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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year Ended December 31, 2001
-------------------
or
[ _ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 0-26850
-------------------------------------------------
FIRST DEFIANCE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
_____________
OHIO 34-1803915
- ------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
601 Clinton Street, Defiance, Ohio 43512
---------------------------------------- ----------
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (419) 782-5015
_______________
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
(Title of class)
_______________
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ _ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
As of March 8, 2002, there were issued and outstanding 6,874,448 shares of
the Registrant's common stock.
The aggregate market value of the voting stock held by non-affiliates of
the Registrant computed by reference to the average bid and ask price of such
stock as of March 8, 2002 was approximately $108.6 million.
_______________
Documents Incorporated by Reference
Part III - Portions of the Proxy Statement for the Annual Meeting of
Shareholders to be held on April 23, 2002 are incorporated by reference into
Part III thereof.
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1
PART I
Item 1. Business
First Defiance Financial Corp. (First Defiance or the Company) is a unitary
thrift holding company that, through its subsidiaries (the "Subsidiaries)
focuses on traditional banking, mortgage banking, and property and casualty,
life and group health insurance products. The Company's traditional banking
activities include originating and servicing residential, commercial, and
consumer loans and providing a broad range of depository services. The Company's
mortgage banking activities consist primarily of purchasing and selling
residential mortgage loans, originating residential mortgages, and servicing
residential mortgage portfolios for investors. The Company's insurance
activities consist primarily of commissions relating to the sale of property and
casualty, life and group health insurance and investment products.
At December 31, 2001, the Company had consolidated assets of $1.1 billion,
consolidated deposits of $631.5 million, and consolidated stockholder's equity
of $111.0 million. The Company was incorporated in Ohio in June of 1995. Its
principal executive offices are located at 601 N. Clinton Street, Defiance, Ohio
43512, and its telephone number is (419) 782-5015.
The Subsidiaries
The Company's core business operations are conducted through the following
Subsidiaries:
First Federal Bank of the Midwest: First Federal Bank of the Midwest (First
Federal) is a federally chartered stock savings bank headquartered in Defiance,
Ohio. It conducts operations through its main office and thirteen full service
branch offices in Defiance, Fulton, Hancock, Henry, Paulding, Seneca, Williams
and Wood Counties in northwest Ohio. First Federal's deposits are insured by the
Federal Deposit Insurance Corporation (FDIC) under the Savings Association
Insurance Fund (SAIF). First Federal is a member of the Federal Home Loan Bank
(FHLB) System.
First Federal is primarily engaged in attracting deposits from the general
public through its offices and using those and other available sources of funds
to originate loans secured by single-family residences (one-to-four-family
units) primarily located in the eight counties in which its offices are located
and in adjacent Putnam County. First Federal also originates other real estate
loans secured by nonresidential and multi-family residential real estate and
construction loans. First Federal also holds a significant number of non-real
estate loans including commercial, home improvement and equity and consumer
finance, primarily automobile loans. In addition, First Federal invests in U.S.
Treasury and federal government agency obligations, obligations of the State of
Ohio and its political subdivisions, mortgage-backed securities which are issued
by federal agencies and corporate bonds.
2
The Leader Mortgage Company: The Leader Mortgage Company LLC (The Leader)
is a wholly owned subsidiary of First Federal. The Leader is a mortgage banking
company which specializes in servicing mortgage loans under various first-time
homebuyer programs sponsored by various state, county and municipal governmental
entities. The Leader's mortgage banking activities consist primarily of
originating or purchasing residential mortgage loans for either direct resale
into secondary markets or to be securitized under various Government National
Mortgage Association (GNMA) bonds. On January 18, 2002, First Defiance announced
that it had entered into a definitive agreement to sell The Leader to U.S. Bank
Home Mortgage, a unit of U.S. Bancorp.
First Insurance & Investments: First Insurance & Investments (First
Insurance) is a wholly owned subsidiary of First Defiance. First Insurance is an
insurance agency that does business in the Defiance, Ohio area. First Insurance
offers property and casualty insurance, life insurance, group health insurance,
and investment products.
Securities
Management determines the appropriate classification of debt securities at
the time of purchase. Debt securities are classified as held-to-maturity when
First Defiance has the positive intent and ability to hold the securities to
maturity. Held-to-maturity securities are stated at amortized cost. Debt
securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value. Loans held-for-sale securitized in the normal course of The Leader's
operations have been classified as trading securities, reported at fair market
value. The securities have been committed to sell at their carrying value.
First Defiance's securities portfolio is managed in accordance with a
written policy adopted by the Board of Directors and administered by the
Investment Committee. The Chief Financial Officer, the Chief Operating Officer,
and the Chief Executive Officer of First Federal can each approve transactions
up to $1 million. Two of the three officers are required to approve transactions
between $1 million and $5 million. All transactions in excess of $5 million must
be approved by the Board of Directors.
First Defiance's investment portfolio includes six CMO and REMIC issues
totaling $3.6 million, all of which are fully amortizing securities. All such
investments are considered derivative securities. None of First Defiance's
investments are considered to be high risk and management does not believe the
risks associated with these investments are significantly different from risks
associated with other pass-through mortgage-backed securities.
3
The amortized cost and fair value of securities at December 31, 2001 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Money market mutual
funds and other mutual funds are not due at a single maturity date. For purposes
of the maturity table, mortgage-backed securities, which are not due at a single
maturity date, have been allocated over maturity groupings based on the
weighted-average contractual maturities of underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
Contractually Maturing Total
--------------------------------------------------------------------------------------------------
Weighted Weighted Weighted Weighted
Under 1 Average 1 - 5 Average 6-10 Average Over 10 Average
Year Rate Years Rate Years Rate Years Rate Amount Yield
--------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Mortgage-backed
securities $ 148 9.18% $ 57 8.79% $ 49 10.23% $ 8,831 6.59% $ 9,084 6.67%
Corporate bonds 5,088 6.63 4,233 6.49 9,322 6.56
REMICs and CMOs 3,207 6.10 339 3.78 3,546 5.88
U.S. Government and
federal agency
obligations 1,997 6.17 15,711 6.02 17,708 6.03
Obligations of
states and
political
subdivisions 40 5.88 3,472 5.54 2,311 4.98 3,023 5.08 8,846 5.24
Trust preferred
stock 2,000 9.13 2,000 9.13
----------- ----------- ---------- ----------- -----------
Total $7,273 $23,473 $5,567 $14,193 50,506
=========== =========== ========== ===========
Mutual funds 2,548
Equity securities 343
Unrealized gain
on securities
available for
sale 1,172
-----------
Total $54,569
===========
The carrying value of investment securities is as follows:
December 31
2001 2000 1999
--------------------------------------------------
(In Thousands)
Available-for-Sale Securities:
Corporate bonds $ 9,616 $ 11,884 $ 14,746
U. S. Treasury and other U. S. Government
agencies and corporations 18,613 17,934 16,374
Obligations of state and political
subdivisions 8,251 6,018 5,381
Other 12,509 17,340 17,445
--------------------------------------------------
Total $ 48,989 $ 53,176 $ 53,946
==================================================
Trading Securities:
U.S. Treasury and other U.S.
Government agencies and corporations $ - $ 234 $ 29,805
--------------------------------------------------
$ - $ 234 $ 29,805
==================================================
4
December 31
2001 2000 1999
-----------------------------------------
(In Thousands)
Held-to-Maturity Securities:
U. S. Treasury and other U. S. Government agencies and
corporations $ 4,950 $ 6,928 $ 8,997
Obligations of state and political
subdivisions 630 769 898
-----------------------------------------
Total $ 5,580 $ 7,697 $ 9,895
=========================================
For additional information regarding First Defiance's investment portfolio refer
to Note 5 to the consolidated financial statements.
Interest-Bearing Deposits
First Defiance had interest-bearing deposits in the FHLB of Cincinnati
amounting to $478,000 and $4.9 million at December 31, 2001 and 2000,
respectively.
Residential Loan Servicing Activities
Residential Mortgage Loan Servicing: First Federal and The Leader each has
its own mortgage servicing portfolio. At December 31, 2001, First Federal
serviced approximately $53.8 million of mortgage loans, while The Leader's
servicing portfolio amounted to approximately $9.1 billion. The Leader's
servicing portfolio includes approximately $156.9 million in loans serviced for
First Federal customers that will be retained by First Federal after the sale to
U.S. Bank Home Mortgage.
Servicing mortgage loans involves a contractual right to receive a fee for
processing and administering loan payments. This processing involves collecting
monthly mortgage payments on behalf of investors, reporting information to those
investors on a monthly basis and maintaining custodial escrow accounts for the
payment of principal and interest to investors and property taxes and insurance
premiums on behalf of borrowers. These payments are held in custodial escrow
accounts at First Federal, where the money can be invested by the Company in
interest-earning assets at returns that historically have been greater than
could be realized by the Company using the custodial escrow deposits as
compensating balances to reduce the effective borrowing cost on the Company's
warehouse credit facilities.
As compensation for its mortgage servicing activities, the Company receives
servicing fees usually ranging from 0.25% to 0.44% per annum of the loan
balances serviced, plus any late charges collected from delinquent borrowers and
other fees incidental to the services provided. At December 31, 2001, the
Company's weighted-average servicing fee was 0.43%. In the event of a default by
the borrower, the Company receives no servicing fees until the default is cured.
The loans serviced by others that First Defiance is retaining after the sale of
The Leader generally pay servicing fees of 0.25% per annum.
5
Servicing is provided on mortgage loans on a recourse or non-recourse
basis. The Company's policy is to accept only a limited number of servicing
assets on a recourse basis. As of December 31, 2001, on the basis of outstanding
principal balances, only .05% of the mortgage servicing contracts owned by the
Company involved recourse servicing. To the extent that servicing is done on a
recourse basis, the Company is exposed to credit risk with respect to the
underlying loan in the event of a repurchase. Additionally, many of the
non-recourse mortgage servicing contracts owned by the Company require the
Company to advance all or part of the scheduled payments to the owner of the
mortgage loan in the event of a default by the borrower. Many owners of mortgage
loans also require the servicer to advance insurance premiums and tax payments
on schedule even though sufficient escrow funds may not be available. The
Company, therefore, must bear the funding costs associated with making such
advances. If the delinquent loan does not become current, these advances are
typically recovered at the time of the foreclosure sale. Foreclosure expenses
are generally not fully reimbursable by the Federal National Mortgage
Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) or GNMA,
for whom the Company provides significant amounts of mortgage loan servicing. As
of December 31, 2001 and 2000, the Company had advanced approximately $18.6
million and $10.0 million, respectively, in funds on behalf of third-party
investors.
Mortgage servicing rights represent a contractual right to service, and not
a beneficial ownership interest in, underlying mortgage loans. Failure to
service the loans in accordance with contract or other applicable requirements
may lead to the termination of the servicing rights and the loss of future
servicing fees. There have been no terminations of mortgage servicing rights by
any mortgage loan owners because of the Company's failure to service the loans
in accordance with its obligations during the three year period ended December
31, 2001.
The following table sets forth certain information regarding the
composition of the Company's mortgage servicing portfolio (excluding loans
subserviced for others) as of the dates indicated:
As of December 31
2001 2000 1999
-----------------------------------------------
(In Thousands)
FHA insured/VA guaranteed loans $ 7,308,739 $ 6,271,122 $ 4,641,778
Conventional loans 1,314,542 1,284,535 1,205,908
Other loans 568,449 435,163 191,377
-----------------------------------------------
Total mortgage servicing portfolio $ 9,191,730 $ 7,990,820 $ 6,039,063
===============================================
Fixed rate loans $ 9,178,893 $ 7,985,351 $ 6,032,886
Adjustable rate loans 12,837 5,469 6,177
-----------------------------------------------
Total mortgage servicing portfolio $ 9,191,730 $ 7,990,820 $ 6,039,063
===============================================
All of the loans in the servicing portfolio to be retained by First Defiance
after the sale of The Leader are fixed rate conventional loans.
6
The following table shows the delinquency statistics for the mortgage loans
serviced by the Company (excluding loans subserviced for others) compared with
national average delinquency rates as of the dates presented:
As of December 31
---------------------------------------------------------------------------------------------------------
2001 2000 1999
---------------------------------------------------------------------------------------------------------
National National National
Company Average(1) Company Average(1) Company Average(1)
---------------------------------------------------------------------------------------------------------
Number Percentage Percentage Number Percentage Percentage Number Percentage Percentage
of of Servicing Of of of Servicing of of of Servicing of
Loans Portfolio Loans Loans Portfolio Loans Loans Portfolio Loans
(2) (2) (2)
---------------------------------------------------------------------------------------------------------
Loans delinquent
for:
30-59 days 9,577 6.84% 3.35% 8,749 7.05% 3.16% 5,102 5.28% 2.74%
60-89 days 2,606 1.86 0.79 2,200 1.77 0.73 1,425 1.47 0.63
90 days and over 2,656 1.90 0.73 1,754 1.41 0.61 1,007 1.04 0.56
---------------------------------------------------------------------------------------------------------
Total delinquencies 14,839 10.60% 4.87% 12,703 10.23% 4.50% 7,534 7.79% 3.93%
=========================================================================================================
Foreclosures 2,270 1.62% 1,383 1.11% 2,167 2.24%
=========================================================================================================
(1) Source: Mortgage Bankers Association, "Delinquency Rates of 1 to 4 Unit
Residential Mortgage Loans" (Seasonally Adjusted) (Data as of September 30,
2001 and December 31, 2000 and 1999, respectively).
(2) Delinquencies and foreclosures generally exceed the national average due to
historically higher rates of delinquencies and foreclosures on FHA insured
and VA guaranteed residential mortgage loans.
The following table sets forth certain information regarding the number and
aggregate principal balance of the mortgage loans serviced by the Company,
including both fixed and adjustable rate loans (excluding loans subserviced for
others), at various mortgage interest rates:
As of December 31
---------------------------------------------------------------------------------------------------------
2001 2000 1999
---------------------------------------------------------------------------------------------------------
Percentage Percentage Percentage
Number Aggregate of Number Aggregate of Aggregate Number Aggregate of Aggregate
Aggregate
of Principal Principal of Principal Principal of Principal Principal
Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance
- ---------------- ---------------------------------------------------------------------------------------------------------
(Dollars in Thousands)
Less than 5.00% 1,197 $ 69,354 0.75% 949 $ 51,062 0.64% 697 $ 32,872 0.54%
5.00% - 5.99% 21,263 1,394,278 15.17 19,635 1,301,249 16.28 18,326 1,238,781 20.51
6.00% - 6.99% 52,764 3,750,823 40.81 45,122 3,165,465 39.61 35,221 2,427,105 40.19
7.00% - 7.99% 45,951 2,891,963 31.46 39,032 2,329,968 29.16 31,094 1,721,873 28.51
8.00% - 8.99% 14,548 830,559 9.04 13,516 757,174 9.48 9,713 501,155 8.30
9.00% and over 4,190 254,753 2.77 5,854 385,902 4.83 1,640 117,277 1.95
---------------------------------------------------------------------------------------------------------
Total 139,913 $9,191,730 100.00% 124,108 $7,990,820 100.00% 96,691 $6,039,063 100.00%
=========================================================================================================
7
Loan administration fees decrease as the principal balance on the
outstanding loan decreases and as the remaining time to maturity of the loan
shortens. The following table sets forth certain information regarding the
remaining maturity of the mortgage loans serviced by the Company (excluding
loans subserviced for others) as of the dates shown.
As of December 31
--------------------------------------------------------------------------------------------
2001 2000
--------------------------------------------------------------------------------------------
Percent of Percent of
Number Percent Unpaid Unpaid Number Percent Unpaid Unpaid
of of Number Principal Principal of of Number Principal Principal
Maturity Loans of Loans Amount Amount Loans of Loans Amount Amount
--------------------------------------------------------------------------------------------
(Dollars in Thousands)
1-5 years 1,832 1.31% $ 113,964 1.24% 3,119 2.51% $ 111,295 1.39%
6-10 years 7,762 5.55 103,961 1.13 6,843 5.51 107,507 1.35
11-15 years 2,169 1.55 145,360 1.58 1,410 1.14 90,667 1.13
16-20 years 14,884 10.64 370,495 4.03 10,528 8.48 337,449 4.22
21-25 years 16,544 11.82 1,060,094 11.53 12,076 9.73 788,008 9.86
More than 25 years 96,722 69.13 7,397,856 80.49 90,132 72.63 6,555,894 82.05
--------------------------------------------------------------------------------------------
Total 139,913 100.00% 9,191,730 100.00% 124,108 100.00% $7,990,820 100.00%
============================================================================================
As of December 31
------------------------------------------------
1999
------------------------------------------------
Percent of
Number Percent Unpaid Unpaid
of of Number Principal Principal
Loans of Loans Amount Amount
------------------------------------------------
1-5 years 4,102 4.24% $ 121,250 2.01%
6-10 years 5,823 6.02 120,517 2.00
11-15 years 1,457 1.51 99,207 1.64
16-20 years 4,894 5.06 209,012 3.46
21-25 years 12,702 13.14 745,418 12.34
More than 25 years 67,713 70.03 4,743,659 78.55
------------------------------------------------
Total 96,691 100.00% $6,039,063 100.00%
================================================
The following table sets forth the geographic distribution of the mortgage
loans (including delinquencies) serviced by the Company (excluding loans
subserviced for others) by state:
As of December 31
--------------------------------------------------------------------------------------------
2001 2000
--------------------------------------------------------------------------------------------
Percent Percent Percent Percent
of of of of
Number Aggregate Aggregate Total Number Aggregate Aggregate Total
of Principal Principal Delinqs. of Principal Principal Delinqs.
State Loans Balance Balance by State(1) Loans Balance Balance by
State(1)
--------------------------------------------------------------------------------------------
(Dollars in Thousands)
Ohio 36,830 $2,522,314 27.44% 21.06% 37,169 $2,425,207 30.35% 24.44%
Florida 26,228 1,744,071 18.97 18.27 24,900 1,653,828 20.70 20.29
California 13,354 908,341 9.88 11.92 7,486 466,504 5.84 5.29
Louisiana 13,332 891,238 9.70 13.24 12,396 829,013 10.37 14.92
Other (2) 50,169 3,125,766 34.01 35.51 42,157 2,616,268 32.74 35.06
--------------------------------------------------------------------------------------------
Total 139,913 $9,191,730 100.00% 100.00% 124,108 $7,990,820 100.00% 100.00%
============================================================================================
As of December 31
--------------------------------------------------
1999
--------------------------------------------------
Percent Percent
of of
Number Aggregate Aggregate Total
of Principal Principal Delinqs.
State Loans Balance Balance by State(1)
--------------------------------------------------
Ohio 35,336 $2,230,168 36.93% 31.46%
Florida 19,245 1,259,712 20.86 22.07
California 1,551 50,793 0.84 0.48
Louisiana 10,226 679,799 11.26 16.30
Other (2) 30,333 1,818,591 30.11 29.69
--------------------------------------------------
Total 96,691 $6,039,063 100.00% 100.00%
==================================================
8
(1) In terms of number of loans outstanding.
(2) No other state accounted for greater than 6.0%, based on aggregate
principal balances of the Company's mortgage loan servicing portfolio as of
December 31, 2001.
Lending Activities
General. A savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus, although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. See "Regulation - Lending Limits." At December
31, 2001, First Federal's limit on loans-to-one borrower was $12.0 million and
its five largest loans or groups of loans to one borrower, including related
entities, were $12.6 million, $9.2 million, $7.4 million, $6.6 million and $5.6
million. All of these loans or groups of loans were performing in accordance
with their terms at December 31, 2001. The largest group of loans to one
borrower, totaling $12.6 million, exceeded the legal lending limit at December
31, 2001. A signed agreement was in place at December 31, 2001 to participate a
portion of these loans with another financial institution, however, funding did
not take place until January 18, 2002. The outstanding loan amounts to this
borrower were $11.3 million on January 31, 2002.
9
Loan Portfolio Composition. The net increase in net loans outstanding over the
prior year was $20.0 million, $70.6 million, and $134.4 million in 2001, 2000,
and 1999, respectively. The loan portfolio contains no foreign loans nor any
concentrations to identified borrowers engaged in the same or similar industries
exceeding 10% of total loans.
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
December 31
----------------------------------------------------------------------
2001 2000 1999
----------------------------------------------------------------------
Amount % Amount % Amount %
----------------------------------------------------------------------
(Dollars in Thousands)
Real estate:
One to four family residential $419,923 52.0% $441,959 56.2% $458,442 64.1%
Five or more family residential (1) 66,288 8.2 44,700 5.7 11,427 1.6
Non-residential real estate (1) 152,511 18.9 125,479 16.0 11,801 1.7
Construction 7,875 1.0 9,627 1.1 7,808 1.1
----------------------------------------------------------------------
Total real estate loans 646,597 80.1 621,765 79.0 489,478 68.5
Other:
Consumer finance 40,922 5.0 52,114 6.6 64,326 9.0
Commercial (1) 83,690 10.4 81,138 10.3 138,125 19.3
Home equity and improvement 36,179 4.5 31,836 4.1 22,781 3.2
Mobile home 12 - 29 - 46 -
----------------------------------------------------------------------
Total non-real estate loans 160,803 19.9 165,117 21.0 225,278 31.5
----------------------------------------------------------------------
Total loans 807,400 100.0% 786,882 100.0% 714,756 100.0%
=========== ========== =========
Less:
Loans in process 2,887 3,415 3,291
Deferred loan origination fees 1,024 1,041 764
Allowance for loan losses 9,937 8,904 7,758
------------- ------------- --------------
Net loans $793,552 $773,522 $702,943
============= ============= ==============
December 31
----------------------------------------------
1998 1997
----------------------------------------------
Amount % Amount %
----------------------------------------------
(Dollars in Thousands)
Real estate:
One to four family residential $365,116 62.7% $255,428 57.0%
Five or more family residential (1) 13,763 2.4 9,363 2.1
Non-residential real estate (1) 16,436 2.8 20,159 4.5
Construction 8,258 1.4 10,148 2.2
----------------------------------------------
Total real estate loans 403,573 69.3 295,098 65.8
Other:
Consumer finance 87,168 15.0 81,111 18.1
Commercial (1) 70,109 12.0 29,758 6.6
Home equity and improvement 18,168 3.2 16,940 3.8
Mobile home 3,117 0.5 25,424 5.7
----------------------------------------------
Total non-real estate loans 178,562 30.7 153,233 34.2
----------------------------------------------
Total loans 582,135 100.0% 448,331 100.0%
========= ==========
Less:
Loans in process 3,250 3,087
Deferred loan origination fees 612 646
Allowance for loan losses 9,789 2,686
-------------- -------------
Net loans $568,484 $441,912
============== =============
(1) Prior to December 31, 2000, most non-residential real estate loans were
reported with all other commercial loans.
Included above, First Defiance had $275.7 million, $232.3 million, $237.6
million, $119.9 and $87,500 million in loans classified as held for sale at
December 31, 2001, 2000, 1999, 1998, and 1997, respectively. The fair value of
such loans, which are all single-family residential mortgage loans, approximated
their carrying value for all years presented.
10
Contractual Principal Repayments and Interest Rates. The following table
sets forth certain information at December 31, 2001 regarding the dollar amount
of gross loans maturing in First Defiance's portfolio, based on the contractual
terms to maturity. Demand loans, loans having no stated schedule of repayments
and no stated maturity and overdrafts are reported as due in one year or less.
Due 3-5 Due 5-10 Due 10-15 Due 15+
Due Due Years Years Years Years
Before Before After After After After
12/31/02 12/31/03 12/31/01 12/31/01 12/31/01 12/31/01 Total
-----------------------------------------------------------------------------------
(In Thousands)
Real estate $337,187 $22,024 $63,685 $142,643 $31,738 $ 49,320 $ 646,597
Non-real estate:
Commercial 45,444 11,663 20,107 5,894 223 359 83,690
Home equity and
improvement 1,797 720 2,205 2,013 432 29,012 36,179
Mobile home -- -- -- -- -- 12 12
Consumer finance 18,114 10,338 12,189 208 57 16 40,922
-----------------------------------------------------------------------------------
Total $402,542 $44,745 $98,186 $150,758 $32,450 $ 78,719 $ 807,400
===================================================================================
The schedule above does not reflect the actual life of the Company's loan
portfolio. The average life of loans is substantially less than their
contractual terms because of prepayments and due-on-sale clauses, which give
First Defiance the right to declare a conventional loan immediately due and
payable in the event, among other things, that the borrower sells the real
property subject to the mortgage and the loan is not repaid.
The following table sets forth the dollar amount of gross loans due after
one year from December 31, 2001 which have fixed interest rates or which have
floating or adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Total
----------------------------------------------------
(In Thousands)
Real estate $ 124,962 $ 184,448 $ 309,410
Commercial 19,295 18,951 38,246
Other 26,891 30,311 57,202
----------------------------------------------------
$ 171,148 $ 233,710 $ 404,858
====================================================
Originations, Purchases and Sales of Loans. The lending activities of First
Defiance are subject to the written, non-discriminatory, underwriting standards
and loan origination procedures established by the Board of Directors and
management. Loan originations are obtained from a variety of sources, including
referrals from real estate brokers, developers, builders, and existing
customers; newspapers and radio advertising; and walk-in customers.
11
First Defiance's loan approval process for all types of loans is intended
to assess the borrowers ability to repay the loan, the viability of the loan,
and the adequacy of the value of the collateral that will secure the loan.
A commercial loan application is first reviewed and underwritten by one of
the commercial loan officers, who may approve credits within their lending
limit. Credits exceeding an individual's lending limit may be approved by
another loan officer with limits sufficient to cover the exposure. All credits
which exceed $100,000 in aggregate exposure must be presented for approval to
the Senior Loan Committee comprised of senior lending personnel. Credits which
exceed $250,000 in aggregate exposure must be presented for approval to the
Executive Loan Committee, a sub-committee of the Board of Directors.
A mortgage loan is initially reviewed by a mortgage loan originator.
Approval for conforming mortgage loans which are sold to the secondary market
occurs centrally by the the Senior Vice President of Mortgage Lending or
approved underwriters. Non-conforming mortgage loans must be approved by either
the Senior Vice President of Mortgage Lending or the Executive Vice President of
Lending.
Consumer loan officers underwrite and may approve direct consumer credits
within their lending limits. Credits exceeding an officer's lending limits may
be approved by another loan officer with limits sufficient to cover the
exposure. All indirect consumer credits are underwritten and approved by a
centralized underwriting department.
First Defiance offers adjustable-rate loans in order to decrease the
vulnerability of its operations to changes in interest rates. The demand for
adjustable-rate loans in First Defiance's primary market area has been a
function of several factors, including customer preference, the level of
interest rates, the expectations of changes in the level of interest rates and
the difference between the interest rates offered for fixed-rate loans and
adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable rate loans represented 2.31% of First Defiance's total
originations of mortgage loans in 2001 compared to 8.96% and 5.87% during 2000
and 1999, respectively.
Adjustable-rate loans decrease the risks associated with changes in
interest rates, but involve other risks, primarily because as interest rates
rise, the payment by the borrower rises to the extent permitted by the terms of
the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher
interest rates.
12
The following table shows total loans originated, loan reductions, and the
net increase in First Defiance's total loans during the periods indicated:
Years ended December 31
2001 2000 1999
------------------------------------------------
(In Thousands)
Loan originations:
Single family residential $ 337,448 $ 95,404 $ 154,142
Multi-family residential (1) 50,507 31,118 313
Non-residential real estate (1) 76,680 47,937 476
Construction 9,693 12,665 10,699
Commercial 68,881 87,858 149,819
Home equity and improvement 20,521 13,832 10,223
Consumer finance 18,783 22,846 21,122
------------------------------------------------
Total loans originated 582,513 311,660 346,794
Purchase of single family residential 1,960,853 2,322,165 1,797,959
Loan reductions:
Loan pay-offs 253,409 143,275 188,128
Mortgage loans sold 2,196,349 2,360,174 1,746,386
Periodic principal repayments 73,578 58,250 77,618
------------------------------------------------
2,523,336 2,561,699 2,012,132
------------------------------------------------
Net increase in total loans $ 20,030 $ 72,126 $ 132,621
================================================
(1) In years prior to 2000, the breakdown between commercial real estate and
non-real estate commercial loans was not available. As a result, all
commercial real estate originations were reported in the commercial
classification.
13
Asset Quality
First Defiance's credit policy establishes guidelines to manage credit risk
and asset quality. These guidelines include loan review and early identification
of problem loans to ensure sound credit decisions. First Defiance's credit
policies and review procedures are meant to minimize the risk and uncertainties
inherent in lending. In following the policies and procedures, management must
rely on estimates, appraisals and evaluations of loans and the possibility that
changes in these could occur because of changing economic conditions.
Delinquent Loans. The following table sets forth information concerning
delinquent loans at December 31, 2001, in dollar amount and as a percentage of
First Defiance's total loan portfolio. The amounts presented represent the total
outstanding principal balances of the related loans, rather than the actual
payment amounts which are past due.
30 to 59 Days 60 to 89 Days
--------------------------- ---------------------------
Amount Percentage Amount Percentage
--------------------------- ---------------------------
(Dollars in Thousands)
Single-family residential $ 1,308 .16% $ 80 .01%
Non-residential and multi-family
residential 522 .06 63 .01
Home equity and improvement 211 .03 25 -
Consumer finance 615 .08 87 .01
Commercial 799 .10 242 .03
--------------------------------------------------------
3,455 .43 497 .06
Single-family residential backed by
government guarantees 956 .12 492 .06
--------------------------------------------------------
Total $ 4,411 .55% $ 989 .12%
========================================================
90 Days and Over Total
---------------------------- ---------------------------
Amount Percentage Amount Percentage
---------------------------- ---------------------------
(Dollars in Thousands)
Single-family residential $ 1,151 .14% $ 2,539 .31%
Non-residential and multi-family
residential 972 .12 1,557 .19
Home equity and improvement 89 .01 325 .04
Consumer finance 49 .01 751 .10
Commercial 110 .01 1,151 .14
--------------------------------------------------------
2,371 .29 6,323 .78
Single-family residential backed by
government guarantees 15,437 1.91 16,885 2.09
--------------------------------------------------------
Total $ 17,808 2.20% $ 23,208 2.87%
========================================================
14
Non-Performing Assets. All loans are reviewed on a regular basis and are
placed on a non-accrual status when, in the opinion of management, the
collectibility of additional interest is deemed insufficient to warrant further
accrual. Generally, First Defiance places all loans more than 90 days past due
on non-accrual status. When a loan is placed on non-accrual status, total unpaid
interest accrued to date is reserved. Subsequent payments are either applied to
the outstanding principal balance or recorded as interest income, depending on
the assessment of the ultimate collectibility of the loan. First Defiance
considers that a loan is impaired when, based on current information and events,
it is probable that it will be unable to collect all amounts due (both principal
and interest) according to the contractual terms of the loan agreement. First
Defiance measures impairment based on the present value of expected future cash
flows discounted at the loan's effective interest rate, the loan's observable
market price, or the fair value of the collateral, if collateral dependent. If
the measure of the impaired loan is less than the recorded investment, First
Defiance will recognize an impairment by creating a valuation allowance. This
policy excludes large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment such as residential mortgage, consumer
installment, and credit card loans. Impairment of loans having recorded
investments of $370,000, $95,000 and $570,000 has been recognized as of December
31, 2001, 2000 and 1999, respectively. There was $40,000 of interest received
and recorded in income during 2001 related to impaired loans including interest
received and recorded in income prior to such impaired loan designation. There
were no amounts recorded in 2000 and $36,000 recorded in 1999. Unrecorded
interest income on these and all non-performing loans in 2001, 2000 and 1999 was
$67,000, $80,000, and $154,000, respectively. The average recorded investment in
impaired loans during 2001, 2000 and 1999 was $501,000, $135,000, and $570,000,
respectively. The total allowance for loan losses related to these loans was
$77,000, $95,000 and $402,000 at December 31, 2001, 2000 and 1999, respectively.
Real estate acquired by foreclosure is classified as real estate owned
until such time as it is sold. In addition, First Defiance also repossesses
other assets securing loans, consisting primarily of automobiles and mobile
homes. When such property is acquired it is recorded at the lower of the
restated loan balance, less any allowance for loss, or fair value. Costs
relating to development and improvement of property are capitalized, whereas
costs relating to holding the property are expensed. Valuations are periodically
performed by management and an allowance for losses is established by a charge
to operations if the carrying value of property exceeds its estimated net
realizable value.
As of December 31, 2001, First Defiance's total non-performing loans
amounted to $2.4 million or 0.32% of total loans, compared to $1.4 million or
0.18% of total loans, at December 31, 2000.
15
The following table sets forth the amounts and categories of First
Defiance's nonperforming assets and troubled debt restructurings at the dates
indicated.
December 31
2001 2000 1999 1998 1997
---------------------------------------------------------------
(Dollars in Thousands)
Non-performing loans:
Single-family residential $ 1,151 $ 671 $ 146 $ 171 $ 313
Non-residential and multi-family
residential real estate 972 572 - - -
Commercial 110 140 737 1,330 570
Mobile home - - - 180 315
Consumer finance 138 66 147 171 167
---------------------------------------------------------------
Total non-performing loans 2,371 1,449 1,030 1,852 1,365
Real estate owned 1,164 271 2,465 1,337 18
Other repossessed assets 55 41 92 180 523
---------------------------------------------------------------
Total repossessed assets 1,219 312 2,557 1,517 541
---------------------------------------------------------------
Total non-performing assets $ 3,590 $ 1,761 $ 3,587 $ 3,369 $ 1,906
===============================================================
Troubled debt restructurings $ - $ - $ - $ - $ -
===============================================================
Total non-performing assets as a
percentage of total assets 0.32% 0.16% 0.36% 0.43% 0.33%
===============================================================
Total non-performing loans and troubled
debt restructurings as a percentage
of total loans 0.32% 0.18% 0.14% 0.33% 0.43%
===============================================================
Total non-performing assets and troubled
debt restructurings as a percentage
of total assets 0.32% 0.16% 0.36% 0.43% 0.33%
===============================================================
Allowance for loan losses as a percent
of total non-performing assets
276.80% 505.62% 216.3% 290.6% 140.9%
===============================================================
In addition to the $2,371,000 of loans reported above and the $370,000 of
loans considered impaired, there are approximately $5,852,000 in performing
loans where known information about possible credit problems of the borrowers
causes management to have doubts as to the ability of such borrowers to comply
with the present loan repayment terms and which may result in the inclusion of
such loans in non-performing loans at some future date. Consideration was given
to loans classified for regulatory purposes as loss, doubtful, substandard, or
special mention that have not been included in non-performing loans. To the
extent that such classified loans are not included in the $5,852,000 potential
problem loans noted above, management believes that such loans will not
materially impact future operating results, liquidity or capital reserves.
16
Allowance for Loan Losses. First Defiance maintains an allowance for loan
losses based upon an assessment of prior loss experience, the volume and type of
lending conducted by First Defiance, industry standards, past due loans, general
economic conditions and other factors related to the collectibility of the loan
portfolio. Although management believes that it uses the best information
available to make such determinations, future adjustments to allowances may be
necessary, and net earnings could be significantly affected, if circumstances
differ substantially from the assumptions used in making the initial
determinations.
At December 31, 2001, First Defiance's allowance for loan losses amounted
to $9.9 million compared to $8.9 million at December 31, 2000. The allowance was
comprised of $6.5 million for credit losses and $3.4 million for foreclosure
losses at December 31, 2001 compared to $6.3 million and $2.6 million for credit
and foreclosure losses respectively at December 31, 2000. As of December 31,
2001 and 2000, $161,000 and $316,000, respectively, constituted an allowance
with respect to specific loans or assets held for sale. The following table sets
forth the activity in First Defiance's allowance for loan losses during the
periods indicated.
Years ended December 31
2001 2000 1999 1998 1997
---------------------------------------------------------------
(Dollars in Thousands)
Allowance at beginning of year $ 8,904 $ 7,758 $ 9,789 $ 2,686 $ 2,217
Provision of credit losses 993 635 155 7,417 1,613
Provision for foreclosure losses 2,877 2,512 1,770 352 --
---------------------------------------------------------------
Total provision 3,870 3,147 1,925 7,769 1,613
---------------------------------------------------------------
Acquired allowance of The Leader -- -- -- 1,194 --
Foreclosure expense charge-offs 2,475 1,550 1,710 352 --
Credit loss charge-off:
One to four family residential real
estate 152 -- -- -- --
Commercial real estate 130 182 -- -- --
Commercial 151 155 107 55 4
Consumer finance 599 692 1,364 1,053 1,078
Mobile home - 2 1,054 620 259
---------------------------------------------------------------
Total credit charge-offs 1,032 1,031 2,525 1,728 1,341
---------------------------------------------------------------
Total charge-offs 3,057 2,581 4,235 2,080 1,341
---------------------------------------------------------------
Recoveries from foreclosure losses 413 358 -- -- -
Recoveries from credit losses 257 222 279 220 197
---------------------------------------------------------------
Total recoveries 670 580 279 220 197
---------------------------------------------------------------
Net charge-offs 2,837 2,001 3,956 1,860 1,144
---------------------------------------------------------------
Ending allowance $ 9,937 $ 8,904 $ 7,758 $ 9,789 $ 2,686
===============================================================
Ending allowance for credit losses $ 6,548 $ 6,330 $ 6,504 $ 8,595 $ 2,686
Ending allowance for foreclosure losses 3,389 2,574 1,254 1,194 --
---------------------------------------------------------------
Total ending allowance $ 9,937 $ 8,904 $ 7,758 $ 9,789 $ 2,686
===============================================================
Allowance for loan losses to total
non-performing loans at end of
year 387.0% 614.5% 753.2% 528.6% 196.8%
Allowance for loan losses to total loans at
end of year 1.88 1.62 1.10 1.68 0.60
Allowance for loan losses to net
charge-offs for the year 350.26 444.98 196.11 470.63 234.79
Net charge-offs for the year to average
loans 0.34 0.27 0.60 0.36 0.27
17
The following table sets forth information concerning the allocation of
First Defiance's allowance for credit losses by loan categories at the dates
indicated. For information about the percent of total loans in each category to
total loans, see "Lending Activities-Loan Portfolio Composition."
December 31
2001 2000 1999
--------------------------------------------------------------------------------
Percent of Percent of Percent of
total loans total loans total loans
Amount by category Amount by category Amount by category
--------------------------------------------------------------------------------
(Dollars in Thousands)
Single family residential $ 613 9.3% $ $ 396 6.3% $843 13.0%
Non-residential and
Multi-family
residential Real
estate (1) 2,847 43.5 2,310 36.5 -- --
Other:
Commercial loans (1) 1,734 26.5 1,355 21.4 2,317 35.6
Mobile home loans 1 -- 1 - 10 0.1
Consumer and home
equity and
improvement loans 1,353 20.7 2,268 35.8 3,334 51.3
--------------------------------------------------------------------------------
$ 6,548 100.0% $ $ 6,330 100.0% $6,504 100.0%
================================================================================
(1) In years prior to 2000, the breakdown between commercial real estate and
non-real estate commercial loans was not available. As a result, all
commercial real estate loans were reported in the commercial
classification.
Sources of Funds
General. Deposits are the primary source of First Defiance's funds for
lending and other investment purposes. In addition to deposits, First Defiance
derives funds from loan principal repayments. Loan repayments are a relatively
stable source of funds, while deposit inflows and outflows are significantly
influenced by general interest rates and money market conditions. Borrowings
from the FHLB may be used on a short-term basis to compensate for reductions in
the availability of funds from other sources. They may also be used on a longer
term basis for general business purposes.
Deposits. First Defiance's deposits are attracted principally from within
First Defiance's primary market area through the offering of a broad selection
of deposit instruments, including checking accounts, money market accounts,
regular savings accounts, and term certificate accounts. Included among these
deposit products are individual retirement account certificates of approximately
$56.7 million at December 31, 2001. Deposit account terms vary, with the
principal differences being the minimum balance required, the time periods the
funds must remain on deposit and the interest rate.
To supplement its funding needs, First Defiance also utilizes brokered
Certificates of Deposit. Such deposits are acquired with maturities ranging from
three months to one year. The total balance of brokered Certificates of Deposit
were $87.0 million and $57.5 million at December 31, 2001 and 2000 respectively.
18
Average balances and average rates paid on deposits are as follows:
Years ended December 31
2001 2000 1999
------------------------- -------------------------- --------------------------
Amount Rate Amount Rate Amount Rate
--------------------------------------------------------------------------------
(Dollars in Thousands)
Non-interest bearing
demand deposits $ 37,597 - $ 25,376 - $13,165 -
Interest bearing
demand deposits 129,470 2.99% 91,934 3.65% 73,377 2.97%
Savings deposits 36,670 1.55 43,818 1.69 53,247 1.65
Time deposits 384,522 5.38 368,077 5.81 333,115 5.06
--------------------------------------------------------------------------------
Totals $ 588,259 4.27% $ 529,205 4.82% $472,904 4.21%
================================================================================
The following table sets forth the maturities of First Defiance's
certificates of deposit having principal amounts of $100,000 or more at December
31, 2001.
(In Thousands)
------------------
Certificates of deposit maturing in quarter ending:
March 31, 2002 $ 38,867
June 30, 2002 24,555
September 30, 2002 13,384
December 31, 2002 13,098
After December 31, 2002 16,329
------------------
Total certificates of deposit with
balances of $100,000 or more $ 106,233
==================
The following table details the deposit accrued interest payable as of December
31:
2001 2000
------------------------------
(In Thousands)
Interest bearing demand deposits and
money market accounts $ 44 $ 88
Savings Accounts 2 3
Certificates 853 889
------------------------------
$ 899 $ 980
==============================
For additional information regarding First Defiance's deposits see Note 10 to
the financial statements.
Borrowings. First Defiance may obtain advances from the FHLB of Cincinnati
upon the security of the common stock it owns in that bank and certain of its
residential mortgage loans, provided certain standards related to
creditworthiness have been met. Such advances are made pursuant to several
credit programs, each of which has its own interest rate and range of
maturities.
19
In addition, First Defiance has utilized funding from banks and other
sources. As of December 31, 2001, First Defiance has $225 million under
revolving warehouse loan agreements with two banks. One agreement is an
uncommitted repurchase line of $150 million secured by mortgage loans available
for sale at the federal funds rate plus 40 basis points. The other agreement is
a $75 million committed line of credit secured by mortgage loans available for
sale at the lower of the federal funds rate plus 125 basis points or the LIBOR
index plus 100 basis points. These funding facilities had $30.4 million
outstanding against them as of December 31, 2001 with a weighted average rate of
2.14%. It is anticipated that those borrowings will be paid in full when The
Leader sale transaction is closed in the 2002 second quarter.
The following table sets forth certain information as to First Defiance's
FHLB advances and other borrowings at the dates indicated.
December 31
2001 2000 1999
--------------------------------------------------------
(Dollars in Thousands)
Long-term:
FHLB advances $ 156,302 $ 116,758 $ 187,410
Weighted average interest rate 5.12% 6.06% 5.28%
Notes 5,970 6,147 6,461
Weighted average interest rate 4.79% 4.96% 4.31%
Short-term:
FHLB advances $ 40,000 $ 106,500 $ 78,000
Weighted average interest rate 4.32% 6.50% 5.00%
Warehouse and other revolving
borrowings $ 48,617 $ 114,278 $ 47,043
Weighted average interest rate 2.90% 7.45% 6.64%
20
The following table sets forth the maximum month-end balance and average
balance of First Defiance's FHLB advances and other borrowings during the
periods indicated.
Years ended December 31
2001 2000 1999
-------------------------------------------------------
(Dollars in Thousands)
Long-term:
Maximum balance - FHLB $ 196,567 $ 187,371 $ 187,410
Average balance - FHLB 164,692 155,146 107,319
Weighted average interest rate
of long-term FHLB advances 5.25% 5.49% 4.83%
Maximum balance - Term $ 6,145 $ 6,309 $ 6,472
Average balance - Term 6,031 6,206 4,449
Weighted average interest rate of term
borrowings 3.60% 4.67% 4.02%
Short-term:
Maximum balance - FHLB $ 111,000 $ 140,250 $ 136,250
Average balance - FHLB 62,695 72,384 88,247
Weighted average interest rate
of short-term FHLB advances 4.32% 6.53% 5.29%
Maximum balance - Warehouse and revolving
credit agreements $ 122,624 $ 114,278 $ 49,632
Average balance - Warehouse
and revolving credit agreements 43,007 56,422 25,272
Weighted average interest rate
of warehouse and revolving credit agreements
4.71% 7.60% 6.47%
The FHLB made a series of fixed rate long-term advances to First Defiance
during 1992 and a long-term fixed rate advance under the FHLB Affordable Housing
Program in 1995, totaling $1.3 million outstanding. Additionally, as of December
31, 2001, there was $155.0 million outstanding under various long-term FHLB
advance programs. First Defiance utilizes short-term advances from the FHLB to
meet cash flow needs and for short-term investment purposes. There were $40.0
million and $106.5 million in short-term advances outstanding at December 31,
2001 and 2000, respectively. First Defiance borrows funds under a variety of
programs at the FHLB. At December 31, 2001, $30.0 million was outstanding under
First Defiance's advance line of credit. The total available under the line is
$175.0 million. Amounts are generally borrowed under this line on an overnight
basis.
As a member of the FHLB of Cincinnati, First Federal must maintain an
investment in the capital stock of that FHLB in an amount equal to the greater
of 1.0% of the aggregate outstanding principal amount of First Federal's
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each year, or 5% of its advances from the FHLB. First Federal
is in compliance with this requirement with an investment in stock of the FHLB
of Cincinnati of $16.3 million at December 31, 2001.
21
Each FHLB is required to establish standards of community investment or
service that its members must maintain for continued access to long-term
advances from the FHLBs. The standards take into account a member's performance
under the Community Reinvestment Act and its record of lending to first-time
home buyers. All long-term advances by each FHLB must be made only to provide
funds for residential housing finance.
For additional information regarding First Defiance's FHLB advances,
warehouse and term debt see Notes 11 and 12 to the financial statements.
Employees
First Defiance had 464 employees at December 31, 2001. None of these
employees are represented by a collective bargaining agent, and First Defiance
believes that it enjoys good relations with its personnel.
Competition
The industries in which the Company operates are highly competitive. The
Company competes for the acquisition of mortgage loan servicing rights and bulk
loan portfolios mainly with mortgage companies, savings associations, commercial
banks and other institutional investors. The Company believes that it has
competed successfully for the acquisition of mortgage loan servicing rights and
bulk loan portfolios by relying on the advantages provided by its unique
corporate structure and the secondary marketing expertise of the employees in
each Subsidiary.
Competition in originating loans arises mainly from mortgage companies,
savings associations and commercial banks. The distinction among market
participants is based primarily on price as well as the quality of customer
service and name recognition. Aggressive pricing policies of the Company's
competitors could in the future result in a decrease in the Company's loan
origination volume and/or a decrease in the profitability of the Company's loan
originations, thereby reducing the Company's revenues and net income. The
Company competes for loans by offering competitive interest rates and product
types and by seeking to provide a higher level of personal service to borrowers
than is furnished by competitors. First Federal has a significant market share
of the lending markets in which it conducts operations.
Management believes that First Federal's most direct competition for
deposits comes from local financial institutions. The distinction among market
participants is based primarily on price and, to a lesser extent, the quality of
customer service and name recognition. First Federal's cost of funds fluctuates
with general market interest rates. During certain interest rate environments,
additional significant competition for deposits may be expected from corporate
and governmental debt securities, as well as from money market mutual funds.
First Federal competes for conventional deposits by emphasizing quality of
service, extensive product lines and competitive pricing.
22
Regulation
General. First Defiance, First Federal and The Leader, as an operating
subsidiary of First Federal, are subject to regulation, examination and
oversight by the OTS. Because First Federal's deposits are insured by the FDIC,
First Federal is also subject to examination and regulation by the FDIC. First
Defiance and First Federal must file periodic reports with the OTS and
examinations are conducted periodically by the OTS and the FDIC to determine
whether First Federal is in compliance with various regulatory requirements and
is operating in a safe and sound manner First Federal and The Leader are subject
to various consumer protection and fair lending laws. These laws govern, among
other things, truth-in-lending disclosure, equal credit opportunity, and, in the
case of First Federal, fair credit reporting and community reinvestment. Failure
to abide by federal laws and regulations governing community reinvestment could
limit the ability of First Federal to open a new branch or engage in a merger
transaction. Community reinvestment regulations evaluate how well and to what
extent First Federal lends and invests in its designated service area, with
particular emphasis on low-to-moderate income communities and borrowers in such
areas.
First Defiance is also subject to various Ohio laws which restrict takeover
bids, tender offers and control-share acquisitions involving public companies
which have significant ties to Ohio.
Regulatory Capital Requirements. First Federal, on a consolidated basis
with The Leader, is required by OTS regulations to meet certain minimum capital
requirements. Current capital requirements call for tangible capital of 1.5% of
adjusted total assets, core capital of 4.0% of adjusted total assets, except for
associations with the highest examination rating and acceptable levels of risk,
and risk-based capital of 8% of risk-weighted assets.
23
The following table sets forth the amount and percentage level of
regulatory capital of First Federal at December 31, 2001, and the amount by
which it exceeds the minimum capital requirements. Tangible and core capital are
reflected as a percentage of adjusted total assets. Total (or risk-based)
capital, which consists of core and supplementary capital, is reflected as a
percentage of risk-weighted assets. Assets are weighted at percentage levels
ranging from 0% to 100% depending on their relative risk.
At December 31, 2001
Amount Percent
------------------ --------------
(In Thousands)
Tangible capital $ 70,568 6.59%
Requirement 16,067 4.00
------------------ --------------
Excess $ 54,501 2.59%
================== ==============
Core capital $ 70,568 6.59%
Requirement 16,067 4.00
------------------ --------------
Excess $ 54,501 2.59%
================== ==============
Total capital $ 79,600 11.03%
Risk-based requirement 57,748 8.00
------------------ --------------
Excess $ 21,852 3.03%
================== ==============
The OTS has adopted regulations governing prompt corrective action to
resolve the problems of capital deficient and otherwise troubled savings
associations. At each successively lower defined capital category, an
association is subject to more restrictive and numerous mandatory or
discretionary regulatory actions or limits, and the OTS has less flexibility in
determining how to resolve the problems of the institution. In addition, the OTS
generally can downgrade an association's capital category, notwithstanding its
capital level, if, after notice and opportunity for hearing, the association is
deemed to be engaging in an unsafe or unsound practice because it has not
corrected deficiencies that resulted in it receiving a less than satisfactory
examination rating on matters other than capital or it is deemed to be in an
unsafe or unsound condition. An undercapitalized association must submit a
capital restoration plan to the OTS and is subject to increased monitoring and
growth restrictions. Critically undercapitalized institutions must be placed in
conservatorship or receivership within 90 days of reaching that capitalization
level, except under limited circumstances.
First Federal's capital at December 31, 2001, meets the standards for a
well-capitalized institution, although its risk-based capital is just slightly
over the threshold for well-capitalized status. The Leader has had a significant
effect on First Federal's risk-based capital, due to the treatment under OTS
regulations of mortgage servicing rights, which comprise a substantial amount of
The Leaders' assets. For risk-based capital calculations, OTS regulations limit
the amount of mortgage servicing rights that generally can be included in
risk-based capital to the lesser of (i) the amount of First Federal's core
capital, or (ii) 90% of the fair value of the servicing assets. As The Leader's
mortgage servicing portfolio has grown at a faster rate than First Federal's
core capital, First Federal's risk-based capital level has been adversely
affected. The pending sale of The Leader will eliminate this issue related to
the capital treatment of mortgage servicing rights and after the sale, First
Federal should easily meet the threshold for well-capitalized status.
24
Federal law prohibits an insured institution from making a capital
distribution to anyone or paying management fees to any person having control of
the association if, after such distribution or payment, the association would be
undercapitalized. In addition, each company controlling an undercapitalized
association must guarantee that the association will comply with its capital
plan until the association has been adequately capitalized on an average during
each of four preceding calendar quarters and must provide adequate assurances of
performance. The amount of such guarantee is limited to the lesser of (a) an
amount equal to 5% of the association's total assets at the time the institution
became undercapitalized or (b) the amount that is necessary to bring the
association into compliance with all capital standards applicable to such
association at the time the association fails to comply with its capital
restoration plan.
Limitations on Capital Distributions. The OTS imposes various restrictions
or requirements on the ability of associations to make capital distributions.
Capital distributions include, without limitation, payments of cash dividends,
repurchases and certain other acquisitions by an association of its shares and
payments to stockholders of another association in an acquisition of such other
association.
An application must be submitted and approval from the OTS must be obtained
by a subsidiary of a savings and loan holding company (i) if the proposed
distribution would cause total distributions for the calendar year to exceed net
income for that year to date plus the savings association's retained net income
for that year to date plus the retained net income for the preceding two years;
(ii) if the savings association will not be at least adequately capitalized
following the capital distribution; or (iii) if the proposed distribution would
violate a prohibition contained in any applicable statute, regulation or
agreement between the savings association and the OTS (or the FDIC), or a
condition imposed on the savings association in an OTS-approved application or
notice. If a savings association subsidiary of a holding company is not required
to file an application, it must file a notice of the proposed capital
distribution with the OTS. First Federal did not pay any dividends to First
Defiance during 2001.
25
Qualified Thrift Lender Test. Savings associations must meet one of two
tests in order to be a qualified thrift lender (QTL). The first test requires a
savings association to maintain a specified level of investments in assets that
are designated as qualifying thrift investments (QTIs). Generally, QTIs are
assets related to domestic residential real estate and manufactured housing,
although they also include credit card, student and small business loans and
stock issued by any FHLB, the FHLMC or the FNMA. Under the QTL test, 65% of an
institution's "portfolio assets" (total assets less goodwill and other
intangibles, property used to conduct business and 20% of liquid assets) must
consist of QTI on a monthly average basis in nine out of every 12 months. The
second test permits a savings association to qualify as a QTL by meeting the
definition of "domestic building and loan association" under the Internal
Revenue Code of 1986, as amended (the "Code"). In order for an institution to
meet the definition of a "domestic building and loan association" under the
Code, at least 60% of its assets must consist of specified types of property,
including cash, loans secured by residential real estate or deposits,
educational loans and certain governmental obligations. The OTS may grant
exceptions to the QTL tests under certain circumstances. If a savings
association fails to meet either one of the QTL tests, the association and its
holding company become subject to certain operating and regulatory restrictions.
At December 31, 2001, First Federal met the QTL Test.
Lending Limits. OTS regulations generally limit the aggregate amount that a
savings association may lend to one borrower (the Lending Limit) to an amount
equal to 15% of the savings association's total capital under the regulatory
capital requirements plus any additional loan reserve not included in total
capital (the Lending Limit Capital). A savings association may loan to one
borrower an additional amount not to exceed 10% of total capital plus additional
reserves if the additional loan amount is fully secured by certain forms of
"readily marketable collateral." Real estate is not considered "readily
marketable collateral." Certain types of loans are not subject to these limits.
In applying these limits, loans to certain borrowers may be aggregated.
Notwithstanding the specified limits, an association may lend to one borrower up
to $500,000 "for any purpose." At December 31, 2001, First Federal had aggregate
loans to its largest borrower which exceeded 10% of its total capital. At that
date, First Federal had an agreement in place to participate a portion of this
relationship to another financial institution. However that participation
agreement was not funded until January 18, 2002.
Transactions with Insiders and Affiliates. Loans to executive officers,
directors and principal shareholders and their related interests must conform to
the Lending Limit, and the total of such loans cannot exceed the association's
Lending Limit Capital. Most loans to directors, executive officers and principal
shareholders must be approved in advance by a majority of the "disinterested"
members of board of directors of the association with any "interested" director
not participating. All loans to directors, executive officers and principal
shareholders must be made on terms substantially the same as offered in
comparable transactions with the general public or as offered to all employees
in a company-wide benefit program. Loans to executive officers are subject to
additional restrictions. First Federal was in compliance with such restrictions
at December 31, 2001.
26
All transactions between savings associations and their affiliates must
comport with Sections 23A and 23B of the Federal Reserve Act (FRA). An affiliate
of a savings association is any company or entity that controls, is controlled
by or is under common control with the savings association. First Defiance is an
affiliate of First Federal. Generally, Sections 23A and 23B of the FRA (i) limit
the extent to which a savings association or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
institution's capital stock and surplus, (ii) limit the aggregate of all such
transactions with all affiliates to an amount equal to 20% of such capital stock
and surplus, and (iii) require that all such transactions be on terms
substantially the same, or at least as favorable to the association, as those
provided in transactions with a non-affiliate. The term "covered transaction"
includes the making of loans, purchase of assets, issuance of a guarantee and
other similar types of transactions. In addition to the limits in Sections 23A
and 23B, a savings association may not make any loan or other extension of
credit to an affiliate unless the affiliate is engaged only in activities
permissible for a bank holding company and may not purchase or invest in
securities of any affiliate except shares of a subsidiary. First Federal was in
compliance with these requirements and restrictions at December 31, 2001.
Federal Deposit Insurance Corporation Regulations. The FDIC has examination
authority over all insured depository institutions, including First Federal, and
has authority to initiate enforcement actions if the FDIC does not believe the
OTS has taken appropriate action to safeguard safety and soundness and the
deposit insurance fund.
The FDIC administers two separate insurance funds, the Bank Insurance Fund
(BIF) for commercial banks and state savings banks and the Savings Association
Insurance Fund (SAIF) for savings associations. The FDIC is required to maintain
designated levels of reserves in each fund. The FDIC may increase assessment
rates for either fund if necessary to restore the fund's ratio of reserves to
insured deposits to its target level within a reasonable time and may decrease
such rates if such target level has been met. The FDIC has established a
risk-based assessment system for both SAIF and BIF members. Under this system,
assessments vary based on the risk the institution poses to its deposit
insurance fund. The risk level is determined based on the institution's capital
level and the FDIC's level of supervisory concern about the institution.
FRB Reserve Requirements. FRB regulations currently require reserves of 3%
of net transaction accounts (primarily NOW accounts) up to $42.8 million
(subject to an exemption of up to $5.5 million), and of 10% of net transaction
accounts in excess of $42.8 million. At December 31, 2001, First Federal was in
compliance with its reserve requirements.
27
Holding Company Regulation. First Defiance is a unitary thrift holding
company and is subject to OTS regulations, examination, supervision and
reporting requirements.
There are generally no restrictions on the activities of unitary thrift
holding companies. The broad latitude to engage in activities under current law
can be restricted if the OTS determines that there is reasonable cause to
believe that the continuation of an activity by a thrift holding company
constitutes a serious risk to the financial safety, soundness or stability of
its subsidiary savings association. The OTS may impose such restrictions as
deemed necessary to address such risk, including limiting (i) payment of
dividends by the savings association, (ii) transactions between the savings
association and its affiliates, and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the holding
company and its affiliates may be imposed on the savings association.
Notwithstanding the foregoing rules as to permissible business activities of a
unitary thrift holding company, if the savings association subsidiary of a
holding company fails to meet the QTL Test, then its unitary holding company
would become subject to the activities restrictions applicable to multiple
holding companies. At December 31, 2001, First Federal met the QTL Test.
Federal law generally prohibits a thrift holding company from controlling
any other savings association or thrift holding company, without prior approval
of the OTS, or from acquiring or retaining more than 5% of the voting shares of
a savings association or holding company thereof, which is not a subsidiary. If
First Defiance were to acquire control of another savings institution, other
than through a merger or other business combination with First Federal, First
Defiance would become a multiple thrift holding company and its activities would
thereafter be limited generally to those activities authorized by the FRB as
permissible for bank holding companies.
28
TAXATION
Federal Taxation
The Company and its subsidiaries are each subject to the federal tax laws
and regulations which apply to corporations generally. Prior to 1996, certain
thrift institutions, including First Federal, were allowed deductions for bad
debts under methods more favorable than those granted to other taxpayers.
Qualified thrift institutions could compute deductions for bad debts using
either the specific charge off method of Section 166 of the Code, or the reserve
method of Section 593 of the Code under which a thrift institution annually
could elect to deduct bad debts under either (i) the "percentage of taxable
income" method applicable only to thrift institutions, or (ii) the "experience"
method that also was available to small banks. Under the "percentage of taxable
income" method, a thrift institution generally was allowed a deduction for an
addition to its bad debt reserve equal to 8% of its taxable income (determined
without regard to this deduction and with additional adjustments). Under the
experience method, a thrift institution was generally allowed a deduction for an
addition to its bad debt reserve equal to the greater of (i) an amount based on
its actual average experience for losses in the current and five preceding
taxable years, or (ii) an amount necessary to restore the reserve to its balance
as of the close of the base year. A thrift institution could elect annually to
compute its allowable addition to bad debt reserves for qualifying loans either
under the experience method or the percentage of taxable income method. For tax
year 1995, First Federal used the percentage of taxable income method.
Effective for taxable years beginning after 1995, thrift institutions that
would be treated as small banks are allowed to utilize the experience method
applicable to such institutions, but thrift institutions that are treated as
large banks are required to use only the specific charge off method. First for
purposes of this method, First Federal was treated as a large bank. The
percentage of taxable income method of accounting for bad debts is no longer
available for any financial institution.
A thrift institution required to change its method of computing reserves
for bad debt treated such change as a change in the method of accounting,
initiated by the taxpayer, and having been made with the consent of the
Secretary of the Treasury. Any adjustment under Section 481(a) of the Code
required to be recaptured with respect to such change generally will be
determined solely with respect to the "applicable excess reserves" of the
taxpayer. First Defiance's applicable excess reserves are taken into income for
Federal tax purposes ratably over a six-taxable year period, beginning with the
first taxable year beginning after 1997.
In addition to the regular income tax, the Company and its subsidiaries are
subject to the alternative minimum tax, which is imposed at a minimum tax rate
of 20% on "alternative minimum taxable income" (which is the sum of a
corporation's regular taxable income, with certain adjustments, and tax
preference items), less any available exemption. Such tax preference items
include interest on certain tax-exempt bonds issued after August 7, 1986. In
addition, 75% of the amount by which a corporation's "adjusted current earnings"
exceeds its alternative minimum taxable income computed without regard to this
preference item and prior to reduction by net operating losses, is included in
alternative minimum taxable income. Net operating losses can offset no more than
90%
29
of alternative minimum taxable income. The alternative minimum tax is imposed to
the extent it exceeds the corporation's regular income tax. Payments of
alternative minimum tax may be used as credits against regular tax liabilities
in future years.
The balance of the pre-1988 reserves is subject to the provisions of
Section 593(e) as modified by the Small Business Job Protection Act which
requires recapture in the case of certain excessive distributions to
shareholders. The pre-1988 reserves may not be utilized for payment of cash
dividends or other distributions to a shareholder (including distributions in
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). Distribution of a cash dividend by a thrift institution to a
shareholder is treated as made: first, out of the institution's post-1951
accumulated earnings and profits; second, out of the pre-1988 reserves; and
third, out of such other accounts as may be proper. To the extent a distribution
by First Federal to the Company is deemed paid out of its pre-1988 reserves
under these rules, the pre-1988 reserves would be reduced and First Federal's
gross income for tax purposes would be increased by the amount which, when
reduced by the income tax, if any, attributable to the inclusion of such amount
in its gross income, equals the amount deemed paid out of the pre-1988 reserves.
As of December 31, 2001, First Federal's pre-1988 reserves for tax purposes
totaled approximately $9.52 million.
The tax returns of First Defiance have been audited or closed without audit
through the tax year ended December 31, 1997. The tax returns for The Leader
have been closed through their tax year ended September 30, 1997. In the opinion
of management, any examination of open returns would not result in a deficiency
which would have a material adverse effect on the financial condition of First
Defiance.
Ohio Taxation
The Company is subject to the Ohio corporation franchise tax, which, as
applied to the Company, is a tax measured by both net earnings and net worth.
The rate of tax is the greater of (i) 5.1% on the first $50,000 of computed Ohio
taxable income and 8.5% of computed Ohio taxable income in excess of $50,000 or
(ii) 0.4% times taxable net worth.
As a holding company, the Company may be entitled to various deductions in
computing taxable net worth that are not generally available to operating
companies. Effective for the 1999 tax year, a corporation that qualifies as a
"qualifying holding company" is exempt from tax on the net worth basis. To be
considered a qualifying holding company, a corporation must satisfy certain
criteria and must make an annual election to be treated as a qualified holding
company for tax purposes. Generally, to qualify as a qualifying holding company,
a large portion of a corporation's assets and income must be attributable to
holdings in other corporations or business organizations.
A special litter tax is also applicable to all corporations, including the
Company, subject to the Ohio corporation franchise tax other than "financial
institutions." If the franchise tax is paid on the net income basis, the litter
tax is equal to .11% of the first $50,000 of computed Ohio taxable income and
.22% of computed Ohio taxable income in excess of $50,000. If the franchise tax
is paid on the net worth basis, the litter tax is equal to .014% times taxable
net worth.
30
First Federal is a "financial institution" for State of Ohio tax purposes.
As such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which is imposed annually at a rate of 1.5% of First Federal's
book net worth determined in accordance with GAAP. Effective for the 2001 tax
year, the tax rate is 1.3% of book net worth. As a "financial institution,"
First Federal is not subject to any tax based upon net income or net profits
imposed by the State of Ohio. On December 31, 1998, The Leader was converted to
a single-member limited liability corporation. As such, its operations are not
subject to state taxation as a separate entity.
Item 2. Properties
At December 31, 2001, First Federal conducted its business from its main
office at 601 Clinton Street, Defiance, Ohio, and thirteen other full service
branches in northwestern Ohio. At December 31, 2001, The Leader conducted its
business from leased office space at 1015 Euclid Avenue, Cleveland, Ohio, and
through a branch location at 709 Brookpark Rd., Brooklyn Heights, OH. First
Insurance conducted its business from leased office space at 419 5th Street,
Suite 1200, Defiance, Ohio.
First Defiance maintains its headquarters in the main office of First
Federal at 601 Clinton Street, Defiance, Ohio.
31
The following table sets forth certain information with respect to the
office and other properties of the Company at December 31, 2001. See Note 9 to
the Consolidated Financial Statements.
Leased/ Net Book Value
Description/address Owned of Property Deposits
- --------------------------------------------------------------------------------
(Dollars in Thousands)
Main Office, First Federal
601 Clinton Street, Defiance, OH Owned $ 6,086 $ 288,637
Branch Offices, First Federal
204 E. High Street, Bryan, OH Owned 1,100 90,995
211 S. Fulton Street, Wauseon, OH Owned 782 40,001
625 Scott Street, Napoleon, OH Owned 1,583 68,689
1050 East Main Street, Montpelier, OH Owned 586 20,086
926 East High Street, Bryan, OH Owned 111 8,106
1333 Woodlawn, Napoleon, OH Owned 74 16,795
825 N. Clinton Street, Defiance, OH Owned 391 10,351
Inside Super K-Mart Leased 83 6,353
190 Stadium Dr., Defiance, OH
905 N. Williams St., Paulding, OH Owned 1,090 17,295
201 E. High St., Hicksville, OH Owned 577 10,166
3900 N. Main St., Findlay, OH Owned 1,433 25,834
11694 N. Countyline St., Fostoria, OH Owned 913 12,734
1204 W. Wooster, Bowling Green, OH Leased -- 15,408
Main Office, The Leader
1015 Euclid Avenue, Cleveland, OH Leased -- N/A
Branch Office, The Leader
709 Brookpark Rd., Brooklyn Heights, OH Leased -- N/A
First Insurance & Investments
419 5th Street, Site 1200, Defiance, OH Leased -- N/A
---------------------------
$ 14,809 $ 631,450
==========================
32
Item 3. Legal Proceedings
First Defiance is involved in routine legal proceedings occurring in the
ordinary course of business which, in the aggregate, are believed by management
to be immaterial to the financial condition of First Defiance.
Item 4. Submission of Matters to a Vote of Securities Holders
No matters were submitted to a vote of securities holders during the fourth
quarter of 2001.
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The Company's common stock trades on The Nasdaq Stock Market under the
symbol "FDEF." As of March 8, 2001, the Company had 1,740 shareholders of
record. The table below shows the reported high and low sales prices of the
common stock and cash dividends declared per share of common stock during the
periods indicated in 2001 and 2000.
December 31, 2001 December 31, 2000
---------------------------------------------- ----------------------------------------------
High Low Dividend High Low Dividend
--------------- --------------- -------------- --------------- --------------- --------------
Quarter Ended:
March 31 $ 15.63 $ 10.69 $ .12 $ 12.50 $ 8.00 $ .11
June 30 17.20 13.50 .12 9.38 7.63 .11
September 30 18.00 13.28 .12 9.63 8.00 .11
December 31 15.24 12.79 .13 11.12 8.38 .12
For information regarding restriction on the payment of dividends, see
"Item 1. Business - Regulation - Limitations on Capital Distributions" in this
report.
33
Item 6. Selected Financial Data
The following table sets forth certain summary consolidated financial data
at or for the periods indicated. This information should be read in conjunction
with the Consolidated Financial Statements and notes thereto included herein.
See "Item 8. Financial Statements and Supplementary Data."
At or For Years ended December 31,
-----------------------------------------------------------------------------
2001 2000 1999 1998 1997
-----------------------------------------------------------------------------
(Dollars in Thousands, except per share data)
Selected Consolidated Financial Data:
Total assets $1,132,613 $1,072,194 $ 987,994 $ 785,399 $ 579,698
Loans held-to maturity, net 517,829 541,208 465,321 448,574 441,824
Loans held-for-sale 275,723 232,314 237,622 119,910 88
Allowance for loan losses 9,937 8,904 7,758 9,789 2,686
Non-performing assets 3,590 1,761 3,587 3,369 1,906
Securities available-for-sale 48,989 53,176 53,946 47,554 82,536
Trading securities - 234 29,805 - -
Securities held-to maturity 5,580 7,697 9,895 13,541 20,953
Mortgage servicing rights 157,369 134,760 97,519 76,452 188
Deposits and borrowers' escrow
balances 754,604 613,881 564,511 511,313 395,983
FHLB advances 196,302 223,258 265,410 168,142 71,665
Stockholders' equity 111,021 99,473 89,416 93,710 106,884
Selected Consolidated Operating
Results:
Total interest income $ 65,864 $ 65,185 $ 53,379 $ 49,056 $ 43,858
Total interest expense 38,886 43,502 31,582 26,946 21,387
Net interest income 26,978 21,683 21,797 22,110 22,471
Provision for loan losses 3,870 3,147 1,925 7,769 1,613
Non-interest income 66,431 53,246 40,794 17,528 1,627
Non-interest expense 68,340 54,905 47,414 26,940 14,093
Income before income taxes 21,199 16,877 13,252 4,929 8,392
Income taxes 7,583 5,914 4,629 1,818 2,985
Net income 13,616 10,963 8,623 3,111 5,407
Basic earnings per share 2.11 1.74 1.33 0.42 0.65
Diluted earnings per share 2.05 1.71 1.29 0.40 0.62
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on average assets 1.24% 1.09% 0.99% 0.45% 0.78%
Return on average equity 13.08% 11.71% 9.52% 2.99% 4.69%
Interest rate spread (1) 3.10% 2.72% 2.86% 3.25% 3.39%
Net interest margin (1) 3.27% 2.80% 3.12% 3.62% 4.24%
Ratio of operating expense to
Average total assets 6.22% 5.44% 5.44% 3.85% 2.51%
34
At or for Years ended December 31,
--------------------------------------------------------------------------------
2001 2000 1999 1998 1997
--------------------------------------------------------------------------------
(Dollars in Thousands, except per share data)
Selected Financial Ratios and Other Data (continued):
Quality Ratios:
Non-performing assets to total
assets at end of period (2) 0.32% 0.16% 0.36% 0.43% 0.33%
Allowance for loan losses to
non-performing assets (2) 276.80% 505.62% 216.28% 209.56% 140.92%
Allowance for loan losses to total
loans receivable 1.25% 1.14% 1.09% 1.69% 0.60%
Capital Ratios:
Equity to total assets at end of 9.80% 9.28% 9.05% 11.93% 18.44%
period
Tangible equity to tangible assets
at end of period 8.74% 8.08% 7.68% 10.41% 18.44%
Average equity to average assets 9.47% 9.27% 10.40% 14.86% 20.55%
Book value per share 16.20 $14.49 $13.12 $12.37 $12.53
Tangible book value per share 14.27 $12.46 $10.97 $10.61 $12.53
Ratio of average interest-earning assets
to average interest-bearing
liabilities 103.73% 101.48% 105.96% 108.43% 121.45%
Cash Earnings:
Cash earnings $ 14,449 $ 11,786 $ 9,382 $ 3,393 $ 5,407
Basic cash earnings per share 2.24 1.87 1.44 0.45 0.65
Diluted cash earnings per share 2.17 1.84 1.40 0.43 0.62
Cash return on average assets 1.31% 1.18% 1.09% 0.49% 0.96%
Cash return on average equity 13.88% 14.87% 11.99% 3.44% 4.69%
Stock Price and Dividend Information:
High $18.00 $12.50 $14.50 $ 15.875 $16.25
Low 10.69 7.63 9.875 11.00 11.75
Close 15.20 10.88 10.50 14.25 16.00
Cash dividends declared per share .49 .45 0.41 0.37 0.33
Dividend payout ratio (3) 23.22% 25.86% 30.83% 88.10% 50.77%
(1) Interest rate spread represents the difference between the weighted average
yield on interest-earnings assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earnings assets.
(2) Non-performing assets consist of non-accrual loans that are contractually
past due 90 days or more; loans that are deemed impaired under the criteria
of FASB Statement No. 114; and real estate, mobile homes and other assets
acquired by foreclosure or deed-in-lieu thereof.
(3) Dividends payout ratio was calculated using basic earnings per share.
35
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
First Defiance is a unitary thrift holding company which conducts business
through its subsidiaries, First Federal, First Insurance and The Leader.
First Federal is a federally chartered savings bank that provides financial
services to communities based in northwest Ohio where it operates 14 full
service branches. First Federal provides a broad range of financial services
including checking accounts, real estate mortgage loans, commercial loans,
consumer loans, home equity loans, and trust services.
First Insurance sells a variety of property and casualty, group health and
life, and individual health and life insurance products and investment and
annuity products. Insurance products are sold through First Insurance's office
in Defiance, Ohio while investment and annuity products are sold through
investment representatives located at two First Federal branch locations.
The Leader is a mortgage banking company that specializes in servicing
loans originated under first-time homebuyer programs. Under these programs,
first-time homebuyers are able to obtain loans at rates generally below market
at the time of closing. The funds for the loans are available as a result of
bond issues through various state and local governmental units. The Leader, as
master servicer under the bond programs, purchases the loans from the
originator, principally other financial institutions or mortgage brokers. Once
purchased by The Leader, the loans under the specific bond programs are packaged
and GNMA securities are issued to the bond trustees under the programs. As of
December 31, 2001, The Leader serviced approximately 104,000 bond program loans
with balances of $7.4 billion. Because the loans under the first-time homebuyer
programs are generally issued at below market rates, they typically have
significantly lower pre-payment rates than conventional mortgage loans. The
Leader also collects a significant amount of ancillary fees, including late
charges. At December 31, 2001, total loans serviced by The Leader, including
bond program loans, conventional loans and loans serviced for various third
parties, consisted of 140,600 loans with a total balance of $9.2 billion. On
January 18, 2002, First Defiance announced that it had signed a definitive
agreement to sell The Leader to U.S. Bank Home Mortgage, a unit of U.S. Bank.
36
Financial Condition
Total assets at December 31, 2001 were $1.133 billion, a 5.6% increase from
the December 31, 2000 total of $1.072 billion.
Net loans receivable (excluding loans held for sale) declined by $23.4
million and investment securities declined by $6.5 million. Those decreases were
offset by increases in cash and cash equivalents, which rose by $15.2 million,
loans held for sale, which increased by $43.4 million, and mortgage servicing
rights, which increased by $22.6 million.
The reduction in loans receivable occurred primarily in the single-family
residential category, which declined by $65.4 million. This reduction was due to
the high level of mortgage loan refinancings that occurred in 2001 due to the
low interest rate environment. The majority of loans refinanced were then sold
into the secondary market to limit the Company's exposure to interest rate risk
on long-term fixed rate loans. Approximately 91% of new first-mortgage loans
made by First Federal in 2001 were sold into the secondary market. Automobile
loans also declined in 2001, by $10.3 million to $33.3 million, continuing a
trend that began in 1999 when the Company implemented more stringent
underwriting guidelines for that type of lending. These declines were partially
offset by increases in loans secured by non-residential real estate (which
increased $27.0 million to $152.5 million), loans secured by multi-family
residential property (which increased $21.6 million to $66.3 million), home
equity and improvement loans (which increased $4.3 million to $36.2 million) and
commercial loans (which increased $2.6 million to $83.7 million).
Loans available for sale and mortgage servicing rights, two assets
primarily associated with The Leader, both increased significantly at December
31, 2001 compared to December 31, 2000. Loans available for sale increased to
$275.7 million at December 31, 2001 from $232.3 million. The increase was
primarily due to the Company's strategy to hold certain higher interest loans in
the warehouse for extended periods to take advantage of the favorable interest
rate spread. Mortgage servicing rights increased to $157.4 million at December
31, 2001 from $134.8 million at December 31, 2000. This growth is a function of
continued loan production at The Leader throughout 2001. The 2001 balance is net
of a $2.8 million impairment reserve. There was no impairment reserve recorded
as of December 31, 2000.
The Company's deposits increased by $85.6 million or 15.7% from $545.9
million at December 31, 2000 to $631.5 million at December 31, 2001. This growth
was realized in checking accounts (which increased $12.9 million or 19.5%),
money market accounts (which increased $33.9 million or 42.9%) and certificates
of deposit (which increased $39.4 million or 10.8%). Of these deposit balances,
$144.6 million were associated with The Leader at December 31, 2001 compared to
$88.6 million at the end of 2000. The certificate of deposit balances include
approximately $87.0 million of brokered CDs at December 31, 2001, up from $57.5
million at December 31, 2000.
First Defiance also realized a significant increase in advance payments by
borrowers for principle, interest, taxes and insurance, which increased from
$68.0 million
37
at December 31, 2000 to $123.2 million at December 31, 2001. This balance
increased due to the increased level of payoffs that were experienced in the
mortgage banking operations. The Company has the right to hold those payoffs for
up to 45 days before they must be remitted to the investors.
As a result of the increases in deposits and advance payment accounts,
First Defiance was able to reduce its FHLB advances by $27.0 million to $196.3
million at December 31, 2001 from $223.3 million at December 31, 2000 and its
warehouse and term note borrowings by $65.8 million to $54.6 million at December
31, 2001 from $120.4 million at December 31, 2000.
Changes in the above balances, and the inability to further pay down fixed
rate FHLB advances, resulted in a higher than normal cash and cash equivalent
balance at December 31, 2001 of $36.1 million compared to $21.0 million at
December 31, 2000. Paydowns and maturities of investment securities which were
not reinvested because funds were deployed elsewhere resulted in the investment
portfolio declining to $54.6 million at December 31, 2001 from $61.1 million at
the end of 2000.
38
Average Balances, Interest Rates and Yields
The following table presents for the periods indicated the total dollar
amounts of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. The table does
not reflect the effect of income taxes.
Year Ended December 31,
-------------------------------------------------------------------------------------
2001 2000
------------------------------------------ -----------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate
--------------- ------------- ------------- ------------- ------------ -------------
Interest-Earning Assets (Dollars in thousands)
Loans receivable $ 783,266 $ 62,109 7.93% $ 730,264 $ 60,382 8.27%
Securities 58,118 3,755 6.46 67,868 4,803 7.08
Dividends on FHLB stock 15,669 1,058 6.75 14,570 1,075 7.38
--------------- ------------- ------------- ------------- ------------ -------------
Total interest-earning assets 857,053 66,922 7.81 812,702 66,260 8.15
Non-interest-earning assets 241,986 196,589
--------------- -------------
Total assets $1,099,039 $1,009,291
=============== =============
Interest-Bearing Liabilities
Interest-bearing deposits 550,661 $ 25,120 4.56 503,829 $ 25,501 4.82
FHLB advances 227,387 11,393 5.01 228,055 13,297 5.83
Warehouse and term notes payable 48,210 2,373 4.92 68,993 4,704 6.82
--------------- ------------- ------------- ------------- ------------ -------------
Total interest-bearing liabilities 826,258 38,886 4.71 800,877 43,502 5.43
Non-interest bearing demand deposits $ 37,597 -- $ 25,376 --
--------------- ------------- ------------- ------------
Total including non-interest-bearing
demand deposits 863,855 38,886 4.50 826,253 43,502 5.26
Other non-interest-bearing liabilities 131,082 89,418
--------------- -------------
Total liabilities 994,937 915,671
Stockholders' equity 104,102 93,620
--------------- -------------
Total liabilities and stockholders' equity $ 1,099,039 $1,009,291
=============== =============
Net interest income; interest rate spread (2) $ 28,036 3.10% $ 22,758 2.72%
============= ============= ============ =============
Net interest margin (3) 3.27% 2.80%
============= =============
Average interest-earning assets to average
interest-bearing liabilities 103.7% 101.5%
============= =============
Year Ended December 31,
------------------------------------------
1999
------------------------------------------
Average Yield/
Balance Interest Rate
-------------- ------------- -------------
Interest-Earning Assets
Loans receivable $657,009 $49,927 7.60%
Securities 56,668 3,452 6.09
Dividends on FHLB stock 12,157 861 7.08
-------------- ------------- -------------
Total interest-earning assets 725,834 54,240 7.47
Non-interest-earning assets 145,667
--------------
Total assets $871,501
==============
Interest-Bearing Liabilities
Interest-bearing deposits 459,748 $19,889 4.21
FHLB advances 195,566 9,872 5.05
Warehouse and term notes payable 29,721 1,821 6.13
-------------- ------------- -------------
Total interest-bearing liabilities 685,035 31,582 4.61
Non-interest bearing demand deposits $ 13,156 --
-------------- -------------
Total including non-interest-bearing
demand deposits 698,191 31,582 4.52
Other non-interest-bearing liabilities 82,691
--------------
Total liabilities 780,882
Stockholders' equity 90,619
--------------
Total liabilities and stockholders' equity $871,501
==============
Net interest income; interest rate spread (2) $22,658 2.86%
============= =============
Net interest margin (3) 3.12%
=============
Average interest-earning assets to average
interest-bearing liabilities 106.0%
=============
(1) At December 31, 2001, the yields earned and rates paid were as follows:
loans receivable, 7.18%; securities, 6.37%; FHLB stock, 5.50%; total
interest-earning assets, 7.10%; deposits, 3.28%; FHLB advances, 4.60%;
warehouse and term notes payable, 2.80%; total interest-bearing
liabilities, 3.60%; and interest rate spread, 3.50%.
(2) Interest rate spread is the difference in the yield on interest-earning
assets and the cost of interest bearing liabilities.
(3) Net interest margin is net interest income divided by average
interest-earning assets.
39
Rate/Volume Analysis
The following table describes the extent to which changes in interest rates
and changes in volume of interest-related assets and liabilities have affected
First Defiance's interest income and expense during the periods indicated. For
each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in volume multiplied by prior year rate), (ii) change in rate (change in rate
multiplied by prior year volume), and (iii) total change in rate and volume. The
combined effect of changes in both rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
Year Ended December 31,
--------------------------------------------------------------------------------------
2001 vs. 2000 2000 vs. 1999
--------------------------------------------------------------------------------------
Increase Increase Increase Increase
(decrease) (decrease) Total (decrease) (decrease) Total
due to due to increase due to due to increase
rate volume (decrease) rate volume (decrease)
--------------------------------------------------------------------------------------
(In thousands)
Interest-Earning Assets
Loans $ (2,656) $ 4,383 $ 1,727 $ 4,888 $ 5,567 $ 10,455
Securities (358) (690) (1,048) 669 682 1,351
Interest-bearing deposits - - - - - -
FHLB stock (98) 81 (17) 43 171 214
--------------------------------------------------------------------------------------
Total interest-earning assets $ (3,112) $ 3,774 $ 662 $ 5,600 $ 6,420 $ 12,020
======================================================================================
Interest-Bearing Liabilities
Deposits $ (2,758) $ 2,377 $ (381) $ 3,244 $ 2,368 $ 5,612
FHLB advances (1,865) (39) (1,904) 1,785 1,640 3,425
Warehouse and term notes payable (914) (1,417) (2,331) 477 2,406 2,883
--------------------------------------------------------------------------------------
Total interest-bearing liabilities $ (5,537) $ 921 $ (4,616) $ 5,506 $ 6,414 $ 11,920
======================================================================================
Increase in net interest income $ 5,278 $ 100
================ ===============
-------------------------------------------
1999 vs. 1998
-------------------------------------------
Increase Increase
(decrease) (decrease) Total
due to due to increase
rate volume (decrease)
-------------------------------------------
Interest-Earning Assets
Loans $ (4,662) $ 11,220 $ 6,558
Securities (89) (1,541) (1,630)
Interest-bearing deposits - (605) (605)
FHLB stock (9) 536 527
-------------------------------------------
Total interest-earning assets $ (4,760) $ (9,610) $ 4,850
===========================================
Interest-Bearing Liabilities
Deposits $ (1,303) $ 2,852 $ 1,549
FHLB advances (995) 6,696 5,701
Warehouse and term notes payable 317 (2,931) (2,614)
-------------------------------------------
Total interest-bearing liabilities $ (1,981) $ 6,617 $ 4,636
===========================================
Increase in net interest income $ 214
===============
40
Results of Operations
General - First Defiance reported net income of $13.62 million for the year
ended December 31, 2001 compared to $10.96 million and $8.62 million for the
years ended December 31, 2000 and 1999 respectively. On a diluted per share
basis, First Defiance earned $2.05, $1.71 and $1.29 for the years ended December
31, 2001, 2000 and 1999 respectively.
Net interest income was $27.0 million for the year ended December 31, 2001,
compared to $21.7 million and $21.8 million for the years ended December 31,
2000 and 1999 respectively. Net interest margin was 3.27%, 2.80% and 3.12% for
the years ended December 31, 2001, 2000 and 1999 respectively. The increase in
net interest margin in 2001 over 2000 is due primarily to an increase in the
interest rate spread from 2.72% for the year ended December 31, 2000 to 3.10%
for 2001, and increases of $12.2 million, $41.7 million and $10.5 million in
average non-interest bearing deposits, average other non-interest bearing
liabilities, and average shareholders equity respectively. The decrease in
margins that were experienced in 2000 compared to 1999 were due primarily to the
financing required to support the $50.9 million increase in average non-interest
earning assets between 1999 and 2000. That increase was primarily the result of
increases in mortgage servicing rights and prepaid expenses and other assets.
The cost of interest bearing liabilities dropped 72 basis points in 2001
compared to 2000 while the yield on interest earning assets fell 34 basis points
between those same periods, resulting in the 38 basis point spread improvement.
The cost of average interest bearing liabilities declined to 4.71% for 2001
compared 5.43% in 2000 while the yields on interest earning assets declined to
7.81% in 2001 from 8.15% in 2000. The decline in rates for both assets and
liabilities was due to falling market rates throughout 2001 spurred by the
Federal Reserve's 11 cuts to the Federal Funds rate. Liability rates fell more
than asset rates primarily due to the improved mix of both interest earning
assets and interest bearing liabilities. On the asset side, loans receivable
balances increased while lower-yielding investment securities balances declined.
On the liability side, non-interest bearing deposits and money market balances
increased at a greater pace than certificates of deposit while FHLB advances
remained flat and outside borrowings declined.
In 2000 compared to 1999, the yield on interest earning assets increased to
8.15% from 7.47% while the cost of interest-bearing liabilities increased to
5.43% from 4.61%. Asset yields increased in 2000 because of increased balances
in non-residential real estate and commercial loans as well as general interest
rate increases. The increase in the cost of funds was the result of several
increases in the targeted Federal Funds rate as well as increased usage of
external funding sources to finance the growth in mortgage banking activities.
The provision for loan losses for the year ended December 31, 2001 was $3.9
million compared to $3.1 million in 2000 and $1.9 million for 1999. The
provision was comprised of $1.0 million for credit losses and $2.9 million to
cover the cost of servicing foreclosed properties in 2001 compared to $499,000
and $2.6 million in credit and foreclosure costs in 2000 respectively and
$155,000 and $1.8 million in credit and foreclosure costs respectively in 1999.
41
For the year ended December 31, 2001, non-interest income was $66.4 million
compared to $53.2 million for 2000 and $40.8 million for 1999. Non-interest
expense for the year ended December 31, 2001 was $68.3 million compared to $54.9
million for 2000 and $47.4 million for 1999.
See also the "Results Reflecting The Sale of The Leader Mortgage Company"
section of Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Net Interest Income - First Defiance's net interest income is determined by
its interest rate spread (i.e. the difference between the yields on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities.
Total interest income increased by only $679,000, or 1.0%, to $65.9 million
for the year ended December 31, 2001 from $65.2 million for the year ended
December 31, 2000. Average loans receivable increased to $783.3 million for 2001
from $730.3 million for 2000 while average investment securities declined to
$58.1 million for 2001 from $67.9 million. Although the average balance of total
interest-earning assets including FHLB stock increased by $44.4 million in 2001
compared to 2000, the yield on those total assets fell to 7.81% in 2001 from
8.15% in 2000.
The average balance of loans held for sale increased to $243.1 million for
2001 compared to $219.6 million for 2000 while the average balance of
non-residential real estate and commercial loans grew to $275.2 million for 2001
from $208.9 million for 2000. Also the average balance of home equity and
improvement loans grew by $6.8 million from December 31, 2000 to December 31,
2001. This growth was partially offset by a $30.0 million decrease in the
average balance of single-family residential loans and a $13.4 million decrease
in the average balance of all consumer loans. The increase in the average
balance of non-residential real estate and commercial loans is the result of the
Company's strategy to increase this type of lending. Residential mortgage loans
declined because falling interest rates caused a high level of refinanced loans,
most of which were subsequently sold into the secondary market. The decline in
consumer loans continues a trend that started in 1999 when the Company tightened
underwriting standards. The increase in the average balance of available for
sale loans is the result of The Leader retaining certain loans which had higher
interest rates than the typical housing finance agency loans that generally
occupy its warehouse. With the anticipated sale of The Leader in 2002, the
available for sale balances will decline substantially while the balance of
investment securities will increase significantly.
In 2000, total interest income increased by $11.8 million, or 22.1%, to
$65.2 million for the year ended December 31, 2000 from $53.4 million for the
year ended December 31, 1999. The increase was due to a $73.3 million increase
in the average balance of loans outstanding for 2000 compared to 1999 and an
increase in yield to 8.27% for 2000 from 7.60% for 1999. The increase in
balances were in non-residential real estate and commercial loans, which
increased in total by $66.8 million, and loans held for sale, which increased by
$32.8 million, offset by declines in residential mortgage and consumer loans.
42
Interest earnings from the investment portfolio and other interest-bearing
deposits decreased to $3.8 million for 2001 from $4.8 million for 2000 as the
average balances declined to $58.1 million for 2001 from $67.9 million for 2000.
The yield on those investments declined 62 basis points during that period to
6.46% for 2001 from 7.08% for 2000. In 1999, interest earnings from the
investment portfolio totaled $3.5 million as the average balance of $56.7
million earned an average yield of 6.09%. Because of the loan demand and the
financing requirements of The Leader, the investment portfolio has been used
primarily as a source of liquidity during the last three years. It is
anticipated that when the sale of The Leader is completed, the investment
portfolio will increase significantly.
Interest expense decreased by $4.6 million, or 10.6%, to $38.9 million in
2001 compared to $43.5 million in 2000. The decrease is due to a decline in the
cost of total interest bearing liabilities to 4.71% for 2001 from 5.43% for
2000. The cost of interest bearing deposits dropped 26 basis points, to 4.56% in
2001 from 4.82% in 2000; the cost of FHLB advances dropped 82 basis points, to
5.01% from 5.83%; and the cost of warehouse and other notes payable dropped 190
basis points, to 4.92% from 6.82%. The Company also experienced $12.2 million or
48.2% growth in its non-interest bearing deposit balances. Interest-bearing
deposit balances increased by $46.8 million in 2001 compared to 2000 with much
of the growth coming in the Company's money market product. The average balance
of FHLB advances remained relatively stable between 2001 and 2000 while the
average balance of warehouse and other term notes payable declined by $20.8
million.
In 2000, interest expense increased by $11.9 million, or 37.7%, to $43.5
million compared to $31.6 million for 1999. The increase is due to the increase
in the average interest bearing liabilities to $800.9 million in 2000 from
$685.0 million in 1999. Additionally, the average cost of funds on
interest-bearing liabilities increased to 5.43% during 2000 from 4.61% during
1999. The increased balances were due to increased funding requirements relating
to loans held for sale and mortgage servicing rights at The Leader and increased
loan growth at First Federal while the increased cost of funds is due to higher
rates in 2000 resulting from several Federal Reserve increases in the targeted
Federal Funds rate during 2000 as well as increased usage of outside financing
sources to finance The Leader's mortgage banking activities. All warehouse and
other notes payable will be paid off at the completion of The Leader sale
transaction in 2002. To the extent possible, certain FHLB advances and brokered
certificates of deposits will be repaid or not replaced as they mature.
As a result of the foregoing, First Defiance's net interest income was
$27.0 million for the year ended December 31, 2001 compared to $21.7 million for
the year ended December 31, 2000 and $21.8 million for the year ended December
31, 1999. Net interest margin for the year ended December 31, 2001 increased to
3.27% from 2.80% for 2000 and 3.12% for 1999.
Provision for Loan Losses - First Defiance's provision for loan losses was
$3.9 million for the year ended December 31, 2001 compared to $3.1 million and
$1.9 million for the years ended December 31, 2000 and 1999 respectively. The
provision for loan losses is comprised of a provision for credit losses, which
accounts for losses on First Federal's loan portfolio, and a
43
provision for foreclosure losses, which accounts for expected administrative and
legal charges necessary to take loans through the foreclosure process.
Foreclosure losses are entirely associated with The Leader's mortgage servicing
portfolio. The credit loss portion of the provision was $1.0 million, $635,000,
and $155,000 respectively in 2001, 2000 and 1999 respectively while the
foreclosure loss portion of the provision was $2.9 million, $2.5 million and
$1.8 million respectively in those same three years.
Provisions for credit losses are charged to earnings to bring the total
allowance for credit losses to a level that is deemed appropriate by management.
Factors considered by management include identifiable risk in the portfolios,
historical experience, the volume and type of lending conducted by First
Defiance, regulatory guidance, the amount of non-performing assets, including
loans which meet the FASB Statement No. 114 definition of impaired, general
economic conditions, particularly as they relate to First Defiance's market
areas, and other factors related to the collectibility of First Defiance's loan
portfolio.
Continued growth in non-residential and commercial loans at First Federal,
which have an inherently higher level of risk than other types of loans, and
concerns about economic conditions in the northwest Ohio market area caused the
provision for credit losses to increase in 2001 from 2000 and 1999 levels. The
allowance for credit losses totaled $6.55 million at December 31, 2001 compared
to $6.33 million at December 31, 2000 and $6.50 million at December 31, 1999.
Total credit charge-offs for 2001 and 2000 were $1.0 million each year and $2.5
million in 1999 while recoveries for those same three years were $257,000,
$222,000 and $279,000 respectively. The high level of charge-offs recorded in
1999 related to underwriting problems First Federal experienced with its
consumer loan portfolio in 1997 and 1998. Those charge-offs were provided for in
a large adjustment to the allowance for loan losses recorded by First Federal in
1998.
First Defiance's non-performing assets at December 31, 2001 were $3.6
million compared to $1.8 million at December 31, 2000. These totals include real
estate owned by The Leader of $1.1 million and $271,000 at the end of 2001 and
2000 respectively. The increase in real estate owned is primarily due to the
slowing economy which tends to impact the borrowers in the programs in which The
Leader specializes. First Federal's non-performing assets were $2.5 million at
December 31, 2001 compared to $1.5 million at December 31, 2000. Non-performing
assets include loans that are 90 days past due and all real estate owned and
other foreclosed assets. Non-performing assets at First Federal at December 31,
2001 and 2000 by category were as follows:
44
December 31
2001 2000
--------------- ------------------
(In thousands)
Non-performing loans:
Single-family residential $1,151 $671
Non-residential and multi-family
residential real estate 972 572
Commercial 110 140
Consumer finance 138 66
--------------- ------------------
Total non-performing loans $2,371 $1,449
Real estate owned and repossessed assets 136 41
--------------- ------------------
Total non-performing assets $2,507 $1,490
=============== ==================
The $972,000 balance of non-performing non-residential and multi-family
residential real estate loans represents a $400,000 or 70% increase from the
2000 level. Total non-residential and multi-family real estate loans increased
by $48.6 million over that same period. Non-performing loans in the
non-residential and multi-family residential real estate loan category represent
.44% of the total loans in that category at December 31, 2001 compared to .34%
at December 31, 2000. This increase is primarily due to one commercial loan that
is more than 90 days past due and management believes the allowance for loan
losses for this loan is adequate to cover any potential loss
The increase in single-family non-performing loans, while significant,
should not materially impact First Defiance's results. These non-performing
loans are comprised of 23 single-family mortgage loans with an average balance
of $50,000 outstanding at December 31, 2001. These loans are generally
well-secured. Management believes the allowance for loan losses is adequate to
cover any potential losses on these loans.
During the year ended December 31, 2001, The Leader recorded a provision
for foreclosure losses totaling $2.8 million compared to foreclosure provisions
of $2.6 million and $1.8 million recorded in 2000 and 1999 respectively. In
2000, management changed its method of estimating the required reserve for
potential losses on foreclosures to more accurately reflect the total risk
inherent in the servicing and loan portfolios at The Leader. This resulted in a
one-time increase in the provision for foreclosure losses of $693,000. Excluding
the one-time adjustment in 2000, the provision for foreclosure losses increased
$1.0 million between 2000 and 2001. This increase is a result of a growing
portfolio and a weaker economy nationwide. The borrowers who participate in the
first-time homebuyers tend to be among the first impacted by a weaker economy.
Non-interest Income - Non-interest income increased by $13.2 million to
$66.4 million in 2001 from $53.2 million in 2000 and $40.8 million in 1999.
$56.2 million of the 2001 non-interest income was related to operations that are
being sold as part of The Leader sale transaction. The Leader accounted for
$46.5 million and $35.9 million of the non-interest income in 2000 and 1999,
respectively.
45
Non-interest income, excluding The Leader, was $10.2 million in 2001
compared to $6.7 million in 2000 and $4.9 million in 1999. The 52.2% increase
from 2000 to 2001 was primarily attributable to gains on sale of mortgage loans,
which increased to approximately $3.1 million in 2001 from approximately
$580,000 in 2000. The increase was the result of record mortgage originations
through First Federal's branch networks caused by low mortgage interest rates
throughout the year. Loan and deposit fees at First Federal increased to $3.2
million in 2001 from $2.3 million in 2000 and commission income at First
Insurance increased to $2.8 million from $2.4 million. In 1999, gains on
mortgage loan sales totaled $876,000 while loan and deposit fees were $1.7
million and insurance agency income was $1.2 million.
The Leader's non-interest income increased each year between 1999 and 2001
because of continued growth in the mortgage servicing portfolio, which resulted
in growth in mortgage servicing fees, and increases in gains on sale, a result
of a significant increase in mortgage production in the first-time homebuyer
programs between 1999 and 2001. Also, 2001 results included $2.5 million in
gains from the sale of certain loans, which had a history of delinquency, out of
the servicing portfolio to a third party. These transactions were accomplished
by purchasing the loans out of the servicing portfolio at par as allowed under
the servicing agreements and then selling the loans to a third party at a
premium.
Non-interest Expense - Total non-interest expense for 2001 was $68.3
million compared to $54.9 million for the year ended December 31, 2000 and $47.4
million for the year ended December 31, 1999. The 2001 total includes $46.0
million of costs associated with The Leader while the 2000 and 1999 totals
include $34.7 million and $29.5 million of The Leader's costs respectively.
Excluding expenses that relate to The Leader, non-interest expense was
$22.9 million for 2001, $20.2 million for 2000 and $17.9 million for 1999. The
$2.7 million increase from 2000 to 2001 was caused primarily by a $1.0 million
increase in compensation and benefits, and a $1.0 million increase in
amortization and impairment of mortgage servicing rights. Compensation and
benefits increased approximately $325,000 because of pay raises, $100,000
because of increases in various forms of incentive compensation linked to the
performance of the Company and $575,000 related to staffing increases, including
a full year of staffing of the Bowling Green, Ohio branch that opened in the
fall of 2000. Mortgage servicing rights amortization and impairment increased
approximately $225,000 because of growth in the servicing portfolio and because
approximately $775,000 of the $2.8 million of the impairment adjustment recorded
by The Leader against its mortgage servicing portfolio related to servicing
rights that will be retained by First Federal after the close of The Leader sale
transaction.
The $11.3 million increase in non-interest expense at The Leader between
2000 and 2001 was almost all related to the amortization and impairment of
mortgage servicing rights. Amortization expense related to the mortgage
servicing portfolio that will be part of The Leader sale increased to $23.0
million in 2001 from $14.7 million in 2000 because of both the increase in
prepayments on the underlying loans in the mortgage servicing portfolio and the
growth in the servicing portfolio itself. The Leader also recorded a total of
$2.8 million of impairment reserves
46
during 2001 as the estimated fair value of certain portions of The Leader's
servicing portfolio was determined to be less than its book value. As noted
above, $772,000 of the $2.8 million of impairment relates to the relatively
small component of the mortgage servicing portfolio that will be retained by
First Federal. Other components of non-interest expense at The Leader changed
only slightly between 2000 and 2001.
The Leader experienced a $1.5 million increase in its compensation and
benefits expense between 1999 and 2000 and the amortization of mortgage
servicing rights also increased by approximately $2.2 million between those two
periods.
Income Taxes - Income tax amounted to $7.6 million in 2001 compared to $5.9
million in 2000 and $4.6 million in 1999. The effective rates for those three
years were 35.8%, 35.0% and 34.9% respectively.
Concentrations of Credit Risk
Financial institutions such as First Defiance generate income primarily
through lending and investing activities. The risk of loss from lending and
investing activities includes the possibility that losses may occur from the
failure of another party to perform according to the terms of the loan or
investment agreement. This possibility is known as credit risk.
Credit risk is increased by lending or investing activities that
concentrate a financial institution's assets in a way that exposes the
institution to a material loss from any single occurrence or group of
occurrences. Diversifying loans and investments to prevent concentrations of
risks is one manner a financial institution can reduce potential losses due to
credit risk. Examples of asset concentrations would include multiple loans made
to a single borrower and loans of inappropriate size relative to the total
capitalization of the institution. Management believes adherence to its loan and
investment policies allows it to control its exposure to concentrations of
credit risk at acceptable levels. First Defiance's loan portfolio is
concentrated geographically in its northwest Ohio market area. There are no
industry concentrations which exceed 10% of the Company's loan portfolio.
Liquidity and Capital Resources
The Company's primary source of liquidity is its core deposit base, raised
through First Federal's branch network, along with unused wholesale sources of
funding and its capital base. These funds, along with investment securities,
provide the ability to meet the needs of depositors while funding new loan
demand and existing commitments.
Cash used in operating activities was $72.9 million, $34.1 million and
$165.4 million for the years ended December 31, 2001, 2000 and 1999
respectively. For each of those three years, the Company used more cash in
operating activities than was provided. The adjustments to reconcile net income
to cash provided by or used in operations during the periods presented consist
primarily of proceeds from the sale of loans (less the origination of loans held
for sale), the provision for loan losses, depreciation expense, goodwill
amortization, ESOP expense related to the release of ESOP shares in accordance
with AICPA SOP 93-6, the origination and amortization of mortgage servicing
rights and increases and decreases in other assets and liabilities.
47
The primary investing activity of First Defiance is lending, which is
funded with cash provided from operations and financing activities, as well as
proceeds from payments on existing loans and proceeds from maturities of
securities. In 2001, cash provided from the sale and maturity of investment
securities totaled $12.6 million while $6.4 million in additional securities
were purchased.
Principal financing activities include the gathering of deposits and
advance payments from loan servicing customers, the utilization of FHLB
advances, and borrowings from other banks. For the year ended December 31, 2001,
deposits and advance payments by loan servicing customers increased by $140.7
million while FHLB advances decreased by $27.0 million and warehouse and term
notes payable decreased by $65.8 million. For additional information about cash
flows from First Defiance's operating, investing and financing activities, see
the Consolidated Statements of Cash Flows included in the Consolidated Financial
Statements.
At December 31, 2001, First Defiance had the following commitments to fund
deposit, advance and borrowing obligations:
Maturity Dates by Period at December 31, 2001
---------------------------------------------------------------------------
Less than After 5 years
Contractual Obligations Total 1 year 1-3 years 4-5 years
- ----------------------------------- --------------- -------------- -------------- -------------- --------------
Savings, checking and demand
accounts $228,537 $228,537 $ -- $ -- $ --
Certificates of deposit 402,913 284,604 108,935 8,889 485
FHLB overnight advances 40,000 40,000 -- -- --
FHLB fixed advances including
interest (1) 207,731 8,144 39,218 41,399 118,969
Committed and uncommitted
short-term mortgage warehouse
loans (2) 30,367 30,367 -- -- --
Revolving lines of credit (3) 18,250 18,250 -- -- --
Other notes payable 5,970 239 483 472 4,776
--------------- -------------- -------------- -------------- --------------
Total contractual cash obligations $933,768 $610,141 $148,636 $50,760 $124,230
=============== ============== ============== ============== ==============
(1) Includes principal payments of $156,302 and interest payments of $51,429
(2) Total available lines are $225,000
(3) Total available line is $20,000
48
At December 31, 2001, First Defiance had the following commitments to fund loan
or line of credit obligations:
Amount of Commitment Expiration by Period
Total ----------------------------------------------------------
Amounts Less than 1
Commitments Committed year 1-3 years 4-5 years After 5 years
- ----------------------------- -------------- -------------- ------------- -------------- --------------
Mortgage loans in process $2,887 $2,887 $ -- $ -- $ --
Commercial loans in process 12,432 114 12,318 -- --
Single-family mortgage loan
originations 12,077 12,077 -- -- --
Nonmortgage loan originations 19,228 19,228 -- -- --
Consumer lines of credit 30,647 37 7,001 182 23,427
Commercial lines of credit 33,750 -- 33,750 -- --
-------------- -------------- ------------- -------------- --------------
Total commitments $111,021 $34,343 $53,069 $182 $23,427
============== ============== ============= ============== ==============
In addition to the above commitments, at December 31, 2001, through The
Leader, First Defiance had commitments to sell $238.4 million of loans held for
sale and to acquire $145.0 million of loans under first-time homebuyer programs,
all of which have offsetting commitments for sale into the secondary market as
GNMA or FNMA mortage-backed securities.
To meet its obligations, management can adjust the rate on savings
certificates to retain deposits in changing interest rate environments; it can
sell or securitize mortgage and non-mortgage loans; and it can turn to other
sources of financing including FHLB advances, the Federal Reserve Bank, bank
lines and brokered certificates of deposit. At December 31, 2001 First Defiance
had $196.4 million of capacity under its lines of credit with other financial
institutions. After the sale of The Leader is complete, all bank lines will be
paid off and retired. FHLB advances will also be paid down to the extent
possible. However, $155.0 million has been borrowed under either fixed or
structured FHLB advances that can not be immediately repaid without significant
penalties. Management anticipates utilizing these advances after the sale of The
Leader to purchase investment securities pending other lending and investment
opportunities.
Stockholders' equity increased by $11.5 million, or 11.6% at December 31,
2001 compared to December 31, 2000. Net income for 2001 was $13.6 million, of
which $3.2 million was returned to shareholders in the form of declared
dividends ($.49 per share). The increase in the market value of available for
sale securities increased equity by $716,000. The vesting of MRP shares and the
release of ESOP shares increased equity by $185,000 and $598,000 respectively.
Stock option exercises increased equity by approximately $360,000. The purchase
of First Defiance's 51,000 of shares of stock for treasury reduced equity by
$748,000. The book value of First Defiance's common stock was $16.20 per share
at December 31, 2001, compared to $14.49 per share at December 31, 2000. The
tangible book value (excluding goodwill) per share was $14.27 and $12.46 at
December 31, 2001 and 2000.
First Federal is subject to various capital requirements of the Office of
Thrift Supervision. At December 31, 2001, First Federal had capital ratios that
exceeded the standard to be
49
considered "well capitalized". For additional information about First Federal's
capital requirements, see Note 14 to the Consolidated Financial Statements.
Results Reflecting the Sale of The Leader Mortgage Company
Beginning in the first quarter of 2002, the reported results for First
Defiance will reflect the activity of The Leader as a discontinued operation.
Had the Consolidated Statements of Income included in this Form 10-K been
reported on that basis, they would have been as follows:
Years Ended December 31
2001 2000 1999
----------------------------------------
(In thousands, except per share amounts)
Interest income:
Loans $42,794 $42,601 $37,430
Investment securities 3,479 3,978 3,308
Interest-bearing deposits 272 362 145
----------------------------------------
Total interest income 46,545 46,941 40,882
Interest expense:
Deposits 20,931 21,409 17,425
FHLB advances and other 4,973 3,676 2,809
Warehouse and term notes payable 1,063 733 192
----------------------------------------
Total interest expense 26,967 25,818 20,427
----------------------------------------
Net interest income 19,578 21,123 20,455
Provision for loan losses 994 635 155
----------------------------------------
Net interest income after provision for loan losses 18,584 20,488 20,300
Non-interest income
Service fees and other charges 3,175 2,329 1,675
Gain on sale of loans 3,061 580 876
Federal Home Loan Bank stock dividends 1,055 1,073 858
Gain (loss) on sale of securities (137) (58) 1
Trust fees 110 238 43
Other 2,956 2,514 1,428
----------------------------------------
10,220 6,676 4,881
Non-interest expense:
Compensation and benefits 12,142 11,094 9,308
Occupancy 2,728 2,644 2,516
Deposit insurance premiums 124 120 380
Franchise tax 1,306 1,117 968
Data processing 1,101 1,277 1,239
Mortgage servicing rights amortization 449 222 167
Impairment of mortgage servicing rights 772 - -
Goodwill amortization 314 300 201
Other expense 4,012 3,398 3,171
----------------------------------------
22,948 20,172 17,950
----------------------------------------
Income from continuing operations before income tax 5,856 6,992 7,232
Income taxes 1,946 2,220 2,380
----------------------------------------
Net income from continuing operations 3,910 4,772 4,852
Discontinued operations, net of tax 9,706 6,191 3,771
----------------------------------------
Net income $13,616 $10,963 $8,623
========================================
Earnings per share:
Basic:
Continuing operations $ .61 $ .76 $ .75
Discontinued operations 1.50 .98 .58
----------------------------------------
$2.11 $1.74 $1.33
========================================
Diluted:
Continuing operations $ .59 $ .74 $ .73
Discontinued operations 1.46 .97 .56
----------------------------------------
$2.05 $1.71 $1.29
========================================
50
The income from continuing operations presented above is not representative
of what the results of First Defiance would have been without The Leader because
of a number of factors, especially the allocation of capital between The Leader
and the other operating units of First Defiance. Income from continuing
operations for First Defiance as presented above are materially impacted by the
banking relationship between First Federal and The Leader which existed
throughout the three-year period presented. It is estimated that First Federal
incurred an after-tax loss of $956,000 for the year ended December 31, 2001 from
the negative spread that existed between the financing provided to The Leader
and First Federal's incremental cost of funds. In 2000 and 1999, First Federal
realized a favorable spread of $917,000 and $357,000 respectively on the
financing provided to The Leader. Factoring out the impact of this financing,
net income from continuing operations reflected above would have been
$4,866,000, $3,855,000 and $4,495,000 for the years ended December 31, 2001,
2000 and 1999,respectively or $.73, $.60 and $.67 per diluted share for the same
three periods respectively.
Pro Forma Income Statement and Balance Sheet
The presentation of discontinued operations above represent how First
Defiance's results would have been presented for GAAP accounting purposes had
the sale of The Leader been finalized prior to December 31, 2001. The Pro Forma
Income Statement presented here represent management's estimate of what
financial results would have been had the proposed sale of The Leader occurred
as of the first business day of 2001. In preparing this pro forma, it was
assumed that available funds would be used to pay off FHLB advances and
warehouse and term debt to the extent that no prepayment penalties will be
incurred. The balance of available funds is assumed to be invested in short-term
investments at a rate of 4.25%. Dollars are in thousands (except per share
amounts).
Interest income $ 56,785
Interest expense 33,135
---------------
Net interest income 23,650
Provision for loan losses 993
---------------
Net interest income after provision 22,657
Non-interest income 9,297
Non-interest expense 21,776
---------------
Income before income taxes 10,178
Income taxes 3,362
---------------
Pro forma net income $ 6,616
===============
Pro forma net income per share $ 1.00
===============
51
The Balance Sheet of First Defiance, prepared on a pro forma basis at
December 31, 2001 to reflect the proposed sale of The Leader would have been as
follows (In thousands):
Assets
Cash and cash equivalents $ 36,116
Investment securities:
Available for sale 268,543
Held to maturity 5,817
--------------
274,360
Loans receivable 495,250
Other assets 44,601
--------------
Total Assets $ 850,327
==============
Liabilities and stockholders' equity
Liabilities:
Deposits $ 564,097
Advances from the FHLB 156,302
Other liabilities 8,908
--------------
729,307
Stockholders' equity 121,020
--------------
Total liabilities and stockholders' equity $ 850,327
==============
These pro forma financial statements are not necessarily representative of
what the results of operations of First Defiance will be subsequent to The
Leader sale transaction.
52
Cash Earnings
First Defiance recorded a total of $887,000 of goodwill amortization
expense in 2001, with $573,000 associated with The Leader and $314,000
associated with First Insurance ($156,000 of First Insurance's goodwill
amortization is tax deductible). The Leader goodwill, which totaled $9.5 million
at December 31, 2001, will be disposed of as part of The Leader sales
transaction
First Defiance analyzes its performance on a net income basis determined in
accordance with accounting principles generally accepted in the United States,
as well as on a cash basis before amortization of goodwill and the related tax
benefit of tax deductible goodwill, referred to in this analysis as "cash basis
results". Cash basis results and related discussions are presented as
supplementary information in this analysis to enhance the readers' understanding
of, and highlight trends in, the Company's core financial results excluding the
effects of amortization of goodwill. Cash basis results should not be viewed as
a substitute for net income and earnings per share as determined in accordance
with accounting principles generally accepted in the United States.
The selected financial data presented in the following table highlights the
performance of First Defiance on a cash basis for each of the three years in the
period ended December 31, 2001. The data has been adjusted to exclude the
amortization of goodwill and the related tax benefit of tax deductible goodwill.
This goodwill resulted from the acquisitions of The Leader and the insurance
agencies which were combined to form First Insurance. All three acquisitions
were recorded using the purchase method of accounting.
The amortization of goodwill does not result in a cash expense and has
essentially no economic impact on liquidity and funds management activity. Cash
basis financial data provides an additional basis for measuring a company's
ability to support future growth, pay dividends, and repurchase shares. The cash
basis data presented in the table below has not been adjusted to exclude the
impact of other noncash items such as depreciation, the provision for loan
losses, and amortization of MRP and ESOP expense.
53
2001 2000 1999
------------------ ----------------- -----------------
(Dollars in thousands, except per share amounts)
Year Ended December 31
Non-interest expense $ 67,453 $ 54,031 $ 46,639
Income before income taxes 22,086 17,751 14,027
Net income 14,447 11,786 9,382
Per Common Share
Net income per basic share $2.24 $1.87 $1.44
Net income per diluted share 2.17 1.84 1.40
Weighted average common shares
(000s) 6,464 6,318 6,502
Weighted average diluted common
shares (000s) 6,646 6,423 6,700
Performance Ratios
Return on average assets 1.33% 1.18% 1.09%
Return on average equity 15.97 14.87 11.99
Ratio of cash operating expense to
tangible assets 6.21 5.43 5.43
Goodwill
Goodwill average balance $ 13,623 $ 14,372 $ 12,519
Goodwill amortization (after tax) 831 823 759
In June 2001 the FASB adopted Statement No. 142, Goodwill and Other
Intangible Assets. This accounting standard, which is required for years
beginning after December 15, 2001, changes the accounting treatment of goodwill.
Previously goodwill was considered a wasting asset and required to be amortized.
Under Statement No. 142, goodwill is no longer amortized but it is to be
reviewed annually for impairment. Management has not yet completed the
impairment analysis for the goodwill recorded at First Insurance, which totaled
$3.7 million at December 31, 2001.
Critical Accounting Policies
First Defiance has established various accounting policies which govern the
application of accounting principles generally accepted in the United States in
the preparation of the its financial statements. The significant accounting
policies of First Defiance are described in the footnotes to the consolidated
financial statements. Certain accounting policies involve significant judgments
and assumptions by management, which have a material impact on the carrying
value of certain assets and liabilities; management considers such accounting
policies to be critical accounting policies. The judgments and assumptions used
by management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of the
judgments and assumptions made by management, actual results
54
could differ from these judgments and estimates, which could have a material
impact on the carrying value of assets and liabilities and the results of
operations of First Defiance.
Allowance for Loan Losses: First Defiance believes the allowance for loan
losses is a critical accounting policy that requires the most significant
judgments and estimates used in preparation of its consolidated financial
statements. Refer to the section entitled Allowance for Loan Losses and Note 3,
Statement of Accounting Policies for a detailed description of the Corporation's
estimation process and methodology related to the allowance for loan losses.
Valuation of Mortgage Servicing Rights: First Defiance believes the
valuations of mortgage servicing rights is a critical accounting policy that
requires significant estimates in preparation of its consolidated financial
statements. First Defiance recognizes as separate assets the value of mortgage
servicing rights, whether those rights are acquired through loan origination
activities or through purchase activities. Refer to the section entitled
Mortgage Servicing Rights and Note 3, Statement of Accounting Policies, for a
detailed description of First Defiance's process and methodology.
FASB 91 - Deferral of Fees: First Defiance believes that SFAS No. 91 -
Deferral of Fees is a critical accounting policy that utilizes estimates in its
preparation of its consolidated financial statements. First Defiance accounts
for loan origination and commitment fees and certain direct loan origination
cost by deferring the net fees, or net costs, and amortizing them as an
adjustment of the related loan's yield. Refer to the section entitled Revenue
Recognition and Note 3, Statement of Accounting Policies, for a detailed
description of First Defiance's process and methodology.
55
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Asset/Liability Management
A significant portion of the Company's revenues and net income is derived
from net interest income and, accordingly, the Company strives to manage its
interest-earning assets and interest-bearing liabilities to generate what
management believes to be an appropriate contribution from net interest income.
Asset and liability management seeks to control the volatility of the Company's
performance due to changes in interest rates. The Company attempts to achieve an
appropriate relationship between rate sensitive assets and rate sensitive
liabilities. First Defiance does not presently use off balance sheet derivatives
to enhance its risk management.
First Defiance monitors interest rate risk on a monthly basis through
simulation analysis that measures the impact changes in interest rates can have
on net interest income. The simulation technique analyzes the effect of a
presumed 100 basis point shift in interest rates (which is consistent with
management's estimate of the range of potential interest rate fluctuations) and
takes into account prepayment speeds on amortizing financial instruments, loan
and deposit volumes and rates, non-maturity deposit assumptions and capital
requirements. This simulation is run for both First Defiance as a consolidated
entity and for First Federal on a stand-alone basis. With the pending sale of
The Leader, management believes the First Federal stand-alone simulation to be
the more meaningful analysis. The results of the simulation indicate that in an
environment where interest rates rise 100 basis points over a 12 month period,
using 2002 projected amounts as a base case, First Defiance's net interest
income would decrease by 1.8%. Were interest rates to fall by 100 basis points
during the same 12-month period, the simulation indicates that net interest
income would increase by 1.8%.
First Defiance has increased its lending activities in the non-residential
real estate and commercial loan areas. While such loans carry higher credit risk
than residential mortgage lending, they tend to be more rate sensitive than
residential mortgage loans. The balance of First Defiance's non-residential and
multi-family real estate loan portfolio increased to $218.8 million, which is
split between $33.3 million of fixed-rate loans and $185.5 million of
adjustable-rate loans at December 31, 2001. The commercial loan portfolio
increased to $83.7 million, which is split between $39.8 million of fixed-rate
loans and $43.9 million of adjustable-rate loans at December 31, 2001. Certain
of the loans classified as adjustable have fixed rates for an initial term that
may be as long as five years. The maturities on fixed-rate loans are generally
less than 7 years. First Defiance also has significant balances of consumer
loans ($40.9 million at December 31, 2001) which tend to have a shorter duration
than residential mortgage loans, and home equity and improvement loans ($36.2
million at December 31, 2001) which fluctuate with changes in the prime lending
rate. Also, to limit its interest rate risk, First Federal sells more than 90%
of its fixed-rate mortgage originations into the secondary market. Historically,
loans with maturities less than 20 years had been retained in portfolio although
First Federal began selling its 15-year fixed-rate mortgage loans in the
secondary market beginning in January 1999.
56
In addition to the simulation analysis, First Federal also prepares an
"economic value of equity" ("EVE") analysis. This analysis calculates the net
present value of First Federal's assets and liabilities in rate shock
environments which range from -200 basis points to +200 basis points. The
results of this analysis are reflected in the following table for the First
Federal stand alone analysis. This analysis is materially different than the
First Defiance consolidated analysis because of interest rate sensitivity
associated with mortgage servicing rights.
December 31, 2001
- -------------------------------------------------------------------------------------------------------------
Economic Value of Equity as % of
Economic Value of Equity Present Value of Assets
---------------------------------------------- ----------------------------------
Change in Rates $ Amount $ Change % Change Ratio Change
(Dollars in Thousands)
- ------------------------ ------------------------------ ------------------ ---------------- -----------------
+ 200 bp 59,640 (12,649) (17.50%) 10.07% (164) bp
+ 100 bp 65,640 (6,649) (9.20%) 10.86% (85) bp
0 bp 72,289 -- -- 11.71% --
-100 bp 73,477 1,188 1.64% 11.75% 4 bp
-200 bp 73,155 866 1.20% 11.61% (10) bp
This analysis is based on First Defiance's internal allocation of capital
between First Federal and The Leader. Once the sale of The Leader is completed,
all of the capital of First Defiance will be included in this analysis.
Management will have an opportunity to control its interest rate risk based on
how the freed up capital is redeployed.
Based on the above analysis, in the event of a 200 basis point change in
interest rates as of December 31, 2001, First Federal would experience a 17.5%
decrease in its economic value of equity in a rising rate environment and only a
1.2% increase in its economic value of equity in a declining rate environment.
During periods of rising rates, the value of monetary assets declines.
Conversely, during periods of falling rates, the value of monetary assets
increases. It should be noted that the amount of change in value of specific
assets and liabilities due to changes in rates is not the same in a rising rate
environment as in a falling rate environment. Based on the EVE analysis, the
decline in the economic value of equity in a rising rate environment is
generally because First Federal has used FHLB advances and deposits with shorter
terms than the assets in which it invests. The average duration of its assets at
December 31, 2001 was 2.19 years while the average duration of its liabilities
was 1.18 years. Management anticipates that it will balance the interest rate
risk that exists on the balance sheet through the additions it makes to its
investment portfolio after the completion of the sale of The Leader.
In evaluating First Federal's exposure to interest rate risk, certain
shortcomings inherent in the each of the methods of analysis presented must be
considered. For example, although certain assets and liabilities may have
similar maturities or periods to repricing, they may react in different degrees
to changes in market interest rates. Also, the interest rates on certain types
of assets and liabilities may fluctuate in advance of changes in market rates
while interest rates on other types of financial instruments may lag behind
current changes in market rates. Furthermore, in the event of changes in rates,
prepayments and early withdrawal levels could
57
differ significantly from the assumptions in calculating the table and the
results therefore may differ from those presented.
Forward Looking Information
Forward looking statements in this report are made in reliance upon the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
The statements in this report which are not historical fact are forward looking
statements and they include, among other statements, the pro forma income
statement and balance sheet which reflect the results of First Defiance as if
the sale of The Leader had occurred as of January 1, 2001, projections about
growth in the Financial Condition section, comments about the adequacy of the
allowance for loan losses and projections about interest rate simulations
included in the Asset/Liability Management section. Actual results may differ
from expectations contained in such forward looking information as a result of
factors including but not limited to the interest rate environment, economic
policy or conditions, federal and state banking and tax regulations, and
competitive factors in the marketplace. Each of these factors could affect
estimates, assumptions, uncertainties and risks considered in the development of
forward looking information and could cause actual results to differ materially
from management's expectation regarding future performance.
58
Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition...............................60
Consolidated Statements of Income............................................62
Consolidated Statements of Stockholders' Equity..............................63
Consolidated Statements of Cash Flows........................................64
Notes to Consolidated Financial Statements...................................66
Report of Independent Auditors..............................................110
59
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
December 31
2001 2000
---------------------------
(In Thousands)
Assets Cash and cash equivalents:
Cash and amounts due from depository institutions $ 11,784 $ 7,320
Interest-bearing deposits 24,332 13,634
---------------------------
36,116 20,954
Investment securities:
Available-for-sale, carried at fair value 48,989 53,176
Trading, carried at fair value -- 234
Held-to-maturity, carried at amortized cost
(fair value $5,678 and $7,770 at
December 31, 2001 and 2000, respectively) 5,580 7,697
---------------------------
54,569 61,107
Loans receivable, net of allowance of $9,937
and $8,904 at December 31, 2001 and 2000,
respectively 517,829 541,208
Loans held for sale 275,723 232,314
Mortgage servicing rights 157,369 134,760
Accrued interest receivable 6,111 5,976
Federal Home Loan Bank stock 16,306 15,251
Premises and equipment 22,242 22,203
Real estate and other assets held for sale 1,219 312
Goodwill, net of accumulated amortization of
$2,805 and $1,918 at December 31, 2001
and 2000, respectively 13,207 13,983
Other assets 31,922 24,126
---------------------------
Total assets $ 1,132,613 $ 1,072,194
===========================
60
December 31
2001 2000
-------------------------------
(In Thousands)
Liabilities and stockholders' equity
Liabilities:
Deposits $ 631,450 $ 545,899
Advances from the Federal Home Loan Bank 196,302 223,258
Warehouse and term notes payable 54,587 120,425
Accrued expenses and other liabilities 15,395 12,546
Deferred taxes 704 2,611
Advance payments by borrowers 123,154 67,982
-------------------------------
Total liabilities 1,021,592 972,721
Stockholders' equity:
Preferred stock, no par value per share:
5,000 shares authorized; no shares issued
Common stock, $.01 par value per share:
20,000 shares authorized; 6,854 and 6,864
shares outstanding, respectively 69 69
Additional paid-in capital 53,725 53,512
Stock acquired by ESOP (2,813) (3,238)
Deferred compensation (82) (204)
Accumulated other comprehensive income,
net of tax of $410 and $22, respectively 763 47
Retained earnings 59,359 49,287
-------------------------------
Total stockholders' equity 111,021 99,473
-------------------------------
Total liabilities and stockholders' equity $ 1,132,613 $ 1,072,194
===============================
See accompanying notes.
61
First Defiance Financial Corp.
Consolidated Statements of Income
Years ended December 31
2001 2000 1999
-------------------------------------
(In Thousands, except per share amount)
Interest income:
Loans $ 62,109 $ 60,382 $ 49,927
Investment securities 3,483 4,441 3,307
Other 272 362 145
-------------------------------------
Total interest income 65,864 65,185 53,379
Interest expense:
Deposits 25,120 25,501 19,889
Federal Home Loan Bank advances and other 11,393 13,297 9,872
Warehouse and term notes payable 2,373 4,704 1,821
-------------------------------------
Total interest expense 38,886 43,502 31,582
-------------------------------------
Net interest income 26,978 21,683 21,797
Provision for loan losses 3,870 3,147 1,925
-------------------------------------
Net interest income after provision for loan losses 23,108 18,536 19,872
Non-interest income:
Mortgage banking income 45,957 36,129 28,156
Service fees and other charges 2,695 2,047 1,411
Gain on sale of loans 11,709 9,546 7,081
Gain on sale of mortgage servicing rights - - 479
Federal Home Loan Bank stock dividends 1,058 1,075 861
Net (loss) gain on sale of available-for-sale securities (137) (58) 1
Trust fees 110 238 43
Other 5,039 4,269 2,762
-------------------------------------
66,431 53,246 40,794
Non-interest expense:
Compensation and benefits 24,126 22,685 19,401
Occupancy 5,191 4,907 4,128
Deposit insurance premiums 124 120 380
Franchise tax 1,306 1,123 983
Data processing 1,187 1,277 1,239
Mortgage servicing rights amortization 23,405 14,963 12,711
Net impairment of mortgage servicing rights 2,859 21 -
Goodwill amortization 887 874 775
Other 9,255 8,935 7,797
-------------------------------------
68,340 54,905 47,414
-------------------------------------
Income before income taxes 21,199 16,877 13,252
Income taxes 7,583 5,914 4,629
-------------------------------------
Net income $ 13,616 $ 10,963 $ 8,623
=====================================
Earnings per share:
Basic $ 2.11 $ 1.74 $ 1.33
=====================================
Diluted $ 2.05 $ 1.71 $ 1.29
=====================================
Dividends declared per share $ 0.49 $ 0.45 $ 0.41
=====================================
See accompanying notes.
62
First Defiance Financial Corp.
Consolidated Statements of Stockholders' Equity
(In Thousands)
Stock Acquired By
----------------------
Additional Management
Common Stock Paid-In Recognition
----------------
Shares Amount Capital ESOP Plan
---------------- ------------------------------------
Balance at January 1, 1999 7,575 $ 76 $ 58,681 $ (4,089) $ (843)
Comprehensive income:
Net income
Change in net unrealized gains and losses on available-for-sale securities,
net of income taxes of $648
Total comprehensive income
ESOP shares released 197 425
Amortization of deferred compensation of Management Recognition Plan (4) 385
Shares issued under stock option plan 55 417
Acquisition of common stock for treasury (816) (8) (6,110)
Dividends declared
------------------------------------------------------
Balance at December 31, 1999 6,814 68 53,181 (3,664) (458)
Comprehensive income:
Net income
Change in net unrealized gains and losses on available-for-sale securities,
net of income taxes of $542
Total comprehensive income
ESOP shares released 71 426
Amortization of deferred compensation of Management Recognition Plan (35) 254
Shares issued under stock option plan 80 1 469
Acquisition of common stock for treasury (30) (174)
Dividends declared
------------------------------------------------------
Balance at December 31, 2000 6,864 69 53,512 (3,238) (204)
Comprehensive income:
Net income
Change in net unrealized gains and losses on available-for-sale securities,
net of income taxes of $432
Total comprehensive income
ESOP shares released 173 425
Amortization of deferred compensation of Management Recognition Plan 63 122
Shares issued under stock option plan 41 360
Acquisition of common stock for treasury (51) (383)
Dividends declared
------------------------------------------------------
Balance at December 31, 2001 $ 6,854 $ 69 $ 53,725 $ (2,813) $ (82)
======================================================
See accompanying notes.
Accumulated
Other Total
Comprehensive Retained Stockholders'
Income Earnings Equity
-----------------------------------------
Balance at January 1, 1999 $ 162 $ 39,723 $ 93,710
Comprehensive income:
Net income 8,623 8,623
Change in net unrealized gains and losses on available-for-sale securities,
net of income taxes of $648 (1,258) (1,258)
-----------
Total comprehensive income 7,365
ESOP shares released 622
Amortization of deferred compensation of Management Recognition Plan 381
Shares issued under stock option plan 417
Acquisition of common stock for treasury (4,276) (10,394)
Dividends declared (2,685) (2,685)
-------------------------------------
Balance at December 31, 1999 (1,096) 41,385 89,416
Comprehensive income:
Net income 10,963 10,963
Change in net unrealized gains and losses on available-for-sale securities,
net of income taxes of $542 1,143 1,143
-----------
Total comprehensive income 12,106
ESOP shares released 497
Amortization of deferred compensation of Management Recognition Plan 219
Shares issued under stock option plan 470
Acquisition of common stock for treasury (154) (328)
Dividends declared (2,907) (2,907)
-------------------------------------
Balance at December 31, 2000 47 49,287 99,473
Comprehensive income:
Net income 13,616 13,616
Change in net unrealized gains and losses on available-for-sale
securities, net of income taxes of $432 716 716
-----------
Total comprehensive income 14,332
ESOP shares released 598
Amortization of deferred compensation of Management Recognition Plan 185
Shares issued under stock option plan 360
Acquisition of common stock for treasury (365) (748)
Dividends declared (3,179) (3,179)
-------------------------------------
Balance at December 31, 2001 $ 763 $ 59,359 $ 111,021
=====================================
See accompanying notes.
63
First Defiance Financial Corp.
Consolidated Statements of Cash Flows
Years ended December 31
2001 2000 1999
-------------------------------------
Operating activities (In Thousands)
Net income $ 13,616 $ 10,963 $ 8,623
Adjustments to reconcile net income to net cash used in
operating activities:
Provision for loan losses 3,870 3,147 1,925
Provision for depreciation 2,197 1,888 1,745
Amortization of deferred compensation expense 185 219 484
Amortization of mortgage servicing rights 23,405 14,963 12,711
Net impairment of of mortgage servicing rights 2,859 21 -
Amortization of goodwill 887 874 775
Release of ESOP shares 598 497 622
(Gain) loss on sale of office properties and equipment -- (60) 31
Net securities (gains) losses 137 58 (1)
Gain on sale of loans (11,709) (9,546) (7,081)
Gain on sale of mortgage servicing rights -- -- (479)
Net securities amortization 33 37 110
Deferred federal income tax (credit) (2,339) (163) 58
Decrease in interest receivable and other assets (7,931) (5,200) (4,499)
Proceeds from sale of loans 2,208,058 2,369,720 1,753,467
Proceeds from sale of mortgage servicing rights -- -- 2,610
Servicing rights on loans sold with servicing retained (48,873) (52,225) (35,909)
Origination of loans held for sale (2,239,758) (2,354,866) (1,895,505)
Net repurchase of loans held for sale (20,812) (13,810) (8,521)
Increase (decrease) in accrued interest and other liabilities 2,668 (608) 3,465
-------------------------------------
Net cash used in operating activities (72,909) (34,091) (165,369)
Investing activities
Proceeds from sale of trading securities 233 29,568 --
Proceeds from maturities of available-for-sale securities 6,395 7,071 20,039
Proceeds from sale of available-for-sale securities 3,919 2,317 2,001
Purchases of available-for-sale securities (5,120) (6,996) (30,395)
Proceeds from maturities of held-to-maturity securities 2,089 2,169 3,594
Proceeds from sale of real estate and other assets held for sale 519 3,325 3,079
Proceeds from sale of office properties and equipment
and investment properties 37 485 416
Acquisition of The Insurance Center of Defiance,
net of cash received -- -- (1,918)
Adjustment of acquisition of First Insurance & Investments -- -- (274)
Acquisition of Moreland Greens -- -- 217
Purchases of Federal Home Loan Bank stock (1,055) (1,070) (3,355)
Purchases of premises and equipment (2,273) (3,205) (4,417)
Net increase in mortgage and other loans 38,895 (66,304) (12,668)
-------------------------------------
Net cash provided by (used in) investing activities 43,639 (32,640) (23,681)
64
First Defiance Financial Corp.
Consolidated Statements of Cash Flows (continued)
Years ended December 31
2001 2000 1999
------------------------------------
Financing activities
Net increase in deposits and advance payments by
borrowers for taxes and insurance 140,723 49,370 53,198
Proceeds from short--term line of credit 6,250 12,000 --
Net increase in Federal Home Loan Bank short--term advances (116,500) 83,500 8,355
Proceeds from Federal Home Loan Bank long--term advances 90,000 -- 105,000
Repayment of Federal Home Loan Bank long--term advances (456) (125,652) (16,087)
Repayment of long term notes (177) (314) (60)
(Decrease) increase in mortgage warehouse loans (71,911) 55,235 47,043
Purchase of common stock for treasury (748) (328) (10,394)
Cash dividends paid (3,109) (2,832) (2,692)
Proceeds from exercise of stock options 360 470 417
------------------------------------
Net cash provided by financing activities 44,432 71,449 184,780
------------------------------------
Increase (decrease) in cash and cash equivalents 15,162 4,718 (4,270)
Cash and cash equivalents at beginning of period 20,954 16,236 20,506
------------------------------------
Cash and cash equivalents at end of period $ 36,116 $ 20,954 $ 16,236
===================================
Supplemental cash flow information:
Interest paid $ 38,985 $ 43,790 $ 30,482
===================================
Income taxes paid $ 8,520 $ 6,400 $ 5,325
===================================
Transfers from loans to real estate
and other assets held for sale $ 391 $ 607 $ 2,533
===================================
Noncash operating activities
Change in deferred taxes on net unrealized gains or
losses on available-for-sale securities $ (432) $ (542) $ 648
===================================
Noncash investing activities
Change in net unrealized gain (loss) on available-for-sale
securities $ 1,148 $ 1,685 $ (1,906)
===================================
Securitization of loans held for sale $ -- $ -- $ 29,805
===================================
Noncash financing activities
Cash dividends declared but not paid $ 848 $ 778 $ 703
===================================
See accompanying notes.
65
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
December 31, 2001
1. Basis of Presentation
First Defiance Financial Corp. (First Defiance) is a holding company that
conducts business through its two wholly owned subsidiaries, First Federal Bank
of the Midwest, Defiance Ohio (First Federal) and First Insurance & Investments
(First Insurance) and First Federal's wholly owned subsidiary, The Leader
Mortgage Company (The Leader). All significant intercompany transactions and
balances are eliminated in consolidation.
First Federal is primarily engaged in attracting deposits from the general
public through its offices and using those and other available sources of funds
to originate loans primarily in the counties in which its offices are located.
First Federal's traditional banking activities include originating and servicing
residential, commercial and consumer loans and providing a broad range of
depository and trust services. First Federal is subject to the regulations of
certain federal agencies and undergoes periodic examinations by those regulatory
authorities.
The Leader is a mortgage banking company that specializes in servicing mortgage
loans under first-time home-buyer programs sponsored by various state, county
and municipal governmental entities. The Leader's mortgage banking activities
consist primarily of originating or purchasing residential mortgage loans for
either direct resale into secondary markets or to be securitized through
Government National Mortgage Association (GNMA) or Fannie Mae. The Leader
generally retains the servicing on these loans.
First Insurance & Investments is an insurance agency that does business in the
Defiance, Ohio area offering property and casualty, group health, and life
insurance and investment and annuity products.
2. Subsequent Event - Discontinued Operations
In January 2002, First Defiance approved and announced the sale of its mortgage
banking line of business, The Leader, to a third party. The transaction is
expected to close in the second quarter of fiscal 2002 and is anticipated to
result in an after-tax gain of $10 million to $12 million ($1.50 to $1.75 per
share.)
Major classes of assets and liabilities of The Leader reflected in the
Consolidated Statements of Financial Condition at December 31, 2001 and 2000
are:
66
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
2. Subsequent Event - Discontinued Operations (continued)
December 31
2001 2000
--------------------------
(In Thousands)
Assets
Loans receivable $22,941 $15,862
Loans held for sale 275,367 232,247
Mortgage servicing rights 156,936 134,086
Prepaid expenses and other assets
30,951 23,529
Goodwill 9,458 10,032
Liabilities
Warehouse and term notes payable to
affiliates 399,635 253,563
Warehouse and term notes payable to
third parties 36,289 108,340
Accrued expenses 8,189 4,803
Net interest income, non-interest income and income before income taxes of The
Leader included in the Consolidated Statements of Income for each of the three
years ended December 31, 2001 were as follows:
2001 2000 1999
----------------------------------------
(In Thousands)
Net interest income $7,878 $1,045 $1,796
Non-interest income 57,133 46,694 36,008
Income before income taxes 14,958 10,388 6,466
67
3. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates. Most significantly, First Defiance uses
estimates in determining the value of the allowance for loan losses and in the
valuation of mortgage servicing rights.
Earnings Per Share
Earnings per share are based on the weighted average number of shares of common
stock outstanding during the period. Basic earnings per share exclude any
dilutive effects of options and unvested stock grants.
Cash and Cash Equivalents
Cash and cash equivalents include amounts due from banks and overnight
investments with the Federal Home Loan Bank (FHLB). Cash and amounts due from
depository institutions includes required balances at the FHLB and Federal
Reserve of approximately $412,000 and $1,360,000, respectively, at December 31,
2001.
Investment Securities
Management determines the appropriate classification of debt securities at the
time of purchase and evaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest
income using the interest method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity until realized.
68
3. Statement of Accounting Policies (continued)
Loans held for sale securitized in the normal course of The Leader's operations
have been classified as trading securities, reported at fair market value. These
securities have been committed to sell at their carrying value.
Realized gains and losses, and declines in value judged to be
other-than-temporary are included in gains (losses) on sale of securities. The
cost of mutual funds sold is based on the average cost method. The cost of all
other securities sold is based on the specific identification method.
Currently, First Defiance invests in derivative securities as part of the
overall asset and liability management process. Such derivative securities are
disclosed in Note 5 and include agency step-up, REMIC and CMO investments. Such
investments are not classified by management as high risk at December 31, 2001
and do not present risk significantly different than other mortgage-backed or
agency securities.
Investments Required by Regulations
As a member of the FHLB System, First Federal is required to own stock of the
FHLB of Cincinnati in an amount principally equal to the greater of 1% of its
net home mortgage loans or 5% of FHLB advances, subject to periodic redemption
at par if the stock owned is over the minimum requirement. FHLB stock is a
restricted equity security that does not have a readily determinable fair value
and is carried at cost.
Loans Receivable
Investment in real estate mortgage loans consists principally of long-term
conventional loans collateralized by first mortgages on single-family
residences, other residential property, and commercial and industrial property.
Such loans that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal adjusted for any charge-offs, the allowance for loan
losses, and any deferred fees or costs on originated loans.
Mortgage loans originated and intended for sale in the secondary market are
classified as loans held for sale and are carried at the lower of cost or
estimated fair value in the aggregate.
69
3. Statement of Accounting Policies (continued)
Nonrefundable fees and related costs associated with originating or acquiring
real estate mortgage and other loans are capitalized and recognized as an
adjustment of the yield of the related loan.
Interest receivable is accrued on loans and credited to income as earned. The
accrual of interest on impaired loans is discontinued when, in management's
opinion, the borrower may be unable to meet payments as they become due. When
interest accrual is discontinued, all unpaid accrued interest is fully reserved.
Interest income is subsequently recognized only to the extent cash payments are
received.
The allowance for loan losses is maintained at a level believed adequate by
management to absorb probable losses inherent in the loan portfolio and is based
on the size and current risk characteristics of the loan portfolio, an
assessment of individual problem loans, actual loss experience, current economic
events in specific industries and geographical areas, and other pertinent
factors including regulatory guidance and general economic conditions.
Determination of the allowance is inherently subjective as it requires
significant estimates, including the amounts and timing of expected future cash
flows on impaired loans, estimated losses on pools of homogeneous loans based on
historical loss experience and consideration of economic trends, all of which
may be susceptible to significant change. Loan losses are charged off against
the allowance, while recoveries of amounts previously charged off are credited
to the allowance. A provision for loan losses is charged to operations based on
management's periodic evaluation of the factors previously mentioned, as well as
other pertinent factors.
Mortgage Servicing Rights
The total cost of loans originated or purchased is allocated between loans and
servicing rights based on the relative fair values of each. The servicing rights
capitalized are amortized in proportion to and over the period of estimated
servicing income.
Mortgage servicing rights are periodically evaluated for impairment. For
purposes of measuring impairment, mortgage servicing rights are stratified based
on predominant risk characteristics of the underlying serviced loans. These risk
characteristics include loan type (fixed or adjustable rate) and interest rate.
Impairment represents the excess of amortized cost of an individual mortgage
servicing rights stratum over its fair value, and is recognized through a
valuation allowance.
70
3. Statement of Accounting Policies (continued)
Fair values for individual stratum are based on the present value of estimated
future cash flows using a discount rate (10.6%) commensurate with the risks
involved. Estimates of fair value include assumptions about prepayment (186%
PSA), default and interest rates, and other factors which are subject to change
over time. Changes in these underlying assumptions could cause the fair value of
mortgage servicing rights, and the related valuation allowance, to change
significantly in the future.
Real Estate and Other Assets Held for Sale
Assets held for sale are comprised of properties acquired through foreclosure
proceedings or acceptance of a deed in lieu of foreclosure. These properties are
carried at the lower of cost or fair value at time of foreclosure or insubstance
foreclosure. Loan losses arising from the acquisition of such property are
charged against the allowance for loan losses.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and
amortization computed principally by the straight-line method over the following
estimated useful lives:
Buildings and improvements 20 to 50 years
Furniture, fixtures and equipment 5 to 15 years
Long-lived assets to be held and those to be disposed of and certain intangibles
are evaluated for impairment using the guidance provided by Statement of
Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of. The provisions of
this statement establish when an impairment loss should be recognized and how it
should be measured.
Income Taxes
Deferred income taxes reflect the temporary tax consequences on future years of
differences between the tax basis and financial statement amounts of assets and
liabilities at each year-end.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As
71
3. Statement of Accounting Policies (continued)
changes in tax laws or rates are enacted, deferred tax assets and liabilities
are adjusted through the provision for income taxes.
An effective tax rate of 35% is used to determine after-tax components of other
comprehensive income included in the statements of stockholders' equity.
Business Combinations
Business combinations, which have been accounted for under the purchase method
of accounting, include the results of operations of the acquired business from
the date of acquisition. Net assets of the companies acquired were recorded at
their estimated fair value as of the date of acquisition.
Intangibles
The excess of the purchase price over the net identifiable tangible assets
acquired in purchase business combinations is recorded as goodwill. Goodwill
relating to The Leader acquisition is being amortized over a twenty-year period.
Goodwill relating to First Insurance & Investments is being amortized over a
fifteen-year period. Amounts paid for non-compete and employment agreements in
conjunction with the acquisition of The Leader have been capitalized and are
being amortized over the life of the agreements. On a periodic basis, management
reviews goodwill and other intangible assets to determine if events or changes
in circumstances indicate the carrying value of such assets is not recoverable,
in which case an impairment charge would be recorded.
The current accounting guidance for goodwill and other intangibles has been
superceded by the provisions of SFAS No. 142, Goodwill and Other Intangible
Assets, which become effective for First Defiance as of January 1, 2002. See
"Accounting Pronouncements Pending Adoption" for further information.
Accounting for Derivative Instruments and Hedging Activities
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as
amended, requires all derivative instruments to be carried at fair value on the
balance sheet. The Statement continues to allow derivative instruments to be
used to hedge various risks and sets forth specific criteria to be used to
determine when hedge accounting can be used. The Statement also provides
72
3. Statement of Accounting Policies (continued)
for offsetting changes in fair value or cash flows of both the derivative and
the hedged asset or liability to be recognized in earnings in the same period;
however, any changes in fair value or cash flow that represent the ineffective
portion of a hedge are required to be recognized in earnings and cannot be
deferred. For derivative instruments not accounted for as hedges, changes in
fair value are to be recognized in earnings as they occur.
On January 1, 2001, First Defiance adopted the Statement. After-tax adjustments
of associated with establishing the fair values of derivative instruments on the
balance sheet reduced net income by approximately $11,000. The transition
amounts were determined based on the interpretive guidance issued by the
Financial Accounting Standards Board.
Accounting Pronouncements Pending Adoption
Goodwill and Other Intangible Assets. In July 2001, the FASB issued SFAS No.
142, Goodwill and Other Intangible Assets, which is effective for fiscal years
beginning after December 31, 2001. Under SFAS No. 142, amortization of goodwill
and intangible assets with indefinite lives is no longer permitted. Management
anticipates that implementing this change will reduce noninterest expense by
approximately $314,000 and increase net income by $260,000, or $0.04 per common
share, for 2002. This does not include an additional $573,000 of annual goodwill
amortization related to The Leader. All expenses associated with The Leader in
2002 prior to the closing are expected to be recorded as discontinued
operations. Goodwill and intagible assets with indefinite lives will be subject
to impairment testing which must be conducted annually. Any impairment losses
that result from the initial application of SFAS No. 142 would be accounted for
as a "cumulative effect of accounting change" on the Consolidated Statement of
Income. Management has not yet completed the impairment testing as of the
transition date of January 1, 2002.
Asset Retirement Obligations. In August 2001, the FASB issued SFAS No. 143,
Accounting for Asset Retirement Obligations. The standard is effective for
fiscal years beginning after June 15, 2002. The standard addresses the
accounting for obligations associated with the retirement of tangible long-lived
assets and requires a liability to be recognized for the fair value of these
obligations in the period they are incurred. Related costs are capitalized as
part of the carrying amounts of the assets to be retired and amortized over the
assets' useful lives. Management has not yet completed the evaluation the impact
on First Defiance's financial condition and results of operations.
73
3. Statement of Accounting Policies (continued)
Impairment or Disposal of Long-Lived Assets. In October 2001, the FASB issued
SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets.
The standard maintains the previous accounting for the impairment or disposal of
long-lived assets, but establishes more restrictive criteria that have to be met
to classify such an asset as "held for sale." SFAS No. 144 also changes the
manner is which expected operating losses from discontinued operations are to be
reported. First Defiance adopted SFAS No. 144 as of January 1, 2002.
4. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per
share:
2001 2000 1999
-----------------------------------------
(In Thousands, except per share amounts)
Numerator for basic and diluted earnings
per share-net income $3,616 $10,963 $8,623
========================================
Denominator:
Denominator for basic earnings per
share-weighted-average shares 6,464 6,318 6,502
Effect of dilutive securities:
Employee stock options 149 39 113
Unvested Management Recognition
Plan stock 33 66 85
----------------------------------------
Dilutive potential common shares 182 105 198
----------------------------------------
Denominator for diluted earnings per
share-adjusted weighted-average shares 6,646 6,423 6,700
========================================
Basic earnings per share $2.11 $ 1.74 $1.33
========================================
Diluted earnings per share $2.05 $ 1.71 $1.29
========================================
74
5. Investment Securities
The following is a summary of available-for-sale and held-to-maturity
securities:
December 31, 2001
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------
(In Thousands)
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 17,708 $ 905 $ -- $ 18,613
Corporate bonds 9,322 294 -- 9,616
Adjustable rate mortgage-backed security
mutual funds 2,548 -- 70 2,478
Adjustable rate mortgage-backed securities 4,134 52 71 4,115
Collateralized mortgage obligations 3,546 69 16 3,599
Trust preferred stock 2,000 12 80 1,932
Equity securities 343 42 -- 385
Obligations of state and political
subdivisions 8,216 131 96 8,251
-----------------------------------------------------------
Totals $ 47,817 $ 1,505 $ 333 $ 48,989
===========================================================
Held-to-Maturity Securities:
FHLMC certificates $ 1,690 $ 25 $ 25 $ 1,690
FNMA certificates 2,389 26 52 2,363
GNMA certificates 871 22 -- 893
Obligations of states and political
subdivisions 630 102 -- 732
-----------------------------------------------------------
Totals $ 5,580 $ 175 $ 77 $ 5,678
===========================================================
75
5. Investment Securities (continued)
December 31, 2000
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
-----------------------------------------------------------
(In Thousands)
Available-for-Sale Securities:
U.S. Treasury securities and obligations
of U.S. Government corporations and
agencies $ 17,672 $ 263 $ 1 $ 17,934
Corporate bonds 11,797 97 10 11,884
Adjustable rate mortgage-backed security
mutual funds 6,606 - 238 6,368
Adjustable rate mortgage-backed securities 2,200 5 - 2,205
REMICs 1,519 16 - 1,535
Collateralized mortgage obligations 4,948 12 25 4,935
Trust preferred stock 2,000 - 135 1,865
Equity securities 343 89 - 432
Obligations of state and political
subdivisions 6,066 37 85 6,018
-----------------------------------------------------------
Totals $ 53,151 $ 519 $ 494 $ 53,176
===========================================================
Held-to-Maturity Securities:
FHLMC certificates $ 2,670 $ 27 $ 18 $ 2,679
FNMA certificates 3,009 19 77 2,951
GNMA certificates 1,249 18 3 1,264
Obligations of states and political
subdivisions 769 107 - 876
-----------------------------------------------------------
Totals $ 7,697 $ 171 $ 98 $ 7,770
===========================================================
The amortized cost and fair value of securities at December 31, 2001 by
contractual maturity are shown below. Expected maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties. Mutual funds are not
due at a single maturity date. For purposes of the maturity table,
mortgage-backed securities, which are not due at a single maturity date, have
been allocated over maturity groupings based on the weighted-average contractual
maturities of the underlying collateral. The mortgage-backed securities may
mature earlier than their weighted-average contractual maturities because of
principal prepayments.
76
5. Investment Securities (continued)
Available-for-Sale Held-to-Maturity
----------------------------------- -------------------------------------
Amortized Amortized
Cost Fair Value Cost Fair Value
--------------------------------------------------------------------------
(In Thousands)
Due in one year or less $ 7,086 $ 7,249 $ 188 $ 193
Due after one year through
five years 23,581 24,731 347 391
Due after five years through
ten years 5,002 5,062 361 430
Due after ten years 9,257 9,084 4,684 4,664
--------------------------------------------------------------------------
44,926 46,126 5,580 5,678
Adjustable rate mortgage-backed
security mutual
funds 2,548 2,478 - -
Equity securities 343 385 - -
--------------------------------------------------------------------------
Totals $ 47,817 $ 48,989 $ 5,580 $ 5,678
==========================================================================
6. Loan Commitments and Delinquencies
Loan commitments are made to accommodate the financial needs of First Defiance's
customers. The associated credit risk is essentially the same as that involved
in extending loans to customers and is subject to First Defiance's normal credit
policies. Collateral such as mortgages on property and equipment, receivables
and inventory is obtained based on management's credit assessment of the
customer. At December 31, 2001, First Defiance's outstanding commitments to fund
long-term mortgage loans amounted to approximately $12.1 million comprised of
approximately 86% fixed rate and 14% adjustable rate loans with rates ranging
from 5.5% to 7.75%. First Defiance's commitment to sell long-term mortgage loans
amounted to $238.3 million as of December 31, 2001. First Defiance's maximum
exposure to credit loss for loan commitments (unfunded loans, unused lines of
credit and letters of credit) was $111.0 million at December 31, 2001.
77
6. Loan Commitments and Delinquencies (continued)
Unpaid balances of loans with contractual payments delinquent 90 days or more
totaled $17,808,000 at December 31, 2001 and $9,521,000 at December 31, 2000
(including $15,437,000 and $8,072,000 at December 31, 2001 and 2000 respectively
of loans that have FHA or VA guarantees or other forms of insurance). First
Federal does not anticipate any significant losses in the collection of these
delinquent loans in excess of the allowance for loan losses.
Impaired loans having recorded investments of $370,000 at December 31, 2001 and
$95,000 at December 31, 2000 have been recognized in conformity with FASB
Statement No. 114, as amended by FASB Statement No. 118. The average recorded
investment in impaired loans during 2001 and 2000 was $501,000 and $135,000,
respectively. The total allowance for loan losses related to these loans was
$202,000 and $95,000 at December 31, 2001 and 2000. There was $40,000 of
interest received and recorded in income during 2001 on impaired loans including
interest received and recorded in income prior to such impaired loan
designation. There was no interest recorded in 2000 and $36,000 recorded in
1999.Loans having carrying values of $391,000 and $607,000 were transferred to
real estate and other assets held for sale in 2001 and 2000, respectively.
First Defiance is not committed to lend additional funds to debtors whose loans
have been modified.
78
7. Loans Receivable
December 31
2001 2000
-------------------------
(In Thousands)
Loans receivable consist of the following at December 31:
Real estate loans:
Secured by single family residential $ 144,201 $ 209,645
Secured by multi-family residential 66,288 44,700
Secured by non-residential real estate 152,511 125,479
Construction 7,875 9,627
--------------------------
370,875 389,451
Other loans:
Automobile 33,323 43,610
Mobile home 12 29
Commercial 83,690 81,138
Home equity and improvement 36,179 31,836
Other 7,598 8,504
--------------------------
160,802 165,117
--------------------------
Total loans 531,677 554,568
Deduct:
Undisbursed loan funds 2,887 3,415
Net deferred loan origination fees and costs 1,024 1,041
Allowance for loan losses 9,937 8,904
--------------------------
Totals $ 517,829 $ 541,208
==========================
79
7. Loans Receivable (continued)
Changes in the allowance for loan losses were as follows:
Years ended December 31
2001 2000 1999
----------------------------------------
(In Thousands)
Allowance at beginning of year $ 8,904 $ 7,758 $ 9,789
Provision for credit losses 993 635 155
Provision for foreclosure losses 2,877 2,512 1,770
----------------------------------------
Total provision 3,870 3,147 1,925
----------------------------------------
Foreclosure expense charge-off 2,475 1,550 1,710
Credit loss charge-off 1,032 1,031 2,525
----------------------------------------
Total charge-offs 3,507 2,581 4,235
----------------------------------------
Recoveries from foreclosure losses 413 358 -
Recoveries from credit losses 257 222 279
----------------------------------------
Total recoveries 670 580 279
----------------------------------------
Net charge-offs 2,837 2,001 3,956
----------------------------------------
Ending allowance $ 9,937 $ 8,904 $ 7,758
========================================
Ending allowance for credit losses $ 6,548 $ 6,330 $ 6,504
Ending allowance for foreclosure losses 3,389 2,574 1,254
----------------------------------------
Total ending allowance $ 9,937 $ 8,904 $ 7,758
========================================
Interest income on loans is as follows:
Years ended December 31
2001 2000 1999
----------------------------------------
(In thousands)
Mortgage loans $ 33,971 $ 35,731 $ 32,453
Other loans 28,138 24,651 17,474
----------------------------------------
Totals $ 62,109 $ 60,382 $ 49,927
========================================
80
7. Loans Receivable (continued)
There are no industry concentrations (exceeding 10% of loans, gross) in First
Federal's non-residential real estate and commercial loan portfolios. Virtually
all of the Company's loans receivable (excluding the mortgage loans available
for sale) are to borrowers in the Northwest Ohio, Northeast Indiana or Southeast
Michigan areas.
8. Mortgage Banking
The activity in Mortgage Servicing Rights (MSRs) is summarized as follows:
Years ended December 31
2001 2000 1999
----------------------------------------------------
(In Thousands)
Balance at beginning of period $ 134,760 $ 97,519 $ 76,452
Loans sold, servicing retained 48,873 52,225 35,909
Proceeds from sale of MSR's - - (2,610)
Gain on sale of MSR's - - 479
Amortization (23,405) (14,963) (12,711)
Impairment of MSR's (2,859) (21) -
----------------------------------------------------
Balance at end of period $ 157,369 $ 134,760 $ 97,519
====================================================
Accumulated amortization of MSRs aggregates approximately $58.7 million, $32.4
million and $17.5 million, at December 31, 2001, 2000 and 1999, respectively.
At December 31, 2001, the estimated fair value of the servicing rights was
$173.3 million, as determined using a mortgage servicing rights valuation model.
81
8. Mortgage Banking (continued)
The Company's servicing portfolio (excluding subserviced loans) is comprised of
the following:
December 31
2001 2000
---------------------------------- -----------------------------------
Number of Principal Number of Principal
Loans Outstanding Loans Outstanding
----------------------------------------------------------------------
(Dollars in Thousands)
GNMA 93,917 $ 6,769,911 85,379 $ 5,885,531
FNMA 14,395 956,037 13,463 874,399
FHLMC 1,985 100,662 2,504 115,296
Other VA, FHA, and conventional
loans 29,616 1,365,120 22,762 1,115,594
----------------------------------------------------------------------
Totals 139,913 $ 9,191,730 124,108 $ 7,990,820
======================================================================
The components of mortgage banking income, net of amortization are as follows:
Years ended December 31
2001 2000 1999
---------------------------------------------------
(In Thousands)
Loan servicing fee income $ 40,576 $ 31,869 $ 25,040
Late charges 5,381 4,260 3,116
---------------------------------------------------
Total mortgage banking income 45,957 36,129 28,156
Gain on sale of loans 11,709 9,546 7,081
Gain on sale of MSR's -- -- 479
Amortization of mortgage servicing rights (23,405) (14,963) (12,711)
Impairment of MSR's (2,859) (21) --
---------------------------------------------------
Totals $ 31,402 $ 30,691 $ 23,005
===================================================
82
9. Premises and Equipment
Premises and equipment are summarized as follows:
December 31
2001 2000
--------------------------------
(In Thousands)
Cost:
Land $ 2,771 $ 2,771
Buildings 15,640 15,602
Leasehold improvements 965 851
Furniture, fixtures and equipment 12,111 10,945
Construction in process 804 82
--------------------------------
32,291 30,251
Less allowances for depreciation and
amortization 10,049 8,048
--------------------------------
$ 22,242 $ 22,203
================================
There was no interest capitalized on construction projects during 2001 or 2000.
The Leader leases office space from a partnership whose controlling partners
include officers of The Leader. The five year lease agreement provides for
annual base rents of $436,000 plus additional rents based on increases in
operating expenses and taxes. There were no outstanding amounts payable under
the lease agreement as of December 31, 2001.
83
10. Deposits
The following schedule sets forth interest expense by type of savings deposit:
Years ended December 31
2001 2000 1999
-----------------------------------------
(In Thousands)
Checking and money market accounts $ 3,871 $ 3,361 $ 2,180
Savings accounts 569 740 879
Certificates 20,680 21,400 16,852
----------------------------------------
25,120 25,501 19,911
Less interest capitalized -- -- 22
----------------------------------------
Totals $ 25,120 $ 25,501 $ 19,889
========================================
At December 31, 2001, accrued interest payable amounted to $899,000 which was
comprised of $853,000, $44,000 and $2,000 for certificates, checking and money
market accounts, and savings accounts, respectively.
A summary of deposit balances is as follows:
December 31
2001 2000
--------------------------------------
(In Thousands)
Savings accounts $ 36,951 $ 37,551
Checking accounts 78,753 65,901
Money Market demand accounts 112,833 78,961
Certificates of deposit 402,913 363,486
--------------------------------------
$ 631,450 $ 545,899
======================================
84
10. Deposits (continued)
Scheduled maturities of certificates of deposit are as follows:
December 31,
2001
---------------------
(In Thousands)
2002 $ 284,604
2003 86,414
2004 22,521
2005 4,226
2006 4,663
2007 and thereafter 485
---------------------
Total $ 402,913
=====================
At December 31, 2001 and 2000 deposits of $146.0 million and $98.9 million,
respectively, were in excess of the $100,000 Federal Deposit Insurance
Corporation insurance limit. At December 31, 2001 and 2000, $18.5 million and
$20.2 million, respectively, in investment securities were pledged as collateral
against public deposits for certificates in excess of $100,000. In addition,
First Federal has a $7,000,000 depository bond with the State of Ohio, which can
be pledged as collateral against public deposits for certificates in excess of
$100,000.
85
11. Advances from Federal Home Loan Bank
First Federal has the ability to borrow funds from the FHLB. First Federal
pledges its single-family residential mortgage loan portfolio as security for
these advances. At December 31, 2001, the total available collateral amounted to
approximately $355.1 million. Advances secured by mortgages must have collateral
to exceed borrowings by 125%. Advances secured by investment securities must
have 100% collateral. The total level of borrowing is also limited to 50% of
total assets. First Federal has a maximum potential to acquire advances of
approximately $284.0 million from the FHLB.
The FHLB has made a series of advances totaling $130.0 million to First Defiance
that have fixed maturity dates but are callable at the option of the FHLB on a
specified date and quarterly thereafter. The terms of these advances are as
follows (in thousands):
Balance Interest Rate Call Date Maturity Date
- ---------------------------------------------------------------------------
$ 10,000 4.94% 12/18/03 12/18/08
15,000 5.64% 01/26/02 10/26/09
10,000 5.84% 03/01/02 09/01/10
20,000 5.83% 01/20/02 10/20/05
10,000 5.95% 02/07/02 11/07/05
15,000 4.52% 01/10/02 01/10/11
10,000 4.76% 01/10/03 01/10/11
10,000 4.93% 02/02/04 02/02/11
20,000 4.07% 03/08/02 03/08/11
10,000 5.14% 03/08/04 03/08/11
When called, First Defiance has the option of paying off these advances, or
converting them to variable rate advances priced at the three month LIBOR rate.
First Defiance has an additional $26.3 million outstanding on a series of fixed
rate long-term advances. Of this amount, $1.2 million is a fixed rate advance
under the FHLB Affordable Housing Program in 1995. The total FHLB long-term
advances bear a weighted average interest rate of 5.12% at December 31, 2001.
86
11. Advances from Federal Home Loan Bank (continued)
Future minimum payments by fiscal year are as follows (in thousands):
2002 $ 8,145
2003 22,394
2004 16,824
2005 36,421
2006 4,978
Thereafter 118,969
------------------
Total minimum payments 207,731
Less amounts representing interest 51,429
------------------
Totals $ 156,302
==================
First Defiance also utilizes short-term advances from the FHLB to meet cash flow
needs and for short-term investment purposes. There were $40.0 million in
short-term advances outstanding at December 31, 2001 and $106.5 million at
December 31, 2000. First Defiance borrows short-term advances under a variety of
programs at FHLB. At December 31, 2001, $30.0 million was outstanding under
First Defiance's REPO Advance line of credit. The total available under the REPO
line is $175.0 million. Amounts are generally borrowed under the REPO line on an
overnight basis. Other advances may be borrowed under the FHLB's short-term
fixed or LIBOR based programs. There was one $10.0 million short-term fixed rate
advance outstanding at December 31, 2001. Information concerning short-term
advances is summarized as follows:
Years ended December 31
2001 2000
---------------------------------------
(In Thousands, except percentages)
Average balance during the year $ 62,695 $ 72,384
Maximum month-end balance during the year 111,000 140,250
Average interest rate during the year 4.32% 6.53%
87
12. Notes Payable
Total mortgage warehouse, revolving and term debt is summarized as follows:
December 31
2001 2000
------------------------------
(In Thousands)
Mortgage warehouse and revolving loans:
$150,000 uncommitted repurchase line of credit with a bank secured
by mortgage loans held for sale, interest at federal funds rate
plus 0.40% (2.15% at December 31, 2001); $133,091 available at
December 31, 2001 $ 16,909 $ 30,616
$75,000 committed revolving warehouse loan agreement with a bank
secured by mortgage loans held for sale, interest at lower of
LIBOR plus 1.00% or federal funds plus 1.25% (2.88% at December
31,2001); $61,542 available at December 31, 2001 13,458 71,662
$20,000 revolving line of credit facility, secured by the stock of
First Federal, interest at LIBOR plus 1.5% (3.62% at
December 31, 2001) $1,750 available at December 31, 2001 18,250 --
$15,000 secured and unsecured revolving lines of credit
facilities, at various rates. -- 12,000
------------------------------
Total mortgage warehouse and revolving loans 48,617 114,278
Term notes payable:
Industrial Development Revenue Bonds payable to Cuyahoga County,
secured by real estate and a letter of credit, interest is
calculated using a tax exempt rate applicable for the prescribed
adjustment period, currently weekly. During 2001 the interest
rate ranged from 1.60% to 5.25%. The issue matures March 1, 2019 4,745 4,890
Notes payable to the City of Cleveland, recorded at discounted
value, secured by real estate with interest at 0% per annum.
Balance due at maturity on March 1, 2009 is $928,450 602 569
Note payable to City of Cleveland Housing Trust Fund, secured by
real estate, interest at 2% per annum, maturing March 1, 2009 407 392
Note payable to bank, secured by real estate, interest at 7% per
annum, maturing March 1, 2019 60 71
Note payable to former employee, unsecured with interest at 5% per
annum, maturing October 1, 2004 107 139
Note payable to bank, secured by business assets, interest at 7.5%
per annum, maturing March 1, 2003 49 86
------------------------------
Total term notes payable 5,970 6,147
------------------------------
Total borrowed money $ 54,587 $ 120,425
==============================
88
12. Notes Payable (continued)
As of December 31, 2001, the maturities of term notes payable during the next
five years and thereafter are as follows (in thousands):
2002 $ 239
2003 230
2004 253
2005 233
2006 239
Thereafter 4,776
------------
$5,970
============
13. Postretirement Benefits
First Federal sponsors a defined benefit postretirement plan that is intended to
supplement Medicare coverage for certain retirees who meet minimum years of
service requirements. Persons who retired prior to April 1, 1997 who completed
20 years of service after age 40 receive full medical coverage at no cost. Such
coverage continues for surviving spouses of those participants for one year,
after which coverage may be continued provided the spouse pays 50% of the
average cost. Persons retiring after April 1, 1997 are provided medical benefits
at a cost based on their combined age and years of service at retirement.
Surviving spouses are also eligible for continued coverage after the retiree is
deceased at a subsidy level that is 10% less than what the retiree is eligible
for. Persons retiring before July 1, 1997 receive dental and vision care in
addition to medical coverage. Persons who retire after July 1, 1997 are not
eligible for dental or vision care, but those retirees and their spouses each
receive up to $200 annually in a medical spending account. Funds in that account
may be used for payment of uninsured medical expenses. Persons who were born
after December 31, 1950 are not eligible for the medical coverage described
above at retirement. Rather, a medical spending account of up to $10,000 (based
on the participant's age and years of service) will be established to reimburse
medical expenses for those individuals.
89
13. Postretirement Benefits (continued)
The plan is not currently funded. The following table summarizes benefit
obligation and plan asset activity for the plan:
December 31
2001 2000
-------------------
(In Thousands)
Change in fair value of plan assets:
Balance at beginning of measurement period $ - $ -
Employer contribution 60 67
Participant contribution 5 4
Benefits paid (65) (71)
-------------------
Balance at end of measurement period - -
Change in benefit obligation:
Balance at beginning of measurement period 789 752
Service cost 22 34
Interest costs 45 47
Participant contribution 5 4
Plan amendments 13 -
Actuarial losses 238 23
Benefits paid (65) (71)
-------------------
Balance at end of measurement period 1,047 789
-------------------
Unfunded status 1,047 789
Unrecognized prior service cost (56) (47)
Unrecognized net (loss)gain (102) 111
-------------------
Accrued postretirement benefit obligation
included in accrued interest and other expenses
in consolidated statement of financial condition $ 889 $853
===================
90
13. Postretirement Benefits (continued)
Net periodic postretirement benefit cost includes the following components:
Years ended December 31
2001 2000 1999
---------------------------
(In Thousands)
Service cost-benefits attributable to service
during the period $ 22 $ 34 $ 34
Interest cost on accumulated postretirement
benefit obligation 45 47 45
Net amortization and deferral 29 1 -
---------------------------
Net periodic postretirement benefit cost $ 96 $ 82 $ 79
===========================
The assumed annual rate of increase in the per capita cost of covered health
care benefits were assumed is 8.00% for 2002 gradually trending downward to
5.00% by the year 2008. The health care cost trend rate assumption has a
significant effect on the amounts reported. To illustrate, increasing the
assumed health care cost trend rate by 1 percentage point for each year would
increase the accumulated postretirement benefit obligation as of December 31,
2001 by $137,000 and the aggregate of the service and interest cost for the year
then ended by $15,000.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.0% for 2001 and 6.5% for 2000 and 1999.
14. Regulatory Matters
First Defiance and First Federal are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the consolidated financial statements. Under capital
guidelines and the regulatory framework for prompt corrective action, First
Federal must meet specific capital guidelines that involve quantitative measures
of First Federal's assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. First Federal's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
91
14. Regulatory Matters (continued)
Quantitative measures established by regulation to ensure capital adequacy
require First Federal to maintain minimum amounts and ratios of Tier I and total
capital to risk-weighted assets and of Tier I capital to average assets. As of
December 31, 2001 and 2000, First Federal meets all capital adequacy
requirements to which it is subject.
The most recent notification from the Office of Thrift Supervision categorized
First Federal as well capitalized under the regulatory framework.
The following schedule presents First Federal's regulatory capital ratios:
Regulatory Capital Standards
---------------------------------------------------------
Actual Required
---------------------------------------------------------
Amount Ratio Amount Ratio
---------------------------------------------------------
(In Thousands, except percentages)
As of December 31, 2001:
Tangible Capital $ 70,568 6.59% $ 16,067 1.50%
Core Capital 70,568 6.59% 42,845 4.00%
Risk-Based Capital 79,600 11.03% 57,748 8.00%
As of December 31, 2000:
Tangible Capital $ 62,569 6.10% $ 15,381 1.5%
Core Capital 62,569 6.10% 41,016 4.0%
Risk-Based Capital 71,210 10.28% 55,410 8.0%
92
15. Income Taxes
The components of income tax expense (credit) are as follows:
Years ended December 31
2001 2000 1999
-----------------------------------------------
(In Thousands)
Current:
Federal $ 9,920 $ 6,077 $ 4,571
State and local 3 - -
Deferred (credit) (2,340) (163) 58
-----------------------------------------------
$ 7,583 $ 5,914 $ 4,629
===============================================
The provision for income taxes differs from that computed at the statutory
corporate tax rate as follows:
Years ended December 31
2001 2000 1999
-----------------------------------------------
(In Thousands)
Tax expense at statutory rate $ 7,418 $ 5,906 $ 4,507
Increases (decreases) in taxes from:
Goodwill amortization 256 256 249
State income tax--net of federal tax -
benefit 2 -
Tax exempt interest income (183) (119) (103)
Other 90 (129) (24)
-----------------------------------------------
Totals $ 7,583 $ 5,914 $ 4,629
===============================================
93
15. Income Taxes (continued)
Deferred federal income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of First Defiance's deferred federal income tax assets and
liabilities are as follows:
December 31
2001 2000
-------------------------
-------------------------
(In Thousands)
Deferred federal income tax assets:
Net unrealized losses on available-for-sale
securities $ -- $ --
Allowance for loan losses 3,628 3,227
Postretirement benefit costs 311 299
Deferred compensation and management
recognition plans 649 723
State income tax 21 22
Other 434 189
--------------------------
Total deferred federal income tax assets 5,043 4,460
Deferred federal income tax liabilities:
Net unrealized gains on available-for-sale securities 411 22
Mortgage servicing rights 2,895 5,081
FHLB stock dividends 1,792 1,423
Deferred loan origination fees and costs (net) 176 116
Fixed assets 379 358
Other 94 71
--------------------------
Total deferred federal income tax liabilities 5,747 7,071
--------------------------
Net deferred federal income tax liability $ (704) $(2,611)
==========================
No valuation allowance was required at December 31, 2001 or 2000.
94
15. Income Taxes (continued)
Retained earnings at December 31, 2001 include financial statement tax bad debt
reserves of $10.14 million. The Small Business Job Protection Act of 1996 passed
on August 20, 1996 eliminated the special bad debt deduction previously granted
solely to thrifts. This results in the recapture of past taxes for permanent
deductions arising from the "applicable excess reserve," which is the total
amount of First Federal's reserve over its base year reserve as of December 31,
1987. The recapture tax is due in six equal annual installments beginning after
December 31, 1996. However, deferral of those payments was permitted for up to
two years, contingent upon satisfying a specified mortgage origination test for
1997 and 1998 (which was met). At December 31, 2001, First Federal had $415,000
in excess of the base year reserves. Deferred taxes have been provided related
to this item. No provision is required to be made for the $9.52 million of base
year reserves.
16. Employee Benefit Plans
Employees of First Defiance are eligible to participate in the First Defiance
Financial Corp. 401(k) Employee Savings Plan (First Defiance 401(k)) if they
meet certain age and service requirements. Under the First Defiance 401(k),
First Defiance matches 50% of the participants' contributions, to a maximum of
3% of compensation. The First Defiance 401(k) also provides for a discretionary
First Defiance contribution in addition to the First Defiance matching
contribution. For the year ended December 31, 2001, First Defiance's matching
contribution was $303,000 and the discretionary company contribution was
$366,000. For the year ended December 31, 2000, First Defiance's matching
contribution was $274,000 and the discretionary company contribution was
$709,000. For the year ended December 31, 1999, First Defiance's matching
contribution was $171,000 and the discretionary contribution was $419,000.
95
16. Employee Benefit Plans (continued)
The Leader sponsored The Leader Mortgage Company Savings and Investment Plan and
Trust (The Leader 401(k)). All employees of The Leader who met certain age and
eligibility requirements were eligible to participate. The Leader matched
employee contributions to The Leader 401(k) 100% up to federally proscribed
limits. Matching contributions to The Leader 401(k) from January 1, 1999 to
March 31, 1999 amounted to $70,000. Effective April 1, 1999, The Leader 401(k)
was merged into the First Defiance 401(k), with all assets and liabilities of
The Leader 401(k) becoming assets and liabilities of the First Defiance 401(k).
First Insurance and Investments sponsored the Stauffer-Mendenhall Agency
Employees Retirement Savings Plan. (First Insurance 401(k)). All employees who
met certain age and eligibility requirements were eligible to participate. First
Insurance matched employee contributions to the First Insurance 401(k) 10% up to
federally proscribed limits. Matching contributions to the First Insurance
401(k) from January 1, 1999 to September 30, 1999 amounted to $3,000. Effective
October 1, 1999, the First Insurance 401(k) was merged into the First Defiance
401(k), with all assets and liabilities of the First Insurance 401(k) becoming
assets and liabilities of the First Defiance 401(k).
First Defiance also has established an Employee Stock Ownership Plan (ESOP)
covering all employees of First Defiance age 21 or older who have at least one
year of credited service. Contributions to the ESOP are made by First Defiance
and are determined by First Defiance's Board of Directors at their discretion.
The contributions may be made in the form of cash or First Defiance common
stock. The annual contributions may not be greater than the amount deductible
for federal income tax purposes and cannot cause First Federal to violate
regulatory capital requirements.
To fund the plan, the ESOP borrowed funds from First Defiance for the purpose of
purchasing shares of First Defiance common stock. The ESOP acquired a total of
863,596 shares in 1993 and 1995. The loan outstanding at December 31, 2001 was
$3,626,000. Principal and interest payments on the loan are due in equal
quarterly installments through June of 2008. The loan is collateralized by the
shares of First Defiance's common stock and is repaid by the ESOP with funds
from the Company's contributions to the ESOP, dividends on unallocated shares
and earnings on ESOP assets.
96
16. Employee Benefit Plans (continued)
As principal and interest payments on the loan are paid, shares are released
from collateral and committed for allocation to active employees, based on the
proportion of debt service paid in the year. Shares held by the ESOP which have
not been released for allocation are reported as stock acquired by the ESOP plan
in the statement of financial condition. As shares are released, First Defiance
records compensation expense equal to the average fair value of the shares over
the period in which the shares were earned. Also, the shares released for
allocation are included in the average shares outstanding for earnings per share
computations. Dividends on allocated shares are recorded as a reduction of
retained earnings and dividends on unallocated shares are recorded as additional
ESOP expense. ESOP compensation expense was $523,000, $328,000 and $470,000 for
2001, 2000 and 1999, respectively. As of December 31, 2001, 548,223 ESOP shares
have been released for allocation of which 536,026 were allocated to
participants. The 315,373 unreleased shares have a fair value of $4.8 million at
December 31, 2001.
The Shareholders of First Defiance approved and established Management
Recognition Plans (MRP) in 1993 and 1996 to provide directors, officers and
employees with a proprietary interest in First Defiance as incentive to
contribute to its success. Cash was contributed to the MRP in the form of
deferred compensation amounting to $800,000 in 1993 and $2,817,452 in 1996. The
$800,000 contributed in 1993 was used to purchase 172,722 shares of First
Defiance common stock. All shares acquired in 1993 were granted on July 19,
1993. All 259,076 of the shares acquired in 1996 have been granted as of
December 31, 2001, not including 46,877 shares forfeited by participants who
terminated before their shares vested. The shares vest at a rate of 20% per year
over five years. First Defiance is amortizing the deferred compensation and
recording additions to stockholder's equity as the shares vest. Compensation
expense attributable to the MRP amounted to $121,000, $255,000 and $385,000 in
2001, 2000 and 1999 respectively.
97
17. Stock Option Plans
First Defiance has established incentive stock option plans for its directors
and its employees and has reserved 1,376,485 shares of common stock for issuance
under the plans. A total of 1,116,204 shares are reserved for employees and
260,281 shares are reserved for directors. As of December 31, 2001, 975,782
options (804,701 for employees and 171,081 for directors) have been granted and
remain outstanding at option prices based on the market value of the underlying
shares on the date the options were granted. There are 158,997 options granted
under the 1993 plan that are currently exercisable, 590,785 options granted
under the 1996 plan that vest at 20% per year beginning in 1997 of which 497,158
are fully vested and currently exercisable and 226,000 options granted under the
2001 plan which vest at 20% per year beginning in 2002. All options expire ten
years from date of grant. Vested options of retirees expire on the earlier of
the scheduled expiration date or five years after the retirement date for the
1993 and 2001 plans and on the earlier of the scheduled expiration date or
twelve months after the retirement date for the 1996 plan. There are 62,000
unvested options held by employees of The Leader at exercise prices ranging from
$11.75 to $14.00 that will vest upon the closing of the sale transaction.
FASB Statement No. 123, Accounting for Stock-Based Compensation defines a fair
value-based method of accounting for stock-based employee compensation plans.
Under the fair value-based method, compensation cost is measured at the grant
date based upon the value of the award and is recognized over the service
period. While the standard encourages entities to adopt this method of
accounting for employee stock compensation plans, it also allows an entity to
continue to measure compensation costs for its plans as prescribed in APB
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. First
Defiance has elected to continue to apply APB 25.
98
17. Stock Option Plans (continued)
The following pro forma information regarding net income and earnings per share
assumes the adoption of Statement No. 123 for stock options. The estimated fair
value of the option is amortized to expense over the option and vesting period.
The fair value was estimated at the date of grant using a Black-Scholes option
pricing model with the following weighted-average assumptions:
December 31
2001 2000 1999
------------------------------------------------------
Risk free interest rate 5.70% 6.00% 5.56%
Dividend yield 3.01% 4.80% 2.49%
Volatility factors of expected market
price of stock 0.268% 0.281% 0.267%
Weighted average expected life 8.65 years 7.48 years 7.49 years
Weighted average grant date fair value
of options granted $ 3.38 $ 3.47 $ 3.48
Based upon the above assumptions, pro forma net income and earnings per share
are as follows:
Years ended December 31
2001 2000 1999
------------------------------------------------------
Pro forma net income $ 13,396 $ 10,616 $ 8,310
======================================================
Pro forma earnings per share:
Basic $ 2.07 $ 1.68 $ 1.28
======================================================
Diluted $ 2.01 $ 1.65 $ 1.25
======================================================
The pro forma effects for 2001, 2000 and 1999 are not likely to be
representative of the pro forma effects for future years.
Because Statement No. 123 is applicable only to options granted subsequent to
December 31, 1994, options granted prior to December 31, 1994 do not have fair
value pro forma information provided.
99
17. Stock Option Plans (continued)
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
First Defiance's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
The following table summarizes stock option activity for 2001 and 2000
2001 2000
-------------------------------------------------------------------------
Range of Range of
Option Option Option Option
Shares Prices Shares Prices
-------------------------------------------------------------------------
Outstanding at January 1 787,888 $4.63 to $15.50 871,426 $4.63 to $15.50
Granted 234,000 $14.00 to $14.05 2,543 $8.25 to $10.516
Exercised (41,106) $4.63 to $14.00 (80,081) $4.63
Expired or canceled (5,000) $11.75 to $14.00 (6,000) $10.50 to $15.50
-------------------------------------------------------------------------
Outstanding at December 31 975,782 $4.63 to $15.50 787,888 $4.63 to $15.50
=========================================================================
Exercisable to:
2001 -- -- 500 $11.75
2002 13,000 $4.63 26,000 $ 4.63
2003 50,581 $4.63 53,697 $ 4.63
2004 -- -- 21,590 $ 6.95
2006 430,104 $10.375 to $10.6875 430,504 $10.375 to $10.6875
2007 68,966 $12.625 to $13.00 68,966 $12.625 to $13.00
2008 129,702 $12.25 to $15.50 137,202 $12.25 to $15.50
2009 46,886 $11.25 to $11.75 46,886 $11.25 to $11.75
2010 2,543 $8.25 to $10.516 2,543 $8.25 to $10.516
2011 234,000 $14.00 to $14.05 -- --
-------------------------------------------------------------------------
975,782 $4.63 to $15.50 787,888 $4.63 to $15.50
=========================================================================
Available for future grant
at December 3l 128,364 14,364
=========================================================================
100
18. Parent Company and Regulatory Restrictions
Dividends paid by First Federal to First Defiance are subject to various legal
and regulatory restrictions. First Federal can initiate dividend payments in
2002, without prior regulatory approval, of $10.9 million, plus an additional
amount equal to their net profits for 2002, as defined by statute, up to the
date of any such dividend declaration. There were no dividends declared in 2001.
Condensed parent company financial statements, which include transactions with
subsidiaries, follow:
December 31
Statements of Financial Condition 2001 2000
-------------------------------
(In Thousands)
Assets
Cash and cash equivalents $ 156 $ 1,056
Investment securities, available for sale,
carried at fair value 87 106
Investment in subsidiaries 126,182 110,237
Loan receivable from First Defiance Employee
Stock Ownership Plan 3,706 4,008
Other assets 142 102
-------------------------------
Total assets $ 130,273 $ 115,509
===============================
Liabilities and stockholders' equity
Notes payable $ 18,250 $ 15,000
Accrued liabilities 1,002 1,036
Stockholders' equity 111,021 99,473
-------------------------------
Total liabilities and stockholders' equity $ 130,273 $ 115,509
===============================
101
18. Parent Company and Regulatory Restrictions (continued)
Years ended December 31
Statements of Income 2001 2000 1999
------------------------------------------------------
(In Thousands)
Interest on subordinated debt $ -- $ -- $ 895
Interest on loan to ESOP 330 362 392
Interest expense on notes payable (953) (624) (5)
Other income 2 20 25
Noninterest expense (638) (629) (758)
------------------------------------------------------
(Loss) income before income
taxes and equity in earnings
of subsidiaries (1,259) (871) 549
Income tax (credit) expense (440) (316) 343
------------------------------------------------------
(Loss) income before equity in earnings of
subsidiaries (819) (555) 206
Equity in earnings of subsidiaries 14,435 11,518 8,417
------------------------------------------------------
Net income $ 13,616 $ 10,963 $ 8,623
======================================================
102
18. Parent Company and Regulatory Restrictions (continued)
Years ended December 31
Statements of Cash Flows 2001 2000 1999
-------------------------------------------
(In Thousands)
Operating activities:
Net income $ 13,616 $ 10,963 $ 8,623
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Provision for depreciation -- 6 7
(Gain) loss on sale of office properties and equipment -- (6) 29
Deferred federal income taxes (credit) -- 28 (19)
Equity in earnings of subsidiaries (14,435) (11,518) (8,417)
Dividends received from subsidiary -- 750 --
Change in other assets and liabilities (136) (563) 825
-------------------------------------------
Net cash (used in) provided by operating activities (955) (340) 1,048
Investing activities
Proceeds from sale of office properties and equipment -- 569 416
Principal payments received for subordinated debt -- -- 22,400
Principal payments received on ESOP loan 302 349 321
Purchase of available-for-sale securities -- -- (70)
Purchase of premises and equipment -- (17) (1,004)
-------------------------------------------
Net cash provided by investing activities 302 901 22,063
Financing activities
Proceeds from short term notes payable 3,250 15,000 --
Stock options exercised 360 470 417
Purchase of common stock for treasury (748) (328) (10,394)
Capital contribution to subsidiaries -- (11,952) (11,080)
Cash dividends paid (3,109) (2,832) (2,692)
-------------------------------------------
Net cash (used in) provided by financing activities (247) 358 (23,749)
-------------------------------------------
Net (decrease) increase in cash and cash equivalents (900) 919 (638)
Cash and cash equivalents at beginning of year 1,056 137 775
-------------------------------------------
Cash and cash equivalents at end of year $ 156 $ 1,056 $ 137
===========================================
Non cash operating activities--change in deferred taxes
on net unrealized (losses) gains on available-for-sale $ 6 $ (13) $ 1
securities
===========================================
Non cash investing activities--change in
net unrealized gain (loss) on available-for-sale securities $ (19) $ 39 $ (3)
===========================================
Non cash financing activities--cash
dividends declared but not paid $ 848 $ 778 $ 703
===========================================
103
19. Fair Value Statement of Consolidated Financial Condition
The following is a comparative condensed consolidated statement of financial
condition based on carrying and estimated fair values of financial instruments
as of December 31, 2001 and 2000. FASB Statement No. 107, Disclosures about Fair
Value of Financial Instruments excludes certain financial instruments and all
nonfinancial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
First Defiance Financial Corp.
Much of the information used to arrive at "fair value" is highly subjective and
judgmental in nature and therefore the results may not be precise. Subjective
factors include, among other things, estimated cash flows, risk characteristics
and interest rates, all of which are subject to change. With the exception of
investment securities, the Company's financial instruments are not readily
marketable and market prices do not exist. Since negotiated prices for the
instruments, which are not readily marketable depend greatly on the motivation
of the buyer and seller, the amounts that will actually be realized or paid per
settlement or maturity of these instruments could be significantly different.
The carrying amount of cash and cash equivalents, warehouse and term notes
payable and advance payments by borrowers for taxes and insurance, as a result
of their short-term nature, is considered to be equal to fair value.
For investment securities, fair value has been based or current market
quotations. If market prices are not available, fair value has been estimated
based upon the quoted price of similar instruments.
The fair value of loans which reprice within 90 days is equal to their carrying
amount. For other loans, the estimated fair value is calculated based on
discounted cash flow analysis, using interest rates currently being offered for
loans with similar terms. The fair value of loans have not been adjusted for
credit risk.
SFAS No. 107 requires that the fair value of demand, savings, NOW and certain
money market accounts be equal to their carrying amount. The Company believes
that the fair value of these deposits is greater than that prescribed by SFAS
No. 107.
For deposits with fixed maturities, fair value is estimated based on interest
rates currently being offered on deposits with similar characteristics and
maturities.
FHLB advances with maturities greater than 90 days are valued based on
discounted cash flow analysis, using interest rates currently being quoted for
similar characteristics and maturities.
104
19. Fair Value Statement of Consolidated Financial Condition (continued)
The cost or value of any call or put options are based on the estimated cost to
settle the option at December 31, 2001.
December 31, 2001 December 31, 2000
-------------------------------- --------------------------------
Carrying Estimated Carrying Estimated
Value Fair Values Value Fair Values
------------------------------------------------------------------
(In Thousands)
Assets:
Cash and cash equivalents $ 36,116 $ 36,116 $ 20,954 $ 20,954
Investment securities 54,569 54,667 61,107 61,180
Loans, net 793,552 813,447 773,522 766,476
------------------------------------------------------------------
884,237 $ 904,230 855,583 $ 848,610
================ =================
Other assets 248,376 216,611
----------------- ----------------
Total assets $ 1,132,613 $ 1,072,194
================= ================
Liabilities and stockholders'
equity:
Deposits $ 631,450 $ 634,680 $ 545,899 $ 545,607
Advances from Federal Home Loan
Bank 196,302 208,646 223,258 221,976
Warehouse and term notes payable 54,587 54,587 120,425 120,425
Advance payments by borrowers
for taxes and insurance 123,154 123,154 67,982 67,982
------------------------------------------------------------------
1,005,493 $ 1,021,067 957,564 $ 955,990
================ =================
Other liabilities 16,099 15,157
----------------- ----------------
1,021,592 972,721
Stockholders' equity 111,021 99,473
----------------- ----------------
Total liabilities and
stockholders' equity $ 1,132,613 $ 1,072,194
================= ================
105
20. Line of Business Reporting
First Defiance operates two major lines of business. Retail banking, which
consists of the operations of First Federal, includes direct and indirect
lending, deposit-gathering, small business services, commercial lending and
consumer finance. Mortgage banking, which consists of the operations of The
Leader, includes buying and selling mortgages to the secondary market and the
subsequent servicing of these sold loans. The business units are identified by
the channels through which the product or service is delivered. The accounting
policies of the individual business units are the same as those of First
Defiance as described in Note 3. The retail-banking unit funds the
mortgage-banking unit and an investment/funding unit within the retail-banking
unit centrally manages interest rate risk. Transactions between business units
are primarily conducted at fair value, resulting in profits that are eliminated
for reporting consolidated results of operations.
The parent unit is comprised of the operations of First Insurance & Investments
and inter-segment income eliminations and unallocated expenses.
2001
----------------------------------------------------------------------
Retail Mortgage
Consolidated Parent Banking Banking
----------------------------------------------------------------------
(In Thousands)
Total interest income $ 65,864 $ (15,641) $ 61,708 $ 19,797
Total interest expense 38,886 (15,017) 41,985 11,918
----------------------------------------------------------------------
Net interest income 26,978 (624) 19,723 7,879
Provision for loan losses 3,870 -- 993 2,877
----------------------------------------------------------------------
Net interest income after provision 23,108 (624) 18,730 5,002
Non-interest income 66,431 2,123 7,174 57,134
Non-interest expense 68,340 2,873 18,289 47,178
----------------------------------------------------------------------
Income before income taxes 21,199 (1,374) 7,615 14,958
Income taxes 7,583 (463) 2,544 5,502
----------------------------------------------------------------------
Net income $ 13,616 $ (911) $ 5,071 $ 9,456
======================================================================
Total assets $ 1,132,613 $ (400,745) $ 1,027,685 $ 505,673
======================================================================
106
20. Line of Business Reporting (continued)
2000
----------------------------------------------------------------------
Retail Mortgage
Consolidated Parent Banking Banking
----------------------------------------------------------------------
(In Thousands)
Total interest income $ 65,185 $ (19,566) $ 66,022 $ 18,729
Total interest expense 43,502 (19,292) 45,110 17,684
----------------------------------------------------------------------
Net interest income 21,683 (274) 20,912 1,045
Provision for loan losses 3,147 -- 635 2,512
----------------------------------------------------------------------
Net interest income after provision 18,536 (274) 20,277 (1,467)
Non-interest income 53,246 2,300 4,252 46,694
Non-interest expense 54,905 2,840 17,226 34,839
----------------------------------------------------------------------
Income before income taxes 16,877 (814) 7,303 10,388
Income taxes 5,914 (241) 2,285 3,870
----------------------------------------------------------------------
Net income $ 10,963 $ (573) $ 5,018 $ 6,518
======================================================================
Total assets $ 1,072,194 $ (310,186) $ 958,607 $ 423,773
======================================================================
1999
----------------------------------------------------------------------
Retail Mortgage
Consolidated Parent Banking Banking
----------------------------------------------------------------------
(In Thousands)
Total interest income $ 53,379 $ (13,960) $ 54,388 $ 12,951
Total interest expense 31,582 (15,231) 35,657 11,156
----------------------------------------------------------------------
Net interest income 21,797 1,271 18,731 1,795
Provision for loan losses 1,925 6 149 1,770
----------------------------------------------------------------------
Net interest income after provision 19,872 1,265 18,582 25
Non-interest income 40,794 1,039 3,747 36,008
Non-interest expense 47,414 1,824 16,023 29,567
----------------------------------------------------------------------
Income before income taxes 13,252 480 6,306 6,466
Income taxes 4,629 374 1,850 2,405
----------------------------------------------------------------------
Net income $ 8,623 $ 106 $ 4,456 $ 4,061
======================================================================
Total assets $ 987,994 $ (362,172) $ 926,139 $ 424,027
======================================================================
107
21. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly consolidated results of operations:
Three Months Ended
------------------------------------------------------------------------
2001 March 31 June 30 September 30 December 31
------------------------------------------------------------------------
(In Thousands, except per share amounts)
Interest income $ 16,431 $ 16,294 $ 16,901 $ 16,238
Interest expense 11,138 9,749 9,540 8,459
------------------------------------------------------------------------
Net interest income 5,293 6,545 7,361 7,779
Provision for loan losses 773 631 1,200 1,266
------------------------------------------------------------------------
Net interest income after provision
for loan
losses 4,520 5,914 6,161 6,513
Loss on sale of securities (45) (15) (45) (32)
Non-interest income 15,311 14,848 16,306 20,103
Non-interest expense 15,107 16,683 17,876 18,675
------------------------------------------------------------------------
Income before income taxes 4,679 4,064 4,546 7,909
Income taxes 1,624 1,478 1,576 2,904
------------------------------------------------------------------------
Net income $ 3,055 $ 2,586 $ 2,970 $ 5,005
========================================================================
Earnings per share:
Basic $ 0.48 $ 0.40 $ 0.46 $ 0.77
========================================================================
Diluted $ 0.47 $ 0.39 $ 0.45 $ 0.75
========================================================================
Average shares outstanding:
Basic 6,366 6,394 6,405 6,489
========================================================================
Diluted 6,536 6,603 6,601 6,643
========================================================================
108
21. Quarterly Consolidated Results of Operations (Unaudited) (continued)
Three Months Ended
------------------------------------------------------------------------
2000 March 31 June 30 September 30 December 31
------------------------------------------------------------------------
(In Thousands, except per share amounts)
Interest income $ 15,830 $ 15,359 $ 16,911 $ 17,085
Interest expense 9,642 10,225 11,687 11,948
------------------------------------------------------------------------
Net interest income 6,188 5,134 5,224 5,137
Provision for loan losses 1,408 581 539 619
------------------------------------------------------------------------
Net interest income after
provision for loan
losses 4,780 4,553 4,685 4,518
Loss on sale of securities -- -- (29) (29)
Non-interest income 11,843 13,118 14,060 14,283
Non-interest expense 13,249 13,814 13,944 13,898
------------------------------------------------------------------------
Income before income taxes 3,374 3,857 4,772 4,874
Income taxes 1,173 1,399 1,604 1,738
------------------------------------------------------------------------
Net income $ 2,201 $ 2,458 $ 3,168 $ 3,136
========================================================================
Earnings per share:
Basic $ 0.35 $ 0.39 $ 0.50 $ 0.49
========================================================================
Diluted $ 0.35 $ 0.38 $ 0.49 $ 0.49
========================================================================
Average shares outstanding:
Basic 6,232 6,305 6,367 6,373
========================================================================
Diluted 6,376 6,407 6,451 6,465
========================================================================
109
Report of Independent Auditors
To the Stockholders and the Board of Directors
First Defiance Financial Corp.
We have audited the consolidated statements of financial condition of First
Defiance Financial Corp. as of December 31, 2001 and 2000, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 2001. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of First Defiance
Financial Corp. at December 31, 2001 and 2000, and the consolidated results of
its operations and cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
/s/Ernst & Young LLP
Cleveland, Ohio
January 18, 2002
110
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference from pages 6
through 12 of the definitive proxy statement dated March 20, 2002.
Item 11. Executive Compensation
The information required herein is incorporated by reference from the
Executive Compensation section beginning on page 14, the Stock Options section
on page 16, the Directors' Compensation section on page 19, and the Employment
Agreements section on pages 19 and 20 of the definitive proxy statement dated
March 20, 2002.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required herein is incorporated by reference from the
Beneficial Ownership section beginning on page 3 of the definitive proxy
statement dated March 20, 2002.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from the
Indebtedness of Management section on page 20 of the definitive proxy statement
dated March 20, 2002.
111
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
The following consolidated financial statements are filed as a part of
this document under "Item 8. Financial Statements and Supplementary
Data."
Consolidated Statements of Financial Condition as of December 31, 2001
and 2000
Consolidated Statements of Income for the years Ended December 31,
2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity for the years Ended
December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years Ended December 31,
2001, 2000 and 1999
Notes to Consolidated Financial Statements
Independent Auditor's Report
(a) (2) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are included in the Notes to Financial Statements
incorporated herein by reference and therefore have been omitted.
112
(a) (3) Exhibits
The following exhibits are either filed as a part of this report or are
incorporated herein by reference to documents previously filed as indicated
below:
Exhibit
Number Description
- -----------------------------------------------------------------------------------------------------------
3.1 Articles of Incorporation *
3.2 Code of Regulations *
3.2 Bylaws *
10.1 1996 Stock Option Plan **
10.2 1996 Management Recognition Plan and Trust **
10.3 2001 Stock Option and Incentive Plan ***
10.4 1993 Stock Incentive Plan *
10.5 1993 Directors' Stock Option Plan *
10.6 Employment Agreement with William J. Small ****
10.7 Employment Agreement with James L. Rohrs **
10.8 Employment Agreement with John C. Wahl **
13 Annual Report to Shareholders and Notice of Annual Meeting of
Shareholders and Proxy Statement **
21 List of Subsidiaries of the Company **
23 Consent of Independent Auditors **
* Incorporated herein by reference to the like numbered exhibit in the
Registrant's Form S-1 (File No. 33-93354).
** Included herein.
*** Incorporated herein by reference to Appendix B to the 2001 Proxy Statement
**** Incorporated herein by reference to Exhibit 10.6 to the 2001 Form 10-K
(b) Reports on Form 8-K
First Defiance Financial Corp. filed a report on Form 8-K with the
Securities and Exchange Commission as of January 24, 2002 which announced
that it had entered into a Purchase and Sale Agreement with U.S. Bank
National Association ("U.S. Bank") for the sale of The Leader Mortgage
Company, LLC, a wholly owned subsidiary of First Federal, to U.S. Bank.
113
SIGNATURES
Pursuant to the requirements of Sections 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
FIRST DEFIANCE FINANCIAL CORP.
March 20, 2002 By: /s/ William J. Small
--------------------
William J. Small
Chairman, President, CEO
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 20, 2002.
Signature Title
/s/ William J. Small Chairman of the Board, President and
- ---------------------------
William J. Small CEO
/s/ John C. Wahl Executive Vice President and CFO
- ---------------------------
John C. Wahl
/s/ Don C. Van Brackel Director, Vice Chairman
- ---------------------------
Don C. Van Brackel
/s/ Stephen L. Boomer Director
- ---------------------------
Stephen L. Boomer
/s/ Dr. Douglas A. Burgei Director
- ---------------------------
Dr. Douglas A. Burgei
/s/ Peter A. Diehl Director
- ---------------------------
Peter A. Diehl
/s/ Dr. John U. Fauster, III Director
- ---------------------------
Dr. John U. Fauster, III
/s/ Dr. Marvin J. Ludwig Director
- ---------------------------
Dr. Marvin J. Ludwig
/s/ Gerald W. Monnin Director
- ---------------------------
Gerald W. Monnin
/s/ Thomas A. Voigt Director
- ---------------------------
Thomas A. Voigt
114