10-Q 1 form10q40017-813.txt FIRST DEFIANCE FINANCIAL, CORP. 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, 2001 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 [ ] Applicable Only to Issuers Involved in Bankruptcy Proceedings During the Preceding Five Years Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by the court. Yes [ ] No [ ] Applicable Only to Corporate Issuers Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value - 6,834,959 shares outstanding at August 10, 2001. FIRST DEFIANCE FINANCIAL CORP. INDEX Page Number ----------- PART I.-FINANCIAL INFORMATION Item 1. Consolidated Condensed Financial Statements (Unaudited): Consolidated Condensed Statements of Financial Condition - June 30, 2001 and December 31, 2000 1 Consolidated Condensed Statements of Income - Three and six months ended June 30, 2001 and 2000 3 Consolidated Condensed Statement of Changes in Stockholders' Equity - Six months ended June 30, 2001 4 Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2001 and 2000 6 Notes to Consolidated Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3. Quantitative and Qualitative Disclosures about Market Risk 31 PART II. OTHER INFORMATION: Item 1. Legal Proceedings 32 Item 2. Changes in Securities 32 Item 3. Defaults upon Senior Securities 32 Item 4. Submission of Matters to a Vote of Security Holders 32 Item 5. Other Information 32 Item 6. Exhibits and Reports on Form 8-K 32 Signatures 33 PART 1-FINANCIAL INFORMATION Item 1. Financial Statements ----------------------------
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (UNAUDITED) (Amounts in thousands, except for share data) ------------------------------------------------------------------------------------------ June 30, 2001 December 31, 2000 ------------- ----------------- ASSETS Cash and cash equivalents: Cash and amounts due from depository institutions $ 12,304 $ 7,320 Interest-bearing deposits 14,417 13,634 ---------- ---------- 26,721 20,954 Securities: Available-for-sale, carried at fair value 51,700 53,176 Trading, carried at fair value -- 234 Held-to-maturity, carried at amortized cost (approximate fair value $6,904 and $7,770 at June 30, 2001 and December 31, 2000, respectively) 6,786 7,697 ---------- ---------- 58,486 61,107 Loans held for sale (at lower of cost or fair value, approximate fair value $218,693 and $232,314 at June 30, 2001 and December 31, 2000, respectively) 218,693 232,314 Loans receivable, net 544,828 541,208 Mortgage servicing rights 145,379 134,760 Accrued interest receivable 6,098 5,976 Federal Home Loan Bank stock 15,804 15,251 Office properties and equipment 21,754 22,203 Real estate and other assets held for sale 508 312 Goodwill, net 13,596 13,983 Other assets 26,654 24,126 ---------- ---------- Total assets $1,078,521 $1,072,194 ========== ==========
See accompanying notes. 1
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Financial Condition (UNAUDITED) (Amounts in thousands, except for share data) ---------------------------------------------------------------------------------------------- June 30, 2001 December 31, 2000 ------------- ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Noninterest-bearing deposits $ 41,964 $ 33,256 Interest-bearing deposits 538,000 512,643 ----------- ----------- Total deposits 579,964 545,899 Advances from Federal Home Loan Bank 256,251 223,258 Warehouse and term notes payable 22,591 120,425 Advance payments by borrowers for taxes and insurance 101,356 67,982 Deferred taxes 2,251 2,611 Other liabilities 12,157 12,546 ----------- ----------- Total liabilities 974,570 972,721 STOCKHOLDERS' EQUITY Preferred stock, no par value per share: 5,000,000 shares authorized; no shares issued -- -- Common stock, $.01 par value per share: 20,000,000 shares authorized; 6,834,956 and 6,863,541 shares outstanding, respectively 68 69 Additional paid-in capital 53,359 53,512 Stock acquired by ESOP (2,919) (3,238) Deferred compensation (146) (204) Accumulated other comprehensive income, net of income taxes of $333 and $(22), respectively 546 47 Retained earnings 53,043 49,287 ----------- ----------- Total stockholders' equity 103,951 99,473 ----------- ----------- Total liabilities and stockholders' equity $ 1,078,521 $ 1,072,194 =========== ===========
See accompanying notes 2
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Income (UNAUDITED) (Amounts in thousands, except per share data) ------------------------------------------------------------------------------------------------- For the Three Months For the Six Months Ended June 30, Ended June 30, 2001 2000 2001 2000 -------- -------- -------- -------- Interest income Loans $ 15,228 $ 14,206 $ 30,652 $ 28,514 Investment securities 917 1,003 1,863 2,474 Interest-bearing deposits 149 150 210 201 -------- -------- -------- -------- Total interest income 16,294 15,359 32,725 31,189 Interest expense Deposits 6,458 6,153 13,539 11,776 FHLB advances and other 2,874 2,842 6,114 5,729 Notes payable and warehouse loans 417 1,230 1,235 2,362 -------- -------- -------- -------- Total interest expense 9,749 10,225 20,888 19,867 -------- -------- -------- -------- Net interest income 6,545 5,134 11,837 11,322 Provision for loan losses 631 581 1,404 1,989 -------- -------- -------- -------- Net interest income after provision for loan losses 5,914 4,553 10,433 9,333 Noninterest income Mortgage banking income 11,032 8,599 22,127 16,703 Loan service fees and other charges 641 481 1,195 872 Dividends on stock 282 266 556 514 Gain on sale of loans 1,691 2,587 3,855 4,531 Loss on sale of securities (15) -- (61) -- Trust income 26 19 55 37 Other noninterest income 1,176 1,166 2,372 2,304 -------- -------- -------- -------- Total noninterest income 14,833 13,118 30,099 24,961 Noninterest expense Compensation and benefits 5,904 5,921 11,793 11,435 Occupancy 1,263 1,205 2,621 2,413 SAIF deposit insurance premiums 30 30 60 58 State franchise tax 313 287 677 582 Data processing 266 315 608 648 Amortization of mortgage servicing rights 5,109 3,699 9,535 7,240 Net impairment of mortgage servicing rights 1,358 5 1,387 3 Amortization of goodwill 222 219 442 435 Other noninterest expense 2,218 2,133 4,666 4,249 -------- -------- -------- -------- Total noninterest expense 16,683 13,814 31,789 27,063 -------- -------- -------- -------- Income before income taxes 4,064 3,857 8,743 7,231 Federal income taxes 1,478 1,399 3,102 2,573 -------- -------- -------- -------- Net income $ 2,586 $ 2,458 $ 5,641 $ 4,658 ======== ======== ======== ======== Earnings per share (Note 4) Basic $ 0.40 $ 0.39 $ 0.88 $ 0.74 ======== ======== ======== ======== Diluted $ 0.39 $ 0.38 $ 0.86 $ 0.73 ======== ======== ======== ======== Dividends declared per share (Note 3) $ 0.12 $ 0.11 $ 0.24 $ 0.22 ======== ======== ======== ======== Average shares outstanding (Note 4) Basic 6,394 6,305 6,381 6,272 ======== ======== ======== ======== Diluted 6,603 6,407 6,571 6,394 ======== ======== ======== ========
See accompanying notes 3
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (UNAUDITED) (Amounts in thousands) --------------------------------------------------------------------------------------------------------------------- 2001 -------------------------------------------------------------- Stock Acquired By Additional Management Common Paid-in Recognition Stock Capital ESOP Plan ----- ------- ---- ---- Balance at December 31 $69 $53,512 $(3,238) $ (204) Comprehensive income: Net income Change in unrealized gains (losses) net of income taxes of $355 Total comprehensive income ESOP shares released 92 319 Amortization of deferred compensation of Management Recognition Plan 58 Shares issued under stock option plan 97 Purchase of common stock for treasury (1) (342) Dividends declared (Note 3) ---- ------- ------- ----- Balance at June 30 $ 68 $53,359 $(2,919) $(146) ==== ======= ======= =====
See accompanying notes 4
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statement of Changes in Stockholders' Equity (Continued) (UNAUDITED) (Amounts in thousands) ------------------------------------------------------------------------------------------------------------------- 2001 2000 ------------------------------------------------- ------------- Net Unrealized gains (losses) on Total Total available-for- Retained Stockholders' Stockholder's sale securities Earnings Equity Equity --------------- -------- ------ ------ Balance at December 31 $ 47 $49,287 $99,473 $89,416 Comprehensive income: Net income 5,641 5,641 4,658 Change in unrealized gains (losses) net of income taxes of $355 499 499 (55) --- ---- Total comprehensive income 6,140 4,603 ESOP shares released 411 389 Amortization of deferred compensation of Management Recognition Plan 58 129 Shares issued under stock option plan 97 364 Purchase of common stock for treasury (325) (668) (9) Dividends declared (Note 3) (1,560) (1,560) (1,418) ---- ------- -------- ------- Balance at June 30 $546 $53,043 $103,951 $93,474 ==== ======= ======== =======
See accompanying notes 5
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (UNAUDITED) (Amounts in thousands) -------------------------------------------------------------------------------------------- Six Months Ended June 30, 2001 2000 ----------- ----------- Operating Activities Net income $ 5,641 $ 4,658 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for loan losses 1,404 1,989 Provision for depreciation 1,098 998 Net securities amortization 11 31 Amortization of mortgage servicing rights 9,535 7,240 Net impairment of mortgage servicing rights 1,387 3 Amortization of goodwill 442 435 Gain on sale of loans (3,855) (4,531) Amortization of Management Recognition Plan deferred compensation 58 129 Release of ESOP Shares 411 389 Gain on disposal of office properties and equipment -- (60) Net securities losses 61 -- Deferred federal income tax credit (715) (602) Proceeds from sale of loans 989,156 1,171,145 Origination of mortgage servicing rights, net (21,541) (24,028) Origination of loans held for sale (971,680) (1,126,699) Increase in interest receivable and other assets (2,705) (4,274) Net repurchase of loans (14,877) (6,151) (Decrease) increase in other liabilities (389) 815 ----------- ----------- Net cash (used in) provided by operating activities (6,558) 21,487 Investing Activities Proceeds from maturities of held-to-maturity securities 896 1,220 Proceeds from maturities of available-for-sale securities 2,915 2,817 Proceeds from sale of available-for-sale securities 1,894 -- Proceeds from sale of trading securities 233 29,563 Proceeds from sales of real estate, mobile homes, and other assets held for sale 324 1,967 Proceeds from sales of office properties and equipment 27 323 Purchases of available-for-sale securities (2,535) (2,392) Purchases of Federal Home Loan Bank stock (553) (511) Purchases of office properties and equipment (676) (1,377) Net decrease (increase) in loans receivable 9,333 (42,443) ----------- ----------- Net cash provided by (used in) investing activities 11,858 (10,833)
6
FIRST DEFIANCE FINANCIAL CORP. Consolidated Condensed Statements of Cash Flows (Continued) (UNAUDITED) (Amounts in thousands) ---------------------------------------------------------------------------------------- Six Months Ended June 30, 2001 2000 --------- --------- Financing Activities Net increase in deposits and advance payments by borrowers for taxes and insurance 67,439 69,305 Repayment of Federal Home Loan Bank long-term advances (257) (100,443) Repayment of term notes payable (156) (305) Net (decrease) increase in Federal Home Loan Bank short-term advances (56,750) 56,000 Proceeds from short-term line of credit 4,600 10,000 Proceeds from Federal Home Loan Bank long term notes 90,000 -- Decrease in mortgage warehouse loans (102,278) (47,043) Purchase of common stock for treasury (668) (9) Cash dividends paid (1,560) (1,408) Proceeds from exercise of stock options 97 364 --------- --------- Net cash provided by (used in) financing activities 467 (13,539) --------- --------- Increase (decrease) in cash and cash equivalents 5,767 (2,885) Cash and cash equivalents at beginning of period 20,954 16,236 --------- --------- Cash and cash equivalents at end of period $ 26,721 $ 13,351 ========= ========= Supplemental cash flow information: Interest paid $ 21,119 $ 19,558 ========= ========= Income taxes paid $ 3,440 $ 3,200 ========= ========= Transfers from loans to real estate and other assets held for sale $ 161 $ 234 ========= ========= Noncash operating activities: Change in deferred tax established on net unrealized gain or loss on available-for-sale securities $ (355) $ 27 ========= ========= Noncash investing activities: Increase (decrease) in net unrealized gain or loss on available-for-sale securities $ 854 $ (82) ========= ========= Noncash financing activities: Cash dividends declared but not paid $ 782 $ 713 ========= =========
See accompanying notes. 7 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 1. Principles of Consolidation The consolidated condensed financial statements include the accounts of First Defiance Financial Corp. ("First Defiance" or "the Company"), its two wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance"), and First Federal's wholly owned mortgage banking company, The Leader Mortgage Company, LLC ("The Leader"). 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, 2000 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, 2001 and for the three-month and six-month periods ending June 30, 2001 and 2000 have been prepared by First Defiance without audit and do not include certain 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. It is suggested that these consolidated condensed financial statements be read in conjunction with the financial statements and notes thereto included in First Defiance's 2000 Annual Report on Form 10-K for the year ended December 31, 2000. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results of operations for the three-month and six-month periods ended June 30, 2001 are not necessarily indicative of the results that may be expected for the entire year. 3. Dividends on Common Stock As of June 30, 2001, First Defiance had declared a quarterly cash dividend of $.12 per share for the second quarter of 2001, payable July 27, 2001. 8 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 4. Earnings Per Share Basic earnings per share as disclosed under Statement of Financial Accounting Standard ("FAS") No. 128 has been calculated by dividing net income by the weighted average number of shares of common stock outstanding for the three and six-month periods ended June 30, 2001 and 2000. 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-month periods ended June 30, 2001 and 2000, the effect of shares issuable under stock option plans and unvested shares under the Management Recognition Plan have been accounted for using the Treasury Stock method. The following table sets forth the computation of basic and diluted earning per share (in thousands except per share data):
Three Months Ended Six Months Ended June 30, June 30, -------- -------- 2001 2000 2001 2000 ------ ------ ------ ------ Numerator for basic and diluted earnings per share - net income $2,586 $2,458 $5,641 $4,658 ====== ====== ====== ====== Denominator: Denominator for basic earnings per share - weighted average shares 6,394 6,305 6,381 6,272 Effect of dilutive securities: Employee stock options 177 38 144 47 Unvested Management Recognition Plan stock 32 64 46 75 ------ ------ ------ ------ Dilutive potential common shares 209 102 190 122 ------ ------ ------ ------ Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 6,603 6,407 6,571 6,394 ====== ====== ====== ====== Basic earnings per share $ .40 $ .39 $ .88 $ .74 ====== ====== ====== ====== Diluted earnings per share $ .39 $ .38 $ .86 $ .73 ====== ====== ====== ======
9 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 5. Loans Loans receivable and held for sale consist of the following (in thousands):
June 30, December 31, 2001 2000 -------- -------- Real Estate: One-to-four family residential real estate $443,803 $478,221 Construction loans 9,311 9,628 Commercial real estate 155,906 132,204 -------- -------- 609,020 620,053 Other Loans: Commercial 90,766 82,851 Consumer finance 45,409 52,142 Home equity and improvement 33,400 31,836 -------- -------- 169,575 166,829 -------- -------- Total mortgage and other loans 778,595 786,882 Deduct: Loans in process 4,590 3,415 Net deferred loan origination fees and costs 1,093 1,041 Allowance for loan loss 9,391 8,904 -------- -------- Totals $763,521 $773,522 ======== ========
6. Mortgage Servicing Rights The activity in Mortgage Servicing Rights ("MSRs") is summarized as follows (in thousands):
Six Months Ended Year Ended June 30, December 31, 2001 2000 ------- -------- Balance at beginning of period $134,760 $97,519 Loans sold, servicing retained 21,541 52,225 Net impairment charge (1,387) (21) Amortization (9,535) (14,963) ------- -------- Balance at end of period $145,379 $134,760 ======== ========
10 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 6. Mortgage Servicing Rights - Continued Accumulated amortization of mortgage servicing rights aggregated approximately $42.0 million and $32.4 million at June 30, 2001 and December 31, 2000, respectively. Additionally, the accumulated reserve for impairment aggregated approximately $1.4 million and $11,000 at June 30, 2001 and December 31, 2000, respectively. The Company's mortgage servicing portfolio (excluding subserviced loans) is comprised of the following as of June 30, 2001 (dollars in thousands):
Number Principal Balance of Loans Outstanding -------- ----------- GNMA 89,739 $6,303,766 FNMA 13,901 909,266 FHLMC 2,397 120,271 Other VA, FHA and Conventional loans 25,764 1,222,463 ------- ---------- 131,801 $8,555,766 ======= ==========
7. Deposits A summary of deposit balances is as follows (in thousands):
June 30, December 31, 2001 2000 --------- ---------- Noninterest-bearing checking accounts $ 41,964 $ 33,256 Interest-bearing checking accounts 31,215 32,645 Savings accounts 37,051 37,551 Money market demand accounts 98,064 78,961 Certificates of deposit 371,670 363,486 --------- ---------- $ 579,964 $ 545,899 ========= ==========
11 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 8. Line of Business Reporting First Defiance operates two major lines of business. Retail banking, which consists of the operations of First Federal, includes direct and indirect lending, deposit-gathering, small business services and consumer finance. Mortgage banking, which consists of the operations of The Leader, includes buying and selling mortgages to the secondary market and the subsequent servicing of these sold loans. The business units are identified by the channels through which the product or service is delivered. The retail-banking unit funds the mortgage-banking unit and an investment/funding unit within the retail-banking unit centrally manages interest rate risk. Transactions between business units are primarily conducted at fair value, resulting in profits that are eliminated for reporting consolidated results of operations. The parent unit is comprised of the operations of First Insurance and inter-segment income elininations and unallocated expenses.
Three-Months Ended June 30, 2001 (in thousands) Retail Mortgage Consolidated Parent Banking Banking ---------- --------- ---------- -------- Total interest income $ 16,294 $ (4,081) $ 16,081 $ 4,294 Total interest expense 9,749 (3,912) 10,904 2,757 ---------- --------- ---------- -------- Net interest income 6,545 (169) 5,177 1,537 Provision for loan losses 631 - 253 378 ---------- --------- ---------- -------- Net interest income after provision 5,914 (169) 4,924 1,159 Non-interest income 14,833 570 1,852 12,411 Non-interest expense 16,683 763 4,246 11,674 ---------- --------- ---------- -------- Income before income taxes 4,064 (362) 2,530 1,896 Income taxes 1,478 (97) 798 777 ---------- --------- ---------- -------- Net income $ 2,586 $ (265) $ 1,732 $ 1,119 ========== ========= ========== ======== Total assets $1,078,521 $(417,467) $1,065,780 $430,208 ========== ========= ========== ========
12 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 8. Line of Business Reporting-Continued
Six-Months Ended June 30, 2001 (in thousands) Retail Mortgage Consolidated Parent Banking Banking ---------- --------- ---------- -------- Total interest income $ 32,725 $ (8,838) $ 33,016 $ 8,547 Total interest expense 20,888 (8,460) 22,748 6,600 ---------- --------- ---------- -------- Net interest income 11,837 (378) 10,268 1,947 Provision for loan losses 1,404 - 387 1,017 ---------- --------- ---------- -------- Net interest income after provision 10,433 (378) 9,881 930 Non-interest income 30,099 1,109 3,298 25,692 Non-interest expense 31,789 1,436 8,772 21,581 ---------- --------- ---------- -------- Income before income taxes 8,743 (705) 4,407 5,041 Income taxes 3,102 (202) 1,408 1,896 ---------- --------- ---------- -------- Net income $ 5,641 $ (503) $ 2,999 $ 3,145 ========== ========= ========== ======== Total assets $1,078,521 $(417,467) $1,065,780 $430,208 ========== ========= ========== ======== Three-Months Ended June 30, 2000 (in thousands) Retail Mortgage Consolidated Parent Banking Banking ---------- --------- ---------- -------- Total interest income $ 15,359 $ (4,532) $ 15,741 $ 4,150 Total interest expense 10,225 (4,484) 10,527 4,182 ---------- --------- ---------- -------- Net interest income 5,134 (48) 5,214 (32) Provision for loan losses 581 - 75 506 ---------- --------- ---------- -------- Net interest income after provision 4,553 (48) 5,139 (538) Non-interest income 13,118 629 1,066 11,423 Non-interest expense 13,814 720 4,332 8,762 ---------- --------- ---------- -------- Income before income taxes 3,857 (139) 1,873 2,123 Income taxes 1,399 (38) 614 823 ---------- --------- ---------- -------- Net income $ 2,458 $ (101) $ 1,259 $ 1,300 ========== ========= ========== ======== Total assets $ 979,762 $(352,625) $966,219 $366,168 ========== ========= ========== ========
13 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 8. Line of Business Reporting-Continued
Six-Months Ended June 30, 2000 (in thousands) Retail Mortgage Consolidated Parent Banking Banking ---------- --------- ---------- -------- Total interest income $ 31,189 $ (8,830) $ 30,645 $ 9,374 Total interest expense 19,867 (8,854) 20,246 8,475 ---------- --------- ---------- -------- Net interest income 11,322 24 10,399 899 Provision for loan losses 1,989 - 311 1,678 ---------- --------- ---------- -------- Net interest income after provision 9,333 24 10,088 (779) Non-interest income 24,961 1,266 1,983 21,712 Non-interest expense 27,063 1,407 8,661 16,995 ---------- --------- ---------- -------- Income before income taxes 7,231 (117) 3,410 3,938 Income taxes 2,573 (9) 1,092 1,490 ---------- --------- ---------- -------- Net income $ 4,658 $ (108) $ 2,318 $ 2,448 ========== ========= ========== ======== Total assets $ 979,762 $(352,625) $ 966,219 $366,168 ========== ========= ========== ========
9. Accounting for Derivative Instruments and Hedging Activities SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, requires all derivative instruments to be carried at fair value on the balance sheet. The Statement continues to allow derivative instruments to be used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be used. The Statement also provides for offsetting changes in fair value or cash flows of both the derivative and the hedged asset or liability to be recognized in earnings in the same period; however, any changes in fair value or cash flow that represent the ineffective portion of a hedge are required to be recognized in earnings. For derivative instruments not accounted for as hedges, changes in fair value are to be recognized in earnings as they occur. On January 1, 2001, First Defiance adopted the Statement. After-tax adjustments associated with establishing the fair values of derivative instruments on the balance sheet reduced net income by approximately $11,000. 14 FIRST DEFIANCE FINANCIAL CORP. Notes to Consolidated Condensed Financial Statements (continued) (Unaudited at June 30, 2001 and 2000) -------------------------------------------------------------------------------- 10. Accounting Pronouncements Pending Adoption Business Combinations. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 114, "Business Combinations" (SFAS 141), which replaces Accounting Principles Board Opinion No. 16. SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations initiated after June 30, 2001. Subsequent to June 30, 2001, First Defiance has not initiated any business combinations that would have qualified for the pooling-of-interest method of accounting. Goodwill and Other Intangible Assets. In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (SFAS 142), which takes effect for fiscal years beginning after December 15, 2001. SFAS 142 replaces Accounting Principles Board Opinion No. 17 and eliminates the amortization of goodwill and intangible assets deemed to have indefinite lives. Goodwill and certain intangible assets are subject to impairment tests which must be conducted at least annually. Impairment losses that result from the initial application of SFAS 142 will be accounted for as a "cumulative effect of accounting change" on First Defiance's income statement. First Defiance will adopt SFAS 142 as of January 1, 2001. Management is currently reviewing SFAS and has not yet determined the extent to which it will impact First Defiance's financial condition and results of operations. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -------------------------------------------------------------------------------- General ------- First Defiance is a holding company which conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance") and First Federal's wholly owned subsidiary, The Leader Mortgage Company, LLC ("The Leader"). First Federal is primarily engaged in attracting deposits from the general public through its offices and using those and other available sources of funds to originate loans primarily in the areas in which its offices are located. The Company's traditional banking activities include originating and servicing residential, commercial and consumer loans; providing a broad range of depository services; and providing trust services. First Federal is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities. The Leader is a mortgage banking company which specializes in servicing mortgage loans originated under first-time home-buyer programs sponsored by various state, county and municipal governmental entities. The Company's mortgage banking activities consist primarily of originating or purchasing residential mortgage loans for either direct resale into secondary markets or to be securitized under various Government National Mortgage Association ("GNMA") mortgage backed securities. First Insurance is an insurance agency that does business in the Defiance, Ohio area. First Insurance offers property and casualty, life insurance, group health, and investment products. First Defiance also invests in U.S. Treasury and federal government agency obligations, money market mutual funds which are comprised of U.S. Treasury obligations, obligations of the State of Ohio and its political subdivisions, mortgage-backed securities which are issued by federal agencies and, to a lesser extent, collateralized mortgage obligations ("CMOs") and real estate mortgage investment conduits ("REMICs"). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. Securities are classified as held-to-maturity when First 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 $6.8 million at June 30, 2001. Loans held-for-sale securitized in the normal course of The Leader's operations have been classified as trading securities, reported at fair market value. The Leader has committed to sell these securities at their carrying value. Securities not classified as held-to-maturity or trading are classified as available-for-sale, which are stated at fair value and had a recorded value of $51.7 million at June 30, 2001. The available-for-sale portfolio consists of U.S. Treasury securities and obligations of U.S. Government corporations and agencies ($18.3 million), corporate bonds ($10.1 million), certain municipal obligations ($7.8 million), adjustable-rate mortgage-backed security mutual funds ($4.5 million), CMOs and REMICs ($6.4 million), mortgage-backed securities ($2.3 million), and preferred stock and other equity investments ($2.3 million). In accordance with FASB Statement No. 115, unrealized holding gains and losses on available-for-sale securities are reported in a separate component of stockholders' equity and are not reported in earnings until realized. Net unrealized holding gains on available-for-sale securities were $879,000 at June 30, 2001, or $546,000 after considering the related deferred tax liability. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest and dividend income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, Federal Home Loan Bank advances, and other borrowings. The Company's non-interest income includes mortgage loan servicing income, other loan administration fees, gains on sales of mortgage loans, and the recognition of mortgage servicing rights generated by The Leader and First Federal. First Defiance's earnings also depend on the provision for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense. Changes in Financial Condition ------------------------------ At June 30, 2001, First Defiance's total assets, deposits (including customer's escrow deposits) and stockholders' equity amounted to $1.079 billion, $681.3 million and $104.0 million, respectively, compared to $1.072 billion, $613.9 million and $99.5 million, respectively, at December 31, 2000. Net loans receivable have increased to $544.8 million at June 30, 2001 from $541.2 million at December 31, 2000. During the same period, loans held-for-sale decreased to $218.7 million at June 30, 2001 from $232.3 million at December 31, 2000. The reduction in the available for sale loans is a result of decreased production in The Leader's bond programs as well as efforts by management to minimize the balance of this lower yielding asset. Mortgage servicing rights increased to $145.4 million at June 30, 2001 from $134.8 at December 31, 2000. Mortgage servicing rights are recorded when loans available for sale are securitized and the value is based on the servicing fees earned on the underlying mortgage loan being serviced, management's estimate of future prepayments and a number of other factors. At June 30, 2001 the weighted average coupon rate of the mortgage servicing portfolio was 7.02% compared to 7.00% at December 31, 2000. The Company has an independent appraisal prepared annually and estimates the fair value each month based upon the results of the appraisal. The most recent independent appraisal was completed as of May 31, 2001. The approximate fair market value of the mortgage servicing rights was $167.8 million at June 30, 2001 compared to $184.9 million at December 31, 2000. The actual value of servicing may vary significantly from the estimated fair value due to changes in interest rates or other market conditions. See Non-Interest Expense discussion included in Management's Discussion and Analysis and Item 3 - Qualitative and Quantitative Disclosure About Market Risk. Deposits increased from $545.9 million at December 31, 2000 to $580.0 million as of June 30, 2001. This increase was the result of a $19.1 million increase in money market demand accounts and a $8.7 million increase in non-interest-bearing checking and a $8.2 million increase in certificates of deposit, net of decreases in interest bearing demand deposit accounts and savings accounts of $1.4 million and $500,000, respectively. The increase in deposits was due to a combination of favorable rates and marketing of the Company's money market demand accounts, increased commercial deposits due to increased activity in both loans and deposits with commercial customers, and the addition and continued growth of recently opened branches. Customer's escrow deposits increased from $68.0 million at December 31, 2000 to $101.4 million at June 30, 2001 due to increases in prepayments in The Leader's loan servicing portfolio. The 17 Leader holds proceeds from prepayments for a period of up to forty-five days prior to being remitted to the investors. Additionally, advances from the Federal Home Loan Bank increased to $256.3 million as of June 30, 2001 from $223.3 million as of December 31, 2000. As a result of the increases in internal sources of funds and increased borrowing capacity at the Federal Home Loan Bank, warehouse and term notes payable decreased from $120.4 million as of December 31, 2000 to $22.6 million. 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. 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Average Balances, Net Interest Income and Yields Earned and Rates Paid ---------------------------------------------------------------------- The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in thousands of dollars and rates, and the net interest margin. Dividends received are included as interest income. The table does not reflect any effect of income taxes. All average balances are based upon daily balances. See Results of Operations section for a discussion of the impact on loan yields resulting from a change in the estimated income on loans 90 days or more past due which have FHA insurance or VA guarantees.
Three Months Ended June 30, ---------------------------------------------------------------------------------------- 2001 2000 ----------------------------------------- ----------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate(1) Balance Interest Rate(1) ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans receivable $ 745,205 $ 15,228 8.17% $ 727,245 $ 14,206 7.81% Securities 59,988 1,066 7.11 64,562 1,153 7.14 FHLB stock 15,530 282 7.26 14,431 266 7.37 ---------- ---------- ---------- ---------- Total interest-earning assets 820,723 16,576 8.08 806,238 15,625 7.75 Non-interest-earning assets 245,050 189,907 ---------- ---------- Total assets $1,065,773 $ 996,145 ========== ========== Interest-bearing liabilities: Deposits $ 572,687 $ 6,458 4.51% $ 530,179 $ 6,153 4.64% FHLB advances and other 230,435 2,874 4.99 203,530 2,842 5.59 Notes payable 27,698 417 6.02 82,990 1,230 5.93 ---------- ---------- ---------- ---------- Total interest-bearing liabilities 830,820 9,749 4.69 816,699 10,225 5.01 ---------- ---------- ---------- ---------- Non-interest-bearing liabilities 132,006 87,595 ---------- ---------- Total liabilities 962,826 904,294 Stockholders' equity 102,947 91,851 ---------- ---------- Total liabilities and stock- holders' equity $1,065,773 $ 996,145 ========== ========== Net interest income; interest rate spread $ 6,827 3.39% $ 5,400 2.74% ========== ==== ========== ==== Net interest margin (2) 3.33% 2.68% ==== ==== Average interest-earning assets to average interest-bearing liabilities 99% 99% == ==
19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued --------------------------------------------------------------------------------
Six Months Ended June 30, ---------------------------------------------------------------------------------------- 2001 2000 ----------------------------------------- ----------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate(1) Balance Interest Rate(1) ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans receivable $ 746,219 $ 30,652 8.22% $ 702,601 $ 28,514 8.12% Securities 60,258 2,073 6.68 74,578 2,675 7.17 FHLB stock 15,392 556 7.22 14,307 514 7.19 ---------- ---------- ---------- ---------- Total interest-earning assets 821,869 33,281 8.10 791,486 31,703 8.01 Non-interest-earning assets 235,420 182,870 ---------- ---------- Total assets $1,057,289 $ 974,356 ========== ========== Interest-bearing liabilities: Deposits $ 571,343 $ 13,539 4.74% $ 517,843 $ 11,776 4.55% FHLB advances and other 230,811 6,114 5.30 210,699 5,729 5.44 Notes payable 38,049 1,235 6.49 75,081 2,362 6.29 ---------- ---------- ---------- ---------- Total interest-bearing liabilities 840,203 20,888 4.97 803,623 19,867 4.94 Non-interest-bearing liabilities 115,279 79,782 ---------- ---------- Total liabilities 955,482 883,405 Stockholders' equity 101,807 90,951 ---------- ---------- Total liabilities and stock- holders' equity $1,057,289 $ 974,356 ========== ========== Net interest income; interest rate spread $ 12,393 3.13% $ 11,836 3.07% ========== ==== ========== ==== Net interest margin (2) 3.02% 2.99% ==== ==== Average interest-earning assets to average interest-bearing liabilities 98% 98% == ==
(1) Annualized (2) Net interest margin is net interest income divided by average interest-earning assets. 20 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Results of Operations --------------------- Three Months Ended June 30, 2001 compared to Three Months Ended June 30, 2000 ----------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $2.6 million for the three months ended June 30, 2001 compared to $2.5 million for the same period in 2000. On a per share basis, basic and diluted earnings per share were $.40 and $.39, respectively, for the 2001 second quarter compared to $.39 and $.38, respectively, for the 2000 second quarter. The results for the quarter included a pre-tax charge of nearly $1.4 million to write down the value of certain segments of the Company's mortgage servicing rights portfolio managed by The Leader. These write-downs were necessitated by increased prepayments as a result of the current lower interest rate environment. This adjustment resulted in an after-tax reduction in earnings of $.14 per share. Cash earnings for the second quarter of 2001 were $2.8 million or $.42 per diluted share compared to $2.7 million or $.42 per diluted share for the same period in 2000. Cash earnings are calculated by excluding the net income impact of amortization of goodwill. Net Interest Income. Net interest income for the quarter ended June 30, 2001 was $6.5 million compared to $5.1 million for the same period in 2000. Net interest margin for the 2001 second quarter was 3.33% compared to 2.68% for the same period in 2000, an increase of 65 basis points. Total interest income increased by $935,000, or 6.1%, from $15.4 million for the three months ended June 30, 2000 to $16.3 million for the three months ended June 30, 2001. The increase was due to a $14.5 million increase in the average balance of interest-earning assets for the second quarter of 2001 when compared to the first quarter of 2000. Additionally, the yield on interest-earning assets increased to 8.08% for the three-month period ended June 30, 2001 from 7.75% for the same period in 2000. Interest earnings from the loan portfolio increased $1.0 million from $14.2 million for the three months ended June 30, 2000 to $15.2 million for the same period in 2001. This increase was due to increases in the average balance of loans receivable and the yield on these loans to $745.2 million and 8.17% for the three-month period ended June 30, 2001, respectively, from $727.2 million and 7.81%, respectively, for the same period in 2000. The improvement in the average yield on the loan portfolio was primarily the result of the continued growth in higher yielding commercial and commercial real estate loans, which comprised 44.1% of the loan portfolio as of June 30, 2001 compared to 36.2% at June 30, 2000. Interest earnings from the investment portfolio decreased to $1.1 million for the three months ended June 30, 2001 compared to $1.2 million for the same period in 2000. The decrease in interest on investments was primarily the result of a $4.6 million decrease in the average balance of investment securities, from $64.6 million for the second quarter of 2000 to $60.0 million for the same period in 2001. Additionally, the yield on the average portfolio balance for the three months ended June 30, 2001 was 7.11% compared to 7.14% for the same period in 2000. 21 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Interest expense decreased by $476,000, or 4.7%, to $9.7 million for the second quarter of 2001 compared to $10.2 million for the same period in 2000. The decrease is primarily due to the 32 basis point decrease in the average cost of interest-bearing liabilities, to 4.69% for the second quarter of 2001 from 5.01% for the same period of 2000. The decrease in funding cost was partially offset by the $14.1 million increase in average interest-bearing liabilities during the same period, from $816.7 million for the three-months ended June 30, 2000 to $830.8 million for the same period in 2001. The increase in average interest-bearing liabilities is primarily due to the funding of a $14.5 million increase in average interest-earning assets noted above combined with a $55.2 million increase in average non-interest-earning assets, from $189.9 million for the second quarter of 2000 to $245.1 million for the same period in 2001. This increase in average non-interest-earning assets was primarily a result of the growth in The Leader's mortgage servicing assets from an average of $109.1 million for the three-months ended June 30, 2000 to $144.4 million for the same period in 2001. The growth in the average balance of assets was partially funded by a $44.4 million increase in the average balance of non-interest-bearing liabilities, from $87.6 million for the three-months ended June 30, 2000 to $132.0 million for the same period in 2001. The growth in the average balance of non-interest-bearing liabilities was primarily the result of a $42.8 million increase in the average balance of customer escrow balances from $73.3 million for the second quarter of 2000 to $116.1 million for the same period in 2001. The decrease in the Company's average cost of interest-bearing liabilities was the result of the Company's strategy in 2000 to position the balance sheet for lower interest rates. The average costs of deposits and FHLB advances declined 13 basis points and 60 basis points, respectively, to 4.51% and 4.99%, respectively for the three-months ended June 30, 2001 from 4.64% and 5.59%, respectively for the same period in 2000. Additionally, the average balance of interest-bearing deposits, the Company's lowest cost source of interest-bearing liabilities, increased from $530.2 million for the three-months ended June 30, 2000 to $572.7 million for the same period in 2001. This growth, a factor of favorable rates on the money market deposit account, effective marketing, increased penetration with commercial accounts and increased volumes at recently opened branches, allowed the Company to reduce the average balance in warehouse and term notes payable, the Company's highest cost source of funding, from $83.0 million for the second quarter of 2000 to $27.7 million for the same period in 2001. Provision for Loan Losses. The provision for loan losses increased slightly to $631,000 for the three-month period ended June 30, 2001 from $581,000 for the same period in 2000. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to the level deemed appropriate by management based on historical experience, the volume and type of lending conducted by First Defiance, industry standards, the amount of non-performing assets and loan charge-off activity, general economic conditions, particularly as they relate to First Defiance's market area, and other factors related to the collectibility of First Defiance's loan portfolio. Non-performing assets, which include loans 90 days or more past due, loans deemed impaired, and repossessed assets, totaled $1.9 million at June 30, 2001, which is .18% of total assets. Non-performing loans and repossessed assets reported do not include $19.0 million for mortgage loans 90 days or more past due which have FHA insurance or VA guarantees. The risk of loss on these loans is generally limited to the administrative cost of foreclosure actions, which is provided for in the allowance for loan losses. The allowance for loan losses at June 30, 2001 was $9.4 million 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- compared to $8.4 million at June 30, 2000 and $8.9 million at December 31, 2000. For the quarter ended June 30, 2001, First Defiance charged off $685,000 of loans against its allowance and realized recoveries of $149,000 from loans previously charged off. During the same quarter in 2000, First Defiance charged off $584,000 in loans and realized recoveries of $192,000. Non-Interest Income. Non-interest income increased substantially in the second quarter of 2001, from $13.1 million for the quarter ended June 30, 2000 to $14.8 million for the same period in 2001. Individual components of non-interest income are as follows: Mortgage Banking Income. Mortgage banking income, which includes servicing fees and late charge income, increased to $11.0 million for the three-month period ended June 30, 2001 compared to $8.6 million for the same period in 2000, an increase of $2.4 million or 28.3%. This increase in mortgage banking income was primarily the result of the growth in the mortgage servicing portfolio from $6.9 billion as of June 30, 2000 to $8.6 billion at June 30, 2001. Gain on Sale of Loans. Gain on sale of loans decreased to $1.7 million for the quarter ended June 30, 2001 from $2.6 million for the same period of 2000. The decrease in gains on sale of loans is a result of a reduction in production of the Company's niche first-time home buyer programs, which have slowed significantly as the borrowers that these programs typically attract have been able to obtain attractive conventional loans in the lower rate environment experienced during the first half of 2001. In a falling interest rate environment, like the industry experienced during the 2001 first half, demand for the first-time homebuyer loans declines initially, resulting in lower loan production levels. Over time, the housing finance agencies generally react to lower market rates with lower program rates. Gains from the first-time homebuyer programs were $576,000 for the 2001 second quarter, a decline from $2.5 million in the same period in 2000. During that same period, loan settlements in these programs decreased to $336.5 million for the 2001 second quarter from $594.8 in the same period in 2000. Gains from conventional mortgage lending, both at First Federal and through The Leader's retail origination division, have offset some of the declines in the first-time homebuyer programs. Total gain on sale from conventional mortgage originations was $1.1 million for the 2001 second quarter, a 1,023% increase from the 2000 second quarter, which totaled only $109,000. Other Non-Interest Income. Other non-interest income, including insurance commission income, dividends on Federal Home Loan Bank stock, loan servicing fees and other charges, and other miscellaneous charges, increased to $2.1 million for the quarter ended June 30, 2001 from $1.9 for the same period in 2000. Deposit fees and other related charges at First Federal increased $197,000, to $530,000 for the three-months ended June 30, 2001 from $333,000 for the same period in 2000. Non-Interest Expense. Total non-interest expense increased from $13.8 million for the quarter ended June 30, 2000 to $16.7 million for the same period in 2001. Excluding amortization and impairment of mortgage servicing rights non-interest expense increased by only 1.0%, from $10.1 million for the second quarter of 2000 to $10.2 million for the same period in 2001. Significant individual components of the increase are as follows: Amortization and Impairment of Mortgage Servicing Rights. Amortization and impairment of mortgage servicing rights (MSRs) increased to $5.1 million and $1.4 million, respectively, for the 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- quarter ended June 30, 2001 from $3.6 million and $5,000, respectively, for the same period in 2000. These increases were due to the growth in the mortgage servicing portfolio from $6.9 billion as of June 30, 2000 to $8.6 billion at June 30, 2001 and increases in prepayments on this portfolio during the second quarter of 2001 compared to the same period in 2000. The lower interest rate environment of the second quarter of 2001 has increased prepayments on the Company's servicing portfolio to 9.79%, annualized, compared to 4.54% for the second quarter of 2000, annualized. The impairment charge was isolated to a specific segment of the Company's servicing portfolio, which is servicing mortgages issued under taxable bond programs with coupon rates exceeding 8%. The total estimated fair value of the Company's servicing portfolio as of June 30, 2001 was $167.8 million, which exceeds book value (excluding the impairment charges recorded) by $20.9 million. While management believes it has accounted for impairment in a conservative manner, further drops in mortgage interest rates or other factors causing prepayments to remain high could result in additional impairment charges. Compensation and Benefits. Compensation and benefits decreased $17,000 from $5.921 million for the quarter ended June 30, 2000 to $5.904 million for the same period in 2001. This decrease was the result of lower compensation due to a reduction in the production levels at The Leader. This decrease is partially offset by staffing increases to handle greater volumes of loans serviced in The Leader's servicing portfolio and the addition of a full service branch in Bowling Green, Ohio in the fourth quarter of 2000. Occupancy. Occupancy expense increased from $1.2 million for the three-month period ended June 30, 2000 to $1.3 for the three months ended June 30, 2001. This increase was a result of expansions throughout the Company. Amortization of Goodwill. Amortization of goodwill amounted to $222,000 in the second quarter of 2001 compared to $219,000 during the same period in 2000. Under the recently issued Financial Accounting Standards Board Statement No. 142, Accounting for Goodwill and Other Intangibles, First Defiance will not amortize goodwill beginning in January 2002. However goodwill will be subject to periodic tests for impairment. Management has not completed the review necessary to determine if any of its goodwill is impaired. Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, deposit premiums, loan servicing, and amortization of other acquisition costs) increased from $2.77 million for the quarter ended June 30, 2000 to $2.83 million for the same period in 2001. The increase in other non-interest expenses was primarily the result of expenses at The Leader relating to increases in the mortgage loan-servicing portfolio. These expenses included postage, examination fees, real estate inspection fees, and collateral handling fees. These increases in other non-interest expenses were partially offset by decreases in amortization of other acquisition costs due to the expiration of certain contractual payments that ended June 30, 2000. First Defiance has computed federal income tax expense in accordance with FASB Statement No. 109 which resulted in an effective tax rate of 36.4% for the quarter ended June 30, 2001 compared to 36.3% for the same period in 2000. 24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- As a result of the above factors, net income for the quarter ended June 30, 2001 was $2.6 million compared to $2.5 million for the comparable period in 2000. On a per share basis, basic and diluted earnings per share for the three months ended June 30, 2001 were $.40 and $.39, respectively, compared to $.39 and $.38, respectively, for the same period in 2000. Average shares outstanding for the basic and diluted calculations were 6,394,000 and 6,603,000, respectively, for the quarter ended June 30, 2001 compared to 6,305,000 and 6,407,000, respectively, for the quarter ended June 30, 2000. First Defiance's board of directors declared a dividend of $.12 per common share as of June 30, 2001. The dividend amounted to $825,321, including dividends on unallocated ESOP shares. It was paid on July 27, 2001. Dividends are subject to determination and declaration by the board of directors, which will take into account First Defiance's financial condition and results of operations, economic conditions, industry standards and regulatory restrictions which affect First Defiance's ability to pay dividends. Six Months Ended June 30, 2001 compared to Six Months Ended June 30, 2000 ------------------------------------------------------------------------- On a consolidated basis, First Defiance had net income of $5.6 million for the six months ended June 30, 2001 compared to $4.7 million for the same period in 2000. On a per share basis, basic and diluted earnings per share were $.88 and $.86, respectively, compared to $.74 and $.73 basic and diluted per share earnings for the same period in 2000. The results for the six-month period ended June 30, 2001 included a $1.4 million pre-tax charge ($.14 per share after-tax) to write down the value of certain segments of the Company's mortgage servicing rights portfolio. Cash earnings for the six-months ended June 30, 2001 were $6.1 million or $.92 per diluted share compared to $5.1 million or $.79 per diluted share for the same period in 2000. Cash earnings are calculated by excluding the net income impact of amortization of goodwill. Net Interest Income. Net interest income before provision for loan losses increased to $11.8 million for the six-month period ending June 30, 2001 compared to $11.3 million for the same period in 2000. The 2000 results included a one-time adjustment of $690,000 for interest on certain loans that were more than 90 days delinquent which had been purchased out of the servicing portfolio by The Leader and which had FHA insurance or VA guarantees. In addition, management enhanced its method of estimating the required reserve for potential losses on foreclosure loans to more accurately reflect the total risk inherent in the servicing and loan portfolios at The Leader. This resulted in a one-time adjustment to provision for loan losses of $693,000. The net impact of these two items essentially offset each other and without these adjustments earnings for the six months ended June 30, 2000 would still have been $.73 per diluted share. The net interest margin for the first half of 2001 was 3.02% compared to 2.99% for the same period in 2000 (2.82% excluding the one-time adjustment noted above). The interest rate spread also increased to 3.13% for the six-month period ended June 30, 2001 from 3.07% for the same period in 2000 (2.89% excluding the one-time adjustment).. Excluding the estimate change, total interest income increased by $2.2 million, or 7.3%, from $30.5 million for the six months ended June 30, 2000 to $32.7 million for the same period in 2001. The increase was due to a $30.4 million increase in the average balance of interest-earning assets for the 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- six months ended June 30, 2001 when compared to the same period in 2000. The yield on interest earning assets increased from 7.84% (8.01% including the change in estimate) for the year-to-date period ended June 30, 2000 to 8.10% for the same period in 2000. Excluding the impact of the change in estimate noted above, interest earnings on the loan portfolio increased $2.9 million to $30.7 million for the six months ended June 30, 2001 from $27.8 million for the same period in 2000. This increase was due to increases in the average balance of loans receivable and the yield on these loans from $702.6 million and 7.92% for the six-month period ended June 30, 2000, respectively, to $746.2 million and 8.22%, respectively, for the same period in 2001. As previously noted, although interest rates have been generally decreasing throughout the first half of 2001, the Company has increased the yield on the loan portfolio as a result of continued growth in higher yielding commercial and commercial real estate loans. Interest earnings from the investment portfolio decreased to $2.1 million for the six months ended June 30, 2001 compared to $2.7 million for the same period in 2000. The decrease in interest income was primarily the result of a $14.3 million decrease in the average balance of investment securities, to $60.3 million for the first six months of 2001 from $74.6 million for the same period in 2000. This decrease resulted from including loans that were securitized pending delivery to the bond trustees in trading securities beginning in late December of 1999. These trading securities were delivered to the trustee during the first quarter of 2000. Additionally, the yield on the average portfolio balance for the six months ended June 30, 2001 was 6.68% compared to 7.17% for the same period in 2000. Interest expense increased by $1.0 million, or 5.1%, to $20.9 million for the six months ended June 30, 2001 compared to $19.9 million for the same period in 2000. The increase is primarily due to the $36.6 million increase in average interest-bearing liabilities, to $840.2 million for the first half of 2001 from $803.6 million for the same period in 2000. The increase in average interest-bearing liabilities is due to the funding of the $30.4 million increase in average interest earning assets noted above combined with the funding of the $52.5 million increase in average non-interest earning assets, from $182.9 million for the first six months of 2000 to $235.4 million for the same period in 2001. This increase in average non-interest earning assets was primarily a result of the growth in The Leader's mortgage servicing assets from an average of $105.3 million for the year-to-date period ended June 30, 2000 to $142.2 million for the same period in 2001. The growth in the average balance of assets was partially funded by a $35.5 million increase in the average balance of non-interest-bearing liabilities, to $115.3 million for the six-months ended June 30, 2001 from $79.8 million for the same period in 2000. The growth in the average balance of non-interest-bearing liabilities was primarily the result of a $33.4 million increase in the average balance of customer escrow balances to $115.3 million for the first half of 2001 from $66.6 million for the same period in 2000. Interest expense also increased due to an increase in the average cost of funds during the first six months of 2001 to 4.97% from 4.94% for the comparable period in 2000. This increase resulted from increases in the average costs of deposits and notes payable of 19 basis points and 20 basis points, respectively, from 4.55% and 6.29%, respectively for the six-months ended June 30, 2000, to 4.74% and 6.49%, respectively, for the same period in 2001. These increases were partially offset by a 14 basis point decrease in the average cost of Federal Home Loan Bank advances, from 5.44% for the first half of 2000 to 5.30% for the same period in 2001. 26 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- Provision for Loan Losses. The provision for loan losses decreased to $1.4 million for the six-months ended June 30, 2001 compared to $2.0 million for the same period in 2000. As noted above, the 2000 amount included the $693,000 adjustment to reflect the change in accounting estimate on foreclosure loans at The Leader. First Defiance charged off $1.2 million of loans against its allowance for loan losses for the six-month period ended June 30, 2001 and realized recoveries of $315,000 from loans previously charged off. During the same period in 2000, First Defiance charged off $1.6 million in loans and realized recoveries of $245,000. Non-Interest Income. Non-interest income increased $5.1 million for the six-month period ended June 30, 2001 to $30.1 million from $25.0 million for the 2001 and 2000 periods, respectively. Individual components of non-interest income are as follows: Mortgage Banking Income. Mortgage banking income, which includes servicing fees and late charge income, increased to $22.1 million for the six-month period ended June 30, 2001 from $16.7 million for the same period in 2000. This increase in mortgage banking income was primarily the result of the growth in the mortgage-servicing portfolio noted in the Results of Operations section for the second quarter of 2001. The Company now services a total of 131,801 loans with a balance of $8.6 billion. Gain on Sale of Loans. Gain on sale of loans decreased to $3.9 million for the six months ended June 30, 2001 from $4.5 million for the same period in 2000. The decrease in gains on sale of loans is a result of the decreased production in The Leader's niche first-time homebuyer programs noted in the Results of Operations section for the second quarter of 2001. Through the first half of 2001, loan settlements under these programs decreased to $851.0 million from $1,063.5 million for the same period in 2000. Other Non-Interest Income. Other non-interest income, including insurance commission income, dividends on Federal Home Loan Bank stock, gains on sale of securities, trust revenues, and other miscellaneous charges, increased to $4.1 million for the six-month period ended June 30, 2001 from $3.7 million for the same period in 2000. The primary reason for the growth in other non-interest income was due to increasing deposit fees at the Company's First Federal Bank subsidiary from $597,000 for the six-month period ended June 30, 2000 to $980,000 for the same period in 2001. Non-Interest Expense. Total non-interest expense increased to $31.8 million for the six-month period ended June 30, 2001 from $27.1 million for the same period in 2000. Excluding amortization and impairment of mortgage servicing rights, non-interest expenses increased by $1.1 million, or 5.3%, from $19.8 million for the first half of 2000 to $20.9 million for the same period of 2001. Significant individual components of the increase are as follows: Amortization and Impairment of Mortgage Servicing Rights. Amortization and impairment of mortgage servicing rights increased from $7.2 million and $3,000, respectively, for the six-month period ended June 30, 2000 to $9.5 million and $1.4 million, respectively, for the same period in 2001 due to the growth in the mortgage servicing portfolio and greater than expected prepayments. See the discussion in the Results of Operations section for the second quarter of 2001. For the first 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- half of 2001, the Company has experienced prepayments in the servicing portfolio of 7.68%, annualized, compared to 4.01%, annualized, for the same period in 2000. Compensation and Benefits. Compensation and benefits increased $358,000, or 3.1%, from $11.4 million for the year-to-date period ended June 30, 2000 to $11.8 million for the same period in 2001. This increase was the result of planned expansions of The Leader's operations, increases at First Federal to support the growth in commercial lending and expansion of the branch network, and general cost of living increases throughout the Company. Occupancy. Occupancy expense increased to $2.6 million for the six-month period ended June 30, 2001 from $2.4 million for the same period in 2000. This increase was a result of expansions throughout the Company. Amortization of Goodwill. Amortization of goodwill amounted to $442,000 for the six months ended June 30, 2001 compared to $435,000 during the same period in 2000. Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, deposit premiums, and loan servicing) increased to $6.0 million for the six-month period ended June 30, 2001 compared to $5.5 million for the same period in 2000. The increase in other non-interest expenses was primarily the result of expenses at The Leader relating to increases in the mortgage loan-servicing portfolio. These expenses include postage, examination fees, real estate inspection fees, and collateral handling fees. The increase in other non-interest expenses was partially offset by the decrease in amortization of other acquisition costs due to the expiration of certain contractual payments that ended June 30, 2000. The effective tax rate utilized for the six months ended June 30, 2001 was 35.5% compared to 35.6% for the six months ended June 30, 2000. As a result of the above factors, net income for the six-month period ended June 30, 2001 increased to $5.6 million from $4.7 million for the six-months ended June 30, 2000. On a per share basis, basic and diluted earnings per share for the six months ended June 30, 2001 were $.88 and $.86, respectively, compared to $.74 and $.73, respectively, for the same period in 2000. As stated above the results for the six months ended June 30, 2001 were negatively impacted by a pre-tax charge of nearly $1.4 million ($.14 per diluted share after tax) to write down the value of certain segments of the Company's mortgage servicing rights portfolio. Average shares outstanding for the basic and diluted calculations were 6,381,000 and 6,571,000, respectively, for the six-months ended June 30, 2001 compared to 6,272,000 and 6,394,000, respectively, for the same period in 2000. Through June 30, 2001, First Defiance has declared dividends totaling $.24 per share. 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 believes it has adequate liquid assets and other sources to meet its funding obligations. OTS regulations which required 28 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued -------------------------------------------------------------------------------- savings institutions to maintain a specific level of liquid assets were repealed during the 2001 first quarter. First Defiance used $6.6 million of cash in operating activities during the first six months of 2001. The Company's cash from operating activities results from net income for the period, adjusted for various non-cash items, including the provision for loan losses, depreciation and amortization, including amortization of mortgage servicing rights, ESOP expense related to release of shares, and changes in loans 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, 2001, First Defiance had $52.8 million in outstanding mortgage loan commitments and loans in process to be funded generally within the next six months and an additional $50.7 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 $221.3 million of loans held-for-sale and it also had commitments to acquire $2.3 billion of mortgage loans under active or pending first-time homebuyer programs, all of which have offsetting commitments for sale into the secondary market as GNMA or FNMA mortgage-backed securities. Also as of June 30, 2001, the total amount of certificates of deposit that are scheduled to mature by June 30, 2002 is $304.0 million. First Defiance believes that it has adequate resources to fund commitments as they arise and that it can adjust the rate on savings certificates to retain deposits in changing interest rate environments. If First Defiance requires funds beyond its internal funding capabilities, advances from the FHLB of Cincinnati and other financial institutions are available. First Defiance, through The Leader, 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. Such investments are not classified as high risk at June 30, 2001 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, 2001. 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations -Continued --------------------------------------------------------------------------------
Tangible Core Risk-Based Capital Capital Capital --------- --------- --------- (Dollars in Thousands) Regulatory capital $ 65,569 $ 65,569 $ 74,097 Minimum required regulatory capital 15,360 40,961 54,534 --------- --------- --------- Excess regulatory capital $ 50,209 $ 22,599 $ 19,563 ========= ========= ========= Regulatory capital as a percentage of assets (1) 6.4% 6.4% 10.9% Minimum capital required as a percentage of assets 1.5% 4.0% 8.0% --------- --------- --------- Excess regulatory capital as a percentage in excess of requirement 4.9% 2.4% 2.9% ========= ========= =========
------------------------ (1) Tangible and core capital are computed as a percentage of adjusted total assets of $1.024 billion. Risk-based capital is computed as a percentage of total risk-weighted assets of $681.7 million. FDIC Insurance The Deposits of First Federal are currently insured by the Savings Association Insurance Fund("SAIF") which is administered by the FDIC. The FDIC also administers the Bank Insurance Fund ("BIF") which generally provides insurance to commercial bank depositors. Both the SAIF and BIF are required by law to maintain a reserve ratio of 1.25% of insured deposits. First Federal's annual deposit insurance premiums for 2001 are approximately $0.019 per $100 of deposits. 30 Item 3. Qualitative and Quantitative Disclosure About Market Risk ----------------------------------------------------------------- As discussed in detail in the 2000 Annual Report on Form 10-K, First Defiance's ability to maximize net income is dependent on management's ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of First Defiance are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance does not use off balance sheet derivatives to enhance its risk management, nor does it engage in trading activities beyond the sale of mortgage loans. First Defiance monitors its exposure to interest rate risk on a monthly basis through simulation analysis which measures the impact changes in interest rates can have on net income. The simulation technique analyses the effect of a presumed 100 basis point shift in interest rates (which is consistent with management's estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, nonmaturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 100 basis points over a 12 month period, using June 2001 amounts as a base case, First Defiance's net interest income would be impacted by less than the board mandated guidelines of 10%. The simulation model used by First Defiance measures the impact of rising and falling interest rates on net interest income only. The Company also monitors the potential change in the value of its mortgage-servicing portfolio given the same 100 basis point shift in interest rates. At June 30, 2001, a 100 basis point decrease in interest rates would require a $6.2 million adjustment to First Defiance's reserve for impairment of MSRs. 31 FIRST DEFIANCE FINANCIAL CORP. PART II-OTHER INFORMATION Item 1. Legal Proceedings First Defiance is not engaged in any legal proceedings of a material nature. Item 2. Changes in Securities Not applicable. Item 3. Defaults upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders Not applicable Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K Not applicable 32 FIRST DEFIANCE FINANCIAL CORP. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized. First Defiance Financial Corp. (Registrant) Date: August 13, 2001 By: /s/ William J. Small --------------- ------------------------ William J. Small Chairman, President and Chief Executive Officer Date: August 13, 2001 By: /s/ John C. Wahl --------------- ------------------- John C. Wahl Senior Vice President, Chief Financial Officer and Treasurer 33