-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, To+fFOqXvrPnkq/MqukZ0u6RngVHMyVeFe5LTaV9LVAHuxFTGmvKz6FN82Bnma9/ QXA3COk8rdR2sJYVIIWxfg== 0000914317-03-001576.txt : 20030515 0000914317-03-001576.hdr.sgml : 20030515 20030515130919 ACCESSION NUMBER: 0000914317-03-001576 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20030515 FILED AS OF DATE: 20030515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST DEFIANCE FINANCIAL CORP CENTRAL INDEX KEY: 0000946647 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 341803915 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26850 FILM NUMBER: 03702887 BUSINESS ADDRESS: STREET 1: 601 CLINTON ST CITY: DEFIANCE STATE: OH ZIP: 43512 BUSINESS PHONE: 4107825015 MAIL ADDRESS: STREET 1: 601 CLINTON ST CITY: DEFIANCE STATE: OH ZIP: 43512 10-Q 1 form10q52073firstdefiance.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 the Quarterly Period Ended March 31, 2003 OR |_| Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from _________to__________ Commission file number 0-26850 First Defiance Financial Corp. (Exact name of registrant as specified in its charter) Ohio 34-1803915 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification) Number) 601 Clinton Street, Defiance, Ohio 43512 (Address or principal executive office) (Zip Code) Registrant's telephone number, including area code: (419) 782-5015 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during 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 |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_| 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 - 6,330,968 shares outstanding at May 9, 2003 FIRST DEFIANCE FINANCIAL CORP. INDEX
Page Number ----------- PART I.-FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements (Unaudited): Consolidated Condensed Statements of Financial Condition - March 31, 2003 and December 31, 2002 2 Consolidated Condensed Statements of Income - Three months ended March 31, 2003 and 2002 4 Consolidated Condensed Statement of Changes in Stockholders' Equity - Three months ended March 31, 2003 5 Consolidated Condensed Statements of Cash Flows - Three months ended March 31, 2003 and 2002 7 Notes to Consolidated Condensed Financial Statements 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures about Market Risk 31 Item 4. Controls and Procedures 31 PART II.-OTHER INFORMATION: Item 1. Legal Proceedings 32 Item 2. Changes in Securities 32 Item 3. Defaults upon Senior Securities 32 Item 4. Submission of Matters to a Vote of Security Holders 32 Item 5. Other Information 32 Item 6. Exhibits and Reports on Form 8-K 32 Signatures 34 Certifications Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002 35
1 PART 1-FINANCIAL INFORMATION Item 1. Financial Statements FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
March 31, 2003 December 31, 2002 -------------- ----------------- ASSETS Cash and cash equivalents: Cash and amounts due from depository institutions $ 25,475 $ 17,263 Interest-bearing deposits 6,475 11,395 -------- -------- 31,950 28,658 Securities: Available-for-sale, carried at fair value 196,536 209,604 Held-to-maturity, carried at amortized cost (approximate fair value $3,730 and $4,129 at March 31, 2003 and December 31, 2002 respectively) 3,527 3,921 -------- -------- 200,063 213,525 Loans held for sale 11,391 15,336 Loans receivable, net 586,507 561,041 Accrued interest receivable 4,734 4,533 Federal Home Loan Bank stock and other interest-earning assets 17,242 18,302 Bank owned life insurance 15,345 15,144 Office properties and equipment 20,460 19,958 Real estate and other assets held for sale 59 206 Goodwill 3,658 3,636 Mortgage servicing rights 2,036 2,090 Other assets 3,131 1,816 -------- -------- Total assets $896,576 $884,245 ======== ========
See accompanying notes. 2 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
March 31, 2003 December 31, 2002 -------------- ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Non-interest-bearing deposits $ 47,673 $ 43,936 Interest-bearing deposits 560,293 555,637 --------- --------- Total deposits 607,966 599,573 Advances from Federal Home Loan Bank 156,147 149,096 Short-term borrowings and other interest-bearing liabilities 1,997 4,308 Advance payments by borrowers for taxes and insurance 169 316 Deferred taxes 2,017 2,299 Other liabilities 8,133 8,543 --------- --------- Total liabilities 776,429 764,135 STOCKHOLDERS' EQUITY Preferred stock, no par value per share: 5,000 shares authorized; no shares issued -- -- Common stock, $.01 par value per share: 20,000 shares authorized; 6,347 and 6,412 shares outstanding, respectively 63 64 Additional paid-in capital 50,432 50,702 Stock acquired by ESOP (2,175) (2,387) Deferred compensation (25) (30) Accumulated other comprehensive income, net of income taxes of $3,127 and $3,477, respectively 6,068 6,455 Retained earnings 65,784 65,306 --------- --------- Total stockholders' equity 120,147 120,110 --------- --------- Total liabilities and stockholders' equity $ 896,576 $ 884,245 ========= =========
See accompanying notes 3 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Income (UNAUDITED) (Amounts in Thousands, except per share data) - --------------------------------------------------------------------------------
For the Three Months Ended March 31, 2003 2002 ------- ------- Interest Income Loans $ 9,338 $ 8,961 Investment securities 2,424 751 Interest-bearing deposits 29 17 ------- ------- Total interest income 11,791 9,729 Interest Expense Deposits 3,534 3,928 FHLB advances and other 1,814 81 Notes payable and warehouse loans 9 192 ------- ------- Total interest expense 5,357 4,201 ------- ------- Net interest income 6,434 5,528 Provision for loan losses 335 582 ------- ------- Net interest income after provision for loan losses 6,099 4,946 Non-interest Income Service fees and other charges 985 798 Insurance commission income 926 883 Dividends on stock 169 181 Gain on sale of loans 1,800 526 Gain/(loss) on sale of securities 631 (15) Trust income 32 31 Income from Bank Owned Life Insurance 201 -- Other non-interest income 47 21 ------- ------- Total non-interest income 4,791 2,425 Non-interest Expense Compensation and benefits 3,708 3,304 Occupancy 728 692 SAIF deposit insurance premiums 24 32 State franchise tax 281 294 Data processing 432 322 Amortization and impairment of mortgage servicing rights 763 224 Amortization and impairment of goodwill and other intangibles -- 200 Other non-interest expense 1,079 925 ------- ------- Total non-interest expense 7,015 5,993 ------- ------- Income from continuing operations before income taxes 3,875 1,378 Federal income taxes 1,157 491 ------- ------- Income from continuing operations 2,718 877 Discontinued operations, net of tax -- 2,015 ------- ------- Income before cumulative effect of a change in accounting principle 2,718 2,902 Cumulative effect of change in method of accounting for goodwill, net of tax -- (194) ------- ------- Net income $ 2,718 $ 2,708 ======= ======= Earnings per share (Note 5) Basic: From continuing operations $ 0.45 $ 0.14 Discontinued operations, net of tax -- $ 0.31 Cumulative effect in method of accounting for goodwill -- $ (0.03) ------- ------- Net income $ 0.45 $ 0.42 ======= ======= Diluted: From continuing operations $ 0.43 $ 0.14 Discontinued operations, net of tax -- $ 0.30 Cumulative effect in method of accounting for goodwill -- $ (0.03) ------- ------- Net income $ 0.43 $ 0.41 ======= ======= Dividends declared per share (Note 4) $ 0.15 $ 0.13 ======= ======= Average shares outstanding (Note 5) Basic 6,074 6,442 ======= ======= Diluted 6,330 6,663 ======= =======
See accompanying notes 4 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
2003 --------------------------------------------------------- Stock Acquired By Additional Management Common Paid-in Recognition Stock Capital ESOP Plan ----- ------- ---- ---- Balance at January 1 $ 64 $ 50,702 $(2,387) $(30) Comprehensive income: Net income Change in unrealized gains net of income taxes of $ 350 Total comprehensive income ESOP shares released 243 212 Amortization of deferred compensation of Management Recognition Plan 5 Shares issued under stock option plan 516 Purchase of common stock for treasury (1) (1,029) Dividends declared (Note 5) ------------------------------------------------ Balance at March 31 $ 63 $ 50,432 $(2,175) $(25) ================================================
See accompanying notes 5 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued) (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
2003 2002 ----------------------------------------------- ------------- Net Unrealized gains (losses) on Total Total available-for- Retained Stockholders' Stockholder's sale securities Earnings Equity Equity --------------- -------- ------ ------ Balance at January 1 $ 6,455 $ 65,306 $ 120,110 $ 111,021 Comprehensive income: Net income 2,718 2,718 2,708 Change in unrealized gains (losses) net of income taxes of $350 (387) (387) (255) --------- --------- Total comprehensive income 2,331 2,453 ESOP shares released 455 360 Amortization of deferred compensation of Management Recognition Plan 5 13 Shares issued under stock option plan 516 363 Purchase of common stock for treasury (1,326) (2,356) (497) Dividends declared (Note 5) (914) (914) (850) ---------------------------------------- --------- Balance at March 31 $ 6,068 $ 65,784 $ 120,147 $ 112,863 ======================================== =========
See accompanying notes 6 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
Three Months Ended March 31, 2003 2002 -------- -------- Operating Activities Net income $ 2,718 $ 2,708 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 335 582 Provision for depreciation 396 414 Net securities amortization 289 12 Amortization of mortgage servicing rights 523 157 Net impairment of mortgage servicing rights 240 68 Net impairment of goodwill -- 438 Gain on sale of loans (1,800) (526) Amortization of Management Recognition Plan deferred compensation 5 13 Release of ESOP Shares 455 360 (Gains) losses on sales of securities (631) 15 Deferred federal income tax credit 67 (158) Proceeds from sale of loans 75,619 32,584 Origination of mortgage servicing rights, net (709) (723) Origination of loans held for sale (69,874) (32,534) Increase in interest receivable and other assets (1,717) (1,004) Decrease in other liabilities (432) (1,325) Increase in assets of discontinued operations -- (5,418) Decrease in liabilities of discontinued operations -- (35,166) -------- -------- Net cash provided by (used in) operating activities 5,484 (39,503) Investing Activities Proceeds from maturities of held-to-maturity securities 387 503 Proceeds from maturities of available-for-sale securities 23,668 1,948 Proceeds from sale of available-for-sale securities 1,670 423 Purchases of available-for-sale securities (12,657) (520) Proceeds from sales of real estate and other assets held for sale 154 105 Proceeds from sale of discontinued operations 1,228 -- Purchases of Federal Home Loan Bank stock (168) (181) Purchases of office properties and equipment (898) (229) Net (increase) decrease in loans receivable (25,808) 4 -------- -------- Net cash provided by (used in) investing activities (12,424) 2,053
7 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (Continued) (UNAUDITED) (Amounts in Thousands) - --------------------------------------------------------------------------------
Three Months Ended March 31, 2003 2002 -------- -------- Financing Activities Net increase (decrease) in deposits 8,246 (8,244) Repayment of Federal Home Loan Bank long-term advances (249) (103) Repayment of term notes payable (10) (160) Net increase (decrease) in Federal Home Loan Bank short-term advances (1,700) 41,500 Net increase in short-term line of credit -- 1,300 Proceeds from Federal Home Loan Bank long term advances 9,000 -- Decrease in securities sold under repurchase agreements (2,301) -- Purchase of common stock for treasury (2,356) (497) Cash dividends paid (914) (850) Proceeds from exercise of stock options 516 363 -------- -------- Net cash used in financing activities 10,232 33,309 -------- -------- Increase in cash and cash equivalents 3,292 (4,141) Cash and cash equivalents at beginning of period 28,658 38,521 -------- -------- Cash and cash equivalents at end of period $ 31,950 $ 34,380 ======== ======== Supplemental cash flow information: Interest paid $ 5,192 $ 4,305 ======== ======== Income taxes paid $ 400 $ 400 ======== ======== Noncash operating activities: Change in deferred tax established on net unrealized gain or loss on available-for-sale securities $ 350 $ 149 ======== ======== Transfers from loans to real estate and other assets held for sale $ 7 $ 163 ======== ======== Noncash investing activities: Increase (decrease) in net unrealized gain or loss on available-for-sale securities $ (737) $ (404) ======== ======== Noncash financing activities: Cash dividends declared but not paid $ 920 $ 850 ======== ========
See accompanying notes. 8 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 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 owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance"), and First Federal's wholly owned mortgage banking company, The Leader Mortgage Company, LLC ("The Leader"). Operations of The Leader were sold to US Bancorp in a transaction that was completed on April 1, 2002. 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, 2002 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 March 31, 2003 and for the three-month period ending March 31, 2003 and 2002 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 accounting principles generally accepted in the United States. For the purposes of these statements, operations of The Leader are presented as results of discontinued operations. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance's 2002 Annual Report on Form 10-K for the year ended December 31, 2002. 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 for the three-month period ended March 31, 2003 are not necessarily indicative of the results that may be expected for the entire year. Stock Compensation At March 31, 2003, the Company had three stock-based compensation plans, which are more fully described in Note 18 in the financial statements included in First Defiance's 2002 Annual Report on Form 10-K. The Company accounts for those plans under recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Under APB No. 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. 9 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Pro forma information regarding net income and earnings per share is required by SFAS No. 123, Accounting for Stock-Based Compensation and has been determined as if First Defiance had accounted for its employee stock options under the fair value method of that Statement. Under the fair-value based method, compensation cost is measured at the grant date based upon the value of the award and recognized over the service period. For purposes of the pro forma disclosures, the estimated fair value of the option is amortized to expense over the options' vesting period. The following pro forma results of operations use a fair value method of accounting for stock options in accordance with SFAS No. 123. The estimated fair value of the options are amortized to expense over the option and vesting period. The fair value was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
March 31 2003 2002 ------------------------------ Risk free interest rate 5.73% 5.74% Dividend yield 2.96% 2.93% Volatility factors of expected market price of stock 0.269% 0.269% Weighted average expected life 8.63 years 8.62 years Weighted average grant date fair value of options granted $3.45 $3.44
Based on the above assumptions, pro forma net income and earnings per share are computed as follows (in thousands, except per share amounts):
Three months ended March 31 2003 2002 --------------------- Income from continuing operations $ 2,718 $ 877 Stock-based compensation using the fair value method, net of tax (51) (52) --------------------- Pro forma net income from continuing operations $ 2,667 $ 825 ===================== Pro forma earnings per share: Basic $ 0.44 $ 0.13 ===================== Diluted $ 0.42 $ 0.12 =====================
10 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Accounting Pronouncements adopted in 2003 Asset Retirement Obligations In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires an entity to record a liability for an obligation associated with the retirement of an asset at the time the liability is incurred by capitalizing the cost as part of the carrying value of the related asset and depreciating it over the remaining useful life of that asset. The standard was effective for the Company beginning January 1, 2003, and its adoption did not have a material impact on the Company's results of operations, financial position or liquidity. Accounting for Costs Associated with Exit or Disposal Activities SFAS No. 146, Accounting for Costs Associated with Exit of Disposal Activities, was issued in June 2002 and replaces Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." The provisions of SFAS No. 146 address the accounting and reporting for one-time employee termination benefits, certain contract termination costs and other costs associated with exit or disposal activities such as facility closings or consolidations and employee relocations. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company has adopted SFAS No. 146 prospectively as of January 1, 2003. Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. On November 25, 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN No. 45) which expands on the accounting guidance of Statements No. 5, 57 and 107 and incorporates without change the provisions of FASB Interpretation No. 34, which is being superseded. 11 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) FIN No. 45, which is applicable to public and non-public entities, significantly changes current practice in the accounting for, and disclosure of, guarantees. Each guarantee meeting the characteristics described in FIN No. 45 is to be recognized and initially measured at fair value, which will be a change from prior practice for most entities. In addition, guarantors must make significant new disclosures, even if the likelihood of the guarantor making payments under the guarantee is remote, which represents another change from prior general practice. FIN No. 45's disclosure requirements was effective for financial statements of interim or annual periods ending after December 15, 2002, while the initial recognition and initial measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. The Company has included FIN No. 45's required disclosures in Note 7. FIN No. 45 recognition and measurement provisions did not have a material impact on the Company's results of operations, financial position or liquidity once adopted by the Company on January 1, 2003. Consolidation of Variable Interest Entities In January 2003, the FASB issued FASB Interpretation No. 46 (FIN No. 46), "Consolidation of Variable Interest Entities". The objective of this interpretation is to provide guidance on how to identify a variable interest entity (VIE) and determine when the assets, liabilities, non-controlling interests and results of operations of a VIE need to be included in a company's consolidated financial statements. A company that holds variable interests in an entity will need to consolidate the entity if the company's interest in the VIE is such that the company will absorb a majority of the VIE's expected loss and/or receive a majority of the entity's expected residual returns, if they occur. FIN No. 46 also requires additional disclosures by primary beneficiaries and other significant variable interest holders. The provisions of this interpretation became effective upon issuance. As of March 31, 2003, the Company was not party to any VIEs. The Company continues to assess the impact, if any, the interpretation will have on results of operation, financial position, or liquidity, as it applies to other areas within the Company. 12 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Accounting Pronouncement adopted in 2002 On January 1, 2002, First Defiance adopted Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets. As required by FAS No. 142, goodwill is no longer amortized into the income statement over an estimated life but rather is tested at least annually for impairment based on specific guidance included in FAS No. 142. Based on an impairment test performed as of January 1, 2002, the Company determined that a portion of previously recorded goodwill related to its First Insurance business unit was impaired. The amount of impairment as of January 1, 2002, which was $238,000 or $194,000 after tax, is reflected in the financial statements as an adjustment for the cumulative effect of an accounting change. During the quarter ended March 31, 2002, management reached a settlement with the former shareholders of one of the agencies acquired to form First Insurance related to an earn-out provision of the original purchase agreement. The payment of $200,000 was recorded as additional goodwill for First Insurance and was considered impaired. This $200,000 impairment adjustment is reported as an operating cost by First Defiance in the 2002 first quarter. Since the first quarter of 2002 no further amount of goodwill has been deemed to be impaired. The balance of goodwill recorded at First Insurance totals $3.7 million at March 31, 2003. 3. Discontinued Operations On April 1, 2002, First Defiance completed the sale of The Leader to US Bancorp. Discontinued operations as reported for the three months ended March 31, 2002 include the operating results of The Leader for that period. Net interest income is allocated to discontinued operations in accordance with Emerging Issues Task Force (EITF) 87-24, based on interest earned by First Federal on intercompany loans to The Leader less interest expense, primarily interest on brokered certificates of deposit and a portion of FHLB advances utilized to fund those intercompany loans. For the first three months of 2002, First Federal had a negative spread in its borrowing relationship with The Leader. The components of discontinued operations for the three months ended March 31, 2002 are as follows (in thousands): Operations of The Leader $ 4,316 Net interest expense allocated to discontinued operations (1,250) ------- Income from discontinued operations before income tax 3,066 Income tax on discontinued operations 1,051 ------- $ 2,015 ======= 13 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 4. Dividends on Common Stock As of March 31, 2003, First Defiance had declared a quarterly cash dividend of $.15 per share for the first quarter of 2003, payable April 25, 2003. 5. Earnings Per Share Basic earnings per share as disclosed under FAS No. 128 has been calculated by dividing net income by the weighted average number of shares of common stock outstanding for the three month period ended March 31, 2003 and 2002. 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 months ended March 31, 2003 and 2002, 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 March 31 2003 2002 --------------------------- Numerator for basic and diluted earnings per share - income from continuing operations $2,718 $ 877 Denominator: Denominator for basic earnings per share - weighted average shares 6,074 6,442 Effect of dilutive securities: Employee stock options 245 199 Unvested management recognition plan stock 11 22 --------------------------- Dilutive potential common shares 256 221 --------------------------- Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 6,330 6,663 =========================== Basic earnings per share from continuing operations $ 0.45 $ 0.14 =========================== Diluted earnings per share from continuing operations $ 0.43 $ 0.14 ===========================
14 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 6. Investment Securities The following is a summary of available-for-sale and held-to-maturity securities (in thousands):
March 31, 2003 ------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------------------------------------ Available-for-Sale Securities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 81,875 $5,964 $ -- $ 87,839 Corporate bonds 23,515 1,422 -- 24,937 Adjustable rate mortgage-backed security mutual funds 2,109 -- 53 2,056 Adjustable rate mortgage-backed securities 24,291 289 -- 24,580 Collateralized mortgage obligations 8,338 140 37 8,441 REMICs 9,711 131 -- 9,842 Trust preferred stock 7,238 76 55 7,259 Equity securities 69 -- 6 63 Obligations of state and political subdivisions 30,192 1,376 49 31,519 ------------------------------------------------ Totals $187,338 $9,398 $200 $196,536 =============================================== Held-to-Maturity Securities: FHLMC certificates $ 815 $ 33 $ 1 $ 847 FNMA certificates 1,546 26 7 1,565 GNMA certificates 576 22 -- 598 Obligations of state and political subdivisions 590 130 -- 720 ------------------------------------------------ Totals $ 3,527 $ 211 $ 8 $ 3,730 ===============================================
15 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 6. Investment Securities (continued)
December 31, 2002 ------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ------------------------------------------------- Available-for-Sale Securities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 95,462 $ 6,373 $ 2 $101,833 Corporate bonds 25,720 1,733 -- 27,453 Adjustable rate mortgage-backed security mutual funds 2,109 -- 54 2,055 Adjustable rate mortgage-backed securities 15,169 269 -- 15,438 REMICs 12,636 232 -- 12,868 Collateralized mortgage obligations 11,380 201 42 11,539 Trust preferred stock 7,238 53 55 7,236 Equity securities 69 -- 2 67 Obligations of state and political subdivisions 29,890 1,283 58 31,115 ------------------------------------------------- Totals $199,673 $10,144 $213 $209,604 ================================================= Held-to-Maturity Securities: FHLMC certificates $ 1,004 $ 32 $ 3 $ 1,033 FNMA certificates 1,691 29 6 1,714 GNMA certificates 636 25 -- 661 Obligations of state and political subdivisions 590 131 -- 721 ------------------------------------------------- Totals $ 3,921 $ 217 $ 9 $ 4,129 =================================================
16 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 7. Commitments, Guarantees and Contingent Liabilities Loan commitments are made to accommodate the financial needs of First Defiance's customers; however, there are no long-term, fixed-rate loan commitments that result in market risk. Standby letters of credit obligate the Company to pay a third party beneficiary when a customer fails to repay an outstanding loan or debt instrument, or fails to perform some contractual nonfinancial obligation. Standby letters of credit are issued to address customers' financing needs and to facilitate customers' trade transactions. In accordance with FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others," certain guarantees issued or modified on or after January 1, 2003, require the recognition of a liability on First Defiance's balance sheet for the "stand ready" obligation with such guarantees If amounts are drawn under standby letters of credit, such amounts are treated as loans. Both loan commitments and standby letters of credit have credit risk, essentially the same as that involved in extending loans to customers, and are subject to the Company's normal credit policies. Collateral (e.g., securities, receivables, inventory and equipment) is obtained based on management's credit assessment of the customer. The Company's maximum obligation to extend credit for loan commitments (unfunded loan and unused lines of credit) and standby letters of credit outstanding was as follows: March 31, December 31, 2003 2002 (in thousands) -------------------------- Commercial $ 71,260 $103,984 Real Estate 22,195 17,537 Consumer 45,403 41,555 Standby Letters of Credit 3,595 2,997 -------------------------- Total $142,453 $166,073 ========================== The remaining weighted average life for outstanding standby letters of credit was less than one year at March 31, 2003. Actual lives of the standby letters of credit are all less than one year. 17 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 8. Loans Loans receivable and held for sale consist of the following (in thousands):
March 31, December 31 2003 2002 ----------------------- Real Estate: One-to-four family residential $149,717 $157,691 Construction 13,342 15,357 Non-residential and multi-family 252,939 227,754 ----------------------- 415,998 400,802 Other Loans: Commercial 106,650 104,070 Consumer finance 35,938 37,579 Home equity and improvement 53,860 49,889 ----------------------- 196,448 191,538 ----------------------- Total real estate and other loans 612,446 592,340 Deduct: Loans in process 5,407 7,255 Net deferred loan origination fees and costs 1,217 1,212 Allowance for loan loss 7,924 7,496 ----------------------- Totals $597,898 $576,377 =======================
Changes in the allowance for loan losses were as follows (in thousands):
Three Months ended March 31 2003 2002 --------------------------- Balance at beginning of period $ 7,496 6,548 Provision for loan losses 335 582 Charge-offs: One-to-four family residential real estate -- 49 Non-residential and multi-family real estate -- 54 Commercial 25 -- Consumer finance 50 147 --------------------------- Total charge-offs 75 250 Recoveries 168 53 --------------------------- Net charge-offs (93) 197 --------------------------- Ending allowance $ 7,924 $6,933 ===========================
18 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at March 31, 2003 and 2002) - -------------------------------------------------------------------------------- 9. Deposits A summary of deposit balances is as follows (in thousands): March 31, December 31, 2003 2002 -------- -------- Non-interest-bearing checking accounts $ 47,673 $ 43,936 Interest-bearing checking accounts 40,718 41,318 Savings accounts 41,375 39,363 Money market demand accounts 132,022 129,036 Certificates of deposit 346,178 345,920 ----------------------- $607,966 $599,573 ======================= 10. Pending Acquisition On February 22, 2003, First Defiance signed a Purchase and Assumption Agreement with RFC Banking Company and its parent Rurban Financial Corp. to acquire banking centers located in Findlay, Ottawa, and McComb, Ohio. Under the terms of the agreement, First Defiance will pay a purchase price equal to 10.5% of all non-brokered deposit accounts plus an agreed upon amount for all furnishings and equipment of those branches. In addition, First Defiance will acquire certain loans of those banking centers. Total deposit balances of those banking centers as of March 31, 2003 were approximately $167 million, of which $36 million were brokered deposits. The approximate balance of the loans to be acquired by First Defiance is $101 million. On May 8, 2003 First Defiance received regulatory approval from the Office of Thrift Supervision to complete the transaction. It is anticipated that the transaction will close during June 2003. 19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations General First Defiance Financial Corp. ("First Defiance" of "the Company") is a holding company which conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance"). First Federal is a federally chartered savings bank that provides financial services to communities based in northwest Ohio where it operates 14 full service branches and one commercial loan production office. First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust services. First Insurance sells a variety of property and casualty, group health and life, and individual health and life insurance products and investment and annuity products. Insurance products are sold through First Insurance's office in Defiance, Ohio while investment and annuity products are sold through registered investment representatives located at two First Federal banking center locations. Effective April 1, 2002, The Leader Mortgage Company, LLC ("The Leader"), a mortgage banking subsidiary of First Federal, was sold to US Bancorp. The operating results the Leader are reported as discontinued operations for the three months ended March 31, 2002. On February 22, 2003, First Defiance signed a Purchase and Assumption Agreement with RFC Banking Company and its parent Rurban Financial Corp. to acquire banking centers located in Findlay, Ottawa, and McComb, Ohio. Under the terms of the agreement, First Defiance will pay a purchase price equal to 10.5% of all non-brokered deposit accounts plus an agreed upon amount for all furnishings and equipment of those branches. In addition, First Defiance will acquire certain loans of those banking centers. Total deposit balances of those banking centers as of March 31, 2003 were approximately $167 million, of which $36 million were brokered deposits. The approximate balance of the loans to be acquired by First Defiance is $101 million. It is anticipated that the transaction, which will be accounting for as a purchase, will close during June 2003. First Defiance invests in U.S. Treasury and federal government agency obligations, obligations of municipal and other political subdivisions, mortgage-backed securities which are issued by federal agencies, corporate bonds, and 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 FAS Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. Securities are classified as held-to-maturity when First Defiance 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 $3.5 million at March 31, 2003. 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 $196.5 million at March 31, 2003. The available-for-sale portfolio consists of U.S. Treasury securities and obligations of U.S. Government corporations and agencies ($87.8 million), corporate bonds ($24.9 million), certain municipal obligations ($31.5 million), CMOs and REMICs ($18.3 million), mortgage backed securities ($24.6 million), preferred stock and other equity investments ($7.3 million) and adjustable-rate mortgage backed security mutual funds ($2.1 million). 20 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued In accordance with FAS No. 115, unrealized holding gains and losses deemed temporary on available-for-sale securities are reported in a separate component of stockholders' equity and are not reported in earnings until realized. Net unrealized holding gains on available-for-sale securities were $9.2 million at March 31, 2003, or $6.1 million after considering the related deferred tax liability. 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 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 deposit and loan servicing fees, gains on sales of mortgage loans, and insurance commissions. First Defiance's earnings also depend on the provision for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, amortization and impairment of mortgage servicing rights and miscellaneous other expenses, as well as federal income tax expense. 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. Changes in Financial Condition At March 31, 2003, First Defiance's total assets, deposits and stockholders' equity amounted to $896.6 million, $608.0 million and $120.1 million, respectively, compared to $884.2 million, $599.6 million and $120.1 million, respectively, at December 31, 2002. Net loans receivable increased to $586.5 million at March 31, 2003 from $561.0 million at December 31, 2002. The increase in loans receivable occurred primarily in non-residential and multi-family real estate loans, which increased by $25.2 million to $252.9 million, home equity and improvement loans, which increased by $3.9 million to $53.9 million, and commercial loans, which increased by $2.5 million to $106.7 million. The increase was partially offset by an $8.0 million decline in one-to-four family residential loans to $149.7 million and a $1.6 million decline in consumer loans to $35.9 million. The investment securities portfolio decreased to $200.0 million at March 31, 2003 from $213.5 million at December 31, 2002. The decrease in the balance in the investment portfolio is the result of redeploying funds from securities as they mature or get called to fund loan growth. At March 31, 2003 there were approximately $6.5 million of interest-bearing deposits held at other financial institutions. These funds may be redeployed into higher earning investments as interest rates rise or will be used to liquidate $24.1 million of brokered certificates of deposit, $14.1 million of which are scheduled to mature over the next 12 months and which will not be renewed. 21 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Deposits increased from $599.6 million at December 31, 2002 to $607.8 million as of March 31, 2003. This growth resulted from a $3.0 million increase in money market demand accounts, to $132.0 million at March 31, 2003 from $129.0 million at December 31, 2002, and a $3.1 million increase in interest and non-interest bearing checking accounts, to $88.4 million at March 31, 2003 from $85.3 million at December 31, 2002. The Company has focused on increasing its lower cost core deposits, and at the same time has been less aggressive in retaining higher cost CDs during 2003. Despite less aggressive pricing, certificates of deposit balances still increased by $258,000 to $346.2 million at March 31, 2003, from $345.9 million at December 31, 2002. This increase occurred even though the Company incurred a $2.0 million decrease in brokered certificates of deposit which matured during the 2003 first quarter and were not replaced. Additionally, FHLB advances increased to $156.1 million at March 31, 2003 from $149.1 million at December 31, 2002. These borrowings were used to fund loan growth and investment strategies and were part of management's strategy to take advantage of the historically low rate environment to lock in long-term funding. Short-term borrowings decreased to $2.0 million at March 31, 2003 from $4.3 million at December 31, 2002. This is a result of a decrease in the balance of securities sold under repurchase agreements, which are a function of customer demand. Following the pending acquisition of the branches in Findlay, McComb, and Ottawa, management estimates that total assets, loans and deposits will be $1.07 billion, $724 million and $782 million respectively 22 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 on FHLB stock are included as interest income. The table reports interest income from tax-exempt loans and investment on a tax-equivalent basis. All average balances are based upon daily balances. The average balance sheet and income statement for 2002 have been adjusted to allocate interest expense associated with financing The Leader's operations to discontinued operations. The average balance of FHLB advances for this yield analysis does not include those advances which were used to finance The Leader's operations. The interest-bearing liabilities reflect only those funds attributable to First Defiance's continuing operations.
Three Months Ended March 31, --------------------------------------------------------------------------- 2003 2002 ------------------------------------ --------------------------------- Average Yield/ Average Yield/ Balance Interest(1) Rate(2) Balance Interest(1) Rate(2) ------- ----------- ------- ------- ----------- ------- Interest-earning assets: Loans receivable $ 589,837 $ 9,398 6.46% $ 496,671 $ 9,003 7.35% Securities 206,645 2,591 5.09 53,499 802 6.08 Interest-earning deposits 6,865 29 1.71 13,607 17 .51 FHLB stock and other 17,960 169 3.82 16,308 181 4.50 ---------- ---------- ---------- ---------- Total interest-earning assets 821,307 12,187 6.02 580,085 10,003 6.99 Non-interest-earning assets (including assets of discontinued operations) 63,231 570,018 ---------- ---------- Total assets $ 884,538 $1,150,103 ========== ========== Interest-bearing liabilities (4): Deposits $ 555,524 $ 3,534 2.58% $ 496,495 $ 3,928 3.21% FHLB advances and other 156,561 1,814 4.70 7,698 81 4.27 Notes payable 3,010 9 1.21 21,430 192 3.63 ---------- ---------- ---------- ---------- Total interest-bearing liabilities 715,095 5,357 3.04 525,623 4,201 3.24 Non-interest bearing deposits 38,339 -- 28,138 -- ---------- ---------- ---------- ---------- Total including non-interest bearing demand deposits 753,434 5,357 2.88 553,761 4,201 3.08 Other non-interest-bearing liabilities (including liabilities of discontinued operations) 10,851 484,257 ---------- ---------- Total liabilities 764,285 1,038,018 Stockholders' equity 120,253 112,085 ---------- ---------- Total liabilities and stock- holders' equity $ 884,538 $1,150,103 ========== ========== Net interest income; interest rate spread $ 6,830 2.98% $ 5,802 3.75% ========== ===== ========== ====== Net interest margin (3) 3.37% 4.06% ===== ====== Average interest-earning assets to average interest-bearing liabilities 115% 110% ===== ======
- ---------------- (1) Interest on certain tax exempt loans and securities is not taxable for Federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%. (2) Annualized (3) Net interest margin is net interest income divided by average interest-earning assets. (4) This analysis does not reflect borrowings to fund discontinued operations. 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Results of Operations On April 1, 2002, First Defiance completed the sale of The Leader to US Bancorp. As a result of this sale, management has included the operating results for The Leader as discontinued operations for all prior periods presented. See Note 3 to the Consolidated Condensed Financial Statements filed with this Form 10-Q. Three Months Ended March 31, 2003 compared to Three Months Ended March 31, 2002 On a consolidated basis, First Defiance had net income of $2.7 million or $.45 per share for the three months ended March 31, 2003 compared to $2.7 million or $0.42 per share in 2002. The 2002 net income included earnings from discontinued operations of $2.0 million or $0.31 per share. Income from continuing operations for the 2002 first quarter was $887,000 or $0.14 per share. Net Interest Income. Net interest income for the quarter ended March 31, 2003 was $6.4 million compared to $5.5 million from continuing operations for the same period in 2002. Net interest margin for the 2003 first quarter was 3.37% compared to 4.06% for the same period in 2002. On a tax-equivalent basis, net interest income for the quarter ended March 31, 2003 was $6.8 million compared to $5.8 million from continuing operations for the same period in 2002. Total interest income increased by $2.1 million to $11.8 million for the three months ended March 31, 2003 from $9.7 million from continuing operations for the three months ended March 31, 2002. On a tax equivalent basis, total interest income increased by $2.2 million to $12.2 million for the three months ended March 31, 2003 from $10.0 million for the three months ended March 31, 2002. Interest on loans increased $377,000 to $9.3 million in the first quarter of 2003 from $9.0 million in the first quarter of 2002. The increase in interest from loans was due to a $93.1 million increase in average loan balances between the first quarter of 2002 and the first quarter of 2003. Much of the benefit of increased loan volumes has been offset by declining portfolio yields. The yield on First Defiance's loan portfolio declined from 7.35% for the three months ended March 31, 2002 to 6.46% for the same period in 2003 because of falling interest rates over that time period. The Company also has experienced a change in the mix of its loan portfolio as commercial loans and non-residential real estate loans were $359.6 million at March 31, 2003, up from $331.8 million at December 31, 2002. During that same time, one-to-four family residential loans, excluding loans held for sale, declined from $157.7 million to $151.7 million. The decline in the one- to four-family residential loan portfolio is the result of increased mortgage loan refinance activity. The Company sells most of its new mortgage loan originations into the secondary market. Interest earnings from the investment portfolio and interest-earning deposits, on a tax equivalent basis, increased $1.8 million to $2.8 million for the three months ended March 31, 2003 compared to $768,000 for the same period in 2002. The increase is due to the investment of the net proceeds received from the sale of The Leader. The average balance of securities for the 2003 first quarter increased to $206.6 million from $53.5 million for the same period in 2002. To 24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued compare the tax-exempt asset yields to taxable yields, amounts are adjusted to pretax equivalents based using a marginal corporate Federal tax rate of 35%. The tax-equivalent adjustments to net interest income for 2003 and 2002 were $227,000 and $93,000 respectively. Total interest expense increased by $1.2 million, to $5.4 million for the first quarter of 2003 compared to $4.2 million from continuing operations for the same period in 2002. Interest expense on FHLB advances increased $1.7 million to $1.8 million for the first quarter of 2003 compared to the same period in 2002. The increase is due primarily to the increase of average balances of FHLB advances. FHLB advances increased $148.9 million to $156.6 million for the quarter ended March 31, 2003 from $7.7 million for the quarter ended March 31, 2002. The average balance sheet and income statement for 2002 have been adjusted to allocate interest expense associated with financing The Leader's operations to discontinued operations. For 2003, all FHLB advances are included in operations as they were used to fund purchases of investment securities and loan growth. Interest expense on interest bearing deposits decreased by $394,000 to $3.5 million for the quarter ended March 31, 2003 from $3.9 million for the quarter ended March 31, 2002. This happened despite growth in deposits because of the change in the mix of deposits from higher costing certificates of deposit to checking and money market deposit accounts. The average cost of funds decreased from 3.08% for the first quarter of 2002 to 2.88% for the first quarter of 2003. The average balances of interest-bearing liabilities increased $189.4 million from $525.6 million in the first quarter of 2002 to $715.1 million in the first quarter of 2003. In 2002, all brokered certificates of deposit were included in discontinued operations and were therefore not a part of the yield analysis. For 2003, those deposits are included in the yield analysis as they fund operations. Provision for Loan Losses. The provision for loan losses was $335,000 in the first quarter of 2003 compared to $582,000 for the first quarter of 2002 despite significant growth in loan balances. The lower provision was due in part to the Company's very low loss experience in the 2003 first quarter, which showed net recoveries of $93,000. 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. Management believes the balance of the allowance for loan losses is appropriate. 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Non-performing assets and asset quality ratios for First Defiance were as follows (in $000's): March 31, December 31, 2003 2002 ----------------------- Non-accrual loans $ 2,756 $ 2,525 Loans over 90 days past due and still accruing -- -- ----------------------- Total non-performing loans $ 2,756 $ 2,525 Real estate owned (REO) 59 206 ----------------------- Total non-performing assets $ 2,815 $ 2,731 ======================= Allowance for loans losses as a percentage of total loans 1.34% 1.32% Allowance for loan losses as a percentage of non-performing assets 281.49% 274.48% Allowance for loan losses as a percentage of non-performing loans 287.52% 287.52% Total non-performing assets as a percentage of total assets 0.31% 0.31% Total non-performing loans as a percentage of total loans 0.46% 0.44% Of the $2.8 million in non-accrual loans, $2.1 million were commercial loans or non-residential real estate loans and $600,000 were residential mortgage loans. The allowance for loan losses at March 31, 2003 was $7.9 million compared to $6.9 million at both March 31, 2002 and $7.5 million at December 31, 2002. For the quarter ended March 31, 2003, First Defiance charged off $75,000 of loans against its allowance and realized recoveries of $168,000 from loans previously charged off. During the same quarter in 2002, First Defiance charged off $250,000 in loans and realized recoveries of $53,000. Non-Interest Income. Non-interest income increased $2.4 million in the first quarter of 2003, to $4.8 million for the quarter ended March 31, 2003 from $2.4 million for the same period in 2002. Individual components of non-interest income are as follows: Gain on Sale of Loans. Gains realized from the sale of mortgage loans increased $1.3 million to $1.8 million for the three months ended March 31, 2003 from $526,000 during the 2002 first quarter. The increase is due to high mortgage loan origination activity in the low interest rate environment. While the Company exited the mortgage banking business at the national level with the sale of The Leader, the origination and servicing of mortgage loans continues to be a core activity of First Federal in its local market areas. Management anticipates that gains from sale of loans will decline from the current levels in a rising interest rate environment. Gain on Sale of Securities. Gains realized from the sale of investment securities was $631,000 in the first quarter of 2003. This was an increase of $646,000 from a loss of $15,000 in the first quarter of 2002. The realization of the gains in the investment portfolio was part of a strategy by management to shorten the duration of assets in the investment portfolio to position the company to benefit from rising rates and to take advantage of a portion of the gains in the portfolio while they exist. 26 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Service Fees. Loan and deposit fees increased $187,000 to $985,000 for the quarter ended March 31, 2003 from $798,000 for the quarter ended March 31, 2002. Increases occurred primarily in loan servicing fees on sold loans, debit card interchange fees, and checking NSF fees. Insurance and Investment Sales Commission. Insurance and investment sales commission income increased $43,000 to $926,000 in the first quarter of 2003 from $883,000 in the same period of 2002. Increases occurred in the property and casualty lines as well as income from the sale of securities and annuities. Bank Owned Life Insurance. Income from bank owned life insurance was $201,000 in the quarter ended March 31, 2003. The Company made an initial $15 million investment in BOLI during the 2002 fourth quarter and accordingly, there was no corresponding income in the 2002 first quarter. Other Non-Interest Income. Other non-interest income, including dividends on Federal Home Loan Bank stock and other miscellaneous charges, increased to $248,000 for the quarter ended March 31, 2003 from $233,000 for the same period in 2002. Non-Interest Expense. Total non-interest expense increased $1.0 million to $7.0 million for the quarter ended March 31, 2003 from $6.0 million for the same period in 2002. Significant individual components of the increase are as follows: Compensation and Benefits. Compensation and benefits increased $404,000 to $3.7 million for the quarter ended March 31, 2003 from $3.3 million for the same period in 2002. The increase was the result of an increase in staffing, including several support positions at central operations, staff increases at several banking centers due to growing volumes, and the addition of a commercial loan origination office in the Toledo, Ohio market which commenced operations in May of 2002. Compensation and benefits also increased due to cost of living and merit increases for existing employees which averaged approximately 4%, higher level of sales commissions at First Insurance due to higher commission premium income and a $157,000 increase in the estimated cost of First Defiance's self-insured group health insurance plan. Amortization and Impairment of Mortgage Servicing Rights. Amortization of mortgage servicing rights ("MSR's") totaled $523,000 in the 2003 first quarter compared to $128,000 in the 2002 first quarter, the result of significant refinancing activity in the First Federal loan servicing portfolio. Also, the Company recognized a $240,000 adjustment for impairment in the value of its MSR portfolio during the 2003 first quarter, the result of the decline in the market value of MSRs in the face of falling interest rates and increased prepayment speeds on mortgage loans in general. There was a $96,000 adjustment for impairment recognized in the first quarter of 2002. First Defiance has a total impairment reserve of $1.6 million recorded against an asset with a book value before reserves of $3.9 million at March 31, 2003. That portfolio represents approximately 4,615 loans with unpaid balances of approximately $355 million. Amortization/Impairment of Goodwill. First Defiance is no longer required to recognize goodwill amortization as an expense but must test for and recognize any impairment in goodwill. There was no goodwill impairment in 2003. During the first quarter of 2002, management evaluated goodwill recorded at First Insurance for the purpose of measuring impairment and 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued determined that such goodwill was impaired by $238,000 ($194,000 or $0.03 per share after tax) as of January 1, 2002. As permitted, this amount is reflected in the income statement as the cumulative effect of a change in accounting principle. In addition to the $238,000 of impaired goodwill, First Defiance paid additional consideration of $200,000 to settle a contingent payout clause under its agreement to acquire First Insurance. The impairment of the goodwill created by that settlement was recorded as an operating expense during the 2002 first quarter. Such impairment totaled $200,000 in the first quarter of 2002. (See Note 2 to the Consolidated Condensed Financial Statements). Other Non-Interest Expenses. Other non-interest expenses (including occupancy, state franchise tax, data processing, and deposit insurance premiums) increased to $2.5 million for the quarter ended March 31, 2003 from $2.3 million for the same period in 2002. First Defiance computes federal income tax expense in accordance with FASB Statement No. 109 which resulted in an effective tax rate of 29.86% for the quarter ended March 31, 2003 compared to 35.63% for the same period in 2002. The reduction in the effective tax rate is a result of investing approximately $32.1 million in municipal securities, and $15.3 million of bank owned life insurance which are both exempt from federal tax. At March 31, 2002, First Defiance had only $8.7 million invested in tax exempt securities and no investment in bank owned life insurance. As a result of the above factors, income for the quarter ended March 31, 2003 was $2.7 million compared to income from continuing operations of $887,000 for the comparable period in 2002. On a per share basis, basic and diluted earnings per share for the three months ended March 31, 2003 were each $0.45 and $.43, respectively, compared to basic and diluted earnings per share from continuing operations of $0.14 and $0.14, respectively, for the quarter ended March 31, 2002. Discontinued Operations. Discontinued operations for the 2002 first quarter period, which represents net income earned by The Leader's operations, were $2.0 million or $0.30 per share. Pending Acquisition. On February 22, 2003, First Defiance signed a Purchase and Assumption Agreement with RFC Banking Company and its parent Rurban Financial Corp. to acquire banking centers located in Findlay, Ottawa, and McComb, Ohio. Under the terms of the agreement, First Defiance will pay a purchase price equal to 10.5% of all non-brokered deposit accounts plus an agreed upon amount for all furnishings and equipment of those branches. In addition, First Defiance will acquire certain loans of those banking centers. Management expects the transaction to increase per share earnings by approximately $.06 for the year ended December 31, 2003. 28 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Liquidity and Capital Resources As a regulated financial institution, First Federal is required to maintain appropriate levels of "liquid" assets to meet short-term funding requirements. First Defiance generated $5.4 million of cash from operating activities during the first three months of 2003. The Company's cash from operating activities resulted from net income for the period, adjusted for various non-cash items, including the provision for loan losses, depreciation and amortization of mortgage servicing rights, ESOP expense related to release of shares, and changes in loans available for sale, interest receivable and other assets, and other liabilities. The primary investing activity of First Defiance is the origination of loans (both for sale in the secondary market and to be held in portfolio), which is funded with cash provided by operations, proceeds from the amortization and prepayments of existing loans, the sale of loans, proceeds from the sale or maturity of securities, borrowings from the FHLB, and customer deposits. At March 31, 2003, First Defiance had $46.8 million in outstanding loan commitments and loans in process to be funded generally within the next six months and an additional $95.6 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 $45.8 million of fixed-rate residential mortgage loans, including $11.4 million of residential mortgage loans held for sale at March 31, 2003 and $34.4 million of residential mortgage loans that are in the process of being originated. Also as of March 31, 2003, the total amount of certificates of deposit that are scheduled to mature by March 31, 2004 is $233.9 million. First Defiance believes that it has adequate resources to fund commitments as they arise and that it can adjust the rate on savings certificates to retain deposits in changing interest rate environments. If First Defiance requires funds beyond its internal funding capabilities, advances from the FHLB of Cincinnati and other financial institutions are available. First Defiance utilizes forward purchase and forward sale agreements to meet the needs of its customers and manage its exposure to fluctuations in the fair value of mortgage loans held for sale and its pipeline. These forward purchase and forward sale agreements are considered to be derivatives as defined by FAS 133, Accounting for Derivatives and Hedging Instruments. The change in value in the forward purchase and forward sale agreements is approximately equal to the change in value in the loans held for sale and the effect of this accounting treatment is not material to the financial statements. First Defiance also 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. $4.3 million of these securities do not pass the FFIEC high risk security test as of March 31, 2003. The weighted average life of these securities exceeds the regulatory test limits in an instantaneous rate increase scenario of 200 and 300 basis points. However, management does not believe the underlying risk of these investments has changed from when they were purchased (and passed the FFIES high risk security test). Also, the overall interest rate risk as measured by management through net interest income simulations remains at an acceptable level. See Item 3 of this Form 10-Q. The remaining $14.0 million of these securities are not classified as high risk at March 31, 2003 and do not present risk significantly different than other mortgage-backed or agency securities. 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued 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 March 31, 2003.
Core Capital Risk-Based Capital Adequately Well Adequately Well Capitalized Capitalized Capitalized Capitalized ----------- ----------- ----------- ----------- Regulatory capital $ 106,000 $ 106,000 $ 113,770 $ 113,770 Minimum required regulatory capital 35,255 44,069 50,099 62,624 ---------- ---------- ---------- ---------- Excess regulatory capital $ 70,745 $ 61,931 $ 63,671 $ 51,146 ========== ========== ========== ========== Regulatory capital as a percentage of assets (1) 12.0% 12.0% 18.2% 18.2% Minimum capital required as a percentage of assets 4.0% 5.0% 8.0% 10.0% ---------- ---------- ---------- ---------- Excess regulatory capital as a percentage of assets 8.0% 7.0% 10.2% 8.2% ========== ========== ========== ==========
(1) Core capital is computed as a percentage of adjusted total assets of $881.4 million. Risk-based capital is computed as a percentage of total risk-weighted assets of $626.2 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 maintain a reserve ratio of 1.25% of insured deposits. First Federal's annual deposit insurance premiums for 2003 are approximately $0.016 per $100 of deposits. 30 Item 3. Qualitative and Quantitative Disclosure About Market Risk As discussed in detail in the 2002 Annual Report on Form 10-K, First Defiance's ability to maximize net income is dependent on management's ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of First Defiance are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance 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 analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with management's estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, nonmaturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 100 basis points over a 12 month period, using March 2003 amounts as a base case, First Defiance's net interest income would be impacted by less than the board mandated guidelines of 10%. Item 4. Controls and Procedures The management of First Defiance is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934. As of March 31, 2003, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of First Defiance's disclosure controls and procedures. Based on that evaluation, management concluded that First Defiance's disclosure controls and procedures as of March 31, 2003 were effective in ensuring that information required to be disclosed in the Interim Report on Form 10-Q were recorded, processed, summarized and reported within the time period required by the United States Securities and Exchange Commission's rules and forms. Management's responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance with accounting principles generally accepted in the United States of America. Management has assessed First Defiance's system of internal control over financial reporting as described in "Internal Control - Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of March 31, 2003, its system of internal control over financial reporting met those criteria. There have been no significant changes in First Defiance's internal controls or in other factors that could significantly affect internal controls subsequent to March 31, 2003. 31 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 At the annual meeting of shareholders held on April 22, 2003, in Defiance, Ohio the shareholders elected three directors to three-year terms. The following is a tabulation of all votes timely cast in person or by proxy by shareholders of First Defiance for the annual meeting: I. Nominees for Director with Three-year Terms Expiring in 2005: NOMINEE FOR WITHHELD Douglas A. Burgei 5,279,553 37,165 Gerald W. Monnin 5,276,315 44,381 Don C. Van Brackel 5,134,225 184,477 Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit 99.1 - Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 99.2 - Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32 (b) Reports on Form 8-K First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission on February 26, 2002 to announce the execution of a Purchase and Assumption Agreement with Rurban Financial Corp. and RFC Banking Company for the purchase of certain assets and assumption of certain liabilities of RFC Banking Company branch offices located in Findlay, Ottawa and McComb, Ohio. First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission on April 24, 2003 which included a copy of the Company's earnings release for the quarter ended March 31, 2003 33 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: May 15, 2003 By: /s/ William J. Small ------------ ----------------------------- William J. Small Chairman, President and Chief Executive Officer Date: May 15, 2003 By: /s/ John C. Wahl ------------ ---------------------------------- John C. Wahl Senior Vice President, Chief Financial Officer and Treasurer 34 First Defiance Financial Corp. CERTIFICATIONS PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION - ------------- I, William J. Small, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First Defiance Financial Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and 35 b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ William J. Small - -------------------- William J. Small Chief Executive Officer CERTIFICATION - ------------- I, John C. Wahl, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First Defiance Financial Corp.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 36 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 15, 2003 /s/ John C. Wahl - ---------------- John C. Wahl Chief Financial Officer 37 EX-99.1 3 ex99-1.txt Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First Defiance Financial Corp. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William J. Small, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ William J. Small - -------------------- William J. Small Chief Executive Officer May 15, 2003 EX-99.2 4 ex99-2.txt Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First Defiance Financial Corp. (the "Company") on Form 10-Q for the period ending June 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, John C. Wahl, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ John C. Wahl - ---------------- John C. Wahl Chief Financial Officer May 15, 2003 -----END PRIVACY-ENHANCED MESSAGE-----