UNITED STATES
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SECURITIES AND EXCHANGE COMMISSION
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Washington, D.C. 20549
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FORM 10-Q
(Mark One)
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 For the Quarterly Period Ended September 30, 2005
OR
Transition Report Pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 For the Transition Period from _________to__________
Commission file number 0-26850
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First Defiance Financial Corp.
-------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-1803915
------------------------------- ------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
601 Clinton Street, Defiance, Ohio 43512
------------------------------------------------- ------------
(Address or principal executive office) (Zip Code)
Registrant's telephone number, including area code: (419) 782-5015
----------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date. Common Stock, $.01 Par Value -
7,060,390 shares outstanding at November 7, 2005
FIRST DEFIANCE FINANCIAL CORP.
INDEX
Page Number
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PART I.-FINANCIAL INFORMATION
Item 1. Consolidated Condensed Financial Statements:
Consolidated Condensed Statements of Financial
Condition - September 30, 2005 (Unaudited)
and December 31, 2004 2
Consolidated Condensed Statements of Income (Unaudited) -
Three and nine months ended September 30, 2005 and 2004 4
Consolidated Condensed Statement of Changes in Stockholders'
Equity (Unaudited) - Nine months ended September 30, 2005 5
Consolidated Condensed Statements of Cash Flows (Unaudited)
- Nine months ended September 30, 2005 and 2004 6
Notes to Consolidated Condensed Financial
Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 24
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 38
Item 4. Controls and Procedures 39
PART II-OTHER INFORMATION:
Item 1. Legal Proceedings 40
Item 2. Unrestricted Sales of Equity
Securities and Use of Proceeds 40
Item 3. Defaults upon Senior Securities 40
Item 4. Submission of Matters to a Vote of Security Holders 40
Item 5. Other Information 40
Item 6. Exhibits 40
Signatures 42
-1-
PART 1-FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(Amounts in Thousands)
--------------------------------------------------------------------------------
(Unaudited)
September 30, 2005 December 31, 2004
------------------ -----------------
ASSETS
Cash and cash equivalents:
Cash and amounts due from
depository institutions $ 36,447 $ 19,891
Interest-bearing deposits 3,587 630
---------- ----------
40,034 20,521
Securities:
Available-for-sale, carried at fair value 113,664 137,003
Held-to-maturity, carried at amortized cost
(approximate fair value $2,020 and $2,376
at September 30, 2005 and December 31,
2004 respectively) 1,939 2,255
---------- ----------
115,603 139,258
Loans held for sale 8,153 2,295
Loans receivable, net of allowance of $13,624 and
$9,956 at September 30, 2005 and December 31,
2004 respectively 1,131,789 878,912
Accrued interest receivable 6,037 4,653
Federal Home Loan Bank stock and other
interest-earning assets 17,293 13,376
Bank owned life insurance 19,122 18,581
Office properties and equipment 32,283 24,248
Real estate and other assets held for sale 170 98
Goodwill 35,345 18,340
Core deposit intangible 4,134 593
Mortgage servicing rights 4,924 3,598
Other assets 2,690 2,194
---------- ----------
Total assets $1,417,577 $1,126,667
========== ==========
See accompanying notes.
-2-
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Financial Condition
(Amounts in Thousands)
--------------------------------------------------------------------------------
(Unaudited)
September 30, 2005 December 31, 2004
------------------ -----------------
LIABILITIES AND
STOCKHOLDERS' EQUITY
Non-interest-bearing deposits $ 92,720 $ 62,450
Interest-bearing deposits 978,337 735,251
----------- -----------
Total deposits 1,071,057 797,701
Advances from Federal Home Loan Bank 164,051 178,213
Notes payable and other interest-bearing liabilities 21,192 14,804
Advance payments by borrowers for taxes and insurance 411 278
Deferred taxes 1,201 934
Other liabilities 10,381 7,863
----------- -----------
Total liabilities 1,268,293 999,793
STOCKHOLDERS' EQUITY
Preferred stock, no par value per share:
5,000 shares authorized; no shares
issued -- --
Common stock, $.01 par value per share:
20,000 shares authorized; 7,060
and 6,280 shares outstanding, respectively 71 63
Additional paid-in capital 72,719 52,131
Stock acquired by ESOP (1,053) (1,479)
Deferred compensation (3) (4)
Accumulated other comprehensive income,
net of income taxes of $136
and $1,148, respectively 254 2,131
Retained earnings 77,296 74,032
----------- -----------
Total stockholders' equity 149,284 126,874
----------- -----------
Total liabilities and stockholders' equity $ 1,417,577 $ 1,126,667
=========== ===========
See accompanying notes
-3-
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Income
(UNAUDITED)
(Amounts in Thousands, except per share data)
--------------------------------------------------------------------------------
Three Months ended Nine Months ended
September 30, September 30,
2005 2004 2005 2004
---- ---- ---- ----
Interest Income
Loans $18,395 $12,205 $50,203 $34,412
Investment securities 1,255 1,633 3,979 5,225
Interest-bearing deposits 72 1 277 37
FHLB stock dividends 210 140 579 471
------- ------- ------- -------
Total interest income 19,932 13,979 55,038 40,145
Interest Expense
Deposits 5,539 3,384 14,395 9,453
FHLB advances and other 2,059 1,843 5,650 5,418
Notes payable and warehouse loans 117 31 313 75
------- ------- ------- -------
Total interest expense 7,715 5,258 20,358 14,946
------- ------- ------- -------
Net interest income 12,217 8,721 34,680 25,199
Provision for loan losses 368 376 1,064 1,244
------- ------- ------- -------
Net interest income after provision for loan
losses 11,849 8,345 33,616 23,955
Non-interest Income
Service fees and other charges 1,511 1,090 4,023 3,119
Mortgage banking income 1,087 332 2,471 2,075
Insurance commission income 966 906 3,229 3,192
Gain on sale of securities 86 302 1,222 694
Trust income 91 69 229 167
Income from Bank Owned Life Insurance 184 194 541 579
Other non-interest income 91 55 444 225
------- ------- ------- -------
Total non-interest income 4,016 2,948 12,159 10,051
Non-interest Expense
Compensation and benefits 6,058 4,274 17,577 13,062
Occupancy 1,197 798 3,424 2,452
SAIF deposit insurance premiums (credit) 34 26 101 12
State franchise tax 290 155 865 467
Acquisition related charges 97 -- 3,457 --
Data processing 813 595 2,404 1,717
Amortization of goodwill and other intangibles 214 28 541 82
Settlement of contingent liability -- 1,927 -- 1,927
Other non-interest expense 1,793 1,204 4,891 3,767
------- ------- ------- -------
Total non-interest expense 10,496 9,007 33,260 23,486
------- ------- ------- -------
Income before income taxes 5,369 2,286 12,515 10,520
Federal income taxes 1,742 606 3,989 3,203
------- ------- ------- -------
Net Income $ 3,627 $ 1,680 $ 8,526 $ 7,317
======= ======= ======= =======
Earnings per share (Note 7)
Basic $ 0.52 $ 0.28 $ 1.25 $ 1.20
======= ======= ======= =======
Diluted $ 0.50 $ 0.27 $ 1.20 $ 1.15
======= ======= ======= =======
Average shares outstanding (Note 7)
Basic 6,966 6,076 6,835 6,103
======= ======= ======= =======
Diluted 7,213 6,332 7,091 6,380
======= ======= ======= =======
Dividends declared per share (Note 5) $ 0.22 $ 0.20 $ 0.66 $ 0.60
======= ======= ======= =======
See accompanying notes
-4-
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statement of Changes in Stockholders' Equity
(UNAUDITED)
(Amounts in Thousands)
--------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
---- ---- ---- ----
Balance at beginning of period $ 147,550 $ 124,452 $ 126,874 $ 124,269
Comprehensive Income
Net income 3,627 1,680 8,526 7,317
Other comprehensive income (loss) (756) 1,098 (1,877) (1,054)
--------- --------- --------- ---------
Total comprehensive income 2,871 2,778 6,649 6,263
ESOP shares released 351 294 1,350 1,271
Amortization of deferred compensation
Of Management Recognition Plan -- 2 1 5
Shares issued under stock option plans 31 47 1,122 1,303
Treasury shares repurchased (323) (939) (1,275) (4,020)
Shares issued to acquire ComBanc, Inc. 333 -- 19,104 --
Common cash dividends declared (Note 5) (1,529) (1,211) (4,541) (3,668)
--------- --------- --------- ---------
Balance at September 30 $ 149,284 $ 125,423 $ 149,284 $ 125,423
========= ========= ========= =========
See Accompanying Notes
-5-
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows
(UNAUDITED)
(Amounts in Thousands)
--------------------------------------------------------------------------------
Nine Months
Ended September 30,
2005 2004
---- ----
Operating Activities
Net income $ 8,526 $ 7,317
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,064 1,244
Provision for depreciation 1,754 1,335
Accretion of premium and discounts on loans,
Securities, deposits and debt obligations 1,145 301
Amortization of mortgage servicing rights 613 547
Net impairment (recovery) of mortgage servicing rights (366) 34
Amortization of core deposit intangible 541 82
Gain on sale of loans (1,809) (1,910)
(Gain) loss on sale of property, plant and equipment (111) 2
Release of ESOP Shares 1,350 1,271
Amortization of Management Recognition Plan
deferred compensation 1 5
Gains on sales of securities (1,222) (694)
Deferred federal income tax expense (credit) 310 (219)
Proceeds from sale of loans 80,779 81,698
Origination of mortgage servicing rights, net (646) (666)
Origination of loans held for sale (84,828) (80,728)
Decrease (increase) in interest receivable and other assets 219 (1,267)
Increase in other liabilities 1,230 2,189
-------- ---------
Net cash provided by operating activities 8,550 10,541
Investing Activities
Proceeds from maturities of held-to-maturity securities 193 343
Proceeds from maturities of available-for-sale securities 21,263 36,279
Proceeds from sale of available-for-sale securities 24,160 10,595
Proceeds from sale of Federal Home Loan Bank stock -- 5,000
Proceeds from sales of real estate and
other assets held for sale 396 978
Proceeds from sale of property, plant and equipment 1,192 --
Net cash received for acquisition of ComBanc, Inc. 52,646 --
Net cash paid for acquisition of Genoa Savings and Loan Co. (602)
Purchases of available-for-sale securities (23,767) (21,491)
Purchases of Federal Home Loan Bank stock (583) (469)
Purchases of office properties and equipment (4,083) (1,547)
Net increase in loans receivable (70,852) (109,935)
-------- ---------
Net cash used in investing activities (37) (80,247)
-6-
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Condensed Statements of Cash Flows (Continued)
(UNAUDITED)
(Amounts in Thousands)
--------------------------------------------------------------------------------
Nine Months Ended
September 30,
2005 2004
---- ----
Financing Activities
Net increase in deposits 33,084 50,546
Repayment of Federal Home Loan Bank long-term advances (1,879) (1,352)
Net (decrease) increase in Federal Home Loan Bank
short-term advances (15,500) 10,500
Decrease in short-term line of credit (2,000) --
Increase (decrease) in securities sold under repurchase agreements 1,778 (215)
Purchase of common stock for treasury (1,275) (4,020)
Cash dividends paid (4,330) (3,668)
Proceeds from exercise of stock options 1,122 1,303
-------- --------
Net cash provided by financing activities 11,000 53,094
-------- --------
Increase (decrease) in cash and cash equivalents 19,513 (16,612)
Cash and cash equivalents at beginning of period 20,521 37,783
-------- --------
Cash and cash equivalents at end of period $ 40,034 $ 21,171
======== ========
Supplemental cash flow information:
Interest paid $ 18,945 $ 14,875
======== ========
Income taxes paid $ 3,558 $ 2,772
======== ========
Noncash operating activities:
Change in deferred tax established on net unrealized
gain or loss on available-for-sale securities $ 1,012 $ 566
======== ========
Transfers from loans to real estate
and other assets held for sale $ 292 $ 635
======== ========
Noncash investing activities:
Decrease in net unrealized gain or loss on
available-for-sale securities $ (2,890) $ (1,620)
======== ========
Noncash financing activities:
Cash dividends declared but not paid $ 1,553 $ 1,211
======== ========
See accompanying notes.
-7-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
1. Principles of Consolidation
The consolidated condensed financial statements include the accounts of First
Defiance Financial Corp. ("First Defiance" or "the Company"), its two wholly
owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and
First Insurance and Investments, Inc. ("First Insurance"). In the opinion of
management, all significant intercompany accounts and transactions have been
eliminated in consolidation.
2. Basis of Presentation
The consolidated condensed statement of financial condition at December 31, 2004
has been derived from the audited financial statements at that date, which were
included in First Defiance's Annual Report on Form 10-K.
The accompanying consolidated condensed financial statements as of September 30,
2005 and for the three and nine-month periods ending September 30, 2005 and 2004
have been prepared by First Defiance without audit and do not include
information or footnotes necessary for the complete presentation of financial
condition, results of operations, and cash flows in conformity with accounting
principles generally accepted in the United States. These consolidated condensed
financial statements should be read in conjunction with the financial statements
and notes thereto included in First Defiance's 2004 Annual Report on Form 10-K
for the year ended December 31, 2004. However, in the opinion of management, all
adjustments, consisting of only normal recurring items, necessary for the fair
presentation of the financial statements have been made. The results for the
three and nine-month period ended September 30, 2005 are not necessarily
indicative of the results that may be expected for the entire year.
Goodwill
Goodwill is the excess of the purchase price over the fair value of the assets
and liabilities of companies acquired through business combinations accounted
for under the purchase method. Goodwill is evaluated for impairment at the
business unit level, which for First Defiance are First Federal and First
Insurance. At September 30, 2005 goodwill totaled $35.3 million, an increase
from the $18.3 million balance reported at December 31, 2004. The increase in
goodwill is the result of the ComBanc, Inc. acquisition, which closed on January
21, 2005 and the Genoa Savings and Loan Company acquisition, which closed on
April 08, 2005. Total goodwill recognized was $12.7 million related to the
acquisition of ComBanc, Inc. and $4.3 million related to the acquisition of the
Genoa Savings and Loan Company.
-8-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Income Taxes
The Company's effective tax rate differs from the statutory 35% federal tax rate
primarily because of the existence of municipal securities and bank owned life
insurance, the earnings of which are exempt from federal income taxes.
Stock Compensation
At September 30, 2005, the Company had three stock-based compensation plans,
which are more fully described in Note 18 in the financial statements included
in First Defiance's 2004 Annual Report on Form 10-K. The Company accounts for
those plans under recognition and measurement principles of Accounting
Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees
and related interpretations. Under APB No. 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of the grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required by
SFAS No. 123, Accounting for Stock-Based Compensation and has been determined as
if First Defiance had accounted for its employee stock options under the fair
value method of that Statement. Under the fair-value based method, compensation
cost is measured at the grant date based upon the value of the award and
recognized over the service period. For purposes of the pro forma disclosures,
the estimated fair value of the option is amortized to expense over the options'
vesting period.
The following pro forma results of operations use a fair value method of
accounting for stock options in accordance with SFAS No. 123. The estimated fair
value of the options are amortized to expense over the option and vesting
period. The fair value was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions:
Nine Months Ending
September 30
2005 2004
--------------------------
Risk free interest rate 4.40% 4.73%
Dividend yield 3.39% 2.96%
Volatility factors of expected market price
of stock 22.40% 22.88%
Weighted average expected life 10.0 years 10.0 years
Weighted average grant date fair value
of options granted $5.67 $6.85
-9-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Based on the above assumptions, pro forma net income and earnings per share are
computed as follows (in thousands, except per share amounts):
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
------------------------------------------------
(In Thousands, except per share amounts)
Net Income $ 3,627 $ 1,680 $ 8,526 $ 7,317
Stock-based compensation using
the fair value method, net of tax (70) (62) (197) (166)
------------------------------------------------
Pro forma net income from
continuing operations $ 3,557 $ 1,618 $ 8,329 $ 7,151
================================================
Earnings per share as reported:
Basic $ 0.52 $ 0.28 $ 1.25 $ 1.20
================================================
Diluted $ 0.50 $ 0.27 $ 1.20 $ 1.15
================================================
Pro forma earnings per share:
Basic $ 0.51 $ 0.27 $ 1.22 $ 1.17
================================================
Diluted $ 0.49 $ 0.26 $ 1.18 $ 1.12
================================================
Recent Accounting Pronouncements
Accounting for Certain Loans or Debt Securities Acquired in a Transfer In
December 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued AICPA Statement of Position
03-3, "Accounting for Certain Loans or Debt Securities Acquired in a Transfer"
(SOP 03-3), which addresses the accounting for differences between contractual
cash flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities (loans) acquired in a transfer. SOP 03-3
limits the yield that may be accreted (accretable yield) to the excess of the
investor's estimate of undiscounted expected principal, interest, and other cash
flows (cash flows expected at acquisition to be collected) over the investor's
initial investment in the loan. Subsequent increases in cash flows expected to
be collected should be recognized prospectively through adjustment of the loan's
yield over its remaining life. Decreases in cash flows expected to be collected
should be recognized as impairment. Loans acquired by First Defiance on January
21, 2005 related to the acquisition of ComBanc, Inc and on April 8, 2005 related
to the acquisition of the Genoa Savings and Loan Company were recorded in
accordance SOP 03-3.
-10-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
2. Basis of Presentation (continued)
Share-Based Payments
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No. 123 (revised 2004), "Share-Based Payment," which revised SFAS No. 123,
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees." This Statement requires an entity to
recognize the cost of employee services received in share-based payment
transactions and measure the cost on a grant-date fair value of the award. That
cost will be recognized over the period during which an employee is required to
provide service in exchange for the award. The provisions of SFAS 123 (revised
2004) will be effective for the Company's financial statements issued for the
first fiscal year beginning after June 15, 2005. First Defiance will adopt SFAS
123 (revised 2004) in the first quarter of 2006. The method for adoption of this
statement is yet to be determined. See SFAS 123 pro forma disclosures included
in this Note 2.
Other Than Temporary Impairments
At a meeting on June 29, 2005, the FASB elected not to provide guidance on the
meaning of other-than-temporary impairment and directed the staff to issue
proposed FSP 03-1-a "Implementation Guidance for the Application of Paragraph 16
of EITF Issue No. 03-1" as final. The final FSP superseded EITF Issue No. 03-1
"The Meaning of Other than Temporary Impairment and its Application to Certain
Investments" and also EITF Topic No. D-44 "Recognition of Other-Than-Temporary
Impairment upon the Plan Sale of a Security Whose Cost Exceeds Fair Value." FSP
FAS 115-1 "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments" replaces the guidance set forth in paragraph 10-18 of issue
03-1 with references to existing other-than-temporary impairment guidance such
as FASB Statement No. 115, SEC Staff Accounting Bulletin No. 59 and APB Opinion
No. 18. FSP FAS 115-1 also will codify the guidance set for in EITF Topic D-44
and clarify that an investor should recognize an impairment loss no later than
when the impairment is deemed other than temporary, even if a decision to sell
has not been made. FSP FAS 115-1 is effective for other-than-temporary
impairment analysis conducted in periods beginning after September 15, 2005.
Management does not believe this guidance will have any material impact on the
financial condition or results of operations of First Defiance.
-11-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
3. Acquisitions
On January 21, 2005, First Defiance completed its acquisition of ComBanc Inc.
("ComBanc"), a bank-holding company operating four retail bank branch offices
headquartered in Delphos, Ohio. The acquisition allows the Company to expand its
product offerings to Allen County, Ohio which is adjacent to the Company's
existing footprint. Under the terms of the merger, each share of ComBanc common
stock was exchanged for .65266 shares of First Defiance common stock, $17.20 in
cash, or a combination of cash and stock. Total consideration in the transaction
was limited to 50% cash and 50% common stock. In connection with the
transaction, 721,164 shares of First Defiance Common stock were issued and $19.0
million of cash was paid. The total cost of the transaction was $37.8 million,
excluding transaction costs. The common shares issued were valued at $26.03 per
share representing an average of the closing market prices for two days before
and after date the final exchange ratio was determined. The assets and
liabilities of ComBanc were recorded on the balance sheet at their fair value as
of the merger date. The results of ComBanc's operations have been included in
First Defiance's consolidated statement of income from the date of acquisition.
On April 8, 2005, the Company completed its acquisition of Genoa Savings and
Loan Company ("Genoa"), a savings and loan operating four branch offices in the
Toledo, Ohio area markets of Genoa, Perrysburg, Oregon, and Maumee. Under the
terms of the agreement, each share of Genoa stock was exchanged for $30.22 in
cash for a total cost of $11 million. The assets and liabilities of Genoa were
recorded on the balance sheet at their fair value as of the merger date. The
results of Genoa' operations have been included in First Defiance's consolidated
statement of income from the date of acquisition.
Refer to Note 4 for discussion on severance and other restructuring costs
incurred in connection with the ComBanc and Genoa mergers. Additionally refer to
Note 2 for further discussion on goodwill and intangible assets recognized in
connection with the ComBanc and Genoa mergers.
-12-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
3. Acquisitions (continued)
The following tables summarize the estimated fair values of the net assets
acquired and the computation of the purchase price and goodwill related to the
acquisitions.
ComBanc Genoa
------- -----
Assets (In thousands)
Cash and cash equivalents $ 71,915 $ 10,599
Investment Securities 502 15
Loans, net of allowance for loan losses 117,313 66,905
Premises and equipment 4,806 2,345
Goodwill and other intangibles 15,643 5,444
Other assets 2,664 3,012
----------------------
Total Assets 212,843 88,320
Liabilities:
Deposits 163,668 76,786
Borrowings 9,863 --
Other liabilities 939 333
----------------------
Total Liabilities 174,470 77,119
----------------------
Net assets acquired $ 38,373 $ 11,201
======================
Purchase price $ 38,373 $ 11,201
Carrying value of net assets acquired (22,637) (6,737)
----------------------
Excess of purchase price over carry value
of net assets acquired 15,736 4,464
Purchase accounting adjustments
Portfolio loans (1,487) (978)
Premises and equipment (672) 1,609
Mortgage service rights (49) (116)
Deposits 322 301
Borrowings 211 --
Deferred tax liabilities 1,582 164
----------------------
Total net tangible assets (93) 980
Core deposit intangibles (2,936) (1,146)
----------------------
Goodwill $ 12,707 $ 4,298
======================
The estimated fair value of ComBanc's and Genoa's acquired assets and
liabilities, including identifiable intangible assets, are preliminary and
subject to refinement as additional information becomes available. Any
subsequent adjustments to the fair values of assets and liabilities acquired,
identifiable intangible assets, or other purchase accounting adjustments will
result in adjustments to goodwill.
-13-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
4. Acquisition Related Charges
During the nine months ended September 30, 2005, First Defiance recognized
$3,457,000 of acquisition related charges associated with the acquisitions.
Acquisition related charges for the ComBanc acquisition totaled $991,000, of
which $471,000 related to severance payments and retention bonuses provided to
ComBanc employees and $385,000 related to termination of certain ComBanc
contracts. Acquisition related charges for the Genoa acquisition totaled $2.5
million, of which approximately $365,000 related to severance payments and
retention bonuses provided to Genoa employees and $1.8 million related to
termination of certain Genoa contracts. Substantially all severance costs will
be paid out by January 2006.
5. Dividends on Common Stock
As of September 30, 2005, First Defiance had declared a quarterly cash dividend
of $.22 per share for the third quarter of 2005, payable October 28, 2005.
6. Other Comprehensive Income (Loss)
Other comprehensive income (loss) consisted of the following:
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
-----------------------------------------------
Securities available for sale:
Unrealized securities gains (losses) arising during period $ (1,078) $ 1,993 $ (1,668) $ (926)
Reclassification adjustment for gains included in income (86) (302) (1,222) (694)
-----------------------------------------------
Other comprehensive income (loss) before income taxes (1,164) 1,691 (2,890) (1,620)
Tax effect 408 (593) 1,013 566
-----------------------------------------------
Total other comprehensive income (loss) $ (756) $ 1,098 $ (1,877) $ (1,054)
===============================================
-14-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
7. Earnings Per Share
Basic earnings per share as disclosed under FAS No. 128 has been calculated by
dividing net income by the weighted average number of shares of common stock
outstanding for the three and nine-month periods ended September 30, 2005 and
2004. First Defiance accounts for the shares issued to its Employee Stock
Ownership Plan ("ESOP") in accordance with Statement of Position 93-6 of the
American Institute of Certified Public Accountants ("AICPA"). As a result,
shares controlled by the ESOP are not considered in the weighted average number
of shares of common stock outstanding until the shares are committed for
allocation to an employee's individual account. In the calculation of diluted
earnings per share for the three and nine months ended September 30, 2005 and
2004, the effect of shares issuable under stock option plans and unvested shares
under the Management Recognition Plan have been accounted for using the Treasury
Stock method.
The following table sets forth the computation of basic and diluted earning per
share (in thousands except per share data):
Three months ended Nine months ended
September 30, September 30,
2005 2004 2005 2004
------------------------------------------
Numerator for basic and diluted
earnings per share - Net income $3,627 $1,680 $8,526 $7,317
Denominator:
Denominator for basic earnings
per share - weighted average shares 6,966 6,076 6,835 6,103
Effect of dilutive securities:
Employee stock options 246 255 255 275
Unvested management recognition
plan stock 1 1 1 2
------------------------------------------
Dilutive potential common shares 247 256 256 277
------------------------------------------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 7,213 6,332 7,091 6,380
==========================================
Basic earnings per share from net income $ 0.52 $ 0.28 $ 1.25 $ 1.20
==========================================
Diluted earnings per share from
net income $ 0.50 $ 0.27 $ 1.20 $ 1.15
==========================================
-15-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
8. Investment Securities
The following is a summary of available-for-sale and held-to-maturity securities
(in thousands):
September 30, 2005
--------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
--------------------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 42,698 $ 337 $ 272 $ 42,763
Mortgage-backed securities 16,854 31 203 16,682
REMICs 2,211 -- 30 2,181
Collateralized mortgage obligations 20,234 29 207 20,056
Trust preferred stock 7,730 76 -- 7,806
Obligations of state and political
subdivisions 23,547 632 3 24,176
--------------------------------------------------------------
Totals $ 113,274 $ 1,105 $ 715 $ 113,664
==============================================================
Held-to-Maturity Securities:
FHLMC certificates $ 357 $ 11 $ -- $ 368
FNMA certificates 791 6 3 794
GNMA certificates 261 2 1 262
Obligations of state and political
subdivisions 530 66 -- 596
--------------------------------------------------------------
Totals $ 1,939 $ 85 $ 4 $ 2,020
==============================================================
-16-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
8. Investment Securities (continued)
The following table summarizes First Defiance's securities that were in an
unrealized loss position at September 30, 2005:
Duration of Unrealized Loss Position
------------------------------------------------------
Less than 12 Months 12 Month or Longer Total
-------------------------- ------------------------- -------------------------
Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loses
-----------------------------------------------------------------------------------
(In Thousands)
At September 30, 2005
Available-for-sale
securities:
U.S. treasury securities
and obligations of
U.S. government
corporations
and agencies $ 26,316 $ (230) $ 1,958 $ (42) $ 28,274 $ (272)
Mortgage-backed
securities 12,511 (185) 624 (18) 13,135 (203)
Collateralized mortgage
obligations 14,480 (147) 4,150 (90) 18,630 (237)
Obligations of state and
political subdivisions 1,018 (2) 20 (1) 1,038 (3)
Held to maturity securities:
Mortgage-backed
securities 141 (2) 142 (2) 283 (4)
-----------------------------------------------------------------------------------
Total temporarily
impaired securities $ 54,466 $ (566) $ 6,894 $ (153) $ 61,360 $ (719)
===================================================================================
First Defiance does not believe the unrealized losses on securities as of
September 30, 2005 represent other-than-temporary impairment. The unrealized
losses are primarily the result of the changes in interest rates and will not
prohibit the Company from receiving its contractual principal and interest
payments. First Defiance has the ability and intent to hold these securities for
a period necessary to recover the amortized cost.
-17-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
8. Investment Securities (continued)
December 31, 2004
-----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
-----------------------------------------------------
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 48,913 $ 1,461 $ 61 $ 50,313
Corporate bonds 6,158 310 -- 6,468
Mortgage-backed securities 16,645 151 16 16,780
REMICs 4,902 -- 26 4,876
Collateralized mortgage obligations 20,027 136 54 20,109
Trust preferred stock 6,228 64 -- 6,292
Equity securities 69 4 -- 73
Obligations of state and political
subdivisions 30,781 1,313 2 32,092
-----------------------------------------------------
Totals $ 133,723 $ 3,439 $ 159 $ 137,003
=====================================================
Held-to-Maturity Securities:
FHLMC certificates $ 459 $ 21 $ 1 $ 479
FNMA certificates 960 12 4 968
GNMA certificates 306 4 1 309
Obligations of state and political
subdivisions 530 90 -- 620
-----------------------------------------------------
Totals $ 2,225 $ 127 $ 6 $ 2,376
=====================================================
-18-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
9. Loans
Loans receivable and held for sale consist of the following (in thousands):
September 30, December 31,
2005 2004
--------------------------------
Real Estate:
One-to-four family residential $ 280,436 $ 190,070
Construction 22,434 15,507
Non-residential and multi-family 524,305 415,164
----------------------------
827,175 620,741
Other Loans:
Commercial 167,990 141,643
Consumer finance 57,018 45,513
Home equity and improvement 111,234 90,839
----------------------------
336,242 277,995
----------------------------
Total real estate and other loans 1,163,417 898,736
Deduct:
Loans in process 8,601 6,340
Net deferred loan origination fees and costs 1,250 1,233
Allowance for loan loss 13,624 9,956
----------------------------
Totals $1,139,942 $ 881,207
============================
Loans acquired in the ComBanc and Genoa acquisitions were as follows by category
(in thousands):
ComBanc Genoa
-----------------------
Real Estate:
One-to-four family residential $ 33,090 $ 36,288
Construction 1,874 4,528
Non-residential and multi-family 59,992 8,261
-----------------------
94,956 49,077
Other Loans:
Commercial 12,660 1,634
Consumer finance 7,211 3,696
Home equity and improvement 4,649 13,362
-----------------------
24,520 18,692
-----------------------
Total real estate and other loans acquired $ 119,476 $ 67,769
=======================
-19-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
9. Loans (continued)
Changes in the allowance for loan losses were as follows (in thousands):
Three Months ended Nine Months ended
September 30, September 30,
2005 2004 2005 2004
--------------------------------------------
Balance at beginning of period $ 13,460 $ 9,537 $ 9,956 $ 8,844
Provision for loan losses 368 376 1,064 1,244
Reserve from Acquisitions -- -- 3,027 --
Charge-offs:
One-to-four family residential
real estate 32 -- 32 52
Non-residential and multi-family
real estate 134 25 201 34
Commercial 65 144 214 283
Consumer finance 74 78 233 149
--------------------------------------------
Total charge-offs 305 247 680 518
Recoveries 101 46 257 141
--------------------------------------------
Net charge-offs 204 201 423 377
--------------------------------------------
Ending allowance $ 13,624 $ 9,712 $ 13,624 $ 9,712
============================================
10. Mortgage Banking Income
Revenue from sales and servicing of mortgage loans consisted of the following
(in thousands):
Three Months ended Nine Months Ended
September 30, September 30
2005 2004 2005 2004
-----------------------------------------------
Gain from sale of mortgage loans $ 705 $ 512 $ 1,682 $ 1,824
Mortgage loan servicing revenue (expense):
Mortgage loan servicing revenue 359 282 1,036 832
Amortization of mortgage servicing rights (217) (141) (613) (547)
Mortgage servicing rights valuation
adjustments 240 (321) 366 (34)
-----------------------------------------------
382 (180) 789 251
-----------------------------------------------
Total revenue from sale and servicing
of mortgage loans $ 1,087 $ 332 $ 2,471 $ 2,075
===============================================
-20-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
11. Deposits
A summary of deposit balances is as follows (in thousands):
September 30, December 31,
2005 2004
------------------------------
Non-interest-bearing checking accounts $ 92,720 $ 62,450
Interest-bearing checking accounts 96,980 74,964
Savings accounts 88,994 52,132
Money market demand accounts 165,564 183,833
Retail time deposits less than $100,000 424,607 272,098
Retail time deposits greater than $100,000 139,752 102,750
National/Brokered time deposits 62,440 49,474
------------------------------
$ 1,071,057 $ 797,701
==============================
Deposits acquired as part of the ComBanc and Genoa acquisitions are as follows
(in thousands):
ComBanc Genoa
------------------------------
Non-interest-bearing checking accounts $ 17,700 $ 5,000
Interest-bearing checking accounts 33,000 2,400
Savings accounts 30,600 11,200
Money market demand accounts 13,200 18,000
Certificates of deposit 69,168 40,186
------------------------------
$ 163,668 $ 76,786
==============================
12. Commitments, Guarantees and Contingent Liabilities
Loan commitments are made to accommodate the financial needs of First Defiance's
customers; however, there are no long-term, fixed-rate loan commitments that
result in market risk. Standby letters of credit obligate the Company to pay a
third party beneficiary when a customer fails to repay an outstanding loan or
debt instrument, or fails to perform some contractual non-financial obligation.
Standby letters of credit are issued to address customers' financing needs and
to facilitate customers' trade transactions. In accordance with FASB
interpretation No. 45, "Guarantor's Guarantees of Indebtedness of Others,"
certain guarantees issued or modified on or after January 1, 2003, require the
recognition of a liability on First Defiance's balance sheet for the "stand
ready" obligation with such guarantees.
If amounts are drawn under standby letters of credit, such amounts are treated
as loans. Both loan commitments and standby letters of credit have credit risk,
essentially the same as that involved in extending loans to customers, and are
subject to the Company's normal credit policies. Collateral (e.g., securities,
receivables, inventory and equipment) is obtained based on management's credit
assessment of the customer.
-21-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
12. Commitments, Guarantees and Contingent Liabilities (continued)
The Company's maximum obligation to extend credit for loan commitments (unfunded
loans and unused lines of credit) and standby letters of credit was as follows:
September 30, December 31,
2005 2004
------------------------------
(In Thousands)
Commercial $ 139,720 $ 112,482
Real Estate 44,342 7,723
Consumer 88,051 66,199
Standby Letters of Credit 10,674 9,921
------------------------------
Total $ 282,787 $ 196,325
==============================
The remaining weighted average life for outstanding standby letters of credit
was less than one year at September 30, 2005. The Company had $3.9 million of
standby letters of credit with a life longer than one year.
13. Postretirement Benefits
First Defiance sponsors a defined benefit postretirement plan that is intended
to supplement Medicare coverage for certain retirees who meet minimum age
requirements. A description of employees or former employees eligible for
coverage is included in Footnote 14 in the financial statements included in
First Defiance's 2004 Annual Report on Form 10-K.
Net periodic postretirement benefit costs include the following components for
the three-month and nine-month periods ended September 30, 2005 and 2004:
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
--------------------------------------------
(In Thousands)
Service cost-benefits attributable
to service during the period $ 13 $ 12 $ 39 $ 36
Interest cost on accumulated
postretirement benefit
obligation 23 24 71 72
Net amortization and deferral 6 6 18 18
--------------------------------------------
Net periodic postretirement
benefit cost $ 42 $ 42 $ 128 $ 126
============================================
-22-
FIRST DEFIANCE FINANCIAL CORP.
Notes to Consolidated Condensed Financial Statements
(Unaudited at September 30, 2005 and 2004)
--------------------------------------------------------------------------------
13. Postretirement Benefits (continued)
Prescription drug coverage was added to Medicare under the Medicare Prescription
Drug Improvement and Modernization Act of 2003 (the Act). The Company continues
to study its options under the Act but believes it will opt for the Federal
subsidy approach. It does not appear that the impact of the Act will be material
to the financial results or position of the Company. As specific authoritative
guidance for matters related to the Act are pending, guidance when issued could
require First Defiance to change previously reported information.
14. Subsequent Event
On October 28, 2005 First Defiance completed the issuance of $20 million
aggregate principal amount Pooled Floating Rate Capital Securities. Those
securities have a 30-year maturity and are redeemable by the Company after five
years. They pay a floating interest rate based on three-month LIBOR plus 1.38%
and reprice on a quarterly basis. The proceeds from the issuance will be used
for general corporate purposes and will have a positive impact on regulatory
capital.
-23-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
General
-------
First Defiance Financial Corp. ("First Defiance" of "the Company") is a holding
company which conducts business through its two wholly owned subsidiaries, First
Federal Bank of the Midwest ("First Federal") and First Insurance and
Investments, Inc. ("First Insurance"). First Federal is a federally chartered
savings bank that provides financial services to communities based in northwest
Ohio where it operates 25 full service branches. On January 21, 2005, First
Defiance completed the acquisition of ComBanc, Inc. ("ComBanc"), a four-branch
bank holding company located in Delphos, Ohio. On April 8, 2005, First Defiance
completed the acquisition of The Genoa Savings and Loan Company ("Genoa"), a
savings and loan which operated four branches in Lucas, Wood and Ottawa
Counties. These acquisitions were accounted for as purchases and consolidated
results include the results of the ComBanc and Genoa branches since the
acquisition dates.First Federal provides a broad range of financial services
including checking accounts, savings accounts, certificates of deposit, real
estate mortgage loans, commercial loans, consumer loans, home equity loans and
trust services. First Insurance sells a variety of property and casualty, group
health and life, and individual health and life insurance products and
investment and annuity products. Insurance products are sold through First
Insurance's office in Defiance, Ohio while investment and annuity products are
sold through registered investment representatives located at three First
Federal banking center locations.
The profitability of First Defiance is primarily dependent on its net interest
income and non-interest income. Net interest income is the difference between
interest income on interest-earning assets, principally loans and securities,
and interest expense on interest-bearing deposits, Federal Home Loan Bank
advances, and other borrowings. The Company's non-interest income includes
deposit and loan servicing fees, mortgage banking income, and insurance
commissions. First Defiance's earnings also depend on the provision for loan
losses and non-interest expenses, such as employee compensation and benefits,
occupancy and equipment expense, deposit insurance premiums and miscellaneous
other expenses, as well as federal income tax expense.
Forward-Looking Information
---------------------------
Certain statements contained in this quarterly report that are not historical
facts, including but not limited to statements that can be identified by the use
of forward-looking terminology such as "may", "will", "expect", "anticipate", or
"continue" or the negative thereof or other variations thereon or comparable
terminology are "forward-looking statements" within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21B of the Securities Act
of 1934, as amended. Actual results could differ materially from those indicated
in such statements due to risks, uncertainties and changes with respect to a
variety of market and other factors.
Changes in Financial Condition
------------------------------
At September 30, 2005, First Defiance's total assets, deposits and stockholders'
equity amounted to $1.42 billion, $1.07 billion and $149.3 million,
respectively, compared to $1.13 billion, $797.7 million and $126.9 million,
respectively, at December 31, 2004.
Net loans receivable, including loans held for sale, increased $258.7 million to
$1.1 billion at September 30, 2005 from $881.2 million at December 31, 2004. The
increase in loans receivable occurred primarily in commercial real estate, which
increased by $109.1 million to $524.3 million, one-to-four
-24-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
family residential loans, which increased by $90.4 million to $280.4 million,
commercial loans, which increased by $26.3 million to $168.0, home equity and
improvement loans, which increased by $20.4 million to $111.2 million, consumer
loans, which increased by $11.5 million to $57.0 million and construction loans,
which increased by $6.9 million to $22.4 million. Of the $258.7 million increase
in total loans, $119.5 million was a result of the ComBanc, Inc acquisition and
$67.8 million was a result of the Genoa Savings and Loan Company acquisition.
The investment securities portfolio decreased to $115.6 million at September 30,
2005 from $139.3 million at December 31, 2004. The decrease in the balance in
the investment portfolio is the result of redeploying funds from securities as
they are sold, mature or get called to fund loan growth. At September 30, 2005
there were approximately $3.6 million of interest-bearing deposits held at other
financial institutions.
Deposits increased from $797.7 million at December 31, 2004 to $1.1 billion at
September 30, 2005. Of the total increase of $273.4 million, $163.7 million of
the increase was a result of the ComBanc, Inc acquisition, $76.8 million of the
increase was a result of the Genoa Savings and Loan Company acquisition and
$33.6 million was the result of organic growth in existing markets. Detail of
ComBanc's and Genoa's deposits as of the respective acquisition dates are as
follows:
ComBanc Genoa
------------------------
(In Thousands)
Non-interest-bearing checking accounts $ 17,700 $ 5,000
Interest-bearing checking accounts 33,000 20,400
Savings and money market demand accounts 43,800 11,200
Certificates of Deposit 69,168 40,186
------------------------
Total Deposits $ 163,668 $ 76,786
========================
Additionally, FHLB advances decreased to $164.1 million at September 30, 2005
from $178.2 million at December 31, 2004. Short-term advances were paid off
following the acquisition of ComBanc, a result of ComBanc's liquidity position.
Short-term borrowings increased to $21.2 million at September 30, 2005 from
$14.8 million at December 31, 2004. This is a result of an increase in the
balance of securities sold under repurchase agreements, principally due to the
ComBanc, Inc acquisition. These accounts are a function of customer demand.
Stockholders' equity increased from $126.9 million at December 31, 2004 to
$149.3 million at September 30, 2005. The increase is a result of issuing
721,164 shares of common stock at $26.03 per common share, totaling $19.1
million, to ComBanc shareholders, $8.5 million of net income, $1.1 million from
the exercise of stock options by First Defiance employees, and the release of
ESOP shares which increased equity by $1.3 million. Those increases were
partially offset by $4.5 million of dividends declared, a decrease in unrealized
gains on available for sale securities (net of tax) of $1.9 million and a $1.3
million decrease due to the repurchase of shares for treasury.
-25-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Average Balances, Net Interest Income and Yields Earned and Rates Paid
----------------------------------------------------------------------
The following table presents for the periods indicated the total dollar amount
of interest from average interest-earning assets and the resultant yields, as
well as the interest expense on average interest-bearing liabilities, expressed
both in thousands of dollars and rates, and the net interest margin. Dividends
received on FHLB stock are included as interest income. The table reports
interest income from tax-exempt loans and investment on a tax-equivalent basis.
All average balances are based upon daily balances.
Three Months Ended September 30,
---------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $1,136,526 $ 18,402 6.42% $ 832,116 $ 12,209 5.84%
Securities 113,832 1,395 4.86 147,358 1,839 4.96
Interest-earning deposits 7,674 72 3.72 835 1 0.48
FHLB stock and other 17,085 210 4.88 13,097 140 4.25
---------- ---------- ---------- ----------
Total interest-earning assets 1,275,117 20,079 6.25 993,406 14,189 5.68
Non-interest-earning assets 136,307 93,799
---------- ----------
Total assets $1,411,424 $1,087,205
========== ==========
Interest-bearing liabilities:
Deposits $ 958,590 $ 5,539 2.29% $ 712,814 $ 3,384 1.89%
FHLB advances and other 184,333 2,059 4.43 172,620 1,843 4.25
Notes payable 19,893 117 2.33 10,317 31 1.20
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,162,816 7,715 2.63 895,751 5,258 2.34
Non-interest bearing deposits 87,697 -- -- 55,641 -- --
---------- ---------- ---------- ----------
Total including non-interest bearing
demand deposits 1,250,513 7,715 2.45 951,392 5,258 2.20
Other non-interest-bearing liabilities 11,579 10,013
---------- ----------
Total liabilities 1,262,092 961,405
Stockholders' equity 149,332 125,800
---------- ----------
Total liabilities and stock-
holders' equity $1,411,424 $1,087,205
========== ==========
Net interest income; interest
rate spread $ 12,364 3.62% $ 8,931 3.34%
========== ===== ========== =====
Net interest margin (3) 3.85% 3.58%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 110% 111%
===== =====
---------------------
(1) Interest on certain tax-exempt loans and securities is not taxable for
Federal income tax purposes. In order to compare the tax-exempt yields on
these assets to taxable yields, the interest earned on these assets is
adjusted to a pre-tax equivalent amount based on the marginal corporate
federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
-26-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Nine Months Ended September 30,
---------------------------------------------------------------------------------
2005 2004
-------------------------------------- --------------------------------------
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
------- ----------- ------- ------- ----------- -------
Interest-earning assets:
Loans receivable $1,069,943 $ 50,220 6.28% $ 789,513 $ 34,424 5.82%
Securities 124,091 4,440 4.78 155,864 5,801 4.97
Interest-earning deposits 11,643 277 3.18 3,086 37 1.60
FHLB stock and other 16,037 579 4.83 15,374 471 4.09
---------- ---------- ---------- ----------
Total interest-earning assets 1,221,714 55,516 6.08 963,837 40,733 5.65
Non-interest-earning assets 121,364 94,242
---------- ----------
Total assets $1,343,078 $1,058,079
========== ==========
Interest-bearing liabilities:
Deposits $ 920,838 $ 14,395 2.09% $ 691,100 $ 9,453 1.83%
FHLB advances and other 167,225 5,650 4.52 167,177 5,418 4.33
Notes payable 17,796 313 2.35 10,241 75 0.98
---------- ---------- ---------- ----------
Total interest-bearing liabilities 1,105,859 20,358 2.46 868,518 14,946 2.30
Non-interest bearing deposits 84,644 -- -- 54,515 -- --
---------- ---------- ---------- ----------
Total including non-interest bearing
demand deposits 1,190,503 20,358 2.29 923,033 14,946 2.16
Other non-interest-bearing liabilities 9,285 9,186
---------- ----------
Total liabilities 1,199,788 932,219
Stockholders' equity 143,290 125,860
---------- ----------
Total liabilities and stock-
holders' equity $1,343,078 $1,058,079
========== ==========
Net interest income; interest
rate spread $ 35,158 3.61% $ 25,787 3.35%
========== ===== ========== =====
Net interest margin (3) 3.85% 3.57%
===== =====
Average interest-earning assets
to average interest-bearing
liabilities 110% 111%
===== =====
----------------------
(1) Interest on certain tax-exempt loans and securities is not taxable for
Federal income tax purposes. In order to compare the tax-exempt yields on
these assets to taxable yields, the interest earned on these assets is
adjusted to a pre-tax equivalent amount based on the marginal corporate
federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average
interest-earning assets.
-27-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Results of Operations
---------------------
Three Months Ended September 30, 2005 compared to Three Months Ended September
------------------------------------------------------------------------------
30, 2004
--------
On a consolidated basis, First Defiance had net income of $3.6 million or $.50
per diluted share for the three months ended September 30, 2005 compared to $1.7
million or $0.27 per diluted share in 2004.
Net Interest Income. Net interest income for the 2005 third quarter was $12.2
million, a 40.1% increase over the $8.7 million earned in the third quarter of
2004. Net interest margin for the 2005 third quarter, on a tax-equivalent basis,
was 3.85%, a 27 basis point improvement from the third quarter of 2004. The
improved margin in 2005 vs. 2004 is due to an improved mix between loans and
investment securities, an increase in the interest rate spread from 3.34% in the
third quarter of 2004 to 3.62% in the third quarter of 2005, and a significant
increase in non-interest bearing liabilities between the two periods.
Average interest-earning assets grew from $993.4 million in the third quarter of
2004 to $1.28 billion in the third quarter of 2005, an increase of 28.3%. The
average balance of loans outstanding increased from $832.1 million in the 2004
third quarter to $1.14 billion in the third quarter of 2005, while the average
balance of investment securities dropped from $147.4 million to $113.8 million
between those same periods. Approximately $117.3 million of the increase in
average loan balances related to the ComBanc acquisition, which closed on
January 21, 2005, and $66.9 million related to the Genoa acquisition, which
closed on April 8, 2005. The remainder of the increase, $120.9 million, is due
to year-over-year balance growth. Yields on loans improved to 6.42% for the 2005
third quarter from 5.84% in the third quarter of 2004 due to recent increases in
the prime interest rate. Overall, yields on interest-earning assets improved to
6.25% in the 2005 third quarter compared to 5.68% during that same period in
2004.
Average interest-bearing deposits increased to $958.6 million in the 2005 third
quarter compared with $712.8 million during the same period of 2004, an increase
of $245.8 million or 34.5%. The ComBanc acquisition added $146.0 million in
average balances of interest-bearing deposits while the Genoa acquisition added
$71.8 million in average balances for the quarter. The average balance in
interest-bearing deposits reflects a decrease in brokered certificates of
deposits (CDs), which averaged $55.3 million in the 2004 third quarter and
compared to $49.0 million in the 2005 period. Excluding the acquisitions and
brokered CDs, average interest-bearing deposits increased by $34.4 million in
the 2005 third quarter compared with the third quarter of 2004. The cost of
interest-bearing deposits increased 40 basis points, to 2.29% for the 2005 third
quarter from 1.89% in 2004 and the cost of Federal Home Loan Bank (FHLB)
advances increased 18 basis points, to 4.43% in the 2005 third quarter from
4.25% in the 2004 third quarter. Overall, total funding costs for
interest-bearing liabilities increased by 29 basis points, to 2.63% in the 2005
third quarter from 2.34% in the same period in 2004. As a result of the above
factors, the interest rate spread improved to 3.62% in the 2005 third quarter
from 3.34% during the third quarter of 2004.
The net interest margin also benefited from growth in the average balance of
non-interest bearing deposits, which increased to $87.7 million in the 2005
third quarter compared with $55.6 million
-28-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
during the 2004 third quarter, an increase of 57.7%. Of that $32.1 million
increase, $17.7 million was due to the ComBanc acquisition, $5.0 million was due
to the Genoa acquisition, and the remaining increase of $9.4 million resulted
from other Company initiatives to grow those balances.
Provision for Loan Losses. The provision for loan losses was $368,000 in the
third quarter of 2005 compared to $376,000 for the third quarter of 2004 despite
significant growth in loan balances. The lower provision was due in part to the
Company's very low loss experience in the 2005 third quarter, which reflected
net charge-offs of $204,000, or 0.07% (annualized) of average loans. Provisions
for loan losses are charged to earnings to bring the total allowance for loan
losses to the level deemed appropriate by management based on the following
factors: historical experience; the volume and type of lending conducted by
First Defiance; the amount of non-performing assets, including loans which meet
the FASB Statement No. 114 definition of impaired; the amount of assets graded
by management as substandard, doubtful, or loss; industry standards; general
economic conditions, particularly as they relate to First Defiance's market
area; and other factors related to the collectibility of First Defiance's loan
portfolio.
Non-performing assets and asset quality ratios for First Defiance were as
follows (in $000's):
September 30, December 31,
2005 2004
-------------------------------
Non-accrual loans $ 6,720 $ 1,893
Loans over 90 days past due and still accruing -- --
-------------------------------
Total non-performing loans $ 6,720 $ 1,893
Real estate owned (REO) 168 98
-------------------------------
Total non-performing assets $ 6,888 $ 1,991
===============================
Allowance for loans losses as a percentage
of total loans 1.18% 1.12%
Allowance for loan losses as a percentage
of non-performing assets 197.79% 500.05%
Allowance for loan losses as a percentage
of non-performing loans 202.74% 525.94%
Total non-performing assets as a percentage
of total assets 0.49% 0.18%
Total non-performing loans as a percentage
of total loans 0.58% 0.21%
Total non-performing loans increased to $6.7 million from $1.9 million at
December 31, 2004 and non-performing assets increased to $6.9 million from $2.0
million. Of the $6.7 million in non-performing loans at September 30, 2005, $4.7
million were acquired in one of the 2005 acquisitions and $2.0 million related
to loans originated by First Defiance. First Defiance's allowance for loan
losses as a percentage of non-performing loans declined to 202.7% at September
30, 2005 from 525.9% at December 31, 2004. The decrease in the coverage ratios
is due primarily to delinquent loans acquired in the acquisitions. However,
those ratios also are impacted by the accounting guidance which requires that
estimated losses on loans deemed impaired as of the acquisition date be recorded
as a purchase discount, which directly reduces the loan balance, as opposed to
establishing an allowance for loan losses. As a result of this accounting, net
loan balances totaling $4.3 million (after deducting
-29-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
appropriate purchase discounts) at September 30, 2005 are deemed impaired and
have no loan loss reserve recorded for them. Approximately $710,000 of these
impaired loans are included in the $6.7 million of non-performing loans with no
offsetting loan loss reserve. In management's opinion, the allowance for loan
losses at September 30, 2005 is sufficient and the provision for loan losses for
both the three and nine-month periods ended September 30, 2005 are consistent
with charge-offs and other information available as of that date.
Non-Interest Income. Non-interest income increased to $4.0 million for the 2005
third quarter compared to $2.9 million during the same period in 2004. First
Defiance realized $86,000 of gains from sales of investment securities during
the 2005 third quarter compared with $302,000 of such gains in the 2004 period.
Excluding securities gains, non-interest income grew by $1.3 million in the 2005
third quarter over the same period in 2004, an improvement of 48.5%. Those
quarter-to-date increases were primarily in service fees and mortgage banking
income. Individual components of non-interest income are as follows:
Mortgage Banking Income. Mortgage banking income increased to $1.1 million for
the quarter ended September 30, 2005 from $332,000 in the same period in 2004.
Increases in the 10-year treasury rate from the end of the second quarter to the
end of the third quarter and a general slowdown in prepayment speeds of
mortgages between those two periods has resulted in an increase in the valuation
of First Defiance's mortgage servicing rights. As a result, First Defiance
realized recovery of previously recorded MSR impairment in the 2005 third
quarter of $240,000 compared with an impairment charge of $321,000 in the 2004
third quarter, a swing of $561,000 between the two periods. MSR amortization and
valuation adjustments are netted against mortgage banking income in the
financial statements. See Note 10 to the unaudited financial statements. Also
during the third quarter of 2005, management determined that certain MSR
impairment related to its servicing of balloon mortgage loans likely will not be
recovered under any rate environment and First Defiance has therefore written
off approximately $110,000 against the impairment reserve. As a result of the
impairment recapture and the permanent write-down, the remaining impairment
reserves as of September 30, 2005 are approximately $131,000.
Gain on Sale of Securities. Gains realized from the sale of investment
securities were $86,000 in the third quarter of 2005. This was a decrease of
$216,000 from a gain of $302,000 in the third quarter of 2004.
Service Fees. Loan and deposit fees increased $421,000 to $1.5 million for the
quarter ended September 30, 2005 from $1.1 million for the quarter ended
September 30, 2004. Increases occurred primarily in loan servicing fees on sold
loans, debit card interchange fees, and checking NSF fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $60,000 to $966,000 in the third quarter of 2005
from $906,000 in the same period of 2004.
Non-Interest Expense. Non-interest expense for the 2005 third quarter was $10.5
million compared with $9.0 million in the 2004 third quarter. The 2005
non-interest expense amount includes $97,000 of acquisition related charges
associated with the second quarter 2005 acquisition of Genoa Savings. The 2004
non-interest expense amount includes $1.9 million of costs associated with the
settlement of certain contingent liabilities related to the 2002 sale of the
-30-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Company's Leader Mortgage subsidiary. If acquisition-related costs and the costs
of the contingent liability are excluded, non-interest expenses for the 2005
third quarter were $10.4 million compared to $7.1 million for the 2004 third
quarter.
Acquisition Related Charges. Second quarter 2005 results included $97,000 of
non-recurring costs associated with the Genoa acquisitions. Acquisition-related
charges consist of items incurred directly as a result of the acquisitions such
as costs to terminate data processing agreements, severance costs to employees
not retained and one-time charges necessary to effect the integration of the
acquisition.
Compensation and Benefits. Compensation and benefits increased $1.8 million to
$6.1 million for the quarter ended September 30, 2005 from $4.3 million for the
same period in 2004. The majority of the increase is due to staffing of the two
acquired companies. Also the Company has incurred significant personnel related
costs related to increased staffing at operations to support the significant
growth and also to deal with expanded internal control and regulatory compliance
requirements. Since April 1, 2004, senior level positions have been added in the
credit administration, accounting and human resource areas along with the
addition of an in-house internal auditor. A total of approximately 25 support
positions have been added since the beginning of 2004. The addition of these new
positions also has resulted in a significant increase in the Company's health
insurance expense in 2005 compared with 2004.
Settlement of Contingent Liability. The 2004 third quarter results included $1.9
million of expense related to the settlement of certain claims related to The
Company's sale in 2002 of its Leader Mortgage Company subsidiary. There were no
contingency settlements in the 2005 third quarter.
Other Non-Interest Expenses. Other non-interest expenses (including occupancy,
state franchise tax, data processing, deposit insurance premiums, and
amortization of intangibles) increased to $4.3 million for the quarter ended
September 30, 2005 from $2.8 million for the same period in 2004.
Occupancy costs increased by $399,000 and data processing costs increased by
$218,000 comparing the third quarter of 2004 and the third quarter of 2005. The
increase in occupancy can be primarily attributed to the addition of seven
full-service branch-banking facilities. Non-interest expense also included
amortization of core deposit intangibles totaling $214,000, compared to just
$28,000 in the 2004 third quarter period, a result of additional core deposit
intangibles acquired as part of the ComBanc and Genoa acquisitions.
The efficiency ratio for the third quarter of 2005 was 64.42% based on GAAP
earnings and 63.82% on a core operating earnings basis (excluding one-time
acquisition related charges). The efficiency ratio for the third quarter of 2004
was 78.65% on GAAP earnings and 62.65% on a core operating earnings basis
(excluding the settlement of a contingent liability).
First Defiance computes federal income tax expense in accordance with FASB
Statement No. 109, which resulted in an effective tax rate of 32.45% for the
quarter ended September 30, 2005 compared to 26.51% for the same period in 2004.
The effective tax rate is lower than the Company's statutory 35% rate because it
has approximately $32.1 million invested in municipal securities, and $19.1
million of bank owned life insurance which are both exempt from federal tax.
-31-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
As a result of the above factors, income for the quarter ended September 30,
2005 was $3.6 million compared to income of $1.7 million for the comparable
period in 2004. On a per share basis, basic and diluted earnings per share for
the three months ended September 30, 2005 were each $0.52 and $.50,
respectively, compared to basic and diluted earnings per share of $0.28 and
$0.27, respectively, for the quarter ended September 30, 2004. Core earnings for
the 2005-third quarter were $3.7 million or $0.51 per diluted share compared to
$2.9 million or $0.46 per diluted share for the 2004-third quarter.
Nine Months Ended September 30, 2005 compared to Nine Months Ended September 30,
--------------------------------------------------------------------------------
2004
----
On a consolidated basis, First Defiance had net income of $8.5 million or $1.20
per diluted share for the nine months ended September 30, 2005 compared to $7.3
million or $1.15 per diluted share in 2004.
Net Interest Income. For the nine months ended September 30, 2005, net interest
income increased to $34.7 million, a 37.6% increase from the nine-month period
ended September 30, 2004. During those periods, net interest margin improved to
3.85% from 3.57%, the result of a 43 basis point increase in the overall yield
of interest earning assets, to 6.08% for the 2005 period from 5.65% during the
first nine months of 2004. During that same period, the cost of interest-bearing
liabilities increased just 16 basis points, to 2.46% in the first nine months of
2005 compared to 2.30% in 2004. The average balance of non-interest bearing
deposits increased by $30.1 million or 55.2% between the first nine months of
2004 and the same period in 2005.
Total interest income increased by $14.9 million to $55.0 million for the nine
months ended September 30, 2005 from $40.1 million for the nine months ended
September 30, 2004. Interest on loans increased $15.8 million to $50.2 million
in the first nine months of 2005 from $34.4 million in the first nine months of
2004. The increase in interest from loans was primarily due to a $280.4 million
increase in average loan balances between the first nine months of 2004 and the
first nine months of 2005. That increase is the result of the ComBanc
acquisition in January 2005 and the Genoa acquisition in April 2005, which added
$119.5 million and $67.6 million in loans, respectively, and due to continued
organic portfolio growth throughout the First Defiance market.
Interest earnings from the investment portfolio and interest-earning deposits,
on a tax equivalent basis, decreased $1.1 million to $4.7 million for the nine
months ended September 30, 2005 compared to $5.8 million for the same period in
2004. The decrease was due to the $23.2 million decline in average balances of
investments to $135.7 million for the first nine months of 2005 compared to
$158.9 million for the first nine months of 2004.
Total interest expense increased $5.4 million to $20.4 million for the first
nine months of 2005 compared to $14.9 million for the same period in 2004.
Interest expense on interest-bearing deposits increased by $4.9 million to $14.4
million for the nine months ended September 30, 2005 from $9.5 million for the
nine months ended September 30, 2004. The average cost of funds increased from
2.30% for the nine months ended September 30, 2004 to 2.46% for the same period
in 2005. The average balances of interest-bearing liabilities increased $237.3
million from $868.5 million in the first nine months of 2004 to $1.11 billion in
the first nine months of 2005.
-32-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Provision for Loan Losses. The provision for loan losses was $1.1 million in the
first nine months of 2005 compared to $1.2 million for the first nine months of
2004 despite significant growth in loan balances. The lower provision is
consistent with the Company's very low loss experience in the first nine months
of 2005, which showed net charge-offs of just $423,000. While asset quality
ratios associated with the allowance as a percentage of non-performing loans
have deteriorated since the start of the year, that deterioration is a factor of
the asset quality of the acquired portfolios. Management believes that the
allowances and related loan purchase discounts acquired with each acquisition
were appropriate and the allowance for loan losses as of September 30, 2005 is
adequate.
Non-Interest Income. Year-to-date, non-interest income increased to $12.2
million for the first nine months of 2005 from $10.1 million recognized in the
same period of 2004. If gains from the sale of securities of $1.2 million and
$694,000 for the first nine months of 2005 and 2004, respectively, are excluded,
non-interest income increased by $1.6 million. Individual non-interest income
components are as follows:
Mortgage Banking Income. Mortgage banking income increased to $2.5 million for
the nine months ended September 30, 2005 from $2.1 million in the same period in
2004. Increases in the 10-year treasury rate from the end of the second quarter
to the end of the third quarter and a general slowdown in prepayment speeds of
mortgages between those two periods has resulted in an increase in the valuation
of First Defiance's mortgage servicing rights. As a result, First Defiance
realized recovery of previously recorded MSR impairment in the first nine months
of 2005 in the amount of $366,000 compared with an impairment charge of $34,000
in the first nine months of 2004. MSR amortization and valuation adjustments are
netted against mortgage banking income in the financial statements.
Gain on Sale of Securities. Gains realized from the sale of investment
securities was $1.2 million for the nine months ended September 30, 2005
compared to $694,000 in the first nine months of 2004.
Service Fees. Loan and deposit fees increased $904,000 to $4.0 million for the
nine months ended September 30, 2005 from $3.1 million for the nine months ended
September 30, 2004. Increases occurred primarily in checking fees and debit card
interchange fees.
Insurance and Investment Sales Commission. Insurance and investment sales
commission income increased $37,000 to $3.23 million in the first nine months of
2005 from $3.19 million in the same period of 2004.
Trust income. Revenue generated by First Federal Bank's trust department
increased to $229,000 for the first nine months of 2005 from $167,000 in the
same period of 2004.
Bank Owned Life Insurance. Income from bank owned life insurance ("BOLI")
decreased $38,000 to $541,000 in the first nine months of 2005 compared to
$579,000 for the nine months ended September 30, 2004. The decline is the result
of declining rates in the general account investments that the insurance is
invested in. The rates on this type of product tend to lag the overall market.
Other Non-Interest Income. Other non-interest income including other
miscellaneous charges, increased to 444,000 for the nine months ended September
30, 2005 from $225,000 for the same period in 2004.
-33-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Non-Interest Expense. For the year-to-date period ended September 30, 2005
non-interest expenses totaled $33.3 million compared to $23.5 million for the
first nine months of 2004. Excluding acquisition-related charges and the
settlement of contingent liabilities, non-interest expense was $29.8 million for
the nine months ended September 30, 2005, and $21.6 million for the nine-months
ended September 30, 2004, which was an increase of $8.2 million. Compensation
and benefits accounted for $4.5 million of the year-to-date increase while
occupancy increased by $972,000, data processing costs increased by $687,000 and
core deposit intangible amortization increased by $459,000. Significant
individual components of the increase are as follows:
Acquisition Related Charges. Year-to-date 2005 results included $3.5 million of
non-recurring costs associated with the ComBanc and Genoa acquisitions.
Acquisition-related charges consist of items incurred directly as a result of
the acquisitions such as costs to terminate data processing agreements,
severance costs to employees not retained and one-time charges necessary to
effect the integration of the acquisition.
Occupancy. Occupancy expense increased to $3.4 million for the nine months ended
September 30, 2005 as compared to $2.5 million for the nine months ended
September 30, 2004. This $972,000 increase is the result of the addition of
seven full-service branch banking facilities obtained in the ComBanc and Genoa
acquisitions.
Compensation and Benefits. Compensation and benefits increased $4.5 million to
$17.6 million for the nine months ended September 30, 2005 from $13.1 million
for the same period in 2004. The increase was also due to the addition of
several new lending positions and a significant number of new support positions
in the credit administration, loan processing, deposit operations, data
processing and accounting areas. These new positions have been added to both
support growth and assure compliance with regulatory and internal control
requirements. The addition of these new positions also has resulted in a
significant increase in the Company's health insurance expense in 2005 compared
with 2004.
Settlement of Contingent Liability. The 2004 year-to-date results included $1.9
million of expense related to the settlement of certain claims related to The
Company's sale in 2002 of its Leader Mortgage Company subsidiary. There were no
contingency settlements in 2005.
Other Non-Interest Expenses. Other non-interest expenses (including state
franchise tax, data processing, amortization of intangibles, and deposit
insurance premiums) increased to $8.8 million for the nine months ended
September 30, 2005 from $6.0 million for the nine months ended September 30,
2004.
The effective federal income tax rate for the nine months ended September 30,
2004 was 31.9% compared to 30.4% for the nine months ended September 30, 2004.
The increase in the effective tax rate is the result of tax-exempt income
(primarily earnings on municipal securities and BOLI) being a smaller percentage
of total income in 2005 compared to the prior year.
As a result of the above factors, net income for the nine months ended September
30, 2005 was $8.5 million compared to $7.3 million for the comparable period in
2004. On a per share basis, basic and
-34-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
diluted earnings per share for the nine months ended September 30, 2005 were
$1.25 and $1.20 respectively, compared to basic and diluted earnings per share
of $1.20 and $1.15, respectively, for the nine months ended September 30, 2004.
On a core operating earnings basis, which excludes one-time acquisition related
charges and the settlement of contingent liability (net of federal income tax),
net income amounted to $10.8 million and $8.6 million, respectively, for the
nine months ended September 30, 2005 and 2004. On a per share basis, core
operating earnings amounted to $1.52 per diluted share for the nine months ended
September 30, 2005 compared to $1.34 per diluted share for the nine months ended
September 30, 2004.
Liquidity and Capital Resources
As a regulated financial institution, First Federal is required to maintain
appropriate levels of "liquid" assets to meet short-term funding requirements.
First Defiance generated $8.5 million of cash from operating activities during
the first nine months of 2005. The Company's cash from operating activities
resulted from net income for the period, adjusted for various non-cash items,
including the provision for loan losses, depreciation and amortization of
mortgage servicing rights, gain on sales of securities, loans and property,
plant and equipment, ESOP expense related to release of shares, and changes in
loans available for sale, interest receivable and other assets, and other
liabilities. The primary investing activity of First Defiance is the origination
of loans, which is funded with cash provided by operations, proceeds from the
amortization and prepayments of existing loans, the sale of loans, proceeds from
the sale or maturity of securities, borrowings from the FHLB, and customer
deposits.
At September 30, 2005, First Defiance had $109.1 million in outstanding loan
commitments and loans in process to be funded generally within the next six
months and an additional $173.7 million committed under existing consumer and
commercial lines of credit and standby letters of credit. Also at that date,
First Defiance had commitments to sell $14.5 million of loans held-for-sale. As
of September 30, 2005, the total amount of certificates of deposit that are
scheduled to mature by September 30, 2006 is $427.9 million. First Defiance
believes that it has adequate resources to fund commitments as they arise and
that it can adjust the rate on savings certificates to retain deposits in
changing interest rate environments. If First Defiance requires funds beyond its
internal funding capabilities, advances from the FHLB of Cincinnati and other
financial institutions are available.
First Defiance utilizes forward purchase and forward sale agreements to meet the
needs of its customers and manage its exposure to fluctuations in the fair value
of mortgage loans held for sale and its pipeline. These forward purchase and
forward sale agreements are considered to be derivatives as defined by FAS 133,
Accounting for Derivatives and Hedging Instruments. The change in value in the
forward purchase and forward sale agreements is approximately equal to the
change in value in the loans held for sale and the effect of this accounting
treatment is not material to the financial statements.
First Defiance also invests in on-balance sheet derivative securities as part of
the overall asset and liability management process. Such derivative securities
include REMIC and CMO investments. As of September 30, 2005, all of these
securities pass the FFIEC high-risk security test. The weighted average life of
these securities does not exceed the test limits in an instantaneous rate
increase scenario of 200 and 300 basis points. The company feels that at this
time the return being realized is worth this
-35-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
risk. The total $22.2 million balance of these securities are not classified as
high risk at September 30, 2005 and do not present risk significantly different
than other mortgage-backed or agency securities.
First Federal is required to maintain specified amounts of capital pursuant to
regulations promulgated by the OTS. The capital standards generally require the
maintenance of regulatory capital sufficient to meet a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
The following table sets forth First Federal's compliance with each of the
capital requirements at September 30, 2005.
Core Capital Risk-Based Capital
---------------------------------------------------------------
Adequately Well Adequately Well
Capitalized Capitalized Capitalized Capitalized
---------------------------------------------------------------
Regulatory capital $ 106,180 $ 106,180 $ 119,761 $ 119,761
Minimum required regulatory capital 55,003 68,754 89,593 111,991
---------------------------------------------------------------
Excess regulatory capital $ 51,177 $ 37,426 $ 30,168 $ 7,770
===============================================================
Regulatory capital as a percentage of assets (1) 7.7% 7.7% 10.7% 10.7%
Minimum capital required as a percentage
of assets 4.0% 5.0% 8.0% 10.0%
---------------------------------------------------------------
Excess regulatory capital as a percentage
of assets 3.7% 2.7% 2.7% 0.7%
===============================================================
(1) Core capital is computed as a percentage of adjusted total assets of $1.4
billion. Risk-based capital is computed as a percentage of total
risk-weighted assets of $1.1 billion.
On October 28, 2005 First Defiance completed the issuance of $20 million
aggregate principal amount Pooled Floating Rate Capital Securities. Those
securities have a 30-year maturity and are redeemable by the Company after five
years. They pay a floating interest rate based on three-month LIBOR plus 1.38%
and reprice on a quarterly basis. The proceeds from the issuance will be used
for general corporate purposes. First Defiance will contribute $10 million of
the proceeds from the issuance of the securities to First Federal as an
additional capital contribution, increasing the level of regulatory capital by
that amount.
-36-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations - Continued
-------------------------
Critical Accounting Policies
First Defiance has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of its financial statements. The significant accounting policies
of First Defiance are described in the footnotes to the consolidated financial
statements included in the Company's Annual Report on Form 10-K. Certain
accounting policies involve significant judgments and assumptions by management,
which have a material impact on the carrying value of certain assets and
liabilities; management considers such accounting policies to be critical
accounting policies. Those policies which are identified and discussed in detail
in the Company's Annual Report on Form 10-K include the Allowance for Loan
Losses, the Valuation of Mortgage Servicing Rights and the Deferral of Fees
under SFAS 91. There have been no material changes in assumptions or judgments
relative to those critical policies during the third quarter of 2005 or during
the nine month period ended September 30, 2005.
FDIC Insurance
The deposits of First Federal are currently insured by the Savings Association
Insurance Fund ("SAIF") which is administered by the FDIC. The FDIC also
administers the Bank Insurance Fund ("BIF") which generally provides insurance
to commercial bank depositors. Both the SAIF and BIF are required by law to
maintain a reserve ratio of 1.25% of insured deposits. First Federal's annual
deposit insurance premiums for 2005 are approximately $0.014 per $100 of
deposits.
-37-
Item 3. Qualitative and Quantitative Disclosure About Market Risk
-----------------------------------------------------------------
As discussed in detail in the 2004 Annual Report on Form 10-K, First Defiance's
ability to maximize net income is dependent on management's ability to plan and
control net interest income through management of the pricing and mix of assets
and liabilities. Because a large portion of assets and liabilities of First
Defiance are monetary in nature, changes in interest rates and monetary or
fiscal policy affect its financial condition and can have significant impact on
the net income of the Company. First Defiance does not use off balance sheet
derivatives to enhance its risk management, nor does it engage in trading
activities beyond the sale of mortgage loans.
First Defiance monitors its exposure to interest rate risk on a monthly basis
through simulation analysis which measures the impact changes in interest rates
can have on net income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, nonmaturity deposit assumptions and capital
requirements. The results of the simulation indicate that in an environment
where interest rates rise 100 basis points over a 12 month period, First
Defiance's net interest income would increase by 2.28% over the base case
scenario. Were interest rates to fall by 100 basis points during the same
12-month period, the simulation indicates that net interest income would
decrease by 2.26%. It should be noted that other areas of First Defiance's
income statement, such as gains from sales of mortgage loans and amortization of
mortgage servicing rights are also impacted by fluctuations in interest rates
but are not considered in the simulation of net interest income.
In addition to the simulation analysis, First Federal also prepares an "economic
value of equity" ("EVE") analysis. This analysis calculates the net present
value of First Federal's assets and liabilities in rate shock environments that
range from -100 basis points to +200 basis points. The results of this analysis
are reflected in the following table.
September 30, 2005
-------------------------------------------------------------------------------------------------------------
Economic Value of Equity as % of
Economic Value of Equity Present Value of Assets
------------------------------------------------- ----------------------------------
Change in Rates $ Amount $ Change % Change Ratio Change
(Dollars in Thousands)
-------------------------------------------------------------------------------------------------------------
+ 200 bp 163,084 (7,289) (4.28%) 12.04% (8) bp
+ 100 bp 167,195 (3,178) (1.87%) 12.11% (1) bp
0 bp 170,373 -- -- 12.12% --
-100 bp 170,575 202 0.12% 11.94% (18) bp
-200 bp 168,484 (1,889) (1.11%) 11.61% (51) bp
-38-
Item 3. Qualitative and Quantitative Disclosures About Mark Risk - Continued
Based on the above analysis, in the event of a 200 basis point increase in
interest rates as of September 30, 2005, First Federal would experience a 4.28%
decrease in its economic value of equity. If rates would fall by 200 basis
points its economic value of equity would decline by 1.11%. During periods of
rising rates, the value of monetary assets declines. Conversely, during periods
of falling rates, the value of monetary assets increases. It should be noted
that the amount of change in value of specific assets and liabilities due to
changes in rates is not the same in a rising rate environment as in a falling
rate environment. Based on the EVE analysis, the change in the economic value of
equity in both rising and falling rate environments is generally negligible
because both its assets and liabilities have relatively short durations and the
durations are fairly closely matched. The average duration of its assets at
September 30, 2005 was 1.74 years while the average duration of its liabilities
was 1.84 years.
In evaluating First Federal's exposure to interest rate risk, certain
shortcomings inherent in the each of the methods of analysis presented must be
considered. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market rates
while interest rates on other types of financial instruments may lag behind
current changes in market rates. Furthermore, in the event of changes in rates,
prepayments and early withdrawal levels could differ significantly from the
assumptions in calculating the table and the results therefore may differ from
those presented.
Item 4. Controls and Procedures
-------------------------------
Disclosure Controls are procedures designed to ensure that information required
to be disclosed in the Company's reports filed under the Exchange Act, such as
this report, is recorded, processed, summarized, and reported within the time
periods specified in the SEC's rules and forms. Disclosure controls are also
designed to ensure that such information is accumulated and communicated to
management, including the Chief Executive Officer and Chief Financial Officer,
as appropriate to allow timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance of achieving the
desired control objectives, as ours are designed to do, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As of September 30, 2005, an evaluation was carried out under the supervision
and with the participation of the Company's management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of its disclosure controls and procedures (as defined in
Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the design and operation of these disclosure controls and procedures were
effective. No significant changes were made in the internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
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FIRST DEFIANCE FINANCIAL CORP.
PART II-OTHER INFORMATION
Item 1. Legal Proceedings
First Defiance is not engaged in any legal proceedings of a material
nature.
Item 2. Unrestricted Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------------------------------------------------------
Total Number of Maximum Number of
Shares Purchased as Shares that May
Average Price Part of Publicly Yet Be Purchased
Total Number of Paid Announced Plans or Under the Plans or
Period Shares Purchased Per Share Programs Programs (a)
-----------------------------------------------------------------------------------------------------------
July 1, 2005 -
July 31, 2005 6,988 $29.70 6,988 424,107
-----------------------------------------------------------------------------------------------------------
August 1, 2005 -
August 31, 2005 3,373 $27.85 3,373 420,734
-----------------------------------------------------------------------------------------------------------
September 1, 2005 -
September 30, 2005 740 $29.10 740 419,994
-----------------------------------------------------------------------------------------------------------
Total for 2005
Third Quarter 11,101 $29.10 11,101 419,994
-----------------------------------------------------------------------------------------------------------
(a) On July 18, 2003, the registrant announced that its Board of Directors had
authorized management to repurchase up to 10% of the Registrant's common
stock through the open market or in any private transaction. The
authorization, which is for 639,828 shares, does not have an expiration
date.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
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(a) Exhibits
Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act
Exhibit 31.2 Certification of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act
Exhibit 32.1 Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act
Exhibit 32.2 Certification of Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act
-41-
FIRST DEFIANCE FINANCIAL CORP.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
First Defiance Financial Corp.
(Registrant)
Date: November 9, 2005 By: /s/ William J. Small
---------------- ------------------------
William J. Small
Chairman, President and
Chief Executive Officer
Date: November 9, 2005 By: /s/ John C. Wahl
---------------- ---------------------------------
John C. Wahl
Executive Vice President, Chief
Financial Officer and
Treasurer
-42-