0001144204-14-028602.txt : 20140508 0001144204-14-028602.hdr.sgml : 20140508 20140508160200 ACCESSION NUMBER: 0001144204-14-028602 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 20140331 FILED AS OF DATE: 20140508 DATE AS OF CHANGE: 20140508 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST DEFIANCE FINANCIAL CORP CENTRAL INDEX KEY: 0000946647 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 341803915 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-26850 FILM NUMBER: 14824817 BUSINESS ADDRESS: STREET 1: 601 CLINTON ST CITY: DEFIANCE STATE: OH ZIP: 43512 BUSINESS PHONE: 4107825015 MAIL ADDRESS: STREET 1: 601 CLINTON ST CITY: DEFIANCE STATE: OH ZIP: 43512 10-Q 1 v377064_10q.htm 10-Q

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the Quarterly Period Ended March 31, 2014

 

OR

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the Transition Period from ___________to__________

 

Commission file number 0-26850

 

  First Defiance Financial Corp.  
(Exact name of registrant as specified in its charter)

 

Ohio       34-1803915
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)

 

601 Clinton Street, Defiance, Ohio     43512
(Address of principal executive office)   (Zip Code)

 

Registrant's telephone number, including area code: (419) 782-5015

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by 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 whether the registrant submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x    No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    ¨ Accelerated filer    x
Non-accelerated filer      ¨ Smaller reporting company      ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes     ¨ No x

 

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value – 9,665,100 shares outstanding at April 30, 2014.

 

 
 

 

FIRST DEFIANCE FINANCIAL CORP.

 

INDEX

 

    Page Number
PART I.-FINANCIAL INFORMATION  
     
Item 1. Consolidated Condensed Financial Statements (Unaudited):  
  Consolidated Condensed Statements of Financial Condition – March 31, 2014 and December 31, 2013 2
     
  Consolidated Condensed Statements of Income - Three months ended March 31, 2014 and 2013 4
     
  Consolidated Condensed Statements of Comprehensive Income – Three months ended March 31, 2014 and 2013 5
     
  Consolidated Condensed Statements of Changes in Stockholders’ Equity – Three months ended March 31, 2014 and 2013 6
     
  Consolidated Condensed Statements of Cash Flows - Three months ended March 31, 2014 and 2013 7
     
  Notes to Consolidated Condensed Financial Statements 8
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 45
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 64
     
Item 4. Controls and Procedures 65
     
PART II-OTHER INFORMATION:  
     
Item 1. Legal Proceedings 66
     
Item 1A. Risk Factors 66
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 66
     
Item 3. Defaults upon Senior Securities 66
     
Item 4. Mine Safety Disclosures 66
     
Item 5. Other Information 66
     
Item 6. Exhibits 67
     
  Signatures 68

 

1
 

 

PART I-FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

(Amounts in Thousands, except share and per share data)

 

 

   March 31,
2014
   December 31,
2013
 
         
Assets          
Cash and cash equivalents:          
Cash and amounts due from depository institutions  $42,183   $36,318 
Federal funds sold   169,000    143,000 
    211,183    179,318 
Securities:          
Available-for-sale, carried at fair value   209,321    198,170 
Held-to-maturity, carried at amortized cost (fair value $383 and $393 at March 31, 2014 and December 31, 2013, respectively)   378    387 
    209,699    198,557 
Loans held for sale   8,771    9,120 
Loans receivable, net of allowance of $24,783 at March 31, 2014 and $24,950 at December 31, 2013, respectively   1,539,170    1,555,498 
Accrued interest receivable   6,122    5,778 
Federal Home Loan Bank stock   13,802    19,350 
Bank owned life insurance   46,934    42,715 
Premises and equipment   38,379    38,597 
Real estate and other assets held for sale   6,028    5,859 
Goodwill   61,525    61,525 
Core deposit and other intangibles   3,208    3,497 
Mortgage servicing rights   9,014    9,106 
Deferred taxes   92    565 
Other assets   9,732    7,663 
Total assets  $2,163,659   $2,137,148 

 

(continued)

 

2
 

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

(Amounts in Thousands, except share and per share data)

 

 

   March 31,
2014
   December 31,
2013
 
         
Liabilities and stockholders’ equity          
Liabilities:          
Deposits  $1,760,617   $1,735,792 
Advances from the Federal Home Loan Bank   22,278    22,520 
Subordinated debentures   36,083    36,083 
Securities sold under repurchase agreements   48,939    51,919 
Advance payments by borrowers   1,209    1,519 
Other liabilities   19,656    17,168 
Total liabilities   1,888,782    1,865,001 
           
Stockholders’ equity:          
Preferred stock, $.01 par value per share: 4,963,000 shares authorized; no shares issued        
Common stock, $.01 par value per share: 25,000,000 shares authorized; 12,735,313 and 12,735,313  shares issued and 9,652,966 and 9,719,521 shares outstanding, respectively   127    127 
Common stock warrant   878    878 
Additional paid-in capital   136,142    136,403 
Accumulated other comprehensive income, net of tax of $897 and $294, respectively   1,665    545 
Retained earnings   186,001    182,290 
Treasury stock, at cost, 3,082,347 and 3,015,792 shares respectively   (49,936)   (48,096)
Total stockholders’ equity   274,877    272,147 
           
Total liabilities and stockholders’ equity  $2,163,659   $2,137,148 

 

See accompanying notes

 

3
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Income

(UNAUDITED)

(Amounts in Thousands, except share and per share data)

 

 

   Three Months Ended 
   March 31, 
   2014   2013 
Interest Income          
Loans  $16,651   $16,796 
Investment securities:          
Taxable   775    678 
Non-taxable   752    725 
Interest-bearing deposits   101    58 
FHLB stock dividends   195    219 
Total interest income   18,474    18,476 
Interest Expense          
Deposits   1,358    1,647 
FHLB advances and other   133    90 
Subordinated debentures   146    152 
Securities sold under repurchase agreements   41    60 
Total interest expense   1,678    1,949 
Net interest income   16,796    16,527 
Provision for loan losses   103    425 
Net interest income after provision for loan losses   16,693    16,102 
Non-interest Income          
Service fees and other charges   2,324    2,385 
Insurance commission income   3,030    3,036 
Mortgage banking income   1,247    2,830 
Gain on sale of non-mortgage loans   3    15 
Gain on sale or call of securities   -    53 
Trust income   278    206 
Income from Bank Owned Life Insurance   219    229 
Other non-interest income   225    251 
Total non-interest income   7,326    9,005 
Non-interest Expense          
Compensation and benefits   8,472    8,798 
Occupancy   1,588    1,632 
FDIC insurance premium   385    656 
State franchise tax   495    629 
Data processing   1,365    1,181 
Amortization of intangibles   289    336 
Other non-interest expense   4,067    4,010 
Total non-interest expense   16,661    17,242 
Income before income taxes   7,358    7,865 
Federal income taxes   2,179    2,306 
Net Income  $5,179   $5,559 
           
Earnings per common share (Note 6)          
Basic  $0.53   $0.57 
Diluted  $0.51   $0.55 
Dividends declared per share (Note 5)  $0.15   $0.10 
Average common shares outstanding (Note 6)          
Basic   9,681    9,736 
Diluted   10,108    10,105 

 

See accompanying notes

 

4
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Comprehensive Income

(UNAUDITED)

(Amounts in Thousands)

 

 

   Three Months Ended
March 31,
 
   2014   2013 
     
Net income  $5,179   $5,559 
           
Other comprehensive income (loss):          
Unrealized gains (losses) on securities available for sale   1,723    (664)
Reclassification adjustment for security gains included in net income(1)   -    (53)
Income tax benefit (expense)   (603)   251 
Other comprehensive income (loss)   1,120    (466)
           
Comprehensive income  $6,299   $5,093 

 

(1) Amounts are included in gains on sale or call of securities on the Consolidated Condensed Statements of Income. Income tax expense associated with the reclassification adjustments, included in federal income taxes, for the three months ended March 31, 2014 and 2013 was $0 and $13, respectively.

 

5
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statement of Changes in Stockholders’ Equity

(Amounts in Thousands, except number of shares)

 

                   Accumulated             
           Common   Additional   Other           Total 
   Preferred   Common   Stock   Paid-In   Comprehensive   Retained   Treasury   Stockholder’s 
   Stock   Stock   Warrant   Capital   Income (Loss)   Earnings   Stock   Equity 
                                 
Balance at January 1, 2014  $-   $127   $878   $136,403   $545   $182,290   $(48,096)  $272,147 
Net income                            5,179         5,179 
Other comprehensive income                       1,120              1,120 
Stock option expense                  20                   20 
7,050 shares issued under stock option plan, with $17 income tax benefit, net of repurchases                  (11)        (19)   106    76 
Restricted share activity under stock incentive Plans, including 5,767 shares issued                  (270)             93    (177)
78,972 shares repurchased                                 (2,039)   (2,039)
Common stock dividends declared                            (1,449)        (1,449)
Balance at March 31, 2014  $-   $127   $878   $136,142   $1,665   $186,001   $(49,936)  $274,877 
                                         
Balance at January 1, 2013  $-   $127   $878   $136,046   $4,274   $164,103   $(47,300)  $258,128 
Net income                            5,559         5,559 
Other comprehensive loss                       (466)             (466)
Stock option expense                  19                   19 
4,870 shares issued under stock option plan, with no income tax benefit, net of repurchases                  (9)        (81)   142    52 
Restricted share activity under stock incentive Plans, including 31,796 shares issued                  (131)        (45)   500    324 
Common stock dividends declared                            (973)        (973)
Balance at March 31, 2013  $-   $127   $878   $135,925   $3,808   $168,563   $(46,658)  $262,643 

 

6
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(UNAUDITED)

(Amounts in Thousands)

 

 

   Three Months Ended 
   March 31, 
   2014   2013 
Operating Activities          
Net income  $5,179   $5,559 
Items not requiring (providing) cash          
Provision for loan losses   103    425 
Depreciation   725    809 
Amortization of mortgage servicing rights, net of impairment recoveries   299    216 
Amortization of core deposit and other intangible assets   289    336 
Net amortization of premiums and discounts on loans and deposits   160    199 
Amortization of premiums and discounts on securities   93    129 
Change in deferred taxes   (129)   27 
Proceeds from the sale of loans held for sale   27,698    112,112 
Originations of loans held for sale   (28,093)   (99,395)
Gain from sale of loans   (644)   (2,191)
Loss from sale of property and equipment   -    1 
Gain from sale or call of securities   -    (53)
Loss on sale or write-down of real estate and other assets held for sale   (38)   17 
Stock option expense   20    19 
Restricted stock expense (credit)   (177)   324 
Income from bank owned life insurance   (219)   (229)
Changes in:          
Accrued interest receivable   (344)   (431)
Other assets   (2,069)   (383)
Other liabilities   2,489    (1,854)
Net cash provided by operating activities   5,342    15,637 
           
Investing Activities          
Proceeds from maturities of held-to-maturity securities   8    16 
Proceeds from maturities, calls and pay-downs of available-for-sale securities   5,496    13,805 
Proceeds from sale of real estate and other assets held for sale   496    785 
Proceeds from the sale of available-for-sale securities   1,654    1,019 
Proceeds from sale of non-mortgage loans   8,679    3,629 
Purchases of available-for-sale securities   (16,672)   (17,647)
Purchase of bank owned life insurance   (4,000)   - 
Purchase of portfolio mortgage loans   (5,118)   - 
Proceeds from Federal Home Loan stock redemption   5,548    1,301 
Purchases of premises and equipment, net   (507)   (365)
Net decrease in loans receivable   13,058    12,447 
Net cash provided by  investing activities   8,642    14,990 
           
Financing Activities          
Net (decrease) increase in deposits and advance payments by borrowers   24,515    (11,229)
Repayment of Federal Home Loan Bank advances   (242)   (12)
Increase (decrease) in securities sold under repurchase agreements   (2,980)   1,045 
Proceeds from exercise of stock options   76    52 
Net cash paid for repurchase of common stock   (2,039)   - 
Cash dividends paid on common stock   (1,449)   (973)
Net cash provided by (used in) financing activities   17,881    (11,117)
Increase in cash and cash equivalents   31,865    19,510 
Cash and cash equivalents at beginning of period   179,318    136,832 
Cash and cash equivalents at end of period  $211,183   $156,342 
           
Supplemental cash flow information:          
Interest paid  $1,662   $1,923 
Income taxes paid  $-   $3,100 
Transfers from loans to real estate and other assets held for sale  $627   $1,310 

 

See accompanying notes.

 

7
 

 

FIRST DEFIANCE FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

(Unaudited at March 31, 2014 and 2013)

 

 

1.Basis of Presentation

 

First Defiance Financial Corp. (“First Defiance” or the “Company”) is a unitary thrift holding company that, through its subsidiaries, First Federal Bank of the Midwest (“First Federal”), First Insurance Group of the Midwest, Inc. (“First Insurance”), and First Defiance Risk Management Inc. (collectively, the Subsidiaries”), focuses on traditional banking and property and casualty, life and group health insurance products. All significant intercompany transactions and balances are eliminated in consolidation.

 

First Federal is primarily engaged in community banking attracting deposits from the general public 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, non-residential real estate, commercial, home improvement and home equity and consumer loans and providing a broad range of depository, trust and wealth management services. First Insurance is an insurance agency that does business in the Defiance, Bryan, Bowling Green, Maumee and Oregon, Ohio areas, offering property and casualty, group health insurance and life insurance products. First Defiance Risk Management is a wholly-owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.

 

The consolidated condensed statement of financial condition at December 31, 2013 has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K.

 

The accompanying consolidated condensed financial statements as of March 31, 2014 and for the three month periods ended March 31, 2014 and 2013 have been prepared by First Defiance without audit and do not include information or footnotes necessary for the complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance's 2013 Annual Report on Form 10-K for the year ended December 31, 2013. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results for the three month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the entire year.

 

8
 

 

2.Significant Accounting Policies

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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. Significant areas where First Defiance uses estimates are the valuation of certain investment securities, the determination of the allowance for loan losses, the valuation of mortgage servicing rights and goodwill, the determination of unrecognized income tax benefits, and the fair value of financial instruments.

 

Earnings Per Common Share

 

Basic earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for the calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, warrants, restricted stock awards and stock grants.

 

Newly Issued but Not Yet Effective Accounting Standards

 

In January 2014, the FASB issued ASU 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The objective of the amendments in ASU 2014-04 to Topic 310, “Receivables - Troubled Debt Restructurings by Creditors,” is to reduce diversity by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2014. An entity can elect to adopt the amendments using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s Consolidated Financial Statements.

 

9
 

 

3.Fair Value

 

FASB ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

 

FASB ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on the best information available. In that regard, FASB ASC Topic 820 established a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

 

·Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by a correlation or other means.

 

·Level 3: Unobservable inputs for determining fair value of assets and liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

 

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

 

10
 

 

Available for sale securities - Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service that uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include federal agency preferred stock securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, corporate bonds and municipal securities. The Company classifies its pooled trust preferred collateralized debt obligations as Level 1 and Level 3. The portfolio consists of collateralized debt obligations backed by pools of trust preferred securities issued by financial institutions and insurance companies. The two collateralized debt obligations, which are backed by financial institutions, are allowed under the Volcker Rule and classified as Level 3 based on the lack of observable market data, the Company estimated fair values based on the observable data available and reasonable unobservable market data. The Company estimated fair value based on a discounted cash flow model, which used appropriately adjusted discount rates reflecting credit and liquidity risks. The Company used an independent third party, which is described further in Note 7.

 

Impaired loans - Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure.  Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach.  The cost method bases value on the cost to replace the current property.  Value of market comparison approach evaluates the sales price of similar properties in the same market area.  The income approach considers net operating income generated by the property and an investors required return.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell.  Such adjustments made in the appraisal process are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

Real Estate held for sale - Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are then reviewed monthly by members of the asset review committee for valuation changes and are accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which may utilize a single valuation approach or a combination of approaches including cost, comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company.  Once received, a member of the Company’s asset quality or collections department reviews the assumptions and approaches utilized in the appraisal.  Appraisal values are discounted from 0% to 20% to account for other factors that may impact the value of collateral. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used, which include:  physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

 

11
 

 

Mortgage servicing rights – On a quarterly basis, mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to the carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level based on a model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and are validated against available market data (Level 2).

 

Mortgage banking derivative - The fair value of mortgage banking derivatives are evaluated monthly based on derivative valuation models using quoted prices for similar assets adjusted for specific attributes of the commitments and other observable market data at the valuation date (Level 2).

 

The following table summarizes the financial assets measured at fair value on a recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

Assets and Liabilities Measured on a Recurring Basis

 

March 31, 2014  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total Fair
Value
 
   (In Thousands) 
Available for sale securities:                    
                     
Obligations of U.S. government corporations and agencies  $-   $4,945   $-   $4,945 
Mortgage-backed - residential   -    42,294    -    42,294 
REMICs   -    1,985    -    1,985 
Collateralized mortgage obligations   -    67,775    -    67,775 
Trust preferred stock   -    -    704    704 
Preferred stock   880    -    -    880 
Corporate bonds   -    6,961    -    6,961 
Obligations of state and political subdivisions   -    83,777    -    83,777 
Mortgage banking derivative - asset   -    345    -    345 
Mortgage banking derivative - liability   -    -    -    - 

 

12
 

 

December 31, 2013  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total Fair
Value
 
   (In Thousands) 
Available for sale securities:                    
                     
Obligations of U.S. Government corporations and agencies  $-   $4,921   $-   $4,921 
Mortgage-backed - residential   -    41,292    -    41,292 
Collateralized mortgage obligations   -    59,841    -    59,841 
Trust preferred stock   1,654    -    582    2,236 
Preferred stock   718    -    -    718 
Corporate bonds   -    8,942    -    8,942 
Obligations of state and political subdivisions   -    80,220         80,220 
Mortgage banking derivative - asset   -    295    -    295 
Mortgage banking derivative - liability   -    -    -    - 

 

The table below presents a reconciliation and income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2014 and March 31, 2013:

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, January 1, 2014  $582 
Total gains or losses (realized/unrealized)     
Included in earnings (unrealized)   - 
Included in other comprehensive income (presented gross of taxes)   122 
Amortization   - 
Sales   - 
Transfers in and/or out of Level 3   - 
Ending balance, March 31, 2014  $704 

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, January 1, 2013  $1,474 
Total gains or losses (realized/unrealized)     
Included in earnings (unrealized)   - 
Included in other comprehensive income (presented gross of taxes)   177 
Amortization   - 
Sales   - 
Transfers in and/or out of Level 3   - 
Ending balance, March 31, 2013  $1,651 

 

13
 

 

The following table summarizes the financial assets measured at fair value on a non-recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

Assets and Liabilities Measured on a Non-Recurring Basis

 

March 31, 2014  Level 1 Inputs   Level 2 Inputs   Level 3 Inputs   Total Fair
Value
 
   (In Thousands) 
Impaired loans                    
1-4 Family Residential Real Estate  $-   $-   $436   $436 
Multi Family Residential   -    -    320    320 
Commercial Real Estate   -    -    7,561    7,561 
Commercial loans   -    -    1,800    1,800 
Total Impaired loans   -    -    10,117    10,117 
Mortgage servicing rights   -    1,255    -    1,255 

 

December 31, 2013  Level 1 Inputs   Level 2 Inputs   Level 3 Inputs   Total Fair
Value
 
   (In Thousands) 
Impaired loans                    
1-4 Family Residential Real Estate  $-   $-   $259   $259 
Multi Family Residential   -    -    338    338 
Commercial Real Estate   -    -    9,590    9,590 
Home Equity and Improvement   -    -    531    531 
Total impaired loans   -    -    10,718    10,718 
Mortgage servicing rights   -    1,370    -    1,370 
Real estate held for sale                    
Residential   -    -    112    112 
CRE   -    -    1,278    1,278 
Total Real Estate held for sale   -    -    1,390    1,390 

 

14
 

 

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of March 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows:

 

   Fair
Value
   Valuation Technique  Unobservable Inputs  Range of
Inputs
   Weighted
Average
 
   (Dollars in Thousands) 
                   
Trust preferred stock  $704   Discounted cash flow  Constant prepayment rate   40%   40%
           Expected asset default   0-30%   15%
           Expected recoveries   10-15%   10%
                      
Impaired Loans- Applies to all loan classes  $10,117   Appraisals which utilize sales comparison, net income and cost approach  Discounts for collection issues and changes in market conditions   0-10%   10%

 

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

 

   Fair
Value
   Valuation Technique  Unobservable Inputs  Range of
Inputs
   Weighted
Average
 
   (Dollars in Thousands) 
                   
Trust preferred stock  $582   Discounted cash flow  Constant prepayment rate   40%   40%
           Expected asset default   0-30%   15%
           Expected recoveries   10-15%   10%
                      
Impaired Loans- Applies to all loan classes  $10,718   Appraisals which utilize sales comparison, net income and cost approach  Discounts for collection issues and changes in market conditions   0-10%   10%
                      
Real estate held for sale – Applies to all classes  $1,390   Appraisals which utilize sales comparison, net income and cost approach  Discounts for changes in market conditions   0-20%   20%

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $10.1 million, with no valuation allowance and a fair value of $10.7 million, with no valuation allowance at March 31, 2014 and December 31, 2013, respectively. A provision expense of $756,000 and $621,000 for the three months ended March 31, 2014 and March 31, 2013, respectively, was included in earnings.

 

Mortgage servicing rights which are carried at the lower of cost or fair value had a fair value of $1.3 million with a valuation allowance of $1.0 million and a fair value of $1.4 million with a valuation allowance of $1.0 million at March 31, 2014 and December 31, 2013, respectively. A charge of $7,000 and a recovery of $473,000 for the three months ended March 31, 2014 and March 31, 2013, respectively, were included in earnings.

 

15
 

 

In accordance with FASB ASC Topic 825, the Fair Value Measurements tables are a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of March 31, 2014 and December 31, 2013. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

 

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, 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 and are classified as Level 1.

 

It was not practicable to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to restrictions placed on its transferability.

 

The fair value of loans that 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, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost of fair value as previously described. The allowance for loan losses is considered to be a reasonable adjustment for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based on binding contracts and quotes from third party investors resulting in a Level 2 classification.

 

The fair value of accrued interest receivable is equal to the carrying amounts resulting in a Level 2 or Level 3 classification which is consistent with its underlying value.

 

The fair value of non-interest bearing deposits are considered equal to the amount payable on demand at the reporting date (i.e. carrying value) and are classified as Level 1. The fair value of savings, NOW and certain money market accounts are equal to their carrying amounts and are a Level 2 classification. Fair values of fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

 

The fair values of securities sold under repurchase agreements are equal to their carrying amounts resulting in a Level 2 classification. The carrying value of subordinated debentures and deposits with fixed maturities is estimated based discounted cash flow analyses based on interest rates currently being offered on instruments with similar characteristics and maturities resulting in a Level 3 classification.

 

16
 

 

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 resulting in a Level 2 classification. The cost or value of any call or put options is based on the estimated cost to settle the option at March 31, 2014.

 

       Fair Value Measurements at March 31, 2014
(In Thousands)
 
   Carrying
Value
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and cash equivalents  $211,183   $211,183   $211,183   $-   $- 
Investment securities   209,699    209,704    880    208,120    704 
Federal Home Loan Bank Stock   13,802    N/A    N/A    N/A    N/A 
Loans, net, including loans held for sale   1,547,941    1,553,255    -    8,838    1,544,417 
Accrued interest receivable   6,122    6,122    -    1,231    4,891 
                          
Financial Liabilities:                         
Deposits  $1,760,617   $1,762,853   $338,412   $1,424,441   $- 
Advances from Federal Home Loan Bank   22,278    22,471    -    22,471    - 
Securities sold under repurchase agreements   48,939    48,939    -    48,939    - 
Subordinated debentures   36,083    35,261    -    -    35,261 

 

       Fair Value Measurements at December 31, 2013
(In Thousands)
 
   Carrying
Value
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and cash equivalents  $179,318   $179,318   $179,318   $-   $- 
Investment securities   198,557    198,563    2,372    195,609    582 
Federal Home Loan Bank Stock   19,350    N/A    N/A    N/A    N/A 
Loans, net, including loans held for sale   1,564,618    1,568,929    -    9,140    1,559,789 
Accrued interest receivable   5,778    5,778    4    696    5,078 
                          
Financial Liabilities:                         
Deposits  $1,735,792   $1,738,216   $348,943   $1,389,273   $- 
Advances from Federal Home Loan Bank   22,520    22,713    -    22,713    - 
Securities sold under repurchase agreements   51,919    51,919    -    51,919    - 
Subordinated debentures   36,083    35,237    -    -    35,237 

 

17
 

 

4.Stock Compensation Plans

 

First Defiance has established equity based compensation plans for its directors and employees. On March 15, 2010, the Board adopted, and the shareholders approved at the 2010 Annual Shareholders Meeting, the First Defiance Financial Corp. 2010 Equity Incentive Plan (the “2010 Equity Plan”). The 2010 Equity Plan replaces all existing plans. All awards currently outstanding under prior plans will remain in effect in accordance with their respective terms. Any new awards will be made under the 2010 Equity Plan. The 2010 Equity Plan allows for issuance of up to 350,000 common shares through the award of options, stock grants, restricted stock units (“RSU”), stock appreciation rights or other stock-based awards.

 

As of March 31, 2014, 240,420 options had been granted and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year except for the 2009 grant to the Company’s executive officers, which vested 40% in 2011 and then 20% annually. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

 

In March 2013, the Company approved a 2013 STIP and a 2013 LTIP for selected members of management.

 

Under the 2013 STIP the participants may earn up to 25% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The participants are required to be employed on the day of payout in order to receive such payment. The final amount of benefits under the 2013 STIP was determined as of December 31, 2013 and paid out in cash in the first quarter of 2014.

 

Under the 2013 LTIP the participants may earn up to 25% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three year period. The Company granted 86,065 RSU’s to the participants in this Plan effective January 1, 2013, which represents the maximum target award. The amount of benefit under the 2013 LTIP will be determined individually at the 12 month period ending December 31, 2013, the 24 month period ending December 31, 2014 and the 36 month period ending December 31, 2015. The awards’ vesting will be as follows: 16.7% of the target award after the end of the performance period ending December 31, 2013, 27.8% of the target award at the end of the performance period ending December 31, 2014 and 55.5% of the target award at the end of the performance period ending December 31, 2015. The benefits earned under the 2013 LTIP Plan will be paid out in equity in the first quarter following the close of the applicable performance period. The participants are required to be employed on the day of payout in order to receive such payment.

 

In March 2014, the Company approved a 2014 STIP and a 2014 LTIP for selected members of management.

 

Under the 2014 STIP the participants may earn up to 30% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The final amount of benefits under the 2014 STIP will be determined as of December 31, 2014 and will be paid out in cash in the first quarter of 2015. The participants are required to be employed on the day of payout in order to receive such payment.

 

18
 

 

Under the 2014 LTIP the participants may earn up to 20% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three year period. The Company granted 30,538 RSU’s to the participants in this Plan effective January 1, 2014, which represents the maximum target award. The amount of benefit under the 2014 LTIP will be determined individually at the end of the 36 month performance period ending December 31, 2016. The awards’ will vest 100% of the target award at the end of the performance period ending December 31, 2016. The benefits earned under the 2014 LTIP Plan will be paid out in equity in the first quarter following the close of the applicable performance period. The participants are required to be employed on the day of payout in order to receive such payment.

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes model. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

 

The fair value of stock options granted during the three months ended March 31, 2014 was determined at the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:

   Three Months ended 
   March 31, 2014 
Expected average risk-free rate   1.64%
Expected average life   7.44 years 
Expected volatility   44.62%
Expected dividend yield   2.17%

 

The weighted-average fair value of options granted for the three months ended March 31, 2014 was $11.25. There were no options granted in the three months ended March 31, 2013.

 

Following is activity under the plans during the three months ended March 31, 2014:

Stock options  Options
Outstanding
   Weighted
Average
Exercise Price
   Weighted
Average
Remaining
Contractual
Term (in years)
   Aggregate
Intrinsic
Value
(in 000’s)
 
Options outstanding, January 1, 2014   251,020   $20.76           
Forfeited or cancelled   4,050    23.75           
Exercised   7,050    11.24           
Granted   500    27.59           
Options outstanding, March 31, 2014   240,420   $21.00    2.92   $1,483 
Vested or expected to vest at March 31, 2014   240,420   $21.11    2.92   $1,483 
Exercisable at March 31, 2014   230,000   $21.49    2.81   $1,307 

 

19
 

 

As of March 31, 2014, there was $7,000 of total unrecognized compensation costs related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 4.1 years.

 

At March 31, 2014, 99,132 RSU’s and 5,767 stock grants were outstanding. Compensation expense is recognized over the performance period based on the achievements of targets as established with the plan documents. A total benefit of $45,000 was recorded during the three months ended March 31, 2014 compared to an expense of $273,000 for the same period in 2013. The benefit in the first quarter of 2014 is due to accrual reversals primarily from the 2013 LTIP adjusting for the actual payout in year one as well as adjusting the estimated payouts in year two and three. There was approximately $255,000 included within other liabilities at March 31, 2014 related to the STIPs and LTIPs.

 

   Restricted Stock Units   Stock Grants 
       Weighted-Average       Weighted-Average 
       Grant Date       Grant Date 
Unvested Shares  Shares   Fair Value   Shares   Fair Value 
                 
Unvested at January 1, 2014   106,061   $18.66    -   $- 
Granted   30,538    25.77    5,767    25.97 
Vested   -    -    -    - 
Forfeited   (37,467)   18.71    -    - 
Unvested at March 31, 2014   99,132   $21.32    5,767   $25.97 

 

The maximum amount of compensation expense that may be recorded for the 2014 STIP and the 2012, 2013 and 2014 LTIPs at March 31, 2014 is approximately $3.8 million. However, the estimated expense expected to be recorded as of March 31, 2014 based on the performance measures in the plans, is $2.2 million of which $1.5 million is unrecognized at March 31, 2014 and will be recognized over the remaining performance periods.

 

5.Dividends on Common Stock

 

First Defiance declared and paid a $0.15 per common stock dividend in the first quarter of 2014 and declared and paid a $0.10 per common stock dividend in the first quarter of 2013.

 

20
 

 

6.Earnings Per Common Share

 

The following table sets forth the computation of basic and diluted earnings per common share:

 

   Three months ended
March 31,
 
   2014   2013 
   (In Thousands, except per
share data)
 
Numerator for basic and diluted earnings per common share – Net income  $5,179   $5,559 
Denominator:          
Denominator for basic earnings per common share – weighted average common shares   9,681    9,736 
Effect of warrants   341    295 
Effect of employee stock options   86    74 
           
Denominator for diluted earnings per common share   10,108    10,105 
Basic earnings per common share  $0.53   $0.57 
           
Diluted earnings per common share  $0.51   $0.55 

 

There were 92,250 shares under option granted to employees excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three months ended March 31, 2014. Options to acquire 144,350 shares were excluded from the diluted earnings per common share calculations as they were anti-dilutive for the three months ended March 31, 2013.

 

7.Investment Securities

 

The following is a summary of available-for-sale and held-to-maturity securities:

 

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
At March 31, 2014  (In Thousands) 
Available-for-Sale Securities:                    
Obligations of U.S. government corporations and agencies  $5,000   $-   $(55)  $4,945 
Mortgage-backed securities – residential   42,183    772    (661)   42,294 
REMICs   1,998    -    (13)   1,985 
Collateralized mortgage obligations   67,721    766    (712)   67,775 
Trust preferred securities and preferred stock   1,610    845    (871)   1,584 
Corporate bonds   6,869    121    (29)   6,961 
Obligations of state and political subdivisions   80,824    3,395    (442)   83,777 
Totals  $206,205   $5,899   $(2,783)  $209,321 

 

21
 

 

   Amortized Cost   Gross
Unrecognized
Gains
   Gross
Unrecognized
Losses
   Fair Value 
   (In Thousands) 
Held-to-Maturity Securities*:                    
FHLMC certificates  $30   $-   $-   $30 
FNMA certificates   115    3    -    118 
GNMA certificates   47    2    -    49 
Obligations of state and political subdivisions   186    -    -    186 
Totals  $378   $5   $-   $383 

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (In Thousands) 
At December 31, 2013                    
Available-for-sale                    
Obligations of U.S. government corporations and agencies  $5,000   $-   $(79)  $4,921 
Mortgage-backed securities - residential   41,368    765    (841)   41,292 
Collateralized mortgage obligations   59,865    739    (763)   59,841 
Trust preferred stock and preferred stock   3,264    683    (993)   2,954 
Corporate bonds   8,854    129    (41)   8,942 
Obligations of state and political subdivisions   78,426    2,704    (910)   80,220 
Total Available-for-Sale  $196,777   $5,020   $(3,627)  $198,170 

 

   Amortized Cost   Gross
Unrecognized
Gains
   Gross
Unrecognized
Losses
   Fair Value 
   (In Thousands) 
Held-to-Maturity*:                    
FHLMC certificates  $31   $-   $-   $31 
FNMA certificates   120    4    -    124 
GNMA certificates   50    2    -    52 
Obligations of states and political subdivisions   186    -    -    186 
Total Held-to-Maturity  $387   $6   $-   $393 

 

*FHLMC, FNMA, and GNMA certificates are residential mortgage-backed securities.

 

The amortized cost and fair value of the investment securities portfolio at March 31, 2014 are shown below by contractual maturity. 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. For purposes of the maturity table, mortgage-backed securities (“MBS”), collateralized mortgage obligations (“CMO”) and REMICs, which are not due at a single maturity date, have not been allocated over the maturity groupings. These securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

 

22
 

 

   Available-for-Sale   Held-to-Maturity 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
   (In Thousands) 
Due in one year or less  $1,003   $1,017   $-   $- 
Due after one year through five years   9,657    9,935    186    186 
Due after five years through ten years   36,787    38,491    -    - 
Due after ten years   46,856    47,824    -    - 
MBS/CMO   111,902    112,054    192    197 
   $206,205   $209,321   $378   $383 

 

Investment securities with a carrying amount of $137.8 million at March 31, 2014 were pledged as collateral on public deposits, securities sold under repurchase agreements, Federal Reserve discount window and FHLB advances.

 

As of March 31, 2014, the Company’s investment portfolio consisted of 347 securities, 78 of which were in an unrealized loss position.

 

The following tables summarize First Defiance’s securities that were in an unrealized loss position at March 31, 2014 and December 31, 2013:

 

   Duration of Unrealized Loss Position         
   Less than 12 Months   12 Months or Longer   Total 
       Gross       Gross         
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loses 
   (In Thousands) 
At March 31, 2014                              
Available-for-sale securities:                              
Obligations of U.S. government corporations and agencies  $1,994   $(6)  $2,951   $(49)  $4,945   $(55)
Mortgage-backed securities - residential   20,869    (591)   1,834    (70)   22,703    (661)
REMICs   -    -    1,985    (13)   1,985    (13)
Collateralized mortgage obligations   31,762    (571)   1,714    (141)   33,476    (712)
Obligations of state and political subdivisions   11,235    (297)   2,816    (145)   14,051    (442)
Corporate bonds   -    -    2,971    (29)   2,971    (29)
Trust preferred stock and preferred stock   -    -    704    (871)   704    (871)
Total temporarily impaired securities  $65,860   $(1,465)  $14,975   $(1,318)  $80,835   $(2,783)

 

23
 

 

   Duration of Unrealized Loss Position         
   Less than 12 Months   12 Months or Longer   Total 
       Gross       Gross         
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loses 
   (In Thousands) 
At December 31, 2013                              
Available-for-sale securities:                              
Obligations of U.S. government corporations and agencies  $4,921   $(79)  $-   $-   $4,921   $(79)
Mortgage-backed securities - residential   24,846    (841)   -    -    24,846    (841)
Collateralized mortgage obligations   26,530    (763)   -    -    26,530    (763)
Corporate bonds   2,959    (41)   -    -    2,959    (41)
Obligations of state and political subdivisions   19,209    (871)   375    (39)   19,584    (910)
Trust preferred stock and preferred stock   -    -    582    (993)   582    (993)
Total temporarily impaired securities  $78,465   $(2,595)  $957   $(1,032)  $79,422   $(3,627)

 

With the exception of the trust preferred securities, the above securities all have fixed interest rates, and all securities have defined maturities. Their fair value is sensitive to movements in market interest rates. First Defiance has the ability and intent to hold these investments for a time necessary to recover the amortized cost without impacting its liquidity position and it is not more than likely that the Company will be required to sell the investments before anticipated recovery.

 

There were no realized gains from the sales of investment securities in the first quarter of 2014, but there were realized gains of $53,000 ($37,000 after tax) in the first quarter of 2013.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment portfolio is evaluated for OTTI by segregating the portfolio into two general segments. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC Topic 320. Certain collateralized debt obligations (“CDOs”) are evaluated for OTTI under FASB ASC Topic 325, Investment – Other.

 

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected compared to the book value of the security and is recognized in earnings. The amount of OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

 

24
 

 

In the first quarter of 2014 and 2013, management determined there was no OTTI.

 

The Company held six CDOs at March 31, 2014. Four of those CDOs were written down in full prior to January 1, 2010. The remaining two CDOs have a total amortized cost of $1.6 million at March 31, 2014 and had OTTI in prior periods.

 

Given the conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, the Company’s CDOs will be classified within Level 3 of the fair value hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

 

As required under FASB ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.

 

The Company’s CDO valuations were supported by analysis prepared by an independent third party. Their approach to determining fair value involved several steps: 1) detailed credit and structural evaluation of each piece of collateral in the CDO; 2) collateral performance projections for each piece of collateral in the CDO (default, recovery and prepayment/amortization probabilities) and 3) discounted cash flow modeling.

 

Trust Preferred CDOs Discount Rate Methodology

 

First Defiance uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific CDO instruments. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for trust preferred CDOs, however, First Defiance looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that nevertheless exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific CDOs. Importantly, as part of the analysis described above, First Defiance considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

 

Fundamental to this evaluation is an assessment of the likelihood of CDO coverage test failures that would have the effect of diverting cash flow away from the relevant CDO bond for some period of time. Generally speaking, the Company adjusts indicative credit spreads upwards in the case of CDOs that have relatively weaker collateral and/or less cushion with respect to overcollateralization and interest coverage test ratios and downwards if the reverse is true. This aspect of the Company’s discount rate methodology is important because there is frequently a great difference in the risks present in CDO instruments that are otherwise very similar (i.e. CDOs with the same basic type of collateral, the same manager, the same vintage, etc., may exhibit vastly different performance characteristics). With respect to this last point, First Defiance notes that given today’s credit environment, characterized by high default and deferral rates, it is typically the case that deal-specific credit performance (determined on the basis of the credit characteristics of remaining collateral) is the best indicator of what a willing market participant would pay for an instrument.

 

25
 

 

The amount of OTTI recognized in accumulated other comprehensive income (“AOCI”) was $566,000 for the above mentioned securities at March 31, 2014. There was $645,000 recognized in AOCI at December 31, 2013.

 

The following table provides additional information related to the two CDO investments for which a balance remains as of March 31, 2014 (dollars in thousands):

 

CDO  Class 

Amortized

Cost

  

Fair

Value

  

Unrealized

Loss

  

OTTI

Losses

2014

  

Lowest

Rating

 

Current

Number of

Banks and

Insurance

Companies

 

Actual

Deferrals

and

Defaults

as a % of

Current

Collateral

  

Expected

Deferrals

and

Defaults as

a % of

Remaining

Performing

Collateral

  

Excess
Sub-
ordination
as a % of
Current
Performing
Collateral

 
TPREF Funding II  B   673    305    368    -   Caa3  16   41.10%   13.48%   -%
Preferred Term Sec XXVII  C-1   902    399    503    -   C  32   26.18%   18.29%   6.39%
Total     $1,575   $704   $871   $-                      

 

There were no changes in the accumulated credit losses recognized in earnings for debt securities during the periods ended March 31, 2014 and 2013.

 

The proceeds from the sales and calls of securities and the associated gains and losses are listed below:

 

   Three Months Ended
March 31,
 
   2014   2013 
   (In Thousands) 
Proceeds  $1,654   $1,019 
Gross realized gains   -    53 
Gross realized losses   -    - 

 

26
 

 

8.Loans

 

Loans receivable consist of the following: (In Thousands)

 

   March 31,
2014
   December 31,
2013
 
Real Estate:          
Secured by 1-4 family residential  $196,940   $195,752 
Secured by multi-family residential   152,318    148,952 
Secured by commercial real estate   656,753    670,666 
Construction   82,049    86,058 
    1,088,060    1,101,428 
Other Loans:          
Commercial   380,144    388,236 
Home equity and improvement   106,632    106,930 
Consumer Finance   16,346    16,902 
    503,122    512,068 
Total loans   1,591,182    1,613,496 
Deduct:          
Undisbursed loan funds   (26,487)   (32,290)
Net deferred loan origination fees and costs   (742)   (758)
Allowance for loan loss   (24,783)   (24,950)
Totals  $1,539,170   $1,555,498 

 

Loan segments have been identified by evaluating the portfolio based on collateral and credit risk characteristics.

 

The following table discloses allowance for loan loss activity for the quarter ended

March 31, 2014 and 2013 by portfolio segment and impairment method: (In Thousands)

 

Quarter Ended March 31,

2014

 

1-4 Family

Residential

Real Estate

  

Multi-

Family

Residential

Real Estate

  

Commercial

Real Estate

   Construction   Commercial  

Home Equity

and

Improvement

  

Consumer

Finance

   Total 
Beginning Allowance  $2,847   $2,508   $12,000   $134   $5,678   $1,635   $148   $24,950 
Charge-Offs   (228)   0    (228)   0    (525)   (184)   (11)   (1,176)
Recoveries   56    3    722    0    76    31    18    906 
Provisions   (36)   104    (507)   4    381    165    (8)   103 
Ending Allowance  $2,639   $2,615   $11,987   $138   $5,610   $1,647   $147   $24,783 

 

Quarter Ended March 31,

2013

 

1-4 Family

Residential

Real Estate

  

Multi-

Family

Residential

Real Estate

  

Commercial

Real Estate

   Construction   Commercial  

Home Equity

and

Improvement

  

Consumer

Finance

   Total 
Beginning Specific Allocations  $3,506   $2,197   $12,702   $75   $6,325   $1,759   $147   $26,711 
Charge-Offs   (206)   0    (266)   0    (205)   (272)   (46)   (995)
Recoveries   99    0    101    0    76    23    19    318 
Provisions   34    213    830    (8)   (892)   213    35    425 
Ending Allowance  $3,433   $2,410   $13,367   $67   $5,304   $1,723   $155   $26,459 

 

27
 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2014: (In Thousands)

 

   1-4 Family   Multi Family                         
   Residential   Residential   Commercial           Home Equity   Consumer     
   Real Estate   Real Estate   Real Estate   Construction   Commercial   & Improvement   Finance   Total 
Allowance for loan losses:                                        
                                         
Ending allowance balance attributable to loans:                                        
                                         
Individually evaluated for impairment  $177   $-   $1,131   $-   $10   $23   $-   $1,341 
                                         
Collectively evaluated for impairment   2,462    2,615    10,856    138    5,600    1,624    147    23,442 
                                         
Acquired with deteriorated credit quality   -    -    -    -    -    -    -    - 
                                         
Total ending allowance balance  $2,639   $2,615   $11,987   $138   $5,610   $1,647   $147   $24,783 
                                         
Loans:                                        
                                         
Loans individually evaluated for impairment  $10,298   $377   $31,163   $262   $7,531   $2,391   $56   $52,078 
                                         
Loans collectively evaluated for impairment   187,001    152,125    627,421    55,283    373,756    104,676    16,277    1,516,539 
                                         
Loans acquired with deteriorated credit quality   27    -    174    -    26    -    -    227 
                                         
Total ending loans balance  $197,326   $152,502   $658,758   $55,545   $381,313   $107,067   $16,333   $1,568,844 

 

28
 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2013: (In Thousands)

 

   1-4 Family   Multi Family                         
   Residential   Residential   Commercial           Home Equity   Consumer     
   Real Estate   Real Estate   Real Estate   Construction   Commercial   & Improvement   Finance   Total 
Allowance for loan losses:                                        
                                         
Ending allowance balance attributable to loans:                                        
                                         
Individually evaluated for impairment  $220   $-   $1,121   $-   $6   $45   $-   $1,392 
                                         
Collectively evaluated for impairment   2,627    2,508    10,879    134    5,672    1,590    148    23,558 
                                         
Acquired with deteriorated credit quality   -    -    -    -    -    -    -    - 
                                         
Total ending allowance balance  $2,847   $2,508   $12,000   $134   $5,678   $1,635   $148   $24,950 
                                         
Loans:                                        
                                         
Loans individually evaluated for impairment  $10,245   $840   $34,874   $263   $8,737   $2,429   $53   $57,441 
                                         
Loans collectively evaluated for impairment   185,923    148,294    637,657    53,467    380,711    104,958    16,838    1,527,848 
                                         
Loans acquired with deteriorated credit quality   29    -    174    -    27    -    -    230 
                                         
Total ending loans balance  $196,197   $149,134   $672,705   $53,730   $389,475   $107,387   $16,891   $1,585,519 

 

29
 

 

The following table presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans: (In Thousands)

 

   Three Months Ended March 31, 2014 
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
 
Residential Owner Occupied  $6,329   $85   $83 
Residential Non Owner Occupied   4,084    38    38 
Total Residential Real Estate     10,413    123    121 
Multi-Family   388    1    1 
CRE Owner Occupied   9,837    36    35 
CRE Non Owner Occupied   19,355    204    204 
Agriculture Land   687    3    2 
Other CRE   1,862    5    5 
Total Commercial Real Estate   31,741    248    246 
Construction   261    3    5 
Commercial Working Capital   2,924    3    3 
Commercial Other   4,959    2    2 
Total Commercial   7,883    5    5 
Home Equity and Home Improvement   2,439    25    25 
Consumer   57    1    1 
Total Impaired Loans  $53,182   $406   $404 

 

30
 

 

The following table presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans: (In Thousands)

 

   Three Months Ended March 31, 2013 
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
 
Residential Owner Occupied  $6,947   $88   $86 
Residential Non Owner Occupied   4,669    35    35 
Total Residential Real Estate   11,616    123    121 
Multi-Family   1,444    7    7 
CRE Owner Occupied   14,701    62    58 
CRE Non Owner Occupied   24,318    203    193 
Agriculture Land   926    9    7 
Other CRE   5,369    1    1 
Total Commercial Real Estate   45,314    275    259 
Construction   22    -    - 
Commercial Working Capital   1,487    4    5 
Commercial Other   6,981    23    22 
Total Commercial   8,468    27    27 
Home Equity and Home Improvement   2,772    34    32 
Consumer   104    2    2 
Total Impaired Loans  $69,740   $468   $448 

 

31
 

 

The following table presents loans individually evaluated for impairment by class of loans: (In Thousands)

 

   March 31, 2014   December 31, 2013 
   Unpaid
Principal
Balance*
   Recorded
Investment
   Allowance
for Loan
Losses
Allocated
   Unpaid
Principal
Balance*
   Recorded
Investment
   Allowance
for Loan
Losses
Allocated
 
With no allowance recorded:                              
Residential Owner Occupied  $4,853   $4,771   $-   $4,744   $4,729   $- 
Residential Non Owner Occupied   4,061    3,967    -    4,844    4,329    - 
Total 1-4 Family Residential Real Estate   8,914    8,738    -    9,588    9,058    - 
Multi-Family Residential Real Estate   527    377    -    989    840    - 
CRE Owner Occupied   9,202    6,799    -    11,105    8,376    - 
CRE Non Owner Occupied   7,600    6,506    -    9,399    7,740    - 
Agriculture Land   497    477    -    629    488    - 
Other CRE   2,305    1,771    -    3,274    2,452    - 
Total Commercial Real Estate   19,604    15,553    -    24,407    19,056    - 
Construction   261    262    -    300    263    - 
Commercial Working Capital   3,134    2,610    -    3,147    3,146    - 
Commercial Other   5,478    4,857    -    6,063    5,415    - 
Total Commercial   8,612    7,467    -    9,210    8,561    - 
Consumer   56    56    -    53    53    - 
Home Equity and Home Improvement   2,228    2,235    -    1,985    1,992    - 
Total loans with no allowance recorded  $40,202   $34,688   $-   $46,532   $39,823   $- 
                               
With an allowance recorded:                              
Residential Owner Occupied  $1,477   $1,477   $175   $1,100   $1,103   $218 
Residential Non Owner Occupied   83    83    2    84    84    2 
Total 1-4 Family Residential Real Estate   1,560    1,560    177    1,184    1,187    220 
Multi-Family Residential Real Estate   -    -    -    -    -    - 
CRE Owner Occupied   3,153    2,707    161    3,212    2,765    166 
CRE Non Owner Occupied   12,592    12,639    961    12,756    12,803    946 
Agriculture Land   211    213    7    195    197    7 
Other CRE   80    52    2    82    53    2 
Total Commercial Real Estate   16,036    15,611    1,131    16,245    15,818    1,121 
Construction   -    -    -    -    -    - 
Commercial Working Capital   -    -    -    -    -    - 
Commercial Other   63    64    10    176    176    6 
Total Commercial   63    64    10    176    176    6 
Consumer   -    -    -    -    -    - 
Home Equity and Home Improvement   155    156    23    436    437    45 
Total loans with an allowance recorded  $17,814   $17,391   $1,341   $18,041   $17,618   $1,392 

 

* Presented gross of charge offs

 

32
 

 

The following table presents the current balance of the aggregate amounts of non-performing assets, comprised of non-performing loans and real estate owned on the dates indicated:

 

   March 31,
2014
   December 31,
2013
 
   (In Thousands) 
Non-accrual loans  $26,774   $27,847 
Loans over 90 days past due and still accruing   -    - 
Total non-performing loans   26,774    27,847 
Real estate and other assets held for sale   6,028    5,859 
Total non-performing assets  $32,802   $33,706 
Troubled debt restructuring, still accruing  $26,654   $27,630 

 

The following table presents the aging of the recorded investment in past due and non accrual loans as of March 31, 2014 by class of loans: (In Thousands)

 

   Current   30-59 days   60-89 days   90+ days   Total
Past Due
   Total Non
Accrual
 
                         
Residential Owner Occupied  $130,405   $469   $490   $782   $1,741   $1,173 
Residential Non Owner Occupied   63,940    196    8    1,036    1,240    1,804 
                               
Total 1-4 Family Residential Real Estate   194,345    665    498    1,818    2,981    2,977 
                               
Multi-Family Residential Real Estate   152,502    -    -    -    -    450 
                               
CRE Owner Occupied   301,710    462    77    3,573    4,112    7,748 
CRE Non Owner Occupied   227,516    30    556    2,087    2,673    5,087 
Agriculture Land   82,129    105    396    72    573    613 
Other Commercial Real Estate   39,630    103    -    312    415    1,786 
                               
Total Commercial Real Estate   650,985    700    1,029    6,044    7,773    15,234 
                               
Construction   55,545    -    -    -    -    - 
                               
Commercial Working Capital   146,532    169    -    392    561    2,471 
Commercial Other   230,415    416    22    3,367    3,805    5,259 
                               
Total Commercial   376,947    585    22    3,759    4,366    7,730 
                               
Consumer Finance   16,287    34    12    -    46    - 
Home Equity/Home Improvement   106,127    352    194    394    940    395 
                               
Total Loans  $1,552,738   $2,336   $1,755   $12,015   $16,106   $26,786 

 

33
 

 

The following table presents the aging of the recorded investment in past due and non accrual loans as of December 31, 2013 by class of loans: (In Thousands)

 

   Current   30-59 days   60-89 days   90+ days   Total
Past Due
   Total Non
Accrual
 
                         
Residential Owner Occupied  $126,855   $1,530   $191   $1,009   $2,730   $1,329 
Residential Non Owner Occupied   65,292    531    403    386    1,320    1,943 
                               
Total 1-4 Family Residential Real Estate   192,147    2,061    594    1,395    4,050    3,272 
                               
Multi-Family Residential Real Estate   149,134    -    -    -    -    583 
                               
CRE Owner Occupied   311,253    334    495    3,671    4,500    7,492 
CRE Non Owner Occupied   225,433    1,067    918    902    2,887    4,717 
Agriculture Land   81,954    21    -    73    94    630 
Other Commercial Real Estate   45,297    -    -    1,287    1,287    2,412 
                               
Total Commercial Real Estate   663,937    1,422    1,413    5,933    8,768    15,251 
                               
Construction   53,730    -    -    -    -    - 
                               
Commercial Working Capital   155,373    -    -    419    419    2,917 
Commercial Other   230,054    37    26    3,566    3,629    5,419 
                               
Total Commercial   385,427    37    26    3,985    4,048    8,336 
                               
Consumer Finance   16,759    131         -    131    - 
Home Equity/Home Improvement   105,657    1,163    155    413    1,731    413 
                               
Total Loans  $1,566,791   $4,814   $2,188   $11,726   $18,728   $27,855 

 

Troubled Debt Restructurings

 

As of March 31, 2014 and December 31, 2013, the Company has a recorded investment in troubled debt restructurings (“TDRs”) of $32.8 million and $33.4 million, respectively. The Company has allocated $1.2 million of specific reserves to those loans at each of March 31, 2014 and December 31, 2013, and has committed to lend additional amounts totaling up to $3,000 and $300,000 at March 31, 2014 and December 31, 2013, respectively.

 

The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Each TDR is uniquely designed to meet the specific needs of the borrower. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral or an additional guarantor is often requested when granting a concession. Commercial mortgage loans modified in a TDR often involve temporary interest-only payments, re-amortization of remaining debt in order to lower payments, and sometimes reducing the interest rate lower than the current market rate. Residential mortgage loans modified in a TDR are comprised of loans where monthly payments are lowered, either through interest rate reductions or principal only payments for a period of time, to accommodate the borrowers’ financial needs, interest is capitalized into principal, or the term and amortization are extended. Home equity modifications are made infrequently and usually involve providing an interest rate that is lower than the borrower would be able to obtain due to credit issues. All retail loans where the borrower is in bankruptcy are classified as TDRs regardless of whether or not a concession is made.

 

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Of the loans modified in a TDR, $6.1 million are on non-accrual status and partial charge-offs have in some cases been taken against the outstanding balance. Loans modified as a TDR may have the financial effect of increasing the allowance associated with the loan. If the loan is determined to be collateral dependent, the estimated fair value of the collateral, less any selling costs is used to determine if there is a need for a specific allowance or charge-off. If the loan is determined to be cash flow dependent, the allowance is measured based on the present value of expected future cash flows discounted at the loan’s pre-modification effective interest rate.

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the three month period ending March 31, 2014 and March 31, 2013:

 

   Loans Modified as a TDR for the Three
Months Ended March 31, 2014
($ in thousands)
   Loans Modified as a TDR for the Three
Months Ended March 31, 2013
($ in thousands)
 
Troubled Debt Restructurings  Number of
Loans
   Recorded Investment
(as of period end)
   Number of
Loans
   Recorded Investment
(as of period end)
 
                 
1-4 Family Owner Occupied   9   $763    4   $367 
1-4 Family Non Owner Occupied   0    -    1    198 
CRE Owner Occupied   0    -    1    29 
CRE Non Owner Occupied   1    361    0    - 
Agriculture Land   0    -    1    219 
Other CRE   0    -    0    0 
Commercial Working Capital or Other   2    321    1    14 
Home Equity and Improvement   3    60    8    492 
Consumer Finance   3    11    2    4 
Total   18   $1,516    18   $1,323 

 

The loans described above decreased the ALLL by $70,000 in the three month period ending March 31, 2014 and by $15,000 in the three month period ending March 31, 2013.

 

Of the 2014 modifications, 6 were made TDRs due to the fact that the borrower has been in bankruptcy, 3 were made TDRs due to a rate reduction, 1 was made a TDR due to an interest only period, 4 were made TDRs due to extending the amortization, 1 was made a TDR due to a reduction in the payment, 1 was made a TDR due to advancing funds to a substandard credit, and 2 were made to refinance current debt for payment relief.

 

The following table presents loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the quarters ending March 31, 2014 and March 31, 2013:

 

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   Three Months Ended March 31, 2014
($ in thousands)
   Three Months Ended March 31, 2013
($ in thousands)
 
Troubled Debt Restructurings
That Subsequently Defaulted
  Number of
Loans
   Recorded Investment
(as of period end)
   Number of
Loans
   Recorded Investment
(as of period end)
 
                 
1-4 Family Owner Occupied   0   $-    4   $312 
1-4 Family Non Owner Occupied   0    -    1    198 
CRE Owner Occupied   0    -    2    858 
CRE Non Owner Occupied   0    -    0    - 
Agriculture Land   0    -    0    - 
Other CRE   0    -    0    - 
Commercial Working Capital or Other   0    -    2    744 
Home Equity and Improvement   0    -    4    53 
Consumer Finance   0    -    0    - 
Total   0   $-    13   $2,165 

 

The TDRs that subsequently defaulted described above decreased the allowance for loan losses by $1,000 for the period ended March 31, 2013.

 

The terms of certain other loans were modified during the period ending March 31, 2014 that did not meet the definition of a TDR. The modification of these loans involved a modification of the terms of a loan to borrowers who were not experiencing financial difficulties. A total of 24 loans were modified under this definition during the three month period ended March 31, 2014.

 

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed on the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.

 

Credit Quality Indicators

 

Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes all non-homogeneous loans, such as commercial and commercial real estate loans and certain homogenous mortgage, home equity and consumer loans. This analysis is performed on a quarterly basis. First Defiance uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

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Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Not Graded. Loans classified as not graded are generally smaller balance residential real estate, home equity and consumer installment loans which are originated primarily by using an automated underwriting system. These loans are monitored based on their delinquency status and are evaluated individually only if they are seriously delinquent.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2014, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (In Thousands)

 

Class  Pass   Special
Mention
   Substandard   Doubtful   Not
Graded
   Total 
                         
1-4 Family Owner Occupied  $3,381   $17   $2,068   $782   $125,899   $132,147 
1-4 Family Non Owner Occupied   50,472    2,975    5,673    -    6,059    65,179 
                               
Total 1-4 Family Real Estate   53,853    2,992    7,741    782    131,958    197,326 
                               
Multi-Family Residential Real Estate   148,487    1,761    1,302    -    952    152,502 
                               
CRE Owner Occupied   282,897    11,643    9,696    -    1,585    305,821 
CRE Non Owner Occupied   200,123    13,014    17,014    -    39    230,190 
Agriculture Land   81,229    570    903    -    -    82,702 
Other CRE   35,536    918    2,908    -    683    40,045 
                               
Total Commercial Real Estate   599,785    26,145    30,521    -    2,307    658,758 
                               
Construction   46,059    -    262    -    9,224    55,545 
                               
Commercial Working Capital   139,428    4,406    3,260    -    -    147,094 
Commercial Other   217,391    10,227    6,601    -    -    234,219 
                               
Total Commercial   356,819    14,633    9,861    -    -    381,313 
                               
Home Equity and Home Improvement   -    -    546    394    106,127    107,067 
Consumer Finance   -    -    46    -    16,287    16,333 
                               
Total Loans  $1,205,003   $45,531   $50,279   $1,176   $266,855   $1,568,844 

 

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As of December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (In Thousands)

 

Class  Pass   Special
Mention
   Substandard   Doubtful   Not
Graded
   Total 
                         
1-4 Family Owner Occupied  $4,287   $18   $3,515   $-   $121,765   $129,585 
1-4 Family Non Owner Occupied   51,660    2,894    5,699    -    6,359    66,612 
                               
Total 1-4 Family Real Estate   55,947    2,912    9,214    -    128,124    196,197 
                               
Multi-Family Residential Real Estate   145,407    875    1,888    -    964    149,134 
                               
CRE Owner Occupied   291,770    10,584    11,665    -    1,734    315,753 
CRE Non Owner Occupied   200,790    10,254    17,185    -    91    228,320 
Agriculture Land   80,418    578    1,051    -    -    82,047 
Other CRE   40,676    2,074    3,104    -    731    46,585 
                               
Total Commercial Real Estate   613,654    23,490    33,005    -    2,556    672,705 
                               
Construction   43,465    -    263    -    10,002    53,730 
                               
Commercial Working Capital   148,703    3,429    3,660    -    -    155,792 
Commercial Other   219,790    6,994    6,899    -    -    233,683 
                               
Total Commercial   368,493    10,423    10,559    -    -    389,475 
                               
Home Equity and Home Improvement   -    -    755    45    106,587    107,387 
Consumer Finance   -    -    31    -    16,860    16,891 
                               
Total Loans  $1,226,966   $37,700   $55,715   $45   $265,093   $1,585,519 

 

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9. Mortgage Banking

 

Net revenues from the sales and servicing of mortgage loans consisted of the following:

 

   Three Months Ended
March 31,
 
   2014   2013 
   (In Thousands) 
Gain from sale of mortgage loans  $641   $2,176 
Mortgage loans servicing revenue (expense):          
Mortgage loans servicing revenue   905    870 
Amortization of mortgage servicing rights   (292)   (689)
Mortgage servicing rights valuation adjustments   (7)   473 
    606    654 
           
Net revenue from sale and servicing of mortgage loans  $1,247   $2,830 

 

The unpaid principal balance of residential mortgage loans serviced for third parties was $1.4 billion at March 31, 2014 and December 31, 2013.

 

Activity for capitalized mortgage servicing rights and the related valuation allowance follows for the three months ended March 31, 2014 and 2013:

 

   March 31,
2014
   March 31,
2013
 
   (In Thousands) 
Mortgage servicing assets:          
Balance at beginning of period  $10,133   $10,121 
Loans sold, servicing retained   207    762 
Amortization   (292)   (689)
Carrying value before valuation allowance at end of period   10,048    10,194 
           
Valuation allowance:          
Balance at beginning of period   (1,027