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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year Ended December 31, 2005
---------------------------------
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-26850
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FIRST DEFIANCE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
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OHIO 34-1803915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
601 Clinton Street, Defiance, Ohio 43512
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (419) 782-5015
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
(Title of class)
---------------
Indicate by check mark if the registrant is a well-known seasoned issued, as
defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark if registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act. Yes |_| No |X|
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |X|
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the 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 |_| No |X|
As of March 3, 2006, there were issued and outstanding 7,152,942 shares of the
Registrant's common stock.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant computed by reference to the average bid and ask price of such stock
as of June 30, 2005 was approximately $175.5 million
---------------
Documents Incorporated by Reference
Part II and Part III - Portions of the Proxy Statement for the Annual Meeting of
Shareholders to be held on April 18, 2006 are incorporated by reference into
Part II and III thereof.
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PART I
Item 1. Business
First Defiance Financial Corp. (First Defiance or the Company) is a
unitary thrift holding company that, through its subsidiaries (the
Subsidiaries), focuses on traditional banking and property and casualty, life
and group health insurance products. The Company's traditional banking
activities include originating and servicing residential, commercial, and
consumer loans and providing a broad range of depository services. The Company's
insurance activities consist primarily of commissions relating to the sale of
property and casualty, life and group health insurance and investment products.
At December 31, 2005, the Company had consolidated assets of $1.461
billion, consolidated deposits of $1.070 billion, and consolidated stockholder's
equity of $151.2 million. The Company was incorporated in Ohio in June of 1995.
Its principal executive offices are located at 601 N. Clinton Street, Defiance,
Ohio 43512, and its telephone number is (419) 782-5015.
First Defiance's Internet site, www.fdef.com contains a hyperlink under
the Investor Relations section to EDGAR where the annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 are available free of charge as soon as
reasonably practicable after First Defiance has filed the report with the SEC
The Subsidiaries
The Company's core business operations are conducted through the following
Subsidiaries:
First Federal Bank of the Midwest: First Federal Bank of the Midwest
(First Federal) is a federally chartered stock savings bank headquartered in
Defiance, Ohio. As of December 31, 2005, it conducts operations through its main
office and 25 full service branch offices in Allen, Defiance, Fulton, Hancock,
Henry, Lucas, Ottawa, Paulding, Putnam, Seneca, Williams and Wood Counties in
northwest Ohio.
On January 21, 2005, First Defiance completed the acquisition of ComBanc,
Inc. (ComBanc) and its subsidiary, the Commercial Bank, Delphos, Ohio. That
acquisition added four branch offices located in Allen County, Ohio which is
adjacent to First Defiance's existing footprint. On April 8, 2005, First
Defiance completed the acquisition of the Genoa Savings and Loan Company,
(Genoa) which added three offices in the metropolitan Toledo, Ohio area.
First Federal is primarily engaged in community banking. It attracts
deposits from the general public through its offices and uses those and other
available sources of funds to originate residential real estate loans,
non-residential real estate loans, commercial loans, home improvement and home
equity loans and consumer loans. In addition, First Federal invests in U.S.
Treasury and federal government agency obligations, obligations of the State of
Ohio and its political subdivisions, mortgage-backed securities which are issued
by federal agencies, including REMICs and CMOs and corporate bonds. First
Federal's deposits are insured by the Federal Deposit Insurance Corporation
(FDIC) under the Savings Association Insurance Fund (SAIF). First Federal is a
member of the Federal Home Loan Bank (FHLB) System.
-2-
First Insurance & Investments: First Insurance & Investments (First
Insurance) is a wholly owned subsidiary of First Defiance. First Insurance is an
insurance agency that does business in the Defiance, Ohio area. First Insurance
offers property and casualty insurance, life insurance, group health insurance,
and investment products.
Securities
First Defiance's securities portfolio is managed in accordance with a
written policy adopted by the Board of Directors and administered by the
Investment Committee. The Chief Financial Officer, the Chief Operating Officer,
and the Chief Executive Officer of First Federal can each approve transactions
up to $1 million. Two of the three officers are required to approve transactions
between $1 million and $5 million. All transactions in excess of $5 million must
be approved by the Board of Directors.
First Defiance's investment portfolio includes 19 CMO and REMIC issues
totaling $21.0 million, all of which are fully amortizing securities. All such
investments are considered derivative securities. None of the securities are
considered to be "high risk" based on the stress test developed by the banking
regulators. Management does not believe the risks associated with any of these
investments are significantly different from risks associated with other
pass-through mortgage-backed securities. First Defiance does not invest in
off-balance sheet derivative securities.
Management determines the appropriate classification of debt securities at
the time of purchase. Debt securities are classified as held-to-maturity when
First Defiance has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost. Debt
securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value.
The amortized cost and fair value of securities at December 31, 2005 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Money market mutual
funds and other mutual funds are not due at a single maturity date. For purposes
of the maturity table, mortgage-backed securities, which are not due at a single
maturity date, have been allocated over maturity groupings based on the
weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
-3-
Contractually Maturing Total
---------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average
Year Rate Years Rate Years Rate Years Rate Amount Yield
---------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage-backed
securities $ 3,590 4.80% $ 10,394 4.81% $ 5,436 4.88% $ 1,752 5.16% $ 21,172 4.86%
REMICs and CMOs 4,303 4.21 11,620 4.45 4,749 4.67 370 4.98 21,042 4.46
U.S. government and
federal agency
obligations 6,000 3.46 33,550 4.60 1,570 4.84 -- -- 41,120 4.44
Obligations of states
and political
subdivisions (1) 745 6.64 5,885 6.23 5,698 6.47 10,940 6.32 23,268 6.35
Trust preferred stock -- -- -- 7,744 6.20 7,744 6.20
--------- --------- --------- --------- --------
Total $ 14,638 $ 61,449 $ 17,453 $ 20,806 114,346
========= ========= ========= ========= ========
Unamortized premiums/
(discounts) 543
Unrealized loss on
securities available
for sale (35)
---------
Total $114,854
=========
(1) Tax exempt yield based on effective tax rate of 35%. Actual coupon rate is
approximately equal to the weighted average rate disclosed in the table times
65%.
The carrying value of investment securities is as follows:
December 31
-----------------------------------
2005 2004 2003
-----------------------------------
(In Thousands)
Available-for-sale securities:
Corporate bonds $ -- $ 6,468 $ 7,716
U. S. treasury and federal agency obligations 41,065 50,313 76,875
Obligations of state and political subdivisions 23,818 32,092 32,835
CMOs, REMICS and mortgage-backed securities 40,395 41,765 43,433
Other 7,801 6,365 7,400
-----------------------------------
Total $ 113,079 $ 137,003 $ 168,259
===================================
Held-to-maturity securities:
Mortgage-backed securities $ 1,330 $ 1,725 $ 2,186
Obligations of state and political
subdivisions 445 530 590
-----------------------------------
Total $ 1,775 $ 2,255 $ 2,776
===================================
For additional information regarding First Defiance's investment portfolio
refer to Note 5 to the consolidated financial statements.
Interest-Bearing Deposits
First Defiance had interest-earning deposits in the FHLB of Cincinnati
amounting to $8.1 million and $456,000 at December 31, 2005 and 2004,
respectively.
-4-
Residential Loan Servicing Activities
Servicing mortgage loans for investors involves a contractual right to
receive a fee for processing and administering loan payments on mortgage loans
that are not owned by the Company and are not included on the Company's balance
sheet. This processing involves collecting monthly mortgage payments on behalf
of investors, reporting information to those investors on a monthly basis and
maintaining custodial escrow accounts for the payment of principal and interest
to investors and property taxes and insurance premiums on behalf of borrowers.
At December 31, 2005, First Federal serviced 7,511 loans totaling $602.5
million. The vast majority of the loans serviced for others are fixed rate
conventional mortgage loans.
As compensation for its mortgage servicing activities, the Company
receives servicing fees, usually 0.25% per annum of the loan balances serviced,
plus any late charges collected from delinquent borrowers and other fees
incidental to the services provided. In the event of a default by the borrower,
the Company receives no servicing fees until the default is cured.
The following table shows the delinquency statistics for the mortgage
loans serviced by the Company as of the dates presented.
December 31
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2005 2004 2003
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Percentage Percentage Percentage
Number of of Servicing Number of of Servicing Number of of Servicing
Loans Portfolio Loans Portfolio Loans Portfolio
----------------------------------------------------------------------------------
Loans delinquent for:
30-59 days 22 0.29% 9 0.16% 2 0.04%
60-89 days 7 0.09 3 0.05 1 0.02
90 days and over 16 0.21 6 0.11 5 0.09
----------------------------------------------------------------------------------
Total delinquencies 45 0.60% 18 0.32% 8 0.15%
==================================================================================
Foreclosures 14 0.19% 5 0.09% 2 0.04%
==================================================================================
The following table sets forth certain information regarding the number
and aggregate principal balance of the mortgage loans serviced by the Company,
including both fixed and adjustable rate loans, at various interest rates:
December 31
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2005 2004 2003
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Percentage Percentage Percentage
Number Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
of Principal Principal of Principal Principal of Principal Principal
Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance
------------------------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Less than 5.00% 865 $ 74,784 12.41% 770 $ 72,321 15.59% 694 $ 66,512 15.36%
5.00% - 5.99% 3,689 310,665 51.56 2,881 244,842 52.79 2,476 213,267 49.24
6.00% - 6.99% 2,356 19,0172 31.56 1,609 126,132 27.20 1,591 122,338 28.24
7.00% - 7.99% 465 21,766 3.61 383 17,810 3.84 522 26,634 6.15
8.00% - 8.99% 108 4,483 0.74 63 2,503 0.54 99 4,179 0.96
9.00% and over 28 641 0.10 4 182 0.04 5 203 0.05
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Total 7,511 $602,511 100.00% 5,710 $463,790 100.00% 5,387 $433,133 100.00%
==================================================================================================================
Loan servicing fees decrease as the principal balance on the outstanding
loan decreases and as the remaining time to maturity of the loan shortens. The
following table sets forth certain information regarding the remaining maturity
of the mortgage loans serviced by the Company as of the dates shown.
-5-
2005 2004
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% of % of
% of Unpaid Unpaid % of Unpaid Unpaid
Number Number Principal Principal Number Number Principal Principal
Maturity of Loans of Loans Amount Amount of Loans of Loans Amount Amount
------------------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
1-5 years 546 7.27% $ 40,710 6.76% 392 6.88% $ 30,317 6.54%
6-10 years 602 8.01 27,965 4.64 614 10.75 41,076 8.86
11-15 years 2,573 34.26 177,564 29.47 2,122 37.16 153,680 33.14
16-20 years 1,006 13.39 83,444 13.85 787 13.78 67,964 14.65
21-25 years 207 2.76 17,254 2.86 107 1.87 8,551 1.84
More than 25 years 2,577 34.31 255,574 42.42 1,688 29.56 162,202 34.97
-------------------------------------------------------------------------------------------
Total 7,511 100.00% $602,511 100.00% 5,710 100.00% $463,790 100.00%
===========================================================================================
2003
--------------------------------------------
% of
% of Unpaid Unpaid
Number Number Principal Principal
Maturity of Loans of Loans Amount Amount
-------------------------------------------------------------------
(Dollars in Thousands)
1-5 years 302 5.61% $ 22,838 5.27%
6-10 years 673 12.49 47,819 11.04
11-15 years 2,130 39.54 156,847 36.21
16-20 years 762 14.15 66,135 15.27
21-25 years 74 1.37 5,147 1.19
More than 25 years 1,446 26.84 134,347 31.02
--------------------------------------------
Total 5,387 100.00% $433,133 100.00%
============================================
Lending Activities
General - A savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. Real estate is not considered "readily marketable
collateral." Certain types of loans are not subject to these limits. In applying
these limits, loans to certain borrowers may be aggregated. Notwithstanding the
specified limits, a savings bank may lend to one borrower up to $500,000 "for
any purpose". At December 31, 2005, First Federal's limit on loans-to-one
borrower was $20.0 million and its five largest loans (including available lines
of credit) or groups of loans to one borrower, including related entities, were
$16.9 million, $15.5 million, $11.3 million, $8.2 million and $8.2 million. All
of these loans or groups of loans were performing in accordance with their terms
at December 31, 2005.
Loan Portfolio Composition - The net increase in net loans receivable over
the prior year was $285.6 million, $143.7 million, and $174.2 million in 2005,
2004, and 2003, respectively. First Defiance acquired net loans of $117.5
million in the ComBanc acquisition and $66.9 million in the Genoa acquisition.
The loan portfolio contains no foreign loans nor any concentrations to
identified borrowers engaged in the same or similar industries exceeding 10% of
total loans.
-6-
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31
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2005 2004 2003
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Amount % Amount % Amount %
-----------------------------------------------------------------------
(Dollars in Thousands)
Real estate:
One to four family residential $ 275,497 23.2% $ 187,775 20.9% $ 162,111 21.6%
Five or more family
residential 50,040 4.2 39,049 4.4 30,322 4.0
Nonresidential real estate 501,943 42.2 376,115 42.0 311,101 41.4
Construction 21,173 1.8 15,507 1.7 16,830 2.3
-----------------------------------------------------------------------
Total real estate loans 848,653 71.4 618,446 69.0 520,364 69.3
Other:
Consumer finance 54,657 4.6 45,213 5.1 39,808 5.3
Commercial 171,289 14.4 141,644 15.8 120,677 16.0
Home equity and improvement 113,000 9.5 90,839 10.1 70,038 9.3
Mobile home 640 .1 299 -- 449 0.1
-----------------------------------------------------------------------
Total non-real estate loans 339,586 28.6 277,995 31.0 230,972 30.7
-----------------------------------------------------------------------
Total loans 1,188,239 100.0% 896,441 100.0% 751,336 100.0%
======= ======= =======
Less:
Loans in process 8,782 6,341 6,079
Deferred loan origination fees 1,303 1,232 1,158
Allowance for loan losses 13,673 9,956 8,844
---------- ---------- ----------
Net loans $1,164,481 $ 878,912 $ 735,255
========== ========== ==========
December 31
----------------------------------------------
2002 2001
----------------------------------------------
Amount % Amount %
----------------------------------------------
(Dollars in Thousands)
Real estate:
One to four family residential $ 142,355 24.7% $ 167,092 32.8%
Five or more family
residential 32,324 5.6 21,757 4.3
Nonresidential real estate 195,431 33.9 152,274 29.9
Construction 15,357 2.6 7,875 1.5
----------------------------------------------
Total real estate loans 385,467 66.8 348,998 68.5
Other:
Consumer finance 37,562 6.5 40,721 8.0
Commercial 104,070 18.0 83,690 16.4
Home equity and improvement 49,889 8.7 36,179 7.1
Mobile home 17 -- 12 --
----------------------------------------------
Total non-real estate loans 191,538 33.2 160,602 31.5
----------------------------------------------
Total loans 577,005 100.0% 509,600 100.0%
======= =======
Less:
Loans in process 7,255 2,887
Deferred loan origination fees 1,212 1,024
Allowance for loan losses 7,496 6,548
---------- ----------
Net loans $ 561,042 $ 499,141
========== ==========
In addition to the loans reported above, First Defiance had $5.2 million,
$2.3 million, $5.9 million, $15.3 million and $672,000 in loans classified as
held for sale at December 31, 2005, 2004, 2003, 2002 and 2001, respectively. The
fair value of such loans, which are all single-family residential mortgage
loans, approximated their carrying value for all years presented.
Contractual Principal, Repayments and Interest Rates - The following table
sets forth certain information at December 31, 2005 regarding the dollar amount
of gross loans maturing in First Defiance's portfolio, based on the contractual
terms to maturity. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdrafts are reported as due in one year or less.
Due 3-5 Due 5-10 Due 10-15 Due 15+
Due Before December 31 Years After December 31
------------------------- -------------------------------------------------------
2006 2007 2005 2005 2005 2005 Total
----------------------------------------------------------------------------------------------
(In Thousands)
Real estate $ 149,864 $ 59,133 $ 149,742 $ 363,642 $ 55,213 $ 71,059 $ 848,653
Nonreal estate:
Commercial 91,203 25,436 43,518 10,561 400 171 171,289
Home equity and improvement 8,926 2,385 25,120 6,999 785 68,785 113,000
Mobile home 122 87 260 148 23 -- 640
Consumer finance 24,437 12,513 16,832 755 106 14 54,657
----------------------------------------------------------------------------------------------
Total $ 274,552 $ 99,554 $ 235,472 $ 382,105 $ 56,527 $ 140,029 $1,188,239
==============================================================================================
The schedule above does not reflect the actual life of the Company's loan
portfolio. The average life of loans is substantially less than their
contractual terms because of prepayments and due-on-sale clauses, which give
First Defiance the right to declare a conventional loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid.
-7-
The following table sets forth the dollar amount of gross loans due after
one year from December 31, 2005 which have fixed interest rates or which have
floating or adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Total
---------------------------------------
(In Thousands)
Real estate $ 170,919 $ 533,031 $ 703,950
Commercial 19,108 60,977 80,085
Other 57,269 77,545 134,814
---------------------------------------
$ 247,296 $ 671,553 $ 918,849
=======================================
Originations, Purchases and Sales of Loans - The lending activities of
First Defiance are subject to the written, non-discriminatory, underwriting
standards and loan origination procedures established by the Board of Directors
and management. Loan originations are obtained from a variety of sources,
including referrals from existing customers, real estate brokers, developers,
builders, and existing customers; newspapers and radio advertising; and walk-in
customers.
First Defiance's loan approval process for all types of loans is intended
to assess the borrower's ability to repay the loan, the viability of the loan,
and the adequacy of the value of the collateral that will secure the loan.
A commercial loan application is first reviewed and underwritten by one of
the commercial loan officers, who may approve credits within their lending
limit. Another loan officer with limits sufficient to cover the exposure must
approve credits exceeding an individual's lending limit. All credits which
exceed $100,000 in aggregate exposure must be presented for review or approval
to the Senior Loan Committee comprised of senior lending personnel. Credits
which exceed $1,000,000 in aggregate exposure must be presented for approval to
the Executive Loan Committee, a committee of First Federal's Board of Directors.
Residential mortgage applications are accepted by retail lenders or branch
managers, who utilize an automated underwriting system to review the loan
request. First Federal also receives mortgage applications via an online
residential mortgage origination system. A final approval of all residential
mortgage applications is made by a member of a centralized underwriting staff
within their designated lending limits. Loan requests in excess or outside an
individual underwriter's limit are approved by the Senior Loan Committee and if
necessary by the Executive Loan Committee.
Retail lenders and branch managers are authorized to originate and approve
direct consumer loan requests that are within policy guidelines and within the
lender's approved lending limit. Loans in excess of any authorized lending limit
or outside of policy must be approved by Senior Loan Committee and if necessary
by the Executive Loan Committee. Indirect consumer loans originated by auto
dealers are underwritten and approved by a designated underwriter in accordance
with company policy and lending limits.
First Defiance offers adjustable-rate loans in order to decrease the
vulnerability of its operations to changes in interest rates. The demand for
adjustable-rate loans in First Defiance's primary market area has been a
function of several factors, including customer preference, the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the interest rates offered for
-8-
fixed-rate loans and adjustable-rate loans. The relative amount of fixed-rate
and adjustable-rate residential loans that can be originated at any time is
largely determined by the demand for each in a competitive environment.
Adjustable-rate loans represented 17.3% of First Defiance's total
originations of mortgage loans in 2005 compared to 22.1% and 14.71% during 2004
and 2003, respectively.
Adjustable-rate loans decrease the risks associated with changes in
interest rates, but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates.
The following table shows total loans originated, loan reductions, and the
net increase in First Defiance's total loans during the periods indicated:
Years Ended December 31
-----------------------------------
2005 2004 2003
-----------------------------------
(In Thousands)
Loan originations:
Single family residential $ 164,687 $ 132,463 $ 291,481
Multi-family residential 85,733 76,483 58,370
Non-residential real estate 162,823 137,524 165,164
Construction 27,637 20,983 20,553
Commercial 133,021 110,915 104,007
Home equity and improvement 34,221 38,552 38,150
Consumer finance 50,056 27,250 19,366
-----------------------------------
Total loans originated 658,178 544,170 697,091
Loans acquired in acquisitions 184,218 -- 79,094
Loan reductions:
Loan pay-offs 261,046 223,976 222,163
Mortgage loans sold 111,345 104,968 293,673
Periodic principal repayments 181,630 70,566 83,879
-----------------------------------
554,021 399,510 599,715
-----------------------------------
Net increase in total loans $ 288,375 $ 144,660 $ 176,470
===================================
The loans acquired in the Genoa acquisition by category were as follows
(excluding mark to market adjustments): Single family residential - $36.3
million, multi-family residential - $719,000, non-residential real estate - $7.5
million, construction - $4.5 million, commercial - $1.7 million, home equity and
improvement - $13.4 million and consumer finance - $3.7 million.
The loans acquired in the ComBanc acquisition by category were as follows
(excluding mark to market adjustments): Single family residential - $33.1
million, multi-family residential - $2.8 million, non-residential real estate -
$57.2 million, construction - $1.9 million, commercial - $12.7 million, home
equity and improvement - $4.6 million and consumer finance - $7.2 million.
The loans acquired in the 2003 branch acquisition by category were as
follows: Single family residential - $21.4 million, non-residential real estate
- $35.4 million, commercial - $16.8 million, home equity and improvement - $1.8
million and consumer finance - $3.6 million.
-9-
Asset Quality
First Defiance's credit policy establishes guidelines to manage credit
risk and asset quality. These guidelines include loan review and early
identification of problem loans to ensure sound credit decisions. First
Defiance's credit policies and review procedures are meant to minimize the risk
and uncertainties inherent in lending. In following the policies and procedures,
management must rely on estimates, appraisals and evaluations of loans and the
possibility that changes in these could occur because of changing economic
conditions.
Delinquent Loans -- The following table sets forth information concerning
delinquent loans at December 31, 2005, in dollar amount and as a percentage of
First Defiance's total loan portfolio. The amounts presented represent the total
outstanding principal balances of the related loans, rather than the actual
payment amounts that are past due.
30 to 59 Days 60 to 89 Days 90 Days and Over Total
--------------------- --------------------- --------------------- ---------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
--------------------- --------------------- --------------------- ---------------------
(Dollars in Thousands)
Single - family residential $ 6,002 0.51% $ 2,832 0.24% $ 1,495 0.13% $10.329 0.88%
Nonresidential and Multi-
family residential 3,565 0.30 7,526 0.64 2,533 0.22 13,624 1.16
Home equity and
improvement 1,191 0.10 301 0.03 281 0.02 1,773 0.15
Consumer finance 614 0.05 145 0.01 356 0.03 1,115 0.10
Commercial 571 0.05 496 0.04 287 0.02 1,354 0.12
------------------------------------------------------------------------------------------------
Total $11,943 1.02% $11,300 0.70% $ 4,952 0.42% $28,195 2.41%
================================================================================================
Nonperforming Assets - All loans are reviewed on a regular basis and are
placed on a non-accrual status when, in the opinion of management, the
collectibility of additional interest is deemed insufficient to warrant further
accrual. Generally, First Defiance places all loans more than 90 days past due
on non-accrual status. When a loan is placed on nonaccrual status, total unpaid
interest accrued to date is reversed. Subsequent payments are either applied to
the outstanding principal balance or recorded as interest income, depending on
the assessment of the ultimate collectibility of the loan. First Defiance
considers that a loan is impaired when, based on current information and events,
it is probable that it will be unable to collect all amounts due (both principal
and interest) according to the contractual terms of the loan agreement. First
Defiance measures impairment based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price, or the fair value of the collateral, if collateral dependent. If
the estimated recoverability of the impaired loan is less than the recorded
investment, First Defiance will recognize impairment by creating a valuation
allowance.
Impaired loans acquired in the ComBanc and Genoa acquisitions have been
accounted for under the provisions of AICPA Statement of Position 03-3 -
Accounting for Certain Loans or Debt Securities Acquired in a Transfer. Such
loans were recorded at their fair value, which was estimated based on the
expected cash flow of the acquired loan. In the Genoa acquisition, 10 loan
relationships with a stated value of $1.5 million were recorded at $735,000. In
the ComBanc acquisition, 13 loan relationships with a stated value of $3.4
million were recorded at $2.1 million. At December 31, 2005, those loans had a
contractual balance of $4.6 million and were recorded at $2.6 million. If
management expectations about the cash flow of those loans changes over time,
the difference will be treated as "accretable" and will be recognized as a yield
adjustment over the remaining life of the respective loan. There were no
significant changes in the expected cash flows of the 23 loans identified as
impaired in the acquisitions during 2005.
-10-
Loans originated by First Federal having recorded investments of $822,000,
$505,000, and $563,000 were considered impaired as of December 31, 2005, 2004
and 2003, respectively. These amounts exclude large groups of small-balance
homogeneous loans that are collectively evaluated for impairment such as
residential mortgage, consumer installment, and credit card loans. There was
$61,000 of interest received and recorded in income during 2005 related to
impaired loans. There was $36,000 and $29,000 recorded in 2004 and 2003
respectively. Unrecorded interest income based on the loan's contractual terms
on these impaired loans and all non-performing loans in 2005, 2004 and 2003 was
$235,000, $102,000, and $73,000, respectively. The average recorded investment
in impaired loans during 2005, 2004 and 2003 (excluding loans accounted for
under SOP 03-3) was $1.1 million, $732,000 and $892,000, respectively. The total
allowance for loan losses related to these loans was $380,000, $253,000, and
$297,000 at December 31, 2005, 2004 and 2003, respectively.
Real estate acquired by foreclosure is classified as real estate owned
until such time as it is sold. First Defiance also repossesses other assets
securing loans, consisting primarily of automobiles. When such property is
acquired it is recorded at the lower of the restated loan balance, less any
allowance for loss, or fair value. Costs relating to development and improvement
of property are capitalized, whereas costs relating to holding the property are
expensed. Valuations are periodically performed by management and an allowance
for losses is established by a charge to operations if the carrying value of
property exceeds its estimated net realizable value.
As of December 31, 2005, First Defiance's total non-performing loans
amounted to $5.0 million or .42% of total loans, compared to $1.9 million or
0.21% of total loans, at December 31, 2004. Non-performing loans are loans which
are more than 90 days past due and are all classified as non-accrual at December
31, 2005. The nonperforming loan balance includes $1.9 million of loans
originated by First Federal also considered impaired and $3.1 million of
acquired loans accounted for under SOP 03-3.
The following table sets forth the amounts and categories of First
Defiance's non-performing assets (excluding impaired loans not considered
non-performing) and troubled debt restructurings at the dates indicated.
-11-
December 31
--------------------------------------------------------
2005 2004 2003 2002 2001
--------------------------------------------------------
(Dollars in Thousands)
Nonperforming loans:
Single-family residential $ 2,648 $ 419 $ 471 $ 404 $ 1,151
Nonresidential and multi-family
residential real estate 1,917 1,014 1,092 1,217 972
Commercial 287 450 949 879 110
Mobile home -- -- -- -- --
Consumer finance 100 10 33 25 157
--------------------------------------------------------
Total nonperforming loans 4,952 1,893 2,545 2,525 2,390
Real estate owned 315 49 397 175 81
Other repossessed assets 89 49 7 31 55
--------------------------------------------------------
Total repossessed assets 404 98 404 206 136
--------------------------------------------------------
Total nonperforming assets $ 5,356 $ 1,991 $ 2,949 $ 2,731 $ 2,526
========================================================
Troubled debt restructurings $ -- $ -- $ -- $ -- $ --
========================================================
Total nonperforming assets as a
percentage of total assets of
continuing operations 0.37% 0.18% 0.28% 0.31% 0.39%
========================================================
Total nonperforming loans and troubled
debt restructurings as a percentage of
total loans 0.42% 0.21% 0.34% 0.43% 0.47%
========================================================
Allowance for loan losses as a percent of
total nonperforming assets 255.28% 500.05% 299.90% 274.48% 259.22%
========================================================
In addition to the $5.4 million of loans reported above and $3.0 million
of loans considered impaired (including loans accounted for under SOP 03-3),
which are not included in the loans reported above, there are approximately
$46.2 million of performing loans where known information about possible credit
problems of the borrowers causes management to have doubts as to the ability of
such borrowers to comply with the present loan repayment terms and which may
result in the inclusion of such loans in non-performing loans at some future
date. In analyzing these loans for the purpose of determining the adequacy of
the allowance for loan losses, management has determined that these loans
generally have significant collateral, strong guarantors, or both.
Allowance for Loan Losses - First Defiance maintains an allowance for loan
losses to absorb probable losses in the loan portfolio. The balance of the
allowance is based upon an assessment of prior loss experience, the volume and
type of lending conducted by First Defiance, industry standards, past due loan
amounts and trends, general economic conditions and other factors related to the
collectibility of the loan portfolio. The Company principally uses its own loss
experience in calculating its loan loss provision. However, in those instances
where the Company's experience with certain types of lending is new or recent
and therefore historical losses are less meaningful, management will consider
such other factors as industry loss statistics, regulatory guidance, experience
of other financial institutions operating in the same geographic area, and
inherent risks associated with the borrower in determining the required
allowance. In evaluating the adequacy of its allowance each quarter, management
grades all loans in the commercial portfolio using a scale of one to ten. Loans
graded in the three worst categories (substandard, doubtful and loss) generally
are specifically reserved for. Loans graded as substandard would generally have
reserves
-12-
that range between zero and 20% based on management's knowledge of the credit
and other local factors. Substandard loans that have no reserves allocated to
them generally exhibit negative financial characteristics, such as poor cash
flow or declining sales, but have offsetting credit strengths, such as an
abundance of collateral or the existence of a strong guarantor. Loans classified
as doubtful are generally reserved at 50% and loans classified as loss are
reserved at 100%, unless other facts and circumstances, such as strength of
collateral or strength of guarantors warrant a different percentage. Management
also engages a third-party to perform an independent loan review on a
semi-annual basis. That third party reviews all loan relationships in excess of
$250,000 and, among other things, challenges management's loan grades.
Loans charged-off are charged against the allowance when such loans meet
the Company's established policy on loan charge-offs and the allowance itself is
adjusted quarterly by recording a provision for loan losses. As such, actual
losses and losses provided for should be approximately the same if the overall
quality, composition and size of the portfolio remains static. To the extent
that the portfolio grows at a rapid rate, such as the Company has experienced,
or overall quality deteriorates, the provision generally will exceed
charge-offs. Although management believes that it uses the best information
available to make such determinations, future adjustments to the allowances may
be necessary, and net earnings could be significantly affected, if circumstances
differ substantially from the assumptions used in making the initial
determinations.
At December 31, 2005, First Defiance's allowance for loan losses amounted
to $13.7 million compared to $10.0 million at December 31, 2004. The following
table sets forth the activity in First Defiance's allowance for loan losses
during the periods indicated.
Years Ended December 31
------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------------------------
(Dollars in Thousands)
Allowance at beginning of year $ 9,956 $ 8,844 $ 7,496 $ 6,548 $ 6,330
Provision for credit losses 1,442 1,549 1,719 1,451 993
Allowance acquired in acquisitions 3,027 -- -- -- --
Charge-offs:
One to four family residential real estate 182 52 18 110 152
Commercial real estate 226 58 162 184 130
Commercial 267 390 375 36 151
Consumer finance 354 186 170 390 599
Home equity and improvement 25 -- -- -- --
------------------------------------------------------------------
Total charge-offs 1,054 686 725 720 1,032
Recoveries 302 249 354 217 257
------------------------------------------------------------------
Net charge-offs 752 437 371 503 775
------------------------------------------------------------------
Ending allowance $ 13,673 $ 9,956 $ 8,844 $ 7,496 $ 6,548
==================================================================
Allowance for loan losses to total non-
performing loans at end of year 276.11% 525.94% 347.50% 296.87% 273.97%
Allowance for loan losses to total loans at end of year 1.16% 1.12% 1.18% 1.32% 1.29%
Allowance for loan losses to net charge-offs for the year 1,813.40% 2,278.26% 2,383.82% 1,490.26% 844.90%
Net charge-offs for the year to average loans 0.07% 0.05% 0.06% 0.10% 0.15%
-13-
The provision for credit losses has remained stable over the five-year
period shown in the above table as the Company's loss experience has remained
relatively low despite significant growth in the loan portfolios. The loan loss
reserve increased significantly in 2005 because of reserves acquired in the
acquisitions. The level of charge-offs increased in 2005 because of activity
related primarily to acquired loans. Management anticipates that the level of
charge-offs will remain higher than historical levels as non-performing loans
acquired in the two acquisitions are charged off. Management also believes the
level of loan loss reserves acquired in the acquisitions is sufficient to cover
anticipated charge-offs of the acquired loans.
The percentage of the allowance for loan losses to total loans increased
in 2005 because of the allowance recorded for the loan balances acquired was at
a higher overall percentage than First Defiance's existing portfolio.
Non-performing assets increased to $5.4 million at December 31, 2005 from $2.0
million at December 31, 2004, because of non-performing loans acquired in the
acquisitions. Management believes all non-performing loans acquired had adequate
allowance for loan losses allocations. No non-performing loans have been
identified since the acquisition dates that were not adequately reserved for as
of those dates. Historical trends are monitored by management on a quarterly
basis and are considered in the establishment of the allowance for loan losses.
The following table sets forth information concerning the allocation of
First Defiance's allowance for loan losses by loan categories at the dates
indicated. For information about the percent of total loans in each category to
total loans, see "Lending Activities-Loan Portfolio Composition."
December 31
--------------------------------------------------------------------------
2005 2004 2003
--------------------------------------------------------------------------
Percent of Percent of Percent of
total loans total loans total loans
Amount by category Amount by category Amount by category
--------------------------------------------------------------------------
Single family residential $ 1,484 23.2% $ 239 22.8% $ 386 24.4%
Nonresidential and
Multi-family
residential real
estate 8,965 46.4 6,538 46.3 6,265 45.1
Other:
Commercial loans 2,287 14.4 2,454 15.8 1,424 15.9
Consumer and home equity
and improvement loans 937 16.0 725 15.1 769 14.6
--------------------------------------------------------------------------
$13,673 100.0% $ 9,956 100.0% $ 8,844 100.0%
==========================================================================
December 31
------------------------------------------------
2002 2001
------------------------------------------------
Percent of Percent of
total loans total loans
Amount by category Amount by category
------------------------------------------------
(Dollars in Thousands)
Single family residential $ 587 29.2% $ 613 34.4%
Nonresidential and
Multi-family
residential real
estate 4,293 38.5 2,847 34.1
Other:
Commercial loans 1,729 17.6 1,734 16.4
Consumer and home equity
and improvement loans 887 14.7 1,354 15.1
------------------------------------------------
$ 7,496 100.0% $ 6,548 100.0%
================================================
Sources of Funds
General - Deposits are the primary source of First Defiance's funds for
lending and other investment purposes. In addition to deposits, First Defiance
derives funds from loan principal repayments. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings
from the FHLB may be used on a short-term basis to compensate for reductions in
the availability of funds from other sources. They may also be used on a
longer-term basis for general business purposes. During 2005, First Defiance
issued $20.0 million of trust preferred securities through an unconsolidated
affiliated trust. Proceeds from the offering were used for general corporate
purposes including funding of dividends and stock buybacks as well as bolstering
regulatory capital at the First Federal level.
-14-
Deposits - First Defiance's deposits are attracted principally from within
First Defiance's primary market area through the offering of a broad selection
of deposit instruments, including checking accounts, money market accounts,
regular savings accounts, and term certificate accounts. Deposit account terms
vary, with the principal differences being the minimum balance required, the
time periods the funds must remain on deposit, and the interest rate.
To supplement its funding needs, First Defiance also utilizes brokered
Certificates of Deposit. Such deposits, which were primarily acquired in prior
years to fund operations now discontinued, have maturities ranging from three
months to one year. The total balance of brokered certificates of deposit was
$37.0 million at December 31, 2005. Brokered CDs at December 31, 2004 totaled
$61.2 million.
Average balances and average rates paid on deposits are as follows:
Years Ended December 31
----------------------------------------------------------------------
2005 2004 2003
-------------------- -------------------- --------------------
Amount Rate Amount Rate Amount Rate
----------------------------------------------------------------------
(Dollars in Thousands)
Non-interest-bearing
demand deposits $ 86,741 -- $ 56,241 -- $ 47,505 --
Interest bearing
demand deposits 273,502 1.19% 232,044 0.74% 198,039 0.74%
Savings deposits 87,708 0.27 53,247 0.25 47,047 0.36
Time deposits 570,826 3.00 413,796 2.68 387,948 3.04
----------------------------------------------------------------------
Totals $1,018,777 2.02% $ 755,328 1.71% $ 680,539 1.97%
======================================================================
The following table sets forth the maturities of First Defiance's
certificates of deposit having principal amounts of $100,000 or more at December
31, 2005 (in thousands):
Certificates of deposit maturing in quarter ending:
March 31, 2006 $ 47,167
June 30, 2006 42,996
September 30, 2006 35,927
December 31, 2006 20,012
After December 31, 2006 37,003
---------
Total certificates of deposit with
balances of $100,000 or more $ 183,105
=========
The following table details the deposit accrued interest payable as of
December 31:
2005 2004
-----------------
(In Thousands)
Interest bearing demand deposits and
money market accounts $ 120 $ 58
Savings Accounts -- --
Certificates 876 432
-----------------
$ 996 $ 490
=================
For additional information regarding First Defiance's deposits see Note 10
to the financial statements.
-15-
Borrowings-- First Defiance may obtain advances from the FHLB of
Cincinnati upon the security of the common stock it owns in that bank and
certain of its residential mortgage loans, non-residential loans and investment
securities provided certain standards related to creditworthiness have been met.
Such advances are made pursuant to several credit programs, each of which has
its own interest rate and range of maturities.
The following table sets forth certain information as to First Defiance's
FHLB advances and other borrowings at the dates indicated.
December 31
--------------------------------------
2005 2004 2003
--------------------------------------
(Dollars in Thousands)
Long-term:
FHLB advances $ 152,460 $ 151,713 $ 153,522
Weighted average interest rate 4.65% 4.62% 4.60%
Short-term:
FHLB advances $ 28,500 $ 26,500 $ 11,000
Weighted average interest rate 3.65% 2.20% 1.12%
Revolving borrowings -- 3,000 --
Weighted average interest rate -- 2.25% --
Securities sold under agreement to repurchase $ 25,748 $ 11,804 $ 12,267
Weighted average interest rate 2.67% 1.57% 0.85%
The following table sets forth the maximum month-end balance and average
balance of First Defiance's Long-term FHLB advances and other borrowings during
the periods indicated.
Years Ended December 31
--------------------------------------
2005 2004 2003
--------------------------------------
(Dollars in Thousands)
Long-term:
FHLB advances:
Maximum balance $ 154,602 $ 153,373 $ 154,930
Average balance 153,267 152,547 152,939
Weighted average interest rate 4.63% 4.61% 4.78%
Term Borrowings:
Maximum balance -- -- $ 7
Average balance -- -- 1
Weighted average interest rate -- -- 7.50%
-16-
The following table sets forth the maximum month-end balance and average
balance of First Defiance's short-term FHLB advances and other borrowings during
the periods indicated.
Years Ended December 31
-----------------------------------
2005 2004 2003
-----------------------------------
(Dollars in Thousands)
Short-term:
FHLB advances:
Maximum balance $ 45,000 $ 28,500 $ 14,250
Average balance 14,313 15,577 2,296
Weighted average interest rate 3.79% 1.55% 1.31%
Revolving credit agreements:
Maximum balance $ 43,799 $ 3,000 $ --
Average balance 301 1,349 --
Weighted average interest rate 2.25% 2.20% --
Securities sold under agreement to repurchase:
Maximum balance $ 25,748 $ 12,606 $ 12,860
Average balance 17,718 10,612 7,569
Weighted average interest rate 2.18% 1.08% 1.02%
First Defiance borrows funds under a variety of programs at the FHLB. As
of December 31, 2005, there was $152.5 million outstanding under various
long-term FHLB advance programs. First Defiance utilizes short-term advances
from the FHLB to meet cash flow needs and for short-term investment purposes.
There were $28.5 million and $26.5 million in short-term advances outstanding at
December 31, 2005 and 2004, respectively. At December 31, 2005, $28.5 million
was outstanding under First Defiance's REPO advance line of credit. The total
available under the line is $100.0 million. Additionally, First Defiance has
$15.0 million available under a Cash Management advance line of credit. Amounts
are generally borrowed under these lines on an overnight basis. First Federal's
total borrowing capacity at the FHLB is limited by various collateral
requirements. Eligible collateral includes mortgage loans, non-mortgage loans,
cash and investment securities. At December 31, 2005, irregardless of amounts
available on the REPO and Cash Management line, First Federal's additional
borrowing capacity with the FHLB was $24.1 million due to these collateral
requirements.
As a member of the FHLB of Cincinnati, First Federal must maintain a
minimum investment in the capital stock of that FHLB in an amount defined in the
FHLB's regulations. First Federal is permitted to own stock in excess of the
minimum requirement and is in compliance with the minimum requirement with an
investment in stock of the FHLB of Cincinnati of $17.5 million at December 31,
2005.
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLB. The standards take into account a member's performance
under the Community Reinvestment Act and its record of lending to first-time
homebuyers. All long-term advances by each FHLB must be made only to provide
funds for residential housing finance.
For additional information regarding First Defiance's FHLB advances and
other debt see Notes 11, 12 and 13 to the financial statements.
-17-
Subordinated Debentures - In October 2005, the Company formed an
affiliated trust, First Defiance Statutory Trust I (the Trust Affiliate), that
issued $20 million of Guaranteed Capital Trust Securities (Trust Preferred
Securities). In connection with the transaction, the Company issued $20.6
million of Junior Subordinated Deferrable Interest Debentures (Subordinated
Debentures) to the Trust Affiliate. The Trust Affiliate was formed for the
purpose of issuing Trust Preferred Securities to third-party investors and
investing the proceeds from the sale of these capital securities solely in
Subordinated Debentures of the Company. The Subordinated Debentures held by the
Trust Affiliate are the sole assets of the trust. Distributions on the Trust
Preferred Securities issued by the Trust Affiliate are payable quarterly at a
variable rate equal to the three-month LIBOR rate plus 1.38%, or 5.87% as of
December 31, 2005.
The Trust Preferred Securities are subject to mandatory redemption, in
whole or in part, upon repayment of the Subordinated Debentures. The Company has
entered into an agreement that fully and unconditionally guarantees the Trust
Preferred Securities subject to the terms of the guarantee. The Trust Preferred
Securities and Subordinated Debentures may be redeemed by the issuer at par
after October 28, 2010.
Employees
First Defiance had 476 employees at December 31, 2005. None of these
employees are represented by a collective bargaining agent, and First Defiance
believes that it enjoys good relations with its personnel.
Competition
Competition in originating loans arises mainly from other savings
associations, commercial banks, and mortgage companies. The distinction among
market participants is based primarily on price and, to a lesser extent, the
quality of customer service and name recognition. The Company competes for loans
by offering competitive interest rates and product types and by seeking to
provide a higher level of personal service to mortgage brokers and borrowers
than is furnished by competitors. However, First Federal does have a significant
market share of the lending markets in which it conducts operations.
Management believes that First Federal's most direct competition for
deposits comes from local financial institutions. The distinction among market
participants is based on price and the quality of customer service and name
recognition. First Federal's cost of funds fluctuates with general market
interest rates. During certain interest rate environments, additional
significant competition for deposits may be expected from corporate and
governmental debt securities, as well as from money market mutual funds. First
Federal competes for conventional deposits by emphasizing quality of service,
extensive product lines and competitive pricing.
-18-
Regulation
General - First Defiance and First Federal are subject to regulation,
examination and oversight by the OTS. Because the FDIC insures First Federal's
deposits, First Federal is also subject to examination and regulation by the
FDIC. First Defiance and First Federal must file periodic reports with the OTS
and examinations are conducted periodically by the OTS and the FDIC to determine
whether First Federal is in compliance with various regulatory requirements and
is operating in a safe and sound manner. First Federal is subject to various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending disclosure, equal credit opportunity, and, in the case
of First Federal, fair credit reporting and community reinvestment. Failure to
abide by federal laws and regulations governing community reinvestment could
limit the ability of First Federal to open a new branch or engage in a merger
transaction. Community reinvestment regulations evaluate how well and to what
extent First Federal lends and invests in its designated service area, with
particular emphasis on low-to-moderate income communities and borrowers in such
areas.
First Defiance is also subject to various Ohio laws which restrict
takeover bids, tender offers and control-share acquisitions involving public
companies which have significant ties to Ohio.
Regulatory Capital Requirements - First Federal is required by OTS
regulations to meet certain minimum capital requirements. Current capital
requirements call for tangible capital of 1.5% of adjusted total assets, core
capital of 4.0% of adjusted total assets, except for associations with the
highest examination rating and acceptable levels of risk, and risk-based capital
of 8% of risk-weighted assets.
The following table sets forth the amount and percentage level of
regulatory capital of First Federal at December 31, 2005, and the amount by
which it exceeds the minimum capital requirements. Tangible and core capital are
reflected as a percentage of adjusted total assets. Total (or risk-based)
capital, which consists of core and supplementary capital, is reflected as a
percentage of risk-weighted assets. Assets are weighted at percentage levels
ranging from 0% to 100% depending on their relative risk.
December 31, 2005
-----------------------
(In Thousands)
Tangible Capital $ 120,029 8.46%
Requirement 21,273 1.50
-----------------------
Excess $ 98,756 6.96%
=======================
Core Capital $ 120,029 8.46%
Requirement 56,729 4.00
-----------------------
Excess $ 63,300 4.46%
=======================
Total risked-based capital $ 133,636 11.84%
Risk-based requirement 90,323 8.00
-----------------------
Excess $ 43,313 3.84%
=======================
First Federal's capital at December 31, 2005, meets the standards for a
well-capitalized institution.
-19-
Transactions with Insiders and Affiliates - Loans to executive officers,
directors and principal shareholders and their related interests must conform to
the lending limits. Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of board of directors of the association with any "interested" director
not participating. All loans to directors, executive officers and principal
shareholders must be made on terms substantially the same as offered in
comparable transactions with the general public or as offered to all employees
in a company-wide benefit program. Loans to executive officers are subject to
additional restrictions. In addition, all related party transactions must be
approved by the Company's audit committee pursuant to Nasdaq Rule 4350(h),
including loans made by financial institutions in the ordinary course of
business. All transactions between savings associations and their affiliates
must comport with Sections 23A and 23B of the Federal Reserve Act (FRA) and the
Federal Reserve Board's Regulation W. An affiliate of a savings association is
any company or entity that controls, is controlled by or is under common control
with the savings association. First Defiance is an affiliate of First Federal.
Holding Company Regulation - First Defiance is a unitary thrift holding
company and is subject to OTS regulations, examination, supervision and
reporting requirements. Federal law generally prohibits a thrift holding company
from controlling any other savings association or thrift holding company,
without prior approval of the OTS, or from acquiring or retaining more than 5%
of the voting shares of a savings association or holding company thereof, which
is not a subsidiary. If First Defiance were to acquire control of another
savings institution, other than through a merger or other business combination
with First Federal, First Defiance would become a multiple thrift holding
company and its activities would thereafter be limited generally to those
activities authorized by the FRB as permissible for bank holding companies.
Item 1A. Risk Factors
Interest Rate Risk
Our earnings and financial condition are dependent to a large degree upon
net interest income, which is the difference between interest earned from loans
and investments and interest paid on deposits and borrowings. The narrowing of
the spread between interest earned on loans and investments and interest paid on
deposits and borrowings could adversely affect our earnings and financial
condition.
Interest rates are highly sensitive to many factors including:
o The rate of inflation;
o Economic conditions;
o Federal monetary policies;
o Stability of domestic and foreign markets.
Changes in market interest rates will also affect the level of prepayments
on loans as well as the payments received on mortgage backed securities,
requiring the reinvestment at lower rates than the loans or securities were
paying.
First Federal Bank originates a significant amount of residential mortgage
loans for sale and for our portfolio. The origination of residential mortgage
loans is highly dependent on the local real estate market and the level of
interest rates. Increasing interest rates tend to reduce the origination of
loans for sale and consequently fee income, which we report as mortgage banking
income. Conversely, decreasing interest rates have the effect of causing clients
to refinance mortgage loans faster than anticipated. This causes the
-20-
value of mortgage servicing rights on the loans sold to be lower than originally
anticipated. If this happens, we may be required to write down the value of our
mortgage servicing rights faster than anticipated, which will increase our
expense and lower our earnings.
Credit Risk
Our earnings and financial condition may be adversely affected if we fail
to adequately manage our credit risk. Our primary business is the origination
and underwriting of loans. This business requires us to take "credit risk" which
is the risk of losing principal and interest income because borrowers fail to
repay their loans. The ability of borrowers to repay their loans and the value
of collateral securing such loans may be affected by a number of factors
including:
o A slowdown in the local economy of our market area or the national
economy;
o A downturn in the business sector in which our loan customer
operates;
o A rapid increase in interest rates.
Economy
We operate our banking and insurance business units within the geographic
area comprised of the northwest corner of the state of Ohio and adjacent
counties in Indiana and Michigan. Weaknesses in this geographic market area
could be caused by such factors as an increase in the unemployment rate, a
decrease in real estate values, or significant increases in interest rates. Any
such weakness could have a negative impact on our earnings and financial
condition because:
o Demand for our products and services may go down;
o Borrowers may be unable to make payments on their loans;
o The value of collateral securing loans may decline;
o The overall quality of the loan portfolio may decline.
Competition
Competition in our market area may reduce our ability to originate loans
and attract and retain deposits. We face competition both in originating loans
and attracting deposits. Competition is intense in the financial services
industry. We compete in our market area by offering superior service and
competitive rates and products. The type of institutions we compete with include
large regional commercial banks, smaller community banks, savings institutions,
mortgage banking firms, credit unions, finance companies, brokerage firms,
insurance agencies and mutual funds. As a result of their size and ability to
achieve economies of scale, certain of our competitors can offer a broader range
of products and services than we offer. To stay competitive in our market area,
we may need to adjust the interest rates on our products to match rates of our
competition, which will have a negative impact on our net interest margin. Our
continued profitability depends on our ability to continue to effectively
compete in our market areas.
-21-
Government Regulation
Our business may be adversely affected by changes in the regulatory
environment or by changes in government policies as a whole. The earnings of
financial institutions such as First Defiance and First Federal are affected by
the policies of the regulatory authorities, including the Federal Reserve Board,
which regulates the money supply, and the Office of Thrift Supervision, which
regulates unitary thrift holding companies such as First Defiance and savings
banks such as First Federal.
Among the methods employed by the Federal Reserve Board are open market
operations in U.S. Government securities, changes in the discount rate on member
bank borrowings, and changes in the reserve requirement against member bank
deposits. These tools are utilized by the Federal Reserve in varying
combinations to influence overall growth and distribution of bank loans,
investments and deposits and they have a significant impact on interest rates
charged on loans and paid on deposits. The influence of the monetary policies of
the Federal Reserve Board are expected to have a continuing and profound effect
on the operating results of commercial and savings banks.
Policies, administration guidelines, and regulatory practices of the
Office of Thrift Supervision and other banking regulators have a significant
impact on the operations of First Federal and First Defiance. It is possible
that certain of those regulations will negatively impact the Company's operating
results or financial condition.
Item 1B. Unresolved Staff Comments
None.
-22-
Item 2. Properties
At December 31, 2005, First Federal conducted its business from its main
office at 601 Clinton Street, Defiance, Ohio, and eighteen other full service
banking centers in northwestern Ohio. First Insurance conducted its business
from leased office space at 419 5th Street, Suite 1200, Defiance, Ohio.
First Defiance maintains its headquarters in the main office of First
Federal at 601 Clinton Street, Defiance, Ohio.
The following table sets forth certain information with respect to the
office and other properties of the Company at December 31, 2005. See Note 9 to
the Consolidated Financial Statements.
Leased/ Net Book Value
Description/address Owned of Property Deposits
---------------------------------------------------------------------------------------
(Dollars in Thousands)
Main Office, First Federal
601 Clinton Street, Defiance, OH Owned $ 5,647 $ 237,278
Branch Offices, First Federal
204 E. High Street, Bryan, OH Owned 954 98,323
211 S. Fulton Street, Wauseon, OH Owned 665 46,476
625 Scott Street, Napoleon, OH Owned 1,387 65,682
1050 East Main Street, Montpelier, OH Owned 494 29,677
926 East High Street, Bryan, OH Owned 93 6,759
1333 Woodlawn, Napoleon, OH Owned 44 17,766
1177 N. Clinton Street, Defiance, OH Leased 1,261 24,700
905 N. Williams St., Paulding, OH Owned 973 32,172
201 E. High St., Hicksville, OH Owned 500 17,661
3900 N. Main St., Findlay, OH Owned 1,268 40,817
11694 N. Countyline St., Fostoria, OH Owned 813 21,153
1226 W. Wooster, Bowling Green, OH Owned 1,236 51,392
301 S. Main St., Findlay, OH Owned 1,126 31,801
405 E. Main St., Ottawa, OH Owned 469 64,258
124 E. Main St., McComb, OH Owned 257 19,648
7591 Patriot Dr., Findlay, OH Owned 1,370 8,001
417 W Dussell Dr., Maumee, OH Leased 1,159 27,915
230 E. Second St., Delphos, OH Owned 1,331 96,089
105 S. Greenlawn Ave., Elida, OH Owned 411 31,052
2600 Allentown Rd., Lima, OH Owned 960 28,532
2285 N. Cole St., Lima, OH Owned 496 9,337
22020 W. State Rt. 51, Genoa, OH Owned 1,099 37,371
2760 Navarre Ave., Oregon, OH Leased 273 16,332
1077 Louisiana Ave., Perrysburg, OH Leased 99 9,309
First Insurance & Investments
419 5th Street, Site 1200, Defiance, OH Leased 193 N/A
--------------------------
$ 24,578 $ 1,069,501
==========================
-23-
Item 3. Legal Proceedings
First Defiance is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition of First Defiance.
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to a vote of securities holders during the
fourth quarter of 2005.
-24-
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters and
Issuers Purchases of Common Stock
The Company's common stock trades on The Nasdaq Stock Market under the
symbol "FDEF." As of March 3, 2006, the Company had approximately 2,170
shareholders of record. The table below shows the reported high and low sales
prices of the common stock and cash dividends declared per share of common stock
during the periods indicated in 2005 and 2004.
Years Ending
-----------------------------------------------------------------
December 31, 2005 December 31, 2004
------------------------------- -------------------------------
High Low Dividend High Low Dividend
------------------------------- -------------------------------
Quarter ended:
March 31 $ 29.90 $ 26.00 $ .22 $ 29.00 $ 26.60 $ .20
June 30 30.46 25.29 .22 28.88 22.07 .20
September 30 31.44 26.21 .22 26.76 22.01 .20
December 31 30.06 25.56 .24 28.90 25.20 .22
The OTS imposes various restrictions or requirements on the ability of
associations to make capital distributions. Capital distributions include,
without limitation, payments of cash dividends, repurchases and certain other
acquisitions by an association of its shares and payments to stockholders of
another association in an acquisition of such other association.
An application must be submitted and approval from the OTS must be
obtained by a subsidiary of a savings and loan holding company (i) if the
proposed distribution would cause total distributions for the calendar year to
exceed net income for that year to date plus the savings association's retained
net income for the preceding two years; (ii) if the savings association will not
be at least adequately capitalized following the capital distribution; or (iii)
if the proposed distribution would violate a prohibition contained in any
applicable statute, regulation or agreement between the savings association and
the OTS (or the FDIC), or a condition imposed on the savings association in an
OTS-approved application or notice. If a savings association subsidiary of a
holding company is not required to file an application, it must file a notice of
the proposed capital distribution with the OTS. First Federal paid $34.4 million
in dividends to First Defiance during 2005 and $5.0 million during 2004.
-25-
First Defiance completed the following common stock repurchases during the
fourth quarter and the year ended December 31, 2005:
Total Number of Maximum
Shares Purchased Number of
as Part of Shares that May
Publicly Yet Be Purchased
Total Number of Average Price Announced Plans Under the Plans
Period Shares Purchased Paid Per Share or Programs or Programs (a)
-------------------------------------------------------------------------------------------------
October 1, 2005 -
October 31, 2005 3,216 $ 28.95 3,216 416,778
November 1, 2005 -
November 30, 2005 -- n/a n/a 416,778
December 1, 2005 -
December 31, 2005 6,586(b) $ 27.10 -- 416,778
Total for 2005
Fourth Quarter 9,802 $ 27.71 3,216 416,778
(a) On July 18, 2003, First Defiance announced that its Board of Directors had
authorized management to repurchase up to 10% of the Registrant's common
stock through open market or in any private transaction. The
authorization, which is for 639,828 shares, does not have an expiration
date.
(b) Shares acquired upon exercise of stock options.
-26-
Item 6. Selected Financial Data
The following table sets forth certain summary consolidated financial data
at or for the periods indicated. Results of operations associated with The
Leader, including certain inter-company financing transactions, are reflected as
discontinued operations for all periods presented. Continuing operations reflect
the results of First Federal, First Insurance and First Defiance holding company
expenses for all periods presented. This information should be read in
conjunction with the Consolidated Financial Statements and notes thereto
included herein. See "Item 8. Financial Statements and Supplementary Data."
At or For Years Ended December 31
------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data
Selected Consolidated Financial Data:
Total assets $ 1,461,082 $ 1,126,667 $ 1,040,599 $ 884,245 $ 1,132,648
Assets of continuing operations 1,461,082 1,126,667 1,040,599 884,245 644,194
Loans held-to maturity, net 1,164,481 878,912 735,255 561,041 499,141
Loans held-for-sale 5,282 2,295 5,872 15,336 672
Allowance for loan losses 13,673 9,956 8,844 7,496 6,548
Nonperforming assets 5,356 1,990 2,949 2,731 2,526
Securities available-for-sale 113,079 137,003 168,259 209,604 48,453
Securities held-to maturity 1,775 2,255 2,776 3,921 5,818
Mortgage servicing rights 5,063 3,598 3,431 2,090 1,821
Deposits and borrowers' escrow balances 1,070,106 797,979 729,227 599,889 615,238
FHLB advances 180,960 178,213 164,522 149,096 196,302
Stockholders' equity 151,216 126,874 124,269 120,110 111,021
Selected Consolidated Operating Results:
Interest income from continuing operations $ 76,174 $ 54,731 $ 50,629 $ 46,908 $ 47,600
Interest expense from continuing operations 28,892 20,381 20,855 22,044 25,602
Net interest income from continuing operations 47,282 34,350 29,774 24,864 21,998
Provision for loan losses 1,442 1,548 1,719 1,451 994
Non-interest income 15,925 13,996 16,843 10,401 8,898
Non-interest expense 43,942 31,200 27,126 24,408 22,681
Income before income taxes 17,823 15,598 17,772 9,406 7,221
Income taxes 5,853 4,802 5,690 2,986 2,423
Income from continuing operations 11,970 10,796 12,082 6,420 4,798
Discontinued operations, net of tax -- -- -- 8,853 8,818
Cumulative effect of change in method of
accounting for goodwill -- -- -- (194) --
Net income 11,970 10,796 12,082 15,079 13,616
Basic earnings per share from continuing
operations 1.75 1.77 2.00 1.01 0.74
Basic earnings per share 1.75 1.77 2.00 2.37 2.11
Diluted earnings per share from continuing
operations 1.69 1.69 1.91 0.97 0.72
Diluted earnings per share 1.69 1.69 1.91 2.28 2.05
-27-
Item 6. Selected Financial Data (continued)
At or For Years Ended December 31
-------------------------------------------------------------
2005 2004 2003 2002 2001
-------------------------------------------------------------
(Dollars in Thousands, Except Per Share Data)
Performance Ratios:
Return on average assets 0.88% 1.01% 1.24% 0.77% 0.69%
Return on average equity 8.26% 8.57% 9.97% 5.39% 4.61%
Interest rate spread (1) 3.63% 3.37% 3.13% 2.92% 3.25%
Net interest margin (1) 3.87% 3.60% 3.42% 3.38% 3.68%
Ratio of operating expense to
Average total assets 3.22% 2.98% 2.91% 3.16% 3.31%
Quality Ratios:
Nonperforming assets to total assets
at end of period (2) 0.37% 0.18% 0.28% 0.31% 0.39%
Allowance for loan losses to
nonperforming assets (2) 255.28% 500.30% 299.90% 274.48% 259.22%
Allowance for loan losses to total
loans receivable 1.16% 1.13% 1.19% 1.32% 1.31%
Capital Ratios (3):
Equity to total assets at end of period 10.35% 11.26% 11.94% 13.58% 17.23%
Tangible equity to tangible assets
at end of period 7.88% 9.74% 10.17% 13.23% 16.75%
Average equity to average assets 10.62% 11.76% 12.43% 14.36% 15.03%
Book value per share $ 21.34 $ 20.20 $ 19.64 $ 18.73 $ 16.20
Tangible book value per share $ 15.81 $ 17.19 $ 16.39 $ 18.17 $ 15.65
Ratio of average interest-earning assets
to average interest-bearing liabilities 110.30% 112.25% 112.25% 115.57% 110.21%
Stock Price and Dividend Information:
High $ 31.44 $ 29.00 $ 30.65 $ 21.44 $ 18.00
Low 25.29 22.01 18.21 15.12 10.69
Close 27.09 28.85 25.90 18.90 15.20
Cash dividends declared per share 0.90 0.82 0.65 0.54 .49
Dividend payout ratio (4) 51.43% 46.33% 32.50% 22.78% 23.22%
(1) Interest rate spread represents the difference between the weighted
average yield on interest-earnings assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earnings assets. Interest
income on tax-exempt securities and loans has been adjusted to a
tax-equivalent basis using the statutory federal income tax rate of 35%.
(2) Nonperforming assets consist of non-accrual loans that are contractually
past due 90 days or more; loans that are deemed impaired under the
criteria of FASB Statement No. 114; and real estate, mobile homes and
other assets acquired by foreclosure or deed-in-lieu thereof.
(3) Capital ratios are based on assets of continuing operations.
(4) Dividends payout ratio was calculated using basic earnings per share.
-28-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
First Defiance is a unitary thrift holding company which conducts business
through its subsidiaries, First Federal and 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 banking centers in 12 northwest Ohio counties. On January 21, 2005,
First Defiance acquired ComBanc, Inc., headquartered in Delphos, Ohio in a
transaction valued at $38.3 million including acquisition costs. ComBanc's
subsidiary, the Commercial Bank, operated four banking offices in Delphos, Lima
and Elida, Ohio. On April 8, 2005, First Defiance acquired The Genoa Savings and
Loan Company (Genoa), in a $11.2 million transaction. Genoa operated offices in
Genoa, Oregon, Perrysburg and Maumee Ohio. The acquired Maumee office was merged
with First Federal's existing Maumee office. First Defiance acquired $117.5
million of loans and $163.7 million of deposits in the ComBanc acquisition and
$66.9 million of loans and $76.8 million of deposits in the Genoa transaction.
For more details on the ComBanc and Genoa acquisitions, see Note 3 -
Acquisitions in the Notes to the Financial Statements.
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 through its extensive branch network.
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 four of First Federal's banking
center locations.
During 2003, First Defiance acquired $166.7 million of deposits, $79.0
million of loans, and three banking center offices located in Findlay, Ottawa
and McComb Ohio (the "RFC acquisition"). First Defiance successfully completed
the RFC acquisition on June 6, 2003 and their results reflect the acquisition
from that date forward. For more details on the RFC acquisition, see Note 3 -
Acquisitions in the Notes to Consolidated Financial Statements.
Financial Condition
Assets at December 31, 2005 totaled $1.46 billion compared to $1.13
billion at December 31, 2004, an increase of $334 million or 29.7%. The increase
was due primarily to the acquisition of ComBanc Inc. its subsidiary the
Commercial Bank as of January 21, 2005 and the acquisition of the Genoa Savings
and Loan Company as of April 8, 2005. ComBanc had assets of $196.0 million as of
January 21, 2005 and Genoa had assets of $83.4 million as of April 8, 2005. The
following table indicates what portion of the change in First Defiance's assets,
liabilities and equity was due to the acquisitions. Fair value adjustments and
purchase accounting entries that have been pushed down to ComBanc and Genoa are
included with their respective acquisition column. Explanations of changes in
individual categories follow the table.
-29-
ComBanc Genoa
Balance at Acquisition Savings All Balance at
Dec. 31, Jan. 21, Acquisition Other Dec. 31,
2004 2005 April 8, 2005 Activity 2005
---------------------------------------------------------------------------
(dollars in thousands)
Assets
Cash and due from banks $ 19,891 $ 3,360 $ (612) $ 21,435 $ 44,066
Interest-bearing deposits 630 49,327 -- (44,767) 5,190
Securities 139,258 502 15 (24,921) 114,854
Loans held for sale 2,295 -- -- 2,987 5,282
Loans 888,868 119,656 67,770 101,860 1,178,154
Less allowance for loan losses (9,956) (2,162) (865) (690) (13,673)
---------------------------------------------------------------------------
Net loans 878,912 117,494 66,905 101,170 1,164,481
Federal Home Loan Bank stock 13,376 1,852 1,481 835 17,544
Premises and equipment, net 24,248 4,106 2,345 1,730 32,429
Core deposit and other intangibles 593 3,077 1,202 (755) 4,117
Goodwill 18,340 12,445 4,299 -- 35,084
Other assets 29,124 2,533 1,230 5,148 38,035
---------------------------------------------------------------------------
Total Assets $ 1,126,667 $ 194,696 $ 76,865 $ 63,668 $ 1,461,082
===========================================================================
Liabilities
Deposits
Non-interest bearing checking $ 62,450 $ 17,665 $ 4,993 $ 18,390 $ 103,498
Interest bearing checking and money market 258,797 33,190 20,369 (35,798) 276,558
Savings 52,132 32,665 11,249 (13,280) 82,766
Certificates of deposit 424,322 80,148 40,175 62,034 606,679
---------------------------------------------------------------------------
Total deposits 797,701 163,668 76,786 31,346 1,069,501
Securities sold under agreements to
Repurchase and other borrowings 14,804 6,610 -- 4,334 25,748
FHLB advances 178,213 3,253 -- (506) 180,960
Junior subordinated debentures -- -- -- 20,619 20,619
Other liabilities 9,075 2,061 79 1,823 13,038
---------------------------------------------------------------------------
Total Liabilities 999,793 175,592 76,865 57,616 1,309,866
Shareholders' Equity 126,874 19,104 -- 5,238 151,216
---------------------------------------------------------------------------
Total Liabilities and Shareholders' equity $ 1,126,667 $ 194,696 $ 76,865 $ 62,854 $ 1,461,082
===========================================================================
Loans
Loans receivable increased by $292.2 million or 32.9% to $1.18 billion at
December 31, 2005 from $888.9 million at December 31, 2004. The increase
included $121.2 million in loans acquired in conjunction with the ComBanc
acquisition and $68.6 million of loans acquired in the Genoa transaction.
Excluding the acquisitions, First Federal's loans grew by $99.5 million, or
11.2% in 2005. The increases by type of loan included $88.9 million in 1-4
family residential real estate loans, $139.5 million in commercial real estate
loans, $28.6 million in commercial loans and $22.2 million of home equity and
improvement loans.
Of the $88.9 million increase in 1-4 family residential real estate loans,
$33.1 million was acquired as part of the ComBanc acquisition and $36.3 million
was acquired from Genoa Savings. Of the $139.5 million increase in commercial
real estate loans, $57.2 million was acquired as part of the ComBanc acquisition
and $7.5 million was acquired from Genoa Savings. Of the $28.6 million increase
in commercial loans, $12.7 million was acquired as part of the ComBanc
acquisition and $1.7 million was acquired from Genoa Savings. Of the $22.2
million increase in home equity and improvement loans, $4.6 million was acquired
as part of the ComBanc acquisition and $13.4 million was acquired from Genoa
Savings.
-30-
Allowance for Loan Losses
The allowance for loan losses represents management's assessment of the
estimated probably credit losses in the loan portfolio at each balance sheet
date. Lending activities contain risks of loan losses. Management analyzes the
adequacy of the allowance for loan losses regularly through reviews of the
performance of the loan portfolio. Consideration is given to economic
conditions, changes in interest rates and the effect of such changes on
collateral values and borrower's ability to pay, changes in the composition of
the loan portfolio, and trends in past due and non-performing loan balances. The
allowance for loan losses is a material estimate that is susceptible to
significant fluctuation and is established through a provision for loan losses
based on management's evaluation of the inherent risk in the loan portfolio. In
addition to extensive in-house loan monitoring procedures, the Company utilizes
an outside party to conduct an independent loan review of all commercial loan
and commercial real estate loan relationships that exceed $250,000 of aggregate
exposure. Management utilizes the results of this outside loan review to assess
the effectiveness of its internal loan grading system as well as to assist in
the assessment of the overall adequacy of the allowance for loan losses
associated with this type of loans.
At December 31, 2005, the allowance for loan losses was $13.7 million
compared to $10.0 million at December 31, 2004. Those balances represented 1.16%
and 1.12% of outstanding loans as of December 31, 2005 and December 31, 2004
respectively. The allowances acquired in the ComBanc and Genoa acquisitions
totaled $2.2 million and $865,000 respectively and they were the most
significant factor in the year over year growth in the allowance balance
In determining the appropriate level for the allowance for loan losses,
First Defiance evaluates all loans in its portfolio. While allowances are
frequently required for loans classified as substandard, it is possible for a
credit relationship to be graded as substandard based on the financial
performance of the credit for which no allowance is required because of other
factors such as value of collateral or creditworthiness of guarantors. At
December 31, 2005, a total of $19.3 million of loans are classified as
substandard for which some level of reserve ranging between 20% and 50% of the
outstanding balance is required. A total of $31.8 million in additional credits
were classified as substandard at December 31, 2005 for which no reserve is
required. First Defiance also has classified $1.0 million as doubtful at
December 31, 2005. First Defiance also utilizes a general reserve percentage for
loans not otherwise classified which ranges from 0.025% for mortgage loans to
1.50% for consumer loans. General reserves for commercial and commercial real
estate loans, the largest category in First Defiance's portfolio, are
established at 1.10% of the outstanding balance. The reserve percentage utilized
for these loans is based on both historical losses in the Company's portfolio,
national statistics on loss percentages, regulatory guidance and empirical
evidence regarding the strength of the economy in First Defiance's general
market area.
First Defiance's ratio of allowance for loan losses to non-performing
loans dropped from 525.9% at the end of 2004 to 276.1% at December 31, 2005, the
result of substantial non-performing loans acquired as part of the two
acquisitions. Through its due diligence prior to making the acquisitions,
management was aware of the existence of non-performing loans in both
portfolios. At December 31, 2005, First Defiance had total non-performing assets
of $5.4 million. Of that, $3.3 million related to either the ComBanc or Genoa
acquisitions. The balance of non-performing assets which either were originated
by First Defiance or acquired in the 2003 RFC branch acquisition were $2.1
million compared to $2.0 million of non-performing assets at December 31, 2004.
While the level of classified loans has increased, year over year, management
believes that the current allowance for loan losses is appropriate and that the
provision for loan losses recorded in 2005 is consistent with both charge-off
experience and the strength of the overall credits in the portfolio.
-31-
First Defiance's non-performing assets at December 31, 2005 were just $5.4
million compared to $2.0 million at December 31, 2004 and $2.9 million at
December 31, 2003. Non-performing assets include loans that are 90 days past due
and all real estate owned and other foreclosed assets. Non-performing assets at
December 31, 2005 and 2004 by category were as follows:
December 31
-----------------
2005 2004
-----------------
(In thousands)
Non-performing loans:
Single-family residential $2,648 $ 419
Non-residential and multi-family residential real estate 1,917 1,013
Commercial 287 450
Consumer finance 100 10
-----------------
Total non-performing loans 4,952 1,892
Real estate owned and repossessed assets 404 98
-----------------
Total non-performing assets $5,356 $1,990
=================
Non-performing loans in the single-family residential, non-residential and
multi-family residential real estate and commercial loan categories represent
..94%, .35% and .17% of the total loans in those categories respectively at
December 31, 2005 compared to 0.22%, 0.24% and 0.32% respectively for the same
categories at December 31, 2004. Management believes that the allowance for loan
losses is adequate to cover any estimated losses from non-performing loans.
Loans Acquired with Impairment
Certain loans acquired in the ComBanc and Genoa acquisitions had evidence
that the credit quality of the loan had deteriorated since its origination and
in management's assessment at the acquisition date it was probable that the
First Defiance would be unable to collect all contractually required payments
due. In accordance with American Institute of Certified Public Accountants
Statement of Position 03-3 - Accounting for Certain Loans or Debt Securities
Acquired in a Transfer (SOP 03-3), these loans have been recorded based on
management's estimate of the fair value of the loans. At the acquisition date of
January 21, 2005, loans with a contractual receivable of $3.4 million were
acquired from Combanc which were deemed impaired. Those loans were recorded at a
net realizable value of $2.1 million. On April 8, 2005, loans with a contractual
receivable of $1.5 million were acquired from Genoa which were deemed impaired.
Those loans were recorded at a net realizable value of $735,000. As of December
31, 2005, the total contractual receivable for those loans was $4.6 million and
the recorded value was $2.6 million.
In determining the fair value of these loans, management evaluated the
likelihood of receiving full payment under the contractual terms. Because of the
nature of the types of loans identified, estimates of specific cash flows are
not readily determinable. The loans acquired that are within the scope of SOP
03-3 are not accounted for using the income recognition model of the SOP because
the Company cannot reasonably estimate cash flows expected to be collected. See
Note 7 in the financial statements.
-32-
High Loan-to-Value Mortgage Loans
The majority of First Defiance's mortgage loans are collateralized by
one-to-four-family residential real estate, have loan-to-value ratios of 80% or
less, and are made to borrowers in good credit standing. Frist Federal usually
requires residential mortgage loan borrowers whose loan-to-value is greater than
80% to purchase private mortgage insurance (PMI). First Federal does originate
and retain a limited number of residential mortgage loans with loan-to-value
ratios that exceed 80% where PMI is not required if the borrower possesses other
demonstrable strengths. The loan-to-value ratios on these loans are generally
limited to 85% and exceptions must be approved by First Federal's senior loan
committee. Mortgage loans whose balances when combined with applicable second
mortgages exceed 80% of the appraised value with no PMI totaled $29.7 million at
December 31, 2005. These loans are generally paying as agreed.
In addition to first mortgages that exceed 80% loan-to-value, First
Defiance makes home equity loans which, when combined with first mortgage loans,
held either by First Federal or by other lenders, have potential exposure in
excess of 80%. First Defiance generally will not make home equity loans that
exceed 90% loan-to-value and exceptions to that guideline must be approved by
First Federal's senior loan committee. First Defiance's total exposure for home
equity loans that exceed 80% is $6.2 million at December 31, 2005. These loans
are generally paying as agreed.
First Defiance does not make interest-only first-mortgage residential
loans, nor does it have residential mortgage loan products, or other consumer
products that allow negative amortization.
Securities
The securities portfolio declined $24.4 million to $114.9 million at
December 31, 2005. Only a minimal amount of securities were acquired in the
acquisitions. The activity in the portfolio in 2005 included $30.3 million of
purchases, $28.9 million of amortization and maturities, $24.2 million of sales
and a net decrease of $3.3 million in market value. The decline in market value
in 2005 was attributable primarily to rising interest rates and that decline is
believed to be temporary. Management took advantage of the 2005 rate environment
and sold a portion of the portfolio in order to realize gains totaling $1.2
million. Proceeds of those sales were used primarily to fund loan growth. In
addition, management maintained approximately $8 million in overnight
investments as of December 31, 2005.
Goodwill and Intangible Assets
Goodwill increased $16.7 million to $35.1 million at December 31, 2005.
The ComBanc and Genoa acquisitions added $12.4 million and $4.3 million
respectively to Goodwill for the year. No impairment of goodwill was recorded in
2005. Core deposit intangibles and other intangible assets increased $3.5
million during 2005 to $4.1 million from just $593,000 at the end of 2004, due
to core deposit and customer relationship intangibles recorded in conjunction
with the acquisitions.
Deposits
Total deposits at December 31 2005 were $1.07 billion compared to $797.7
million at December 31, 2004, an increase of 34.1%. The ComBanc acquisition
added $163.7 million of deposits and Genoa added $76.8 million. The remaining
activity was a net increase of $31.3 million. Non-interest bearing checking grew
by $41.0 million while money market and interest bearing checking accounts grew
by $17.8 million, savings by $30.6 million, and certificates of deposit by
$182.4 million. Excluding the acquisitions, non-interest bearing accounts
increased by $18.4 million during 2005 and certificates of deposit increased by
$62.0 million while interest bearing checking and money market accounts declined
by $35.8 million and savings accounts declined by $13.3. This swing is
attributable to improved CD rates during 2005. Management periodically utilizes
brokered certificates of deposit to supplement its funding needs. At
-33-
December 31, 2005 the balance of brokered CDs totaled $37.0 million, down from
$49.5 million at December 31, 2004.
Borrowings
FHLB advances totaled $181.0 million at December 31, 2005 compared to
$178.2 million at December 31, 2004. The balance at the end of 2005 includes
$110.0 million of convertible advances with rates ranging from 4.07% to 5.84%.
These advances are all callable by the FHLB, at which point they would convert
to a three-month LIBOR advance if not paid off. Those advances have final
maturity dates ranging from 2010 to 2013. In addition, First Defiance has
advances totaling $27 million that are callable by the FHLB only if the
three-month LIBOR rate exceeds a strike rate ranging from 7.5% to 8.0%. The rate
on those advances ranges from 3.48% to 5.14%. First Defiance also has $14.3
million outstanding at the FHLB under a series of fixed-rate loans and $28.5
million borrowed on an overnight basis at December 31, 2005.
First Defiance also has $25.8 million of securities that have been sold at
December 31, 2005 with agreements to repurchase, an increase of this type of
funding of $14.0 million over December 31, 2004. The ComBanc acquisition
accounted for approximately $6.6 million of that growth.
In October 2005, the Company issued $20.6 million of Subordinated
Debentures. These debentures were issued to an unconsolidated affiliated trust
that purchased them with the proceeds from a $20 million issued of trust
preferred securities to an outside party. The proceeds of the Subordinated
Debentures were used for general corporate purposes. The Subordinated Debentures
have a rate equal to three-month LIBOR plus 1.38%.
Capital Resources
Total shareholders' equity increased $24.3 million to $151.2 million at
December 31, 2005. This increase is primarily comprised of $19.1 million of
stock issued in conjunction with the ComBanc acquisition and $12.0 million for
net income. Those increases were offset by $6.2 million of dividends ($0.90 per
share declared), $2.2 million in after-tax market value adjustments to the
available for sale securities portfolio and $1.5 million for treasury stock
repurchases. The Company's board of directors authorized the repurchase of
640,000 shares in 2003. A total of 54,531 shares were repurchased in 2005 at an
average cost of $28.37 and 416,778 shares remain to be purchased under the
authorization. Equity also increased by $1.3 million to reflect the release of
shares in the Employee Stock Ownership Plan and by $1.8 million as a result of
stock option exercises and the related tax benefit of non-qualified option
exercises.
-34-
Average Balances, Interest Rates and Yields
The following table presents for the periods indicated the total dollar
amounts of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. The table does
not reflect the effect of income taxes:
Year Ended December 31,
-------------------------------------------------------------------------------------------------
2005 2004 2003
-------------------------------------------------------------------------------------------------
Average Interest Yield/ Average Interest Yield/ Average Interest Yield/
Balance (1) Rate(2) Balance (1) Rate(2) Balance (1) Rate(2)
-------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Interest-Earning Assets:
Loans receivable $1,089,942 69,732 6.40% $ 806,877 47,360 5.87% $667,165 $41,233 6.18%
Securities 121,510 5,873 4.88% 152,316 7,499 4.92% 186,631 9,186 4.92%
Interest-earning deposits 10,410 364 3.50% 2,447 43 1.76% 22,082 280 1.27%
Dividends on FHLB stock 16,352 829 5.07% 14,839 612 4.12% 17,552 695 3.96%
-------------------------------------------------------------------------------------------------
Total interest-earning assets 1,238,214 76,798 6.20% 976,482 55,514 5.69% 893,430 51,394 5.75%
Non-interest-earning assets 126,583 94,321 81,617
---------- ---------- --------
Total Assets $1,364,797 $1,070,803 $975,047
========== ========== ========
Interest-Bearing Liabilities:
Interest-bearing deposits $ 932,036 $20,615 2.21% $ 699,087 $12,950 1.85% $633,034 $13,435 2.12%
FHLB advances 168,330 7,625 4.53% 169,463 7,317 4.32% 155,301 7,343 4.73%
Other borrowings 18,736 451 2.41% 10,608 114 1.07% 7,570 77 1.02%
Subordinated debentures 3,441 201 5.84% -- -- -- -- -- --
-------------------------------------------------------------------------------------------------
Total interest-bearing
liabilities 1,122,543 28,892 2.57% 879,158 20,381 2.32% 795,905 20,855 2.62%
Non-interest bearing
demand deposits 86,741 -- 56,241 -- 47,505 --
-------------------- -------------------- ------------------
Total including non-
interest- bearing
demand deposits 1,209,284 28,892 2.39% 935,399 20,381 2.18% 843,410 20,855 2.47%
Other non-interest liabilities 10,530 9,484 10,403
---------- ---------- --------
Total Liabilities 1,219,814 935,399 853,813
Stockholders' equity 144,983 125,920 121,234
---------- ---------- --------
Total liabilities and
stockholders' equity $1,364,797 $1,070,803 $975,047
========== ========== ========
Net interest income; interest
rate spread (3) $47,906 3.63% $35,133 3.37% $30,539 3.13%
================= ================= =================
Net interest margin (4) 3.87% 3.60% 3.45%
======= ======= ======
Average interest-earning
assets to average interest-
bearing liabilities 110.3% 104.4% 112.3%
======= ======= ======
(1) Interest on certain tax exempt loans (amounting to $47,000, $29,000 and
$61,000 in 2005, 2004 and 2003 respectively) and tax-exempt securities
($1.2 million, $1.5 million and $1.4 million in 2005, 2004 and 2003) is
not taxable for Federal income tax purposes. The average balance of such
loans was $1.0 million, $722,000 and $870,000 in 2005, 2004 and 2003 while
the average balance of such securities was $25.1 million, $32.8 million
and $30.5 million in 2005, 2004 and 2003 respectively. 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) At December 31, 2005, the yields earned and rates paid were as follows:
loans receivable, 6.69%; securities, 5.03%; FHLB stock, 5.75%; total
interest-earning assets, 6.54%; deposits, 2.40%; FHLB advances, 4.57%;
other borrowings, 2.68%; total interest-bearing liabilities, 2.72%; and
interest rate spread, 3.82%.
(3) Interest rate spread is the difference in the yield on interest-earning
assets and the cost of interest-bearing liabilities.
(4) Net interest margin is net interest income divided by average
interest-earning assets.
-35-
Rate/Volume Analysis
The following table describes the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected First Defiance's interest income and expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided on changes attributable to (i) changes in
volume (change in volume multiplied by prior year rate), (ii) change in rate
(change in rate multiplied by prior year volume), and (iii) total change in rate
and volume. The combined effect of changes in both rate and volume has been
allocated proportionately to the change due to rate and the change due to
volume.
Year Ended December 31,
--------------------------------------------------------------------------------
2005 vs. 2004 2004 vs. 2003
--------------------------------------------------------------------------------
Increase Increase Increase Increase
(decrease) (decrease) Total (decrease) (decrease) Total
due to due to increase due to due to increase
rate volume (decrease) rate volume (decrease)
--------------------------------------------------------------------------------
Interest-Earning Assets
Loans $ 4,567 $ 17,805 $ 22,372 $ (1,936) $ 8,063 $ 6,127
Securities (135) (1,491) (1,626) 2 (1,689) (1,687)
Interest-earning
deposits 75 246 321 182 (419) (237)
FHLB stock 150 67 217 31 (114) (83)
-------------------------------------------------------------------------------
Total interest-earning
assets $ 4,657 $ 16,627 $ 21,284 $ (1,721) $ 5,841 $ 4,120
===============================================================================
Interest-Bearing Liabilities
Deposits $ 2,821 $ 4,844 $ 7,665 $ (2,702) $ 2,217 $ (485)
FHLB advances 357 (49) 308 516 (542) (26)
Term notes 208 129 337 5 32 37
Subordinated Debentures -- 201 201 -- -- --
-------------------------------------------------------------------------------
Total interest- bearing
liabilities $ 3,386 $ 5,125 $ 8,511 $ (2,181) $ 1,707 $ (474)
===============================================================================
Increase in net interest income $ 12,773 $ 4,594
======== ========
-36-
Results of Operations
General -- First Defiance reported net income of $12.0 million for the
year ended December 31, 2005 compared to $10.8 million and $12.1 million for the
years ended December 31, 2004 and 2003 respectively. On a diluted per share
basis, First Defiance earned $1.69 in 2005, $1.69 in 2004 and $1.91 in 2003.
The 2005 net income amount includes $3.5 million of acquisition related
costs that were incurred as part of the ComBanc and Genoa acquisitions. These
costs included such items as the expense to terminate data processing contracts,
severance agreements with employees who were not retained, and other costs
resulting from the acquisition or related transition efforts. After tax, these
costs amounted to $2.3 million, or $.32 per share. The 2004 results included a
$1.9 million pretax charge to reflect final settlement of certain contingent
liabilities related to the sale of the Company's 2002 sale of the former Leader
Mortgage subsidiary to US Bancorp. After tax, that amount was $1.25 million or
$0.20 per diluted share. Excluding these non-operating items, core earnings were
$14.2 million, $12.0 million and $12.1 million for the years ended December 31,
2005, 2004 and 2003 respectively. On a diluted per share basis, core earnings
amounted to $2.01, $1.89 and $1.91 for those three periods. A reconciliation of
GAAP earnings to core earnings is as follows:
Year Ended December 31,
--------------------------------
2005 2004 2003
--------------------------------
(in thousands)
GAAP Net Income $ 11,970 $ 10,796 $ 12,082
One-time acquisition related charges 3,476 -- --
Settlement of contingent liability -- 1,927 --
Tax effect (1,217) (674) --
--------------------------------
Core Operating Earnings $ 14,229 $ 12,049 $ 12,082
================================
Basic earnings per share:
GAAP $ 1.75 $ 1.77 $ 2.00
================================
Core Operating Earnings $ 2.08 $ 2.07 $ 2.00
================================
Diluted earnings per share:
GAAP $ 1.69 $ 1.69 $ 1.91
================================
Core Operating Earnings $ 2.01 $ 1.89 $ 1.91
================================
Net interest income was $47.3 million for the year ended December 31, 2005
compared to $35.1 million and $29.8 million for the years ended December 31,
2004 and 2003 respectively. The tax-equivalent net interest margin was 3.87%,
3.62% and 3.45% for the years ended December 31, 2005, 2004 and 2003
respectively. The increase in margin between 2004 and 2005 is due to an improved
interest rate spread, which increased to 3.63% for the year ended December 31,
2005 compared to 3.39% for 2004. The improved spread resulted from a 51 basis
point improvement in the yield on interest-earning assets to 6.20% in 2005 from
5.71% in 2004 while the cost of interest bearing liabilities between the two
periods increased by just 26 basis points, from 2.32% in 2004 to 2.58% in 2005.
Margin also improved in 2005 as a result of the improved mix between loans and
investment securities, the $30.5 million increase in the average balance of
non-interest bearing deposits and a $19.1 million increase in average equity for
the year. The increase in the margin between 2003 and 2004 is due to an improved
interest rate spread, which increased from 3.13% in 2003 to 3.37% in 2004, a
result primarily due to a 30 basis point reduction the the
-37-
Company's overall cost of interest bearing liabilities (from 2.62% to 2.32%)
compared to a drop of just six basis points on the yield of interest earning
assets (from 5.75% in 2003 to 5.69% in 2004). Margin also improved in 2004 due
to an $8.7 million increase in the average balance in non-interest bearing
deposits and a $4.7 million increase in capital.
The 51 basis point improvement in asset yields in 2005 is due to 53 basis
point improvement in the yield on loans and a $30.8 million decline in lower
yielding securities that were replaced with higher yielding loans. Further
yields improved on interest bearing deposits and on FHLB stock in 2005 compared
to 2004. The decline in asset yields in 2004 compared to 2003 is the result of a
31 basis point decline in the yield on loans, which dropped to 5.87% in 2004
from 6.18% in 2003. That decline was partially offset by an improved asset mix
as average loan balances increased from $667.2 million in 2003 to $806.9 million
in 2004 while the average balance in securities declined from $186.6 million in
2003 to $152.3 million in 2004 and the average balance of interest bearing
deposits declined from $22.1 million in 2003 to just $2.4 million in 2004.
The provision for loan losses totaled $1.4 million, $1.5 million and $1.7
million for 2005, 2004 and 2003 respectively while charge-offs were $1.1
million, $685,000 and $725,000 and recoveries were $302,000, $249,000 and
$354,000 respectively in those same years. As a percentage of average loans, net
charge-offs were 0.07% for the year ended December 31, 2005 compared to 0.05%
and 0.06% for 2004 and 2003 respectively.
For the year ended December 31, 2005, non-interest income was $15.9
million compared to $14.0 million for 2004 and $16.8 million for 2003.
Non-interest expense for the year ended December 31, 2005 was $43.9 million
($40.5 million excluding acquisition related charges) compared to $31.2 million
for 2004 ($29.3 million excluding the settlement of a contingent liability) and
$27.1 million for 2003.
Net Interest Income - First Defiance's net interest income is determined
by its interest rate spread (i.e. the difference between the yields on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Total interest income increased by $21.4 million, or 39.2% to $76.2
million for the year ended December 31, 2005 from $54.7 million for the year
ended December 31, 2004. The increase in income was due to an increase in the
average balance in loans receivable, to $1.09 billion for the twelve months of
2005 compared to $806.9 million for 2004. During the same period the average
balance of investment securities dropped to $121.5 million for all of 2005 from
$152.3 million for the year ended December 31, 2004. In addition to the increase
in loan balances, the yield on loans increased to 6.40% on average for 2005
compared to 5.87% in 2004, a 53 basis point improvement.
The increase in the average balance of loans resulted primarily from the
acquisitions, where $190.0 million of loans were acquired. However, First
Defiance continues to also have strong internal loan growth as average loan
balances grew by an additional $93 million during 2005. For the year, First
Defiance's commercial real estate loans grew by $139.5 million ($71.2 million
excluding loans acquired in the acquisitions), one-to-four residential loans
grew by $88.9 million ($13.1 million excluding the acquisitions), commercial
loans grew by $28.6 million ($13.7 million excluding the acquisitions) and home
equity and improvement loans grew by $22.2 million ($4.2 million excluding the
acquisitions).
Interest income from the investment portfolio declined to $5.9 million in
2005 from $7.3 million in 2004. The decline is due to the decrease in the
average balance from $152.3 million to $121.5 million between 2004 and 2005. As
securities matured or were sold, the proceeds were generally used to fund loan
-38-
growth. The tax equivalent yield on the investment portfolio was 4.83% in 2005
compared to 5.08% in 2004 as several of the higher yielding securities in the
portfolio were sold to take advantage of gain positions. First Defiance's
balance in interest bearing deposits with other banks increased significantly
following several of the securities sales. With recent increases in interest
rates, the cost of carrying those liquid assets has declined relative to longer
investment options.
Total interest income increased by $4.2 million, or 8.4% to $54.1 million
for the year ended December 31, 2004 from $49.9 million for the year ended
December 31, 2003. The increase in income was due to an increase in the average
balance of loans receivable, to $806.9 million for the twelve months of 2004
compared to $667.2 million for 2003. During the same period, the average balance
of lower yielding investment securities declined to $152.3 million in 2004 from
$186.6 million in 2003 and funds held on deposit at other financial institutions
dropped to an average of just $2.4 million in 2004 from $22.1 million in 2003.
While loan yields between 2003 and 2004 dropped to 5.87% from 6.18%, that 31
basis point decline was more than offset by the change in the mix between loans
and lower yielding assets. The increase in the average balance of loans
receivable was due primarily to the growth in the Company's commercial real
estate loans, which increased by $73.7 million or 21.6% between December 31,
2003 and December 31, 2004. In addition, balances in one-to-four family
residential real estate loans, commercial loans and home equity loans increased
by $22.1 million, $21.0 million and $20.8 million respectively from the
beginning to the end of 2004. Interest income from the investment portfolio
decreased to $6.7 million for 2004 from $8.5 million in 2003.
Interest expense increased by $8.5 million in 2005 compared to 2004, to
$28.9 million from $20.4 million. This increase was due to a $232.9 million
increase in the average balance of interest bearing deposits in 2005 compared to
2004 as well as a 36 basis point increase in the cost of those deposits. Total
interest bearing deposits acquired in the acquisitions was $217.8 million. For
the year, the actual balance of interest-bearing deposits increased by $230.8
from December 31, 2004 to December 31, 2005. Of that growth, $182.4 million was
in certificates of deposit, which have a higher cost than transaction accounts.
Interest expense on interest-bearing deposits was $20.6 million in 2005 and
$12.9 million in 2004. Expenses on FHLB advances and other funding interest
bearing funding sources was not significantly different between 2004 and 2005.
First Defiance issued $20.6 million of junior subordinated debentures in
conjunction with a trust preferred offering by an unconsolidated affiliated
subsidiary. Interest expense recognized by the Company related to those
subordinated debentures was $201,000 in 2005.
Interest expense declined by $474,000 in 2004 from 2003, to $20.4 million
from $20.9 million. This decline was the result of a decline in interest rates
paid on deposits and the utilization of overnight Federal Home Loan Bank
advances to help short-term funding needs. Interest expense on interest bearing
deposits was $12.95 million for 2004 compared to $13.4 million for 2003 despite
the fact that the average balance of interest-bearing deposits increased to
$699.1 million for 2004 from $633.0 million for 2003. The growth in the average
balance of deposits occurred in both transaction accounts (savings accounts,
money market accounts, and interest-bearing checking accounts which increased in
total to $285.3 million at December 31, 2004 from $245.1 million at December 31,
2003) and in certificates of deposits (which increased to $413.8 million at
December 31, 2004 from $387.9 million at December 31, 2003). The average cost of
FHLB advances declined to 4.32% in 2004 from 4.73% in 2003 because of an
increase in the average balance of over-night or short-term advances during the
year. At December 31, 2004, FHLB advances included $26.5 million of overnight
advances, compared to just $11.0 million at December 31, 2003. The average
balance of short-term advances was $15.6 million for 2004 compared to $2.3
million for 2003. There was no change in the balance or rates paid on long-term
advances during 2004.
-39-
As a result of the foregoing, First Defiance's net interest income was
$47.3 million for the year ended December 31, 2005 compared to $34.3 million for
the year ended December 31, 2004 and $29.8 million for the year ended December
31, 2003. Net interest margin from continuing operations calculated on a
tax-equivalent basis was 3.87% for 2005 compared to 3.62% in 2004 and 3.45% in
2003. In addition to the factors cited above, net interest margin is also
favorably impacted by an increase in non-interest bearing deposits, which
increased to an average balance of $86.7 million in 2005 from an average of
$56.2 million in 2004 and $47.5 million in 2003.
Provision for Loan Losses - First Defiance's provision for loan losses was
$1.4 million for the year ended December 31, 2005 compared to $1.5 million and
$1.7 million for the years ended December 31, 2004 and 2003 respectively.
Provisions for loan losses are charged to earnings to bring the total
allowance for loan losses to a level deemed appropriate by management to absorb
probable losses in the loan portfolio. Factors considered by management include
identifiable risk in the portfolios; 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;
general economic conditions, particularly as they relate to First Defiance's
market areas; and other factors related to the collectability of First
Defiance's loan portfolio. See also the Allowance for Loan Losses in
Management's Discussion and Analysis and Note 7 to the audited financial
statements.
Non-interest Income - Non-interest income increased by $1.9 million or
13.8% in 2005 to $15.9 million from $14.0 million for the year ended December
31, 2004. In 2003, $16.8 million of non-interest income was recognized. Most of
the increase in 2005 was in service fees and other charges, which increased to
$5.6 million for the year ended December 31, 2005 from $4.2 million for 2004, an
increase of $1.4 million or 32.9%. Increased fees resulting from the larger
account base following the acquisitions was the primary reason for the increase
in service fees. Service fee income was $3.5 million in 2003
Mortgage banking income includes gains from the sale of mortgage loans,
fees for servicing mortgage loans for others, and an offset for amortization of
mortgage servicing rights, and adjustments for impairment in the value of
mortgage servicing rights. Mortgage banking income totaled $3.3 million, $2.8
million and $6.8 million in 2005, 2004 and 2003 respectively. That $574,000 of
growth in 2005 over 2004 was primarily attributable to the recapture of $417,000
of previously recorded mortgage servicing rights impairment and a $295,000
increase in mortgage servicing fees resulting from a $139 million increase in
the portfolio of mortgage loans serviced for others. Gains from the sale of
mortgage loans totaled $2.3 million for both 2005 and 2004. The higher level of
mortgage banking income in 2003 was the result of significant mortgage loan
origination activity, a result of the major mortgage refinancing wave which
occurred in those periods. Gains from sale of loans in 2003 were $7.0 million.
The higher level of gains in 2003 was offset somewhat by higher levels of
mortgage servicing rights amortization ($2.0 million in 2003 compared to just
$784,000 and $704,000 in 2005 and 2004 respectively). Also there have been
significant fluctuations in the level of mortgage servicing rights impairment
adjustments over the past three years, ranging from impairment expense of
$717,000 and $1,000 in 2003 and 2004 respectively, to a recovery of previously
recorded impairment of $417,000 in 2005. The balance of the impairment allowance
stands at just $82,000 at the end of 2005 following the recording of a $108,000
permanent mortgage servicing rights write-down in 2005. See Note 8 to the
financial statements.
First Defiance also realized $1.2 million of securities gains in 2005
compared to $1.4 million in 2004 and $1.6 million in 2003. In all three years,
management took advantage of favorable prices in the
-40-
bond portfolio as long-term interest rates stayed low. Generally as investments
were sold out of the investment portfolio, the related proceeds were used to
fund loan growth or they were reinvested in shorter-term securities in order to
position the Company for an eventual overall rate increase.
Non-interest Expense -- Total non-interest expense for 2005 was $43.9
million compared to $31.2 million for the year ended December 31, 2004 and $27.1
million for the year ended December 31, 2003. The 2005 results include $3.5
million of acquisition related charges while the 2004 amount includes a charge
of $1.9 million related to the final settlement of a contingent liability
related to First Defiance's 2002 sale of its Leader Mortgage subsidiary.
Non-interest expense, excluding the acquisition related charges in 2005 and the
settlement of the contingency in 2004, was $40.4 million and $29.3 million
respectively for those two years.
Compensation and benefits increased by $6.0 million in 2005 compared to
2004, to $23.4 million in 2005 from $17.4 million in 2004. Most of the increase
in compensation was due to staffing increases resulting from the acquisitions,
the addition of staff in central operations to service the larger branch network
and continued increases in the cost of First Defiance's health insurance. The
total number of full-time equivalent employees increased to 428 at the end of
2005 compared to 322 at the end of 2004. Also in 2005, occupancy costs increased
to $4.7 million from $3.3 million in 2004, state franchise tax increased to $1.3
million from $868,000, and data processing increased to $3.2 million from $2.4
million. The majority of these increases were a result of the growth due to the
acquisitions. Also in 2005, amortization of intangibles including core deposit
intangibles and customer relationship intangibles increase to $755,000 from just
$110,000 in 2004, a result of the amortization of intangibles acquired in the
acquisitions. First Defiance's other non-interest expense category also
increased to $6.9 million in 2005 from $5.2 million in 2004. Increases in that
category resulted from higher levels of advertising (up $503,000), printing and
office supplies (up $168,000), postage (up $223,000) and bad check charge-offs
and other related deposit account losses (up $247,000).
The increase in non-interest expense in 2004 from 2003 was the primarily
due to a $1.3 million increase in compensation and benefits expense. Occupancy
costs and data processing costs also increased in 2004 by $254,000 and $522,000
respectively.
As noted, the 2005 non-interest expense included $3.5 million of
acquisition related costs. Of these costs, $1.05 million related to the ComBanc
acquisition and $2.45 related to the Genoa acquisition. For ComBanc, the most
significant costs included $471,000 in severance and other termination payments
to employees not retained, $222,000 related to the cancellation of certain
contracts. For Genoa, the most significant costs included $1.3 million for the
termination of a long-term data processing contract and other long-term
contracts and lease arrangements and $364,000 for severance and other payments
to employees not retained.
Income Taxes - Income taxes amounted to $5.9 million in 2005 compared to
$4.8 million in 2004 and 5.7 million in 2003. The effective tax rates for those
years were 32.8%, 30.8%, and 32.0% respectively. The tax rate is lower than the
statutory 35% tax rate for the Company because of investments in tax-exempt
securities and in BOLI. The earnings on such investments are not subject to
federal income tax. The increase in the effective tax rate in 2005 compared to
2004 is primarily the result of lower levels of interest income from tax-exempt
securities in 2005 compared to 2004 and a reduction in earnings from BOLI. See
note 16 to the financial statements.
-41-
Concentrations of Credit Risk
Financial institutions such as First Defiance generate income primarily
through lending and investing activities. The risk of loss from lending and
investing activities includes the possibility that losses may occur from the
failure of another party to perform according to the terms of the loan or
investment agreement. This possibility is known as credit risk.
Lending or investing activities that concentrate assets in a way that
exposes the Company to a material loss from any single occurrence or group of
occurrences increases credit risk. Diversifying loans and investments to prevent
concentrations of risks is one manner a financial institution can reduce
potential losses due to credit risk. Examples of asset concentrations would
include multiple loans made to a single borrower and loans of inappropriate size
relative to the total capitalization of the institution. Management believes
adherence to its loan and investment policies allows it to control its exposure
to concentrations of credit risk at acceptable levels. First Defiance's loan
portfolio is concentrated geographically in its northwest Ohio market area.
There are no industry concentrations that exceed 10% of the Company's loan
portfolio.
Liquidity and Capital Resources
The Company's primary source of liquidity is its core deposit base, raised
through First Federal's branch network, along with unused wholesale sources of
funding and its capital base. These funds, along with investment securities,
provide the ability to meet the needs of depositors while funding new loan
demand and existing commitments.
Cash generated from operating activities was $16.6 million, $16.3 million
and $23.1 million in 2005, 2004 and 2003 respectively. The adjustments to
reconcile net income to cash provided by or used in operations during the
periods presented consist primarily of proceeds from the sale of loans (less the
origination of loans held for sale), the provision for loan losses, depreciation
expense, the origination, amortization and impairment of mortgage servicing
rights, ESOP expense related to the release of ESOP shares in accordance with
AICPA SOP 93-6 and increases and decreases in other assets and liabilities.
In a typical year, the primary investing activity of First Defiance is
lending, which is funded with cash provided from operating and financing
activities, as well as proceeds from payment on existing loans and proceeds from
maturities of investment securities. In 2005, First Defiance completed the
acquisitions of ComBanc and Genoa. In the case of the ComBanc acquisition, which
was purchased with a combination of stock and cash, First Defiance realized an
increase in cash of $52.7 million after netting the cash that was acquired from
ComBanc. ComBanc's cash level was high because they liquidated their investment
portfolio in advance of the acquisition closing date. In the case of the Genoa
acquisition, the acquisition resulted in a net reduction in cash of $612,000
after netting Genoa's cash balances against the purchase price. In 2003, First
Defiance completed the RFC acquisition, which increased cash from investing
activities by $70.1 million as deposits acquired exceeded the purchase price
plus loans acquired.
In considering the more typical investing activities, during 2005, $27.9
million and $24.2 million was generated from the maturity or sale of
available-for-sale investment securities, respectively, while $104.1 million was
used fund loan growth and $30.3 million was used to purchase available-for-sale
investment securities. During 2004, $42.8 million and $20.7 million was
generated from the maturity of investment securities and sale of
available-for-sale investment securities, respectively, while $144.7 million was
used fund loan growth and $34.3 million was used to purchase available-for-sale
investment securities. During 2003, $64.9 million and $22.2 million was realized
from the maturity of investment securities and
-42-
sale of investment securities respectively while $97.4 million was used to fund
loan growth and $48.9 million was used to purchase available for sale
securities.
Principal financing activities include the gathering of deposits, the
utilization of FHLB advances, the sale of securities under agreements to
repurchase such securities and borrowings from other banks. In addition, First
Defiance also purchased common stock for its treasury. For 2005, total deposits
(excluding deposits acquired in the acquisitions) increased by $31.9 million,
including $44.4 million of growth in retail deposit balances. The amount of
deposits acquired from CD brokers or other out of market sources declined in
2005 by $12.5 million. For the year ended December 31, 2004, deposits increased
by $69.1 million, including $58.6 million of growth in retail deposits generated
by the First Federal Bank branch network, and $10.5 million in net growth in
deposits acquired from CD brokers or other out of market sources. For the year
ended December 31, 2003, deposits declined by $37.3 million, primarily do to the
Company not replacing $32.0 million of maturing brokered certificates of deposit
which were no longer needed. Also in 2005, First Defiance issued $20.6 million
of subordinated debentures to an unconsolidated affiliated trust and that trust
issued $20 million of trust preferred stock to outside investors. Also in 2005,
Short-term advances from the FHLB increased by $2 million and borrowings on
lines of credit from other banks of $3 million were paid off. Also securities
sold under repurchase arrangements increased by $7.3 million. In 2004, First
Defiance borrowed $15.5 million in short-term advances from the FHLB and $3.0
million on from other financial institutions under short-term lines of credit.
In 2003, First Defiance borrowed $9 million from the FHLB under long-term
advance agreements and an additional $8 million was borrowed on short-term
advances. Also, the Company repurchased $1.5 million, $4.7 million, $4.4 million
of common stock for treasury in 2005, 2004 and 2003 respectively. For additional
information about cash flows from First Defiance's operating, investing and
financing activities, see the Consolidated Statements of Cash Flows included in
the Consolidated Financial Statements.
At December 31, 2005, First Defiance had the following commitments to fund
deposit, advance and borrowing obligations:
Maturity Dates by Period at December 31, 2005
------------------------------------------------------------------
Less than After 5
Contractual Obligations Total 1 year 1-3 years 4-5 years years
-----------------------------------------------------------------------------------------------------------------
(In Thousands)
Savings, checking and demand accounts $ 462,822 $ 462,822 $ -- $ -- $ --
Certificates of deposit 606,679 451,010 151,439 3,385 845
FHLB overnight advances 28,500 28,500 -- -- --
FHLB fixed advances including interest (1) 194,092 8,301 26,376 23,056 136,359
Subordinated debentures 20,619 -- -- -- 20,619
Securities sold under repurchase agreements 25,748 25,748 -- -- --
Lease obligations 4,489 344 476 406 3,263
------------------------------------------------------------------
Total contractual cash obligations $1,342,949 $ 976,725 $ 178,291 $ 26,847 $ 161,086
==================================================================
(1) Includes principal payments of $152,298 and interest payments of $41,794
-43-
At December 31, 2005, First Defiance had the following commitments to fund
loan or line of credit obligations:
Amount of Commitment Expiration by Period
Total --------------------------------------------------
Amounts Less than After 5
Commitments Committed 1 year 1-3 years 4-5 years years
------------------------------------------------------------------------------------------------------
(In Thousands)
Residential real estate
loans in process $ 44,998 $ 44,998 $ -- $ -- $ --
Commercial loans in process 8,629 8,629 -- -- --
One-to-four family mortgage loan
originations 12,097 6,757 4,974 -- 366
Multifamily originations 8,626 1,881 -- -- 6,745
Other real estate originations 48,310 12,550 11,556 10,914 13,290
Nonmortgage loan originations 3,024 182 2,067 475 300
Consumer lines of credit 90,428 5,682 9,707 13,350 61,689
Commercial lines of credit 59,870 43,276 15,807 2 785
----------------------------------------------------------------
Total loan commitments 275,982 123,955 44,111 24,741 83,175
Standby letters of credit 8,785 4,802 389 3,594 --
----------------------------------------------------------------
Total Commitments $284,767 $128,757 $ 44,500 $ 28,335 $ 83,175
================================================================
In addition to the above commitments, at December 31, 2005 First Defiance
had commitments to sell $8.5 million of loans held for sale to Freddie Mac.
To meet its obligations, management can adjust the rate of savings
certificates to retain deposits in changing interest rate environments; it can
sell or securitize mortgage and non-mortgage loans; and it can turn to other
sources of financing including FHLB advances, the Federal Reserve Bank, bank
lines and brokered certificates of deposit. At December 31, 2005 First Defiance
had $64.1 million capacity under its agreements with the FHLB and other banks.
First Defiance is subject to various capital requirements of the Office of
Thrift Supervision. At December 31, 2005, First Federal had capital ratios that
exceeded the standard to be considered "well capitalized". For additional
information about First Federal's capital requirements, see Note 15 to the
Consolidated Financial Statements.
-44-
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. Certain accounting policies involve significant judgments
and assumptions by management, which have a material impact on the carrying
value of certain assets and liabilities; management considers such accounting
policies to be critical accounting policies. The judgments and assumptions used
by management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of the
judgments and assumptions made by management, actual results could differ from
these judgments and estimates, which could have a material impact on the
carrying value of assets and liabilities and the results of operations of First
Defiance.
Allowance for Loan Losses: First Defiance believes the allowance for loan
losses is a critical accounting policy that requires the most significant
judgments and estimates used in preparation of its consolidated financial
statements. In determining the appropriate estimate for the allowance for loan
losses, management considers a number of factors relative to both specific
credits in the loan portfolio and macro-economic factors relative to the economy
of the United States as a whole and the economy of the northwest Ohio region in
which the Company does business.
Factors relative to specific credits that are considered include a
customer's payment history, a customer's recent financial performance, an
assessment of the value of collateral held, knowledge of the customer's
character, the financial strength and commitment of any guarantors, the
existence of any customer or industry concentrations, changes in a customer's
competitive environment, and any other issues that may impact a customer's
ability to meet his obligations.
Economic factors that are considered include levels of unemployment and
inflation, specific plant or business closings in the Company's market area, the
impact of strikes or other work stoppages, the impact of weather or
environmental conditions, especially relative to agricultural borrowers and
other matters than may have an impact on the economy as a whole.
In addition to the identification of specific customers who may be
potential credit problems, management considers its historical losses, the
results of independent loan reviews, an assessment of the adherence to
underwriting standards, the loss experience being reported by other financial
institutions operating in the Company's market area, and other factors in
providing for loan losses that have not been specifically classified. While
management believes its allowance for loan losses is conservatively determined
based on the above factors, it does not believe the allowances to be excessive
or unnecessary. Refer to the section titled "Allowance for Loan Losses" and Note
2, Statement of Accounting Policies for a further description of the Company's
estimation process and methodology related to the allowance for loan losses.
-45-
Valuation of Mortgage Servicing Rights: First Defiance believes the
valuations of mortgage servicing rights is a critical accounting policy that
requires significant estimates in preparation of its consolidated financial
statements. First Defiance recognizes as separate assets the value of mortgage
servicing rights, which are acquired through loan origination activities. First
Defiance does not purchase any mortgage servicing rights.
Key assumptions made by management relative to the valuation of mortgage
servicing rights include the stratification policy used in valuing servicing,
assumptions relative to future prepayments of mortgages, the potential value of
any escrow deposits maintained or ancillary income received as a result of the
servicing activity and discount rates used to value the present value of a
future cash flow stream. In assessing the value of the mortgage servicing rights
portfolio, management utilizes a third party that specializes in valuing
servicing portfolios. That third party reviews key assumptions with management
prior to completing the valuation. Prepayment speeds are determined based on
projected median prepayment speeds for 15 and 30 year mortgage backed
securities. Those speeds are then adjusted up or down based on the size of the
loan. The discount rate used in this analysis is the pretax yield generally
required by purchasers of bulk servicing rights as of the valuation date. The
value of mortgage servicing rights is especially vulnerable in a falling
interest rate environment. Refer also to the section entitled Mortgage Servicing
Rights and Note 2, Statement of Accounting Policies, and Note 8, Mortgage
Banking, for a further description of First Defiance's valuation process,
methodology and assumptions along with sensitivity analyses.
Forward Looking Information
Forward looking statements in this report are made in reliance upon the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The statements in this report which are not historical fact are forward looking
statements and they include, among other statements, projections about growth in
the Financial Condition section, comments about the adequacy of the allowance
for loan losses and projections about interest rate simulations included in the
Asset/Liability Management section. Actual results may differ from expectations
contained in such forward looking information as a result of factors including
but not limited to the interest rate environment, economic policy or conditions,
federal and state banking and tax regulations, and competitive factors in the
marketplace. Each of these factors could affect estimates, assumptions,
uncertainties and risks considered in the development of forward looking
information and could cause actual results to differ materially from
management's expectation regarding future performance.
-46-
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Asset/Liability Management
A significant portion of the Company's revenues and net income is derived
from net interest income and, accordingly, the Company strives to manage its
interest-earning assets and interest-bearing liabilities to generate an
appropriate contribution from net interest income. Asset and liability
management seeks to control the volatility of the Company's performance due to
changes in interest rates. The Company attempts to achieve an appropriate
relationship between rate sensitive assets and rate sensitive liabilities. First
Defiance does not presently use off balance sheet derivatives to enhance its
risk management.
First Defiance monitors interest rate risk on a monthly basis through
simulation analysis that measures the impact changes in interest rates can have
on net interest income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, non-maturity deposit assumptions and capital
requirements. 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 just 1.75% over the base case
scenario. Were interest rates to fall by 100 basis points during the same
12-month period, the simulation indicates that net interest income would
decrease by only 1.72%. 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.
The majority of First Defiance's lending activities are in the
non-residential real estate and commercial loan areas. While such loans carry
higher credit risk than residential mortgage lending, they tend to be more rate
sensitive than residential mortgage loans. The balance of First Defiance's
non-residential and multi-family real estate loan portfolio was $552.0 million,
which is split between $93.6 million of fixed-rate loans and $458.4 million of
adjustable-rate loans at December 31, 2005. The commercial loan portfolio
increased to $171.3 million, which is split between $70.2 million of fixed-rate
loans and $101.1 million of adjustable-rate loans at December 31, 2005. Certain
of the loans classified as adjustable have fixed rates for an initial term that
may be as long as five years. The maturities on fixed-rate loans are generally
less than 7 years. First Defiance also has significant balances of consumer
loans ($55.3 million at December 31, 2005) which tend to have a shorter duration
than residential mortgage loans, and home equity and improvement loans ($113.0
million at December 31, 2005) which fluctuate with changes in the prime lending
rate. Also, to limit its interest rate risk, (as well as to provide liquidity)
First Federal sells a majority of its fixed-rate mortgage originations into the
secondary market.
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 -300 basis points to +300 basis points. The results
of this analysis are reflected in the following table.
-47-
December 31, 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)
-------------------------------------------------------------------------------------------------
+ 300 bp 165,307 (21,390) (11.46%) 12.04% (84) bp
+ 200 bp 172,774 (13,923) (7.46%) 12.36% (52) bp
+ 100 bp 180,028 (6,669) (3.57%) 12.65% (23) bp
0 bp 186,697 -- -- 12.88% --
-100 bp 191,267 4,570 2.45% 12.98% 10 bp
-200 bp 193,131 6,434 3.45% 12.91% 3 bp
-300 bp 194,686 7,989 4.28% 12.83% (5) bp
Based on the above analysis, in the event of a 200 basis point increase in
interest rates as of December 31, 2005, First Federal would experience a 7.46%
decrease in its economic value of equity. If rates would fall by 200 basis
points its economic value of equity would increase by 3.45%. 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 relatively low because
both its assets and liabilities have relatively short durations and the
durations are fairly closely matched. The average duration of its assets at
December 31, 2005 was 1.75 years while the average duration of its liabilities
was 1.54 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.
-48-
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-49-
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Registered Public Accounting Firms................... 51
Consolidated Statements of Financial Condition.............................. 53
Consolidated Statements of Income........................................... 55
Consolidated Statements of Stockholders' Equity............................. 56
Consolidated Statements of Cash Flows....................................... 57
Notes to Consolidated Financial Statements.................................. 59
-50-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
First Defiance Financial Corp.
Defiance, Ohio
We have audited the accompanying consolidated statement of financial condition
of First Defiance Financial Corp. as of December 31, 2005 and the related
consolidated statements of income, stockholders' equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit. The consolidated
financial statements of First Defiance Financial Corp. as of December 31, 2004
and for the years ended December 31, 2004 and 2003 were audited by other
auditors whose report dated March 8, 2005 expressed an unqualified opinion on
those statements.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Defiance
Financial Corp. as of December 31, 2005, and the results of its operations and
its cash flows for the year then ended in conformity with accounting principles
generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated March 10, 2006 expressed an unqualified opinion thereon.
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Cleveland, Ohio
March 10, 2006
-51-
Report of Independent Registered Public Accounting Firm
On Consolidated Financial Statements
The Board of Directors
First Defiance Financial Corp.
We have audited the accompanying consolidated statement of financial condition
of First Defiance Financial Corp. and subsidiaries as of December 31, 2004, and
the related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the two years in the period ended December 31, 2004.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Defiance
Financial Corp. and subsidiaries at December 31, 2004, and the consolidated
results of their operations and their cash flows for each of the two years in
the period ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles.
/s/ Ernst & Young LLP
Cleveland, Ohio
March 8, 2005
-52-
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
December 31
2005 2004
-------------------------
(In Thousands)
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions $ 44,066 $ 19,891
Interest-bearing deposits 5,190 630
-------------------------
49,256 20,521
Securities:
Available-for-sale, carried at fair value 113,079 137,003
Held-to-maturity, carried at amortized cost
(fair value $1,845 and $2,376 at December 31,
2005 and 2004, respectively) 1,775 2,255
-------------------------
114,854 139,258
Loans receivable, net of allowance of $13,673 and
$9,956 at December 31, 2005 and 2004, respectively 1,164,481 878,912
Loans held for sale 5,282 2,295
Mortgage servicing rights 5,063 3,598
Accrued interest receivable 6,207 4,653
Federal Home Loan Bank stock and other
interest-earning assets 17,544 13,376
Bank owned life insurance 24,346 18,581
Premises and equipment 32,429 24,248
Real estate and other assets held for sale 404 98
Goodwill 35,084 18,340
Core deposit and other intangibles 4,117 593
Other assets 2,015 2,194
-------------------------
Total assets $ 1,461,082 $ 1,126,667
=========================
-53-
December 31
2005 2004
---------------------------
(In Thousands)
Liabilities and stockholders' equity
Liabilities:
Deposits $ 1,069,501 $ 797,701
Advances from the Federal Home Loan Bank 180,960 178,213
Short term borrowings and other interest-bearing liabilities 25,748 14,804
Subordinated debentures 20,619 --
Advance payments by borrowers 605 278
Deferred taxes 795 934
Other liabilities 11,638 7,863
---------------------------
Total liabilities 1,309,866 999,793
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; 11,701 and 10,982 shares issued
and 7,085 and 6,280 shares outstanding, respectively 117 110
Additional paid-in capital 108,628 88,528
Stock acquired by ESOP (1,053) (1,479)
Deferred compensation (2) (4)
Accumulated other comprehensive income (loss),
net of tax of $(13) and $1,148, respectively (22) 2,131
Retained earnings 112,041 106,598
Treasury stock, at cost, 4,616 and 4,702
shares respectively (68,493) (69,010)
---------------------------
Total stockholders' equity 151,216 126,874
---------------------------
Total liabilities and stockholders' equity $ 1,461,082 $ 1,126,667
===========================
See accompanying notes.
-54-
First Defiance Financial Corp.
Consolidated Statements of Income
Years Ended December 31
2005 2004 2003
----------------------------------------
(In Thousands, Except Per Share Amount)
Interest income
Loans $ 69,708 $ 47,345 $ 41,165
Investment securities 5,273 6,731 8,491
Interest-bearing deposits 364 43 280
FHLB stock dividends 829 612 695
----------------------------------------
Total interest income 76,174 54,731 50,631
Interest expense
Deposits 20,615 12,950 13,435
Federal Home Loan Bank advances and other 7,625 7,317 7,343
Subordinated debentures 201 -- --
Notes payable 451 114 77
----------------------------------------
Total interest expense 28,892 20,381 20,855
----------------------------------------
Net interest income 47,282 34,350 29,776
Provision for loan losses 1,442 1,548 1,719
----------------------------------------
Net interest income after provision for loan losses 45,840 32,802 28,057
Noninterest income
Service fees and other charges 5,603 4,215 3,504
Mortgage banking income 3,345 2,771 6,771
Insurance commissions 4,185 4,052 3,712
Gain on sale of securities 1,222 1,426 1,575
Trust income 282 225 161
Income from bank owned life insurance 765 947 809
Other noninterest income 523 360 309
----------------------------------------
Total noninterest income 15,925 13,996 16,841
Noninterest expense
Compensation and benefits 23,446 17,422 16,120
Occupancy 4,651 3,294 3,040
SAIF deposit insurance premiums 136 40 183
State franchise tax 1,285 868 1,118
Acquisition related charges 3,476 -- --
Data processing 3,247 2,363 1,841
Amortization of intangibles 755 110 70
Settlement of contingent liability -- 1,927 --
Other noninterest expense 6,946 5,176 4,754
----------------------------------------
Total noninterest expense 43,942 31,200 27,126
----------------------------------------
Income before income taxes 17,823 15,598 17,772
Federal income taxes 5,853 4,802 5,690
----------------------------------------
Net income $ 11,970 $ 10,796 $ 12,082
========================================
Earnings per share:
Basic $ 1.75 $ 1.77 $ 2.00
Diluted $ 1.69 $ 1.69 $ 1.91
Dividends declared per share $ 0.90 $ 0.82 $ 0.65
See accompanying notes.
-55-
First Defiance Financial Corp.
Consolidated Statements of Stockholders' Equity
(In Thousands)
Stock Acquired By
------------------------
Additional Management
Common Treasury Paid-In Recognition
Stock Stock Capital ESOP Plan
----------------------------------------------------------------
Balance at January 1, 2003 $ 110 $ (63,782) $ 86,255 $ (2,387) $ (30)
Comprehensive income:
Net income -- -- -- -- --
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of $(1,314) (a) -- -- -- -- --
Total comprehensive income
ESOP shares released -- -- 596 483 --
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $31 -- -- 31 -- 19
Shares issued under stock option plan,
including income tax benefit of $236 -- 1,931 236 -- --
Acquisition of common stock for treasury -- (4,406) -- -- --
Dividends declared -- -- -- --
----------------------------------------------------------------
Balance at December 31, 2003 110 (66,257) 87,118 (1,904) (11)
Comprehensive income:
Net income -- -- -- -- --
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of ($1,015) (a) -- -- -- -- --
Total comprehensive income
ESOP shares released -- -- 845 425 --
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $12 -- -- 12 -- 7
Shares issued under stock option plan,
including income tax benefit of $553 -- 1,938 553 -- --
Acquisition of common stock for treasury -- (4,691) -- -- --
Dividends declared -- -- -- -- --
----------------------------------------------------------------
Balance at December 31, 2004 110 (69,010) 88,528 (1,479) (4)
Comprehensive income:
Net income -- -- -- -- --
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of ($1,015) (a) -- -- -- -- --
Total comprehensive income
ESOP shares released -- -- 924 426 --
Shares issued to acquire ComBanc, Inc. 7 186 18,911 -- --
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $4 -- -- 4 -- 2
Shares issued under stock option plan,
including income tax benefit of $261 -- 1,878 261 -- --
Acquisition of common stock for treasury -- (1,547) -- -- --
Dividends declared -- -- -- -- --
----------------------------------------------------------------
Balance at December 31, 2005 $ 117 $ (68,493) $ 108,628 $ (1,053) $ (2)
================================================================
Accumulated
Other Total
Comprehensive Retained Stockholders'
Income (Loss) Earnings Equity
-----------------------------------------
Balance at January 1, 2003 $ 6,455 $ 93,489 $ 120,110
Comprehensive income:
Net income -- 12,082 12,082
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of $(1,314) (a) (2,438) -- (2,438)
-----------
Total comprehensive income 9,644
ESOP shares released -- -- 1,079
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $31 -- -- 50
Shares issued under stock option plan,
including income tax benefit of $236 -- (436) 1,731
Acquisition of common stock for treasury -- -- (4,406)
Dividends declared -- (3,939) (3,939)
-----------------------------------------
Balance at December 31, 2003 4,017 101,196 124,269
Comprehensive income:
Net income -- 10,796 10,796
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of ($1,015) (a) (1,886) -- (1,886)
-----------
Total comprehensive income 8,910
ESOP shares released -- -- 1,270
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $12 -- -- 19
Shares issued under stock option plan,
including income tax benefit of $553 -- (383) 2,108
Acquisition of common stock for treasury -- -- (4,691)
Dividends declared -- (5,011) (5,011)
-----------------------------------------
Balance at December 31, 2004 2,131 106,598 126,874
Comprehensive income:
Net income -- 11,970 11,970
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of ($1,015) (a) (2,153) -- (2,153)
-----------
Total comprehensive income 9,817
ESOP shares released -- -- 1,350
Shares issued to acquire ComBanc, Inc. -- -- 19,104
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $4 -- -- 6
Shares issued under stock option plan,
including income tax benefit of $261 -- (317) 1,822
Acquisition of common stock for treasury -- -- (1,547)
Dividends declared -- (6,210) (6,210)
-----------------------------------------
Balance at December 31, 2005 $ (22) $ 112,041 $ 151,216
=========================================
(a) Net of reclassification adjustments. Reclassification adjustments
represent net unrealized gains (losses) as of December 31 of the prior
year on securities available-for-sale that were sold during the current
year. The reclassification adjustment was $1.3 million ($844,000 after
tax) in 2005, $1.82 million ($1.18 million after tax) in 2004 and$1.39
million ($905,000 after tax) in 2003.
See accompanying notes.
-56-
First Defiance Financial Corp.
Consolidated Statements of Cash Flows
Years Ended December 31
2005 2004 2003
-----------------------------------------
(In Thousands)
Operating activities
Net income $ 11,970 $ 10,796 $ 12,082
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,442 1,548 1,719
Provision for depreciation 2,396 1,798 1,645
Net amortization of premium and discounts on loans,
securities, deposits and debt obligations 1,152 564 988
Amortization of mortgage servicing rights 784 704 1,998
Net impairment (recovery) of mortgage servicing rights (417) 1 (746)
Amortization of intangibles 755 110 70
Gain on sale of loans (2,426) (2,523) (7,173)
Amortization of Management Recognition Plan
deferred compensation 6 19 50
Gain on sale of property, plant and equipment (116) -- --
FHLB stock dividends (835) (610) (692)
Release of ESOP shares 1,350 1,270 1,079
Gains on sales of securities (1,222) (1,426) (1,575)
Deferred federal income tax 249 90 874
Proceeds from sale of loans 112,731 106,620 307,717
Origination of loans held for sale (114,332) (101,391) (293,673)
Income from bank owned life insurance (765) (947) (809)
Change in interest receivable and other assets 1,285 (136) 82
Change in accrued interest and other liabilities 2,574 (234) (546)
-----------------------------------------
Net cash provided by operating activities 16,581 16,253 23,090
Investing activities
Proceeds from maturities of held-to-maturity securities 357 403 1,125
Proceeds from maturities of available-for-sale securities 27,882 42,850 64,852
Proceeds from sale of available-for-sale securities 24,160 20,747 22,233
Proceeds from sale of real estate and other assets held for sale 475 996 338
Proceeds from sale of office properties and equipment 1,286 2 --
Proceeds from sale of discontinued operations -- -- 1,228
Purchases of available-for-sale securities (30,271) (34,262) (48,885)
Proceeds from sale of Federal Home Loan Bank stock -- 5,000 --
Purchases of office properties and equipment (5,296) (2,202) (3,506)
Investment in bank owned life insurance (5,000) -- (2,000)
Proceed from insurance death benefit -- 318 --
Acquisition of banking center offices -- -- 70,132
Net cash received for acquisition of ComBanc, Inc. 52,687 -- --
Net cash paid for acquisition of Genoa Savings and Loan Co. (612) -- --
Net increase in loans receivable (104,103) (144,660) (97,376)
-----------------------------------------
Net cash (used in) provided by investing activities (38,435) (110,808) 8,141
-57-
First Defiance Financial Corp.
Consolidated Statements of Cash Flows (continued)
Years Ended December 31
2005 2004 2003
--------------------------------------
Financing activities
Net increase (decrease) in deposits 31,931 69,090 (37,343)
Repayment of Federal Home Loan Bank long-term advances (2,457) (1,809) (1,574)
Repayment of term notes payable -- -- (10)
Net increase in Federal Home Loan Bank
short-term advances 2,000 15,500 8,000
Net increase (decrease) in short-term line of credit (3,000) 3,000 --
Proceeds from Federal Home Loan Bank long-term advances -- -- 9,000
Increase (decrease) in securities sold under repurchase agreements 7,334 (463) 6,671
Proceeds from issuance of subordinated debentures 20,619 -- --
Purchase of common stock for treasury (1,547) (4,691) (4,406)
Cash dividends paid (5,852) (4,889) (3,939)
Proceeds from exercise of stock options 1,561 1,555 1,495
--------------------------------------
Net cash provided by (used in) financing activities 50,589 77,293 (22,106)
--------------------------------------
Increase (decrease) in cash and cash equivalents 28,735 (17,262) 9,125
Cash and cash equivalents at beginning of period 20,521 37,783 28,658
--------------------------------------
Cash and cash equivalents at end of period $ 49,256 $ 20,521 $ 37,783
======================================
Supplemental cash flow information
Interest paid $ 28,327 $ 20,432 $ 21,047
======================================
Income taxes paid $ 5,053 $ 4,149 $ 5,063
======================================
Transfers from loans to other real estate owned
and other assets held for sale $ 605 $ 690 $ 536
======================================
--------------------------------------------------------------------------------
First Defiance acquired all of the capital stock ComBanc Inc. and the Genoa
Savings and Loan Company for $38.3 million and $11.2 million respectively in
2005. In conjunction with the acquisitions, liabilities were assumed as follows:
ComBanc Genoa Total
--------------------------------------
Fair value of assets acquired $ 213,927 $ 88,077 $ 302,004
Purchase price (38,339) (11,212) (49,551)
--------------------------------------
Liabilities assumed $ 175,588 $ 76,865 $ 252,453
======================================
In 2003, First Defiance acquired three banking center offices from another bank
in a cash transaction. Liabilities assumed in that transaction, which consisted
solely of deposits, totaled $166.7 million.
--------------------------------------------------------------------------------
See accompanying notes.
-58-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003
1. Basis of Presentation
First Defiance Financial Corp. (First Defiance) is a holding company that
conducts business through its two wholly owned subsidiaries, First Federal Bank
of the Midwest, Defiance Ohio (First Federal) and First Insurance & Investments
(First Insurance). All significant intercompany transactions and balances are
eliminated in consolidation.
First Federal is primarily engaged in attracting deposits from the general
public through its offices and using those and other available sources of funds
to originate loans primarily in the counties in which its offices are located.
First Federal's traditional banking activities include originating and servicing
residential, commercial and consumer loans and providing a broad range of
depository and trust services. First Insurance & Investments is an insurance
agency that does business in the Defiance, Ohio area offering property and
casualty, group health, and life insurance and investment and annuity products.
2. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. Significant areas where First Defiance uses estimates are the
determination of the allowance for loan losses, the valuation of mortgage
servicing rights and goodwill, and the determination of post-retirement
benefits.
Earnings Per Share
Earnings per share are based on the weighted average number of shares of common
stock outstanding during the period. Basic earnings per share exclude any
dilutive effects of options and unvested stock grants. Diluted earnings per
common share includes the dilutive effect of additional potential common shares
issuable under stock options and stock grants. Unreleased shares held by the
Company's Employee Stock Ownership Plan are not included in average shares for
purposes of calculating earnings per share. As shares are released for
allocation, they are included in the average shares outstanding. Also see note
17.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income.
Other comprehensive income includes unrealized gains and losses on securities
available for sale.
-59-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Cash and Cash Equivalents
Cash and cash equivalents include amounts due from banks and overnight
investments with the Federal Home Loan Bank (FHLB). Cash and amounts due from
depository institutions includes required balances at the FHLB and Federal
Reserve of approximately $175,000 and $100,000, respectively, at December 31,
2005. Net cash flows are reported for customer loan and deposit transactions,
interest bearing deposits in other financial institutions, and repurchase
agreements.
Investment Securities
Management determines the appropriate classification of debt securities at the
time of purchase and evaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest
income using the interest method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity until realized. Realized gains and
losses, and unrealized losses judged to be other-than-temporary, are included in
gains (losses) on securities. Realized gains and losses on securities sold is
based on the specific identification method.
Currently, First Defiance invests in derivative securities as part of the
overall asset and liability management process. Such derivative securities are
disclosed in Note 5 and include agency step-up, REMIC and CMO investments. Such
investments are not classified by management as high risk at December 31, 2005
and do not present risk significantly different than other mortgage-backed or
agency securities.
FHLB Stock
As a member of the FHLB System, First Federal is required to own stock of the
FHLB of Cincinnati in an amount principally equal to 0.15% of total assets plus
an amount of at least 2% but no more than 4% of its non-grandfathered mission
asset activity (as defined in the FHLB's regulations). First Federal is
permitted to own stock in excess of the minimum requirement. FHLB stock is a
restricted equity security that does not have a readily determinable fair value
and is carried at cost.
Loans Receivable
Loans are reported at the principal amount outstanding, net of deferred loan
fees and costs and the allowance for loan losses. Deferred fees net of deferred
incremental loan origination costs, is amortized to interest income generally
over the contractual life of the loan using the interest method.
-60-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Mortgage loans originated and intended for sale in the secondary market are
classified as loans held for sale and are carried at the lower of cost or
estimated fair value in the aggregate.
Interest receivable is accrued on loans and credited to income as earned. The
accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is reversed.
Interest income is subsequently recognized only to the extent cash payments are
received. The accrual of interest on these loans is generally resumed after a
pattern of repayment has been established and the collection of principal and
interest is reasonably assured.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable incurred losses in the loan portfolio and is based
on the size and current risk characteristics of the loan portfolio, an
assessment of individual problem loans, actual loss experience, current economic
events in specific industries and geographical areas, and other pertinent
factors including regulatory guidance and general economic conditions.
Determination of the allowance is inherently subjective as it requires
significant estimates, including the amounts and timing of expected future cash
flows on impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience and consideration of economic trends, all of which
may be susceptible to significant change.
Loan losses are charged off against the allowance when in management's
estimation it is unlikely that the loan will be collected, while recoveries of
amounts previously charged off are credited to the allowance. A provision for
loan losses is charged to operations based on management's periodic evaluation
of the factors previously mentioned, as well as other pertinent factors in order
to maintain the allowance for loan losses at the level deemed adequate by
management. The determination of whether a loan is considered past due or
delinquent is based on the contractual payment terms.
A loan is impaired when full payment under the loan terms is not expected.
Commercial and commercial real estate loans are individually evaluated for
impairment. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Large groups of smaller
balance homogeneous loans, such as consumer and residential real estate loans,
are collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.
Acquired Loans
Valuation allowances for all acquired loans subject to SOP 03-3 reflect only
those losses incurred after acquisition--that is, the present value of cash
flows expected at acquisition that are not expected to be collected. Valuation
allowances are established only subsequent to acquisition of the loans.
-61-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
The Company acquires loans individually and in groups or portfolios. At
acquisition, the Company reviews each loan to determine whether there is
evidence of deterioration of credit quality since origination and if it is
probable that it will be unable to collect all amounts due according to the
loan's contractual terms. If both conditions exist, the Company determines
whether each such loan is to be accounted for individually or whether such loans
will be assembled into pools of loans based on common risk characteristics
(credit score, loan type, and date of origination). The Company considers
expected prepayments, and estimates the amount and timing of undiscounted
expected principal, interest, and other cash flows (expected at acquisition) for
each loan and subsequently aggregated pool of loans. The Company determines the
excess of the loan's or pool's scheduled contractual principal and contractual
interest payments over all cash flows expected at acquisition as an amount that
should not be accreted (nonaccretable difference). The remaining
amount--representing the excess of the loan's cash flows expected to be
collected over the amount paid--is accreted into interest income over the
remaining life of the loan or pool (accretable yield).
Over the life of the loan or pool, the Company continues to estimate cash flows
expected to be collected, and evaluates whether the present value of its loans
determined using the effective interest rates has decreased and if so,
recognizes a loss. The present value of any subsequent increase in the loan's or
pool's actual cash flows or cash flows expected to be collected is used first to
reverse any existing valuation allowance for that loan or pool. For any
remaining increases in cash flows expected to be collected, the Company adjusts
the amount of accretable yield recognized on a prospective basis over the loan's
or pool's remaining life.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as
commitments to make loans and commercial letters of credit, issued to meet
customer financing needs. The face amount for these items represents the
exposure to loss, before considering customer collateral or ability to repay.
Such financial instruments are recorded when they are funded.
Marketing Costs
Marketing costs totaled $1.04 million, $592,000, and $524,000, in 2005, 2004,
and 2003, respectively, and are expensed as incurred.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary
course of business, are recorded as liabilities when the likelihood of loss is
probable and an amount or range of loss can be reasonably estimated. Management
does not believe there now are such matters that will have a material effect on
the financial statements.
-62-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Dividend Restriction
Banking regulations require maintaining certain capital levels and may limit the
dividends paid by the bank to the holding company. These restrictions pose no
practical limit on the ability of the bank or holding company to pay dividends
at historical levels. See Note 19.
Mortgage Servicing Rights
The total cost of loans originated or purchased is allocated between loans and
servicing rights based on the relative fair values of each at the time of sale.
The servicing rights capitalized are amortized in proportion to and over the
period of estimated servicing income.
Mortgage servicing rights are periodically evaluated for impairment. For
purposes of measuring impairment, mortgage servicing rights are stratified based
on predominant risk characteristics of the underlying serviced loans. These risk
characteristics include loan type (fixed or adjustable rate) and interest rate.
Impairment represents the excess of amortized cost of an individual mortgage
servicing rights stratum over its fair value, and is recognized through a
valuation allowance.
Fair values for individual stratum are based on the present value of estimated
future cash flows using a discount rate commensurate with the risks involved.
Estimates of fair value include assumptions about prepayment, default and
interest rates, and other factors which are subject to change over time. Changes
in these underlying assumptions could cause the fair value of mortgage servicing
rights, and the related valuation allowance, to change significantly in the
future.
Real Estate and Other Assets Held for Sale
Other assets held for sale are comprised of properties acquired through
foreclosure proceedings or acceptance of a deed in lieu of foreclosure. These
properties are carried at the lower of cost or fair value, less estimated costs
to dispose, at the time of foreclosure or insubstance foreclosure. Losses
arising from the acquisition of such property are charged against the allowance
for loan losses at the time of acquisition. If fair value declines subsequent to
foreclosure, a valuation allowance is recorded through expense. Costs after
acquisition are expensed.
Premises and Equipment and Long Lived Assets
Premises and equipment are carried at cost less accumulated depreciation and
amortization computed principally by the straight-line method over the following
estimated useful lives:
Buildings and improvements 20 to 50 years
Furniture, fixtures and equipment 3 to 15 years
-63-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Long-lived assets to be held and those to be disposed of and certain intangibles
are evaluated for impairment using the guidance provided by Statement of
Financial Accounting Standards (SFAS) No. 144, Accounting for Long-Lived Assets
to be Disposed of, relative to accounting for long-lived assets and accounting
for long-lived assets to be disposed of either through sale, abandonment,
exchange or a distribution to owners.
Income Taxes
Deferred income taxes reflect the temporary tax consequences on future years of
differences between the tax basis and financial statement amounts of assets and
liabilities at each year-end.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
An effective tax rate of 35% is used to determine after-tax components of other
comprehensive income (loss) included in the statements of stockholders' equity.
Business Combinations
Business combinations, which have been accounted for under the purchase method
of accounting, include the results of operations of the acquired business from
the date of acquisition. Net assets of companies acquired are recorded at their
estimated fair value as of the date of acquisition.
Goodwill and Other Intangibles
Core deposit intangibles are a measure of the value of checking and savings
deposits acquired in business combinations accounted for under the purchase
method. Core deposit intangibles are amortized on an accelerated basis over the
estimated lives of the existing deposit relationships acquired, but not
exceeding 10 years. Customer Relationship Intangibles are a measure of the value
of customer relationships accounted for under the purchase method. The Customer
Relationship Intangible is amortized over the estimated contractual life of the
existing relationship and is limited to 10 years. Goodwill is the excess of the
purchase price over the fair value of the assets and liabilities of companies
acquired through business combinations accounted for under the purchase method.
Goodwill is evaluated at the business unit level, which for First Defiance is
First Federal Bank and First Insurance. At December 31, 2005 and December 31,
2004, goodwill at First Federal totaled $31.3 million and $14.5 million
respectively, core deposit intangibles were $3.6 million and $593,000
respectively in 2005 and 2004 and customer relationship intangibles at December
31, 2005 were $512,000. At December 31, 2005 and 2004 goodwill totaled $3.8
million and $3.8 million respectively at First Insurance.
-64-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Core deposit intangibles are amortized over the life of the related deposits,
not to exceed ten years. Amortization expense for core deposit intangibles was
$693,000, $110,000 and $70,000 in 2005, 2004 and 2003 respectively. Customer
relationship intangibles are amortized over the estimated live of the customer
relationship, not to exceed 10 years. Amortization expense for customer
relationship intangibles in 2005 was $62,000. Amortization of intangibles is
expected to total $719,000, $573,000, $469,000, $410,000, and $402,000 in 2006,
2007, 2008, 2009 and 2010 respectively. Goodwill is not subject to amortization
but its value is assessed annually to determine if there is any impairment of
value.
Settlement of Contingent Liability
First Defiance sold its former Leader Mortgage subsidiary in 2002. During 2004,
the Purchaser of that unit asserted certain claims against First Defiance under
the Purchase and Sale Agreement. First Defiance settled all matters related to
the sale of Leader Mortgage in the 2004 third quarter and it recognized a
pre-tax charge of $1.9 million, which is included in the 2004 Consolidated
Statement of Income.
Stock Compensation Plans
At December 31, 2005, the Company had four stock-based compensations plans,
which are more fully described in Note 18. 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
Corporation'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-based compensation plans
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 which was originally developed for use in estimating the
fair value of traded options, which have different characteristics from the
Company's employee stock options. The model is also sensitive to changes in
assumptions, which can materially affect the fair value estimate. The following
weighted-average assumptions were used to determine the fair value of options
granted during the years presented on First Defiance common stock:
-65-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
December 31,
----------------------------------
2005 2004 2003
----------------------------------
Risk free interest rate 4.40% 4.73% 4.39%
Dividend yield 3.39% 2.96% 3.01%
Volatility factors of expected
market price of stock 22.4% 22.9% 22.7%
Weighted average expected life 10 years 10 years 10 years
Weighted average grant date fair
value of options granted $ 5.67 $ 6.85 $ 4.97
Based upon the above assumptions, pro forma net income and earnings per share
are as follows:
Years Ended December 31
-----------------------------------
2005 2004 2003
-----------------------------------
Net income $ 11,970 $ 10,796 $ 12,082
Stock-based compensation using the
fair value method, net of tax (268) (222) (186)
-----------------------------------
Pro forma net income $ 11,702 $ 10,574 $ 11,896
===================================
Earnings per share as reported:
Basic $ 1.75 $ 1.77 $ 2.00
===================================
Diluted $ 1.69 $ 1.69 $ 1.91
===================================
Pro forma earnings per share:
Basic $ 1.71 $ 1.74 $ 1.97
===================================
Diluted $ 1.65 $ 1.66 $ 1.88
===================================
Company Owned Life Insurance
The Company has purchased life insurance policies on certain key executives.
Company owned life insurance is recorded at its cash surrender value, or the
amount that can be realized.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market
information and other assumptions, as more fully disclosed in a separate note.
Fair value estimates involve uncertainties and matters of significant judgment
regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in
assumptions or in market conditions could significantly affect the estimates.
-66-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Operating Segments
While the chief decision-makers monitor the revenue streams of the various
products and services, the identifiable segments are not material and operations
are managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the financial service operations are considered by
management to be aggregated in one reportable segment.
Reclassifications
Some items in the prior year financial statements were reclassified to conform
to the current presentation.
Recent Accounting Pronouncements
Accounting for Stock Compensation
In December 2004, the FASB revised SFAS 123, Accounting for Stock-Based
Compensation. SFAS No. 123(R), Share-Based Payments which replaces SFAS No. 123
and supersedes APB Opinion No. 25 establishes accounting requirements for
share-based compensation to employees and carries forward prior guidance on
accounting for awards to non-employees. In 2005, the FASB issued further
guidance on the classification and measurement of freestanding financial
instruments originally issued for employee service and the application of grant
date as defined in SFAS 123(R). First Defiance will be required to adopt this
statement on January 1, 2006. The pro forma disclosures previously permitted
under SFAS No. 123 no longer will be an alternative to financial statement
recognition. Under SFAS No. 123(R), the Company must determine the appropriate
fair value model to be used for valuing share-based payments, the amortization
method for compensation cost and the transition method to be used at date of
adoption.
The permitted transition methods include either retrospective or prospective
adoption. Under the retrospective option, prior periods may be restated either
as of the beginning of the year of adoption or for all periods presented. The
prospective method requires that compensation expense be recorded for all
unvested stock options at the beginning of the first quarter of adoption of SFAS
No. 123R, while the retrospective methods would record compensation expense for
all unvested stock options beginning with the first period presented. The
Company plans to use the retrospective method and no prior periods will be
adjusted. Management does not believe that the adoption of SFAS No. 123R will
result in share-based expense amounts that are materially different than the
current pro forma disclosures under SFAS No. 123 set forth above. See Note 18
for additional information regarding stock options outstanding at year-end.
-67-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
2. Statement of Accounting Policies (continued)
Meaning of Other Than Temporary Impairment
In November 2005, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position (FSP) 115-1, The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments. This FSP provides additional guidance on
when an investment in a debt or equity securities should be considered impaired
and when that impairment should be considered other-than-temporary and
recognized as a loss in earnings. Specifically, the guidance clarifies 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.
The FSP also requires certain disclosures about unrealized losses that have not
been recognized as other-than-temporary impairments. Management has applied the
guidance in this FSP in the 2005 financial statements.
Accounting Changes and Error Corrections
In May 2005, the FASB issued SFAS 154, Accounting Changes and Error Corrections,
which changes the accounting for and reporting of a change in accounting
principle. This statement applies to all voluntary changes in accounting
principle and changes required by an accounting pronouncement in the unusual
instance that the pronouncement does not include specific transition provisions.
This statement requires retrospective application to prior period financial
statements of changes in accounting principle, unless it is impractical to
determine either the period-specific or cumulative effects of the change. SFAS
154 is effective for accounting changes made in fiscal years beginning after
December 15, 2005. The adoption of this standard is not expected to have a
material effect on financial condition, results of operations, or liquidity of
the Company.
Accounting For Certain Loans or Debt Securities Acquired in a Transfer
In December 2003, the American Institute of Certified Public Accountants issued
Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer. SOP 03-3 requires acquired loans, including
debt securities, to be recorded at the amount of the purchaser's initial
investment and prohibits carrying over valuation allowances from the seller for
those individually evaluated loans that have evidence of deterioration in credit
quality since origination, and it is probable all contractual cash flows on the
loan will be unable to be collected. SOP 03-3 also requires the excess of all
undiscounted cash flows expected to be collected at acquisition over the
purchaser's initial investment to be recognized as interest income on a
level-yield basis over the life of the loan. Subsequent increases in cash flows
expected to be collected are recognized prospectively through an adjustment of
the loan's yield over its remaining life, while subsequent decreases are
recognized as impairment. Loans carried at fair value, mortgage loans held for
sale, and loans to borrowers in good standing under revolving credit agreements
are excluded from the scope of SOP 03-3. The Corporation adopted the provisions
of SOP 03-03 effective January 1, 2005. See Note 7 for further details.
-68-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
3. Acquisitions
On April 8, 2005, The Company acquired the Genoa Savings and Loan Company
("Genoa"), a savings and loan headquartered in Genoa, Ohio for a total purchase
price of $11.2 million including direct acquisition costs of $220,000. Genoa
shareholders received cash of $11.0 million in the all-cash transaction.
On January 21, 2005, First Defiance acquired ComBanc, Inc. ("ComBanc"), a
bank-holding company and its wholly-owned subsidiary, the Commercial Bank by
acquiring all of the outstanding capital stock of ComBanc for an aggregate
purchase price of $38.3 million, including direct acquisition costs of $542,000.
ComBanc shareholders received 733,775 shares of First Defiance stock and cash of
$18.7 million.
The acquisitions enhance First Defiance's community bank operations by giving
them a larger presence in the Toledo, Ohio market area following the Genoa
acquisition and allowing them to expand into the Allen County, Ohio area, which
is adjacent to existing markets, following the ComBanc acquisition. The value of
the common stock issued for the ComBanc acquisition was determined based on an
average of the closing price for two days before and after the date the final
exchange terms were determined. The following table presents the allocation of
the purchase price, including direct acquisition costs, for the Genoa and
ComBanc acquisitions to assets acquired and liabilities assumed, based on their
fair values:
Genoa ComBanc
-----------------------
(in thousands)
Assets
Cash and cash equivalents $ 10,600 $ 71,915
Investment securities 15 502
Loans, net of allowances for loan losses 66,905 117,494
Premises and equipment 2,345 4,106
Goodwill and other intangibles 5,501 15,522
Other assets 2,711 4,388
-----------------------
Total assets acquired 88,077 213,927
Liabilities
Deposits 76,786 163,668
Borrowings -- 9,863
Other liabilities 79 2,057
-----------------------
Total liabilities acquired 76,865 175,588
-----------------------
Net assets acquired $ 11,212 $ 38,339
=======================
-69-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
3. Acquisitions (continued)
Genoa ComBanc
---------------------------
(in thousands)
Purchase price $ 11,212 $ 38,339
Carrying value of net assets acquired (6,737) (22,615)
---------------------------
Excess of purchase price over carrying
value of net assets acquired 4,475 15,724
Purchase accounting adjustments:
Portfolio loans 978 1,668
Investment securities -- 9
Premises and equipment (1,620) 651
Mortgage servicing rights 116 49
Deposits (301) (322)
Borrowings -- (211)
Deferred tax liabilities (199) (1,642)
---------------------------
Total net tangible assets (1,026) 202
Core deposit and customer
relationship intangibles 1,202 3,077
---------------------------
Goodwill $ 4,299 $ 12,445
===========================
The following (unaudited) pro forma consolidated results of operations have been
prepared as if the acquisitions of ComBanc and Genoa occurred as of the
beginning of each period presented.
December 31
----------------------------------------
2005 2004
----------------------------------------
(in thousands, except per share amounts)
Net interest income $ 48,542 $ 44,085
Net income $ 13,775 $ 10,057
Net income per share - basic $ 2.00 $ 1.47
Net income per share - Diluted $ 1.93 $ 1.42
-70-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
3. Acquisitions (continued)
The pro forma results include amortization of fair value adjustments on loans,
deposits and FHLB advances, amortization of newly created intangibles, and
post-merger acquisition related charges. The pro forma average common shares
outstanding used to compute the pro forma basic and diluted income per share
includes adjustments for shares issued for the ComBanc acquisition. The pro
forma results presented do not include $3.5 million of acquisition related costs
included in First Defiance's 2005 income statement, nor do they reflect cost
savings or revenue enhancements anticipated from the acquisitions. These pro
forma results are not necessarily indicative of what actually would have
occurred if the acquisitions had been completed as of the beginning of each
period presented, nor are they necessarily indicative of future results.
On February 22, 2003, First Defiance entered into a purchase and assumption
agreement with RFC Banking Company and its parent Rurban Financial Corp. to
acquire banking center offices located in Findlay, Ottawa and McComb, Ohio and
related deposit liabilities, certain loans and other assets associated with the
business of those branches. On June 6, 2003, First Defiance completed the
purchase of the banking center offices and the reported results include the
operations of these acquired banking centers assets and liabilities from that
acquisition date and thereafter. Total deposits acquired through the acquisition
were $166.7 million. Additionally, loan balances acquired by First Defiance in
the transaction were approximately $79 million, which included $35.4 million of
non-residential real estate loans, $16.8 million of commercial loans, $3.6
million of consumer loans, $1.8 million of home equity loans and $21.4 million
of residential mortgages. Other assets acquired included $2.0 million of
premises and equipment and $443,000 of interest receivable and other assets.
Cash received, net of the premium paid, was $70.1 million. Total consideration
for the acquisition was 10.5% of acquired non-brokered deposits plus an agreed
upon amount for all furnishings and equipment.
As of the final closing, First Defiance paid a net premium of $12.5 million and
recorded fair value increases (reductions) on acquired loans of ($1.2) million
and acquired deposits of $2.3 million to record them at fair value and recorded
transaction costs and other adjustments of approximately $900,000. These items
resulted in total intangibles of $16.9 million including goodwill of $16.1
million and a core deposit intangible of $772,000. During 2004, First Defiance
recorded adjustments to the original purchase price, reducing goodwill balances
by $1.6 million. The core deposit is being amortized over 10 years and goodwill
was recorded in accordance with SFAS No. 142 and accordingly is not subject to
amortization. All intangible assets acquired as part of this acquisition are
deductible for Federal income tax purposes over 15 years.
-71-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
4. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
2005 2004 2003
----------------------------------------
(In Thousands, Except Per Share Amounts)
Numerator for basic and diluted earnings per
share-net income $ 11,970 $ 10,796 $ 12,082
========================================
Denominator:
Denominator for basic earnings per
share-weighted-average shares 6,843 6,094 6,036
Effect of dilutive securities:
Employee stock options 252 275 277
Unvested Management Recognition Plan stock 1 2 6
----------------------------------------
Dilutive potential common shares 253 277 283
----------------------------------------
Denominator for diluted earnings per
share-adjusted weighted-average shares 7,096 6,371 6,319
========================================
Basic earnings per share $ 1.75 $ 1.77 $ 2.00
========================================
Diluted earnings per share $ 1.69 $ 1.69 $ 1.91
========================================
-72-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
5. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities:
December 31, 2005
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------
(In Thousands)
Available-for-sale securities:
U.S. treasury securities and obligations
of U.S. government corporations and
agencies $ 41,173 $ 217 $ (325) $ 41,065
Mortgage-backed securities 19,959 35 (263) 19,731
REMICs 998 -- (7) 991
Collateralized mortgage obligations 20,002 1 (330) 19,673
Trust preferred stock 7,725 76 -- 7,801
Obligations of state and political
subdivisions 23,257 574 (13) 23,818
----------------------------------------------------
Totals $ 113,114 $ 903 $ (938) $ 113,079
====================================================
Held-to-maturity securities:
FHLMC certificates $ 333 $ 11 $ -- $ 344
FNMA certificates 756 4 (3) 757
GNMA certificates 241 -- (1) 240
Obligations of states and political
subdivisions 445 59 -- 504
----------------------------------------------------
Totals $ 1,775 $ 74 $ (4) $ 1,845
====================================================
-73-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
5. Investment Securities (continued)
December 31, 2004
----------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------------
(In Thousands)
Available-for-sale securities:
U.S. treasury securities and obligations
of U.S. government corporations and agencies $ 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 states and political
subdivisions 530 90 -- 620
----------------------------------------------------
Totals $ 2,255 $ 127 $ (6) $ 2,376
====================================================
The amortized cost and fair value of securities at December 31, 2005 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. For purposes of the
maturity table, mortgage-backed securities, which are not due at a single
maturity date, have been allocated over maturity groupings based on the
weighted-average contractual maturities of the underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
-74-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
5. Investment Securities (continued)
Available-for-Sale Held-to-Maturity
----------------------- -----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------------------------------------------
(In Thousands)
Due in one year or less $ 14,200 $ 14,027 $ 449 $ 455
Due after one year through
five years 60,715 60,516 923 959
Due after five years through
ten years 17,200 17,244 357 384
Due after ten years 20,999 21,292 46 47
---------------------------------------------------
113,114 113,079 1,775 1,845
===================================================
Investment securities with carrying amounts of $82.3 million and $91.9 million
at December 31, 2005 and 2004, respectively, were pledged as collateral on
public deposits, securities sold under repurchase agreements and FHLB advances
and for other purposes required or permitted by law.
-75-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
5. Investment Securities (continued)
The following table summarizes First Defiance's securities that were in an
unrealized loss position at December 31, 2005 and December 31, 2004:
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 December 31, 2005
Available-for-sale securities:
U.S. treasury securities and
obligations of U.S.
government corps
and agencies $ 16,873 $ (173) $ 8,845 $ (152) $ 25,718 $ (325)
Mortgage-backed securities 9,488 (151) 4,352 (112) 13,840 (263)
Collateralized mortgage
obligations and REMICs 5,780 (62) 11,687 (275) 17,467 (337)
Obligations of state and political
subdivisions 1,368 (13) 20 -- 1,388 (13)
Held to maturity securities:
Agency certificates 320 (1) 177 (3) 497 (4)
----------------------------------------------------------------------------------
Total temporarily impaired securities $ 33,829 $ (400) $ 25,081 $ (542) $ 58,910 $ (942)
==================================================================================
At December 31, 2004
Available-for-sale securities:
U.S. treasury securities and
obligations of U.S.
government corps
and agencies $ 16,817 $ (61) $ -- $ -- $ 16,817 $ (61)
Mortgage-backed securities 3,312 (6) 759 (10) 4,071 (16)
Collateralized mortgage
obligations and REMICs 11,601 (80) -- -- 11,601 (80)
Obligations of state and
political subdivisions 510 (1) 158 (1) 668 (2)
Held to maturity securities:
Agency certificates 124 (2) 253 (4) 377 (6)
----------------------------------------------------------------------------------
Total temporarily impaired securities $ 32,364 $ (150) $ 1,170 $ (15) $ 33,534 $ (165)
==================================================================================
The above securities all have fixed interest rates and defined maturities. Their
fair value is sensitive to movements in market interest rates. First Defiance
has the ability and intent to hold these investments for a time necessary to
recover the amortized cost without impacting its liquidity position. Realized
gains from the sale of investment securities totaled $1.2 million, $1.4 million
and $1.6 million in 2005, 2004 and 2003 respectively. Realized losses from
securities transactions were $5,000 in 2005 and $65,000 in 2003. There were no
realized losses during 2004.
-76-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
6. Commitments and Contingent Liabilities
Loan Commitments
Loan commitments are made to accommodate the financial needs of First Federal's
customers; however, there are no long-term, fixed-rate loan commitments that
result in market risk. Standby letters of credit commit the Company to make
payments on behalf of customers when certain specified future events occur. They
primarily are issued to facilitate customers' trade transactions.
Both arrangements have credit risk, essentially the same as that involved in
extending loans to customers, and are subject to the Company's normal credit
policies. Collateral (e.g., securities, receivables, inventory and equipment) is
obtained based on Management's credit assessment of the customer.
The Company's maximum obligation to extend credit for loan commitments (unfunded
loans and unused lines of credit) and standby letters of credit outstanding on
December 31 was as follows (in thousands):
2005 2004
------------------------
Loan commitments $ 275,982 $ 186,404
Standby letters of credit 8,785 9,921
------------------------
Total $ 284,767 $ 196,325
========================
Lease Agreements
The Company has entered into lease agreements covering First Insurance's main
office, one banking center location and the land on which one banking center was
constructed and numerous stand-alone Automated Teller Machine sites with varying
terms and options to renew.
Future minimum commitments under non-cancelable operating leases are as follows
(in thousands):
2006 $ 344
2007 269
2008 207
2009 214
2010 192
Thereafter 3,263
-------
Total $ 4,489
=======
Rentals under operating leases and data processing costs amounted to $329,000,
$237,000, and $195,000, in 2005, 2004, and 2003, respectively.
-77-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
7. Loans Receivable
December 31
----------------------------
2005 2004
----------------------------
(In Thousands)
Loans receivable consist of the following at December 31:
Real estate loans:
Secured by single family residential $ 275,497 $ 187,775
Secured by multi-family residential 50,040 39,049
Secured by non-residential real estate 501,943 376,115
Construction 21,173 15,507
----------------------------
848,653 618,446
Other loans:
Automobile 37,584 34,391
Commercial 171,289 141,644
Home equity and improvement 113,000 90,839
Other 17,713 11,121
----------------------------
339,586 277,995
----------------------------
Total loans 1,188,239 896,441
Deduct:
Undisbursed loan funds (8,782) (6,341)
Net deferred loan origination fees and costs (1,303) (1,232)
Allowance for loan losses (13,673) (9,956)
----------------------------
Totals $ 1,164,481 $ 878,912
============================
-78-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
7. Loans Receivable (continued)
Changes in the allowance for loan losses were as follows:
Years Ended December 31
--------------------------------
2005 2004 2003
--------------------------------
(In Thousands)
Allowance at beginning of year $ 9,956 $ 8,844 $ 7,496
Provision for credit losses 1,442 1,548 1,719
Acquired in acquisitions 3,027 -- --
Charge-offs 1,054 685 725
Recoveries 302 249 354
--------------------------------
Net charge-offs 752 436 371
--------------------------------
Ending allowance $ 13,673 $ 9,956 $ 8,844
================================
Unpaid balances of loans with contractual payments delinquent 90 days or more
totaled $5.0 million at December 31, 2005 and $1.9 million at December 31, 2004.
Impaired loans having recorded investments of $822,000 at December 31, 2005 and
$505,000 at December 31, 2004, have been recognized in conformity with FASB
Statement No. 114, as amended by FASB Statement No. 118. The average recorded
investment in impaired loans during 2005, 2004 and 2003 was $1.1 million,
$732,000, and $892,000 respectively. The total allowance for loan losses related
to these loans was $380,000 and $253,000 at December 31, 2005 and 2004. There
was $61,000, $36,000 and $29,000 of interest received and recorded in income
during 2005, 2004 and 2003 respectively on impaired loans during the impairment
period. Loans having carrying values of $605,000 and $690,000 were transferred
to real estate and other assets held for sale in 2005 and 2004, respectively. At
December 31, 2005 and December 31, 2004, non-performing loans were $5.0 million
and $1.9 million respectively. There was no accrued interest recorded on
impaired or non-performing loans at December 31, 2005 or 2004. Also there were
no loans deemed impaired for which there was no allowance for loan loss
allocation at December 31, 2005 or 2004.
First Defiance is not committed to lend additional funds to debtors whose loans
have been modified.
-79-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
7. Loans Receivable (continued)
Certain loans acquired in the ComBanc and Genoa acquisitions had evidence that
the credit quality of the loan had deteriorated since its origination and in
management's assessment at the acquisition date it was probable that the First
Defiance would be unable to collect all contractually required payments due. In
accordance with American Institute of Certified Public Accountants Statement of
Position 03-3 - Accounting for Certain Loans or Debt Securities Acquired in a
Transfer (SOP 03-3), these loans have been recorded based on management's
estimate of the fair value of the loans. Detail of these loans are as follows:
Contractual Recorded
Amount Impairment Loan
Receivable Discount Receivable
--------------------------------------
(in thousands)
Amounts recorded in acquisition:
Genoa $ 1,547 $ 812 $ 735
ComBanc 3,426 1,376 2,050
--------------------------------------
Total acquired 4,973 2,188 2,785
Principal payments received (175) -- (175)
Loans written down (169) (169) --
Loan accretion recorded -- -- --
--------------------------------------
Balance at December 31, 2005 $ 4,629 $ 2,019 $ 2,610
======================================
In determining the fair value of these loans, management evaluated the
likelihood of receiving full payment under the contractual terms. Because of the
nature of the types of loans identified, estimates of specific cash flows are
not readily determinable. The loans acquired that are within the scope of SOP
03-3 are not accounted for using the income recognition model of the SOP because
the Company cannot reasonably estimate cash flows expected to be collected.
Interest income on loans is as follows:
Years Ended December 31
------------------------------------
2005 2004 2003
------------------------------------
(In Thousands)
Commercial and non-residential
real-estate loans $ 49,869 $ 34,506 $ 28,145
Mortgage loans 9,549 6,272 7,144
Other loans 10,290 6,567 5,876
------------------------------------
Totals $ 69,708 $ 47,345 $ 41,165
====================================
There are no industry concentrations (exceeding 10% of gross loans) in First
Federal's non-residential real estate and commercial loan portfolios. The
Company's loans receivable are primarily to borrowers in the Northwest Ohio,
Northeast Indiana or Southeast Michigan areas.
-80-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
Outstanding loan balances at December 31, 2005 and 2004 include loans to
executive officers and directors and their affiliates totaling $5.25 million and
$5.30 million respectively. All such loans are paying as agreed.
8. Mortgage Banking
Net revenues from the sales and servicing of mortgage loans consisted of the
following:
Years Ended December 31
-----------------------------------
2005 2004 2003
-----------------------------------
(In Thousands)
Gain from sale of mortgage loans $ 2,291 $ 2,350 $ 7,047
Mortgage loan servicing revenue (expense):
Mortgage loan servicing revenue 1,421 1,126 976
Amortization of mortgage servicing rights (784) (704) (1,998)
Mortgage servicing rights valuation adjustments 417 (1) 746
-----------------------------------
1,054 421 (276)
-----------------------------------
Net revenue from sale and servicing of mortgage
loans $ 3,345 $ 2,771 $ 6,771
===================================
The unpaid principal balance of residential mortgage loans serviced for third
parties was $602.5 million at December 31, 2005 compared to $463.8 million at
December 31, 2004.
Years Ended December 31
-----------------------------------
2005 2004 2003
-----------------------------------
(In Thousands)
Mortgage servicing assets:
Balance at beginning of period $ 4,205 $ 4,037 $ 3,442
Loans sold, servicing retained 906 872 2,593
NBV of servicing assets acquired 926 -- --
Impairment deemed permanent (108) -- --
Amortization (784) (704) (1,998)
-----------------------------------
Carrying value before valuation allowance
at end of period 5,145 4,205 4,037
Valuation allowance:
Balance at beginning of period (607) (606) (1,352)
Impairment recovery (charges) 417 (1) 746
Impairment deemed permanent 108 -- --
-----------------------------------
Balance at end of period (82) (607) (606)
===================================
Net carrying value of MSRs at end of period $ 5,063 $ 3,598 $ 3,431
===================================
Fair value of MSRs at end of period $ 6,471 $ 3,743 $ 3,573
===================================
-81-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
8. Mortgage Banking (continued)
The Company's servicing portfolio is comprised of the following:
December 31
------------------------------------------------------
2005 2004
------------------------- -------------------------
Number of Principal Number of Principal
Investor Loans Outstanding Loans Outstanding
-------------------------------------------------------------------------
(Dollars in Thousands)
Fannie Mae 601 $ 39,094 562 $ 34,351
Freddie Mac 6,858 562,199 5,148 429,439
Other 52 1,218 -- --
------------------------------------------------------
Totals 7,511 $ 602,511 5,710 $ 463,790
======================================================
Significant assumptions at December 31, 2005 used in determining the value of
MSRs include a weighted average prepayment rate of 189 PSA and a weighted
average discount rate of 8.95%.
A sensitivity analysis of the current fair value to immediate 10% and 20%
adverse changes in those assumptions as of December 31, 2005 is presented below.
These sensitivities are hypothetical. Changes in fair value based on a 10%
variation in assumptions generally cannot be extrapolated because the
relationship of the change in the assumption to the change in fair value may not
be linear. Also, the effect of a variation in a particular assumption on the
fair value of the MSR is calculated independently without changing any other
assumption. In reality, changes in one factor may result in changes in another
(for example, changes in mortgage interest rates, which drive changes in
prepayment rate estimates, could result in changes in the discount rates), which
might magnify or counteract the sensitivities.
10% Adverse 20% Adverse
Change Change
---------------------------
(Dollars in Thousands)
Assumption:
Decline in fair value from increase in prepayment rate $ 255 $ 490
Declines in fair value from increase in discount rate 201 394
-82-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
9. Premises and Equipment
Premises and equipment are summarized as follows:
December 31
2005 2004
---------------------
(In Thousands)
Cost:
Land $ 5,071 $ 3,913
Buildings 25,764 20,401
Leasehold improvements 416 539
Furniture, fixtures and equipment 15,649 12,205
Construction in process 1,020 850
---------------------
47,920 37,908
Less allowances for depreciation and amortization 15,491 13,660
---------------------
$ 32,429 $ 24,248
=====================
Depreciation expense was $2.4 million, $1.8 million and $1.6 million for the
years ended December 31, 2005, 2004 and 2003 respectively.
10. Deposits
The following schedule sets forth interest expense by type of savings deposit:
Years Ended December 31
2005 2004 2003
-----------------------------------
(In Thousands)
Checking and money market accounts $ 3,264 $ 1,722 $ 1,466
Savings accounts 239 134 169
Certificates of deposit 17,119 11,100 11,810
-----------------------------------
20,622 12,956 13,445
Less interest capitalized (7) (6) (10)
-----------------------------------
Totals $ 20,615 $ 12,950 $ 13,435
===================================
At December 31, 2005, accrued interest payable on deposit accounts amounted to
$996,000, which was comprised of $876,000 and $120,000 for certificates of
deposit and checking and money market accounts respectively.
-83-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
10. Deposits (continued)
A summary of deposit balances is as follows:
December 31
--------------------------
2005 2004
--------------------------
(In Thousands)
Non-interest bearing checking accounts $ 103,498 $ 62,450
Interest bearing checking and money
market accounts 276,558 258,797
Savings deposits 82,766 52,132
Retail certificates of deposit less than $100,000 408,384 272,098
Retail certificates of deposit greater than $100,000 161,305 102,750
Brokered or national certificates of deposit 36,990 49,474
--------------------------
$ 1,069,501 $ 797,701
==========================
Scheduled maturities of certificates of deposit at December 31, 2005 are as
follows (in thousands):
2006 $ 451,010
2007 137,332
2008 14,107
2009 1,716
2010 1,669
2011 and thereafter 845
---------
Total $ 606,679
=========
At December 31, 2005 and 2004, deposits of $303.3 million and $214.6 million,
respectively, were in excess of the $100,000 Federal Deposit Insurance
Corporation insurance limit. At December 31, 2005 and 2004, $42.4 million and
$57.0 million, respectively, in investment securities were pledged as collateral
against public deposits for certificates in excess of $100,000 and an additional
$38.7 million and $1.3 million of securities were pledged at December 31, 2005
and December 31, 2004, respectively as collateral against deposits from private
entities in excess of $100,000. Also, First Federal has pledged $7.8 of cash on
deposit at the FHLB as collateral against public deposits at December 31, 2005
and it also holds $13,700,000 in depository bonds at December 31, 2005 with
governmental entities, which can be pledged as collateral against public
deposits in excess of $100,000.
-84-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
11. Advances from Federal Home Loan Bank
First Federal has the ability to borrow funds from the FHLB. First Federal
pledges its single-family residential mortgage loan portfolio, certain
investment securities and certain multi-family or non-residential real estate
loans as security for these advances. Advances secured by investment securities
must have collateral of at least 105% of the borrowing. Advances secured by
residential mortgages must have collateral of at least 125% of the borrowings.
Advances secured by multi-family or non-residential real estate loans securities
must have 300% collateral coverage. The total level of borrowing is also limited
to 50% of total assets and at least 50% of the borrowings must be secured by
either one-to-four family residential mortgages or investment securities. Total
loans pledged to the FHLB at December 31, 2005 were $465.9 million. First
Federal has a maximum potential to acquire advances of approximately $205.6
million from the FHLB at December 31, 2005.
As of December 31, 2005, the FHLB has made a series of advances totaling $111.0
million to First Defiance that have fixed maturity dates but are callable at the
option of the FHLB on a specified date and quarterly thereafter. The terms of
these advances are as follows (in thousands):
Balance Fixed Interest Rate Call Date Maturity Date
-----------------------------------------------------------------------------
$ 15,000 5.44% 01/26/06 10/23/13
10,000 5.84% 03/01/06 09/01/10
20,000 4.61% 01/20/06 10/21/13
10,000 4.71% 02/07/06 11/07/13
15,000 4.52% 01/10/06 01/10/11
10,000 4.76% 01/10/06 01/10/11
10,000 4.93% 02/02/06 02/02/11
20,000 4.07% 03/08/06 03/08/11
1,000 4.56% 03/11/06 12/11/08
The FHLB has made advances totaling $27.0 million to First Defiance that have
fixed maturity dates but which are callable after the call date only when
three-month LIBOR rates exceed the agreed upon strike rate in the advance
contract. The terms of these advances are as follows (in thousands):
Fixed LIBOR
Balance Interest Rate Call Date Maturity Date "Strike" Rate
-----------------------------------------------------------------------------
$ 10,000 5.14% 03/08/06 03/08/11 7.5%
7,000 3.54% 01/15/06 10/15/12 8.0%
5,000 3.85% 02/02/06 11/06/12 8.0%
5,000 3.48% 02/25/06 02/25/13 7.5%
When called, First Defiance has the option of paying off these advances, or
converting them to variable rate advances priced at the three month LIBOR rate.
-85-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
11. Advances from Federal Home Loan Bank (continued)
First Defiance has an additional $14.3 million outstanding on a series of fixed
rate long-term advances. Of this amount, $1.1 million is a fixed rate advance
under the FHLB Affordable Housing Program in 1995. The total FHLB long-term
advances including all convertible advances bear a weighted average interest
rate of 4.65 % at December 31, 2005.
Future minimum payments by fiscal year based on maturity date are as follows (in
thousands):
2006 $ 8,301
2007 8,018
2008 18,358
2009 6,625
2010 16,431
Thereafter 136,359
---------
Total minimum payments 194,092
Less amounts representing interest 41,794
---------
Totals $ 152,298
=========
First Defiance also utilizes short-term advances from the FHLB to meet cash flow
needs and for short-term investment purposes. There were $28.5 million in
short-term advances outstanding at December 31, 2005 at an interest rate of
4.12% and $26.5 million at December 31, 2004 at an interest rate of 2.20%. First
Defiance borrows short-term advances under a variety of programs at FHLB. At
December 31, 2005, $28.5 million was outstanding under First Defiance's REPO
Advance line of credit. The total available under the REPO Advance line is
$100.0 million. In addition, First Defiance has $15.0 million available under a
Cash Management Advance line of credit and there were no borrowings against that
line at December 31, 2004 or 2005. Amounts are generally borrowed under the Cash
Management and REPO lines on an overnight basis. Other advances may be borrowed
under the FHLB's short-term fixed or LIBOR based programs. Information
concerning short-term advances is summarized as follows:
Years Ended December 31
----------------------------------
2005 2004
----------------------------------
(In Thousands, Except Percentages)
Average daily balance during the year $ 14,313 $ 15,577
Maximum month-end balance during the year 45,000 28,500
Average interest rate during the year 3.79% 1.55%
-86-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
12. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trust
In October 2005, the Company formed an affiliated trust, First Defiance
Statutory Trust I (the Trust Affiliate), that issued $20 million of Guaranteed
Capital Trust Securities (Trust Preferred Securities). In connection with the
transaction, the Company issued $20.6 million of Junior Subordinated Deferrable
Interest Debentures (Subordinated Debentures) to the Trust Affiliate. The Trust
Affiliate was formed for the purpose of issuing Trust Preferred Securities to
third-party investors and investing the proceeds from the sale of these capital
securities solely in Subordinated Debentures of the Company. The Junior
Debentures held by the Trust Affiliate are the sole assets of the trust.
Distributions on the Trust Preferred Securities issued by the Trust Affiliate
are payable quarterly at a variable rate equal to the three-month LIBOR rate
plus 1.38%, or 5.87% as of December 31, 2005.
The Trust Preferred Securities are subject to mandatory redemption, in whole or
in part, upon repayment of the Subordinated Debentures. The Company has entered
into an agreement that fully and unconditionally guarantees the Trust Preferred
Securities subject to the terms of the guarantee. The Trust Preferred Securities
and Junior Debentures may be redeemed by the issuer at par after October 28,
2010.
-87-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
13. Notes Payable and Other Short-term Borrowings
Total short term borrowings, revolving and term debt is summarized as follows:
December 31
2005 2004
----------------------------------
(In Thousands)
Securities sold under agreement to repurchase (rate of 2.68% and
1.57% at December 31, 2005 and 2004, respectively) $ 25,748 $ 11,804
Revolving line of credit facility to financial institution, unsecured,
at fed funds rate -- 3,000
----------------------------------
Total other short-term borrowings $ 25,748 $ 14,804
==================================
Years Ended December 31
----------------------------------
2005 2004
----------------------------------
(In Thousands, Except Percentages)
Securities sold under agreement to repurchase
Average daily balance during year $ 17,718 $ 10,612
Maximum month-end balance during the year 25,748 12,606
Average interest rate during the year 2.18% 1.08%
Revolving line of credit facilities to financial institutions
Average daily balance during year $ 301 $ 1,349
Maximum month-end balance during the year 43,799 3,000
Average interest rate during the year 2.25% 2.20%
As of December 31, 2005, First Defiance had the following line of credit
facilities available for short-term borrowing purposes:
A $15 million revolving line of credit facility with a financial
institution. The facility is unsecured and has an interest rate of fed
funds rate plus 0.45%. There were no amounts outstanding on the line at
December 31, 2005 or 2004. The maximum borrowed at any point in time under
the line was $4.0 million and $15.0 million in 2005 and 2004,
respectively. The average balance outstanding for the year was $67,000 and
$244,000 in 2005 and 2004, respectively.
A $20 million fed funds line of credit with a financial institution. The
line is unsecured and has an interest rate of the institution's fed funds
rate. There were no amounts outstanding on the line at December 31, 2005
and 2004. The maximum borrowed at any point in time under the line was
$20.0 million in both 2005 and 2004, and the average balance outstanding
was $554,000 and $228,000 in 2005 and 2004, respectively.
A $5.0 million revolving line of credit with a financial institution.
There was no amount outstanding on the line at December 31, 2005. The line
is secured by the stock of First Federal Bank and the interest rate is
either the lender's prime rate or LIBOR plus 1.75%, whichever is selected
by First Defiance. The maximum borrowed in 2005 under the line was $3.0
million and the average outstanding balance for 2005 was $1.3 million. The
Company had a $10.0 revolving line of credit available under similar terms
in 2004 and it was not used.
-88-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. 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. First Federal employees who retired prior to April 1, 1997 who
completed 20 years of service after age 40 receive full medical coverage at no
cost. Such coverage continues for surviving spouses of those participants for
one year, after which coverage may be continued provided the spouse pays 50% of
the average cost. First Federal employees retiring after April 1, 1997 are
provided medical benefits at a cost based on their combined age and years of
service at retirement. Surviving spouses are also eligible for continued
coverage after the retiree is deceased at a subsidy level that is 10% less than
what the retiree is eligible for. First Federal employees retiring before July
1, 1997 receive dental and vision care in addition to medical coverage. First
Federal employees who retire after July 1, 1997 are not eligible for dental or
vision care, but those retirees and their spouses each receive up to $200
annually in a medical spending account. Funds in that account may be used for
payment of uninsured medical expenses. First Federal employees who were born
after December 31, 1950 are not eligible for the medical coverage described
above at retirement. Rather, a medical spending account of up to $10,000 (based
on the participant's age and years of service) will be established to reimburse
medical expenses for those individuals. First Insurance employees who were born
before December 31, 1950 can continue coverage until they reach age 65, or in
lieu of continuing coverage, can elect the medical spending account option,
subject to eligibility requirements. Employees hired or acquired after January
1, 2003 are eligible only for the medical spending account option.
The plan is not currently funded. The following table summarizes benefit
obligation and plan asset activity for the plan measured as of December 31 each
year:
December 31
----------------------
2005 2004
----------------------
(In Thousands)
Change in benefit obligation:
Benefit obligation at beginning of year $ 1,630 $ 1,553
Service cost 49 48
Interest cost 97 97
Participant contribution 34 28
Plan amendments 38 31
Actuarial gains (141) (3)
Benefits paid (126) (124)
----------------------
Benefit obligation at end of year 1,581 1,630
Change in fair value of plan assets:
Balance at beginning of measurement period -- --
Employer contribution 92 96
Participant contribution 34 28
Benefits paid (126) (124)
----------------------
Balance at end of measurement period -- --
----------------------
Funded status (1,581) (1,630)
Unrecognized prior service cost 77 71
Unrecognized net loss 317 516
----------------------
Accrued postretirement benefit obligation included in other liabilities
in consolidated statement of financial condition $ (1,187) $ (1,043)
======================
-89-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. Postretirement Benefits (continued)
Net periodic postretirement benefit cost includes the following components:
Years Ended December 31
--------------------------
2005 2004 2003
--------------------------
(In Thousands)
Service cost-benefits attributable to service
during the period $ 49 $ 48 $ 36
Interest cost on accumulated postretirement
benefit obligation 97 97 83
Net amortization and deferral 25 23 14
--------------------------
Net periodic postretirement benefit cost $ 171 $ 168 $ 133
==========================
The following assumptions were used in determining the components of the
postretirement benefit obligation:
2005 2004
-------------------
Weighted average discount rates:
Used to determine benefit obligations at December 31 5.75% 6.00%
Used to determine net periodic postretirement benefit
cost for years ended December 31 6.00% 6.00%
Assumed health care cost trend rates at December 31:
Health care cost trend rate assumed for next year 8.00% 8.50%
Rate to which the cost trend rate is assumed to decline
(the ultimate trend rate) 4.00% 4.00%
Year that rate reaches ultimate trend rate 2014 2014
The following benefits are expected to be paid over the next five years and in
aggregate for the next five years thereafter. The Company has elected to opt for
the Federal subsidy approach in lieu of coverage under Medicare Part D. These
amounts include an estimate of that tax-free Federal subsidy:
Before Reflecting Impact of After Reflecting
Medicate Part D Medicare Part D Medicare Part D
Subsidy Subsidy Subsidy
----------------------------------------------------------
(In Thousands)
2006 $ 100 $ (19) $ 81
2007 104 (19) 85
2008 113 (21) 92
2009 115 (26) 89
20010 126 (28) 98
2011 through 2015 708 (192) 516
-90-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
14. Postretirement Benefits (continued)
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage-point change in assumed
health care cost trend rates would have the following effect (in thousands):
One-Percentage-Point One-Percentage-Point
Increase Decrease
--------------------------------------------
Effect on total of service and interest cost $ 19 $ (16)
Effect on postretirement benefit obligation 197 (166)
15. Regulatory Matters
First Federal is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
consolidated financial statements. Under capital guidelines and the regulatory
framework for prompt corrective action, First Federal must meet specific capital
guidelines that involve quantitative measures of First Federal's assets,
liabilities and certain off-balance-sheet items as calculated under regulatory
accounting practices. First Federal's capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk
weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require First Federal to maintain minimum amounts and ratios of Tier I and total
capital to risk-weighted assets and of Tier I capital to average assets. As of
December 31, 2005 and 2004, First Federal meets all capital adequacy
requirements to which it is subject and the most recent notification from the
Office of Thrift Supervision (OTS) categorized First Federal as well capitalized
under the regulatory framework. The following schedule presents First Federal's
regulatory capital ratios:
Required for Capital Required to be
Actual Adequacy Purposes Well Capitalized
--------------------- --------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
----------------------------------------------------------------------------
As of December 31, 2005
Tangible Capital $ 120,029 8.46% $ 21,273 1.50% N/A N/A
Tier 1 (Core) Capital 120,029 8.46% 56,729 4.00% $ 70,911 5.00%
Tier 1 Capital to risk-weighted assets 120,029 10.63% 45,161 4.00% 67,742 6.00%
Risk-Based Capital 133,636 11.84% 90,323 8.00% 112,904 10.00%
As of December 31, 2004
Tangible Capital $ 102,342 9.29% $ 16,533 1.50% N/A N/A
Tier 1 (Core) Capital 102,342 9.29% 44,089 4.00% $ 55,111 5.00%
Tier 1 Capital to risk-weighted assets 102,342 11.59% 35,326 4.00% 52,989 6.00%
Risk-Based Capital 112,267 12.71% 70,653 8.00% 88,316 10.00%
First Defiance is a unitary thrift holding company and is regulated by the OTS.
The OTS does not have defined capital requirements for unitary thrift holding
companies.
-91-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
16. Income Taxes
The components of income tax expense for continuing operations (credit) are as
follows:
Years Ended December 31
-----------------------------
2005 2004 2003
-----------------------------
(In Thousands)
Current:
Federal $ 5,367 $ 4,677 $ 4,783
State and local 7 35 33
Deferred 479 90 874
-----------------------------
$ 5,853 $ 4,802 $ 5,690
=============================
The provision for income taxes differs from that computed at the statutory
corporate tax rate as follows:
Years Ended December 31
--------------------------------
2005 2004 2003
--------------------------------
(In Thousands)
Tax expense at statutory rate (35%) $ 6,238 $ 5,457 $ 6,220
Increases (decreases) in taxes from:
ESOP adjustments 193 83 29
State income tax - net of federal tax benefit -- 23 21
Tax exempt interest income (394) (498) (468)
Bank owned life insurance (268) (332) (283)
Other 84 69 171
--------------------------------
Totals $ 5,853 $ 4,802 $ 5,690
================================
Deferred federal income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes.
-92-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
16. Income Taxes (continued)
Significant components of First Defiance's deferred federal income tax assets
and liabilities are as follows:
December 31
--------------------
2005 2004
--------------------
(In Thousands)
Deferred federal income tax assets:
Allowance for loan losses $ 4,565 $ 3,477
Impaired loans 706 --
Deferred compensation and management recognition plans 547 337
Postretirement benefit costs 415 365
Accrued Vacation 259 186
Deposit and FHLB advance mark to market 150 --
Net unrealized losses on available-for-sale securities 13 --
Other 532 43
--------------------
Total deferred federal income tax assets 7,187 4,408
Deferred federal income tax liabilities:
Net unrealized gains on available-for-sale securities -- 1,147
FHLB stock dividends 2,585 1,868
Fixed assets 1,277 967
Mortgage servicing rights 1,207 587
Core Deposit Intangible 1,265 --
Goodwill 1,084 685
Loan mark to market 564 --
Other -- 88
--------------------
Total deferred federal income tax liabilities 7,982 5,342
--------------------
Net deferred federal income tax liability $ (795) $ (934)
====================
The realization of the Company's deferred tax assets is dependent upon the
Company's ability to generate taxable income in future periods and the reversal
of deferred tax liabilities during the same period. The Company has evaluated
the available evidence supporting the realization of its deferred tax assets and
determined it is more likely than not that the assets will be realized and thus
no valuation allowance was required at December 31, 2005.
Retained earnings at December 31, 2005 include approximately $11.0 million for
which no tax provision for federal income taxes has been made. This amount
represents the tax bad debt reserve at December 31, 1987, which is the end of
the Company's bse year for purposes of calculating the bad debt deduction for
tax purposes. If this portion of retained earnings is used in the future for any
purpose other than to absorb bad debts, the amount used will be added to future
taxable income. The unrecorded deferred tax liability on the above amount at
December 31, 2005 was approximately $3.85 million.
-93-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
17. Employee Benefit Plans
Employees of First Defiance are eligible to participate in the First Defiance
Financial Corp. 401(k) Employee Savings Plan (First Defiance 401(k)) if they
meet certain age and service requirements. Under the First Defiance 401(k),
First Defiance matches 50% of the participants' contributions, to a maximum of
3% of compensation. The First Defiance 401(k) also provides for a discretionary
First Defiance contribution in addition to the First Defiance matching
contribution. First Defiance matching contributions totaled $333,000, $293,000
and $258,000 for the years ended December 31, 2005, 2004 and 2003 respectively.
There were no discretionary contributions in any of those years.
First Defiance also has established an Employee Stock Ownership Plan (ESOP)
covering all employees of First Defiance age 21 or older who have at least one
year of credited service. Contributions to the ESOP are made by First Defiance
and are determined by First Defiance's Board of Directors at their discretion.
The contributions may be made in the form of cash or First Defiance common
stock. The annual contributions may not be greater than the amount deductible
for federal income tax purposes and cannot cause First Federal to violate
regulatory capital requirements.
To fund the plan, the ESOP borrowed funds from First Defiance for the purpose of
purchasing shares of First Defiance common stock. The ESOP acquired a total of
863,596 shares in 1993 and 1995. The loan outstanding at December 31, 2005 was
$1,722,000. Principal and interest payments on the loan are due in equal
quarterly installments through June of 2008. The loan is collateralized by the
shares of First Defiance's common stock and is repaid by the ESOP with funds
from the Company's contributions to the ESOP, dividends on unallocated shares
and earnings on ESOP assets.
As principal and interest payments on the loan are paid, shares are released
from collateral and committed for allocation to active employees, based on the
proportion of debt service paid in the year. Shares held by the ESOP which have
not been released for allocation are reported as stock acquired by the ESOP plan
in the statement of financial condition. As shares are released, First Defiance
records compensation expense equal to the average fair value of the shares over
the period in which the shares were earned. Also, the shares released for
allocation are included in the average shares outstanding for earnings per share
computations. Dividends on allocated shares are recorded as a reduction of
retained earnings and dividends on unallocated shares are recorded as additional
ESOP expense. ESOP compensation expense was $976,000, $956,000, and $802,000,
for 2005, 2004 and 2003, respectively. As of December 31, 2005, 743,385 ESOP
shares have been released for allocation of which 731,187 were allocated to
participants, compared to 694,594 released and 682,397 allocated at December 31,
2004. The 120,211 unreleased shares have a fair value of $3.3 million at
December 31, 2005, while the fair value of 169,002 unreleased shares at December
31, 2004 was $5.9 million. A total of $532,000 and $487,000 of dividends in 2005
and 2004, respectively, were used for debt service.
-94-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
18. Stock Option Plans
First Defiance has established incentive stock option plans for its directors
and its employees and has reserved 1,727,485 shares of common stock for issuance
under the plans. A total of 1,467,204 shares are reserved for employees and
260,281 shares are reserved for directors. As of December 31, 2005, 569,099
options (545,912 for employees and 23,187 for directors) have been granted and
remain outstanding at option prices based on the market value of the underlying
shares on the date the options were granted. There are 50,186 options granted
under the 1993 plan that are currently exercisable, 232,863 options granted
under the 1996 plan that vest at 20% per year beginning in 1997 of which 224,910
are fully vested and currently exercisable, 247,500 options granted under the
2001 plan which vest at 20% per year beginning in 2002, of which 129,150 are
fully vested and currently exercisable and 38,550 options granted under the 2005
plan which vest at 20% per year beginning in 2006. All options expire ten years
from date of grant. Vested options of retirees expire on the earlier of the
scheduled expiration date or five years after the retirement date for the 1993,
2001 and 2005 plans and on the earlier of the scheduled expiration date or
twelve months after the retirement date for the 1996 plan.
The following table summarizes stock option activity for 2005, 2004, and 2003:
Weighted
Options Average Option
Outstanding Prices
----------------------------
Balance at January 1, 2003 808,320 12.12
Granted 57,000 20.47
Exercised or cashed out (136,537) 10.95
Expired or canceled (1,050) 15.32
----------------------------
Balance at December 31, 2003 727,733 $ 12.99
Granted 48,750 27.03
Exercised (135,390) 11.49
Expired or canceled (1,500) 18.40
----------------------------
Balance at December 31, 2004 639,593 $ 14.36
Granted 61,253 25.98
Exercised (127,197) 12.27
Expired or canceled (4,550) 24.25
----------------------------
Balance at December 31, 2005 569,099 $ 16.00
============================
As of December 31, 2005 and 2004, 314,050 and 19,753 shares, respectively, were
available for grant under the Company's stock option plans.
-95-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
18. Stock Option Plans (continued)
Information about stock options outstanding is as follows:
Weighted
Average
Remaining Weighted
Range of Weighted Average Contractual Average
Exercise Prices Outstanding Exercise Price Life (in years) Exercisable Exercise Price
-----------------------------------------------------------------------------------------------------------
$8.25 - $12.99 173,252 $ 10.64 0.86 173,252 $ 10.64
$13.00 - $17.99 230,044 14.11 4.15 196,644 14.13
$18.00 - $22.99 52,450 19.42 7.18 22,000 19.36
$23.00 - $27.70 113,353 26.45 8.80 12,350 26.93
------------------------------------------------------------------------------------
Total at 12/31/05 569,099 $ 16.00 4.35 404,246 $ 13.31
====================================================================================
Total at 12/31/04 639,593 $ 14.36 4.37 475,954 $ 12.54
====================================================================================
Total at 12/31/03 727,733 $ 12.99 4.65 555,427 $ 12.02
====================================================================================
19. Parent Company and Regulatory Restrictions
Dividends paid by First Federal to First Defiance are subject to various
regulatory restrictions. In accordance with these restrictions, First Federal
can initiate dividend payments in 2006 only equal to or less than 2006 net
profits. However, First Federal can request OTS approval to pay a dividend in
excess of 2006 net profits.
Condensed parent company financial statements, which include transactions with
subsidiaries, follow:
December 31
----------------------
Statements of Financial Condition 2005 2004
----------------------
(In Thousands)
Assets
Cash and cash equivalents $ 9,406 $ 466
Investment securities, available for sale, carried at fair value 1,494 1,073
Investment in subsidiaries 160,035 124,179
Loan receivable from First Defiance Employee Stock Ownership Plan 1,760 2,312
Other assets 668 83
----------------------
Total assets $ 173,363 $ 128,113
======================
Liabilities and stockholders' equity:
Subordinated debentures $ 20,619 $ --
Accrued liabilities 1,528 1,239
Stockholders' equity 151,216 126,874
----------------------
Total liabilities and stockholders' equity $ 173,363 $ 128,113
======================
-96-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
19. Parent Company and Regulatory Restrictions (continued)
Years Ended December 31
--------------------------------------
Statements of Income 2005 2004 2003
--------------------------------------
(In Thousands)
Interest on loan to ESOP $ 169 $ 214 $ 257
Interest expense (275) (3) (4)
Other income 102 45 42
Noninterest expense (637) (470) (568)
--------------------------------------
Loss before income taxes and equity in earnings of subsidiaries (641) (214) (273)
Income tax (credit) (212) (56) (75)
--------------------------------------
Loss before equity in earnings of subsidiaries (429) (158) (198)
Equity in earnings of subsidiaries 12,399 10,954 12,280
--------------------------------------
Net income $ 11,970 $ 10,796 $ 12,082
======================================
Years Ended December 31
--------------------------------------
Statements of Cash Flows 2005 2004 2003
--------------------------------------
(In Thousands)
Operating activities:
Net income $ 11,970 $ 10,796 $ 12,082
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Equity in earnings of subsidiaries (12,399) (10,954) (12,280)
Dividends received from subsidiary 34,415 5,500 5,000
Change in other assets and liabilities 232 699 751
--------------------------------------
Net cash (used in) provided by operating activities 34,218 6,041 5,553
Investing activities:
Investment in unconsolidated trust subsidiary (619) -- --
Cash paid for ComBanc, Inc., (18,693) -- --
Cash paid for Genoa Savings and Loan Company (10,869) -- --
Principal payments received on ESOP loan 552 505 464
Purchase of available-for-sale securities (500) -- --
Sale of available-for-sale securities 70
--------------------------------------
Net cash (used in) provided by investing activities (30,059) 505 464
Financing activities:
Proceeds from issuance of subordinated debt securities 20,619 -- --
Capital contribution to subsidiary (10,000) -- --
Stock options exercised 1,561 1,556 1,495
Purchase of common stock for treasury (1,547) (4,691) (4,406)
Cash dividends paid (5,852) (5,011) (3,939)
--------------------------------------
Net cash used in financing activities 4,781 (8,146) (6,850)
--------------------------------------
Net increase (decrease) in cash and cash equivalents 8,940 (1,600) (833)
Cash and cash equivalents at beginning of year 466 2,066 2,899
--------------------------------------
Cash and cash equivalents at end of year $ 9,406 $ 466 $ 2,066
======================================
-97-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
20. Fair Value Statement of Consolidated Financial Condition
The following is a comparative condensed consolidated statement of financial
condition based on carrying and estimated fair values of financial instruments
as of December 31, 2005 and 2004. FASB Statement No. 107, Disclosures about Fair
Value of Financial Instruments excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
First Defiance Financial Corp.
Much of the information used to arrive at "fair value" is highly subjective and
judgmental in nature and therefore the results may not be precise. Subjective
factors include, among other things, estimated cash flows, risk characteristics
and interest rates, all of which are subject to change. With the exception of
investment securities, the Company's financial instruments are not readily
marketable and market prices do not exist. Since negotiated prices for the
instruments, which are not readily marketable depend greatly on the motivation
of the buyer and seller, the amounts that will actually be realized or paid per
settlement or maturity of these instruments could be significantly different.
The carrying amount of cash and cash equivalents, warehouse and term notes
payable and advance payments by borrowers for taxes and insurance, as a result
of their short-term nature, is considered to be equal to fair value.
For investment securities, fair value has been based or current market
quotations. If market prices are not available, fair value has been estimated
based upon the quoted price of similar instruments.
The fair value of loans which reprice within 90 days is equal to their carrying
amount. For other loans, the estimated fair value is calculated based on
discounted cash flow analysis, using interest rates currently being offered for
loans with similar terms. The allowance for loan losses is considered to be a
reasonable adjustment for credit risk.
SFAS No. 107 requires that the fair value of demand, savings, NOW and certain
money market accounts be equal to their carrying amount. The Company believes
that the fair value of these deposits may be greater or less than that
prescribed by SFAS No. 107.
The carrying amount of Subordinated Debentures is considered to be equal to fair
value as a result of their interest rate structure. For deposits with fixed
maturities, fair value is estimated based on interest rates currently being
offered on deposits with similar characteristics and maturities.
-98-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
20. Fair Value Statement of Consolidated Financial Condition (continued)
FHLB advances with maturities greater than 90 days are valued based on
discounted cash flow analysis, using interest rates currently being quoted for
similar characteristics and maturities. The cost or value of any call or put
options are based on the estimated cost to settle the option at December 31,
2005.
December 31, 2005 December 31, 2004
-------------------------- --------------------------
Carrying Estimated Carrying Estimated
Value Fair Values Value Fair Values
--------------------------------------------------------
(In Thousands)
Assets:
Cash and cash equivalents $ 49,256 $ 49,256 $ 20,521 $ 20,521
Investment securities 114,854 114,924 139,258 139,379
Loans, net, including loans
held for sale 1,169,763 1,165,508 881,207 878,205
--------------------------------------------------------
1,333,873 $ 1,329,688 1,040,986 $ 1,038,105
=========== ===========
Other assets 127,209 85,681
----------- -----------
Total assets $ 1,461,082 $ 1,126,667
=========== ===========
Liabilities and stockholders' equity:
Deposits $ 1,069,501 $ 1,067,279 $ 797,701 $ 798,287
Advances from Federal Home
Loan Bank 180,960 179,435 181,213 183,750
Subordinated debentures 20,619 20,619
Short term borrowings and other interest bearing liabilities 25,748 25,748 11,804 11,804
Advance payments by borrowers
for taxes and insurance 605 605 278 278
--------------------------------------------------------
1,297,433 $ 1,293,686 990,996 $ 994,119
=========== ===========
Other liabilities 12,433 8,797
----------- -----------
Total liabilities 1,309,866 999,793
Stockholders' equity 151,216 126,874
----------- -----------
Total liabilities and
stockholders' equity $ 1,461,082 $ 1,126,667
=========== ===========
-99-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
21. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly consolidated results of operations:
Three Months Ended
-------------------------------------------------------
March 31* June 30* September 30 December 31
-------------------------------------------------------
(In Thousands, Except Per Share Amounts)
2005
Interest income $ 16,436 $ 18,669 $ 19,932 $ 21,137
Interest expense 5,826 6,816 7,715 8,535
-------------------------------------------------------
Net interest income 10,610 11,853 12,217 12,602
Provision for loan losses 347 349 368 378
-------------------------------------------------------
Net interest income after provision for loan losses 10,263 11,504 11,849 12,224
Gain on sale of securities 621 515 86 --
Noninterest income 3,640 3,365 3,930 3,768
Noninterest expense 10,244 12,518 10,496 10,684
-------------------------------------------------------
Income before income taxes 4,280 2,866 5,369 5,308
Income taxes 1,409 838 1,742 1,864
-------------------------------------------------------
Net income $ 2,871 $ 2,028 $ 3,627 $ 3,444
=======================================================
Earnings per share:
Basic $ 0.43 $ 0.30 $ 0.53 $ 0.50
Diluted $ 0.41 $ 0.28 $ 0.51 $ 0.48
Average shares outstanding:
Basic 6,668 6,869 6,908 6,927
Diluted 6,945 7,119 7,159 7,161
* - The significant increase in noninterest expense and resulting decline in
net income for the quarters ended March 31 and June 30, 2005 was primarily
due to $884,000 and $2.5 million in those quarters respectively of
acquisition related charges associated with the previously disclosed 2005
acquisitions.
-100-
First Defiance Financial Corp.
Notes to Consolidated Financial Statements (continued)
22. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three Months Ended
------------------------------------------------------
March 31 June 30 September 30 December 31
------------------------------------------------------
(In Thousands, Except Per Share Amounts)
2004
Interest income $ 13,002 $ 13,163 $ 13,979 $ 14,587
Interest expense 4,806 4,881 5,258 5,436
------------------------------------------------------
Net interest income 8,196 8,282 8,721 9,151
Provision for loan losses 379 490 376 303
------------------------------------------------------
Net interest income after provision for loan losses 7,817 7,792 8,345 8,848
Gain on sale of securities 98 293 302 733
Noninterest income 2,738 3,976 2,646 3,210
Noninterest expense 7,055 7,425 9,007 7,713
------------------------------------------------------
Income before income taxes 3,598 4,636 2,286 5,078
Income taxes 1,105 1,492 606 1,599
------------------------------------------------------
Net income $ 2,493 $ 3,144 $ 1,680 $ 3,479
======================================================
Earnings per share:
Basic $ 0.41 $ 0.51 $ 0.28 $ 0.57
Diluted $ 0.39 $ 0.49 $ 0.26 $ 0.55
Average shares outstanding:
Basic 6,113 6,125 6,084 6,063
Diluted 6,427 6,385 6,340 6,341
-101-
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 9a. Controls and Procedures
First Defiance's management carried out an evaluation, under the
supervision and with the participation of the chief executive officer and the
chief financial officer, of the effectiveness of the design and operation of
First Defiance's disclosure controls and procedures (as such term is defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2005,
pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the chief
executive officer along with the chief financial officer concluded that First
Defiance's disclosure controls and procedures as of December 31, 2005, are
effective in timely alerting them to material information relating to First
Defiance Financial Corp. (including its consolidated subsidiaries) required to
be included in First Defiance's periodic filings under the Exchange Act.
Management's Report on Internal Control Over Financial Reporting
The management of First Defiance Financial Corp. is responsible for
establishing and maintaining adequate internal control over financial reporting.
First Defiance's internal control over financial reporting is a process designed
under the supervision of First Defiance's chief executive officer and chief
financial officer to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of First Defiance's financial statements
for external reporting purposes in accordance with U.S. generally accepted
accounting principles.
First Defiance's management assessed the effectiveness of its internal
control over financial reporting as of December 31, 2005 based on the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in "Internal Control-Integrated Framework." Based on the assessment,
management determined that, as of December 31, 2005, First Defiance's internal
control over financial reporting is effective based on those criteria.
Management's assessment of the effectiveness of First Defiance's internal
control over financial reporting as of December 31, 2005 has been audited by
Crowe Chizek and Company LLC, an independent registered public accounting firm,
as stated in their report appearing on page 103.
/s/ William J. Small /s/ John C. Wahl
William J. Small John C. Wahl
Chairman, President and Executive Vice President and
Chief Executive Officer Chief Financial Officer
Changes in Internal Control over Financial Reporting
There were no changes in First Defiance's internal control over financial
reporting during the quarter ended December 31, 2005 that have materially
affected, or are reasonably likely to materially affect First Defiance's
internal control over financial reporting.
-102-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
First Defiance Financial Corp.
Defiance, Ohio
We have audited management's assertion, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that First
Defiance Financial Corp. (the Company) maintained effective internal control
over financial reporting as of December 31, 2005, based on criteria established
in Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, management's assessment that First Defiance Financial Corp.
maintained effective internal control over financial reporting as of December
31, 2005, is fairly stated, in all material respects, based on criteria
established in Internal Control - Integrated Framework issued by the Committee
of Sponsoring
-103-
Organizations of the Treadway Commission (COSO). Also in our opinion, First
Defiance Financial Corp. maintained, in all material respects, effective
internal control over financial reporting as of December 31, 2005 based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO)
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated statement of
financial condition of First Defiance Financial Corp. as of December 31, 2005,
and the related consolidated statements of income, stockholders' equity and cash
flows for the year then ended and our report dated March 10, 2006 expressed an
unqualified opinion on those consolidated financial statements.
/s/ Crowe Chizek and Company LLC
Crowe Chizek and Company LLC
Cleveland, Ohio
March 10, 2006
-104-
Item 9b. Other Information
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference from the
section captioned "Information Regarding Directors and Executive Officers" of
the definitive proxy statement dated March 17, 2006.
Item 11. Executive Compensation
The information required herein is incorporated by reference from the
sections captioned "Board Fees", "Executive Compensation", "Compensation
Committee Report on Executive Compensation", "Stock Options", "Employment
Agreements", and "Performance Graph" of the definitive proxy statement dated
March 17, 2006.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters
The information required herein is incorporated by reference from the
section captioned "Beneficial Ownership" of the definitive proxy statement dated
March 17, 2006.
First Defiance maintains the 1993 Stock Incentive Plan, the 1993
Directors' Stock Option plan, the 1996 Stock Option Plan, the 2001 Stock Option
and Incentive Plan and the 2005 Stock Option and Inventive Plan (collectively,
the "Plans") and the 1996 Management Recognition Plan and Trust ("MRP") under
which it may issue equity securities to its directors, officers and employees in
exchange for goods and services. All of the Plans and the MRP were approved by
the shareholders of First Defiance.
The following table shows, as of December 31, 2005, the number of common
shares issuable upon the exercise of outstanding stock options, the weighted
average exercise price of those stock options, and the number of common shares
remaining for future issuance under the Plans and the MRP, excluding shares
issuable upon exercise of outstanding stock options.
-105-
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Shareholder Matters (continued)
Equity Compensation Plan Information
-------------------------------------------------------------------------------------------------------------
Number of securities
Number of securities to remaining available for
be issued upon Weighted-average future issuance under
exercise of outstanding exercise price of equity compensation plans
options, warrants and outstanding options, (excluding securities
Plan Category rights warrants and rights reflected in column (a))
-------------------------------------------------------------------------------------------------------------
(a) (b) (c)
----------------------------------------------------------------------------
1993 Stock Incentive Plan 50,186 $ 12.14 -0-
1996 Stock Option Plan 232,863 $ 12.42 -0-
2001 Stock Option and
Incentive Plan 247,500 $ 18.62 1,600
2005 Stock Option and
Incentive Plan 38,550 $ 25.89 312,450
1996 Management
Recognition Plan and Trust N/A N/A 155
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from the
section captioned "Indebtedness of Management" of the definitive proxy statement
dated March 17, 2006.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated herein by reference
under the section captioned "Independent Registered Public Accounting Firm" of
the definitive proxy statement dated March 17, 2006.
-106-
PART IV
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Financial Statements
The following consolidated financial statements are filed as a part
of this document under "Item 8. Financial Statements and Supplementary
Data."
Reports of Independent Registered Public Accounting Firms
Consolidated Statements of Financial Condition as of December 31,
2005 and 2004
Consolidated Statements of Income for the years ended December 31,
2005, 2004, and 2003
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 2005, 2004, and 2003
Consolidated Statements of Cash Flows for the years ended December
31, 2005, 2004, and 2003
Notes to Consolidated Financial Statements
(a) (2) Financial Statement Schedules
All schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are included in the Notes to
Consolidated Financial Statements incorporated herein by reference and
therefore have been omitted.
-107-
(a) (3) Exhibits
The following exhibits are either filed as a part of this report or
are incorporated herein by reference to documents previously filed as
indicated below:
Exhibit
Number Description
-----------------------------------------------------------------------------------
3.1 Articles of Incorporation (1)
3.2 Code of Regulations (1)
3.2 Bylaws (1)
10.1 1996 Stock Option Plan (2)
10.2 Form of Incentive Stock Option Award Agreement (3)
10.3 Form of Nonqualified Stock Option Award Agreement (3)
10.4 1996 Management Recognition Plan and Trust (2)
10.5 2001 Stock Option and Incentive Plan (5)
10.6 1993 Stock Incentive Plan (1)
10.7 Employment Agreement with William J. Small (6)
10.8 Employment Agreement with James L. Rohrs (2)
10.9 Employment Agreement with John C. Wahl (2)
10.10 Employment Agreement with Gregory R. Allen (7)
10.11 Description of Annual Bonus (4)
10.12 2005 Stock Option and Incentive Plan (8)
13 Annual Report to Shareholders and Notice of Annual Meeting
of Shareholders and Proxy Statement (4)
14 Code of Ethics (4)
21 List of Subsidiaries of the Company (4)
23.1 Consent of Crowe Chizek and Company LLC (4)
23.2 Consent of Ernst & Young LLP (4)
31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (4)
31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002 (4)
32.1 Certification of Chief Executive Officer and Chief Financial
Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
2002 (4)
(1) Incorporated herein by reference to the like numbered exhibit in the
Registrant's Form S-1 (File No. 33-93354).
(2) Incorporated herein by reference to like numbered exhibit in Registrant's
2001 Form 10-K
(3) Incorporated herein by reference to like numbered exhibit in Registrant's
2004 Form 10-K
(4) Included herein
(5) Incorporated herein by reference to Appendix B to the 2001 Proxy Statement
(6) Incorporated herein by reference to like numbered exhibit in Registrant's
2000 Form 10-K
(7) Incorporated herein by reference to like numbered exhibit in Registrant's
2002 Form 10-K
(8) Incorporated herein by reference to Appendix A to the 2005 Proxy Statement
-108-
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST DEFIANCE FINANCIAL CORP.
March 10, 2006 By: /s/ John C. Wahl
-----------------------------------------------
John C. Wahl, Exec.V.P, Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 10, 2006.
Signature Title
----------------------------------- -------------------------------------
/s/ William J. Small Chairman of the Board, President and
----------------------------------- Chief Executive Officer
William J. Small
/s/ John C. Wahl Executive Vice President and
----------------------------------- Chief Financial Officer
John C. Wahl
/s/ James L. Rohrs Director, Executive Vice President
-----------------------------------
James L. Rohrs
/s/ Stephen L. Boomer Director, Vice Chairman
-----------------------------------
Stephen L. Boomer
/s/ John L. Bookmyer Director
-----------------------------------
John L. Bookmyer
/s/ Dr. Douglas A. Burgei Director
-----------------------------------
Dr. Douglas A. Burgei
/s/ Peter A. Diehl Director
-----------------------------------
Peter A. Diehl
/s/ Dr. John U. Fauster, III Director
-----------------------------------
Dr. John U. Fauster, III
/s/ Dwain I. Metzger Director
-----------------------------------
Dwain I. Metzger
/s/ Gerald W. Monnin Director
-----------------------------------
Gerald W. Monnin
/s/ Samuel S. Strausbaugh Director
-----------------------------------
Samuel S. Strausbaugh
/s/ Thomas A. Voigt Director
-----------------------------------
Thomas A. Voigt
-109-