the comparable period in 1999. The average cost of those advances increased to 5.59% from 4.89% for the three months ended June 30, 2000 and 1999, respectively. These increase in the cost of FHLB advances was the result of several increases to the targeted Fed Funds rate initiated by the Federal Reserve throughout 1999 and continuing in 2000. Provision for Loan Losses. The provision for loan losses for the quarter ended June 30, 2000 was $581,000 compared to $202,000 during the same period in 1999. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to the level deemed appropriate by management based on historical experience, the volume and type of lending conducted by First Defiance, industry standards, the amount of non-performing assets and loan charge-off activity, general economic conditions, particularly as they relate to First Defiance's market area, and other factors related to the collectibility of First Defiance's loan portfolio. The increased provision reflects the shift in First Federal's portfolio to a larger concentration of commercial loans. It also includes increased provision for losses associated with both the cost of servicing foreclosed loans in the servicing portfolio and the rapid growth in that servicing portfolio. Non-performing assets, which include loans 90 days or more past due, loans deemed impaired, and repossessed assets totaled $1.3 million at June 30, 2000, which is .14% of total assets. Non-performing loans and repossessed assets reported do not include $7.6 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 June 30, 2000 was $8.4 million compared to $8.5 million at June 30, 1999 and $7.8 million at December 31, 1999. For the quarter ended June 30, 2000, First Defiance charged off $588,000 of loans against its allowance and realized recoveries of $211,000 from loans previously charged off. During the same quarter in 1999, First Defiance charged off $1.1 million in loans and realized recoveries of $96,000. Non-Interest Income. Non-interest income increased substantially in the second quarter of 2000, from $9.8 million for the quarter ended June 30, 1999 to $13.1 million for the same period in 2000. Individual components of non-interest income are as follows: Mortgage Banking Income. Mortgage banking income, which includes servicing fees and late charge income, increased to $8.6 million for the three-month period ended June 30, 2000 compared to $6.6 million for the same period in 1999. This increase in mortgage banking income was primarily the result of the growth in the mortgage-servicing portfolio from $5.1 billion as of June 30, 1999 to $6.9 billion at June 30, 2000. Gain on Sale of Loans. Gain on sale of loans increased from $1.6 million for the quarter ended June 30, 1999 to $2.6 million for the same period of 2000. The increased gain on sale of loans is associated with increased secondary market activi 20 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- ties at The Leader. For the 2000 second quarter, The Leader originated $619.5 million in loans compared to $370.3 million in production during the same period in 1999. 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 $1.9 million for the quarter ended June 30, 2000 from $1.6 million for the same period in 1999. Other income for the three-month period ended June 30, 1999 included a $479,000 gain realized on the sale of non-core servicing rights. There were no sales of loan servicing in the current year. Commission revenue increases at First Insurance, due to the September 1, 1999 acquisition of the Defiance, Ohio office of Insurance and Risk Management, accounted for $466,000 of the increase from the quarter ended June 30, 1999 to the quarter ended June 30, 2000. Non-Interest Expense. Total non-interest expense increased $2.2 million from $11.6 million for the quarter ended June 30, 1999 to $13.8 million for the same period in 2000. Significant individual components of the increase are as follows: Compensation and Benefits. Compensation and benefits increased $1.2 million from $4.7 million for the quarter ended June 30, 1999 to $5.9 million for the same period in 2000. This increase was the result of planned expansions of The Leader's operations, increases at First Federal to support the growth in commercial lending and the expansion of the branch network, and the additional staff at First Insurance acquired through the acquisition of the Insurance and Risk Management office. Occupancy. Occupancy expense increased to $1.2 million for the three-month period ended June 30, 2000 from $1.0 million for the three months ended June 30, 1998. This increase was the result of the branch expansions at First Federal, office renovation and expansion at The Leader, and the addition of the Insurance and Risk Management office at First Insurance. Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing rights (MSRs) increased to $3.7 million for the quarter ended June 30, 2000 from $3.1 million for the same period in 1999. This increase was due to the growth in the mortgage-servicing portfolio from $5.1 billion as of June 30, 1999 to $6.9 billion as of June 30, 2000. Due to increases in interest rates, management has concluded that there are no impairment issues with the servicing portfolio. The loan prepayments of The Leader's servicing portfolio have fallen to 4.71% for the second quarter of 2000, annualized, compared to 9.53% for the same period in 1999, annualized. Amortization of Goodwill and Other Acquisition Related Costs. Amortization of goodwill and other acquisition costs amounted to $612,000 in the second quarter of 2000 compared to $576,000 during the same period in 1999. This increase was due to First Insurance's acquisition of the Defiance office of Insurance and Risk Management in the third quarter of 1999. Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, deposit premiums, and loan servicing) increased to $2.4 million for the quarter ended June 30, 2000 from $2.2 million for the same period in 1999. First Defiance has computed federal income tax expense in accordance with FASB Statement No. 109 which resulted in an effective tax rate of 36.3% for the quarter ended June 30, 2000 compared to 34.3% for the same period in 1999. The higher rate for the 2000 second quarter resulted from 21 increasing the effective rate to 35% in the second quarter from the 34% rate used during the 2000 first quarter As a result of the above factors, net income for the quarter ended June 30, 2000 was $2,458,000 compared to $2,371,000 for the comparable period in 1999. On a per share basis, basic and diluted earnings per share for the three months ended June 30, 2000 were $.39 and $.38 respectively compared to $.37 and $.35, respectively, for the same period in 1999. As stated above, the results for the quarter ended June 30, 1999 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 6,305,000 and 6,407,000, respectively, for the quarter ended June 30, 2000 compared to 6,489,000 and 6,670,000, respectively, for the quarter ended June 30, 1999. First Defiance's board of directors declared a dividend of $.11 per common share as of June 30, 2000. The dividend amounted to $711,327, including dividends on unallocated ESOP shares. It was paid on July 28, 2000. 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. 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Six Months Ended June 30, 2000 compared to Six Months Ended June 30, 1999 ------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $4.7 million for the six-months ended June 30, 2000 compared to $4.3 million for the same period in 1999. On a per share basis, basic and diluted earnings per share were $.74 and $.73, respectively, compared to $.66 and $.63 basic and diluted per share earnings for the same period in 1999. As discussed in the quarterly results above, the 1999 second quarter included a one-time gain on sale of certain non-core servicing rights of $479,000 (or $.05 per share). Cash earnings for the six-months ended June 30, 2000 were $5.1 million or $.79 per diluted share compared to $4.7 million or $.69 per diluted share for the same period in 1999. 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 $11.3 million for the six-month period ending June 30, 2000 compared to $11.2 million for the same period in 1999. The Company's year-to-date net interest margin through June 30, 2000 decreased to 2.99% compared to 3.43% for the same period in 1999. Interest rate spread also decreased to 3.07% for the six-month period ended June 30, 2000 from 3.19% for the same period in 1999. The net interest margin was favorably impacted by a first quarter change in the estimate of interest receivable on certain loans that are more than 90 days delinquent which have been repurchased out of the servicing portfolio by The Leader. This change in estimate of interest receivable resulted in a 20 basis point increase in the yield on interest-earning assets for the six-month period ended June 30, 2000. Without that change, the year-to-date net interest margin would have been 2.82%. In addition, management enhanced its method of estimating the required reserve for potential losses on foreclosure loans to more accurately reflect the total risk inherent in the servicing and loan portfolios at The Leader. This resulted in a one-time adjustment to provision for loan losses of $693,000. The net impact of these two items essentially offset each other and without these adjustments earnings for the year would still be $.73 per diluted share. Excluding the estimate change, total interest income increased by $5.4 million, or 21.4%, from $25.1 million for the six-months ended June 30, 1999 to $30.5 million for the same period in 2000. The increase was due to a $100.7 million increase in the average balance of interest-earning assets for the six-months ended June 30, 2000 when compared to the same period in 1999. The yield on interest earning assets increased from 7.51% for the year-to-date period ended June 30, 1999 to 7.84% for the same period in 2000 excluding the impact of the change in estimate noted above (8.01% including the change in estimate). Excluding the estimate change, interest earnings on the loan portfolio increased $4.3 million from $23.5 million for the six-months ended June 30, 1999 to $27.8 million for the same period in 2000. This increase was due to increases in the average balance of loans receivable and the yield on these loans from $613.7 million and 7.66% for the six-month period ended June 30, 1999, respectively, to $702.6 million and 7.92%, respectively, for the same period in 2000. Interest earnings from the investment portfolio increased to $2.5 million for the six months ended June 30, 2000 compared to $1.6 million for the same period in 1999. The increase in interest income was primarily the result of a $19.1 million increase in the average balance of investment 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- securities, from $55.5 million for the first six months of 1999 to $74.6 million for the same period in 2000. This increase resulted from including loans that were securitized pending delivery to the bond trustees in trading securities beginning in late December of 1999. These trading securities were delivered to the trustee during the first quarter of 2000. Additionally, the yield on the average portfolio balance for the six months ended June 30, 2000 was 7.17% compared to 5.90% for the same period in 1999. Interest expense increased by $6.0 million, or 43.2%, to $19.9 million for the six months ended June 30, 2000 compared to $13.9 million for the same period in 1999. The increase is primarily due to the funding of the $100.7 million increase in average interest earning assets noted above combined with a $48.8 million increase in average non-interest earning assets, from $134.1 million for the first six months of 1999 to $182.9 million for the same period in 2000. This increase in average non-interest earning assets was primarily a result of the growth in The Leader's mortgage servicing assets from an average of $78.8 million for the year-to-date period ended June 30, 1999 to $105.3 million for the same period in 2000. These increased funding requirements resulted in a $160.6 million increase in the average balance of total interest-bearing liabilities from $643.0 million for the six months ended June 30, 1999 to $803.6 million for the same period of 2000. Interest expense also increased due to an increase in the average cost of funds during the first six months of 2000 to 4.94% from 4.32% for the comparable period in 1999. This increase resulted from increases in the average costs of deposits, FHLB advances, and notes payable of 46 basis points, 57 basis points, and 28 basis points, respectively, from 4.09%, 4.87%, and 6.01%, respectively for the six-months ended June 30, 1999, to 4.55%, 5.44%, and 6.29%, respectively for the same period in 2000. These increases were the result of several increases to the targeted Fed Funds rate initiated by the Federal Reserve throughout 1999 and continuing through the second quarter of 2000. Provision for Loan Losses. The provision for loan losses increased to $2.0 million for the six-months ended June 30, 2000 compared to $712,000 for the same period in 1999. As noted above, $693,000 of this increase was the result of the change in accounting estimate on foreclosure loans at The Leader. First Defiance charged off $1.6 million of loans against its allowance for loan losses for the six-month period ended June 30, 2000 and realized recoveries of $249,000 from loans previously charged off. During the same period in 1999, First Defiance charged off $1.9 million in loans and realized recoveries of $146,000. Non-Interest Income. Non-interest income increased $6.2 million for the six-month period ended June 30, 2000 from $18.8 million to $25.0 million for the 1999 and 2000 periods, respectively. Individual components of non-interest income are as follows: Mortgage Banking Income. Mortgage banking income, which includes servicing fees and late charge income, increased to $16.7 million for the six-month period ended June 30, 2000 from $13.1 million for the same period in 1999. This increase in mortgage banking income was primarily the result of the growth in the mortgage servicing portfolio noted in the Results of Operations section for the second quarter of 2000. The Leader now services a total of 110,000 loans with a balance of nearly $7.0 billion. 24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Gain on Sale of Loans. Gain of sale of loans increased from $3.2 million for the six-months ended June 30, 1999 to $4.5 million for the same period in 2000. The increase in gains on sale of loans is a result of continued strong production levels at The Leader. Year-to-date the number of loans produced has increased by 66% over 1999 from 9,512 for the first six months of 1999 to 15,803 for the same period in 2000. The dollar balance of loans produced has increased by 72% over that same period, from $635.5 million during the first half of 1999 compared to $1.094 billion during the same period in 2000. Other Non-Interest Income. Other non-interest income, including insurance commission income, dividends on Federal Home Loan Bank stock, gains on sale of securities, and other miscellaneous charges, increased to $3.7 million for the first half of 2000 from $2.5 million for the same period in 1999. Commission revenue increases at First Insurance accounted for $909,000 of the year over year increase due to the 1999 third quarter acquisition of the Insurance and Risk Management office. Additionally, as previously noted, during the second quarter of 1999 The Leader recognized a $479,000 gain on sale of non-core servicing rights. Non-Interest Expense. Total non-interest expense increased $4.4 million from $22.7 million for the six-month period ended June 30, 1999 to $27.1 for the same period in 2000. Significant individual components of the increase are as follows: Compensation and Benefits. Compensation and benefits increased $2.4 million from $9.0 million for the year-to-date period ended June 30, 1999 to $11.4 million for the same period in 2000. This increase was the result of planned expansions of The Leader's operations, increases at First Federal to support the growth in commercial lending and expansion of the branch network, and the additional staff at First Insurance acquired through the acquisition of the Insurance and Risk Management office. Occupancy. Occupancy expense increased to $2.4 million for the six-month period ended June 30, 2000 from $1.9 million for the same period in 1999. This increase was a result of expansions throughout the Company. Amortization of Mortgage Servicing Rights. Amortization of mortgage servicing rights increased to $7.2 million for the six-month period ended June 30, 2000 from $6.4 million for the same period in 1999 due to the growth in the mortgage servicing portfolio. Amortization of Goodwill and Other Acquisition Costs. $1.22 million in amortization of goodwill and other acquisition costs was recognized for the six-month period ended June 30, 2000 compared to $1.15 million for the same period in 1999, due to the purchase of The Leader and the First Insurance. Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, deposit premiums, and loan servicing) increased to $4.7 million for the six-month period ended June 30, 2000 compared to $4.3 million for the same period in 1999. The effective tax rate utilized for the six months ended June 30, 2000 was 35.6% compared to 35.4% for the six months ended June 30, 1999. 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- As a result of the above factors, net income for the six-month period ended June 30, 2000 increased to $4.7 million from $4.3 million for the six-months ended June 30, 1999. On a per share basis, basic and diluted earnings per share for the six months ended June 30, 2000 were $.74 and $.73 respectively compared to $.66 and $.63, respectively, for the same period in 1999. As stated above the results for the six months ended June 30, 1999 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 6,272,000 and 6,394,000 respectively for the six-months ended June 30, 2000 compared to 6,614,000 and 6,835,000 respectively for the same period in 1999. Through June 30, 2000, First Defiance has declared dividends totaling $.22 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 six-month period ended June 30, 2000. First Defiance generated $21.5 million in cash for operating activities during the first six months of 2000. The Company's cash flow from 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, 2000, First Defiance had $20.6 million in outstanding mortgage loan commitments and loans in process to be funded generally within the next six months and an additional $45.3 million committed under existing consumer and commercial lines of credit and standby letters of credit. Also at that date, First Defiance had commitments to sell $198.9 million of loans held-for-sale and it also had commitments to acquire $1.635 billion of mortgage loans under active first-time homebuyer programs, all of which have offsetting commitments for sale into the secondary market as GNMA or FNMA mortgage backed securities. Also as of June 30, 2000, the total amount of certificates of deposit that are scheduled to mature by June 30, 2001 is $350.7 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 26 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- environments. If First Defiance requires funds beyond its internal funding capabilities, additional advances from the FHLB of Cincinnati are available. Currently First Defiance invests in on-balance sheet derivative securities as part of the overall asset and liability management process. Such derivative securities include REMIC and CMO investments. Such investments are not classified as high risk at June 30, 2000 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. 27 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, 2000.
Tangible Core Risk-Based Capital Capital Capital (1) ------- ------- -------------- (Dollars in Thousands) Regulatory capital $62,644 $62,644 $68,560 Minimum required regulatory capital 14,107 37,621 50,083 ------- ------- -------- Excess regulatory capital $48,537 $25,023 $18,477 ======= ======= ======= Regulatory capital as a percentage of assets (2) 6.7% 6.7% 11.0% Minimum capital required as a percentage of assets 1.5% 4.0% 8.0% ------- ------- ------ Excess regulatory capital as a percentage in excess of requirement 5.2% 2.7% 3.0% ====== ===== =====
(1) Does not reflect the interest-rate risk component in the risk-based capital requirement, discussed above. (2) Tangible capital and core capital are computed as a percentage of adjusted total assets of $940.5 million. Risk-based capital is computed as a percentage of total risk-weighted assets of $626.0 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 2000 are approximately $0.0052 per $100 of deposits. 28 Item 3. Qualitative and Quantitative Disclosure About Market Risk As discussed in detail in the 1999 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 monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance does not use off balance sheet derivatives to enhance its risk management, nor does it engage in trading activities beyond the sale of mortgage loans. First Defiance monitors its exposure to interest rate risk on a monthly basis through simulation analysis which measures the impact changes in interest rates can have on net income. The simulation technique 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, 2000 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, 2000, a 100 basis point decrease in interest rate would not materially impact the valuation reserve for mortgage servicing rights. 29 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 30 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 11, 2000 By: /s/ William J. Small --------------- -------------------- William J. Small Chairman, President and Chief Executive Officer Date: August 11, 2000 By: /s/ John C. Wahl --------------- ---------------- John C. Wahl Executive Vice President, Chief Financial Officer and Treasurer 31