10-K 1 form10k_42819.txt ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 _______________ FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year Ended December 31, 2001 ------------------- or [ _ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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 Identification Number) incorporation or organization) 601 Clinton Street, Defiance, Ohio 43512 ---------------------------------------- ---------- (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (419) 782-5015 _______________ Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $0.01 Per Share (Title of class) _______________ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] As of March 8, 2002, there were issued and outstanding 6,874,448 shares of the Registrant's common stock. The aggregate market value of the voting stock held by non-affiliates of the Registrant computed by reference to the average bid and ask price of such stock as of March 8, 2002 was approximately $108.6 million. _______________ Documents Incorporated by Reference Part III - Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on April 23, 2002 are incorporated by reference into Part III thereof. ================================================================================ 1 PART I Item 1. Business First Defiance Financial Corp. (First Defiance or the Company) is a unitary thrift holding company that, through its subsidiaries (the "Subsidiaries) focuses on traditional banking, mortgage banking, and property and casualty, life and group health insurance products. The Company's traditional banking activities include originating and servicing residential, commercial, and consumer loans and providing a broad range of depository services. The Company's mortgage banking activities consist primarily of purchasing and selling residential mortgage loans, originating residential mortgages, and servicing residential mortgage portfolios for investors. The Company's insurance activities consist primarily of commissions relating to the sale of property and casualty, life and group health insurance and investment products. At December 31, 2001, the Company had consolidated assets of $1.1 billion, consolidated deposits of $631.5 million, and consolidated stockholder's equity of $111.0 million. The Company was incorporated in Ohio in June of 1995. Its principal executive offices are located at 601 N. Clinton Street, Defiance, Ohio 43512, and its telephone number is (419) 782-5015. The Subsidiaries The Company's core business operations are conducted through the following Subsidiaries: First Federal Bank of the Midwest: First Federal Bank of the Midwest (First Federal) is a federally chartered stock savings bank headquartered in Defiance, Ohio. It conducts operations through its main office and thirteen full service branch offices in Defiance, Fulton, Hancock, Henry, Paulding, Seneca, Williams and Wood Counties in northwest Ohio. First Federal's deposits are insured by the Federal Deposit Insurance Corporation (FDIC) under the Savings Association Insurance Fund (SAIF). First Federal is a member of the Federal Home Loan Bank (FHLB) System. 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 secured by single-family residences (one-to-four-family units) primarily located in the eight counties in which its offices are located and in adjacent Putnam County. First Federal also originates other real estate loans secured by nonresidential and multi-family residential real estate and construction loans. First Federal also holds a significant number of non-real estate loans including commercial, home improvement and equity and consumer finance, primarily automobile loans. In addition, First Federal invests in U.S. Treasury and federal government agency obligations, obligations of the State of Ohio and its political subdivisions, mortgage-backed securities which are issued by federal agencies and corporate bonds. 2 The Leader Mortgage Company: The Leader Mortgage Company LLC (The Leader) is a wholly owned subsidiary of First Federal. The Leader is a mortgage banking company which specializes in servicing mortgage loans under various first-time homebuyer programs sponsored by various state, county and municipal governmental entities. The Leader's mortgage banking activities consist primarily of originating or purchasing residential mortgage loans for either direct resale into secondary markets or to be securitized under various Government National Mortgage Association (GNMA) bonds. On January 18, 2002, First Defiance announced that it had entered into a definitive agreement to sell The Leader to U.S. Bank Home Mortgage, a unit of U.S. Bancorp. First Insurance & Investments: First Insurance & Investments (First Insurance) is a wholly owned subsidiary of First Defiance. First Insurance is an insurance agency that does business in the Defiance, Ohio area. First Insurance offers property and casualty insurance, life insurance, group health insurance, and investment products. Securities Management determines the appropriate classification of debt securities at the time of purchase. Debt securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value. 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 securities have been committed to sell at their carrying value. First Defiance's securities portfolio is managed in accordance with a written policy adopted by the Board of Directors and administered by the Investment Committee. The Chief Financial Officer, the Chief Operating Officer, and the Chief Executive Officer of First Federal can each approve transactions up to $1 million. Two of the three officers are required to approve transactions between $1 million and $5 million. All transactions in excess of $5 million must be approved by the Board of Directors. First Defiance's investment portfolio includes six CMO and REMIC issues totaling $3.6 million, all of which are fully amortizing securities. All such investments are considered derivative securities. None of First Defiance's investments are considered to be high risk and management does not believe the risks associated with these investments are significantly different from risks associated with other pass-through mortgage-backed securities. 3 The amortized cost and fair value of securities at December 31, 2001 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Money market mutual funds and other mutual funds are not due at a single maturity date. For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.
Contractually Maturing Total -------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Weighted Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average Year Rate Years Rate Years Rate Years Rate Amount Yield -------------------------------------------------------------------------------------------------- (Dollars in Thousands) Mortgage-backed securities $ 148 9.18% $ 57 8.79% $ 49 10.23% $ 8,831 6.59% $ 9,084 6.67% Corporate bonds 5,088 6.63 4,233 6.49 9,322 6.56 REMICs and CMOs 3,207 6.10 339 3.78 3,546 5.88 U.S. Government and federal agency obligations 1,997 6.17 15,711 6.02 17,708 6.03 Obligations of states and political subdivisions 40 5.88 3,472 5.54 2,311 4.98 3,023 5.08 8,846 5.24 Trust preferred stock 2,000 9.13 2,000 9.13 ----------- ----------- ---------- ----------- ----------- Total $7,273 $23,473 $5,567 $14,193 50,506 =========== =========== ========== =========== Mutual funds 2,548 Equity securities 343 Unrealized gain on securities available for sale 1,172 ----------- Total $54,569 =========== The carrying value of investment securities is as follows: December 31 2001 2000 1999 -------------------------------------------------- (In Thousands) Available-for-Sale Securities: Corporate bonds $ 9,616 $ 11,884 $ 14,746 U. S. Treasury and other U. S. Government agencies and corporations 18,613 17,934 16,374 Obligations of state and political subdivisions 8,251 6,018 5,381 Other 12,509 17,340 17,445 -------------------------------------------------- Total $ 48,989 $ 53,176 $ 53,946 ================================================== Trading Securities: U.S. Treasury and other U.S. Government agencies and corporations $ - $ 234 $ 29,805 -------------------------------------------------- $ - $ 234 $ 29,805 ==================================================
4
December 31 2001 2000 1999 ----------------------------------------- (In Thousands) Held-to-Maturity Securities: U. S. Treasury and other U. S. Government agencies and corporations $ 4,950 $ 6,928 $ 8,997 Obligations of state and political subdivisions 630 769 898 ----------------------------------------- Total $ 5,580 $ 7,697 $ 9,895 =========================================
For additional information regarding First Defiance's investment portfolio refer to Note 5 to the consolidated financial statements. Interest-Bearing Deposits First Defiance had interest-bearing deposits in the FHLB of Cincinnati amounting to $478,000 and $4.9 million at December 31, 2001 and 2000, respectively. Residential Loan Servicing Activities Residential Mortgage Loan Servicing: First Federal and The Leader each has its own mortgage servicing portfolio. At December 31, 2001, First Federal serviced approximately $53.8 million of mortgage loans, while The Leader's servicing portfolio amounted to approximately $9.1 billion. The Leader's servicing portfolio includes approximately $156.9 million in loans serviced for First Federal customers that will be retained by First Federal after the sale to U.S. Bank Home Mortgage. Servicing mortgage loans involves a contractual right to receive a fee for processing and administering loan payments. This processing involves collecting monthly mortgage payments on behalf of investors, reporting information to those investors on a monthly basis and maintaining custodial escrow accounts for the payment of principal and interest to investors and property taxes and insurance premiums on behalf of borrowers. These payments are held in custodial escrow accounts at First Federal, where the money can be invested by the Company in interest-earning assets at returns that historically have been greater than could be realized by the Company using the custodial escrow deposits as compensating balances to reduce the effective borrowing cost on the Company's warehouse credit facilities. As compensation for its mortgage servicing activities, the Company receives servicing fees usually ranging from 0.25% to 0.44% per annum of the loan balances serviced, plus any late charges collected from delinquent borrowers and other fees incidental to the services provided. At December 31, 2001, the Company's weighted-average servicing fee was 0.43%. In the event of a default by the borrower, the Company receives no servicing fees until the default is cured. The loans serviced by others that First Defiance is retaining after the sale of The Leader generally pay servicing fees of 0.25% per annum. 5 Servicing is provided on mortgage loans on a recourse or non-recourse basis. The Company's policy is to accept only a limited number of servicing assets on a recourse basis. As of December 31, 2001, on the basis of outstanding principal balances, only .05% of the mortgage servicing contracts owned by the Company involved recourse servicing. To the extent that servicing is done on a recourse basis, the Company is exposed to credit risk with respect to the underlying loan in the event of a repurchase. Additionally, many of the non-recourse mortgage servicing contracts owned by the Company require the Company to advance all or part of the scheduled payments to the owner of the mortgage loan in the event of a default by the borrower. Many owners of mortgage loans also require the servicer to advance insurance premiums and tax payments on schedule even though sufficient escrow funds may not be available. The Company, therefore, must bear the funding costs associated with making such advances. If the delinquent loan does not become current, these advances are typically recovered at the time of the foreclosure sale. Foreclosure expenses are generally not fully reimbursable by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) or GNMA, for whom the Company provides significant amounts of mortgage loan servicing. As of December 31, 2001 and 2000, the Company had advanced approximately $18.6 million and $10.0 million, respectively, in funds on behalf of third-party investors. Mortgage servicing rights represent a contractual right to service, and not a beneficial ownership interest in, underlying mortgage loans. Failure to service the loans in accordance with contract or other applicable requirements may lead to the termination of the servicing rights and the loss of future servicing fees. There have been no terminations of mortgage servicing rights by any mortgage loan owners because of the Company's failure to service the loans in accordance with its obligations during the three year period ended December 31, 2001. The following table sets forth certain information regarding the composition of the Company's mortgage servicing portfolio (excluding loans subserviced for others) as of the dates indicated:
As of December 31 2001 2000 1999 ----------------------------------------------- (In Thousands) FHA insured/VA guaranteed loans $ 7,308,739 $ 6,271,122 $ 4,641,778 Conventional loans 1,314,542 1,284,535 1,205,908 Other loans 568,449 435,163 191,377 ----------------------------------------------- Total mortgage servicing portfolio $ 9,191,730 $ 7,990,820 $ 6,039,063 =============================================== Fixed rate loans $ 9,178,893 $ 7,985,351 $ 6,032,886 Adjustable rate loans 12,837 5,469 6,177 ----------------------------------------------- Total mortgage servicing portfolio $ 9,191,730 $ 7,990,820 $ 6,039,063 ===============================================
All of the loans in the servicing portfolio to be retained by First Defiance after the sale of The Leader are fixed rate conventional loans. 6 The following table shows the delinquency statistics for the mortgage loans serviced by the Company (excluding loans subserviced for others) compared with national average delinquency rates as of the dates presented:
As of December 31 --------------------------------------------------------------------------------------------------------- 2001 2000 1999 --------------------------------------------------------------------------------------------------------- National National National Company Average(1) Company Average(1) Company Average(1) --------------------------------------------------------------------------------------------------------- Number Percentage Percentage Number Percentage Percentage Number Percentage Percentage of of Servicing Of of of Servicing of of of Servicing of Loans Portfolio Loans Loans Portfolio Loans Loans Portfolio Loans (2) (2) (2) --------------------------------------------------------------------------------------------------------- Loans delinquent for: 30-59 days 9,577 6.84% 3.35% 8,749 7.05% 3.16% 5,102 5.28% 2.74% 60-89 days 2,606 1.86 0.79 2,200 1.77 0.73 1,425 1.47 0.63 90 days and over 2,656 1.90 0.73 1,754 1.41 0.61 1,007 1.04 0.56 --------------------------------------------------------------------------------------------------------- Total delinquencies 14,839 10.60% 4.87% 12,703 10.23% 4.50% 7,534 7.79% 3.93% ========================================================================================================= Foreclosures 2,270 1.62% 1,383 1.11% 2,167 2.24% =========================================================================================================
(1) Source: Mortgage Bankers Association, "Delinquency Rates of 1 to 4 Unit Residential Mortgage Loans" (Seasonally Adjusted) (Data as of September 30, 2001 and December 31, 2000 and 1999, respectively). (2) Delinquencies and foreclosures generally exceed the national average due to historically higher rates of delinquencies and foreclosures on FHA insured and VA guaranteed residential mortgage loans. The following table sets forth certain information regarding the number and aggregate principal balance of the mortgage loans serviced by the Company, including both fixed and adjustable rate loans (excluding loans subserviced for others), at various mortgage interest rates:
As of December 31 --------------------------------------------------------------------------------------------------------- 2001 2000 1999 --------------------------------------------------------------------------------------------------------- Percentage Percentage Percentage Number Aggregate of Number Aggregate of Aggregate Number Aggregate of Aggregate Aggregate of Principal Principal of Principal Principal of Principal Principal Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance ---------------- --------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Less than 5.00% 1,197 $ 69,354 0.75% 949 $ 51,062 0.64% 697 $ 32,872 0.54% 5.00% - 5.99% 21,263 1,394,278 15.17 19,635 1,301,249 16.28 18,326 1,238,781 20.51 6.00% - 6.99% 52,764 3,750,823 40.81 45,122 3,165,465 39.61 35,221 2,427,105 40.19 7.00% - 7.99% 45,951 2,891,963 31.46 39,032 2,329,968 29.16 31,094 1,721,873 28.51 8.00% - 8.99% 14,548 830,559 9.04 13,516 757,174 9.48 9,713 501,155 8.30 9.00% and over 4,190 254,753 2.77 5,854 385,902 4.83 1,640 117,277 1.95 --------------------------------------------------------------------------------------------------------- Total 139,913 $9,191,730 100.00% 124,108 $7,990,820 100.00% 96,691 $6,039,063 100.00% =========================================================================================================
7 Loan administration fees decrease as the principal balance on the outstanding loan decreases and as the remaining time to maturity of the loan shortens. The following table sets forth certain information regarding the remaining maturity of the mortgage loans serviced by the Company (excluding loans subserviced for others) as of the dates shown.
As of December 31 -------------------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------------------- Percent of Percent of Number Percent Unpaid Unpaid Number Percent Unpaid Unpaid of of Number Principal Principal of of Number Principal Principal Maturity Loans of Loans Amount Amount Loans of Loans Amount Amount -------------------------------------------------------------------------------------------- (Dollars in Thousands) 1-5 years 1,832 1.31% $ 113,964 1.24% 3,119 2.51% $ 111,295 1.39% 6-10 years 7,762 5.55 103,961 1.13 6,843 5.51 107,507 1.35 11-15 years 2,169 1.55 145,360 1.58 1,410 1.14 90,667 1.13 16-20 years 14,884 10.64 370,495 4.03 10,528 8.48 337,449 4.22 21-25 years 16,544 11.82 1,060,094 11.53 12,076 9.73 788,008 9.86 More than 25 years 96,722 69.13 7,397,856 80.49 90,132 72.63 6,555,894 82.05 -------------------------------------------------------------------------------------------- Total 139,913 100.00% 9,191,730 100.00% 124,108 100.00% $7,990,820 100.00% ============================================================================================
As of December 31 ------------------------------------------------ 1999 ------------------------------------------------ Percent of Number Percent Unpaid Unpaid of of Number Principal Principal Loans of Loans Amount Amount ------------------------------------------------ 1-5 years 4,102 4.24% $ 121,250 2.01% 6-10 years 5,823 6.02 120,517 2.00 11-15 years 1,457 1.51 99,207 1.64 16-20 years 4,894 5.06 209,012 3.46 21-25 years 12,702 13.14 745,418 12.34 More than 25 years 67,713 70.03 4,743,659 78.55 ------------------------------------------------ Total 96,691 100.00% $6,039,063 100.00% ================================================ The following table sets forth the geographic distribution of the mortgage loans (including delinquencies) serviced by the Company (excluding loans subserviced for others) by state:
As of December 31 -------------------------------------------------------------------------------------------- 2001 2000 -------------------------------------------------------------------------------------------- Percent Percent Percent Percent of of of of Number Aggregate Aggregate Total Number Aggregate Aggregate Total of Principal Principal Delinqs. of Principal Principal Delinqs. State Loans Balance Balance by State(1) Loans Balance Balance by State(1) -------------------------------------------------------------------------------------------- (Dollars in Thousands) Ohio 36,830 $2,522,314 27.44% 21.06% 37,169 $2,425,207 30.35% 24.44% Florida 26,228 1,744,071 18.97 18.27 24,900 1,653,828 20.70 20.29 California 13,354 908,341 9.88 11.92 7,486 466,504 5.84 5.29 Louisiana 13,332 891,238 9.70 13.24 12,396 829,013 10.37 14.92 Other (2) 50,169 3,125,766 34.01 35.51 42,157 2,616,268 32.74 35.06 -------------------------------------------------------------------------------------------- Total 139,913 $9,191,730 100.00% 100.00% 124,108 $7,990,820 100.00% 100.00% ============================================================================================
As of December 31 -------------------------------------------------- 1999 -------------------------------------------------- Percent Percent of of Number Aggregate Aggregate Total of Principal Principal Delinqs. State Loans Balance Balance by State(1) -------------------------------------------------- Ohio 35,336 $2,230,168 36.93% 31.46% Florida 19,245 1,259,712 20.86 22.07 California 1,551 50,793 0.84 0.48 Louisiana 10,226 679,799 11.26 16.30 Other (2) 30,333 1,818,591 30.11 29.69 -------------------------------------------------- Total 96,691 $6,039,063 100.00% 100.00% ================================================== 8 (1) In terms of number of loans outstanding. (2) No other state accounted for greater than 6.0%, based on aggregate principal balances of the Company's mortgage loan servicing portfolio as of December 31, 2001. Lending Activities General. A savings bank generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable securities. See "Regulation - Lending Limits." At December 31, 2001, First Federal's limit on loans-to-one borrower was $12.0 million and its five largest loans or groups of loans to one borrower, including related entities, were $12.6 million, $9.2 million, $7.4 million, $6.6 million and $5.6 million. All of these loans or groups of loans were performing in accordance with their terms at December 31, 2001. The largest group of loans to one borrower, totaling $12.6 million, exceeded the legal lending limit at December 31, 2001. A signed agreement was in place at December 31, 2001 to participate a portion of these loans with another financial institution, however, funding did not take place until January 18, 2002. The outstanding loan amounts to this borrower were $11.3 million on January 31, 2002. 9 Loan Portfolio Composition. The net increase in net loans outstanding over the prior year was $20.0 million, $70.6 million, and $134.4 million in 2001, 2000, and 1999, respectively. The loan portfolio contains no foreign loans nor any concentrations to identified borrowers engaged in the same or similar industries exceeding 10% of total loans. The following table sets forth the composition of the Company's loan portfolio by type of loan at the dates indicated.
December 31 ---------------------------------------------------------------------- 2001 2000 1999 ---------------------------------------------------------------------- Amount % Amount % Amount % ---------------------------------------------------------------------- (Dollars in Thousands) Real estate: One to four family residential $419,923 52.0% $441,959 56.2% $458,442 64.1% Five or more family residential (1) 66,288 8.2 44,700 5.7 11,427 1.6 Non-residential real estate (1) 152,511 18.9 125,479 16.0 11,801 1.7 Construction 7,875 1.0 9,627 1.1 7,808 1.1 ---------------------------------------------------------------------- Total real estate loans 646,597 80.1 621,765 79.0 489,478 68.5 Other: Consumer finance 40,922 5.0 52,114 6.6 64,326 9.0 Commercial (1) 83,690 10.4 81,138 10.3 138,125 19.3 Home equity and improvement 36,179 4.5 31,836 4.1 22,781 3.2 Mobile home 12 - 29 - 46 - ---------------------------------------------------------------------- Total non-real estate loans 160,803 19.9 165,117 21.0 225,278 31.5 ---------------------------------------------------------------------- Total loans 807,400 100.0% 786,882 100.0% 714,756 100.0% =========== ========== ========= Less: Loans in process 2,887 3,415 3,291 Deferred loan origination fees 1,024 1,041 764 Allowance for loan losses 9,937 8,904 7,758 ------------- ------------- -------------- Net loans $793,552 $773,522 $702,943 ============= ============= ============== December 31 ---------------------------------------------- 1998 1997 ---------------------------------------------- Amount % Amount % ---------------------------------------------- (Dollars in Thousands) Real estate: One to four family residential $365,116 62.7% $255,428 57.0% Five or more family residential (1) 13,763 2.4 9,363 2.1 Non-residential real estate (1) 16,436 2.8 20,159 4.5 Construction 8,258 1.4 10,148 2.2 ---------------------------------------------- Total real estate loans 403,573 69.3 295,098 65.8 Other: Consumer finance 87,168 15.0 81,111 18.1 Commercial (1) 70,109 12.0 29,758 6.6 Home equity and improvement 18,168 3.2 16,940 3.8 Mobile home 3,117 0.5 25,424 5.7 ---------------------------------------------- Total non-real estate loans 178,562 30.7 153,233 34.2 ---------------------------------------------- Total loans 582,135 100.0% 448,331 100.0% ========= ========== Less: Loans in process 3,250 3,087 Deferred loan origination fees 612 646 Allowance for loan losses 9,789 2,686 -------------- ------------- Net loans $568,484 $441,912 ============== =============
(1) Prior to December 31, 2000, most non-residential real estate loans were reported with all other commercial loans. Included above, First Defiance had $275.7 million, $232.3 million, $237.6 million, $119.9 and $87,500 million in loans classified as held for sale at December 31, 2001, 2000, 1999, 1998, and 1997, respectively. The fair value of such loans, which are all single-family residential mortgage loans, approximated their carrying value for all years presented. 10 Contractual Principal Repayments and Interest Rates. The following table sets forth certain information at December 31, 2001 regarding the dollar amount of gross loans maturing in First Defiance's portfolio, based on the contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less.
Due 3-5 Due 5-10 Due 10-15 Due 15+ Due Due Years Years Years Years Before Before After After After After 12/31/02 12/31/03 12/31/01 12/31/01 12/31/01 12/31/01 Total ----------------------------------------------------------------------------------- (In Thousands) Real estate $337,187 $22,024 $63,685 $142,643 $31,738 $ 49,320 $ 646,597 Non-real estate: Commercial 45,444 11,663 20,107 5,894 223 359 83,690 Home equity and improvement 1,797 720 2,205 2,013 432 29,012 36,179 Mobile home -- -- -- -- -- 12 12 Consumer finance 18,114 10,338 12,189 208 57 16 40,922 ----------------------------------------------------------------------------------- Total $402,542 $44,745 $98,186 $150,758 $32,450 $ 78,719 $ 807,400 ===================================================================================
The schedule above does not reflect the actual life of the Company's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give First Defiance the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The following table sets forth the dollar amount of gross loans due after one year from December 31, 2001 which have fixed interest rates or which have floating or adjustable interest rates. Floating or Fixed Adjustable Rates Rates Total ---------------------------------------------------- (In Thousands) Real estate $ 124,962 $ 184,448 $ 309,410 Commercial 19,295 18,951 38,246 Other 26,891 30,311 57,202 ---------------------------------------------------- $ 171,148 $ 233,710 $ 404,858 ==================================================== Originations, Purchases and Sales of Loans. The lending activities of First Defiance are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Board of Directors and management. Loan originations are obtained from a variety of sources, including referrals from real estate brokers, developers, builders, and existing customers; newspapers and radio advertising; and walk-in customers. 11 First Defiance's loan approval process for all types of loans is intended to assess the borrowers ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will secure the loan. A commercial loan application is first reviewed and underwritten by one of the commercial loan officers, who may approve credits within their lending limit. Credits exceeding an individual's lending limit may be approved by another loan officer with limits sufficient to cover the exposure. All credits which exceed $100,000 in aggregate exposure must be presented for approval to the Senior Loan Committee comprised of senior lending personnel. Credits which exceed $250,000 in aggregate exposure must be presented for approval to the Executive Loan Committee, a sub-committee of the Board of Directors. A mortgage loan is initially reviewed by a mortgage loan originator. Approval for conforming mortgage loans which are sold to the secondary market occurs centrally by the the Senior Vice President of Mortgage Lending or approved underwriters. Non-conforming mortgage loans must be approved by either the Senior Vice President of Mortgage Lending or the Executive Vice President of Lending. Consumer loan officers underwrite and may approve direct consumer credits within their lending limits. Credits exceeding an officer's lending limits may be approved by another loan officer with limits sufficient to cover the exposure. All indirect consumer credits are underwritten and approved by a centralized underwriting department. First Defiance offers adjustable-rate loans in order to decrease the vulnerability of its operations to changes in interest rates. The demand for adjustable-rate loans in First Defiance's primary market area has been a function of several factors, including customer preference, the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates offered for fixed-rate loans and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate residential loans that can be originated at any time is largely determined by the demand for each in a competitive environment. Adjustable rate loans represented 2.31% of First Defiance's total originations of mortgage loans in 2001 compared to 8.96% and 5.87% during 2000 and 1999, respectively. Adjustable-rate loans decrease the risks associated with changes in interest rates, but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. 12 The following table shows total loans originated, loan reductions, and the net increase in First Defiance's total loans during the periods indicated:
Years ended December 31 2001 2000 1999 ------------------------------------------------ (In Thousands) Loan originations: Single family residential $ 337,448 $ 95,404 $ 154,142 Multi-family residential (1) 50,507 31,118 313 Non-residential real estate (1) 76,680 47,937 476 Construction 9,693 12,665 10,699 Commercial 68,881 87,858 149,819 Home equity and improvement 20,521 13,832 10,223 Consumer finance 18,783 22,846 21,122 ------------------------------------------------ Total loans originated 582,513 311,660 346,794 Purchase of single family residential 1,960,853 2,322,165 1,797,959 Loan reductions: Loan pay-offs 253,409 143,275 188,128 Mortgage loans sold 2,196,349 2,360,174 1,746,386 Periodic principal repayments 73,578 58,250 77,618 ------------------------------------------------ 2,523,336 2,561,699 2,012,132 ------------------------------------------------ Net increase in total loans $ 20,030 $ 72,126 $ 132,621 ================================================
(1) In years prior to 2000, the breakdown between commercial real estate and non-real estate commercial loans was not available. As a result, all commercial real estate originations were reported in the commercial classification. 13 Asset Quality First Defiance's credit policy establishes guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to ensure sound credit decisions. First Defiance's credit policies and review procedures are meant to minimize the risk and uncertainties inherent in lending. In following the policies and procedures, management must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur because of changing economic conditions. Delinquent Loans. The following table sets forth information concerning delinquent loans at December 31, 2001, in dollar amount and as a percentage of First Defiance's total loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
30 to 59 Days 60 to 89 Days --------------------------- --------------------------- Amount Percentage Amount Percentage --------------------------- --------------------------- (Dollars in Thousands) Single-family residential $ 1,308 .16% $ 80 .01% Non-residential and multi-family residential 522 .06 63 .01 Home equity and improvement 211 .03 25 - Consumer finance 615 .08 87 .01 Commercial 799 .10 242 .03 -------------------------------------------------------- 3,455 .43 497 .06 Single-family residential backed by government guarantees 956 .12 492 .06 -------------------------------------------------------- Total $ 4,411 .55% $ 989 .12% ======================================================== 90 Days and Over Total ---------------------------- --------------------------- Amount Percentage Amount Percentage ---------------------------- --------------------------- (Dollars in Thousands) Single-family residential $ 1,151 .14% $ 2,539 .31% Non-residential and multi-family residential 972 .12 1,557 .19 Home equity and improvement 89 .01 325 .04 Consumer finance 49 .01 751 .10 Commercial 110 .01 1,151 .14 -------------------------------------------------------- 2,371 .29 6,323 .78 Single-family residential backed by government guarantees 15,437 1.91 16,885 2.09 -------------------------------------------------------- Total $ 17,808 2.20% $ 23,208 2.87% ========================================================
14 Non-Performing Assets. All loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collectibility of additional interest is deemed insufficient to warrant further accrual. Generally, First Defiance places all loans more than 90 days past due on non-accrual status. When a loan is placed on non-accrual status, total unpaid interest accrued to date is reserved. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. First Defiance considers that a loan is impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan agreement. First Defiance measures impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral, if collateral dependent. If the measure of the impaired loan is less than the recorded investment, First Defiance will recognize an impairment by creating a valuation allowance. This policy excludes large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment such as residential mortgage, consumer installment, and credit card loans. Impairment of loans having recorded investments of $370,000, $95,000 and $570,000 has been recognized as of December 31, 2001, 2000 and 1999, respectively. There was $40,000 of interest received and recorded in income during 2001 related to impaired loans including interest received and recorded in income prior to such impaired loan designation. There were no amounts recorded in 2000 and $36,000 recorded in 1999. Unrecorded interest income on these and all non-performing loans in 2001, 2000 and 1999 was $67,000, $80,000, and $154,000, respectively. The average recorded investment in impaired loans during 2001, 2000 and 1999 was $501,000, $135,000, and $570,000, respectively. The total allowance for loan losses related to these loans was $77,000, $95,000 and $402,000 at December 31, 2001, 2000 and 1999, respectively. Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold. In addition, First Defiance also repossesses other assets securing loans, consisting primarily of automobiles and mobile homes. When such property is acquired it is recorded at the lower of the restated loan balance, less any allowance for loss, or fair value. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management and an allowance for losses is established by a charge to operations if the carrying value of property exceeds its estimated net realizable value. As of December 31, 2001, First Defiance's total non-performing loans amounted to $2.4 million or 0.32% of total loans, compared to $1.4 million or 0.18% of total loans, at December 31, 2000. 15 The following table sets forth the amounts and categories of First Defiance's nonperforming assets and troubled debt restructurings at the dates indicated.
December 31 2001 2000 1999 1998 1997 --------------------------------------------------------------- (Dollars in Thousands) Non-performing loans: Single-family residential $ 1,151 $ 671 $ 146 $ 171 $ 313 Non-residential and multi-family residential real estate 972 572 - - - Commercial 110 140 737 1,330 570 Mobile home - - - 180 315 Consumer finance 138 66 147 171 167 --------------------------------------------------------------- Total non-performing loans 2,371 1,449 1,030 1,852 1,365 Real estate owned 1,164 271 2,465 1,337 18 Other repossessed assets 55 41 92 180 523 --------------------------------------------------------------- Total repossessed assets 1,219 312 2,557 1,517 541 --------------------------------------------------------------- Total non-performing assets $ 3,590 $ 1,761 $ 3,587 $ 3,369 $ 1,906 =============================================================== Troubled debt restructurings $ - $ - $ - $ - $ - =============================================================== Total non-performing assets as a percentage of total assets 0.32% 0.16% 0.36% 0.43% 0.33% =============================================================== Total non-performing loans and troubled debt restructurings as a percentage of total loans 0.32% 0.18% 0.14% 0.33% 0.43% =============================================================== Total non-performing assets and troubled debt restructurings as a percentage of total assets 0.32% 0.16% 0.36% 0.43% 0.33% =============================================================== Allowance for loan losses as a percent of total non-performing assets 276.80% 505.62% 216.3% 290.6% 140.9% ===============================================================
In addition to the $2,371,000 of loans reported above and the $370,000 of loans considered impaired, there are approximately $5,852,000 in performing loans where known information about possible credit problems of the borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in the inclusion of such loans in non-performing loans at some future date. Consideration was given to loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been included in non-performing loans. To the extent that such classified loans are not included in the $5,852,000 potential problem loans noted above, management believes that such loans will not materially impact future operating results, liquidity or capital reserves. 16 Allowance for Loan Losses. First Defiance maintains an allowance for loan losses based upon an assessment of prior loss experience, the volume and type of lending conducted by First Defiance, industry standards, past due loans, general economic conditions and other factors related to the collectibility of the loan portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to allowances may be necessary, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations. At December 31, 2001, First Defiance's allowance for loan losses amounted to $9.9 million compared to $8.9 million at December 31, 2000. The allowance was comprised of $6.5 million for credit losses and $3.4 million for foreclosure losses at December 31, 2001 compared to $6.3 million and $2.6 million for credit and foreclosure losses respectively at December 31, 2000. As of December 31, 2001 and 2000, $161,000 and $316,000, respectively, constituted an allowance with respect to specific loans or assets held for sale. The following table sets forth the activity in First Defiance's allowance for loan losses during the periods indicated.
Years ended December 31 2001 2000 1999 1998 1997 --------------------------------------------------------------- (Dollars in Thousands) Allowance at beginning of year $ 8,904 $ 7,758 $ 9,789 $ 2,686 $ 2,217 Provision of credit losses 993 635 155 7,417 1,613 Provision for foreclosure losses 2,877 2,512 1,770 352 -- --------------------------------------------------------------- Total provision 3,870 3,147 1,925 7,769 1,613 --------------------------------------------------------------- Acquired allowance of The Leader -- -- -- 1,194 -- Foreclosure expense charge-offs 2,475 1,550 1,710 352 -- Credit loss charge-off: One to four family residential real estate 152 -- -- -- -- Commercial real estate 130 182 -- -- -- Commercial 151 155 107 55 4 Consumer finance 599 692 1,364 1,053 1,078 Mobile home - 2 1,054 620 259 --------------------------------------------------------------- Total credit charge-offs 1,032 1,031 2,525 1,728 1,341 --------------------------------------------------------------- Total charge-offs 3,057 2,581 4,235 2,080 1,341 --------------------------------------------------------------- Recoveries from foreclosure losses 413 358 -- -- - Recoveries from credit losses 257 222 279 220 197 --------------------------------------------------------------- Total recoveries 670 580 279 220 197 --------------------------------------------------------------- Net charge-offs 2,837 2,001 3,956 1,860 1,144 --------------------------------------------------------------- Ending allowance $ 9,937 $ 8,904 $ 7,758 $ 9,789 $ 2,686 =============================================================== Ending allowance for credit losses $ 6,548 $ 6,330 $ 6,504 $ 8,595 $ 2,686 Ending allowance for foreclosure losses 3,389 2,574 1,254 1,194 -- --------------------------------------------------------------- Total ending allowance $ 9,937 $ 8,904 $ 7,758 $ 9,789 $ 2,686 =============================================================== Allowance for loan losses to total non-performing loans at end of year 387.0% 614.5% 753.2% 528.6% 196.8% Allowance for loan losses to total loans at end of year 1.88 1.62 1.10 1.68 0.60 Allowance for loan losses to net charge-offs for the year 350.26 444.98 196.11 470.63 234.79 Net charge-offs for the year to average loans 0.34 0.27 0.60 0.36 0.27 17
The following table sets forth information concerning the allocation of First Defiance's allowance for credit losses by loan categories at the dates indicated. For information about the percent of total loans in each category to total loans, see "Lending Activities-Loan Portfolio Composition."
December 31 2001 2000 1999 -------------------------------------------------------------------------------- Percent of Percent of Percent of total loans total loans total loans Amount by category Amount by category Amount by category -------------------------------------------------------------------------------- (Dollars in Thousands) Single family residential $ 613 9.3% $ $ 396 6.3% $843 13.0% Non-residential and Multi-family residential Real estate (1) 2,847 43.5 2,310 36.5 -- -- Other: Commercial loans (1) 1,734 26.5 1,355 21.4 2,317 35.6 Mobile home loans 1 -- 1 - 10 0.1 Consumer and home equity and improvement loans 1,353 20.7 2,268 35.8 3,334 51.3 -------------------------------------------------------------------------------- $ 6,548 100.0% $ $ 6,330 100.0% $6,504 100.0% ================================================================================
(1) In years prior to 2000, the breakdown between commercial real estate and non-real estate commercial loans was not available. As a result, all commercial real estate loans were reported in the commercial classification. Sources of Funds General. Deposits are the primary source of First Defiance's funds for lending and other investment purposes. In addition to deposits, First Defiance derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings from the FHLB may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer term basis for general business purposes. Deposits. First Defiance's deposits are attracted principally from within First Defiance's primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, regular savings accounts, and term certificate accounts. Included among these deposit products are individual retirement account certificates of approximately $56.7 million at December 31, 2001. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. To supplement its funding needs, First Defiance also utilizes brokered Certificates of Deposit. Such deposits are acquired with maturities ranging from three months to one year. The total balance of brokered Certificates of Deposit were $87.0 million and $57.5 million at December 31, 2001 and 2000 respectively. 18 Average balances and average rates paid on deposits are as follows:
Years ended December 31 2001 2000 1999 ------------------------- -------------------------- -------------------------- Amount Rate Amount Rate Amount Rate -------------------------------------------------------------------------------- (Dollars in Thousands) Non-interest bearing demand deposits $ 37,597 - $ 25,376 - $13,165 - Interest bearing demand deposits 129,470 2.99% 91,934 3.65% 73,377 2.97% Savings deposits 36,670 1.55 43,818 1.69 53,247 1.65 Time deposits 384,522 5.38 368,077 5.81 333,115 5.06 -------------------------------------------------------------------------------- Totals $ 588,259 4.27% $ 529,205 4.82% $472,904 4.21% ================================================================================
The following table sets forth the maturities of First Defiance's certificates of deposit having principal amounts of $100,000 or more at December 31, 2001. (In Thousands) ------------------ Certificates of deposit maturing in quarter ending: March 31, 2002 $ 38,867 June 30, 2002 24,555 September 30, 2002 13,384 December 31, 2002 13,098 After December 31, 2002 16,329 ------------------ Total certificates of deposit with balances of $100,000 or more $ 106,233 ================== The following table details the deposit accrued interest payable as of December 31: 2001 2000 ------------------------------ (In Thousands) Interest bearing demand deposits and money market accounts $ 44 $ 88 Savings Accounts 2 3 Certificates 853 889 ------------------------------ $ 899 $ 980 ============================== For additional information regarding First Defiance's deposits see Note 10 to the financial statements. Borrowings. First Defiance may obtain advances from the FHLB of Cincinnati upon the security of the common stock it owns in that bank and certain of its residential mortgage loans, provided certain standards related to creditworthiness have been met. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities. 19 In addition, First Defiance has utilized funding from banks and other sources. As of December 31, 2001, First Defiance has $225 million under revolving warehouse loan agreements with two banks. One agreement is an uncommitted repurchase line of $150 million secured by mortgage loans available for sale at the federal funds rate plus 40 basis points. The other agreement is a $75 million committed line of credit secured by mortgage loans available for sale at the lower of the federal funds rate plus 125 basis points or the LIBOR index plus 100 basis points. These funding facilities had $30.4 million outstanding against them as of December 31, 2001 with a weighted average rate of 2.14%. It is anticipated that those borrowings will be paid in full when The Leader sale transaction is closed in the 2002 second quarter. The following table sets forth certain information as to First Defiance's FHLB advances and other borrowings at the dates indicated.
December 31 2001 2000 1999 -------------------------------------------------------- (Dollars in Thousands) Long-term: FHLB advances $ 156,302 $ 116,758 $ 187,410 Weighted average interest rate 5.12% 6.06% 5.28% Notes 5,970 6,147 6,461 Weighted average interest rate 4.79% 4.96% 4.31% Short-term: FHLB advances $ 40,000 $ 106,500 $ 78,000 Weighted average interest rate 4.32% 6.50% 5.00% Warehouse and other revolving borrowings $ 48,617 $ 114,278 $ 47,043 Weighted average interest rate 2.90% 7.45% 6.64%
20 The following table sets forth the maximum month-end balance and average balance of First Defiance's FHLB advances and other borrowings during the periods indicated.
Years ended December 31 2001 2000 1999 ------------------------------------------------------- (Dollars in Thousands) Long-term: Maximum balance - FHLB $ 196,567 $ 187,371 $ 187,410 Average balance - FHLB 164,692 155,146 107,319 Weighted average interest rate of long-term FHLB advances 5.25% 5.49% 4.83% Maximum balance - Term $ 6,145 $ 6,309 $ 6,472 Average balance - Term 6,031 6,206 4,449 Weighted average interest rate of term borrowings 3.60% 4.67% 4.02% Short-term: Maximum balance - FHLB $ 111,000 $ 140,250 $ 136,250 Average balance - FHLB 62,695 72,384 88,247 Weighted average interest rate of short-term FHLB advances 4.32% 6.53% 5.29% Maximum balance - Warehouse and revolving credit agreements $ 122,624 $ 114,278 $ 49,632 Average balance - Warehouse and revolving credit agreements 43,007 56,422 25,272 Weighted average interest rate of warehouse and revolving credit agreements 4.71% 7.60% 6.47%
The FHLB made a series of fixed rate long-term advances to First Defiance during 1992 and a long-term fixed rate advance under the FHLB Affordable Housing Program in 1995, totaling $1.3 million outstanding. Additionally, as of December 31, 2001, there was $155.0 million outstanding under various long-term FHLB advance programs. First Defiance utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. There were $40.0 million and $106.5 million in short-term advances outstanding at December 31, 2001 and 2000, respectively. First Defiance borrows funds under a variety of programs at the FHLB. At December 31, 2001, $30.0 million was outstanding under First Defiance's advance line of credit. The total available under the line is $175.0 million. Amounts are generally borrowed under this line on an overnight basis. As a member of the FHLB of Cincinnati, First Federal must maintain an investment in the capital stock of that FHLB in an amount equal to the greater of 1.0% of the aggregate outstanding principal amount of First Federal's residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 5% of its advances from the FHLB. First Federal is in compliance with this requirement with an investment in stock of the FHLB of Cincinnati of $16.3 million at December 31, 2001. 21 Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLBs. The standards take into account a member's performance under the Community Reinvestment Act and its record of lending to first-time home buyers. All long-term advances by each FHLB must be made only to provide funds for residential housing finance. For additional information regarding First Defiance's FHLB advances, warehouse and term debt see Notes 11 and 12 to the financial statements. Employees First Defiance had 464 employees at December 31, 2001. None of these employees are represented by a collective bargaining agent, and First Defiance believes that it enjoys good relations with its personnel. Competition The industries in which the Company operates are highly competitive. The Company competes for the acquisition of mortgage loan servicing rights and bulk loan portfolios mainly with mortgage companies, savings associations, commercial banks and other institutional investors. The Company believes that it has competed successfully for the acquisition of mortgage loan servicing rights and bulk loan portfolios by relying on the advantages provided by its unique corporate structure and the secondary marketing expertise of the employees in each Subsidiary. Competition in originating loans arises mainly from mortgage companies, savings associations and commercial banks. The distinction among market participants is based primarily on price as well as the quality of customer service and name recognition. Aggressive pricing policies of the Company's competitors could in the future result in a decrease in the Company's loan origination volume and/or a decrease in the profitability of the Company's loan originations, thereby reducing the Company's revenues and net income. The Company competes for loans by offering competitive interest rates and product types and by seeking to provide a higher level of personal service to borrowers than is furnished by competitors. First Federal has a significant market share of the lending markets in which it conducts operations. Management believes that First Federal's most direct competition for deposits comes from local financial institutions. The distinction among market participants is based primarily on price and, to a lesser extent, the quality of customer service and name recognition. First Federal's cost of funds fluctuates with general market interest rates. During certain interest rate environments, additional significant competition for deposits may be expected from corporate and governmental debt securities, as well as from money market mutual funds. First Federal competes for conventional deposits by emphasizing quality of service, extensive product lines and competitive pricing. 22 Regulation General. First Defiance, First Federal and The Leader, as an operating subsidiary of First Federal, are subject to regulation, examination and oversight by the OTS. Because First Federal's deposits are insured by the FDIC, First Federal is also subject to examination and regulation by the FDIC. First Defiance and First Federal must file periodic reports with the OTS and examinations are conducted periodically by the OTS and the FDIC to determine whether First Federal is in compliance with various regulatory requirements and is operating in a safe and sound manner First Federal and The Leader are subject to various consumer protection and fair lending laws. These laws govern, among other things, truth-in-lending disclosure, equal credit opportunity, and, in the case of First Federal, fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations governing community reinvestment could limit the ability of First Federal to open a new branch or engage in a merger transaction. Community reinvestment regulations evaluate how well and to what extent First Federal lends and invests in its designated service area, with particular emphasis on low-to-moderate income communities and borrowers in such areas. First Defiance is also subject to various Ohio laws which restrict takeover bids, tender offers and control-share acquisitions involving public companies which have significant ties to Ohio. Regulatory Capital Requirements. First Federal, on a consolidated basis with The Leader, is required by OTS regulations to meet certain minimum capital requirements. Current capital requirements call for tangible capital of 1.5% of adjusted total assets, core capital of 4.0% of adjusted total assets, except for associations with the highest examination rating and acceptable levels of risk, and risk-based capital of 8% of risk-weighted assets. 23 The following table sets forth the amount and percentage level of regulatory capital of First Federal at December 31, 2001, and the amount by which it exceeds the minimum capital requirements. Tangible and core capital are reflected as a percentage of adjusted total assets. Total (or risk-based) capital, which consists of core and supplementary capital, is reflected as a percentage of risk-weighted assets. Assets are weighted at percentage levels ranging from 0% to 100% depending on their relative risk. At December 31, 2001 Amount Percent ------------------ -------------- (In Thousands) Tangible capital $ 70,568 6.59% Requirement 16,067 4.00 ------------------ -------------- Excess $ 54,501 2.59% ================== ============== Core capital $ 70,568 6.59% Requirement 16,067 4.00 ------------------ -------------- Excess $ 54,501 2.59% ================== ============== Total capital $ 79,600 11.03% Risk-based requirement 57,748 8.00 ------------------ -------------- Excess $ 21,852 3.03% ================== ============== The OTS has adopted regulations governing prompt corrective action to resolve the problems of capital deficient and otherwise troubled savings associations. At each successively lower defined capital category, an association is subject to more restrictive and numerous mandatory or discretionary regulatory actions or limits, and the OTS has less flexibility in determining how to resolve the problems of the institution. In addition, the OTS generally can downgrade an association's capital category, notwithstanding its capital level, if, after notice and opportunity for hearing, the association is deemed to be engaging in an unsafe or unsound practice because it has not corrected deficiencies that resulted in it receiving a less than satisfactory examination rating on matters other than capital or it is deemed to be in an unsafe or unsound condition. An undercapitalized association must submit a capital restoration plan to the OTS and is subject to increased monitoring and growth restrictions. Critically undercapitalized institutions must be placed in conservatorship or receivership within 90 days of reaching that capitalization level, except under limited circumstances. First Federal's capital at December 31, 2001, meets the standards for a well-capitalized institution, although its risk-based capital is just slightly over the threshold for well-capitalized status. The Leader has had a significant effect on First Federal's risk-based capital, due to the treatment under OTS regulations of mortgage servicing rights, which comprise a substantial amount of The Leaders' assets. For risk-based capital calculations, OTS regulations limit the amount of mortgage servicing rights that generally can be included in risk-based capital to the lesser of (i) the amount of First Federal's core capital, or (ii) 90% of the fair value of the servicing assets. As The Leader's mortgage servicing portfolio has grown at a faster rate than First Federal's core capital, First Federal's risk-based capital level has been adversely affected. The pending sale of The Leader will eliminate this issue related to the capital treatment of mortgage servicing rights and after the sale, First Federal should easily meet the threshold for well-capitalized status. 24 Federal law prohibits an insured institution from making a capital distribution to anyone or paying management fees to any person having control of the association if, after such distribution or payment, the association would be undercapitalized. In addition, each company controlling an undercapitalized association must guarantee that the association will comply with its capital plan until the association has been adequately capitalized on an average during each of four preceding calendar quarters and must provide adequate assurances of performance. The amount of such guarantee is limited to the lesser of (a) an amount equal to 5% of the association's total assets at the time the institution became undercapitalized or (b) the amount that is necessary to bring the association into compliance with all capital standards applicable to such association at the time the association fails to comply with its capital restoration plan. Limitations on Capital Distributions. The OTS imposes various restrictions or requirements on the ability of associations to make capital distributions. Capital distributions include, without limitation, payments of cash dividends, repurchases and certain other acquisitions by an association of its shares and payments to stockholders of another association in an acquisition of such other association. An application must be submitted and approval from the OTS must be obtained by a subsidiary of a savings and loan holding company (i) if the proposed distribution would cause total distributions for the calendar year to exceed net income for that year to date plus the savings association's retained net income for that year to date plus the retained net income for the preceding two years; (ii) if the savings association will not be at least adequately capitalized following the capital distribution; or (iii) if the proposed distribution would violate a prohibition contained in any applicable statute, regulation or agreement between the savings association and the OTS (or the FDIC), or a condition imposed on the savings association in an OTS-approved application or notice. If a savings association subsidiary of a holding company is not required to file an application, it must file a notice of the proposed capital distribution with the OTS. First Federal did not pay any dividends to First Defiance during 2001. 25 Qualified Thrift Lender Test. Savings associations must meet one of two tests in order to be a qualified thrift lender (QTL). The first test requires a savings association to maintain a specified level of investments in assets that are designated as qualifying thrift investments (QTIs). Generally, QTIs are assets related to domestic residential real estate and manufactured housing, although they also include credit card, student and small business loans and stock issued by any FHLB, the FHLMC or the FNMA. Under the QTL test, 65% of an institution's "portfolio assets" (total assets less goodwill and other intangibles, property used to conduct business and 20% of liquid assets) must consist of QTI on a monthly average basis in nine out of every 12 months. The second test permits a savings association to qualify as a QTL by meeting the definition of "domestic building and loan association" under the Internal Revenue Code of 1986, as amended (the "Code"). In order for an institution to meet the definition of a "domestic building and loan association" under the Code, at least 60% of its assets must consist of specified types of property, including cash, loans secured by residential real estate or deposits, educational loans and certain governmental obligations. The OTS may grant exceptions to the QTL tests under certain circumstances. If a savings association fails to meet either one of the QTL tests, the association and its holding company become subject to certain operating and regulatory restrictions. At December 31, 2001, First Federal met the QTL Test. Lending Limits. OTS regulations generally limit the aggregate amount that a savings association may lend to one borrower (the Lending Limit) to an amount equal to 15% of the savings association's total capital under the regulatory capital requirements plus any additional loan reserve not included in total capital (the Lending Limit Capital). A savings association may loan to one borrower an additional amount not to exceed 10% of total capital plus additional reserves if the additional loan amount is fully secured by certain forms of "readily marketable collateral." Real estate is not considered "readily marketable collateral." Certain types of loans are not subject to these limits. In applying these limits, loans to certain borrowers may be aggregated. Notwithstanding the specified limits, an association may lend to one borrower up to $500,000 "for any purpose." At December 31, 2001, First Federal had aggregate loans to its largest borrower which exceeded 10% of its total capital. At that date, First Federal had an agreement in place to participate a portion of this relationship to another financial institution. However that participation agreement was not funded until January 18, 2002. Transactions with Insiders and Affiliates. Loans to executive officers, directors and principal shareholders and their related interests must conform to the Lending Limit, and the total of such loans cannot exceed the association's Lending Limit Capital. Most loans to directors, executive officers and principal shareholders must be approved in advance by a majority of the "disinterested" members of board of directors of the association with any "interested" director not participating. All loans to directors, executive officers and principal shareholders must be made on terms substantially the same as offered in comparable transactions with the general public or as offered to all employees in a company-wide benefit program. Loans to executive officers are subject to additional restrictions. First Federal was in compliance with such restrictions at December 31, 2001. 26 All transactions between savings associations and their affiliates must comport with Sections 23A and 23B of the Federal Reserve Act (FRA). An affiliate of a savings association is any company or entity that controls, is controlled by or is under common control with the savings association. First Defiance is an affiliate of First Federal. Generally, Sections 23A and 23B of the FRA (i) limit the extent to which a savings association or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, (ii) limit the aggregate of all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus, and (iii) require that all such transactions be on terms substantially the same, or at least as favorable to the association, as those provided in transactions with a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and other similar types of transactions. In addition to the limits in Sections 23A and 23B, a savings association may not make any loan or other extension of credit to an affiliate unless the affiliate is engaged only in activities permissible for a bank holding company and may not purchase or invest in securities of any affiliate except shares of a subsidiary. First Federal was in compliance with these requirements and restrictions at December 31, 2001. Federal Deposit Insurance Corporation Regulations. The FDIC has examination authority over all insured depository institutions, including First Federal, and has authority to initiate enforcement actions if the FDIC does not believe the OTS has taken appropriate action to safeguard safety and soundness and the deposit insurance fund. The FDIC administers two separate insurance funds, the Bank Insurance Fund (BIF) for commercial banks and state savings banks and the Savings Association Insurance Fund (SAIF) for savings associations. The FDIC is required to maintain designated levels of reserves in each fund. The FDIC may increase assessment rates for either fund if necessary to restore the fund's ratio of reserves to insured deposits to its target level within a reasonable time and may decrease such rates if such target level has been met. The FDIC has established a risk-based assessment system for both SAIF and BIF members. Under this system, assessments vary based on the risk the institution poses to its deposit insurance fund. The risk level is determined based on the institution's capital level and the FDIC's level of supervisory concern about the institution. FRB Reserve Requirements. FRB regulations currently require reserves of 3% of net transaction accounts (primarily NOW accounts) up to $42.8 million (subject to an exemption of up to $5.5 million), and of 10% of net transaction accounts in excess of $42.8 million. At December 31, 2001, First Federal was in compliance with its reserve requirements. 27 Holding Company Regulation. First Defiance is a unitary thrift holding company and is subject to OTS regulations, examination, supervision and reporting requirements. There are generally no restrictions on the activities of unitary thrift holding companies. The broad latitude to engage in activities under current law can be restricted if the OTS determines that there is reasonable cause to believe that the continuation of an activity by a thrift holding company constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings association. The OTS may impose such restrictions as deemed necessary to address such risk, including limiting (i) payment of dividends by the savings association, (ii) transactions between the savings association and its affiliates, and (iii) any activities of the savings association that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings association. Notwithstanding the foregoing rules as to permissible business activities of a unitary thrift holding company, if the savings association subsidiary of a holding company fails to meet the QTL Test, then its unitary holding company would become subject to the activities restrictions applicable to multiple holding companies. At December 31, 2001, First Federal met the QTL Test. Federal law generally prohibits a thrift holding company from controlling any other savings association or thrift holding company, without prior approval of the OTS, or from acquiring or retaining more than 5% of the voting shares of a savings association or holding company thereof, which is not a subsidiary. If First Defiance were to acquire control of another savings institution, other than through a merger or other business combination with First Federal, First Defiance would become a multiple thrift holding company and its activities would thereafter be limited generally to those activities authorized by the FRB as permissible for bank holding companies. 28 TAXATION Federal Taxation The Company and its subsidiaries are each subject to the federal tax laws and regulations which apply to corporations generally. Prior to 1996, certain thrift institutions, including First Federal, were allowed deductions for bad debts under methods more favorable than those granted to other taxpayers. Qualified thrift institutions could compute deductions for bad debts using either the specific charge off method of Section 166 of the Code, or the reserve method of Section 593 of the Code under which a thrift institution annually could elect to deduct bad debts under either (i) the "percentage of taxable income" method applicable only to thrift institutions, or (ii) the "experience" method that also was available to small banks. Under the "percentage of taxable income" method, a thrift institution generally was allowed a deduction for an addition to its bad debt reserve equal to 8% of its taxable income (determined without regard to this deduction and with additional adjustments). Under the experience method, a thrift institution was generally allowed a deduction for an addition to its bad debt reserve equal to the greater of (i) an amount based on its actual average experience for losses in the current and five preceding taxable years, or (ii) an amount necessary to restore the reserve to its balance as of the close of the base year. A thrift institution could elect annually to compute its allowable addition to bad debt reserves for qualifying loans either under the experience method or the percentage of taxable income method. For tax year 1995, First Federal used the percentage of taxable income method. Effective for taxable years beginning after 1995, thrift institutions that would be treated as small banks are allowed to utilize the experience method applicable to such institutions, but thrift institutions that are treated as large banks are required to use only the specific charge off method. First for purposes of this method, First Federal was treated as a large bank. The percentage of taxable income method of accounting for bad debts is no longer available for any financial institution. A thrift institution required to change its method of computing reserves for bad debt treated such change as a change in the method of accounting, initiated by the taxpayer, and having been made with the consent of the Secretary of the Treasury. Any adjustment under Section 481(a) of the Code required to be recaptured with respect to such change generally will be determined solely with respect to the "applicable excess reserves" of the taxpayer. First Defiance's applicable excess reserves are taken into income for Federal tax purposes ratably over a six-taxable year period, beginning with the first taxable year beginning after 1997. In addition to the regular income tax, the Company and its subsidiaries are subject to the alternative minimum tax, which is imposed at a minimum tax rate of 20% on "alternative minimum taxable income" (which is the sum of a corporation's regular taxable income, with certain adjustments, and tax preference items), less any available exemption. Such tax preference items include interest on certain tax-exempt bonds issued after August 7, 1986. In addition, 75% of the amount by which a corporation's "adjusted current earnings" exceeds its alternative minimum taxable income computed without regard to this preference item and prior to reduction by net operating losses, is included in alternative minimum taxable income. Net operating losses can offset no more than 90% 29 of alternative minimum taxable income. The alternative minimum tax is imposed to the extent it exceeds the corporation's regular income tax. Payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. The balance of the pre-1988 reserves is subject to the provisions of Section 593(e) as modified by the Small Business Job Protection Act which requires recapture in the case of certain excessive distributions to shareholders. The pre-1988 reserves may not be utilized for payment of cash dividends or other distributions to a shareholder (including distributions in dissolution or liquidation) or for any other purpose (except to absorb bad debt losses). Distribution of a cash dividend by a thrift institution to a shareholder is treated as made: first, out of the institution's post-1951 accumulated earnings and profits; second, out of the pre-1988 reserves; and third, out of such other accounts as may be proper. To the extent a distribution by First Federal to the Company is deemed paid out of its pre-1988 reserves under these rules, the pre-1988 reserves would be reduced and First Federal's gross income for tax purposes would be increased by the amount which, when reduced by the income tax, if any, attributable to the inclusion of such amount in its gross income, equals the amount deemed paid out of the pre-1988 reserves. As of December 31, 2001, First Federal's pre-1988 reserves for tax purposes totaled approximately $9.52 million. The tax returns of First Defiance have been audited or closed without audit through the tax year ended December 31, 1997. The tax returns for The Leader have been closed through their tax year ended September 30, 1997. In the opinion of management, any examination of open returns would not result in a deficiency which would have a material adverse effect on the financial condition of First Defiance. Ohio Taxation The Company is subject to the Ohio corporation franchise tax, which, as applied to the Company, is a tax measured by both net earnings and net worth. The rate of tax is the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable income and 8.5% of computed Ohio taxable income in excess of $50,000 or (ii) 0.4% times taxable net worth. As a holding company, the Company may be entitled to various deductions in computing taxable net worth that are not generally available to operating companies. Effective for the 1999 tax year, a corporation that qualifies as a "qualifying holding company" is exempt from tax on the net worth basis. To be considered a qualifying holding company, a corporation must satisfy certain criteria and must make an annual election to be treated as a qualified holding company for tax purposes. Generally, to qualify as a qualifying holding company, a large portion of a corporation's assets and income must be attributable to holdings in other corporations or business organizations. A special litter tax is also applicable to all corporations, including the Company, subject to the Ohio corporation franchise tax other than "financial institutions." If the franchise tax is paid on the net income basis, the litter tax is equal to .11% of the first $50,000 of computed Ohio taxable income and .22% of computed Ohio taxable income in excess of $50,000. If the franchise tax is paid on the net worth basis, the litter tax is equal to .014% times taxable net worth. 30 First Federal is a "financial institution" for State of Ohio tax purposes. As such, it is subject to the Ohio corporate franchise tax on "financial institutions," which is imposed annually at a rate of 1.5% of First Federal's book net worth determined in accordance with GAAP. Effective for the 2001 tax year, the tax rate is 1.3% of book net worth. As a "financial institution," First Federal is not subject to any tax based upon net income or net profits imposed by the State of Ohio. On December 31, 1998, The Leader was converted to a single-member limited liability corporation. As such, its operations are not subject to state taxation as a separate entity. Item 2. Properties At December 31, 2001, First Federal conducted its business from its main office at 601 Clinton Street, Defiance, Ohio, and thirteen other full service branches in northwestern Ohio. At December 31, 2001, The Leader conducted its business from leased office space at 1015 Euclid Avenue, Cleveland, Ohio, and through a branch location at 709 Brookpark Rd., Brooklyn Heights, OH. First Insurance conducted its business from leased office space at 419 5th Street, Suite 1200, Defiance, Ohio. First Defiance maintains its headquarters in the main office of First Federal at 601 Clinton Street, Defiance, Ohio. 31 The following table sets forth certain information with respect to the office and other properties of the Company at December 31, 2001. See Note 9 to the Consolidated Financial Statements. Leased/ Net Book Value Description/address Owned of Property Deposits -------------------------------------------------------------------------------- (Dollars in Thousands) Main Office, First Federal 601 Clinton Street, Defiance, OH Owned $ 6,086 $ 288,637 Branch Offices, First Federal 204 E. High Street, Bryan, OH Owned 1,100 90,995 211 S. Fulton Street, Wauseon, OH Owned 782 40,001 625 Scott Street, Napoleon, OH Owned 1,583 68,689 1050 East Main Street, Montpelier, OH Owned 586 20,086 926 East High Street, Bryan, OH Owned 111 8,106 1333 Woodlawn, Napoleon, OH Owned 74 16,795 825 N. Clinton Street, Defiance, OH Owned 391 10,351 Inside Super K-Mart Leased 83 6,353 190 Stadium Dr., Defiance, OH 905 N. Williams St., Paulding, OH Owned 1,090 17,295 201 E. High St., Hicksville, OH Owned 577 10,166 3900 N. Main St., Findlay, OH Owned 1,433 25,834 11694 N. Countyline St., Fostoria, OH Owned 913 12,734 1204 W. Wooster, Bowling Green, OH Leased -- 15,408 Main Office, The Leader 1015 Euclid Avenue, Cleveland, OH Leased -- N/A Branch Office, The Leader 709 Brookpark Rd., Brooklyn Heights, OH Leased -- N/A First Insurance & Investments 419 5th Street, Site 1200, Defiance, OH Leased -- N/A --------------------------- $ 14,809 $ 631,450 ========================== 32 Item 3. Legal Proceedings First Defiance is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of First Defiance. Item 4. Submission of Matters to a Vote of Securities Holders No matters were submitted to a vote of securities holders during the fourth quarter of 2001. PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters The Company's common stock trades on The Nasdaq Stock Market under the symbol "FDEF." As of March 8, 2001, the Company had 1,740 shareholders of record. The table below shows the reported high and low sales prices of the common stock and cash dividends declared per share of common stock during the periods indicated in 2001 and 2000.
December 31, 2001 December 31, 2000 ---------------------------------------------- ---------------------------------------------- High Low Dividend High Low Dividend --------------- --------------- -------------- --------------- --------------- -------------- Quarter Ended: March 31 $ 15.63 $ 10.69 $ .12 $ 12.50 $ 8.00 $ .11 June 30 17.20 13.50 .12 9.38 7.63 .11 September 30 18.00 13.28 .12 9.63 8.00 .11 December 31 15.24 12.79 .13 11.12 8.38 .12
For information regarding restriction on the payment of dividends, see "Item 1. Business - Regulation - Limitations on Capital Distributions" in this report. 33 Item 6. Selected Financial Data The following table sets forth certain summary consolidated financial data at or for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and notes thereto included herein. See "Item 8. Financial Statements and Supplementary Data."
At or For Years ended December 31, ----------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ----------------------------------------------------------------------------- (Dollars in Thousands, except per share data) Selected Consolidated Financial Data: Total assets $1,132,613 $1,072,194 $ 987,994 $ 785,399 $ 579,698 Loans held-to maturity, net 517,829 541,208 465,321 448,574 441,824 Loans held-for-sale 275,723 232,314 237,622 119,910 88 Allowance for loan losses 9,937 8,904 7,758 9,789 2,686 Non-performing assets 3,590 1,761 3,587 3,369 1,906 Securities available-for-sale 48,989 53,176 53,946 47,554 82,536 Trading securities - 234 29,805 - - Securities held-to maturity 5,580 7,697 9,895 13,541 20,953 Mortgage servicing rights 157,369 134,760 97,519 76,452 188 Deposits and borrowers' escrow balances 754,604 613,881 564,511 511,313 395,983 FHLB advances 196,302 223,258 265,410 168,142 71,665 Stockholders' equity 111,021 99,473 89,416 93,710 106,884 Selected Consolidated Operating Results: Total interest income $ 65,864 $ 65,185 $ 53,379 $ 49,056 $ 43,858 Total interest expense 38,886 43,502 31,582 26,946 21,387 Net interest income 26,978 21,683 21,797 22,110 22,471 Provision for loan losses 3,870 3,147 1,925 7,769 1,613 Non-interest income 66,431 53,246 40,794 17,528 1,627 Non-interest expense 68,340 54,905 47,414 26,940 14,093 Income before income taxes 21,199 16,877 13,252 4,929 8,392 Income taxes 7,583 5,914 4,629 1,818 2,985 Net income 13,616 10,963 8,623 3,111 5,407 Basic earnings per share 2.11 1.74 1.33 0.42 0.65 Diluted earnings per share 2.05 1.71 1.29 0.40 0.62 Selected Financial Ratios and Other Data: Performance Ratios: Return on average assets 1.24% 1.09% 0.99% 0.45% 0.78% Return on average equity 13.08% 11.71% 9.52% 2.99% 4.69% Interest rate spread (1) 3.10% 2.72% 2.86% 3.25% 3.39% Net interest margin (1) 3.27% 2.80% 3.12% 3.62% 4.24% Ratio of operating expense to Average total assets 6.22% 5.44% 5.44% 3.85% 2.51%
34
At or for Years ended December 31, -------------------------------------------------------------------------------- 2001 2000 1999 1998 1997 -------------------------------------------------------------------------------- (Dollars in Thousands, except per share data) Selected Financial Ratios and Other Data (continued): Quality Ratios: Non-performing assets to total assets at end of period (2) 0.32% 0.16% 0.36% 0.43% 0.33% Allowance for loan losses to non-performing assets (2) 276.80% 505.62% 216.28% 209.56% 140.92% Allowance for loan losses to total loans receivable 1.25% 1.14% 1.09% 1.69% 0.60% Capital Ratios: Equity to total assets at end of 9.80% 9.28% 9.05% 11.93% 18.44% period Tangible equity to tangible assets at end of period 8.74% 8.08% 7.68% 10.41% 18.44% Average equity to average assets 9.47% 9.27% 10.40% 14.86% 20.55% Book value per share 16.20 $14.49 $13.12 $12.37 $12.53 Tangible book value per share 14.27 $12.46 $10.97 $10.61 $12.53 Ratio of average interest-earning assets to average interest-bearing liabilities 103.73% 101.48% 105.96% 108.43% 121.45% Cash Earnings: Cash earnings $ 14,449 $ 11,786 $ 9,382 $ 3,393 $ 5,407 Basic cash earnings per share 2.24 1.87 1.44 0.45 0.65 Diluted cash earnings per share 2.17 1.84 1.40 0.43 0.62 Cash return on average assets 1.31% 1.18% 1.09% 0.49% 0.96% Cash return on average equity 13.88% 14.87% 11.99% 3.44% 4.69% Stock Price and Dividend Information: High $18.00 $12.50 $14.50 $ 15.875 $16.25 Low 10.69 7.63 9.875 11.00 11.75 Close 15.20 10.88 10.50 14.25 16.00 Cash dividends declared per share .49 .45 0.41 0.37 0.33 Dividend payout ratio (3) 23.22% 25.86% 30.83% 88.10% 50.77%
(1) Interest rate spread represents the difference between the weighted average yield on interest-earnings assets and the weighted average rate on interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-earnings assets. (2) Non-performing assets consist of non-accrual loans that are contractually past due 90 days or more; loans that are deemed impaired under the criteria of FASB Statement No. 114; and real estate, mobile homes and other assets acquired by foreclosure or deed-in-lieu thereof. (3) Dividends payout ratio was calculated using basic earnings per share. 35 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations First Defiance is a unitary thrift holding company which conducts business through its subsidiaries, First Federal, First Insurance and The Leader. First Federal is a federally chartered savings bank that provides financial services to communities based in northwest Ohio where it operates 14 full service branches. First Federal provides a broad range of financial services including checking accounts, 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 investment representatives located at two First Federal branch locations. The Leader is a mortgage banking company that specializes in servicing loans originated under first-time homebuyer programs. Under these programs, first-time homebuyers are able to obtain loans at rates generally below market at the time of closing. The funds for the loans are available as a result of bond issues through various state and local governmental units. The Leader, as master servicer under the bond programs, purchases the loans from the originator, principally other financial institutions or mortgage brokers. Once purchased by The Leader, the loans under the specific bond programs are packaged and GNMA securities are issued to the bond trustees under the programs. As of December 31, 2001, The Leader serviced approximately 104,000 bond program loans with balances of $7.4 billion. Because the loans under the first-time homebuyer programs are generally issued at below market rates, they typically have significantly lower pre-payment rates than conventional mortgage loans. The Leader also collects a significant amount of ancillary fees, including late charges. At December 31, 2001, total loans serviced by The Leader, including bond program loans, conventional loans and loans serviced for various third parties, consisted of 140,600 loans with a total balance of $9.2 billion. On January 18, 2002, First Defiance announced that it had signed a definitive agreement to sell The Leader to U.S. Bank Home Mortgage, a unit of U.S. Bank. 36 Financial Condition Total assets at December 31, 2001 were $1.133 billion, a 5.6% increase from the December 31, 2000 total of $1.072 billion. Net loans receivable (excluding loans held for sale) declined by $23.4 million and investment securities declined by $6.5 million. Those decreases were offset by increases in cash and cash equivalents, which rose by $15.2 million, loans held for sale, which increased by $43.4 million, and mortgage servicing rights, which increased by $22.6 million. The reduction in loans receivable occurred primarily in the single-family residential category, which declined by $65.4 million. This reduction was due to the high level of mortgage loan refinancings that occurred in 2001 due to the low interest rate environment. The majority of loans refinanced were then sold into the secondary market to limit the Company's exposure to interest rate risk on long-term fixed rate loans. Approximately 91% of new first-mortgage loans made by First Federal in 2001 were sold into the secondary market. Automobile loans also declined in 2001, by $10.3 million to $33.3 million, continuing a trend that began in 1999 when the Company implemented more stringent underwriting guidelines for that type of lending. These declines were partially offset by increases in loans secured by non-residential real estate (which increased $27.0 million to $152.5 million), loans secured by multi-family residential property (which increased $21.6 million to $66.3 million), home equity and improvement loans (which increased $4.3 million to $36.2 million) and commercial loans (which increased $2.6 million to $83.7 million). Loans available for sale and mortgage servicing rights, two assets primarily associated with The Leader, both increased significantly at December 31, 2001 compared to December 31, 2000. Loans available for sale increased to $275.7 million at December 31, 2001 from $232.3 million. The increase was primarily due to the Company's strategy to hold certain higher interest loans in the warehouse for extended periods to take advantage of the favorable interest rate spread. Mortgage servicing rights increased to $157.4 million at December 31, 2001 from $134.8 million at December 31, 2000. This growth is a function of continued loan production at The Leader throughout 2001. The 2001 balance is net of a $2.8 million impairment reserve. There was no impairment reserve recorded as of December 31, 2000. The Company's deposits increased by $85.6 million or 15.7% from $545.9 million at December 31, 2000 to $631.5 million at December 31, 2001. This growth was realized in checking accounts (which increased $12.9 million or 19.5%), money market accounts (which increased $33.9 million or 42.9%) and certificates of deposit (which increased $39.4 million or 10.8%). Of these deposit balances, $144.6 million were associated with The Leader at December 31, 2001 compared to $88.6 million at the end of 2000. The certificate of deposit balances include approximately $87.0 million of brokered CDs at December 31, 2001, up from $57.5 million at December 31, 2000. First Defiance also realized a significant increase in advance payments by borrowers for principle, interest, taxes and insurance, which increased from $68.0 million 37 at December 31, 2000 to $123.2 million at December 31, 2001. This balance increased due to the increased level of payoffs that were experienced in the mortgage banking operations. The Company has the right to hold those payoffs for up to 45 days before they must be remitted to the investors. As a result of the increases in deposits and advance payment accounts, First Defiance was able to reduce its FHLB advances by $27.0 million to $196.3 million at December 31, 2001 from $223.3 million at December 31, 2000 and its warehouse and term note borrowings by $65.8 million to $54.6 million at December 31, 2001 from $120.4 million at December 31, 2000. Changes in the above balances, and the inability to further pay down fixed rate FHLB advances, resulted in a higher than normal cash and cash equivalent balance at December 31, 2001 of $36.1 million compared to $21.0 million at December 31, 2000. Paydowns and maturities of investment securities which were not reinvested because funds were deployed elsewhere resulted in the investment portfolio declining to $54.6 million at December 31, 2001 from $61.1 million at the end of 2000. 38 Average Balances, Interest Rates and Yields The following table presents for the periods indicated the total dollar amounts 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 dollars and rates, and the net interest margin. The table does not reflect the effect of income taxes.
Year Ended December 31, ------------------------------------------------------------------------------------- 2001 2000 ------------------------------------------ ----------------------------------------- Average Yield/ Average Yield/ Balance Interest Rate (1) Balance Interest Rate --------------- ------------- ------------- ------------- ------------ ------------- Interest-Earning Assets (Dollars in thousands) Loans receivable $ 783,266 $ 62,109 7.93% $ 730,264 $ 60,382 8.27% Securities 58,118 3,755 6.46 67,868 4,803 7.08 Dividends on FHLB stock 15,669 1,058 6.75 14,570 1,075 7.38 --------------- ------------- ------------- ------------- ------------ ------------- Total interest-earning assets 857,053 66,922 7.81 812,702 66,260 8.15 Non-interest-earning assets 241,986 196,589 --------------- ------------- Total assets $1,099,039 $1,009,291 =============== ============= Interest-Bearing Liabilities Interest-bearing deposits 550,661 $ 25,120 4.56 503,829 $ 25,501 4.82 FHLB advances 227,387 11,393 5.01 228,055 13,297 5.83 Warehouse and term notes payable 48,210 2,373 4.92 68,993 4,704 6.82 --------------- ------------- ------------- ------------- ------------ ------------- Total interest-bearing liabilities 826,258 38,886 4.71 800,877 43,502 5.43 Non-interest bearing demand deposits $ 37,597 -- $ 25,376 -- --------------- ------------- ------------- ------------ Total including non-interest-bearing demand deposits 863,855 38,886 4.50 826,253 43,502 5.26 Other non-interest-bearing liabilities 131,082 89,418 --------------- ------------- Total liabilities 994,937 915,671 Stockholders' equity 104,102 93,620 --------------- ------------- Total liabilities and stockholders' equity $ 1,099,039 $1,009,291 =============== ============= Net interest income; interest rate spread (2) $ 28,036 3.10% $ 22,758 2.72% ============= ============= ============ ============= Net interest margin (3) 3.27% 2.80% ============= ============= Average interest-earning assets to average interest-bearing liabilities 103.7% 101.5% ============= =============
Year Ended December 31, ------------------------------------------ 1999 ------------------------------------------ Average Yield/ Balance Interest Rate -------------- ------------- ------------- Interest-Earning Assets Loans receivable $657,009 $49,927 7.60% Securities 56,668 3,452 6.09 Dividends on FHLB stock 12,157 861 7.08 -------------- ------------- ------------- Total interest-earning assets 725,834 54,240 7.47 Non-interest-earning assets 145,667 -------------- Total assets $871,501 ============== Interest-Bearing Liabilities Interest-bearing deposits 459,748 $19,889 4.21 FHLB advances 195,566 9,872 5.05 Warehouse and term notes payable 29,721 1,821 6.13 -------------- ------------- ------------- Total interest-bearing liabilities 685,035 31,582 4.61 Non-interest bearing demand deposits $ 13,156 -- -------------- ------------- Total including non-interest-bearing demand deposits 698,191 31,582 4.52 Other non-interest-bearing liabilities 82,691 -------------- Total liabilities 780,882 Stockholders' equity 90,619 -------------- Total liabilities and stockholders' equity $871,501 ============== Net interest income; interest rate spread (2) $22,658 2.86% ============= ============= Net interest margin (3) 3.12% ============= Average interest-earning assets to average interest-bearing liabilities 106.0% =============
(1) At December 31, 2001, the yields earned and rates paid were as follows: loans receivable, 7.18%; securities, 6.37%; FHLB stock, 5.50%; total interest-earning assets, 7.10%; deposits, 3.28%; FHLB advances, 4.60%; warehouse and term notes payable, 2.80%; total interest-bearing liabilities, 3.60%; and interest rate spread, 3.50%. (2) Interest rate spread is the difference in the yield on interest-earning assets and the cost of interest bearing liabilities. (3) Net interest margin is net interest income divided by average interest-earning assets. 39 Rate/Volume Analysis The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected First Defiance's interest income and expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) change in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume.
Year Ended December 31, -------------------------------------------------------------------------------------- 2001 vs. 2000 2000 vs. 1999 -------------------------------------------------------------------------------------- Increase Increase Increase Increase (decrease) (decrease) Total (decrease) (decrease) Total due to due to increase due to due to increase rate volume (decrease) rate volume (decrease) -------------------------------------------------------------------------------------- (In thousands) Interest-Earning Assets Loans $ (2,656) $ 4,383 $ 1,727 $ 4,888 $ 5,567 $ 10,455 Securities (358) (690) (1,048) 669 682 1,351 Interest-bearing deposits - - - - - - FHLB stock (98) 81 (17) 43 171 214 -------------------------------------------------------------------------------------- Total interest-earning assets $ (3,112) $ 3,774 $ 662 $ 5,600 $ 6,420 $ 12,020 ====================================================================================== Interest-Bearing Liabilities Deposits $ (2,758) $ 2,377 $ (381) $ 3,244 $ 2,368 $ 5,612 FHLB advances (1,865) (39) (1,904) 1,785 1,640 3,425 Warehouse and term notes payable (914) (1,417) (2,331) 477 2,406 2,883 -------------------------------------------------------------------------------------- Total interest-bearing liabilities $ (5,537) $ 921 $ (4,616) $ 5,506 $ 6,414 $ 11,920 ====================================================================================== Increase in net interest income $ 5,278 $ 100 ================ ===============
------------------------------------------- 1999 vs. 1998 ------------------------------------------- Increase Increase (decrease) (decrease) Total due to due to increase rate volume (decrease) ------------------------------------------- Interest-Earning Assets Loans $ (4,662) $ 11,220 $ 6,558 Securities (89) (1,541) (1,630) Interest-bearing deposits - (605) (605) FHLB stock (9) 536 527 ------------------------------------------- Total interest-earning assets $ (4,760) $ (9,610) $ 4,850 =========================================== Interest-Bearing Liabilities Deposits $ (1,303) $ 2,852 $ 1,549 FHLB advances (995) 6,696 5,701 Warehouse and term notes payable 317 (2,931) (2,614) ------------------------------------------- Total interest-bearing liabilities $ (1,981) $ 6,617 $ 4,636 =========================================== Increase in net interest income $ 214 ===============
40 Results of Operations General - First Defiance reported net income of $13.62 million for the year ended December 31, 2001 compared to $10.96 million and $8.62 million for the years ended December 31, 2000 and 1999 respectively. On a diluted per share basis, First Defiance earned $2.05, $1.71 and $1.29 for the years ended December 31, 2001, 2000 and 1999 respectively. Net interest income was $27.0 million for the year ended December 31, 2001, compared to $21.7 million and $21.8 million for the years ended December 31, 2000 and 1999 respectively. Net interest margin was 3.27%, 2.80% and 3.12% for the years ended December 31, 2001, 2000 and 1999 respectively. The increase in net interest margin in 2001 over 2000 is due primarily to an increase in the interest rate spread from 2.72% for the year ended December 31, 2000 to 3.10% for 2001, and increases of $12.2 million, $41.7 million and $10.5 million in average non-interest bearing deposits, average other non-interest bearing liabilities, and average shareholders equity respectively. The decrease in margins that were experienced in 2000 compared to 1999 were due primarily to the financing required to support the $50.9 million increase in average non-interest earning assets between 1999 and 2000. That increase was primarily the result of increases in mortgage servicing rights and prepaid expenses and other assets. The cost of interest bearing liabilities dropped 72 basis points in 2001 compared to 2000 while the yield on interest earning assets fell 34 basis points between those same periods, resulting in the 38 basis point spread improvement. The cost of average interest bearing liabilities declined to 4.71% for 2001 compared 5.43% in 2000 while the yields on interest earning assets declined to 7.81% in 2001 from 8.15% in 2000. The decline in rates for both assets and liabilities was due to falling market rates throughout 2001 spurred by the Federal Reserve's 11 cuts to the Federal Funds rate. Liability rates fell more than asset rates primarily due to the improved mix of both interest earning assets and interest bearing liabilities. On the asset side, loans receivable balances increased while lower-yielding investment securities balances declined. On the liability side, non-interest bearing deposits and money market balances increased at a greater pace than certificates of deposit while FHLB advances remained flat and outside borrowings declined. In 2000 compared to 1999, the yield on interest earning assets increased to 8.15% from 7.47% while the cost of interest-bearing liabilities increased to 5.43% from 4.61%. Asset yields increased in 2000 because of increased balances in non-residential real estate and commercial loans as well as general interest rate increases. The increase in the cost of funds was the result of several increases in the targeted Federal Funds rate as well as increased usage of external funding sources to finance the growth in mortgage banking activities. The provision for loan losses for the year ended December 31, 2001 was $3.9 million compared to $3.1 million in 2000 and $1.9 million for 1999. The provision was comprised of $1.0 million for credit losses and $2.9 million to cover the cost of servicing foreclosed properties in 2001 compared to $499,000 and $2.6 million in credit and foreclosure costs in 2000 respectively and $155,000 and $1.8 million in credit and foreclosure costs respectively in 1999. 41 For the year ended December 31, 2001, non-interest income was $66.4 million compared to $53.2 million for 2000 and $40.8 million for 1999. Non-interest expense for the year ended December 31, 2001 was $68.3 million compared to $54.9 million for 2000 and $47.4 million for 1999. See also the "Results Reflecting The Sale of The Leader Mortgage Company" section of Management's Discussion and Analysis of Financial Condition and Results of Operations. Net Interest Income - First Defiance's net interest income is determined by its interest rate spread (i.e. the difference between the yields on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities. Total interest income increased by only $679,000, or 1.0%, to $65.9 million for the year ended December 31, 2001 from $65.2 million for the year ended December 31, 2000. Average loans receivable increased to $783.3 million for 2001 from $730.3 million for 2000 while average investment securities declined to $58.1 million for 2001 from $67.9 million. Although the average balance of total interest-earning assets including FHLB stock increased by $44.4 million in 2001 compared to 2000, the yield on those total assets fell to 7.81% in 2001 from 8.15% in 2000. The average balance of loans held for sale increased to $243.1 million for 2001 compared to $219.6 million for 2000 while the average balance of non-residential real estate and commercial loans grew to $275.2 million for 2001 from $208.9 million for 2000. Also the average balance of home equity and improvement loans grew by $6.8 million from December 31, 2000 to December 31, 2001. This growth was partially offset by a $30.0 million decrease in the average balance of single-family residential loans and a $13.4 million decrease in the average balance of all consumer loans. The increase in the average balance of non-residential real estate and commercial loans is the result of the Company's strategy to increase this type of lending. Residential mortgage loans declined because falling interest rates caused a high level of refinanced loans, most of which were subsequently sold into the secondary market. The decline in consumer loans continues a trend that started in 1999 when the Company tightened underwriting standards. The increase in the average balance of available for sale loans is the result of The Leader retaining certain loans which had higher interest rates than the typical housing finance agency loans that generally occupy its warehouse. With the anticipated sale of The Leader in 2002, the available for sale balances will decline substantially while the balance of investment securities will increase significantly. In 2000, total interest income increased by $11.8 million, or 22.1%, to $65.2 million for the year ended December 31, 2000 from $53.4 million for the year ended December 31, 1999. The increase was due to a $73.3 million increase in the average balance of loans outstanding for 2000 compared to 1999 and an increase in yield to 8.27% for 2000 from 7.60% for 1999. The increase in balances were in non-residential real estate and commercial loans, which increased in total by $66.8 million, and loans held for sale, which increased by $32.8 million, offset by declines in residential mortgage and consumer loans. 42 Interest earnings from the investment portfolio and other interest-bearing deposits decreased to $3.8 million for 2001 from $4.8 million for 2000 as the average balances declined to $58.1 million for 2001 from $67.9 million for 2000. The yield on those investments declined 62 basis points during that period to 6.46% for 2001 from 7.08% for 2000. In 1999, interest earnings from the investment portfolio totaled $3.5 million as the average balance of $56.7 million earned an average yield of 6.09%. Because of the loan demand and the financing requirements of The Leader, the investment portfolio has been used primarily as a source of liquidity during the last three years. It is anticipated that when the sale of The Leader is completed, the investment portfolio will increase significantly. Interest expense decreased by $4.6 million, or 10.6%, to $38.9 million in 2001 compared to $43.5 million in 2000. The decrease is due to a decline in the cost of total interest bearing liabilities to 4.71% for 2001 from 5.43% for 2000. The cost of interest bearing deposits dropped 26 basis points, to 4.56% in 2001 from 4.82% in 2000; the cost of FHLB advances dropped 82 basis points, to 5.01% from 5.83%; and the cost of warehouse and other notes payable dropped 190 basis points, to 4.92% from 6.82%. The Company also experienced $12.2 million or 48.2% growth in its non-interest bearing deposit balances. Interest-bearing deposit balances increased by $46.8 million in 2001 compared to 2000 with much of the growth coming in the Company's money market product. The average balance of FHLB advances remained relatively stable between 2001 and 2000 while the average balance of warehouse and other term notes payable declined by $20.8 million. In 2000, interest expense increased by $11.9 million, or 37.7%, to $43.5 million compared to $31.6 million for 1999. The increase is due to the increase in the average interest bearing liabilities to $800.9 million in 2000 from $685.0 million in 1999. Additionally, the average cost of funds on interest-bearing liabilities increased to 5.43% during 2000 from 4.61% during 1999. The increased balances were due to increased funding requirements relating to loans held for sale and mortgage servicing rights at The Leader and increased loan growth at First Federal while the increased cost of funds is due to higher rates in 2000 resulting from several Federal Reserve increases in the targeted Federal Funds rate during 2000 as well as increased usage of outside financing sources to finance The Leader's mortgage banking activities. All warehouse and other notes payable will be paid off at the completion of The Leader sale transaction in 2002. To the extent possible, certain FHLB advances and brokered certificates of deposits will be repaid or not replaced as they mature. As a result of the foregoing, First Defiance's net interest income was $27.0 million for the year ended December 31, 2001 compared to $21.7 million for the year ended December 31, 2000 and $21.8 million for the year ended December 31, 1999. Net interest margin for the year ended December 31, 2001 increased to 3.27% from 2.80% for 2000 and 3.12% for 1999. Provision for Loan Losses - First Defiance's provision for loan losses was $3.9 million for the year ended December 31, 2001 compared to $3.1 million and $1.9 million for the years ended December 31, 2000 and 1999 respectively. The provision for loan losses is comprised of a provision for credit losses, which accounts for losses on First Federal's loan portfolio, and a 43 provision for foreclosure losses, which accounts for expected administrative and legal charges necessary to take loans through the foreclosure process. Foreclosure losses are entirely associated with The Leader's mortgage servicing portfolio. The credit loss portion of the provision was $1.0 million, $635,000, and $155,000 respectively in 2001, 2000 and 1999 respectively while the foreclosure loss portion of the provision was $2.9 million, $2.5 million and $1.8 million respectively in those same three years. Provisions for credit losses are charged to earnings to bring the total allowance for credit losses to a level that is deemed appropriate by management. Factors considered by management include identifiable risk in the portfolios, historical experience, the volume and type of lending conducted by First Defiance, regulatory guidance, the amount of non-performing assets, including loans which meet the FASB Statement No. 114 definition of impaired, general economic conditions, particularly as they relate to First Defiance's market areas, and other factors related to the collectibility of First Defiance's loan portfolio. Continued growth in non-residential and commercial loans at First Federal, which have an inherently higher level of risk than other types of loans, and concerns about economic conditions in the northwest Ohio market area caused the provision for credit losses to increase in 2001 from 2000 and 1999 levels. The allowance for credit losses totaled $6.55 million at December 31, 2001 compared to $6.33 million at December 31, 2000 and $6.50 million at December 31, 1999. Total credit charge-offs for 2001 and 2000 were $1.0 million each year and $2.5 million in 1999 while recoveries for those same three years were $257,000, $222,000 and $279,000 respectively. The high level of charge-offs recorded in 1999 related to underwriting problems First Federal experienced with its consumer loan portfolio in 1997 and 1998. Those charge-offs were provided for in a large adjustment to the allowance for loan losses recorded by First Federal in 1998. First Defiance's non-performing assets at December 31, 2001 were $3.6 million compared to $1.8 million at December 31, 2000. These totals include real estate owned by The Leader of $1.1 million and $271,000 at the end of 2001 and 2000 respectively. The increase in real estate owned is primarily due to the slowing economy which tends to impact the borrowers in the programs in which The Leader specializes. First Federal's non-performing assets were $2.5 million at December 31, 2001 compared to $1.5 million at December 31, 2000. Non-performing assets include loans that are 90 days past due and all real estate owned and other foreclosed assets. Non-performing assets at First Federal at December 31, 2001 and 2000 by category were as follows: 44 December 31 2001 2000 --------------- ------------------ (In thousands) Non-performing loans: Single-family residential $1,151 $671 Non-residential and multi-family residential real estate 972 572 Commercial 110 140 Consumer finance 138 66 --------------- ------------------ Total non-performing loans $2,371 $1,449 Real estate owned and repossessed assets 136 41 --------------- ------------------ Total non-performing assets $2,507 $1,490 =============== ================== The $972,000 balance of non-performing non-residential and multi-family residential real estate loans represents a $400,000 or 70% increase from the 2000 level. Total non-residential and multi-family real estate loans increased by $48.6 million over that same period. Non-performing loans in the non-residential and multi-family residential real estate loan category represent .44% of the total loans in that category at December 31, 2001 compared to .34% at December 31, 2000. This increase is primarily due to one commercial loan that is more than 90 days past due and management believes the allowance for loan losses for this loan is adequate to cover any potential loss The increase in single-family non-performing loans, while significant, should not materially impact First Defiance's results. These non-performing loans are comprised of 23 single-family mortgage loans with an average balance of $50,000 outstanding at December 31, 2001. These loans are generally well-secured. Management believes the allowance for loan losses is adequate to cover any potential losses on these loans. During the year ended December 31, 2001, The Leader recorded a provision for foreclosure losses totaling $2.8 million compared to foreclosure provisions of $2.6 million and $1.8 million recorded in 2000 and 1999 respectively. In 2000, management changed its method of estimating the required reserve for potential losses on foreclosures to more accurately reflect the total risk inherent in the servicing and loan portfolios at The Leader. This resulted in a one-time increase in the provision for foreclosure losses of $693,000. Excluding the one-time adjustment in 2000, the provision for foreclosure losses increased $1.0 million between 2000 and 2001. This increase is a result of a growing portfolio and a weaker economy nationwide. The borrowers who participate in the first-time homebuyers tend to be among the first impacted by a weaker economy. Non-interest Income - Non-interest income increased by $13.2 million to $66.4 million in 2001 from $53.2 million in 2000 and $40.8 million in 1999. $56.2 million of the 2001 non-interest income was related to operations that are being sold as part of The Leader sale transaction. The Leader accounted for $46.5 million and $35.9 million of the non-interest income in 2000 and 1999, respectively. 45 Non-interest income, excluding The Leader, was $10.2 million in 2001 compared to $6.7 million in 2000 and $4.9 million in 1999. The 52.2% increase from 2000 to 2001 was primarily attributable to gains on sale of mortgage loans, which increased to approximately $3.1 million in 2001 from approximately $580,000 in 2000. The increase was the result of record mortgage originations through First Federal's branch networks caused by low mortgage interest rates throughout the year. Loan and deposit fees at First Federal increased to $3.2 million in 2001 from $2.3 million in 2000 and commission income at First Insurance increased to $2.8 million from $2.4 million. In 1999, gains on mortgage loan sales totaled $876,000 while loan and deposit fees were $1.7 million and insurance agency income was $1.2 million. The Leader's non-interest income increased each year between 1999 and 2001 because of continued growth in the mortgage servicing portfolio, which resulted in growth in mortgage servicing fees, and increases in gains on sale, a result of a significant increase in mortgage production in the first-time homebuyer programs between 1999 and 2001. Also, 2001 results included $2.5 million in gains from the sale of certain loans, which had a history of delinquency, out of the servicing portfolio to a third party. These transactions were accomplished by purchasing the loans out of the servicing portfolio at par as allowed under the servicing agreements and then selling the loans to a third party at a premium. Non-interest Expense - Total non-interest expense for 2001 was $68.3 million compared to $54.9 million for the year ended December 31, 2000 and $47.4 million for the year ended December 31, 1999. The 2001 total includes $46.0 million of costs associated with The Leader while the 2000 and 1999 totals include $34.7 million and $29.5 million of The Leader's costs respectively. Excluding expenses that relate to The Leader, non-interest expense was $22.9 million for 2001, $20.2 million for 2000 and $17.9 million for 1999. The $2.7 million increase from 2000 to 2001 was caused primarily by a $1.0 million increase in compensation and benefits, and a $1.0 million increase in amortization and impairment of mortgage servicing rights. Compensation and benefits increased approximately $325,000 because of pay raises, $100,000 because of increases in various forms of incentive compensation linked to the performance of the Company and $575,000 related to staffing increases, including a full year of staffing of the Bowling Green, Ohio branch that opened in the fall of 2000. Mortgage servicing rights amortization and impairment increased approximately $225,000 because of growth in the servicing portfolio and because approximately $775,000 of the $2.8 million of the impairment adjustment recorded by The Leader against its mortgage servicing portfolio related to servicing rights that will be retained by First Federal after the close of The Leader sale transaction. The $11.3 million increase in non-interest expense at The Leader between 2000 and 2001 was almost all related to the amortization and impairment of mortgage servicing rights. Amortization expense related to the mortgage servicing portfolio that will be part of The Leader sale increased to $23.0 million in 2001 from $14.7 million in 2000 because of both the increase in prepayments on the underlying loans in the mortgage servicing portfolio and the growth in the servicing portfolio itself. The Leader also recorded a total of $2.8 million of impairment reserves 46 during 2001 as the estimated fair value of certain portions of The Leader's servicing portfolio was determined to be less than its book value. As noted above, $772,000 of the $2.8 million of impairment relates to the relatively small component of the mortgage servicing portfolio that will be retained by First Federal. Other components of non-interest expense at The Leader changed only slightly between 2000 and 2001. The Leader experienced a $1.5 million increase in its compensation and benefits expense between 1999 and 2000 and the amortization of mortgage servicing rights also increased by approximately $2.2 million between those two periods. Income Taxes - Income tax amounted to $7.6 million in 2001 compared to $5.9 million in 2000 and $4.6 million in 1999. The effective rates for those three years were 35.8%, 35.0% and 34.9% respectively. Concentrations of Credit Risk Financial institutions such as First Defiance generate income primarily through lending and investing activities. The risk of loss from lending and investing activities includes the possibility that losses may occur from the failure of another party to perform according to the terms of the loan or investment agreement. This possibility is known as credit risk. Credit risk is increased by lending or investing activities that concentrate a financial institution's assets in a way that exposes the institution to a material loss from any single occurrence or group of occurrences. Diversifying loans and investments to prevent concentrations of risks is one manner a financial institution can reduce potential losses due to credit risk. Examples of asset concentrations would include multiple loans made to a single borrower and loans of inappropriate size relative to the total capitalization of the institution. Management believes adherence to its loan and investment policies allows it to control its exposure to concentrations of credit risk at acceptable levels. First Defiance's loan portfolio is concentrated geographically in its northwest Ohio market area. There are no industry concentrations which exceed 10% of the Company's loan portfolio. Liquidity and Capital Resources The Company's primary source of liquidity is its core deposit base, raised through First Federal's branch network, along with unused wholesale sources of funding and its capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments. Cash used in operating activities was $72.9 million, $34.1 million and $165.4 million for the years ended December 31, 2001, 2000 and 1999 respectively. For each of those three years, the Company used more cash in operating activities than was provided. The adjustments to reconcile net income to cash provided by or used in operations during the periods presented consist primarily of proceeds from the sale of loans (less the origination of loans held for sale), the provision for loan losses, depreciation expense, goodwill amortization, ESOP expense related to the release of ESOP shares in accordance with AICPA SOP 93-6, the origination and amortization of mortgage servicing rights and increases and decreases in other assets and liabilities. 47 The primary investing activity of First Defiance is lending, which is funded with cash provided from operations and financing activities, as well as proceeds from payments on existing loans and proceeds from maturities of securities. In 2001, cash provided from the sale and maturity of investment securities totaled $12.6 million while $6.4 million in additional securities were purchased. Principal financing activities include the gathering of deposits and advance payments from loan servicing customers, the utilization of FHLB advances, and borrowings from other banks. For the year ended December 31, 2001, deposits and advance payments by loan servicing customers increased by $140.7 million while FHLB advances decreased by $27.0 million and warehouse and term notes payable decreased by $65.8 million. For additional information about cash flows from First Defiance's operating, investing and financing activities, see the Consolidated Statements of Cash Flows included in the Consolidated Financial Statements. At December 31, 2001, First Defiance had the following commitments to fund deposit, advance and borrowing obligations:
Maturity Dates by Period at December 31, 2001 --------------------------------------------------------------------------- Less than After 5 years Contractual Obligations Total 1 year 1-3 years 4-5 years ----------------------------------- --------------- -------------- -------------- -------------- -------------- Savings, checking and demand accounts $228,537 $228,537 $ -- $ -- $ -- Certificates of deposit 402,913 284,604 108,935 8,889 485 FHLB overnight advances 40,000 40,000 -- -- -- FHLB fixed advances including interest (1) 207,731 8,144 39,218 41,399 118,969 Committed and uncommitted short-term mortgage warehouse loans (2) 30,367 30,367 -- -- -- Revolving lines of credit (3) 18,250 18,250 -- -- -- Other notes payable 5,970 239 483 472 4,776 --------------- -------------- -------------- -------------- -------------- Total contractual cash obligations $933,768 $610,141 $148,636 $50,760 $124,230 =============== ============== ============== ============== ==============
(1) Includes principal payments of $156,302 and interest payments of $51,429 (2) Total available lines are $225,000 (3) Total available line is $20,000 48 At December 31, 2001, First Defiance had the following commitments to fund loan or line of credit obligations:
Amount of Commitment Expiration by Period Total ---------------------------------------------------------- Amounts Less than 1 Commitments Committed year 1-3 years 4-5 years After 5 years ----------------------------- -------------- -------------- ------------- -------------- -------------- Mortgage loans in process $2,887 $2,887 $ -- $ -- $ -- Commercial loans in process 12,432 114 12,318 -- -- Single-family mortgage loan originations 12,077 12,077 -- -- -- Nonmortgage loan originations 19,228 19,228 -- -- -- Consumer lines of credit 30,647 37 7,001 182 23,427 Commercial lines of credit 33,750 -- 33,750 -- -- -------------- -------------- ------------- -------------- -------------- Total commitments $111,021 $34,343 $53,069 $182 $23,427 ============== ============== ============= ============== ==============
In addition to the above commitments, at December 31, 2001, through The Leader, First Defiance had commitments to sell $238.4 million of loans held for sale and to acquire $145.0 million of loans under first-time homebuyer programs, all of which have offsetting commitments for sale into the secondary market as GNMA or FNMA mortage-backed securities. To meet its obligations, management can adjust the rate on savings certificates to retain deposits in changing interest rate environments; it can sell or securitize mortgage and non-mortgage loans; and it can turn to other sources of financing including FHLB advances, the Federal Reserve Bank, bank lines and brokered certificates of deposit. At December 31, 2001 First Defiance had $196.4 million of capacity under its lines of credit with other financial institutions. After the sale of The Leader is complete, all bank lines will be paid off and retired. FHLB advances will also be paid down to the extent possible. However, $155.0 million has been borrowed under either fixed or structured FHLB advances that can not be immediately repaid without significant penalties. Management anticipates utilizing these advances after the sale of The Leader to purchase investment securities pending other lending and investment opportunities. Stockholders' equity increased by $11.5 million, or 11.6% at December 31, 2001 compared to December 31, 2000. Net income for 2001 was $13.6 million, of which $3.2 million was returned to shareholders in the form of declared dividends ($.49 per share). The increase in the market value of available for sale securities increased equity by $716,000. The vesting of MRP shares and the release of ESOP shares increased equity by $185,000 and $598,000 respectively. Stock option exercises increased equity by approximately $360,000. The purchase of First Defiance's 51,000 of shares of stock for treasury reduced equity by $748,000. The book value of First Defiance's common stock was $16.20 per share at December 31, 2001, compared to $14.49 per share at December 31, 2000. The tangible book value (excluding goodwill) per share was $14.27 and $12.46 at December 31, 2001 and 2000. First Federal is subject to various capital requirements of the Office of Thrift Supervision. At December 31, 2001, First Federal had capital ratios that exceeded the standard to be 49 considered "well capitalized". For additional information about First Federal's capital requirements, see Note 14 to the Consolidated Financial Statements. Results Reflecting the Sale of The Leader Mortgage Company Beginning in the first quarter of 2002, the reported results for First Defiance will reflect the activity of The Leader as a discontinued operation. Had the Consolidated Statements of Income included in this Form 10-K been reported on that basis, they would have been as follows:
Years Ended December 31 2001 2000 1999 ---------------------------------------- (In thousands, except per share amounts) Interest income: Loans $42,794 $42,601 $37,430 Investment securities 3,479 3,978 3,308 Interest-bearing deposits 272 362 145 ---------------------------------------- Total interest income 46,545 46,941 40,882 Interest expense: Deposits 20,931 21,409 17,425 FHLB advances and other 4,973 3,676 2,809 Warehouse and term notes payable 1,063 733 192 ---------------------------------------- Total interest expense 26,967 25,818 20,427 ---------------------------------------- Net interest income 19,578 21,123 20,455 Provision for loan losses 994 635 155 ---------------------------------------- Net interest income after provision for loan losses 18,584 20,488 20,300 Non-interest income Service fees and other charges 3,175 2,329 1,675 Gain on sale of loans 3,061 580 876 Federal Home Loan Bank stock dividends 1,055 1,073 858 Gain (loss) on sale of securities (137) (58) 1 Trust fees 110 238 43 Other 2,956 2,514 1,428 ---------------------------------------- 10,220 6,676 4,881 Non-interest expense: Compensation and benefits 12,142 11,094 9,308 Occupancy 2,728 2,644 2,516 Deposit insurance premiums 124 120 380 Franchise tax 1,306 1,117 968 Data processing 1,101 1,277 1,239 Mortgage servicing rights amortization 449 222 167 Impairment of mortgage servicing rights 772 - - Goodwill amortization 314 300 201 Other expense 4,012 3,398 3,171 ---------------------------------------- 22,948 20,172 17,950 ---------------------------------------- Income from continuing operations before income tax 5,856 6,992 7,232 Income taxes 1,946 2,220 2,380 ---------------------------------------- Net income from continuing operations 3,910 4,772 4,852 Discontinued operations, net of tax 9,706 6,191 3,771 ---------------------------------------- Net income $13,616 $10,963 $8,623 ======================================== Earnings per share: Basic: Continuing operations $ .61 $ .76 $ .75 Discontinued operations 1.50 .98 .58 ---------------------------------------- $2.11 $1.74 $1.33 ======================================== Diluted: Continuing operations $ .59 $ .74 $ .73 Discontinued operations 1.46 .97 .56 ---------------------------------------- $2.05 $1.71 $1.29 ========================================
50 The income from continuing operations presented above is not representative of what the results of First Defiance would have been without The Leader because of a number of factors, especially the allocation of capital between The Leader and the other operating units of First Defiance. Income from continuing operations for First Defiance as presented above are materially impacted by the banking relationship between First Federal and The Leader which existed throughout the three-year period presented. It is estimated that First Federal incurred an after-tax loss of $956,000 for the year ended December 31, 2001 from the negative spread that existed between the financing provided to The Leader and First Federal's incremental cost of funds. In 2000 and 1999, First Federal realized a favorable spread of $917,000 and $357,000 respectively on the financing provided to The Leader. Factoring out the impact of this financing, net income from continuing operations reflected above would have been $4,866,000, $3,855,000 and $4,495,000 for the years ended December 31, 2001, 2000 and 1999,respectively or $.73, $.60 and $.67 per diluted share for the same three periods respectively. Pro Forma Income Statement and Balance Sheet The presentation of discontinued operations above represent how First Defiance's results would have been presented for GAAP accounting purposes had the sale of The Leader been finalized prior to December 31, 2001. The Pro Forma Income Statement presented here represent management's estimate of what financial results would have been had the proposed sale of The Leader occurred as of the first business day of 2001. In preparing this pro forma, it was assumed that available funds would be used to pay off FHLB advances and warehouse and term debt to the extent that no prepayment penalties will be incurred. The balance of available funds is assumed to be invested in short-term investments at a rate of 4.25%. Dollars are in thousands (except per share amounts). Interest income $ 56,785 Interest expense 33,135 --------------- Net interest income 23,650 Provision for loan losses 993 --------------- Net interest income after provision 22,657 Non-interest income 9,297 Non-interest expense 21,776 --------------- Income before income taxes 10,178 Income taxes 3,362 --------------- Pro forma net income $ 6,616 =============== Pro forma net income per share $ 1.00 =============== 51 The Balance Sheet of First Defiance, prepared on a pro forma basis at December 31, 2001 to reflect the proposed sale of The Leader would have been as follows (In thousands): Assets Cash and cash equivalents $ 36,116 Investment securities: Available for sale 268,543 Held to maturity 5,817 -------------- 274,360 Loans receivable 495,250 Other assets 44,601 -------------- Total Assets $ 850,327 ============== Liabilities and stockholders' equity Liabilities: Deposits $ 564,097 Advances from the FHLB 156,302 Other liabilities 8,908 -------------- 729,307 Stockholders' equity 121,020 -------------- Total liabilities and stockholders' equity $ 850,327 ============== These pro forma financial statements are not necessarily representative of what the results of operations of First Defiance will be subsequent to The Leader sale transaction. 52 Cash Earnings First Defiance recorded a total of $887,000 of goodwill amortization expense in 2001, with $573,000 associated with The Leader and $314,000 associated with First Insurance ($156,000 of First Insurance's goodwill amortization is tax deductible). The Leader goodwill, which totaled $9.5 million at December 31, 2001, will be disposed of as part of The Leader sales transaction First Defiance analyzes its performance on a net income basis determined in accordance with accounting principles generally accepted in the United States, as well as on a cash basis before amortization of goodwill and the related tax benefit of tax deductible goodwill, referred to in this analysis as "cash basis results". Cash basis results and related discussions are presented as supplementary information in this analysis to enhance the readers' understanding of, and highlight trends in, the Company's core financial results excluding the effects of amortization of goodwill. Cash basis results should not be viewed as a substitute for net income and earnings per share as determined in accordance with accounting principles generally accepted in the United States. The selected financial data presented in the following table highlights the performance of First Defiance on a cash basis for each of the three years in the period ended December 31, 2001. The data has been adjusted to exclude the amortization of goodwill and the related tax benefit of tax deductible goodwill. This goodwill resulted from the acquisitions of The Leader and the insurance agencies which were combined to form First Insurance. All three acquisitions were recorded using the purchase method of accounting. The amortization of goodwill does not result in a cash expense and has essentially no economic impact on liquidity and funds management activity. Cash basis financial data provides an additional basis for measuring a company's ability to support future growth, pay dividends, and repurchase shares. The cash basis data presented in the table below has not been adjusted to exclude the impact of other noncash items such as depreciation, the provision for loan losses, and amortization of MRP and ESOP expense. 53
2001 2000 1999 ------------------ ----------------- ----------------- (Dollars in thousands, except per share amounts) Year Ended December 31 Non-interest expense $ 67,453 $ 54,031 $ 46,639 Income before income taxes 22,086 17,751 14,027 Net income 14,447 11,786 9,382 Per Common Share Net income per basic share $2.24 $1.87 $1.44 Net income per diluted share 2.17 1.84 1.40 Weighted average common shares (000s) 6,464 6,318 6,502 Weighted average diluted common shares (000s) 6,646 6,423 6,700 Performance Ratios Return on average assets 1.33% 1.18% 1.09% Return on average equity 15.97 14.87 11.99 Ratio of cash operating expense to tangible assets 6.21 5.43 5.43 Goodwill Goodwill average balance $ 13,623 $ 14,372 $ 12,519 Goodwill amortization (after tax) 831 823 759
In June 2001 the FASB adopted Statement No. 142, Goodwill and Other Intangible Assets. This accounting standard, which is required for years beginning after December 15, 2001, changes the accounting treatment of goodwill. Previously goodwill was considered a wasting asset and required to be amortized. Under Statement No. 142, goodwill is no longer amortized but it is to be reviewed annually for impairment. Management has not yet completed the impairment analysis for the goodwill recorded at First Insurance, which totaled $3.7 million at December 31, 2001. 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 the its financial statements. The significant accounting policies of First Defiance are described in the footnotes to the consolidated financial statements. 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. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results 54 could differ from these judgments and estimates, which could have a material impact on the carrying value of assets and liabilities and the results of operations of First Defiance. Allowance for Loan Losses: First Defiance believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of its consolidated financial statements. Refer to the section entitled Allowance for Loan Losses and Note 3, Statement of Accounting Policies for a detailed description of the Corporation's estimation process and methodology related to the allowance for loan losses. Valuation of Mortgage Servicing Rights: First Defiance believes the valuations of mortgage servicing rights is a critical accounting policy that requires significant estimates in preparation of its consolidated financial statements. First Defiance recognizes as separate assets the value of mortgage servicing rights, whether those rights are acquired through loan origination activities or through purchase activities. Refer to the section entitled Mortgage Servicing Rights and Note 3, Statement of Accounting Policies, for a detailed description of First Defiance's process and methodology. FASB 91 - Deferral of Fees: First Defiance believes that SFAS No. 91 - Deferral of Fees is a critical accounting policy that utilizes estimates in its preparation of its consolidated financial statements. First Defiance accounts for loan origination and commitment fees and certain direct loan origination cost by deferring the net fees, or net costs, and amortizing them as an adjustment of the related loan's yield. Refer to the section entitled Revenue Recognition and Note 3, Statement of Accounting Policies, for a detailed description of First Defiance's process and methodology. 55 Item 7A. Quantitative and Qualitative Disclosure About Market Risk Asset/Liability Management A significant portion of the Company's revenues and net income is derived from net interest income and, accordingly, the Company strives to manage its interest-earning assets and interest-bearing liabilities to generate what management believes to be an appropriate contribution from net interest income. Asset and liability management seeks to control the volatility of the Company's performance due to changes in interest rates. The Company attempts to achieve an appropriate relationship between rate sensitive assets and rate sensitive liabilities. First Defiance does not presently use off balance sheet derivatives to enhance its risk management. 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. This simulation is run for both First Defiance as a consolidated entity and for First Federal on a stand-alone basis. With the pending sale of The Leader, management believes the First Federal stand-alone simulation to be the more meaningful analysis. The results of the simulation indicate that in an environment where interest rates rise 100 basis points over a 12 month period, using 2002 projected amounts as a base case, First Defiance's net interest income would decrease by 1.8%. Were interest rates to fall by 100 basis points during the same 12-month period, the simulation indicates that net interest income would increase by 1.8%. First Defiance has increased its lending activities in the non-residential real estate and commercial loan areas. While such loans carry higher credit risk than residential mortgage lending, they tend to be more rate sensitive than residential mortgage loans. The balance of First Defiance's non-residential and multi-family real estate loan portfolio increased to $218.8 million, which is split between $33.3 million of fixed-rate loans and $185.5 million of adjustable-rate loans at December 31, 2001. The commercial loan portfolio increased to $83.7 million, which is split between $39.8 million of fixed-rate loans and $43.9 million of adjustable-rate loans at December 31, 2001. Certain of the loans classified as adjustable have fixed rates for an initial term that may be as long as five years. The maturities on fixed-rate loans are generally less than 7 years. First Defiance also has significant balances of consumer loans ($40.9 million at December 31, 2001) which tend to have a shorter duration than residential mortgage loans, and home equity and improvement loans ($36.2 million at December 31, 2001) which fluctuate with changes in the prime lending rate. Also, to limit its interest rate risk, First Federal sells more than 90% of its fixed-rate mortgage originations into the secondary market. Historically, loans with maturities less than 20 years had been retained in portfolio although First Federal began selling its 15-year fixed-rate mortgage loans in the secondary market beginning in January 1999. 56 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 which range from -200 basis points to +200 basis points. The results of this analysis are reflected in the following table for the First Federal stand alone analysis. This analysis is materially different than the First Defiance consolidated analysis because of interest rate sensitivity associated with mortgage servicing rights.
December 31, 2001 ------------------------------------------------------------------------------------------------------------- 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 59,640 (12,649) (17.50%) 10.07% (164) bp + 100 bp 65,640 (6,649) (9.20%) 10.86% (85) bp 0 bp 72,289 -- -- 11.71% -- -100 bp 73,477 1,188 1.64% 11.75% 4 bp -200 bp 73,155 866 1.20% 11.61% (10) bp
This analysis is based on First Defiance's internal allocation of capital between First Federal and The Leader. Once the sale of The Leader is completed, all of the capital of First Defiance will be included in this analysis. Management will have an opportunity to control its interest rate risk based on how the freed up capital is redeployed. Based on the above analysis, in the event of a 200 basis point change in interest rates as of December 31, 2001, First Federal would experience a 17.5% decrease in its economic value of equity in a rising rate environment and only a 1.2% increase in its economic value of equity in a declining rate environment. 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 decline in the economic value of equity in a rising rate environment is generally because First Federal has used FHLB advances and deposits with shorter terms than the assets in which it invests. The average duration of its assets at December 31, 2001 was 2.19 years while the average duration of its liabilities was 1.18 years. Management anticipates that it will balance the interest rate risk that exists on the balance sheet through the additions it makes to its investment portfolio after the completion of the sale of The Leader. 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 57 differ significantly from the assumptions in calculating the table and the results therefore may differ from those presented. Forward Looking Information Forward looking statements in this report are made in reliance upon the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The statements in this report which are not historical fact are forward looking statements and they include, among other statements, the pro forma income statement and balance sheet which reflect the results of First Defiance as if the sale of The Leader had occurred as of January 1, 2001, projections about growth in the Financial Condition section, comments about the adequacy of the allowance for loan losses and projections about interest rate simulations included in the Asset/Liability Management section. Actual results may differ from expectations contained in such forward looking information as a result of factors including but not limited to the interest rate environment, economic policy or conditions, federal and state banking and tax regulations, and competitive factors in the marketplace. Each of these factors could affect estimates, assumptions, uncertainties and risks considered in the development of forward looking information and could cause actual results to differ materially from management's expectation regarding future performance. 58 Item 8. Financial Statements and Supplementary Data INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Consolidated Statements of Financial Condition...............................60 Consolidated Statements of Income............................................62 Consolidated Statements of Stockholders' Equity..............................63 Consolidated Statements of Cash Flows........................................64 Notes to Consolidated Financial Statements...................................66 Report of Independent Auditors..............................................110 59 First Defiance Financial Corp. Consolidated Statements of Financial Condition December 31 2001 2000 --------------------------- (In Thousands) Assets Cash and cash equivalents: Cash and amounts due from depository institutions $ 11,784 $ 7,320 Interest-bearing deposits 24,332 13,634 --------------------------- 36,116 20,954 Investment securities: Available-for-sale, carried at fair value 48,989 53,176 Trading, carried at fair value -- 234 Held-to-maturity, carried at amortized cost (fair value $5,678 and $7,770 at December 31, 2001 and 2000, respectively) 5,580 7,697 --------------------------- 54,569 61,107 Loans receivable, net of allowance of $9,937 and $8,904 at December 31, 2001 and 2000, respectively 517,829 541,208 Loans held for sale 275,723 232,314 Mortgage servicing rights 157,369 134,760 Accrued interest receivable 6,111 5,976 Federal Home Loan Bank stock 16,306 15,251 Premises and equipment 22,242 22,203 Real estate and other assets held for sale 1,219 312 Goodwill, net of accumulated amortization of $2,805 and $1,918 at December 31, 2001 and 2000, respectively 13,207 13,983 Other assets 31,922 24,126 --------------------------- Total assets $ 1,132,613 $ 1,072,194 =========================== 60 December 31 2001 2000 ------------------------------- (In Thousands) Liabilities and stockholders' equity Liabilities: Deposits $ 631,450 $ 545,899 Advances from the Federal Home Loan Bank 196,302 223,258 Warehouse and term notes payable 54,587 120,425 Accrued expenses and other liabilities 15,395 12,546 Deferred taxes 704 2,611 Advance payments by borrowers 123,154 67,982 ------------------------------- Total liabilities 1,021,592 972,721 Stockholders' equity: Preferred stock, no par value per share: 5,000 shares authorized; no shares issued Common stock, $.01 par value per share: 20,000 shares authorized; 6,854 and 6,864 shares outstanding, respectively 69 69 Additional paid-in capital 53,725 53,512 Stock acquired by ESOP (2,813) (3,238) Deferred compensation (82) (204) Accumulated other comprehensive income, net of tax of $410 and $22, respectively 763 47 Retained earnings 59,359 49,287 ------------------------------- Total stockholders' equity 111,021 99,473 ------------------------------- Total liabilities and stockholders' equity $ 1,132,613 $ 1,072,194 =============================== See accompanying notes. 61 First Defiance Financial Corp. Consolidated Statements of Income
Years ended December 31 2001 2000 1999 ------------------------------------- (In Thousands, except per share amount) Interest income: Loans $ 62,109 $ 60,382 $ 49,927 Investment securities 3,483 4,441 3,307 Other 272 362 145 ------------------------------------- Total interest income 65,864 65,185 53,379 Interest expense: Deposits 25,120 25,501 19,889 Federal Home Loan Bank advances and other 11,393 13,297 9,872 Warehouse and term notes payable 2,373 4,704 1,821 ------------------------------------- Total interest expense 38,886 43,502 31,582 ------------------------------------- Net interest income 26,978 21,683 21,797 Provision for loan losses 3,870 3,147 1,925 ------------------------------------- Net interest income after provision for loan losses 23,108 18,536 19,872 Non-interest income: Mortgage banking income 45,957 36,129 28,156 Service fees and other charges 2,695 2,047 1,411 Gain on sale of loans 11,709 9,546 7,081 Gain on sale of mortgage servicing rights - - 479 Federal Home Loan Bank stock dividends 1,058 1,075 861 Net (loss) gain on sale of available-for-sale securities (137) (58) 1 Trust fees 110 238 43 Other 5,039 4,269 2,762 ------------------------------------- 66,431 53,246 40,794 Non-interest expense: Compensation and benefits 24,126 22,685 19,401 Occupancy 5,191 4,907 4,128 Deposit insurance premiums 124 120 380 Franchise tax 1,306 1,123 983 Data processing 1,187 1,277 1,239 Mortgage servicing rights amortization 23,405 14,963 12,711 Net impairment of mortgage servicing rights 2,859 21 - Goodwill amortization 887 874 775 Other 9,255 8,935 7,797 ------------------------------------- 68,340 54,905 47,414 ------------------------------------- Income before income taxes 21,199 16,877 13,252 Income taxes 7,583 5,914 4,629 ------------------------------------- Net income $ 13,616 $ 10,963 $ 8,623 ===================================== Earnings per share: Basic $ 2.11 $ 1.74 $ 1.33 ===================================== Diluted $ 2.05 $ 1.71 $ 1.29 ===================================== Dividends declared per share $ 0.49 $ 0.45 $ 0.41 =====================================
See accompanying notes. 62 First Defiance Financial Corp. Consolidated Statements of Stockholders' Equity (In Thousands)
Stock Acquired By ---------------------- Additional Management Common Stock Paid-In Recognition ---------------- Shares Amount Capital ESOP Plan ---------------- ------------------------------------ Balance at January 1, 1999 7,575 $ 76 $ 58,681 $ (4,089) $ (843) Comprehensive income: Net income Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $648 Total comprehensive income ESOP shares released 197 425 Amortization of deferred compensation of Management Recognition Plan (4) 385 Shares issued under stock option plan 55 417 Acquisition of common stock for treasury (816) (8) (6,110) Dividends declared ------------------------------------------------------ Balance at December 31, 1999 6,814 68 53,181 (3,664) (458) Comprehensive income: Net income Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $542 Total comprehensive income ESOP shares released 71 426 Amortization of deferred compensation of Management Recognition Plan (35) 254 Shares issued under stock option plan 80 1 469 Acquisition of common stock for treasury (30) (174) Dividends declared ------------------------------------------------------ Balance at December 31, 2000 6,864 69 53,512 (3,238) (204) Comprehensive income: Net income Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $432 Total comprehensive income ESOP shares released 173 425 Amortization of deferred compensation of Management Recognition Plan 63 122 Shares issued under stock option plan 41 360 Acquisition of common stock for treasury (51) (383) Dividends declared ------------------------------------------------------ Balance at December 31, 2001 $ 6,854 $ 69 $ 53,725 $ (2,813) $ (82) ====================================================== See accompanying notes. Accumulated Other Total Comprehensive Retained Stockholders' Income Earnings Equity ----------------------------------------- Balance at January 1, 1999 $ 162 $ 39,723 $ 93,710 Comprehensive income: Net income 8,623 8,623 Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $648 (1,258) (1,258) ----------- Total comprehensive income 7,365 ESOP shares released 622 Amortization of deferred compensation of Management Recognition Plan 381 Shares issued under stock option plan 417 Acquisition of common stock for treasury (4,276) (10,394) Dividends declared (2,685) (2,685) ------------------------------------- Balance at December 31, 1999 (1,096) 41,385 89,416 Comprehensive income: Net income 10,963 10,963 Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $542 1,143 1,143 ----------- Total comprehensive income 12,106 ESOP shares released 497 Amortization of deferred compensation of Management Recognition Plan 219 Shares issued under stock option plan 470 Acquisition of common stock for treasury (154) (328) Dividends declared (2,907) (2,907) ------------------------------------- Balance at December 31, 2000 47 49,287 99,473 Comprehensive income: Net income 13,616 13,616 Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $432 716 716 ----------- Total comprehensive income 14,332 ESOP shares released 598 Amortization of deferred compensation of Management Recognition Plan 185 Shares issued under stock option plan 360 Acquisition of common stock for treasury (365) (748) Dividends declared (3,179) (3,179) ------------------------------------- Balance at December 31, 2001 $ 763 $ 59,359 $ 111,021 =====================================
See accompanying notes. 63 First Defiance Financial Corp. Consolidated Statements of Cash Flows
Years ended December 31 2001 2000 1999 ------------------------------------- Operating activities (In Thousands) Net income $ 13,616 $ 10,963 $ 8,623 Adjustments to reconcile net income to net cash used in operating activities: Provision for loan losses 3,870 3,147 1,925 Provision for depreciation 2,197 1,888 1,745 Amortization of deferred compensation expense 185 219 484 Amortization of mortgage servicing rights 23,405 14,963 12,711 Net impairment of of mortgage servicing rights 2,859 21 - Amortization of goodwill 887 874 775 Release of ESOP shares 598 497 622 (Gain) loss on sale of office properties and equipment -- (60) 31 Net securities (gains) losses 137 58 (1) Gain on sale of loans (11,709) (9,546) (7,081) Gain on sale of mortgage servicing rights -- -- (479) Net securities amortization 33 37 110 Deferred federal income tax (credit) (2,339) (163) 58 Decrease in interest receivable and other assets (7,931) (5,200) (4,499) Proceeds from sale of loans 2,208,058 2,369,720 1,753,467 Proceeds from sale of mortgage servicing rights -- -- 2,610 Servicing rights on loans sold with servicing retained (48,873) (52,225) (35,909) Origination of loans held for sale (2,239,758) (2,354,866) (1,895,505) Net repurchase of loans held for sale (20,812) (13,810) (8,521) Increase (decrease) in accrued interest and other liabilities 2,668 (608) 3,465 ------------------------------------- Net cash used in operating activities (72,909) (34,091) (165,369) Investing activities Proceeds from sale of trading securities 233 29,568 -- Proceeds from maturities of available-for-sale securities 6,395 7,071 20,039 Proceeds from sale of available-for-sale securities 3,919 2,317 2,001 Purchases of available-for-sale securities (5,120) (6,996) (30,395) Proceeds from maturities of held-to-maturity securities 2,089 2,169 3,594 Proceeds from sale of real estate and other assets held for sale 519 3,325 3,079 Proceeds from sale of office properties and equipment and investment properties 37 485 416 Acquisition of The Insurance Center of Defiance, net of cash received -- -- (1,918) Adjustment of acquisition of First Insurance & Investments -- -- (274) Acquisition of Moreland Greens -- -- 217 Purchases of Federal Home Loan Bank stock (1,055) (1,070) (3,355) Purchases of premises and equipment (2,273) (3,205) (4,417) Net increase in mortgage and other loans 38,895 (66,304) (12,668) ------------------------------------- Net cash provided by (used in) investing activities 43,639 (32,640) (23,681)
64 First Defiance Financial Corp. Consolidated Statements of Cash Flows (continued)
Years ended December 31 2001 2000 1999 ------------------------------------ Financing activities Net increase in deposits and advance payments by borrowers for taxes and insurance 140,723 49,370 53,198 Proceeds from short--term line of credit 6,250 12,000 -- Net increase in Federal Home Loan Bank short--term advances (116,500) 83,500 8,355 Proceeds from Federal Home Loan Bank long--term advances 90,000 -- 105,000 Repayment of Federal Home Loan Bank long--term advances (456) (125,652) (16,087) Repayment of long term notes (177) (314) (60) (Decrease) increase in mortgage warehouse loans (71,911) 55,235 47,043 Purchase of common stock for treasury (748) (328) (10,394) Cash dividends paid (3,109) (2,832) (2,692) Proceeds from exercise of stock options 360 470 417 ------------------------------------ Net cash provided by financing activities 44,432 71,449 184,780 ------------------------------------ Increase (decrease) in cash and cash equivalents 15,162 4,718 (4,270) Cash and cash equivalents at beginning of period 20,954 16,236 20,506 ------------------------------------ Cash and cash equivalents at end of period $ 36,116 $ 20,954 $ 16,236 =================================== Supplemental cash flow information: Interest paid $ 38,985 $ 43,790 $ 30,482 =================================== Income taxes paid $ 8,520 $ 6,400 $ 5,325 =================================== Transfers from loans to real estate and other assets held for sale $ 391 $ 607 $ 2,533 =================================== Noncash operating activities Change in deferred taxes on net unrealized gains or losses on available-for-sale securities $ (432) $ (542) $ 648 =================================== Noncash investing activities Change in net unrealized gain (loss) on available-for-sale securities $ 1,148 $ 1,685 $ (1,906) =================================== Securitization of loans held for sale $ -- $ -- $ 29,805 =================================== Noncash financing activities Cash dividends declared but not paid $ 848 $ 778 $ 703 ===================================
See accompanying notes. 65 First Defiance Financial Corp. Notes to Consolidated Financial Statements December 31, 2001 1. Basis of Presentation First Defiance Financial Corp. (First Defiance) is a holding company that conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest, Defiance Ohio (First Federal) and First Insurance & Investments (First Insurance) and First Federal's wholly owned subsidiary, The Leader Mortgage Company (The Leader). All significant intercompany transactions and balances are eliminated in consolidation. 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 counties in which its offices are located. First Federal's traditional banking activities include originating and servicing residential, commercial and consumer loans and providing a broad range of depository and trust services. First Federal is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities. The Leader is a mortgage banking company that specializes in servicing mortgage loans under first-time home-buyer programs sponsored by various state, county and municipal governmental entities. The Leader's mortgage banking activities consist primarily of originating or purchasing residential mortgage loans for either direct resale into secondary markets or to be securitized through Government National Mortgage Association (GNMA) or Fannie Mae. The Leader generally retains the servicing on these loans. First Insurance & Investments is an insurance agency that does business in the Defiance, Ohio area offering property and casualty, group health, and life insurance and investment and annuity products. 2. Subsequent Event - Discontinued Operations In January 2002, First Defiance approved and announced the sale of its mortgage banking line of business, The Leader, to a third party. The transaction is expected to close in the second quarter of fiscal 2002 and is anticipated to result in an after-tax gain of $10 million to $12 million ($1.50 to $1.75 per share.) Major classes of assets and liabilities of The Leader reflected in the Consolidated Statements of Financial Condition at December 31, 2001 and 2000 are: 66 First Defiance Financial Corp. Notes to Consolidated Financial Statements 2. Subsequent Event - Discontinued Operations (continued) December 31 2001 2000 -------------------------- (In Thousands) Assets Loans receivable $22,941 $15,862 Loans held for sale 275,367 232,247 Mortgage servicing rights 156,936 134,086 Prepaid expenses and other assets 30,951 23,529 Goodwill 9,458 10,032 Liabilities Warehouse and term notes payable to affiliates 399,635 253,563 Warehouse and term notes payable to third parties 36,289 108,340 Accrued expenses 8,189 4,803 Net interest income, non-interest income and income before income taxes of The Leader included in the Consolidated Statements of Income for each of the three years ended December 31, 2001 were as follows: 2001 2000 1999 ---------------------------------------- (In Thousands) Net interest income $7,878 $1,045 $1,796 Non-interest income 57,133 46,694 36,008 Income before income taxes 14,958 10,388 6,466 67 3. Statement of Accounting Policies Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Most significantly, First Defiance uses estimates in determining the value of the allowance for loan losses and in the valuation of mortgage servicing rights. Earnings Per Share Earnings per share are based on the weighted average number of shares of common stock outstanding during the period. Basic earnings per share exclude any dilutive effects of options and unvested stock grants. Cash and Cash Equivalents Cash and cash equivalents include amounts due from banks and overnight investments with the Federal Home Loan Bank (FHLB). Cash and amounts due from depository institutions includes required balances at the FHLB and Federal Reserve of approximately $412,000 and $1,360,000, respectively, at December 31, 2001. Investment Securities Management determines the appropriate classification of debt securities at the time of purchase and evaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity and are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Debt securities not classified as held-to-maturity and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity until realized. 68 3. Statement of Accounting Policies (continued) 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. These securities have been committed to sell at their carrying value. Realized gains and losses, and declines in value judged to be other-than-temporary are included in gains (losses) on sale of securities. The cost of mutual funds sold is based on the average cost method. The cost of all other securities sold is based on the specific identification method. Currently, First Defiance invests in derivative securities as part of the overall asset and liability management process. Such derivative securities are disclosed in Note 5 and include agency step-up, REMIC and CMO investments. Such investments are not classified by management as high risk at December 31, 2001 and do not present risk significantly different than other mortgage-backed or agency securities. Investments Required by Regulations As a member of the FHLB System, First Federal is required to own stock of the FHLB of Cincinnati in an amount principally equal to the greater of 1% of its net home mortgage loans or 5% of FHLB advances, subject to periodic redemption at par if the stock owned is over the minimum requirement. FHLB stock is a restricted equity security that does not have a readily determinable fair value and is carried at cost. Loans Receivable Investment in real estate mortgage loans consists principally of long-term conventional loans collateralized by first mortgages on single-family residences, other residential property, and commercial and industrial property. Such loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Mortgage loans originated and intended for sale in the secondary market are classified as loans held for sale and are carried at the lower of cost or estimated fair value in the aggregate. 69 3. Statement of Accounting Policies (continued) Nonrefundable fees and related costs associated with originating or acquiring real estate mortgage and other loans are capitalized and recognized as an adjustment of the yield of the related loan. Interest receivable is accrued on loans and credited to income as earned. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is fully reserved. Interest income is subsequently recognized only to the extent cash payments are received. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual loss experience, current economic events in specific industries and geographical areas, and other pertinent factors including regulatory guidance and general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors. Mortgage Servicing Rights The total cost of loans originated or purchased is allocated between loans and servicing rights based on the relative fair values of each. The servicing rights capitalized are amortized in proportion to and over the period of estimated servicing income. Mortgage servicing rights are periodically evaluated for impairment. For purposes of measuring impairment, mortgage servicing rights are stratified based on predominant risk characteristics of the underlying serviced loans. These risk characteristics include loan type (fixed or adjustable rate) and interest rate. Impairment represents the excess of amortized cost of an individual mortgage servicing rights stratum over its fair value, and is recognized through a valuation allowance. 70 3. Statement of Accounting Policies (continued) Fair values for individual stratum are based on the present value of estimated future cash flows using a discount rate (10.6%) commensurate with the risks involved. Estimates of fair value include assumptions about prepayment (186% PSA), default and interest rates, and other factors which are subject to change over time. Changes in these underlying assumptions could cause the fair value of mortgage servicing rights, and the related valuation allowance, to change significantly in the future. Real Estate and Other Assets Held for Sale Assets held for sale are comprised of properties acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of cost or fair value at time of foreclosure or insubstance foreclosure. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Premises and Equipment Premises and equipment are carried at cost less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives: Buildings and improvements 20 to 50 years Furniture, fixtures and equipment 5 to 15 years Long-lived assets to be held and those to be disposed of and certain intangibles are evaluated for impairment using the guidance provided by Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The provisions of this statement establish when an impairment loss should be recognized and how it should be measured. Income Taxes Deferred income taxes reflect the temporary tax consequences on future years of differences between the tax basis and financial statement amounts of assets and liabilities at each year-end. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As 71 3. Statement of Accounting Policies (continued) changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. An effective tax rate of 35% is used to determine after-tax components of other comprehensive income included in the statements of stockholders' equity. Business Combinations Business combinations, which have been accounted for under the purchase method of accounting, include the results of operations of the acquired business from the date of acquisition. Net assets of the companies acquired were recorded at their estimated fair value as of the date of acquisition. Intangibles The excess of the purchase price over the net identifiable tangible assets acquired in purchase business combinations is recorded as goodwill. Goodwill relating to The Leader acquisition is being amortized over a twenty-year period. Goodwill relating to First Insurance & Investments is being amortized over a fifteen-year period. Amounts paid for non-compete and employment agreements in conjunction with the acquisition of The Leader have been capitalized and are being amortized over the life of the agreements. On a periodic basis, management reviews goodwill and other intangible assets to determine if events or changes in circumstances indicate the carrying value of such assets is not recoverable, in which case an impairment charge would be recorded. The current accounting guidance for goodwill and other intangibles has been superceded by the provisions of SFAS No. 142, Goodwill and Other Intangible Assets, which become effective for First Defiance as of January 1, 2002. See "Accounting Pronouncements Pending Adoption" for further information. 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 72 3. Statement of Accounting Policies (continued) 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 and cannot be deferred. 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 of associated with establishing the fair values of derivative instruments on the balance sheet reduced net income by approximately $11,000. The transition amounts were determined based on the interpretive guidance issued by the Financial Accounting Standards Board. Accounting Pronouncements Pending Adoption Goodwill and Other Intangible Assets. In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, which is effective for fiscal years beginning after December 31, 2001. Under SFAS No. 142, amortization of goodwill and intangible assets with indefinite lives is no longer permitted. Management anticipates that implementing this change will reduce noninterest expense by approximately $314,000 and increase net income by $260,000, or $0.04 per common share, for 2002. This does not include an additional $573,000 of annual goodwill amortization related to The Leader. All expenses associated with The Leader in 2002 prior to the closing are expected to be recorded as discontinued operations. Goodwill and intagible assets with indefinite lives will be subject to impairment testing which must be conducted annually. Any impairment losses that result from the initial application of SFAS No. 142 would be accounted for as a "cumulative effect of accounting change" on the Consolidated Statement of Income. Management has not yet completed the impairment testing as of the transition date of January 1, 2002. Asset Retirement Obligations. In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. The standard is effective for fiscal years beginning after June 15, 2002. The standard addresses the accounting for obligations associated with the retirement of tangible long-lived assets and requires a liability to be recognized for the fair value of these obligations in the period they are incurred. Related costs are capitalized as part of the carrying amounts of the assets to be retired and amortized over the assets' useful lives. Management has not yet completed the evaluation the impact on First Defiance's financial condition and results of operations. 73 3. Statement of Accounting Policies (continued) Impairment or Disposal of Long-Lived Assets. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. The standard maintains the previous accounting for the impairment or disposal of long-lived assets, but establishes more restrictive criteria that have to be met to classify such an asset as "held for sale." SFAS No. 144 also changes the manner is which expected operating losses from discontinued operations are to be reported. First Defiance adopted SFAS No. 144 as of January 1, 2002. 4. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share:
2001 2000 1999 ----------------------------------------- (In Thousands, except per share amounts) Numerator for basic and diluted earnings per share-net income $3,616 $10,963 $8,623 ======================================== Denominator: Denominator for basic earnings per share-weighted-average shares 6,464 6,318 6,502 Effect of dilutive securities: Employee stock options 149 39 113 Unvested Management Recognition Plan stock 33 66 85 ---------------------------------------- Dilutive potential common shares 182 105 198 ---------------------------------------- Denominator for diluted earnings per share-adjusted weighted-average shares 6,646 6,423 6,700 ======================================== Basic earnings per share $2.11 $ 1.74 $1.33 ======================================== Diluted earnings per share $2.05 $ 1.71 $1.29 ========================================
74 5. Investment Securities The following is a summary of available-for-sale and held-to-maturity securities:
December 31, 2001 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------- (In Thousands) Available-for-Sale Securities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 17,708 $ 905 $ -- $ 18,613 Corporate bonds 9,322 294 -- 9,616 Adjustable rate mortgage-backed security mutual funds 2,548 -- 70 2,478 Adjustable rate mortgage-backed securities 4,134 52 71 4,115 Collateralized mortgage obligations 3,546 69 16 3,599 Trust preferred stock 2,000 12 80 1,932 Equity securities 343 42 -- 385 Obligations of state and political subdivisions 8,216 131 96 8,251 ----------------------------------------------------------- Totals $ 47,817 $ 1,505 $ 333 $ 48,989 =========================================================== Held-to-Maturity Securities: FHLMC certificates $ 1,690 $ 25 $ 25 $ 1,690 FNMA certificates 2,389 26 52 2,363 GNMA certificates 871 22 -- 893 Obligations of states and political subdivisions 630 102 -- 732 ----------------------------------------------------------- Totals $ 5,580 $ 175 $ 77 $ 5,678 ===========================================================
75 5. Investment Securities (continued)
December 31, 2000 ----------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------------------------------------------------------- (In Thousands) Available-for-Sale Securities: U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ 17,672 $ 263 $ 1 $ 17,934 Corporate bonds 11,797 97 10 11,884 Adjustable rate mortgage-backed security mutual funds 6,606 - 238 6,368 Adjustable rate mortgage-backed securities 2,200 5 - 2,205 REMICs 1,519 16 - 1,535 Collateralized mortgage obligations 4,948 12 25 4,935 Trust preferred stock 2,000 - 135 1,865 Equity securities 343 89 - 432 Obligations of state and political subdivisions 6,066 37 85 6,018 ----------------------------------------------------------- Totals $ 53,151 $ 519 $ 494 $ 53,176 =========================================================== Held-to-Maturity Securities: FHLMC certificates $ 2,670 $ 27 $ 18 $ 2,679 FNMA certificates 3,009 19 77 2,951 GNMA certificates 1,249 18 3 1,264 Obligations of states and political subdivisions 769 107 - 876 ----------------------------------------------------------- Totals $ 7,697 $ 171 $ 98 $ 7,770 ===========================================================
The amortized cost and fair value of securities at December 31, 2001 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mutual funds are not due at a single maturity date. For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of the underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments. 76 5. Investment Securities (continued)
Available-for-Sale Held-to-Maturity ----------------------------------- ------------------------------------- Amortized Amortized Cost Fair Value Cost Fair Value -------------------------------------------------------------------------- (In Thousands) Due in one year or less $ 7,086 $ 7,249 $ 188 $ 193 Due after one year through five years 23,581 24,731 347 391 Due after five years through ten years 5,002 5,062 361 430 Due after ten years 9,257 9,084 4,684 4,664 -------------------------------------------------------------------------- 44,926 46,126 5,580 5,678 Adjustable rate mortgage-backed security mutual funds 2,548 2,478 - - Equity securities 343 385 - - -------------------------------------------------------------------------- Totals $ 47,817 $ 48,989 $ 5,580 $ 5,678 ==========================================================================
6. Loan Commitments and Delinquencies Loan commitments are made to accommodate the financial needs of First Defiance's customers. The associated credit risk is essentially the same as that involved in extending loans to customers and is subject to First Defiance's normal credit policies. Collateral such as mortgages on property and equipment, receivables and inventory is obtained based on management's credit assessment of the customer. At December 31, 2001, First Defiance's outstanding commitments to fund long-term mortgage loans amounted to approximately $12.1 million comprised of approximately 86% fixed rate and 14% adjustable rate loans with rates ranging from 5.5% to 7.75%. First Defiance's commitment to sell long-term mortgage loans amounted to $238.3 million as of December 31, 2001. First Defiance's maximum exposure to credit loss for loan commitments (unfunded loans, unused lines of credit and letters of credit) was $111.0 million at December 31, 2001. 77 6. Loan Commitments and Delinquencies (continued) Unpaid balances of loans with contractual payments delinquent 90 days or more totaled $17,808,000 at December 31, 2001 and $9,521,000 at December 31, 2000 (including $15,437,000 and $8,072,000 at December 31, 2001 and 2000 respectively of loans that have FHA or VA guarantees or other forms of insurance). First Federal does not anticipate any significant losses in the collection of these delinquent loans in excess of the allowance for loan losses. Impaired loans having recorded investments of $370,000 at December 31, 2001 and $95,000 at December 31, 2000 have been recognized in conformity with FASB Statement No. 114, as amended by FASB Statement No. 118. The average recorded investment in impaired loans during 2001 and 2000 was $501,000 and $135,000, respectively. The total allowance for loan losses related to these loans was $202,000 and $95,000 at December 31, 2001 and 2000. There was $40,000 of interest received and recorded in income during 2001 on impaired loans including interest received and recorded in income prior to such impaired loan designation. There was no interest recorded in 2000 and $36,000 recorded in 1999.Loans having carrying values of $391,000 and $607,000 were transferred to real estate and other assets held for sale in 2001 and 2000, respectively. First Defiance is not committed to lend additional funds to debtors whose loans have been modified. 78 7. Loans Receivable
December 31 2001 2000 ------------------------- (In Thousands) Loans receivable consist of the following at December 31: Real estate loans: Secured by single family residential $ 144,201 $ 209,645 Secured by multi-family residential 66,288 44,700 Secured by non-residential real estate 152,511 125,479 Construction 7,875 9,627 -------------------------- 370,875 389,451 Other loans: Automobile 33,323 43,610 Mobile home 12 29 Commercial 83,690 81,138 Home equity and improvement 36,179 31,836 Other 7,598 8,504 -------------------------- 160,802 165,117 -------------------------- Total loans 531,677 554,568 Deduct: Undisbursed loan funds 2,887 3,415 Net deferred loan origination fees and costs 1,024 1,041 Allowance for loan losses 9,937 8,904 -------------------------- Totals $ 517,829 $ 541,208 ==========================
79 7. Loans Receivable (continued) Changes in the allowance for loan losses were as follows:
Years ended December 31 2001 2000 1999 ---------------------------------------- (In Thousands) Allowance at beginning of year $ 8,904 $ 7,758 $ 9,789 Provision for credit losses 993 635 155 Provision for foreclosure losses 2,877 2,512 1,770 ---------------------------------------- Total provision 3,870 3,147 1,925 ---------------------------------------- Foreclosure expense charge-off 2,475 1,550 1,710 Credit loss charge-off 1,032 1,031 2,525 ---------------------------------------- Total charge-offs 3,507 2,581 4,235 ---------------------------------------- Recoveries from foreclosure losses 413 358 - Recoveries from credit losses 257 222 279 ---------------------------------------- Total recoveries 670 580 279 ---------------------------------------- Net charge-offs 2,837 2,001 3,956 ---------------------------------------- Ending allowance $ 9,937 $ 8,904 $ 7,758 ======================================== Ending allowance for credit losses $ 6,548 $ 6,330 $ 6,504 Ending allowance for foreclosure losses 3,389 2,574 1,254 ---------------------------------------- Total ending allowance $ 9,937 $ 8,904 $ 7,758 ========================================
Interest income on loans is as follows:
Years ended December 31 2001 2000 1999 ---------------------------------------- (In thousands) Mortgage loans $ 33,971 $ 35,731 $ 32,453 Other loans 28,138 24,651 17,474 ---------------------------------------- Totals $ 62,109 $ 60,382 $ 49,927 ========================================
80 7. Loans Receivable (continued) There are no industry concentrations (exceeding 10% of loans, gross) in First Federal's non-residential real estate and commercial loan portfolios. Virtually all of the Company's loans receivable (excluding the mortgage loans available for sale) are to borrowers in the Northwest Ohio, Northeast Indiana or Southeast Michigan areas. 8. Mortgage Banking The activity in Mortgage Servicing Rights (MSRs) is summarized as follows:
Years ended December 31 2001 2000 1999 ---------------------------------------------------- (In Thousands) Balance at beginning of period $ 134,760 $ 97,519 $ 76,452 Loans sold, servicing retained 48,873 52,225 35,909 Proceeds from sale of MSR's - - (2,610) Gain on sale of MSR's - - 479 Amortization (23,405) (14,963) (12,711) Impairment of MSR's (2,859) (21) - ---------------------------------------------------- Balance at end of period $ 157,369 $ 134,760 $ 97,519 ====================================================
Accumulated amortization of MSRs aggregates approximately $58.7 million, $32.4 million and $17.5 million, at December 31, 2001, 2000 and 1999, respectively. At December 31, 2001, the estimated fair value of the servicing rights was $173.3 million, as determined using a mortgage servicing rights valuation model. 81 8. Mortgage Banking (continued) The Company's servicing portfolio (excluding subserviced loans) is comprised of the following:
December 31 2001 2000 ---------------------------------- ----------------------------------- Number of Principal Number of Principal Loans Outstanding Loans Outstanding ---------------------------------------------------------------------- (Dollars in Thousands) GNMA 93,917 $ 6,769,911 85,379 $ 5,885,531 FNMA 14,395 956,037 13,463 874,399 FHLMC 1,985 100,662 2,504 115,296 Other VA, FHA, and conventional loans 29,616 1,365,120 22,762 1,115,594 ---------------------------------------------------------------------- Totals 139,913 $ 9,191,730 124,108 $ 7,990,820 ======================================================================
The components of mortgage banking income, net of amortization are as follows:
Years ended December 31 2001 2000 1999 --------------------------------------------------- (In Thousands) Loan servicing fee income $ 40,576 $ 31,869 $ 25,040 Late charges 5,381 4,260 3,116 --------------------------------------------------- Total mortgage banking income 45,957 36,129 28,156 Gain on sale of loans 11,709 9,546 7,081 Gain on sale of MSR's -- -- 479 Amortization of mortgage servicing rights (23,405) (14,963) (12,711) Impairment of MSR's (2,859) (21) -- --------------------------------------------------- Totals $ 31,402 $ 30,691 $ 23,005 ===================================================
82 9. Premises and Equipment Premises and equipment are summarized as follows: December 31 2001 2000 -------------------------------- (In Thousands) Cost: Land $ 2,771 $ 2,771 Buildings 15,640 15,602 Leasehold improvements 965 851 Furniture, fixtures and equipment 12,111 10,945 Construction in process 804 82 -------------------------------- 32,291 30,251 Less allowances for depreciation and amortization 10,049 8,048 -------------------------------- $ 22,242 $ 22,203 ================================ There was no interest capitalized on construction projects during 2001 or 2000. The Leader leases office space from a partnership whose controlling partners include officers of The Leader. The five year lease agreement provides for annual base rents of $436,000 plus additional rents based on increases in operating expenses and taxes. There were no outstanding amounts payable under the lease agreement as of December 31, 2001. 83 10. Deposits The following schedule sets forth interest expense by type of savings deposit: Years ended December 31 2001 2000 1999 ----------------------------------------- (In Thousands) Checking and money market accounts $ 3,871 $ 3,361 $ 2,180 Savings accounts 569 740 879 Certificates 20,680 21,400 16,852 ---------------------------------------- 25,120 25,501 19,911 Less interest capitalized -- -- 22 ---------------------------------------- Totals $ 25,120 $ 25,501 $ 19,889 ======================================== At December 31, 2001, accrued interest payable amounted to $899,000 which was comprised of $853,000, $44,000 and $2,000 for certificates, checking and money market accounts, and savings accounts, respectively. A summary of deposit balances is as follows: December 31 2001 2000 -------------------------------------- (In Thousands) Savings accounts $ 36,951 $ 37,551 Checking accounts 78,753 65,901 Money Market demand accounts 112,833 78,961 Certificates of deposit 402,913 363,486 -------------------------------------- $ 631,450 $ 545,899 ====================================== 84 10. Deposits (continued) Scheduled maturities of certificates of deposit are as follows: December 31, 2001 --------------------- (In Thousands) 2002 $ 284,604 2003 86,414 2004 22,521 2005 4,226 2006 4,663 2007 and thereafter 485 --------------------- Total $ 402,913 ===================== At December 31, 2001 and 2000 deposits of $146.0 million and $98.9 million, respectively, were in excess of the $100,000 Federal Deposit Insurance Corporation insurance limit. At December 31, 2001 and 2000, $18.5 million and $20.2 million, respectively, in investment securities were pledged as collateral against public deposits for certificates in excess of $100,000. In addition, First Federal has a $7,000,000 depository bond with the State of Ohio, which can be pledged as collateral against public deposits for certificates in excess of $100,000. 85 11. Advances from Federal Home Loan Bank First Federal has the ability to borrow funds from the FHLB. First Federal pledges its single-family residential mortgage loan portfolio as security for these advances. At December 31, 2001, the total available collateral amounted to approximately $355.1 million. Advances secured by mortgages must have collateral to exceed borrowings by 125%. Advances secured by investment securities must have 100% collateral. The total level of borrowing is also limited to 50% of total assets. First Federal has a maximum potential to acquire advances of approximately $284.0 million from the FHLB. The FHLB has made a series of advances totaling $130.0 million to First Defiance that have fixed maturity dates but are callable at the option of the FHLB on a specified date and quarterly thereafter. The terms of these advances are as follows (in thousands): Balance Interest Rate Call Date Maturity Date --------------------------------------------------------------------------- $ 10,000 4.94% 12/18/03 12/18/08 15,000 5.64% 01/26/02 10/26/09 10,000 5.84% 03/01/02 09/01/10 20,000 5.83% 01/20/02 10/20/05 10,000 5.95% 02/07/02 11/07/05 15,000 4.52% 01/10/02 01/10/11 10,000 4.76% 01/10/03 01/10/11 10,000 4.93% 02/02/04 02/02/11 20,000 4.07% 03/08/02 03/08/11 10,000 5.14% 03/08/04 03/08/11 When called, First Defiance has the option of paying off these advances, or converting them to variable rate advances priced at the three month LIBOR rate. First Defiance has an additional $26.3 million outstanding on a series of fixed rate long-term advances. Of this amount, $1.2 million is a fixed rate advance under the FHLB Affordable Housing Program in 1995. The total FHLB long-term advances bear a weighted average interest rate of 5.12% at December 31, 2001. 86 11. Advances from Federal Home Loan Bank (continued) Future minimum payments by fiscal year are as follows (in thousands): 2002 $ 8,145 2003 22,394 2004 16,824 2005 36,421 2006 4,978 Thereafter 118,969 ------------------ Total minimum payments 207,731 Less amounts representing interest 51,429 ------------------ Totals $ 156,302 ================== First Defiance also utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. There were $40.0 million in short-term advances outstanding at December 31, 2001 and $106.5 million at December 31, 2000. First Defiance borrows short-term advances under a variety of programs at FHLB. At December 31, 2001, $30.0 million was outstanding under First Defiance's REPO Advance line of credit. The total available under the REPO line is $175.0 million. Amounts are generally borrowed under the REPO line on an overnight basis. Other advances may be borrowed under the FHLB's short-term fixed or LIBOR based programs. There was one $10.0 million short-term fixed rate advance outstanding at December 31, 2001. Information concerning short-term advances is summarized as follows: Years ended December 31 2001 2000 --------------------------------------- (In Thousands, except percentages) Average balance during the year $ 62,695 $ 72,384 Maximum month-end balance during the year 111,000 140,250 Average interest rate during the year 4.32% 6.53% 87 12. Notes Payable Total mortgage warehouse, revolving and term debt is summarized as follows:
December 31 2001 2000 ------------------------------ (In Thousands) Mortgage warehouse and revolving loans: $150,000 uncommitted repurchase line of credit with a bank secured by mortgage loans held for sale, interest at federal funds rate plus 0.40% (2.15% at December 31, 2001); $133,091 available at December 31, 2001 $ 16,909 $ 30,616 $75,000 committed revolving warehouse loan agreement with a bank secured by mortgage loans held for sale, interest at lower of LIBOR plus 1.00% or federal funds plus 1.25% (2.88% at December 31,2001); $61,542 available at December 31, 2001 13,458 71,662 $20,000 revolving line of credit facility, secured by the stock of First Federal, interest at LIBOR plus 1.5% (3.62% at December 31, 2001) $1,750 available at December 31, 2001 18,250 -- $15,000 secured and unsecured revolving lines of credit facilities, at various rates. -- 12,000 ------------------------------ Total mortgage warehouse and revolving loans 48,617 114,278 Term notes payable: Industrial Development Revenue Bonds payable to Cuyahoga County, secured by real estate and a letter of credit, interest is calculated using a tax exempt rate applicable for the prescribed adjustment period, currently weekly. During 2001 the interest rate ranged from 1.60% to 5.25%. The issue matures March 1, 2019 4,745 4,890 Notes payable to the City of Cleveland, recorded at discounted value, secured by real estate with interest at 0% per annum. Balance due at maturity on March 1, 2009 is $928,450 602 569 Note payable to City of Cleveland Housing Trust Fund, secured by real estate, interest at 2% per annum, maturing March 1, 2009 407 392 Note payable to bank, secured by real estate, interest at 7% per annum, maturing March 1, 2019 60 71 Note payable to former employee, unsecured with interest at 5% per annum, maturing October 1, 2004 107 139 Note payable to bank, secured by business assets, interest at 7.5% per annum, maturing March 1, 2003 49 86 ------------------------------ Total term notes payable 5,970 6,147 ------------------------------ Total borrowed money $ 54,587 $ 120,425 ==============================
88 12. Notes Payable (continued) As of December 31, 2001, the maturities of term notes payable during the next five years and thereafter are as follows (in thousands): 2002 $ 239 2003 230 2004 253 2005 233 2006 239 Thereafter 4,776 ------------ $5,970 ============ 13. Postretirement Benefits First Federal sponsors a defined benefit postretirement plan that is intended to supplement Medicare coverage for certain retirees who meet minimum years of service requirements. Persons who retired prior to April 1, 1997 who completed 20 years of service after age 40 receive full medical coverage at no cost. Such coverage continues for surviving spouses of those participants for one year, after which coverage may be continued provided the spouse pays 50% of the average cost. Persons retiring after April 1, 1997 are provided medical benefits at a cost based on their combined age and years of service at retirement. Surviving spouses are also eligible for continued coverage after the retiree is deceased at a subsidy level that is 10% less than what the retiree is eligible for. Persons retiring before July 1, 1997 receive dental and vision care in addition to medical coverage. Persons who retire after July 1, 1997 are not eligible for dental or vision care, but those retirees and their spouses each receive up to $200 annually in a medical spending account. Funds in that account may be used for payment of uninsured medical expenses. Persons who were born after December 31, 1950 are not eligible for the medical coverage described above at retirement. Rather, a medical spending account of up to $10,000 (based on the participant's age and years of service) will be established to reimburse medical expenses for those individuals. 89 13. Postretirement Benefits (continued) The plan is not currently funded. The following table summarizes benefit obligation and plan asset activity for the plan: December 31 2001 2000 ------------------- (In Thousands) Change in fair value of plan assets: Balance at beginning of measurement period $ - $ - Employer contribution 60 67 Participant contribution 5 4 Benefits paid (65) (71) ------------------- Balance at end of measurement period - - Change in benefit obligation: Balance at beginning of measurement period 789 752 Service cost 22 34 Interest costs 45 47 Participant contribution 5 4 Plan amendments 13 - Actuarial losses 238 23 Benefits paid (65) (71) ------------------- Balance at end of measurement period 1,047 789 ------------------- Unfunded status 1,047 789 Unrecognized prior service cost (56) (47) Unrecognized net (loss)gain (102) 111 ------------------- Accrued postretirement benefit obligation included in accrued interest and other expenses in consolidated statement of financial condition $ 889 $853 =================== 90 13. Postretirement Benefits (continued) Net periodic postretirement benefit cost includes the following components: Years ended December 31 2001 2000 1999 --------------------------- (In Thousands) Service cost-benefits attributable to service during the period $ 22 $ 34 $ 34 Interest cost on accumulated postretirement benefit obligation 45 47 45 Net amortization and deferral 29 1 - --------------------------- Net periodic postretirement benefit cost $ 96 $ 82 $ 79 =========================== The assumed annual rate of increase in the per capita cost of covered health care benefits were assumed is 8.00% for 2002 gradually trending downward to 5.00% by the year 2008. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rate by 1 percentage point for each year would increase the accumulated postretirement benefit obligation as of December 31, 2001 by $137,000 and the aggregate of the service and interest cost for the year then ended by $15,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% for 2001 and 6.5% for 2000 and 1999. 14. Regulatory Matters First Defiance and First Federal are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the consolidated financial statements. Under capital guidelines and the regulatory framework for prompt corrective action, First Federal must meet specific capital guidelines that involve quantitative measures of First Federal's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. First Federal's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. 91 14. Regulatory Matters (continued) Quantitative measures established by regulation to ensure capital adequacy require First Federal to maintain minimum amounts and ratios of Tier I and total capital to risk-weighted assets and of Tier I capital to average assets. As of December 31, 2001 and 2000, First Federal meets all capital adequacy requirements to which it is subject. The most recent notification from the Office of Thrift Supervision categorized First Federal as well capitalized under the regulatory framework. The following schedule presents First Federal's regulatory capital ratios:
Regulatory Capital Standards --------------------------------------------------------- Actual Required --------------------------------------------------------- Amount Ratio Amount Ratio --------------------------------------------------------- (In Thousands, except percentages) As of December 31, 2001: Tangible Capital $ 70,568 6.59% $ 16,067 1.50% Core Capital 70,568 6.59% 42,845 4.00% Risk-Based Capital 79,600 11.03% 57,748 8.00% As of December 31, 2000: Tangible Capital $ 62,569 6.10% $ 15,381 1.5% Core Capital 62,569 6.10% 41,016 4.0% Risk-Based Capital 71,210 10.28% 55,410 8.0%
92 15. Income Taxes The components of income tax expense (credit) are as follows:
Years ended December 31 2001 2000 1999 ----------------------------------------------- (In Thousands) Current: Federal $ 9,920 $ 6,077 $ 4,571 State and local 3 - - Deferred (credit) (2,340) (163) 58 ----------------------------------------------- $ 7,583 $ 5,914 $ 4,629 ===============================================
The provision for income taxes differs from that computed at the statutory corporate tax rate as follows:
Years ended December 31 2001 2000 1999 ----------------------------------------------- (In Thousands) Tax expense at statutory rate $ 7,418 $ 5,906 $ 4,507 Increases (decreases) in taxes from: Goodwill amortization 256 256 249 State income tax--net of federal tax - benefit 2 - Tax exempt interest income (183) (119) (103) Other 90 (129) (24) ----------------------------------------------- Totals $ 7,583 $ 5,914 $ 4,629 ===============================================
93 15. Income Taxes (continued) Deferred federal income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of First Defiance's deferred federal income tax assets and liabilities are as follows:
December 31 2001 2000 ------------------------- ------------------------- (In Thousands) Deferred federal income tax assets: Net unrealized losses on available-for-sale securities $ -- $ -- Allowance for loan losses 3,628 3,227 Postretirement benefit costs 311 299 Deferred compensation and management recognition plans 649 723 State income tax 21 22 Other 434 189 -------------------------- Total deferred federal income tax assets 5,043 4,460 Deferred federal income tax liabilities: Net unrealized gains on available-for-sale securities 411 22 Mortgage servicing rights 2,895 5,081 FHLB stock dividends 1,792 1,423 Deferred loan origination fees and costs (net) 176 116 Fixed assets 379 358 Other 94 71 -------------------------- Total deferred federal income tax liabilities 5,747 7,071 -------------------------- Net deferred federal income tax liability $ (704) $(2,611) ==========================
No valuation allowance was required at December 31, 2001 or 2000. 94 15. Income Taxes (continued) Retained earnings at December 31, 2001 include financial statement tax bad debt reserves of $10.14 million. The Small Business Job Protection Act of 1996 passed on August 20, 1996 eliminated the special bad debt deduction previously granted solely to thrifts. This results in the recapture of past taxes for permanent deductions arising from the "applicable excess reserve," which is the total amount of First Federal's reserve over its base year reserve as of December 31, 1987. The recapture tax is due in six equal annual installments beginning after December 31, 1996. However, deferral of those payments was permitted for up to two years, contingent upon satisfying a specified mortgage origination test for 1997 and 1998 (which was met). At December 31, 2001, First Federal had $415,000 in excess of the base year reserves. Deferred taxes have been provided related to this item. No provision is required to be made for the $9.52 million of base year reserves. 16. Employee Benefit Plans Employees of First Defiance are eligible to participate in the First Defiance Financial Corp. 401(k) Employee Savings Plan (First Defiance 401(k)) if they meet certain age and service requirements. Under the First Defiance 401(k), First Defiance matches 50% of the participants' contributions, to a maximum of 3% of compensation. The First Defiance 401(k) also provides for a discretionary First Defiance contribution in addition to the First Defiance matching contribution. For the year ended December 31, 2001, First Defiance's matching contribution was $303,000 and the discretionary company contribution was $366,000. For the year ended December 31, 2000, First Defiance's matching contribution was $274,000 and the discretionary company contribution was $709,000. For the year ended December 31, 1999, First Defiance's matching contribution was $171,000 and the discretionary contribution was $419,000. 95 16. Employee Benefit Plans (continued) The Leader sponsored The Leader Mortgage Company Savings and Investment Plan and Trust (The Leader 401(k)). All employees of The Leader who met certain age and eligibility requirements were eligible to participate. The Leader matched employee contributions to The Leader 401(k) 100% up to federally proscribed limits. Matching contributions to The Leader 401(k) from January 1, 1999 to March 31, 1999 amounted to $70,000. Effective April 1, 1999, The Leader 401(k) was merged into the First Defiance 401(k), with all assets and liabilities of The Leader 401(k) becoming assets and liabilities of the First Defiance 401(k). First Insurance and Investments sponsored the Stauffer-Mendenhall Agency Employees Retirement Savings Plan. (First Insurance 401(k)). All employees who met certain age and eligibility requirements were eligible to participate. First Insurance matched employee contributions to the First Insurance 401(k) 10% up to federally proscribed limits. Matching contributions to the First Insurance 401(k) from January 1, 1999 to September 30, 1999 amounted to $3,000. Effective October 1, 1999, the First Insurance 401(k) was merged into the First Defiance 401(k), with all assets and liabilities of the First Insurance 401(k) becoming assets and liabilities of the First Defiance 401(k). First Defiance also has established an Employee Stock Ownership Plan (ESOP) covering all employees of First Defiance age 21 or older who have at least one year of credited service. Contributions to the ESOP are made by First Defiance and are determined by First Defiance's Board of Directors at their discretion. The contributions may be made in the form of cash or First Defiance common stock. The annual contributions may not be greater than the amount deductible for federal income tax purposes and cannot cause First Federal to violate regulatory capital requirements. To fund the plan, the ESOP borrowed funds from First Defiance for the purpose of purchasing shares of First Defiance common stock. The ESOP acquired a total of 863,596 shares in 1993 and 1995. The loan outstanding at December 31, 2001 was $3,626,000. Principal and interest payments on the loan are due in equal quarterly installments through June of 2008. The loan is collateralized by the shares of First Defiance's common stock and is repaid by the ESOP with funds from the Company's contributions to the ESOP, dividends on unallocated shares and earnings on ESOP assets. 96 16. Employee Benefit Plans (continued) As principal and interest payments on the loan are paid, shares are released from collateral and committed for allocation to active employees, based on the proportion of debt service paid in the year. Shares held by the ESOP which have not been released for allocation are reported as stock acquired by the ESOP plan in the statement of financial condition. As shares are released, First Defiance records compensation expense equal to the average fair value of the shares over the period in which the shares were earned. Also, the shares released for allocation are included in the average shares outstanding for earnings per share computations. Dividends on allocated shares are recorded as a reduction of retained earnings and dividends on unallocated shares are recorded as additional ESOP expense. ESOP compensation expense was $523,000, $328,000 and $470,000 for 2001, 2000 and 1999, respectively. As of December 31, 2001, 548,223 ESOP shares have been released for allocation of which 536,026 were allocated to participants. The 315,373 unreleased shares have a fair value of $4.8 million at December 31, 2001. The Shareholders of First Defiance approved and established Management Recognition Plans (MRP) in 1993 and 1996 to provide directors, officers and employees with a proprietary interest in First Defiance as incentive to contribute to its success. Cash was contributed to the MRP in the form of deferred compensation amounting to $800,000 in 1993 and $2,817,452 in 1996. The $800,000 contributed in 1993 was used to purchase 172,722 shares of First Defiance common stock. All shares acquired in 1993 were granted on July 19, 1993. All 259,076 of the shares acquired in 1996 have been granted as of December 31, 2001, not including 46,877 shares forfeited by participants who terminated before their shares vested. The shares vest at a rate of 20% per year over five years. First Defiance is amortizing the deferred compensation and recording additions to stockholder's equity as the shares vest. Compensation expense attributable to the MRP amounted to $121,000, $255,000 and $385,000 in 2001, 2000 and 1999 respectively. 97 17. Stock Option Plans First Defiance has established incentive stock option plans for its directors and its employees and has reserved 1,376,485 shares of common stock for issuance under the plans. A total of 1,116,204 shares are reserved for employees and 260,281 shares are reserved for directors. As of December 31, 2001, 975,782 options (804,701 for employees and 171,081 for directors) have been granted and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. There are 158,997 options granted under the 1993 plan that are currently exercisable, 590,785 options granted under the 1996 plan that vest at 20% per year beginning in 1997 of which 497,158 are fully vested and currently exercisable and 226,000 options granted under the 2001 plan which vest at 20% per year beginning in 2002. All options expire ten years from date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or five years after the retirement date for the 1993 and 2001 plans and on the earlier of the scheduled expiration date or twelve months after the retirement date for the 1996 plan. There are 62,000 unvested options held by employees of The Leader at exercise prices ranging from $11.75 to $14.00 that will vest upon the closing of the sale transaction. FASB Statement No. 123, Accounting for Stock-Based Compensation defines a fair value-based method of accounting for stock-based employee compensation plans. Under the fair value-based method, compensation cost is measured at the grant date based upon the value of the award and is recognized over the service period. While the standard encourages entities to adopt this method of accounting for employee stock compensation plans, it also allows an entity to continue to measure compensation costs for its plans as prescribed in APB Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. First Defiance has elected to continue to apply APB 25. 98 17. Stock Option Plans (continued) The following pro forma information regarding net income and earnings per share assumes the adoption of Statement No. 123 for stock options. The estimated fair value of the option is 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:
December 31 2001 2000 1999 ------------------------------------------------------ Risk free interest rate 5.70% 6.00% 5.56% Dividend yield 3.01% 4.80% 2.49% Volatility factors of expected market price of stock 0.268% 0.281% 0.267% Weighted average expected life 8.65 years 7.48 years 7.49 years Weighted average grant date fair value of options granted $ 3.38 $ 3.47 $ 3.48
Based upon the above assumptions, pro forma net income and earnings per share are as follows:
Years ended December 31 2001 2000 1999 ------------------------------------------------------ Pro forma net income $ 13,396 $ 10,616 $ 8,310 ====================================================== Pro forma earnings per share: Basic $ 2.07 $ 1.68 $ 1.28 ====================================================== Diluted $ 2.01 $ 1.65 $ 1.25 ======================================================
The pro forma effects for 2001, 2000 and 1999 are not likely to be representative of the pro forma effects for future years. Because Statement No. 123 is applicable only to options granted subsequent to December 31, 1994, options granted prior to December 31, 1994 do not have fair value pro forma information provided. 99 17. Stock Option Plans (continued) The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because First Defiance's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The following table summarizes stock option activity for 2001 and 2000
2001 2000 ------------------------------------------------------------------------- Range of Range of Option Option Option Option Shares Prices Shares Prices ------------------------------------------------------------------------- Outstanding at January 1 787,888 $4.63 to $15.50 871,426 $4.63 to $15.50 Granted 234,000 $14.00 to $14.05 2,543 $8.25 to $10.516 Exercised (41,106) $4.63 to $14.00 (80,081) $4.63 Expired or canceled (5,000) $11.75 to $14.00 (6,000) $10.50 to $15.50 ------------------------------------------------------------------------- Outstanding at December 31 975,782 $4.63 to $15.50 787,888 $4.63 to $15.50 ========================================================================= Exercisable to: 2001 -- -- 500 $11.75 2002 13,000 $4.63 26,000 $ 4.63 2003 50,581 $4.63 53,697 $ 4.63 2004 -- -- 21,590 $ 6.95 2006 430,104 $10.375 to $10.6875 430,504 $10.375 to $10.6875 2007 68,966 $12.625 to $13.00 68,966 $12.625 to $13.00 2008 129,702 $12.25 to $15.50 137,202 $12.25 to $15.50 2009 46,886 $11.25 to $11.75 46,886 $11.25 to $11.75 2010 2,543 $8.25 to $10.516 2,543 $8.25 to $10.516 2011 234,000 $14.00 to $14.05 -- -- ------------------------------------------------------------------------- 975,782 $4.63 to $15.50 787,888 $4.63 to $15.50 ========================================================================= Available for future grant at December 3l 128,364 14,364 =========================================================================
100 18. Parent Company and Regulatory Restrictions Dividends paid by First Federal to First Defiance are subject to various legal and regulatory restrictions. First Federal can initiate dividend payments in 2002, without prior regulatory approval, of $10.9 million, plus an additional amount equal to their net profits for 2002, as defined by statute, up to the date of any such dividend declaration. There were no dividends declared in 2001. Condensed parent company financial statements, which include transactions with subsidiaries, follow:
December 31 Statements of Financial Condition 2001 2000 ------------------------------- (In Thousands) Assets Cash and cash equivalents $ 156 $ 1,056 Investment securities, available for sale, carried at fair value 87 106 Investment in subsidiaries 126,182 110,237 Loan receivable from First Defiance Employee Stock Ownership Plan 3,706 4,008 Other assets 142 102 ------------------------------- Total assets $ 130,273 $ 115,509 =============================== Liabilities and stockholders' equity Notes payable $ 18,250 $ 15,000 Accrued liabilities 1,002 1,036 Stockholders' equity 111,021 99,473 ------------------------------- Total liabilities and stockholders' equity $ 130,273 $ 115,509 ===============================
101 18. Parent Company and Regulatory Restrictions (continued)
Years ended December 31 Statements of Income 2001 2000 1999 ------------------------------------------------------ (In Thousands) Interest on subordinated debt $ -- $ -- $ 895 Interest on loan to ESOP 330 362 392 Interest expense on notes payable (953) (624) (5) Other income 2 20 25 Noninterest expense (638) (629) (758) ------------------------------------------------------ (Loss) income before income taxes and equity in earnings of subsidiaries (1,259) (871) 549 Income tax (credit) expense (440) (316) 343 ------------------------------------------------------ (Loss) income before equity in earnings of subsidiaries (819) (555) 206 Equity in earnings of subsidiaries 14,435 11,518 8,417 ------------------------------------------------------ Net income $ 13,616 $ 10,963 $ 8,623 ======================================================
102 18. Parent Company and Regulatory Restrictions (continued)
Years ended December 31 Statements of Cash Flows 2001 2000 1999 ------------------------------------------- (In Thousands) Operating activities: Net income $ 13,616 $ 10,963 $ 8,623 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Provision for depreciation -- 6 7 (Gain) loss on sale of office properties and equipment -- (6) 29 Deferred federal income taxes (credit) -- 28 (19) Equity in earnings of subsidiaries (14,435) (11,518) (8,417) Dividends received from subsidiary -- 750 -- Change in other assets and liabilities (136) (563) 825 ------------------------------------------- Net cash (used in) provided by operating activities (955) (340) 1,048 Investing activities Proceeds from sale of office properties and equipment -- 569 416 Principal payments received for subordinated debt -- -- 22,400 Principal payments received on ESOP loan 302 349 321 Purchase of available-for-sale securities -- -- (70) Purchase of premises and equipment -- (17) (1,004) ------------------------------------------- Net cash provided by investing activities 302 901 22,063 Financing activities Proceeds from short term notes payable 3,250 15,000 -- Stock options exercised 360 470 417 Purchase of common stock for treasury (748) (328) (10,394) Capital contribution to subsidiaries -- (11,952) (11,080) Cash dividends paid (3,109) (2,832) (2,692) ------------------------------------------- Net cash (used in) provided by financing activities (247) 358 (23,749) ------------------------------------------- Net (decrease) increase in cash and cash equivalents (900) 919 (638) Cash and cash equivalents at beginning of year 1,056 137 775 ------------------------------------------- Cash and cash equivalents at end of year $ 156 $ 1,056 $ 137 =========================================== Non cash operating activities--change in deferred taxes on net unrealized (losses) gains on available-for-sale $ 6 $ (13) $ 1 securities =========================================== Non cash investing activities--change in net unrealized gain (loss) on available-for-sale securities $ (19) $ 39 $ (3) =========================================== Non cash financing activities--cash dividends declared but not paid $ 848 $ 778 $ 703 ===========================================
103 19. Fair Value Statement of Consolidated Financial Condition The following is a comparative condensed consolidated statement of financial condition based on carrying and estimated fair values of financial instruments as of December 31, 2001 and 2000. FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance Financial Corp. Much of the information used to arrive at "fair value" is highly subjective and judgmental in nature and therefore the results may not be precise. Subjective factors include, among other things, estimated cash flows, risk characteristics and interest rates, all of which are subject to change. With the exception of investment securities, the Company's financial instruments are not readily marketable and market prices do not exist. Since negotiated prices for the instruments, which are not readily marketable depend greatly on the motivation of the buyer and seller, the amounts that will actually be realized or paid per settlement or maturity of these instruments could be significantly different. The carrying amount of cash and cash equivalents, warehouse and term notes payable and advance payments by borrowers for taxes and insurance, as a result of their short-term nature, is considered to be equal to fair value. For investment securities, fair value has been based or current market quotations. If market prices are not available, fair value has been estimated based upon the quoted price of similar instruments. The fair value of loans which reprice within 90 days is equal to their carrying amount. For other loans, the estimated fair value is calculated based on discounted cash flow analysis, using interest rates currently being offered for loans with similar terms. The fair value of loans have not been adjusted for credit risk. SFAS No. 107 requires that the fair value of demand, savings, NOW and certain money market accounts be equal to their carrying amount. The Company believes that the fair value of these deposits is greater than that prescribed by SFAS No. 107. For deposits with fixed maturities, fair value is estimated based on interest rates currently being offered on deposits with similar characteristics and maturities. FHLB advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using interest rates currently being quoted for similar characteristics and maturities. 104 19. Fair Value Statement of Consolidated Financial Condition (continued) The cost or value of any call or put options are based on the estimated cost to settle the option at December 31, 2001.
December 31, 2001 December 31, 2000 -------------------------------- -------------------------------- Carrying Estimated Carrying Estimated Value Fair Values Value Fair Values ------------------------------------------------------------------ (In Thousands) Assets: Cash and cash equivalents $ 36,116 $ 36,116 $ 20,954 $ 20,954 Investment securities 54,569 54,667 61,107 61,180 Loans, net 793,552 813,447 773,522 766,476 ------------------------------------------------------------------ 884,237 $ 904,230 855,583 $ 848,610 ================ ================= Other assets 248,376 216,611 ----------------- ---------------- Total assets $ 1,132,613 $ 1,072,194 ================= ================ Liabilities and stockholders' equity: Deposits $ 631,450 $ 634,680 $ 545,899 $ 545,607 Advances from Federal Home Loan Bank 196,302 208,646 223,258 221,976 Warehouse and term notes payable 54,587 54,587 120,425 120,425 Advance payments by borrowers for taxes and insurance 123,154 123,154 67,982 67,982 ------------------------------------------------------------------ 1,005,493 $ 1,021,067 957,564 $ 955,990 ================ ================= Other liabilities 16,099 15,157 ----------------- ---------------- 1,021,592 972,721 Stockholders' equity 111,021 99,473 ----------------- ---------------- Total liabilities and stockholders' equity $ 1,132,613 $ 1,072,194 ================= ================
105 20. 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, commercial lending 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 accounting policies of the individual business units are the same as those of First Defiance as described in Note 3. 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 & Investments and inter-segment income eliminations and unallocated expenses.
2001 ---------------------------------------------------------------------- Retail Mortgage Consolidated Parent Banking Banking ---------------------------------------------------------------------- (In Thousands) Total interest income $ 65,864 $ (15,641) $ 61,708 $ 19,797 Total interest expense 38,886 (15,017) 41,985 11,918 ---------------------------------------------------------------------- Net interest income 26,978 (624) 19,723 7,879 Provision for loan losses 3,870 -- 993 2,877 ---------------------------------------------------------------------- Net interest income after provision 23,108 (624) 18,730 5,002 Non-interest income 66,431 2,123 7,174 57,134 Non-interest expense 68,340 2,873 18,289 47,178 ---------------------------------------------------------------------- Income before income taxes 21,199 (1,374) 7,615 14,958 Income taxes 7,583 (463) 2,544 5,502 ---------------------------------------------------------------------- Net income $ 13,616 $ (911) $ 5,071 $ 9,456 ====================================================================== Total assets $ 1,132,613 $ (400,745) $ 1,027,685 $ 505,673 ======================================================================
106 20. Line of Business Reporting (continued)
2000 ---------------------------------------------------------------------- Retail Mortgage Consolidated Parent Banking Banking ---------------------------------------------------------------------- (In Thousands) Total interest income $ 65,185 $ (19,566) $ 66,022 $ 18,729 Total interest expense 43,502 (19,292) 45,110 17,684 ---------------------------------------------------------------------- Net interest income 21,683 (274) 20,912 1,045 Provision for loan losses 3,147 -- 635 2,512 ---------------------------------------------------------------------- Net interest income after provision 18,536 (274) 20,277 (1,467) Non-interest income 53,246 2,300 4,252 46,694 Non-interest expense 54,905 2,840 17,226 34,839 ---------------------------------------------------------------------- Income before income taxes 16,877 (814) 7,303 10,388 Income taxes 5,914 (241) 2,285 3,870 ---------------------------------------------------------------------- Net income $ 10,963 $ (573) $ 5,018 $ 6,518 ====================================================================== Total assets $ 1,072,194 $ (310,186) $ 958,607 $ 423,773 ====================================================================== 1999 ---------------------------------------------------------------------- Retail Mortgage Consolidated Parent Banking Banking ---------------------------------------------------------------------- (In Thousands) Total interest income $ 53,379 $ (13,960) $ 54,388 $ 12,951 Total interest expense 31,582 (15,231) 35,657 11,156 ---------------------------------------------------------------------- Net interest income 21,797 1,271 18,731 1,795 Provision for loan losses 1,925 6 149 1,770 ---------------------------------------------------------------------- Net interest income after provision 19,872 1,265 18,582 25 Non-interest income 40,794 1,039 3,747 36,008 Non-interest expense 47,414 1,824 16,023 29,567 ---------------------------------------------------------------------- Income before income taxes 13,252 480 6,306 6,466 Income taxes 4,629 374 1,850 2,405 ---------------------------------------------------------------------- Net income $ 8,623 $ 106 $ 4,456 $ 4,061 ====================================================================== Total assets $ 987,994 $ (362,172) $ 926,139 $ 424,027 ======================================================================
107 21. Quarterly Consolidated Results of Operations (Unaudited) The following is a summary of the quarterly consolidated results of operations:
Three Months Ended ------------------------------------------------------------------------ 2001 March 31 June 30 September 30 December 31 ------------------------------------------------------------------------ (In Thousands, except per share amounts) Interest income $ 16,431 $ 16,294 $ 16,901 $ 16,238 Interest expense 11,138 9,749 9,540 8,459 ------------------------------------------------------------------------ Net interest income 5,293 6,545 7,361 7,779 Provision for loan losses 773 631 1,200 1,266 ------------------------------------------------------------------------ Net interest income after provision for loan losses 4,520 5,914 6,161 6,513 Loss on sale of securities (45) (15) (45) (32) Non-interest income 15,311 14,848 16,306 20,103 Non-interest expense 15,107 16,683 17,876 18,675 ------------------------------------------------------------------------ Income before income taxes 4,679 4,064 4,546 7,909 Income taxes 1,624 1,478 1,576 2,904 ------------------------------------------------------------------------ Net income $ 3,055 $ 2,586 $ 2,970 $ 5,005 ======================================================================== Earnings per share: Basic $ 0.48 $ 0.40 $ 0.46 $ 0.77 ======================================================================== Diluted $ 0.47 $ 0.39 $ 0.45 $ 0.75 ======================================================================== Average shares outstanding: Basic 6,366 6,394 6,405 6,489 ======================================================================== Diluted 6,536 6,603 6,601 6,643 ========================================================================
108 21. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three Months Ended ------------------------------------------------------------------------ 2000 March 31 June 30 September 30 December 31 ------------------------------------------------------------------------ (In Thousands, except per share amounts) Interest income $ 15,830 $ 15,359 $ 16,911 $ 17,085 Interest expense 9,642 10,225 11,687 11,948 ------------------------------------------------------------------------ Net interest income 6,188 5,134 5,224 5,137 Provision for loan losses 1,408 581 539 619 ------------------------------------------------------------------------ Net interest income after provision for loan losses 4,780 4,553 4,685 4,518 Loss on sale of securities -- -- (29) (29) Non-interest income 11,843 13,118 14,060 14,283 Non-interest expense 13,249 13,814 13,944 13,898 ------------------------------------------------------------------------ Income before income taxes 3,374 3,857 4,772 4,874 Income taxes 1,173 1,399 1,604 1,738 ------------------------------------------------------------------------ Net income $ 2,201 $ 2,458 $ 3,168 $ 3,136 ======================================================================== Earnings per share: Basic $ 0.35 $ 0.39 $ 0.50 $ 0.49 ======================================================================== Diluted $ 0.35 $ 0.38 $ 0.49 $ 0.49 ======================================================================== Average shares outstanding: Basic 6,232 6,305 6,367 6,373 ======================================================================== Diluted 6,376 6,407 6,451 6,465 ========================================================================
109 Report of Independent Auditors To the Stockholders and the Board of Directors First Defiance Financial Corp. We have audited the consolidated statements of financial condition of First Defiance Financial Corp. as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Defiance Financial Corp. at December 31, 2001 and 2000, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. /s/Ernst & Young LLP Cleveland, Ohio January 18, 2002 110 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant The information required herein is incorporated by reference from pages 6 through 12 of the definitive proxy statement dated March 20, 2002. Item 11. Executive Compensation The information required herein is incorporated by reference from the Executive Compensation section beginning on page 14, the Stock Options section on page 16, the Directors' Compensation section on page 19, and the Employment Agreements section on pages 19 and 20 of the definitive proxy statement dated March 20, 2002. Item 12. Security Ownership of Certain Beneficial Owners and Management The information required herein is incorporated by reference from the Beneficial Ownership section beginning on page 3 of the definitive proxy statement dated March 20, 2002. Item 13. Certain Relationships and Related Transactions The information required herein is incorporated by reference from the Indebtedness of Management section on page 20 of the definitive proxy statement dated March 20, 2002. 111 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) (1) Financial Statements The following consolidated financial statements are filed as a part of this document under "Item 8. Financial Statements and Supplementary Data." Consolidated Statements of Financial Condition as of December 31, 2001 and 2000 Consolidated Statements of Income for the years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Stockholders' Equity for the years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows for the years Ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements Independent Auditor's Report (a) (2) Financial Statement Schedules All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are included in the Notes to Financial Statements incorporated herein by reference and therefore have been omitted. 112 (a) (3) Exhibits The following exhibits are either filed as a part of this report or are incorporated herein by reference to documents previously filed as indicated below:
Exhibit Number Description ----------------------------------------------------------------------------------------------------------- 3.1 Articles of Incorporation * 3.2 Code of Regulations * 3.2 Bylaws * 10.1 1996 Stock Option Plan ** 10.2 1996 Management Recognition Plan and Trust ** 10.3 2001 Stock Option and Incentive Plan *** 10.4 1993 Stock Incentive Plan * 10.5 1993 Directors' Stock Option Plan * 10.6 Employment Agreement with William J. Small **** 10.7 Employment Agreement with James L. Rohrs ** 10.8 Employment Agreement with John C. Wahl ** 13 Annual Report to Shareholders and Notice of Annual Meeting of Shareholders and Proxy Statement ** 21 List of Subsidiaries of the Company ** 23 Consent of Independent Auditors **
* Incorporated herein by reference to the like numbered exhibit in the Registrant's Form S-1 (File No. 33-93354). ** Included herein. *** Incorporated herein by reference to Appendix B to the 2001 Proxy Statement **** Incorporated herein by reference to Exhibit 10.6 to the 2001 Form 10-K (b) Reports on Form 8-K First Defiance Financial Corp. filed a report on Form 8-K with the Securities and Exchange Commission as of January 24, 2002 which announced that it had entered into a Purchase and Sale Agreement with U.S. Bank National Association ("U.S. Bank") for the sale of The Leader Mortgage Company, LLC, a wholly owned subsidiary of First Federal, to U.S. Bank. 113 SIGNATURES Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST DEFIANCE FINANCIAL CORP. March 20, 2002 By: /s/ William J. Small -------------------- William J. Small Chairman, President, CEO Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 20, 2002. Signature Title /s/ William J. Small Chairman of the Board, President and --------------------------- William J. Small CEO /s/ John C. Wahl Executive Vice President and CFO --------------------------- John C. Wahl /s/ Don C. Van Brackel Director, Vice Chairman --------------------------- Don C. Van Brackel /s/ Stephen L. Boomer Director --------------------------- Stephen L. Boomer /s/ Dr. Douglas A. Burgei Director --------------------------- Dr. Douglas A. Burgei /s/ Peter A. Diehl Director --------------------------- Peter A. Diehl /s/ Dr. John U. Fauster, III Director --------------------------- Dr. John U. Fauster, III /s/ Dr. Marvin J. Ludwig Director --------------------------- Dr. Marvin J. Ludwig /s/ Gerald W. Monnin Director --------------------------- Gerald W. Monnin /s/ Thomas A. Voigt Director --------------------------- Thomas A. Voigt 114