-----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, Kbt93A7X1j1fDdNmEnDph/SRHqROOQziLsAGtjIjagrrmd8UdT9KtdVat8w7lXII Mu0ImhLkHGhG+8GlVDPXxg== 0000914317-05-002564.txt : 20050809 0000914317-05-002564.hdr.sgml : 20050809 20050809145737 ACCESSION NUMBER: 0000914317-05-002564 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050809 DATE AS OF CHANGE: 20050809 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: 051009298 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 form10q-70331_fdfc.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 June 30, 2005 ------------- 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 - 7,051,892 shares outstanding at August 5, 2005 FIRST DEFIANCE FINANCIAL CORP. INDEX
Page Number ----------- PART I.-FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements: Consolidated Condensed Statements of Financial Condition - June 30, 2005 and December 31, 2004 2 Consolidated Condensed Statements of Income - Three and six months ended June 30, 2005 and 2004 4 Consolidated Condensed Statement of Changes in Stockholders' Equity - Six months ended June 30, 2005 5 Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2005 and 2004 7 Notes to Consolidated Condensed Financial Statements 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 24 Item 3. Quantitative and Qualitative Disclosures about Market Risk 39 Item 4. Controls and Procedures 40 PART II-OTHER INFORMATION: Item 1. Legal Proceedings 41 Item 2. Changes in Securities 41 Item 3. Defaults upon Senior Securities 41 Item 4. Submission of Matters to a Vote of Security Holders 41 Item 5. Other Information 41 Item 6. Exhibits and Reports on Form 8-K 41 Signatures 43
1 PART 1-FINANCIAL INFORMATION Item 1. Financial Statements - ---------------------------- FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (Amounts in Thousands)
- ---------------------------------------------------------------------------------------- June 30, 2005 December 31, 2004 ------------- ----------------- ASSETS (unaudited) Cash and cash equivalents: Cash and amounts due from depository institutions $ 31,100 $ 19,891 Interest-bearing deposits 7,244 630 ------------- ------------- 38,344 20,521 Securities: Available-for-sale, carried at fair value 110,515 137,003 Held-to-maturity, carried at amortized cost (approximate fair value $2,159 and $2,376 at June 30, 2005 and December 31, 2004 respectively) 2,059 2,255 ------------- ------------- 112,574 139,258 Loans held for sale 7,224 2,295 Loans receivable, net of allowance of $13,460 and $9,956 at June 30, 2005 and December 31, 2004 respectively 1,120,201 878,912 Accrued interest receivable 5,772 4,653 Federal Home Loan Bank stock and other interest-earning assets 17,083 13,376 Bank owned life insurance 18,939 18,581 Office properties and equipment 31,690 24,248 Real estate and other assets held for sale 487 98 Goodwill and other intangibles 39,704 18,933 Mortgage servicing rights 4,625 3,598 Other assets 2,983 2,194 ------------- ------------- Total assets $ 1,399,626 $ 1,126,667 ============= =============
See accompanying notes. 2 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (Amounts in Thousands)
- ------------------------------------------------------------------------------------------- June 30, 2005 December 31, 2004 ------------- ----------------- (unaudited) LIABILITIES AND STOCKHOLDERS' EQUITY Non-interest-bearing deposits $ 87,172 $ 62,450 Interest-bearing deposits 959,309 735,251 ------------- ------------- Total deposits 1,046,481 797,701 Advances from Federal Home Loan Bank 173,716 178,213 Notes payable and other interest-bearing liabilities 20,875 14,804 Advance payments by borrowers for taxes and insurance 291 278 Deferred taxes 1,538 934 Other liabilities 9,175 7,863 ------------- ------------- Total liabilities 1,252,076 999,793 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; 7,056 and 6,280 shares outstanding, respectively 71 63 Additional paid-in capital 72,246 52,131 Stock acquired by ESOP (1,160) (1,479) Deferred compensation (3) (4) Accumulated other comprehensive income, net of income taxes of $544 and $1,148, respectively 1,010 2,131 Retained earnings 75,386 74,032 ------------- ------------- Total stockholders' equity 147,550 126,874 ------------- ------------- Total liabilities and stockholders' equity $ 1,399,626 $ 1,126,667 ============= =============
See accompanying notes 3 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, 2005 2004 2005 2004 ---- ---- ---- ---- Interest Income Loans $ 17,045 $ 11,279 $ 31,808 $ 22,207 Investment securities 1,286 1,727 2,724 3,592 Interest-bearing deposits 134 4 205 36 -------- -------- -------- -------- Total interest income 18,465 13,010 34,737 25,835 Interest Expense Deposits 4,911 3,071 8,856 6,069 FHLB advances and other 1,791 1,790 3,591 3,575 Notes payable and warehouse loans 114 20 195 43 -------- -------- -------- -------- Total interest expense 6,816 4,881 12,642 9,687 -------- -------- -------- -------- Net interest income 11,649 8,129 22,095 16,148 Provision for loan losses 349 490 696 868 -------- -------- -------- -------- Net interest income after provision for loan losses 11,300 7,639 21,399 15,280 Non-interest Income Service fees and other charges 1,755 1,373 3,188 2,578 Insurance commission income 1,050 1,223 2,263 2,286 Dividends on stock and other interest income 204 153 369 330 Gain on sale of loans 588 804 1,098 1,393 Gain on sale of securities 515 293 1,136 392 Trust income 61 50 139 98 Income from Bank Owned Life Insurance 180 192 357 385 Other non-interest income 56 43 231 92 -------- -------- -------- -------- Total non-interest income 4,409 4,131 8,781 7,554 Non-interest Expense Compensation and benefits 6,006 4,473 11,518 8,788 Occupancy 1,198 842 2,227 1,682 SAIF deposit insurance premiums (credit) 37 28 68 (14) State franchise tax 290 157 574 312 Acquisition related charges 2,476 -- 3,360 -- Data processing 778 579 1,591 1,122 Amortization of mortgage servicing rights 230 233 396 406 Net impairment (recovery) of mortgage servicing rights 95 (524) (126) (287) Amortization of intangibles 214 27 328 55 Other non-interest expense 1,519 1,319 3,098 2,536 -------- -------- -------- -------- Total non-interest expense 12,843 7,134 23,034 14,600 -------- -------- -------- -------- Income before income taxes 2,866 4,636 7,146 8,234 Federal income taxes 838 1,492 2,247 2,597 -------- -------- -------- -------- Net Income $ 2,028 $ 3,144 $ 4,899 $ 5,637 ======== ======== ======== ======== Earnings per share (Note 6) Basic $ 0.29 $ 0.51 $ 0.72 $ 0.92 ======== ======== ======== ======== Diluted $ 0.28 $ 0.49 $ 0.70 $ 0.88 ======== ======== ======== ======== Average shares outstanding (Note 6) Basic 6,887 6,125 6,771 6,115 ======== ======== ======== ======== Diluted 7,134 6,385 7,031 6,402 ======== ======== ======== ======== Dividends declared per share (Note 5) $ 0.22 $ 0.20 $ 0.44 $ 0.40 ======== ======== ======== ========
See accompanying notes 4 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (UNAUDITED) (Amounts in Thousands)
- ---------------------------------------------------------------------------------------------------- 2005 ----------------------------------------------------- Stock Acquired By ----------------- Additional Management Common Paid-in Recognition Stock Capital ESOP Plan ----- ------- ---- ---- Balance at January 1 $ 63 $52,131 $(1,479) $ (4) Comprehensive income: Net income Change in unrealized gains (losses) net of income taxes of $604 Total comprehensive income ESOP shares released 680 319 Amortization of deferred compensation of Management Recognition Plan 1 Shares issued under stock option plan 1 1,090 Purchase of common stock for treasury (419) Shares issued to acquire ComBanc, Inc 7 18,764 Dividends declared (Note 5) -------------------------------------------- Balance at June 30 $ 71 $72,246 $(1,160) $ (3) ============================================
See accompanying notes 5 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued) (UNAUDITED) (Amounts in Thousands)
- ---------------------------------------------------------------------------------------------------------- 2005 2004 ---------------------------------------------------------- Net Unrealized gains (losses) on Total Total available-for- Retained Stockholders Stockholder's sale securities Earnings Equity Equity --------------- -------- ------ ------ Balance at January 1 $2,131 $ 74,032 $ 126,874 124,269 Comprehensive income: Net income 4,899 4,899 5,637 Change in unrealized gains (losses) net of income taxes of $604 (1,121) (1,121) (2,152) --------- --------- Total comprehensive income 3,778 3,485 ESOP shares released 999 977 Amortization of deferred compensation of Management Recognition Plan 1 3 Shares issued under stock option plan 1,091 1,256 Purchase of common stock for treasury (533) (952) (3,081) Shares issued to acquire ComBanc, Inc 18,771 -- Dividends declared (Note 5) (3,012) (3,012) (2,457) ------------------------------------------------------- Balance at June 30 $1,010 $ 75,386 $ 147,550 124,452 =======================================================
See accompanying notes 6 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (UNAUDITED) (Amounts in Thousands)
- ------------------------------------------------------------------------------------------- Six Months Ended June 30, 2005 2004 ---- ---- Operating Activities Net income $ 4,899 $ 5,637 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 696 868 Provision for depreciation 1,121 905 Accretion of premium and discounts on loans, Securities, deposits and debt obligations 811 228 Amortization of mortgage servicing rights 396 405 Net recovery of mortgage servicing rights impairment (126) (287) Amortization of core deposit intangible 328 54 Gain on sale of loans (1,098) (1,393) (Gain) loss on sale of property, plant and equipment (111) 2 Release of ESOP Shares 999 977 Amortization of Management Recognition Plan deferred compensation 1 3 Gains on sales of securities (1,136) (392) Deferred federal income tax expense 246 249 Proceeds from sale of loans 46,423 59,514 Origination of mortgage servicing rights, net (370) (470) Origination of loans held for sale (50,254) (56,197) Decrease (increase) in interest receivable and other assets 374 (1,049) Increase (decrease) in other liabilities 31 (202) -------- -------- Net cash provided by operating activities 3,230 8,852 Investing Activities Proceeds from maturities of held-to-maturity securities 193 190 Proceeds from maturities of available-for-sale securities 18,088 29,056 Proceeds from sale of available-for-sale securities 21,561 5,293 Proceeds from sale of Federal Home Loan Bank stock -- 4,671 Proceeds from sales of real estate and other assets held for sale 140 729 Proceeds from sale of property, plant and equipment 1,190 -- Net cash received for acquisition of ComBanc, Inc 52,301 -- Net cash paid for acquisition of Genoa Savings and Loan Co (604) Purchases of available-for-sale securities (13,779) (20,101) Purchases of Federal Home Loan Bank stock (373) -- Purchases of office properties and equipment (2,855) (951) Net increase in loans receivable (58,644) (74,141) -------- -------- Net cash provided by (used in) investing activities 17,218 (55,254)
7 FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (Continued) (UNAUDITED) (Amounts in Thousands)
- ---------------------------------------------------------------------------------- Six Months Ended June 30, 2005 2004 ---- ---- Financing Activities Net increase in deposits 8,314 24,246 Repayment of Federal Home Loan Bank long-term advances (1,227) (899) Net increase (decrease) in Federal Home Loan Bank short-term advances (6,500) 13,000 Decrease in securities sold under repurchase agreements (539) (2,907) Purchase of common stock for treasury (952) (3,081) Cash dividends paid (2,812) (2,457) Proceeds from exercise of stock options 1,091 1,256 -------- -------- Net cash (used in) provided by financing activities (2,625) 29,158 -------- -------- Increase (decrease) in cash and cash equivalents 17,823 (17,254) Cash and cash equivalents at beginning of period 20,521 37,783 -------- -------- Cash and cash equivalents at end of period $ 38,344 $ 20,539 ======== ======== Supplemental cash flow information: Interest paid $ 6,466 $ 9,843 ======== ======== Income taxes paid $ 2,158 $ 2,078 ======== ======== Noncash operating activities: Change in deferred tax established on net unrealized gain or loss on available-for-sale securities $ 604 $ 999 ======== ======== Transfers from loans to real estate and other assets held for sale $ 353 $ 531 ======== ======== Noncash investing activities: Decrease in net unrealized gain or loss on available-for-sale securities $ (1,725) $ (3,310) ======== ======== Noncash financing activities: Cash dividends declared but not paid $ 1,543 $ 1,218 ======== ========
See accompanying notes. 8 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 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"). 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, 2004 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, 2005 and for the three and six-month periods ending June 30, 2005 and 2004 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. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance's 2004 Annual Report on Form 10-K for the year ended December 31, 2004. 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 and six-month period ended June 30, 2005 are not necessarily indicative of the results that may be expected for the entire year. Goodwill Goodwill is the excess of the purchase price over the fair value of the assets and liabilities of companies acquired through business combinations accounted for under the purchase method. Goodwill is evaluated at the business unit level, which for First Defiance are First Federal Bank and First Insurance. At June 30, 2005, goodwill totaled $39.7 million, an increase from the $18.9 million balance reported at December 31, 2004. The increase in goodwill is the result of the ComBanc, Inc acquisition, which closed on January 21, 2005 and the Genoa Savings and Loan Company acquisition, which closed on April 8, 2005. Total goodwill recognized was $15.7 million related to the acquisition of ComBanc, Inc. and $5.4 million related to the acquisition of the Genoa Savings and Loan Company. 9 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Income Taxes The Company's effective tax rate differs from the statutory 35% federal tax rate primarily due to municipal securities and bank owned life insurance, the earnings of which are exempt from federal income taxes. Stock Compensation At June 30, 2005, 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 2004 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. 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: June 30 2005 2004 -------------------------- Risk free interest rate 5.43% 5.54% Dividend yield 3.06% 2.95% Volatility factors of expected market price of stock 0.251% 0.261% Weighted average expected life 8.32 years 8.89 years Weighted average grant date fair value of options granted $3.94 $3.77 Based on the above assumptions, pro forma net income and earnings per share are computed as follows (in thousands, except per share amounts): 10 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Three months ended Six months ended June 30, June 30, 2005 2004 2005 2004 ---------------------------------------- (In Thousands, except per share amounts) Net Income $ 2,028 $ 3,144 $ 4,899 $ 5,637 Stock-based compensation using the fair value method, net of tax (71) (59) (127) (104) ---------------------------------------- Pro forma net income from continuing operations $ 1,957 $ 3,085 $ 4,772 $ 5,533 ======================================== Earnings per share as reported: Basic $ 0.29 $ 0.51 $ 0.72 $ 0.92 ======================================== Diluted $ 0.28 $ 0.49 $ 0.70 $ 0.88 ======================================== Pro forma earnings per share: Basic $ 0.28 $ 0.50 $ 0.70 $ 0.90 ======================================== Diluted $ 0.27 $ 0.48 $ 0.68 $ 0.87 ======================================== Recent Accounting Pronouncements Accounting for Certain Loans or Debt Securities Acquired in a Transfer In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued AICPA Statement of Position 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer" (SOP 03-3), which addresses the accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer. SOP 03-3 limits the yield that may be accreted (accretable yield) to the excess of the investor's estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor's initial investment in the loan. Subsequent increases in cash flows expected to be collected should be recognized prospectively through adjustment of the loan's yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment. Loans acquired by First Defiance on January 21, 2005 related to the acquisition of ComBanc, Inc and on April 8, 2005 related to the acquisition of the Genoa Savings and Loan Company were recorded in accordance SOP 03-3. 11 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Share-Based Payments In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), "Share-Based Payment," which revised SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." This Statement requires an entity to recognize the cost of employee services received in share-based payment transactions and measure the cost on a grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The provisions of SFAS 123 (revised 2004) will be effective for the Company's financial statements issued for the first fiscal year beginning after June 15, 2005. First Defiance will adopt SFAS 123 (revised 2004) in the first quarter of 2006. The method for adoption of this statement is yet to be determined. See SFAS 123 pro forma disclosures included in this Note 2. Other Than Temporary Impairments At a meeting on June 29, 2005, the FASB elected not to provide guidance on the meaning of other-than-temporary impairment and directed the staff to issue proposed FSP 03-1-a "Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1" as final. The final FSP superseded EITF Issue No. 03-1 "The Meaning of Other than Temporary Impairment and its Application to Certain Investments" and also EITF Topic No. D-44 "Recognition of Other-Than-Temporary Impairment upon the Plan Sale of a Security Whose Cost Exceeds Fair Value." FSP FAS 115-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" replaces the guidance set forth in paragraph 10-18 of issue 03-1 with references to existing other-than-temporary impairment guidance such as FASB Statement No. 115, SEC Staff Accounting Bulletin No. 59 and APB Opinion No. 18. FSP FAS 115-1 also will codify the guidance set for in EITF Topic D-44 and clarify that an investor should recognize an impairment loss no later than when the impairment is deemed other than temporary, even if a decision to sell has not been made. FSP FAS 115-1 is effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. Management does not believe this guidance will have any material impact on the financial condition or results of operations of First Defiance. 12 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 2. Basis of Presentation (continued) Accounting Changes and Error Corrections On June 1, 2005, the FASB issued Statement No. 154, "Accounting Changes and Error Corrections" ("SFAS 154"). SFAS 154 replaces APB Opinion No. 20 "Accounting Changes", and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS 154 applies to all voluntary changes in accounting principle, as well as changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors made occurring in fiscal years beginning after June 1, 2005. The adoption of this standard is not expected to have a material impact on the financial condition or results of operations of First Defiance. 3. Acquisitions On January 21, 2005, First Defiance completed its acquisition of ComBanc Inc. ("ComBanc"), a bank-holding company operating four retail bank branch offices headquartered in Delphos, Ohio. The acquisition allows the Company to expand its product offerings to Allen County, Ohio which is adjacent to the Company's existing footprint. Under the terms of the merger, each share of ComBanc common stock was exchanged for .65266 shares of First Defiance common stock, $17.20 in cash, or a combination of cash and stock. Total consideration in the transaction was limited to 50% cash and 50% common stock. In connection with the transaction, 721,164 shares of First Defiance Common stock were issued and $19.0 million of cash was paid. The total cost of the transaction was $37.8 million. The common shares issued were valued at $26.03 per share representing an average of the closing market prices for two days before and after date the final exchange ratio was determined. The assets and liabilities of ComBanc were recorded on the balance sheet at their fair value as of the merger date. The results of ComBanc's operations have been included in First Defiance's consolidated statement of income from the date of acquisition. On April 8, 2005, the Company completed its acquisition of Genoa Savings and Loan Company ("Genoa"), a savings and loan operating four branch offices in the Toledo, Ohio area markets of Genoa, Perrysburg, Oregon, and Maumee. Under the terms of the agreement, each share of Genoa stock was exchanged for $30.22 in cash for a total cost of $11 million. The assets and liabilities of Genoa were recorded on the balance sheet at their fair value as of the merger date. The results of Genoa' operations have been included in First Defiance's consolidated statement of income from the date of acquisition. Refer to Note 4 for discussion on severance and other restructuring costs incurred in connection with the ComBanc and Genoa mergers. Additionally refer to Note 2 for further discussion on goodwill and intangible assets recognized in connection with the ComBanc and Genoa mergers. 13 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 3. Acquisitions (continued) The following tables summarize the estimated fair values of the net assets acquired and the computation of the purchase price and goodwill related to the acquisitions. ComBanc Genoa ------- ----- Assets (In thousands) Cash and cash equivalents $ 71,915 $ 10,599 Investment Securities 502 15 Loans, net of allowance for loan losses 117,313 66,905 Premises and equipment 4,806 2,345 Goodwill and other intangibles 15,656 5,443 Other assets 2,624 3,011 ---------------------- Total Assets 212,816 88,318 Liabilities: Deposits 163,668 76,786 Borrowings 9,863 -- Other liabilities 939 332 ---------------------- Total Liabilities 174,470 77,118 ---------------------- Net assets acquired $ 38,346 $ 11,200 ====================== Purchase price $ 38,346 $ 11,200 Carrying value of net assets acquired (22,618) (6,737) ---------------------- Excess of purchase price over carry value of net assets acquired 15,728 4,463 Purchase accounting adjustments Portfolio loans (1,487) (978) Premises and equipment (651) 1,609 Mortgage service rights (49) (116) Deposits 322 301 Borrowings 211 -- Deferred tax liabilities 1,582 164 ---------------------- Total net tangible assets (72) 980 Core deposit intangibles (2,936) (1,146) ---------------------- Goodwill $ 12,720 $ 4,297 ====================== The estimated fair value of ComBanc's and Genoa's acquired assets and liabilities, including identifiable intangible assets, are preliminary and subject to refinement as additional information becomes available. Any subsequent adjustments to the fair values of assets and liabilities acquired, identifiable intangible assets, or other purchase accounting adjustments will result in adjustments to goodwill. 14 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 4. Acquisition Related Charges During the six months ended June 30, 2005, First Defiance recognized $3,360,000 of acquisition related charges associated with the acquisitions. Acquisition related charges for the ComBanc acquisition totaled $975,000, of which $471,000 related to severance payments and retention bonuses provided to ComBanc employees and $385,000 related to termination of certain ComBanc contracts. Acquisition related charges for the Genoa acquisition totaled $2.4 million, of which approximately $313,000 related to severance payments and retention bonuses provided to Genoa employees and $1.8 million related to termination of certain Genoa contracts. Substantially all severance costs will be paid out by January 2006. 5. Dividends on Common Stock As of June 30, 2005, First Defiance had declared a quarterly cash dividend of $.22 per share for the second quarter of 2005, payable July 22, 2005. 6. 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, 2005 and 2004. 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, 2005 and 2004, 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. 15 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 6. Earnings Per Share (continued) The following table sets forth the computation of basic and diluted earning per share (in thousands except per share data): Three months ended Six months ended June 30, June 30, 2005 2004 2005 2004 ------------------------------------ Numerator for basic and diluted earnings per share - Net income $2,028 $3,144 $4,899 $5,637 Denominator: Denominator for basic earnings per share - weighted average shares 6,887 6,125 6,771 6,115 Effect of dilutive securities: Employee stock options 246 258 259 285 Unvested management recognition plan stock 1 2 1 2 ------------------------------------ Dilutive potential common shares 247 260 260 287 ------------------------------------ Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 7,134 6,385 7,031 6,402 ==================================== Basic earnings per share from net income $ 0.29 $ 0.51 $ 0.72 $ 0.92 ==================================== Diluted earnings per share from net income $ 0.28 $ 0.49 $ 0.70 $ 0.88 ==================================== 16 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 7. Investment Securities The following is a summary of available-for-sale and held-to-maturity securities (in thousands):
June 30, 2005 -------------------------------------------------------- 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 $ 42,682 $ 685 $ 115 $ 43,252 Mortgage-backed securities 16,488 82 53 16,517 REMICs 2,284 -- 13 2,271 Collateralized mortgage obligations 18,021 89 110 18,000 Trust preferred stock 6,230 66 -- 6,296 Equity securities 64 9 -- 73 Obligations of state and political subdivisions 23,192 914 -- 24,106 -------------------------------------------------------- Totals $ 108,961 $ 1,845 $ 291 $ 110,515 ======================================================== Held-to-Maturity Securities: FHLMC certificates $ 365 $ 12 $ -- $ 377 FNMA certificates 886 13 3 896 GNMA certificates 278 3 1 280 Obligations of state and political subdivisions 530 76 -- 606 -------------------------------------------------------- Totals $ 2,059 $ 104 $ 4 $ 2,159 ========================================================
17 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 7. Investment Securities (continued) The following table summarizes First Defiance's securities that were in an unrealized loss position at June 30, 2005:
Duration of Unrealized Loss Position -------------------------------------------------- Less than 12 Months 12 Month or Longer Total -------------------------- ----------------------- ------------------------ Gross Gross Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loses ----------------------------------------------------------------------------- (In Thousands) At June 30, 2005 Available-for-sale securities: U.S. treasury securities and obligations of U.S. government corporations and agencies $ 20,401 $ (84) $ 1,970 $ (31) $ 22,371 $ (115) Mortgage-backed securities 7,686 (40) 675 (13) 8,361 (53) Collateralized mortgage obligations 10,092 (54) 5,137 (69) 15,229 (123) Held to maturity securities: Mortgage-backed securities 126 (2) 155 (2) 281 (4) ---------------------------------------------------------------------------- Total temporarily impaired securities $ 38,305 $ (179) $ 7,957 $ (115) $ 46,262 $ (295) ============================================================================
First Defiance does not believe the unrealized losses on securities, individually or in the aggregate, as of June 30, 2005, represent an other-than-temporary impairment. The unrealized losses are primarily the result of the changes in interest rates and will not prohibit the Company from receiving its contractual principal and interest payments. First Defiance has the ability and intent to hold these securities for a period necessary to recover the amortized cost. 18 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 7. Investment Securities (continued)
December 31, 2004 -------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Value Cost Gains Losses -------------------------------------------------------- Available-for-Sale Securities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 48,913 $ 1,461 $ 61 $ 50,313 Corporate bonds 6,158 310 -- 6,468 Mortgage-backed securities 16,645 151 16 16,780 REMICs 4,902 -- 26 4,876 Collateralized mortgage obligations 20,027 136 54 20,109 Trust preferred stock 6,228 64 -- 6,292 Equity securities 69 4 -- 73 Obligations of state and political subdivisions 30,781 1,313 2 32,092 -------------------------------------------------------- Totals $ 133,723 $ 3,439 $ 159 $ 137,003 ======================================================== Held-to-Maturity Securities: FHLMC certificates $ 459 $ 21 $ 1 $ 479 FNMA certificates 960 12 4 968 GNMA certificates 306 4 1 309 Obligations of state and political subdivisions 530 90 -- 620 -------------------------------------------------------- Totals $ 2,225 $ 127 $ 6 $ 2,376 ========================================================
19 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 8. Loans Loans receivable and held for sale consist of the following (in thousands): June 30, December 31, 2005 2004 ---------- ------------ Real Estate: One-to-four family residential $ 291,036 $ 190,070 Construction 24,000 15,507 Non-residential and multi-family 496,599 415,164 ------------------------ 811,635 620,741 Other Loans: Commercial 172,351 141,643 Consumer finance 57,223 45,513 Home equity and improvement 111,291 90,839 ------------------------ 340,865 277,995 ------------------------ Total real estate and other loans 1,152,500 898,736 Deduct: Loans in process 10,372 6,340 Net deferred loan origination fees and costs 1,243 1,233 Allowance for loan loss 13,460 9,956 ------------------------ Totals $1,127,425 $ 881,207 ======================== Loans acquired in the ComBanc and Genoa acquisitions were as follows by category (in thousands): ComBanc Genoa ------------------------ Real Estate: One-to-four family residential $ 33,100 $ 36,000 Construction 1,900 4,500 Non-residential and multi-family 59,900 8,100 ------------------------ 94,900 48,600 Other Loans: Commercial 13,000 2,000 Consumer finance 6,700 3,600 Home equity and improvement 4,600 13,400 ------------------------ 24,300 19,000 ------------------------ Total real estate and other loans acquired $ 119,200 $ 67,600 ======================== 20 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 8. Loans (continued) Changes in the allowance for loan losses were as follows (in thousands):
Three Months ended Six Months ended June 30, June 30, 2005 2004 2005 2004 --------------------------------------------- Balance at beginning of period $ 12,749 $ 9,167 $ 9,956 $ 8,844 Provision for loan losses 349 490 696 869 Allowance from Acquisitions 865 -- 3,027 -- Reclassification between allowance for loan loss and purchase loan discount on prior quarter acquisition (376) -- -- -- Charge-offs: One-to-four family residential real estate -- -- -- 52 Non-residential and multi-family real estate -- 9 67 9 Commercial 104 125 149 139 Consumer finance 100 33 157 71 --------------------------------------------- Total charge-offs 204 167 373 271 Recoveries 77 47 154 95 --------------------------------------------- Net charge-offs 127 120 221 176 --------------------------------------------- Ending allowance $ 13,460 $ 9,537 $ 13,460 $ 9,537 =============================================
9. Deposits A summary of deposit balances is as follows (in thousands): June 30, December 31, 2005 2004 ------------------------ Non-interest-bearing checking accounts $ 87,172 $ 62,450 Interest-bearing checking accounts 99,816 74,964 Savings accounts 94,391 52,132 Money market demand accounts 171,302 183,833 Certificates of deposit 593,800 424,322 ------------------------ $1,046,481 $ 797,701 ======================== 21 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 9. Deposits (continued) Deposits acquired as part of the ComBanc and Genoa acquisitions are as follows (in thousands): ComBanc Genoa ---------------------- Non-interest-bearing checking accounts $ 17,700 $ 5,000 Interest-bearing checking accounts 33,000 2,400 Savings accounts 30,600 11,200 Money market demand accounts 13,200 18,000 Certificates of deposit 68,800 39,900 ---------------------- $ 163,300 $ 76,500 ====================== 10. 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 non-financial 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 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 loans and unused lines of credit) and standby letters of credit was as follows: June 30, December 31, 2005 2004 ----------------------- (In Thousands) Commercial $ 116,381 $ 112,482 Real Estate 66,599 14,647 Consumer 85,504 66,199 Standby Letters of Credit 9,795 9,921 ---------------------- Total $ 278,279 $ 203,249 ====================== 22 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2005 and 2004) - -------------------------------------------------------------------------------- 10. Commitments, Guarantees and Contingent Liabilities (continued) The remaining weighted average life for outstanding standby letters of credit was less than one year at June 30, 2005. The Company had $3.8 million of standby letters of credit with a life longer than one year. In conjunction with the Genoa acquisition, First Defiance acquired commitments to repurchase certain loans sold with recourse by Genoa. At June 30, 2005 the balance of loans sold with recourse totaled $588,000. 11. Postretirement Benefits First Defiance sponsors a defined benefit postretirement plan that is intended to supplement Medicare coverage for certain retirees who meet minimum age requirements. A description of employees or former employees eligible for coverage is included in Footnote 14 in the financial statements included in First Defiance's 2004 Annual Report on Form 10-K. Net periodic postretirement benefit costs include the following components for the three-month and six-month periods ended June 30, 2005 and 2004: Three Months Ended Six Months Ended June 30, June 30, 2005 2004 2005 2004 ------------------------------------- (In Thousands) Service cost-benefits attributable to service during the period $ 14 $ 12 $ 26 $ 24 Interest cost on accumulated postretirement benefit obligation 24 24 48 48 Net amortization and deferral 6 6 12 12 ------------------------------------- Net periodic postretirement benefit cost $ 44 $ 42 $ 86 $ 84 ==================================== Prescription drug coverage was added to Medicare under the Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act). The Company has assumed that it will opt for coverage under Medicare Part D rather than the Federal subsidy approach. As specific authoritative guidance for matters related to the Act are pending, guidance when issued could require First Defiance to change previously reported information. 23 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 23 full service branches. On January 21, 2005, First Defiance completed the acquisition of ComBanc, Inc. ("ComBanc"), a four-branch bank holding company located in Delphos, Ohio. The acquisition was accounted for as a purchase and consolidated results include the results of the ComBanc branches from January 21. On April 8, 2005, First Defiance completed the acquisition of The Genoa Savings and Loan Company ("Genoa"), a savings and loan which operated four branches in Lucas, Wood and Ottawa Counties. First Defiance merged Genoa's Maumee branch with its existing First Federal facility in the same market and this acquisition increased the number of full service branches from 23 to 26. On April 25, 2005, First Federal's Defiance North and Super K-Mart branches were merged, reducing the total to 25. 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 three First Federal banking center locations. 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 $2.1 million at June 30, 2005. 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 $110.5 million at June 30, 2005. The available-for-sale portfolio consists of U.S. Treasury securities and obligations of U.S. Government corporations and agencies ($43.3 million), certain municipal obligations ($24.1 million), CMOs and REMICs ($20.3 million), mortgage backed securities ($16.5 million) and preferred stock and other equity investments ($6.3 million). 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 $1.6 million at June 30, 2005, or $1.1 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 24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- 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 June 30, 2005, First Defiance's total assets, deposits and stockholders' equity amounted to $1.40 billion, $1.05 billion and $147.6 million, respectively, compared to $1.13 billion, $797.7 million and $126.9 million, respectively, at December 31, 2004. Net loans receivable increased $246.2 million to $1.1 billion at June 30, 2005 from $881.2 million at December 31, 2004. The increase in loans receivable occurred primarily in one-to-four family residential loans, which increased by $101.0 million to $291.0 million, non-residential and multi-family real estate loans, which increased by $81.4 million to $496.6 million, commercial loans, which increased by $30.7 million to $172.4, home equity and improvement loans, which increased by $20.5 million to $111.3 million, consumer loans, which increased by $11.7 million to $57.2 million and construction loans, which increased by $8.5 million to $24.0 million. Of the $246.2 million increase in total loans, $119.5 million was a result of the ComBanc, Inc acquisition and $67.6 million was a result of the Genoa Savings and Loan Company acquisition. The investment securities portfolio decreased to $112.6 million at June 30, 2005 from $139.3 million at December 31, 2004. The decrease in the balance in the investment portfolio is the result of redeploying funds from securities as they are sold, mature or get called to fund loan growth. At June 30, 2005 there were approximately $7.2 million of interest-bearing deposits held at other financial institutions. Deposits increased from $797.7 million at December 31, 2004 to $1.0 billion at June 30, 2005. Of the total increase of $248.8 million, $163.3 million of the increase was a result of the ComBanc, Inc acquisition, $76.5 million of the increase was a result of the Genoa Savings and Loan Company acquisition and $9.0 million was the result of organic growth in existing markets. Detail of ComBanc's and Genoa's deposits as of the respective acquisition dates are as follows: 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- ComBanc Genoa ---------------------- (In Thousands) Non-interest-bearing demand deposits $ 17,700 $ 5,000 Interest-bearing demand deposits and money market savings deposits 33,000 20,400 Savings deposits 43,800 11,200 Time deposits 68,800 39,900 ---------------------- Total Deposits $ 163,300 $ 76,500 ====================== Additionally, FHLB advances decreased to $173.7 million at June 30, 2005 from $178.2 million at December 31, 2004. Short-term advances were paid off following the acquisition of ComBanc, a result of ComBanc's liquidity position. Short-term borrowings increased to $20.9 million at June 30, 2005 from $14.8 million at December 31, 2004. This is a result of an increase in the balance of securities sold under repurchase agreements, principally due to the ComBanc, Inc acquisition. These accounts are a function of customer demand. Stockholders' equity increased from $126.9 million at December 31, 2004 to $147.6 million at June 30, 2005. The increase is a result of issuing 721,164 shares of common stock at $26.03 per common share, totaling $18.8 million, to ComBanc shareholders, $4.9 million of net income, $1.1 million from the exercise of stock options by First Defiance employees, and the release of ESOP shares which increased equity by $1.0 million. Those increases were partially offset by $3.0 million of dividends declared, a decrease in unrealized gains on available for sale securities (net of tax) of $1.1 million and a $1.0 million decrease due to the repurchase of shares for treasury. 26 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.
Three Months Ended June 30, ------------------------------------------------------------------------- 2005 2004 ---------------------------------- ---------------------------------- Average Yield/ Average Yield/ Balance Interest(1) Rate(2) Balance Interest(1) Rate(2) ------- ----------- ------- ------- ----------- ------- Interest-earning assets: Loans receivable $1,091,178 $ 17,053 6.27% $ 786,575 $ 11,283 5.77% Securities 121,792 1,439 4.74 154,995 1,915 4.97 Interest-earning deposits 17,314 134 3.10 347 4 4.64 FHLB stock and other 16,195 204 5.05 15,256 153 4.03 ---------- -------- ---------- -------- Total interest-earning assets 1,246,479 18,830 6.06 957,173 13,355 5.61 Non-interest-earning assets 135,650 93,289 ---------- ---------- Total assets $1,382,129 $1,050,462 ========== ========== Interest-bearing liabilities: Deposits $ 957,094 $ 4,911 2.06% $ 687,293 $ 3,071 1.80% FHLB advances and other 156,528 1,791 4.59 165,668 1,790 4.35 Notes payable 18,861 114 2.42 9,666 20 0.83 ---------- -------- ---------- -------- Total interest-bearing liabilities 1,132,483 6,816 2.41 862,627 4,881 2.28 Non-interest bearing deposits 91,867 -- -- 54,795 -- -- ---------- -------- ---------- -------- Total including non-interest bearing demand deposits 1,224,350 6,816 2.23 917,422 4,881 2.14 Other non-interest-bearing liabilities 10,579 7,131 ---------- ---------- Total liabilities 1,234,929 924,553 Stockholders' equity 147,200 125,909 ---------- ---------- Total liabilities and stock- holders' equity $1,382,129 $1,050,462 ---------- ---------- Net interest income; interest rate spread $ 12,014 3.65% $ 8,474 3.33% ======== ==== ======== ==== Net interest margin (3) 3.87% 3.56% ==== ==== Average interest-earning assets to average interest-bearing liabilities 110% 111% ==== ====
- ---------------- (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. 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - --------------------------------------------------------------------------------
Six Months Ended June 30, ------------------------------------------------------------------------- 2005 2004 ---------------------------------- ---------------------------------- Average Yield/ Average Yield/ Balance Interest(1) Rate(2) Balance Interest(1) Rate(2) ------- ----------- ------- ------- ----------- ------- Interest-earning assets: Loans receivable $1,036,652 $ 31,819 6.19% $ 768,211 $ 22,215 5.82% Securities 129,221 3,044 4.75 160,117 3,962 4.98 Interest-earning deposits 13,627 205 3.03 4,418 36 1.64 FHLB stock and other 15,513 369 4.80 16,512 330 4.02 ---------- -------- ---------- -------- Total interest-earning assets 1,195,013 35,437 5.98 949,258 26,543 5.62 Non-interest-earning assets 113,892 94,259 ---------- ---------- Total assets $1,308,905 $1,043,517 ========== ========== Interest-bearing liabilities: Deposits $ 901,961 $ 8,856 1.98% $ 680,243 $ 6,069 1.79% FHLB advances and other 158,671 3,591 4.56 164,455 3,575 4.37 Notes payable 16,748 195 2.35 10,203 43 0.85 ---------- -------- ---------- -------- Total interest-bearing liabilities 1,077,380 12,642 2.37 854,901 9,687 2.28 Non-interest bearing deposits 83,117 -- -- 53,952 -- -- ---------- -------- ---------- -------- Total including non-interest bearing demand deposits 1,160,497 12,642 2.20 908,853 9,687 2.14 Other non-interest-bearing liabilities 8,139 8,774 ---------- ---------- Total liabilities 1,168,636 917,627 Stockholders' equity 140,269 125,890 ---------- ---------- Total liabilities and stock- holders' equity $1,308,905 $1,043,517 ========== ========== Net interest income; interest rate spread $ 22,795 3.61% $ 16,856 3.34% ======== ==== ======== ==== Net interest margin (3) 3.85% 3.57% ==== ==== Average interest-earning assets to average interest-bearing liabilities 111% 111% ==== ====
- --------------- (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. 28 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- Results of Operations - --------------------- Three Months Ended June 30, 2005 compared to Three Months Ended June 30, 2004 - ----------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $2.0 million or $.29 per share for the three months ended June 30, 2005 compared to $3.1 million or $0.51 per share in 2004. Net Interest Income. Net interest income for the 2005 second quarter was $11.6 million, a 43.2% increase over the $8.1 million earned in the second quarter of 2004. Net interest margin for the 2005-second quarter, on a tax-equivalent basis, was 3.87%, a 31 basis point improvement from the second quarter of 2004 and a 5 basis point improvement over the margin reported for the 2005 first quarter. The improved margin is due to an improved mix between loans and investment securities and lower cost of funds due to growth in the average balance of non-interest bearing deposits. Average interest earning assets grew from $957.2 million in the second quarter of 2004 to $1.25 billion in the second quarter of 2005, an increase of 30.6%. The average balance of loans outstanding increased from $786.6 million in the 2004 second quarter to $1.09 billion in the second quarter of 2005, while the average balance of investment securities dropped from $155.0 million to $121.8 million between the second quarter of 2004 and the second quarter of 2005. Approximately $117 million of the increase in average loan balances related to the ComBanc acquisition, which closed on January 21, 2005, and $67 million related to the Genoa acquisition, which closed on April 8, 2005. The remainder of the $119.4 million total increase is due to year-over-year balance growth. Yields on loans improved to 6.27% for the 2005-second quarter from 5.77% in the second quarter of 2004. Overall yields on interest-earning assets improved to 6.06% in the 2005-second quarter compared to 5.61% during that same period in 2004. The second quarter yield was also a 17 basis point improvement over the 5.89% yield realized in the 2005 first quarter. Average interest-bearing deposits increased to $957.1 million in the 2005-second quarter compared with $687.3 million during the same period of 2004, an increase of $269.8 million or 39.3%. The ComBanc acquisition added $146 million in average balances of interest-bearing deposits while the Genoa acquisition added $66 million in average balances for the quarter. The average balance in interest-bearing deposits also reflects an increase in brokered certificates of deposits (CDs), which averaged $39.2 million in the 2004-second quarter and increased to $46.3 million in the 2005 period. Excluding the acquisition and brokered CDs, interest-earning deposits increased by $50.4 million in the 2005-second quarter compared with the second quarter of 2004. The cost of interest bearing deposits increased 26 basis points, to 2.06% for the 2005-second quarter from 1.80% in the second quarter of 2004 and the cost of Federal Home Loan Bank (FHLB) advances increased 24 basis points, to 4.59% in the 2005 second quarter from 4.35% in the 2004 second quarter. However, an improved mix between advances and deposits resulted in an overall increase in funding costs of just 13 basis points, to 2.41% for the 2005 second quarter from 2.28% in the 2004 second quarter. As a result, the interest rate spread improved to 3.65% in the 2005 second quarter from 3.33% during the second quarter of 2004. 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- The net interest margin also benefited from significant growth in the average balance of non-interest bearing deposits, which increased to $91.9 million in the 2005 second quarter compared with $54.8 million during the 2004 second quarter, an increase of 67.7%. Of that $37.1 million increase, $17.7 million was due to the ComBanc acquisition, $4.6 million was due to the Genoa acquisition and the remaining increase of $14.8 million resulted from other Company initiatives to grow those balances. Provision for Loan Losses. The provision for loan losses was $349,000 in the second quarter of 2005 compared to $490,000 for the second quarter of 2004 despite significant growth in loan balances. The lower provision was due in part to the Company's very low loss experience in the 2005 second quarter, which reflected net charge-offs of $127,000, or 0.05% (annualized) of average loans. 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 the following factors: historical experience; the volume and type of lending conducted by First Defiance; the amount of non-performing assets, including loans which meet the FASB Statement No. 114 definition of impaired; the amount of assets graded by management as substandard, doubtful, or loss; industry standards; 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. Non-performing assets and asset quality ratios for First Defiance were as follows (in $000's): June 30, December 31, 2005 2004 -------------------------- Non-accrual loans $ 4,745 $ 1,893 Loans over 90 days past due and still accruing -- -- ----------------------- Total non-performing loans $ 4,745 $ 1,893 Real estate owned (REO) 431 98 ----------------------- Total non-performing assets $ 5,176 $ 1,991 ======================= Allowance for loans losses as a percentage of total loans 1.18% 1.12% Allowance for loan losses as a percentage of non-performing assets 260.05% 500.05% Allowance for loan losses as a percentage of non-performing loans 283.67% 525.94% Total non-performing assets as a percentage of total assets 0.37% 0.18% Total non-performing loans as a percentage of total loans 0.42% 0.21% Of the $4.7 million in non-performing loans, $2.8 million were commercial loans or non-residential real estate loans and $1.7 million were residential mortgage loans. ComBanc, which had $119.2 million in loans as of the acquisition date, and Genoa, which had $67.6 million in loans as of the acquisition date, each originated $1.6 million of the non-performing loan balances as of June 30, 2005 while First Defiance, with over $900 million in originated loans, had $1.5 million of non-performing loan balances. The allowance for loan losses at June 30, 2005 was $13.5 million 30 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- compared to $9.5 million at June 30, 2004 and $10.0 million at December 31, 2004. Of the $3.5 million increase in allowance since the start of 2005, $3.0 million was recorded as part of the purchase accounting entries. For the quarter ended June 30, 2005, First Defiance charged off $204,000 of loans against its allowance and realized recoveries of $77,000 from loans previously charged off. During the same quarter in 2004, First Defiance charged off $167,000 in loans and realized recoveries of $47,000. Overall, management believes that credit quality remains very good. While the allowance as a percentage of non-performing assets and non-performing loans has declined from over 500% to the 260% and 285% levels, those lower percentages are due in part to a higher concentration of non-performing mortgage loans, particularly following the Genoa acquisition. Historically losses on mortgage loans are less than losses on commercial or consumer loans. Also the allowance as a percentage of total loans has actually increased from 1.12% at December 31, 2004 to 1.18% at June 30, 2005. Additionally, loans deemed to be impaired as of the acquisition dates were recorded net of a purchase accounting discount in accordance with AICPA Statement of Position 03-3 "Accounting for Certain Loans or Debt Securities Acquired in a Transfer." Those loans, which totaled $2.2 million and $729,000 for ComBanc and Genoa respectively (net), are loans which may be past due but have no associated allowance balance because of the fair value accounting requirement. Overall, management believes that the allowance for loan losses is appropriate. Non-Interest Income. Non-interest income increased $278,000 in the second quarter of 2005, to $4.4 million for the quarter ended June 30, 2005 from $4.1 million for the same period in 2004. Excluding securities gains, non-interest income grew by $56,000 in the 2005-second quarter over the same period in 2004. Those year-to-date increases were primarily in service fees and other charges while gains from loan sales declined. Individual components of non-interest income are as follows: Gain on Sale of Loans. Gains realized from the sale of mortgage loans decreased $216,000 to $588,000 for the three months ended June 30, 2005 from $804,000 during the 2004-second quarter. This reduction is attributed both to competitive market factors and an increase in the origination of adjustable rate mortgages which First Defiance typically retains in its portfolio.. Gain on Sale of Securities. Gains realized from the sale of investment securities were $515,000 in the second quarter of 2005. This was an increase of $222,000 from a gain of $293,000 in the second quarter of 2004. Service Fees. Loan and deposit fees increased $382,000 to $1.8 million for the quarter ended June 30, 2005 from $1.4 million for the quarter ended June 30, 2004. 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 decreased $173,000 to $1.0 million in the second quarter of 2005 from $1.2 million in the same period of 2004. Commissions from the sale of property and casualty insurance and group and individual health and life insurance was up slightly period over period but those increases were offset by a decline in commissions from non-deposit investment product sales, which have declined due to a drop in annuity sales and a shift from a commission based model to a financial planning model. 31 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- Other Non-Interest Income. Other non-interest income, including dividends on Federal Home Loan Bank stock, income from Bank Owned Life Insurance and other miscellaneous charges, increased to $501,000 for the quarter ended June 30, 2005 from $438,000 for the same period in 2004. Non-Interest Expense. Total non-interest expense increased $5.7 million to $12.8 million for the quarter ended June 30, 2005 from $7.1 million for the same period in 2004. Excluding acquisition-related charges and MSR impairment-related items, First Defiance incurred non-interest expenses totaling $10.3 million for the 2005 second quarter compared to $7.7 million in the second quarter of 2004, an increase of $2.6 million or 33.8%. Significant individual components of the increase are as follows: Acquisition Related Charges. Second quarter 2005 results included $2.5 million of non-recurring costs associated with the ComBanc ($100,000) and Genoa ($2.4 million) acquisitions. Acquisition-related charges consist of items incurred directly as a result of the acquisitions such as costs to terminate data processing agreements, severance costs to employees not retained and one-time charges necessary to effect the integration of the acquisition. The Genoa acquisition had significant costs associated with its former data processing contracts which had significant terms remaining. Compensation and Benefits. Compensation and benefits increased $1.5 million to $6.0 million for the quarter ended June 30, 2005 from $4.5 million for the same period in 2004. The increase was primarily the result of the ComBanc and Genoa acquisitions. The increase was also due to the addition of several new lending positions and a significant number of new support positions in the credit administration, loan processing, deposit operations, data processing and accounting areas. These new positions have been added to both support growth and assure compliance with regulatory and internal control requirements. The addition of these new positions also has resulted in a significant increase in the Company's health insurance expense in 2005 compared with 2004. In general, anticipated staff reductions at both acquisitions have been realized with the ComBanc reductions being fully implemented by the start of the second quarter and the Genoa staff reductions occurring throughout the second quarter. It is anticipated that $22,000 of staff related expenses were incurred in the 2005 second quarter that will be eliminated in future quarterly periods Amortization and Impairment of Mortgage Servicing Rights. Amortization of mortgage servicing rights ("MSR's") totaled $230,000 in the 2005 second quarter compared to $233,000 in the 2004 second quarter. A flattening of the yield curve and a decline in the rate of 10-year Treasury securities during the 2005 second quarter resulted in a decline in the market value of mortgage servicing rights. As a result, First Defiance recorded $95,000 of MSR impairment during the quarter. In the 2004 second quarter, First Defiance recaptured $524,000 of previously recorded impairment reserves, a fluctuation of $619,000 between the two periods. At June 30, 2005, First Defiance has $481,000 of remaining reserves for MSR impairment. Other Non-Interest Expenses. Other non-interest expenses (including occupancy, state franchise tax, data processing, deposit insurance premiums, and amortization of intangibles) increased to $4.0 million for the quarter ended June 30, 2005 from $3.0 million for the same period in 2004. Occupancy costs increased by $356,000 and data processing costs increased by $199,000 between the second quarter of 2004 and the second quarter of 2005. The increase in occupancy can be primarily 32 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- attributed to the addition of seven full-service branch-banking facilities. Non-interest expense also included amortization of core deposit intangibles totaling $214,000, compared to just $27,000 in the 2004 second quarter period, a result of additional core deposit intangibles acquired as part of the ComBanc and Genoa acquisitions. The efficiency ratio for the second quarter of 2005 was 81.8% compared to an efficiency ratio of 58.7% for the second quarter of 2004. The significant fluctuation in the efficiency ratio is due to the $2.5 million of acquisition related charges incurred in the 2005 fourth quarter and the $619,000 period over period swing in MSR impairment. First Defiance computes federal income tax expense in accordance with FASB Statement No. 109, which resulted in an effective tax rate of 29.24% for the quarter ended June 30, 2005 compared to 32.18% for the same period in 2004. The effective tax rate is lower than the Company's statutory 35% rate because it has approximately $32.7 million invested in municipal securities, and $18.9 million of bank owned life insurance which are both exempt from federal tax. As a result of the above factors, income for the quarter ended June 30, 2005 was $2.0 million compared to income of $3.1 million for the comparable period in 2004. On a per share basis, basic and diluted earnings per share for the three months ended June 30, 2005 were each $0.29 and $.28, respectively, compared to basic and diluted earnings per share from continuing operations of $0.51 and $0.49, respectively, for the quarter ended June 30, 2004. Core earnings for the 2005 second quarter were $3.6 million or $0.51 per diluted share. Six Months Ended June 30, 2005 compared to Six Months Ended June 30, 2004 - ------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $4.9 million or $0.70 per share for the six months ended June 30, 2005 compared to $5.6 million or $0.88 per share in 2004. Net Interest Income. Net interest income for the six months ended June 30, 2005 was $22.1 million compared to $16.1 million for the same period in 2004. On a tax equivalent basis, net interest income for the six months ended June 30, 2005 was $22.4 million compared to $16.5 million for the same period in 2004. Net interest margin for the 2005 first half was 3.85% compared to 3.57% for the same period in 2004. The improvement resulted from a 36 basis point increase in the overall yield of interest earning assets, to 5.98% for the 2005 period from 5.62% during the first six months of 2004. During that same period, the cost of interest-bearing liabilities increased just nine basis points, to 2.37% in the first half of 2005 compared to 2.28% in 2004. The average balance of non-interest bearing deposits increased by $29.2 million or 54.1% between the first half of 2004 and the first half of 2005. Total interest income increased by $8.9 million to $34.7 million for the six months ended June 30, 2005 from $25.8 million for the six months ended June 30, 2004. Interest on loans increased $9.6 million to $31.8 million in the first half of 2005 from $22.2 million in the first half of 2004. The increase in interest from loans was due to a $268.4 million increase in average loan balances between the first half of 2004 and the first half of 2005. That increase is the result of the ComBanc acquisition in January 2005 and the Genoa acquisition in April 2005, which added $119.5 million and $67.6 million in loans, respectively, and due to continued organic portfolio growth throughout the First Defiance market. Interest earnings from the investment portfolio and interest-earning deposits, on a tax equivalent basis, decreased $749,000 to $3.2 million for the six months ended June 30, 2005 compared to $4.0 million 33 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- for the same period in 2004. The decrease was due to the $30.9 million decline in average balances of investments to $129.2 million for the first half of 2005 compared to $160.1 million for the first half of 2004. Total interest expense increased $2.9 million to $12.6 million for the first half of 2005 compared to $9.7 million for the same period in 2004. Interest expense on interest-bearing deposits increased by $2.8 million to $8.9 million for the six months ended June 30, 2005 from $6.1 million for the six months ended June 30, 2004. The average cost of funds increased from 2.28% for the six months ended June 30, 2004 to 2.37% for the same period in 2005. The average balances of interest-bearing liabilities increased $225.1 million from $854.9 million in the first half of 2004 to $1.08 billion in the first half of 2005. Provision for Loan Losses. The provision for loan losses was $696,000 in the first half of 2005 compared to $868,000 for the first half of 2004 despite significant growth in loan balances. The lower provision is consistent with the Company's very low loss experience in the first half of 2005, which showed net charge-offs of just $221,000. 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 the following factors: historical experience; the volume and type of lending conducted by First Defiance; the amount of non-performing assets, including loans which meet the FASB Statement No. 114 definition of impaired; the amount of assets graded by management as substandard, doubtful, or loss; industry standards; 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. While asset quality ratios associated with the allowance as a percentage of non-performing loans has deteriorated since the start of the year, that deterioration is a factor of the asset quality of the acquired portfolios. Management believes that the allowances and related loan purchase discounts acquired with each acquisition were appropriate and they believe that the allowance for loan losses as of June 30, 2005 is adequate. Non-Interest Income. Year-to-date, non-interest income increased to $8.8 million for the first half of 2005 from $7.6 million recognized in the first six months of 2004. If gains from the sale of securities of $1.1 million and $392,000 for the first half of 2005 and 2004, respectively, are excluded, non-interest income increased by $483,000. Those year-to-date increases were primarily in service fees and other charges, which increased to $3.2 million from $2.6 million while gains from loan sales declined to $1.1 million from $1.4 million. Individual non-interest income components are as follows: Gain on Sale of Loans. Gains realized from the sale of mortgage loans decreased $295,000 to $1.1 million for the six months ended June 30, 2005 from $1.4 million during the first half of 2004. The decline is due in part to an increase in the percentage of adjustable rate mortgage loans originated. Management generally retains all adjustable rate mortgages in the portfolio. Gain on Sale of Securities. Gains realized from the sale of investment securities was $1.1 million for the six months ended June 30, 2005 compared to $392,000 in the first half of 2004. Service Fees. Loan and deposit fees increased $610,000 to $3.2 million for the six months ended June 30, 2005 from $2.6 million for the six months ended June 30, 2004. Increases occurred primarily in 34 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- loan servicing fees on mortgage loans serviced for others, checking NSF fees and debit card interchange fees. Insurance and Investment Sales Commission. Insurance and investment sales commission income decreased $23,000 to $2.3 million in the first half of 2005 from $2.3 million in the same period of 2004. This decreased occurred despite the fact that insurance commission income in the first quarter included a significant increase in contingent commission income. Contingent commissions are amounts that are paid by insurance companies based on factors such as favorable underwriting experience and achievement of certain premium levels. Such contingent income amounted to $356,000 in 2005 compared to just $155,000 in 2004. The overall decline in sales commissions resulted from a decline in investment product sales as the Company has begun to transition from a commission based model in that area to a more stable financial planning model. Bank Owned Life Insurance. Income from bank owned life insurance ("BOLI") decreased $28,000 to $357,000 in the first half of 2005 compared to $385,000 for the six months ended June 30, 2004. The decline is the result of declining rates in the general account investments that the insurance is invested in. The rates on this type of product tends to lag the overall market. Other Non-Interest Income. Other non-interest income, including dividends on Federal Home Loan Bank stock and other miscellaneous charges, increased to $219,000 for the six months ended June 30, 2005 from $520,000 for the same period in 2004. Non-Interest Expense. Non-interest expense for the 2005 for the six months ended June 30, 2005 were $23.0 million compared with $14.6 million for the six months ended June 30, 2004. The 2005 amount includes acquisition-related charges of $3.4 million related to the Genoa and ComBanc acquisitions. Acquisition-related charges consist of items incurred directly as a result of the acquisitions such as costs to terminate data processing agreements, severance costs to employees not retained and one- time charges necessary to effect the integration of the acquisition. Significant individual components of the increase are as follows: Acquisition Related Charges. . Year-to-date 2005 results included $3.4 million of non-recurring costs associated with the ComBanc and Genoa acquisitions. Acquisition-related charges consist of items incurred directly as a result of the acquisitions such as costs to terminate data processing agreements, severance costs to employees not retained and one-time charges necessary to effect the integration of the acquisition. Occupancy. Occupancy expense increased to $2.2 million for the six months ended June 30, 2005 as compared to $1.7 million for the sex months ended June 30, 2004. This $500,000 increase is the result of the addition of seven full-service branch banking facilities obtained in the ComBanc and Genoa acquisitions. Compensation and Benefits. Compensation and benefits increased $2.7 million to $11.5 million for the six months ended June 30, 2005 from $8.8 million for the same period in 2004. The increase was also due to the addition of several new lending positions and a significant number of new support positions in the credit administration, loan processing, deposit operations, data processing and accounting areas. These new positions have been added to both support growth and assure compliance 35 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- with regulatory and internal control requirements. The addition of these new positions also has resulted in a significant increase in the Company's health insurance expense in 2005 compared with 2004. Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles, impairment of mortgage servicing rights and deposit insurance premiums) increased to $5.5 million for the six months ended June 30, 2005 from $3.7 million for the six months ended June 30, 2004. The effective federal income tax rate utilized for the six months ended June 30, 2004 was 31.4% compared to 31.5% for the six months ended June 30, 2004. The increase in the effective tax rate is the result of tax-exempt income (primarily earnings on municipal securities and BOLI) being a smaller percentage of total income in 2005 compared to the prior year. As a result of the above factors, income for the six months ended June 30, 2005 was $4.9 million compared to $5.6 million for the comparable period in 2004. On a per share basis, basic and diluted earnings per share for the six months ended June 30, 2005 were $0.72 and $0.70 respectively, compared to basic and diluted earnings per share of $0.92 and $0.88, respectively, for the six months ended June 30, 2004. Excluding the one-time acquisition related charges, basic and diluted earnings per share for the six months ended June 30, 2005 were $1.05 and $1.01 respectively, compared to basic and diluted earnings per share of $0.92 and $0.88 for the six months ended June 30, 2004. 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 $3.2 million of cash from operating activities during the first six months of 2005. 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, gain on sales of securities, loans and property, plant and equipment, 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 June 30, 2005, First Defiance had $98.6 million in outstanding loan commitments and loans in process to be funded generally within the next six months and an additional $166.8 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 $12.8 million of loans held-for-sale. As of June 30, 2005, the total amount of certificates of deposit that are scheduled to mature by June 30, 2006 is $346.5 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. 36 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- 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. As of June 30, 2005, all of these securities pass the FFIEC high-risk security test. The weighted average life of these securities does not exceed the test limits in an instantaneous rate increase scenario of 200 and 300 basis points. The company feels that at this time the return being realized is worth this risk. The total $25.0 million balance of these securities are not classified as high risk at June 30, 2005 and do not present risk significantly different than other mortgage-backed or agency securities. First Federal is required to maintain specified amounts of capital pursuant to regulations promulgated by the OTS. The capital standards generally require the maintenance of regulatory capital sufficient to meet a tangible capital requirement, a core capital requirement, and a risk-based capital requirement. The following table sets forth First Federal's compliance with each of the capital requirements at June 30, 2005.
Core Capital Risk-Based Capital ----------------------------------------------------------- Adequately Well Adequately Well Capitalized Capitalized Capitalized Capitalized ----------------------------------------------------------- Regulatory capital $ 103,445 $ 103,445 $ 116,848 $ 116,848 Minimum required regulatory capital 54,262 67,828 87,421 109,276 ----------------------------------------------------------- Excess regulatory capital $ 49,183 $ 35,617 $ 29,427 $ 7,572 =========================================================== Regulatory capital as a percentage of assets (1) 7.6% 7.6% 10.7% 10.7% Minimum capital required as a percentage of assets 4.0% 5.0% 8.0% 10.0% ----------------------------------------------------------- Excess regulatory capital as a percentage of assets 3.6% 2.6% 2.7% 0.7% ===========================================================
(1) Core capital is computed as a percentage of adjusted total assets of $1.2 billion. Risk-based capital is computed as a percentage of total risk-weighted assets of $1.0 billion. Critical Accounting Policies First Defiance has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. The significant accounting policies of First Defiance are described in the footnotes to the consolidated financial statements included in the Company's Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. Those policies which are identified and discussed in detail in the 37 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued - -------------------------------------------------------------------------------- Company's Annual Report on Form 10-K include the Allowance for Loan Losses, the Valuation of Mortgage Servicing Rights and the Deferral of Fees under SFAS 91. There have been no material changes in assumptions or judgments relative to those critical policies during the second quarter of 2005. 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 2005 are approximately $0.014 per $100 of deposits. 38 Item 3. Qualitative and Quantitative Disclosure About Market Risk - ----------------------------------------------------------------- As discussed in detail in the 2004 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 interest rate risk on a monthly basis through simulation analysis that measures the impact changes in interest rates can have on net interest 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, non-maturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise 100 basis points over a 12 month period, First Defiance's net interest income would increase by 1.84% over the base case scenario. Were interest rates to fall by 100 basis points during the same 12-month period, the simulation indicates that net interest income would decrease by only 0.88%. It should be noted that other areas of First Defiance's income statement, such as gains from sales of mortgage loans and amortization of mortgage servicing rights are also impacted by fluctuations in interest rates but are not considered in the simulation of net interest income. In addition to the simulation analysis, First Federal also prepares an "economic value of equity" ("EVE") analysis. This analysis calculates the net present value of First Federal's assets and liabilities in rate shock environments that range from -100 basis points to +200 basis points. The results of this analysis are reflected in the following table.
June 30, 2005 - ------------------------------------------------------------------------------------------------------------- Economic Value of Equity as % of Economic Value of Equity Present Value of Assets ------------------------------------------------------------------------------------ Change in Rates $ Amount $ Change % Change Ratio Change (Dollars in Thousands) - ------------------------------------------------------------------------------------------------------------- + 200 bp 152,604 (2,873) (1.85%) 11.44% 19 bp + 100 bp 154,460 (1,017) (0.65%) 11.37% 12 bp 0 bp 155,477 -- -- 11.25% -- -100 bp 153,518 (1,959) (1.26%) 10.93% (32) bp -200 bp 149,257 (6,220) (4.00%) 10.47% (78) bp
39 Item 3. Qualitative and Quantitative Disclosures About Mark Risk - Continued Based on the above analysis, in the event of a 200 basis point increase in interest rates as of June 30, 2005, First Federal would experience a 1.85% decrease in its economic value of equity. If rates would fall by 200 basis points its economic value of equity would decline by 4.00%. During periods of rising rates, the value of monetary assets declines. Conversely, during periods of falling rates, the value of monetary assets increases. It should be noted that the amount of change in value of specific assets and liabilities due to changes in rates is not the same in a rising rate environment as in a falling rate environment. Based on the EVE analysis, the change in the economic value of equity in both rising and falling rate environments is generally negligible because both its assets and liabilities have relatively short durations and the durations are fairly closely matched. The average duration of its assets at June 30, 2005 was 1.69 years while the average duration of its liabilities was 1.93 years. In evaluating First Federal's exposure to interest rate risk, certain shortcomings inherent in the each of the methods of analysis presented must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates while interest rates on other types of financial instruments may lag behind current changes in market rates. Furthermore, in the event of changes in rates, prepayments and early withdrawal levels could differ significantly from the assumptions in calculating the table and the results therefore may differ from those presented. Item 4. Controls and Procedures - ------------------------------- Disclosure Controls are procedures designed to ensure that information required to be disclosed in the Company's reports filed under the Exchange Act, such as this report, is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Within the 90-day period prior to the filing of this report, an evaluation was carried out under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. No significant changes were made in the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. 40 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
- ------------------------------------------------------------------------------------------------------------- Total Number of Maximum Number of Shares Purchased as Shares that May Average Price Part of Publicly Yet Be Purchased Total Number of Paid Announced Plans or Under the Plans or Period Shares Purchased Per Share Programs Programs (a) - ------------------------------------------------------------------------------------------------------------- April 1, 2005 - April 30, 2005 988 $26.75 988 435,819 - ------------------------------------------------------------------------------------------------------------- May 1, 2005 - May 31, 2005 4,000 $26.55 4,000 431,819 - ------------------------------------------------------------------------------------------------------------- June 1, 2005 - June 30, 2005 8,044 $29.58 724 (b) 431,095 - ------------------------------------------------------------------------------------------------------------- Total for 2005 Second Quarter 13,032 $28.43 5,712 (b) 431,095 - -------------------------------------------------------------------------------------------------------------
(a) On July 18, 2003, the registrant announced that its Board of Directors had authorized management to repurchase up to 10% of the Registrant's common stock through the open market or in any private transaction. The authorization, which is for 639,828 shares, does not have an expiration date. (b) 7,320 shares were tendered as payment for the exercise of stock options as permitted under the Company's option plans. These shares are not included in the shares purchased as part of publicly announced plans or programs 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 41 (a) Exhibits Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act Exhibit 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act Exhibit 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act Exhibit 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act (b) Reports on Form 8-K First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission on July 20, 2005, which included a included a copy of the Company's earnings release for the quarter and six months ended June 30,2005. First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission on July 19, 2005, which included a conference call script of the Company's earnings release for the quarter ended June 30, 2005 and six months ended June 30, 2005. First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission on June 13, 2005 under items 4.01 and 9.01, announcing Changes in Registrant's Certifying Accountant. 42 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 9, 2005 By: /s/ William J. Small -------------- --------------------------------- William J. Small Chairman, President and Chief Executive Officer Date: August 9, 2005 By: /s/ John C. Wahl -------------- --------------------------------- John C. Wahl Senior Vice President, Chief Financial Officer and Treasurer 43 EX-31.1 2 ex31-1.txt EXHIBIT 31.1 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially effect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2005 /s/ William J. Small ---------------- --------------------------------------- William J. Small Chairman, President and Chief Executive Officer EX-31.2 3 ex31-2.txt EXHIBIT 31.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially effect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2005 /s/ John C. Wahl ------------------ ---------------------------------- John C. Wahl Executive Vice President and Chief Financial Officer EX-32.1 4 ex32-1.txt EXHIBIT 32.1 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 In connection with the Quarterly Report of First Defiance Financial Corp. (the "Company") on Form 10-Q for the period ending June 30, 2005 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. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this quarterly report on Form 10-Q that: 1. The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and 2. The information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. Date: August 9, 2005 /s/ William J. Small ------------------- --------------------------------- William J. Small Chief Executive Officer EX-32.2 5 ex32-2.txt EXHIBIT 32.2 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 In connection with the Quarterly Report of First Defiance Financial Corp. (the "Company") on Form 10-Q for the period ending June 30, 2005 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. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this quarterly report on Form 10-Q that: 1. The Report fully complies with the requirements of sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, and 2. The information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. Date: August 9, 2005 /s/ John C. Wahl ------------------- --------------------------------- John C. Wahl Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----