================================================================================
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, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number ________________
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)
Registrants 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 Registrants 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 ]
<PAGE>
As of March 30, 1999, there were issued and outstanding 7,157,362
shares of the Registrants 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 26, 1999 was approximately $72.5 million.
-----------------
Documents Incorporated by References
List hereunder the following documents incorporated by reference and
the Part of the Form 10-K into which the document is incorporated.
(1) Portions of the Registrant's Annual Report to Stockholders for the fiscal
year ended December 31, 1998 are incorporated into Part II, Items 5-8 of
this Form 10-K.
(2) Portions of the Registrant's definitive proxy statement for its 1999 Annual
Meeting of Stockholders are incorporated into Part III, Items 10-13 of this
Form 10-K.
================================================================================
<PAGE>
PART I
Item 1. Business
First Defiance Financial Corp. ("First Defiance" or the "Company") is a
unitary thrift holding company that, through is subsidiaries (the
"Subsidiaries") focuses on traditional banking, mortgage banking, and property
and casualty and life 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 and life insurance products.
At December 31, 1998, the Company had consolidated assets of $785.4
million, consolidated deposits of $434.0 million, and consolidated stockholder's
equity $93.7 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 Savings and Loan: First Federal Savings and Loan ("First
Federal") is a federally chartered stock savings and loan headquartered in
Defiance, Ohio. It conducts operations through its main office and eleven full
service branch offices in Defiance, Fulton, Hancock, Henry, Paulding, Putnam,
and Williams 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
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 seven counties in which its
offices are located. 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, consumer finance
loans, primarily automobile loans, and mobile home 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, commercial paper, and corporate
bonds.
<PAGE>
The Leader Mortgage Company: The Leader Mortgage Company ("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.
The Insurance Center of Defiance: The Insurance Center of Defiance
("the Insurance Center") is wholly owned subsidiary of First Defiance. The
Insurance Center is an insurance agency that does business in the Defiance, Ohio
area under the name of the Stauffer-Mendenhall Agency. The Stauffer-Mendenhall
Agency offers property and casualty and life insurance 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.
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. All securities transactions must be approved by the
Investment Committee and reported to the Board of Directors.
First Defiance's investment portfolio includes six CMO and REMIC issues
totaling $9.3 million, all of which are fully amortizing securities, and one
separate agency security totaling $2.0 million which has a step-up feature. 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 to be significantly different from risks
associated with other pass-through mortgage backed or agency securities. First
Defiance does not invest in off-balance sheet derivative securities.
The amortized cost and fair value of securities at December 31, 1998 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.
<PAGE>
The mortgage-backed securities may mature earlier than their weighted-average
contractual maturities because of principal prepayments.
<TABLE>
<CAPTION>
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Mortgage-backed
securities $ -- --% $ 1,583 7.66% $ 350 9.03% $10,598 7.05% $12,531 7.18%
Corporate bonds 4,039 7.50 7,034 6.12 -- -- -- -- 11,073 6.62
REMICs and CMOs 5,423 7.50 -- -- 2,795 6.57 803 6.95 9,021 7.16
U.S. Government and
federal agency
obligations 1,998 6.00 1,018 6.24 4,005 6.57 -- -- 7,021 6.36
Obligations of
states and
political 112 6.76 814 5.41 4,219 5.57 1,117 5.01 6,262 5.47
subdivisions
Commercial paper 5,961 5.84 -- -- -- -- -- -- 5,961 5.84
------- ------- ------- ------- ------
Total $17,533 $10,449 $11,369 $12,518 51,869
======= ======= ======= ======= ======
Mutual funds 8,981
Unrealized loss
on securities
available for
sale 245
-------
Total $61,095
=======
</TABLE>
<PAGE>
The book value of investment securities is as follows:
<TABLE>
<CAPTION>
December 31
1998 1997 1996
---------------- ----------------- -----------------
(In thousands)
<S> <C> <C> <C>
Available-for-Sale Securities:
Corporate bonds $11,196 $10,113 $ -
U. S. Treasury and other U. S. Government
agencies and corporations 7,063 58,851 $44,234
Obligations of state and political subdivisions
5,286 550 -
Other 24,009 12,922 33,173
------- ------- -------
Totals $47,554 $82,436 $77,407
======= ======= =======
Held-to-Maturity Securities:
U. S. Treasury and other U. S. Government
agencies and corporations $12,531 $19,715 $24,513
Obligations of state and political subdivisions
1,010 1,238 1,424
------- ------- -------
Totals $13,541 $20,953 $25,937
======= ======= =======
</TABLE>
For additional information regarding First Defiance's investment portfolio refer
to Note 4 to the consolidated financial statements.
Interest-Bearing Deposits
First Defiance has interest-bearing deposits in the FHLB of Cincinnati
amounting to $5.3 million and $1.6 million at December 31, l998 and l997.
Residential Loan Servicing Activities
Residential Mortgage Loan Servicing: First Federal and The Leader each
has its own mortgage servicing portfolio. At December 31, 1998, First Federal
serviced approximately $62 million of mortgage loans, while The Leader's
servicing portfolio amounted to approximately $4.8 billion.
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.
<PAGE>
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,
1998, the Company's weighted-average servicing fee was .41%. In the event of a
default by the borrower, the Company receives no servicing fees until the
default is cured.
Servicing is provided on mortgage loans on a recourse or nonrecourse
basis. The Company's policy is to accept only a limited number of servicing
assets on a recourse basis. As of December 31, 1998, on the basis of outstanding
principal balances, only .13% 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
nonrecourse 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
the Government National Mortgage Association ("GNMA"), for whom the Company
provides significant amounts of mortgage loan servicing. As of December 31,
1998, the Company had advanced approximately $2.3 million 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. To date, 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.
In order to track information on its servicing portfolio, The Leader
utilizes an in-house data processing system with an IBM AS/400 as its main
frame. Management believes that this system gives The Leader greater flexibility
to customize data for the end user and sufficient capacity to support
anticipated expansion of its residential mortgage loan servicing portfolio.
<PAGE>
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:
<TABLE>
<CAPTION>
As of December 31
1998 1997 1996
---------------- ----------------- -----------------
(In thousands)
<S> <C> <C> <C>
FHA insured/VA guaranteed residential $3,616,245
Conventional loans 1,086,575 $17,844 $11,295
Other loans 153,049
---------- ------- -------
Total mortgage servicing portfolio $4,855,869 $17,844 $11,295
========== ======= =======
Fixed rate loans $4,847,764 $17,844 $11,295
Adjustable rate loans 8,105
---------- ------- -------
Total mortgage servicing portfolio $4,855,869 $17,844 $11,295
========== ======= =======
</TABLE>
<PAGE>
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:
<TABLE>
<CAPTION>
As of December 31
---------------------------------------------------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------------------------------------------------
National National National
Company Average(1) Company Average(1) Company Average(1)
---------------------------------------------------------------------------------------------------------
Number Percentage Percentage Number Percentage Percentage Number Percentage Percentage
of of of of of of of of of
Loans Servicing Loans Loans Servicing Loans Loans Servicing Loans
Portfolio Portfolio Portfolio
(2) (2) (2)
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Loans delinquent
for:
30-59 days 5,155 6.23% 2.96% 5 1.78% 3.03% 2 1.12% 3.04%
60-89 days 1,435 1.73 .68 - .71 - - .71
90 days and
over 818 .99 .60 1 .36 .62 - - .62
---------------------------------------------------------------------------------------------------------
Total
delinquencies 7,408 8.95% 4.24% 6 2.14% 4.36% 2 1.12% 4.37%
=========================================================================================================
Foreclosures 2,161 2.61% - - - 1.11% - - 0.87%
=========================================================================================================
</TABLE>
(1) Source: Mortgage Bankers Association, "Delinquency Rates of I to 4 Unit
Residential Mortgage Loans" (Seasonally Adjusted) (Data as of December 31,
1998, 1997 and 1996, respectively).
(2) Delinquencies and foreclosures generally exceed the national average due to
historically higher rates of delinquencies and foreclosures on FHA insured
and VA guarenteed Residential Mortgage loans.
<PAGE>
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:
<TABLE>
<CAPTION>
As of December 31
---------------------------------------------------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------------------------------------------------
Percentage Percentage Percentage
Number Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
of Principal Principal of Principal Principal of Principal Principal
Rate Loans Balance Balance Loans Balance Balance Loans Balance Balance
---- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Less than 5.00% 1,144 $ 33,215 .68%
5.00% - 5.99% 9,510 565,162 11.64
6.00% - 6.99% 29,068 1,818,721 37.45
7.00% - 7.99% 30,383 1,718,098 35.38 54 $ 3,904 21.88% 34 $ 2,483 21.98%
8.00% - 8.99% 12,310 480,142 9.89 216 13,540 75.88% 133 8,370 74.10
9.00% and over 355 240,531 4.96 11 400 2.24 11 442 3.92
=========================================================================================================
Total 82,770 $4,855,869 100.00% 281 $17,844 100.00% 178 $11,295 100.00%
=========================================================================================================
</TABLE>
<PAGE>
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. The changes in the
remaining maturities as a percentage of unpaid principal between 1998, 1997 and
1996, as reflected below, are the result of acquisitions of mortgage servicing
rights completed during 1998.
<TABLE>
<CAPTION>
As of December 31
-------------------------------------------------------------------------------------------
1998 1997
-------------------------------------------------------------------------------------------
Percentage Percentage
Number Percentage Unpaid Unpaid Number Percentage 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)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1-5 years 5,843 7.06% $ 147,446 3.04%
6-10 years 5,053 6.10 147,092 3.03
11-15 years 1,756 2.12 104,796 2.16
16-20 years 6,643 8.03 288,755 5.95
21-25 years 16,136 19.49 960,928 19.79
More than 25 years 47,339 57.20 3,206,852 66.03 281 100.00% $17,844 100.00%
===========================================================================================
Total 82,770 100.00% $4,855,869 100.00% 281 100.00% $17,844 100.00%
===========================================================================================
<CAPTION>
As of December 31
------------------------------------------------
1996
------------------------------------------------
Percentage
Number Percentage Unpaid Unpaid
of of Number Principal Principal
Maturity Loans of Loans Amount Amount
-------- ------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
1-5 years
6-10 years
11-15 years
16-20 years
21-25 years
More than 25 years 178 100.00% $11,295 100.00%
================================================
Total 178 100.00% $11,295 100.00%
================================================
</TABLE>
<PAGE>
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:
<TABLE>
<CAPTION>
As of December 31
--------------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------------------------
Percentage Percentage Percentage Percentage
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)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Ohio 36,761 $2,153,287 44.34% 38.12% 281 $17,844 100.00% 100.00%
Florida 14,688 955,047 19.67 19.74
Louisiana 6,836 443,228 9.13 10.96
Other (2) 24,485 1,304,307 26.86 31.18
============================================================================================
Total 82,770 $4,855,869 100.00% 100.00% 281 $17,844 100.00% 100.00%
============================================================================================
<CAPTION>
As of December 31
-------------------------------------------------
1996
-------------------------------------------------
Percentage Percentage
of of
Number Aggregate Aggregate Total
of Principal Principal Delinqs.
State Loans Balance Balance by State(1)
----- -------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C>
Ohio 178 $11,295 100.00% 100.00%
Florida
Louisiana
Other (2)
=================================================
Total 178 $11,295 100.00% 100.00%
=================================================
</TABLE>
(1) In terms of number of loans outstanding.
(2) No other state accounted for greater than 6.00%, based on aggregate
principal balances of the Company's mortgage loan servicing portfolio as of
December 31, 1998.
<PAGE>
Lending Activities
General. A savings association 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 - Federal Regulation
of Savings Associations." At December 31, 1998, First Federal's limit on
loans-to-one borrower was $9.6 million and its five largest loans or groups of
loans to one borrower, including related entities, aggregated $7.0 million, $7.0
million, $6.7 million, $5.6 million and $3.7 million. All of these loans or
groups of loans were performing in accordance with their terms at December 31,
1998.
Loan Portfolio Composition. The net increase in net loans outstanding
over the prior year was $126.6 million, $26.0 million, and $30.7 million in
1998, 1997 and 1996, 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.
<PAGE>
The following table sets forth the composition of the Company's loan
portfolio by type of loan at the dates indicated.
<TABLE>
<CAPTION>
December 31
--------------------------------------------------------------------------------------------
1998 1997 1996 1995
--------------------------------------------------------------------------------------------
Amount % Amount % Amount % Amount %
--------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate:
Single-family residential $365,116 62.7% $255,428 57.0% $241,787 57.1% $224,639 57.4%
Multi-family residential 13,763 2.4 9,363 2.1 9,175 2.2 16,929 4.3
Non-residential real estate 16,436 2.8 20,159 4.5 21,348 5.0 19,780 5.1
Construction 8,258 1.4 10,148 2.2 11,412 2.7 8,200 2.1
--------------------------------------------------------------------------------------------
Total real estate loans 403,573 69.3 295,098 65.8 283,722 67.0 269,548 68.9
Other:
Consumer finance 87,168 15.0 81,111 18.1 74,019 17.5 61,810 15.8
Commercial 70,109 12.0 29,758 6.6 26,674 6.3 23,647 6.0
Home equity and improvement 18,168 3.2 16,940 3.8 13,570 3.2 11,875 3.0
Mobile home 3,117 .5 25,424 5.7 25,199 6.0 24,671 6.3
--------------------------------------------------------------------------------------------
Total non-real estate loans 178,562 30.7 153,233 34.2 139,462 33.0 122,003 31.1
--------------------------------------------------------------------------------------------
Total loans 582,135 100.0% 448,331 100.0% 423,184 100.0% 391,551 100.0%
===== ===== ===== =====
Less:
Loans in process 3,250 3,087 4,474 3,971
Deferred loan origination fees 612 646 568 559
Allowance for loan losses 9,789 2,686 2,217 1,817
-------- -------- -------- --------
Net loans $568,484 $441,912 $415,925 $385,204
======== ======== ======== ========
<PAGE>
<CAPTION>
December 31
---------------------
1994
---------------------
Amount %
---------------------
(Dollars in thousands)
<S> <C> <C>
Real estate:
Single-family residential $222,035 61.6%
Multi-family residential 7,577 2.1
Non-residential real estate 19,888 5.5
Construction 6,858 1.9
---------------------
Total real estate loans 256,358 71.1
Other:
Consumer finance 52,491 14.6
Commercial 17,436 4.8
Home equity and improvement 10,265 2.8
Mobile home 24,191 6.7
---------------------
Total non-real estate loans 104,383 28.9
---------------------
Total loans 360,741 100.0%
=====
Less:
Loans in process 3,440
Deferred loan origination fees 631
Allowance for loan losses 1,733
--------
Net loans $354,937
========
</TABLE>
<PAGE>
Included above, First Defiance had $119.9 million, $87,500, $558,600
and $3.8 million in loans classified as held for sale at December 31, 1998,
1997, 1996 and 1995, respectively. The fair value of such loans, which are all
single-family residential mortgage loans, exceeded their carrying value by
$187,000, $2,000, $5,000 and $64,000 as of December 31, 1998, 1997, 1996 and
1995, respectively.
Contractual Principal Repayments and Interest Rates. The following
table sets forth certain information at December 31, 1998 regarding the dollar
amount of loans maturing in First Defiance's portfolio, based on the contractual
terms to maturity, before giving effect to net items. Demand loans, loans having
no stated schedule of repayments and no stated maturity and overdrafts are
reported as due in one year or less.
<TABLE>
<CAPTION>
Due 3-5 Due 5-10 Due 10-15 Due 15+
Due Due Years Years Years Years
Before Before After After After After
12/31/99 12/31/00 12/31/98 12/31/98 12/31/98 12/31/98 Total
---------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
Real estate $123,290 $13,534 $ 51,125 $78,332 $63,237 $74,055 $403,573
Non-real estate:
Commercial 26,424 11,377 14,729 11,443 1,938 4,198 70,109
Home equity and
improvement 3,613 711 1,713 1,331 195 10,605 18,168
Mobile home 238 229 751 999 574 326 3,117
Consumer finance 28,718 22,401 34,854 1,146 49 - 87,168
---------------------------------------------------------------------------------------
Total $182,283 $48,252 $103,172 $93,251 $65,993 $89,184 $582,135
=======================================================================================
</TABLE>
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.
<PAGE>
The following table sets forth the dollar amount of all loans, before
net items, due after one year from December 31, l998 which have fixed interest
rates or which have floating or adjustable interest rates.
<TABLE>
<CAPTION>
Floating or
Fixed Adjustable
Rates Rates Total
-----------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Real estate $206,437 $73,846 $280,283
Non-real estate:
Commercial 35,370 8,315 43,685
Other 64,658 11,226 75,884
-----------------------------------------------------
$306,465 $93,387 $399,852
=====================================================
</TABLE>
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.
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 credit is first reviewed and underwritten by a commercial
loan officer, 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, a committee of senior lending personnel. Credits which exceed
$250,000 in aggregate exposure must be presented to 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 Chief Underwriter or the Vice President of Mortgage
Lending. Non-conforming mortgage loans must be approved by either the Vice
President of Mortgage Lending or the Executive Vice President of Lending.
A consumer loan officer underwrites 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
centrally.
<PAGE>
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 14.0% of First Federal's total
originations of mortgage loans in 1998 compared to 34.7% and 26.0% during 1997
and 1996, respectively. First Defiance continues to hold adjustable-rate
securities in order to further reduce its interest-rate gap.
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.
<PAGE>
The following table shows total loans originated, loan reductions, and
the net increase in First Defiance's total loans during the periods indicated:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
-----------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Loan originations:
One to four family residential $163,355 $ 72,752 $ 70,494
Five or more family residential 2,168 1,464 1,414
Non-residential real estate 4,025 5,153 5,006
Construction 13,852 11,044 15,936
Commercial 98,148 31,435 25,298
Mobile home 3,083 5,945 6,465
Home equity and improvement 15,381 10,103 6,448
Consumer 60,068 54,994 53,698
-----------------------------------------------------
Total loans originated 360,080 192,890 184,759
Loans acquired through purchase of The Leader:
One to four family residential 127,170 - -
Five or more family residential 4,302 - -
-----------------------------------------------------
131,472 - -
Purchase of one to four family residential 596,681 - -
Loan reductions:
Loan pay-offs 185,793 106,840 87,879
Mortgage loans sold 674,066 8,242 13,332
Periodic principal repayments 94,570 52,661 51,915
-----------------------------------------------------
954,429 167,743 153,126
-----------------------------------------------------
Net increase in total loans $133,804 $ 25,147 $ 31,633
=====================================================
</TABLE>
<PAGE>
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, 1998, 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.
<TABLE>
<CAPTION>
Non-residential and
Single-family multi-family Home equity
residential residential Mobile home and improvement
----------------------------------------------------------------------------------------------------
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
----------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Loans delinquent for:
30-59 days $ 887 .15% $197 .03% $ 638 .11% $70 .01%
60-89 days 289 .05 267 .05
90 days and over 11,173 1.92 180 .03
====================================================================================================
Total delinquent loans $12,349 2.12% $197 .03% $1,085 .19% $70 .01%
====================================================================================================
<CAPTION>
Consumer
finance Commercial Total
-------------------------------------------------------------------------
Amount Percentage Amount Percentage Amount Percentage
-------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Loans delinquent for:
30-59 days $1,378 .24% $ 925 .16% $ 4,095 .70%
60-89 days 392 .07 948 .17
90 days and over 171 .03 1,330 .23 12,854 2.21
=========================================================================
Total delinquent loans $1,941 .34% $2,255 .39% $17,897 3.08%
=========================================================================
</TABLE>
<PAGE>
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
collection 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 they will be unable to collect all amounts due (both
principal and interest) according to the contractual terms of the loan
agreement. When a loan is impaired, 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 $427,000, $537,000 and
$1.6 million has been recognized as of December 31, 1998, 1997 and 1996,
respectively. Interest received and recorded in income during 1998, 1997 and
1996 on impaired loans including interest received and recorded in income prior
to such impaired loan designation amounted to $155,000, $53,000 and $156,000,
respectively. Unrecorded interest income on these and all non-performing loans
in 1998, 1997 and 1996 was $36,000, $24,000 and $34,000, respectively. The
average recorded investment in impaired loans during 1998, 1997 and 1996 was
$427,000, $1.30 million and $1.45 million, respectively. The total allowance for
loan losses related to these loans was $277,000, $327,000 and $804,000 at
December 31, 1998, 1997 and 1996, 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, 1998, First Defiance's total non-performing loans
amounted to $12,854,000 or 2.21% of total loans, compared to $1,365,000 or .30%
of total loans, at December 31, 1997.
<PAGE>
The following table sets forth the amounts and categories of First
Defiance's nonperforming assets and troubled debt restructurings at the dates
indicated.
<TABLE>
<CAPTION>
December 31
1998 1997 1996 1995 1994
--------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Non-performing loans:
Single-family residential $ 171 $ 313 $ 88 $263 $207
Mortgage banking activities 11,002 - - - -
Non-residential and multi-family
residential real estate - - 19 - 18
Commercial 1,330 570 1,561 268 294
Mobile home 180 315 193 130 163
Consumer finance 171 167 111 111 16
--------------------------------------------------------------
Total non-performing loans 12,854 1,365 1,972 772 698
Real estate owned 1,337 18 - 1 3
Other repossessed assets 180 523 267 172 164
--------------------------------------------------------------
Total repossessed assets 1,517 541 267 173 167
==============================================================
Total non-performing assets $ 14,371 $1,906 $2,239 $945 $865
==============================================================
Troubled debt restructurings $ - $ - $ - $437 $443
==============================================================
Total non-performing assets as a
percentage of total assets 1.83% .33% .41% .18% .18%
==============================================================
Total non-performing loans and troubled
debt restructurings as a percentage of
total loans 2.47% .43% .53% .35% .36%
==============================================================
Total non-performing assets and troubled
debt restructurings as a percentage of
total assets 1.83% .33% .41% .26% .28%
==============================================================
Allowance for loan losses as a percent of
total non-performing assets
68.1% 140.9% 99.0% 192.3% 200.5%
==============================================================
</TABLE>
<PAGE>
Allowance for Loan Losses. It is management's policy to maintain 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, l998, First Defiance's allowance for loan losses
amounted to $9.8 million compared to $2.7 million at December 31, 1997. As of
December 31, 1998 and l997, $1,073,000 and $499,000, respectively, constituted
an allowance with respect to specific loans or assets held for sale. Charge-offs
in non-real estate loans increased $387,000 for the year ended December 31, 1998
over 1997 due to increases in lending and delinquencies in this area.
<PAGE>
The following table sets forth the activity in First Defiance's
allowance for loan losses during the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31
1998 1997 1996 1995 1994
--------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
Allowance at beginning of year $2,686 $2,217 $1,817 $1,733 $1,662
Provisions 7,769 1,613 1,020 374 426
Acquired allowance of The Leader 1,194 - - - -
Charge-offs:
Single-family real estate 352 - - - 19
Non-real estate:
Consumer finance 1,053 1,078 430 230 222
Mobile home 620 259 334 91 159
Commercial 55 4 12 23 1
--------------------------------------------------------------
Total non-real estate 1,728 1,341 776 344 382
--------------------------------------------------------------
Total charge-offs 2,080 1,341 776 344 401
Recoveries:
Consumer finance 220 195 152 51 46
Commercial - - 4 - -
Mobile home - 2 - - -
Assets held for sale - - 3 -
--------------------------------------------------------------
Total 220 197 156 54 46
--------------------------------------------------------------
Allowance at end of year $9,789 $2,686 $2,217 $1,817 $1,733
==============================================================
Allowance for loan losses to total
non-performing loans at end of year 76.2% 196.8% 112.4% 235.4% 248.3%
Allowance for loan losses to total loans
at end of year 1.68% .60% .52% .46% .48%
Allowance for loan losses to net
chargeoffs for the year 470.63 234.79 357.58 626.55 515.77
Net charge offs for the year to average
loans .36 .27 .16 .08 .10
</TABLE>
<PAGE>
The following table sets forth information concerning the allocation of
First Defiance's allowance for loan losses by loan categories at the dates
indicated. For information about the percent of total loans in each category to
total loans, see "- Lending Activities - Loan Portfolio Composition."
<TABLE>
<CAPTION>
December 31
1998 1997 1996
------------------------------------------------------------------------------
Percent of Percent of Percent of
total loans total loans total loans
Amount by category Amount by category Amount by category
------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Real estate mortgage loans $1,654 69.3% $ 351 65.8% $ 307 67.0%
Other:
Commercial business loans 1,760 12.0 828 6.6 866 6.3
Mobile home loans 1,309 .5 361 5.7 208 6.0
Consumer and home equity
and improvement loans 5,066 18.2 1,146 21.9 836 20.7
==============================================================================
$9,789 100.0% $ 2,686 100.0% $ 2,217 100.0%
==============================================================================
</TABLE>
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 Federal Home Loan Bank 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 NOW accounts, money market accounts,
regular savings accounts, and term certificate accounts. Included among these
deposit products are individual retirement account certificates of approximately
$52.8 million at December 31, l998. 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.
<PAGE>
Average balances and average rates paid on deposits are as follows:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
----------------------- ----------------------- ------------------------
Amount Rate Amount Rate Amount Rate
------------ ------------ ------------ ------------ ------------ -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Noninterest bearing
demand deposits $ 2,547 - % $ 2,545 - % $ 1,902 - %
Interest bearing demand
deposits 66,806 2.65 48,766 2.88 45,649 2.45
Savings deposits 56,135 1.95 63,028 2.58 67,926 3.00
Time deposits 283,766 5.44 268,235 5.58 265,967 5.80
-------- ---- -------- ---- -------- ----
Totals $409,254 4.48% $382,574 4.70% $381,444 4.87%
======== ==== ======== ==== ======== ====
</TABLE>
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, 1998.
<TABLE>
<CAPTION>
(In thousands)
Certificates of deposit maturing in quarter ending:
<S> <C>
March 31, 1999 $ 8,776
June 30, 1999 11,072
September 30, 1999 6,428
December 31, 1999 6,424
After December 31, 1999 12,381
--------
Total certificates of deposit with
balances of $100,000 or more $45,081
========
</TABLE>
<PAGE>
The following table details the deposit accrued interest payable as of December
31:
<TABLE>
<CAPTION>
1998 1997
---------------- -----------------
(In thousands)
<S> <C> <C>
Demand, NOW and money market accounts $ 78 $ 72
Savings Accounts 2 4
Certificates 645 1,325
---- ------
$725 $1,401
==== ======
</TABLE>
For additional information regarding First Defiance's deposits see Note 9 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. Such advances are generally available to meet seasonal and other
withdrawals of deposit accounts and to permit increased lending. See "Regulation
- - Federal Regulation of Savings Associations - Federal Home Loan Bank System."
The following table sets forth certain information as to First
Defiance's FHLB advances at the dates indicated.
<TABLE>
<CAPTION>
December 31
1998 1997 1996
-----------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Long-term:
FHLB advances $98,497 $ 4,529 $ 5,601
Weighted average interest rate 4.93% 6.57% 6.58%
Short-term:
FHLB advances $69,645 $67,136 $35,220
Weighted average interest rate 5.18% 5.85% 6.28%
</TABLE>
<PAGE>
The following table sets forth the maximum month-end balance and
average balance of First Defiance's FHLB advances during the periods indicated.
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
-----------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Long-term:
Maximum balance $98,497 $ 5,601 $ 6,842
Average balance 21,829 4,529 6,115
Weighted average interest rate of FHLB advances 5.87% 6.19% 6.59%
Short-term:
Maximum balance $69,645 $70,135 $35,220
Average balance 49,462 53,039 8,310
Weighted average interest rate of FHLB advances 5.43% 5.77% 5.59%
</TABLE>
$2.2 million of First Defiance's outstanding long-term FHLB advances
were obtained in the first calendar quarter of 1992 as part of the Company's
asset and liability management strategy and $1.3 million were obtained in the
fourth quarter in 1995 as part of the FHLB's Affordable Housing Program. First
Defiance utilizes short-term advances from the FHLB to meet cash flow needs and
for short-term investment purposes. There were $69.6 and $67.1 million in
short-term advances outstanding at December 31, 1998 and 1997, respectively.
First Defiance borrows funds under a variety of programs at the FHLB. At
December 31, 1998, $68.0 million was outstanding under First Defiance's REPO
Advance line of credit. The total available under the REPO line is $150.0
million. Amounts are generally borrowed under the REPO line on an overnight
basis. The $1.6 million of other advances are borrowed under the FHLB's
short-term fixed or LIBOR based programs.
<PAGE>
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. Dividends received on
Federal Home Loan Bank stock are included as interest income. The table does not
reflect the effect of income taxes.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------
1998 1997
----------------------------------------- -----------------------------------------
Average Yield/ Average Yield/
Balance Interest Rate (1) Balance Interest Rate
------------- ------------- ------------- ------------- ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets
Loans receivable $521,968 $43,369 8.31% $428,550 $37,302 8.70%
Securities 81,320 5,082 6.25 103,304 6,556 6.35
Interest bearing deposits 12,259 605 4.94 - - -
Dividends on FHLB stock 4,669 334 7.15 3,355 242 7.21
------------- ------------- ------------- ------------- ------------- -------------
Total interest-earning assets 620,216 49,390 7.96 535,209 44,100 8.24
Non-interest-earning assets 78,706 25,500
============= =============
Total assets $698,922 $560,709
============= =============
Interest-Bearing Liabilities
Deposits $409,254 18,340 4.48 $382,574 17,992 4.70
FHLB advances 75,062 4,171 5.56 58,100 3,394 5.84
Warehouse and term notes payable 87,668 4,435 5.06 - - -
------------- ------------- ------------- ------------- ------------- -------------
Total interest-bearing liabilities 571,984 26,946 4.71 440,674 21,386 4.85
Non-interest-bearing liabilities 23,046 4,804
------------- -------------
Total liabilities 595,030 445,478
Stockholders' equity 103,892 115,231
============= =============
Total liabilities and stockholders' equity $698,922 $560,709
============= =============
Net interest income; interest rate spread $22,444 3.25% $22,714 3.39%
============= =============
============= =============
Net interest margin (2) 3.62% 4.24%
============= =============
Average interest-earning assets to average
interest-bearing liabilities 108% 121%
============= =============
<PAGE>
<CAPTION>
------------------------------------------
1996
------------------------------------------
Average Yield/
Balance Interest Rate
------------- ------------- --------------
(Dollars in thousands)
<S> <C> <C> <C>
Interest-Earning Assets
Loans receivable $399,949 $34,635 8.66%
Securities 107,702 6,622 6.15
Interest bearing deposits - - -
Dividends on FHLB stock 2,955 207 7.00
------------- ------------- --------------
Total interest-earning assets 510,606 41,464 8.12
Non-interest-earning assets 18,257
=============
Total assets $528,863
=============
Interest-Bearing Liabilities
Deposits $381,444 $18,579 4.87
FHLB advances 15,828 880 5.56
Warehouse and term notes payable - - -
------------- ------------- --------------
Total interest-bearing liabilities 397,272 19,459 4.90
Non-interest-bearing liabilities 4,311
-------------
Total liabilities 401,583
Stockholders' equity 127,280
=============
Total liabilities and stockholders' equity $528,863
=============
Net interest income; interest rate spread $22,005 3.22%
============= ==============
Net interest margin (2) 4.31%
==============
Average interest-earning assets to average
interest-bearing liabilities 129%
==============
</TABLE>
(1) At December 31, 1998, the yields earned and rates paid were as follows:
loans receivable, 7.81%; securities, 6.41%; other interest-earning assets,
7.00%; total interest-earning assets, 7.67%; deposits, 4.17%; FHLB
advances, 5.12%; total interest-bearing liabilities, 4.44%; and interest
rate spread 3.23%.
(2) Net interest margin is net interest income divided by average
interest-earning assets.
<PAGE>
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.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------------------
1998 vs. 1997 1997 vs. 1996
----------------------------------------- -----------------------------------------
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)
<S> <C> <C> <C> <C> <C> <C>
Interest-Earning Assets
Loans $(2,064) $ 8,131 $ 6,067 $ 190 $2,477 $2,667
Securities (79) (1,395) (1,474) 204 (270) (66)
Interest bearing deposits - 605 605 - - -
FHLB stock (3) 95 92 7 28 35
============= ============= ============= ============= ============= =============
Total interest-earning assets $(2,146) $ 7,436 $ 5,290 $ 401 $2,235 $2,636
============= ============= ============= ============= ============= =============
Interest-Bearing Liabilities
Deposits $ (907) $ 1,255 $ 348 $(642) $ 55 $ (587)
FHLB advances (214) 991 777 164 2,350 2,514
Warehouse and term notes payable - 4,435 4,435 - - -
============= ============= ============= ============= ============= =============
Total interest-bearing liabilities $(1,121) $ 6,681 $ 5,560 $(478) $2,405 $1,927
============= ============= ============= ============= ============= =============
Increase (decrease) in net interest income $ (270) $ 709
============= =============
<PAGE>
<CAPTION>
Year Ended December 31,
------------------------------------------
1996 vs. 1995
------------------------------------------
Increase Increase
(decrease) (decrease) Total
due to due to increase
rate volume (decrease)
------------- ------------- --------------
(In thousands)
<S> <C> <C> <C>
Interest-Earning Assets
Loans $(146) $2,778 $2,632
Securities (29) 89 60
Interest bearing deposits - - -
FHLB stock 5 11 16
============= ============= ==============
Total interest-earning assets $(170) $2,878 $2,708
============= ============= ==============
Interest-Bearing Liabilities
Deposits $(522) $ 244 $ (278)
FHLB advances (335) (217) (552)
Warehouse and term notes payable - - -
============= ============= ==============
Total interest-bearing liabilities $(857) $ 27 $ (830)
============= ============= ==============
Increase (decrease) in net interest income $3,538
==============
</TABLE>
<PAGE>
Employees
First Defiance had 328 full-time employees at December 31, 1998. 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 mortgage loans arises mainly from other
mortgage companies, savings associations and commercial banks. The distinction
among market participants is based primarily on price and, to a lesser extent,
the quality of customer service and name recognition. Aggressive pricing
policies of the Company's competitors, especially during a declining period of
mortgage loan originations, could in the future result in a decrease in the
Company's mortgage 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 mortgage brokers and borrowers than is furnished by
competitors. However, the First Federal does have a significant market share of
the lending markets in which it conducts operations.
Management believes that First Federal's most direct competition for
deposits comes from local financial institutions. The distinction among market
participants is based 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.
<PAGE>
REGULATION
General. First Defiance, First Federal, and Leader 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 is a member of the FHLB of Cincinnati.
First Federal and 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 an
association to open a new branch or engage in a merger transaction. Community
reinvestment regulations evaluate how well and to what extent an institution
lends and invests in its designated service area, with particular emphasis on
low-to-moderate income communities and borrowers in such areas. First Federal
has received a satisfactory examination rating under those regulations.
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.
<PAGE>
Regulatory Capital Requirements. First Federal is required by OTS
regulations to meet certain minimum capital requirements. The following table
sets forth the amount and percentage level of regulatory capital of First
Federal at December 31, 1998, 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, 1998
-----------------------------------
Amount Percent
(In thousands)
Tangible capital $52,265 6.80%
Requirement 11,537 1.50
================= =================
Excess $40,728 5.30%
================= =================
Core capital $52,265 6.80%
Requirement 30,766 3.00
================= =================
Excess $21,499 3.80%
================= =================
Risk-based capital $82,187 14.82%
Risk-based requirement 44,363 8.00
================= =================
Excess $37,824 6.82%
================= =================
Current capital requirements call for tangible capital of 1.5% of
adjusted total assets, core capital of 3.0% of adjusted total assets and
risk-based capital of 8% of risk-weighted assets. The OTS has proposed to amend
the core capital requirement so that those associations that do not have the
highest examination rating and exceed an acceptable level of risk will be
required to maintain core capital of from 4% to 5%, depending on the
association's examination rating and overall risk. First Federal does not
anticipate that it will be adversely affected if the core capital requirement
regulation is amended as proposed. First Federal's current core capital level is
6.80% of adjusted total assets.
The OTS has adopted an interest rate risk component to the risk-based
capital requirement, though the implementation of that component has been
delayed. Pursuant to that requirement, a savings association would have to
measure the effect of an immediate 200 basis point change in interest rates on
the value of its portfolio, as determined under the methodology established by
the OTS. If the measured interest rate risk is above the level deemed normal
under the regulation, the association will be required to deduct one-half of
that excess exposure from its total capital when determining its level of
risk-based capital. Pending implementation of the interest rate risk component,
the OTS has the authority to impose a higher individualized capital requirement
on any savings association it deems to have excess interest rate risk. The OTS
also may adjust the risk-based capital requirement on an individual basis for
any association to take into account risks due to concentrations of credit and
non-traditional activities.
<PAGE>
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. The OTS has defined
these capital levels as follows: (1) well-capitalized associations must have
total risk-based capital of at least 10%, core risk-based capital (consisting
only of items that qualify for inclusion in core capital) of at least 6% and
core capital of at least 5%; (2) adequately capitalized associations are those
that meet the regulatory minimum of total risk-based capital of at least 8%,
core risk-based capital (consisting only of items that qualify for inclusion in
core capital) of at least 4% and core capital of at least 4% (except for
associations receiving the highest examination rating and with an acceptable
level of risk, in which case the level is at least 3%); (3) undercapitalized
associations are those that do not meet regulatory limits, but that are not
significantly undercapitalized; (4) significantly undercapitalized associations
have total risk-based capital of less than 6%, core risk-based capital
(consisting only of items that qualify for inclusion in core capital) of less
than 3% or core capital of less than 3%; and (5) critically undercapitalized
associations are those with tangible equity of less than 2% of total assets. 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, 1998, meets the standards for a well-capitalized
institution.
<PAGE>
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 aggregate liability pursuant to 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, including dividend payments. An association which has converted
to stock form is prohibited from declaring or paying any dividends or from
repurchasing any of its stock if, as a result, the net worth of the association
would be reduced below the amount required to be maintained for the liquidation
account established in connection with its mutual to stock conversion. OTS
regulations also establish a three-tier system limiting capital distributions
according to ratings of associations based on their capital level and
supervisory condition.
Tier 1 consists of associations that, before and after the proposed
distribution, meet their fully phased-in capital requirements. Associations in
this category may make capital distributions during any calendar year equal to
the greater of 100% of net income, current year-to-date, plus 50% of the amount
by which the lesser of the association's tangible, core or risk-based capital
exceeds its capital requirement for such capital component, as measured at the
beginning of the calendar year, or the amount authorized for a Tier 2
association. A Tier 1 association deemed to be in need of more than normal
supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association. Tier
2 consists of associations that before and after the proposed distribution meet
their current minimum, but not fully phased-in, capital requirements, as such
requirements are defined by OTS regulations. Associations in this category may
make capital distributions of up to 75% of net income over the four most recent
quarters. Tier 3 associations do not meet current minimum capital requirements
and must obtain OTS approval of any capital distribution.
First Federal meets the requirements for a Tier 1 Association and has
not been notified of any need for more than normal supervision. As a subsidiary
of First Defiance, First Federal is required to give the OTS 30 days notice
prior to declaring any dividend on its common shares. The OTS may object to the
dividend during that 30-day period based on safety and soundness concerns.
Moreover, the OTS may prohibit any capital distribution otherwise permitted by
regulation if the OTS determines that such distribution would constitute an
unsafe or unsound practice. First Federal paid dividends of $20 million to First
Defiance during 1998.
<PAGE>
Liquidity. OTS regulations require that each savings association
maintain an average daily balance of liquid assets (cash, certain time deposits,
bankers' acceptances and specified United States government, state or federal
agency obligations) equal to a monthly average of not less than 4% of its net
withdrawable savings deposits plus borrowings payable in one year or less.
Monetary penalties may be imposed upon associations failing to meet liquidity
requirements. The eligible liquidity of First Federal, as computed under current
regulations, at December 31, 1998, was $48.3 million, or 10.01% and exceeded the
4.0% liquidity requirement by approximately $29 million.
Qualified Thrift Lender Test. Savings associations are required to meet
the Qualified Thrift Lender ("QTL") Test. Prior to September 30, 1996, the QTL
Test required savings associations to maintain a specified level of investments
in assets that are designated as qualifying thrift investments ("QTI"), which
are generally related to domestic residential real estate and manufactured
housing and include stock issued by any FHLB, the FHLMC or the FNMA. Under this
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 9 out of every 12 months.
Congress created a second QTL Test, effective September 30, 1996, pursuant to
which a savings association may also qualify as a QTL thrift if at least 60% of
the institution's assets (on a tax basis) consist of specified assets (generally
loans secured by residential real estate or deposits, educational loans, cash
and certain governmental obligations). The OTS may grant exceptions to the QTL
Test under certain circumstances. If a savings association fails to meet the QTL
Test, the association and its holding company become subject to certain
operating and regulatory restrictions. A savings association that fails to meet
the QTL Test will not be eligible for new FHLB advances. At December 31, 1998,
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, 1998, First Federal was in
compliance with this lending limit.
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, 1998.
<PAGE>
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, 1998.
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 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.
Federal legislation, which was effective September 30, 1996, provided
for the racapitalization of the SAIF by means of a special assessment of $.657
per $100 of SAIF deposits held at March 31, 1995, in order to increase the SAIF
reserves to the level required by law. First Federal paid a special assessment
of $2.5 million, which was accounted for and recorded as of September 30, 1996.
FRB Reserve Requirements. FRB regulations currently require that
reserves of 3% of net transaction accounts (primarily NOW accounts) up to $46.5
million (subject to an exemption of up to $4.9 million), and of 10% of net
transaction accounts in excess of $46.5 million. At December 31, 1998, First
Federal was in compliance with its reserve requirements.
Federal Home Loan Banks. The FHLBs provide credit to their members in
the form of advances. First Federal is a member of the FHLB of Cincinnati and
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 $10.8 million at December 31, 1998.
<PAGE>
Upon the origination or renewal of a loan or advance, the FHLB of
Cincinnati is required by law to obtain and maintain a security interest in
collateral in one or more of the following categories: fully disbursed, whole
first mortgage loans on improved residential property or securities representing
a whole interest in such loans; securities issued, insured or guaranteed by the
United States government or an agency thereof; deposits in any FHLB; or other
real estate related collateral (up to 30% of the member association's capital)
acceptable to the applicable FHLB, if such collateral has a readily
ascertainable value and the FHLB can perfect its security interest in the
collateral.
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.
Holding Company Regulation. First Defiance is a unitary savings and
loan holding company and is subject to OTS regulations, examination, supervision
and reporting requirements.
There are generally no restrictions on the activities of unitary
savings and loan 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 savings
and loan 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 savings and loan holding company, if the savings association subsidiary
of a holding company fails to meet the QTL Test, then such unitary holding
company would become subject to the activities restrictions applicable to
multiple holding companies. At December 31, 1998, First Federal met the QTL
Test.
Federal law generally prohibits a savings and loan holding company from
controlling any other savings association or savings and loan 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 savings and loan
holding company. Unless the acquisition is an emergency thrift acquisition and
each subsidiary savings association meets the QTL Test, the activities of First
Defiance and any of its subsidiaries (other than First Federal or other
subsidiary savings associations) would thereafter be limited generally to those
activities authorized by the FRB as permissible for bank holding companies,
unless the OTS by regulation prohibits or limits such activities for savings and
loan holding companies. Those activities must also be approved by the OTS prior
to being engaged in by a multiple holding company.
<PAGE>
For several years, Congress has been considering various changes to the
powers, activities and regulation of banks and savings associations and their
holding companies and subsidiaries. First Defiance cannot predict at this time
whether and when Congress will actually adopt "financial modernization"
legislation or in what form it will be adopted. Proposals currently being
considered would expand the range of activities in which banks and their
affiliates may engage and restrict the range of activities in which savings
associations and their affiliates may engage. It is not anticipated that the
current activities of First Defiance and its subsidiaries will be materially
affected by any such legislation.
Mortgage Banking Operations. Because The Leader conducts business with
various government sponsored enterprises and government agencies, it is required
in those cases to utilize underwriting guidelines which, among other things,
include anti-discrimination provisions, require provisions for inspections,
appraisals and credit reports on prospective borrowers and fix maximum loan
amounts. Moreover, the Leader is required annually to submit to HUD, FNMA, GNMA
and FHLMC audited financial statements, and each regulatory entity maintains its
own financial guidelines for determining net worth and eligibility requirements.
The Leader's affairs are also subject to examination by HUD, FNMA, GNMA and
FHLMC at any time to assure compliance with the applicable regulations, policies
and procedures. Mortgage loan origination activities are subject to, among other
things, the Equal Credit Opportunity Act, Federal Truth-in-Lending Act and the
Real Estate Settlement Procedures Act of 1974, as amended, and the regulations
promulgated thereunder that prohibit discrimination and require the disclosure
of certain basic information to mortgagors concerning credit terms and
settlement costs.
Additionally, there are various state and local laws and regulations
affecting the Leader's operations. The Leader is licensed in those states in
which it does business requiring such a license where failure to be licensed
would have a material adverse effect on First Defiance, The Leader, its
business, or its assets.
Mortgage origination operations also may be subject to state usury statutes.
Insurance Operations. The Insurance Center of Defiance and its agents
are appropriately licensed to sell property and casualty and life insurance
products. The Insurance Center is subject to the regulation by the Ohio
Department of Insurance.
<PAGE>
TAXATION
Federal Taxation
The Company and its subsidiaries are each subject to the federal tax
laws and regulations which apply to corporations generally. Certain thrift
institutions, including First Federal, were prior to the enactment of the Small
Business Jobs Protection Act, which was signed into law on August 21, 1996,
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.
Section 1616(a) of the Small Business Job Protection Act repealed the
Section 593 reserve method of accounting for bad debts by thrift institutions,
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, while 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.
<PAGE>
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. The amount of the applicable excess reserves being taken into account
ratably over a six-taxable year period, beginning with the first taxable year
beginning after 1995, subject to the residential loan requirement described
below. In the case of a thrift institution that becomes a large bank, the amount
of the institution's applicable excess reserves generally is the excess of (i)
the balances of its reserve for losses on qualifying real property loans
(generally loans secured by improved real estate) and its reserve for losses on
nonqualifying loans (all other types of loans) as of the close of its last
taxable year beginning before January 1, 1996, over (ii) the balances of such
reserves as of the close of its last taxable year beginning before January 1,
1988 (ie., the "pre-1988 reserves"). In the case of a thrift institution that
becomes a small bank, the amount of the institution's applicable excess reserves
generally is the excess of (i) the balances of its reserve for losses on
qualifying real property loans and its reserve for losses on nonqualifying loans
as of the close of its last taxable year beginning before January 1, 1996, over
(ii) the greater of the balance of (a) its pre-1988 reserves or (b) what the
thrift's reserves would have been at the close of its last year beginning before
January 1, 1996, had the thrift always used the experience method.
For taxable years that began after December 31, 1995, and before
January 1, 1998, if a thrift met the residential loan requirement for a tax
year, the recapture of the applicable excess reserves otherwise required to be
taken into account as a Code Section 481(a) adjustment for the year was
suspended. A thrift meets the residential loan requirement if, for the tax year,
the principal amount of residential loans made by the thrift during the year was
not less than its base amount. The "base amount" generally was the average of
the principal amounts of the residential loans made by the thrift during the six
most recent tax years beginning before January 1, 1996. First Federal met the
test for 1996 and 1997 and the Section 481(a) adjustment was suspended until
1998.
A residential loan is a loan as described in Section 7701(a)(19)(C)(v)
(generally a loan secured by residential real and church property and certain
mobile homes), but only to the extent that the loan is made to the owner of the
property to acquire, construct, or improve the property.
<PAGE>
In addition to the regular income tax, the Company and its subsidiaries
are subject to a minimum tax. An alternative minimum tax 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% 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. In addition, for taxable years after 1986 and
before 1996, the Company and its subsidiaries are also subject to an
environmental tax equal to 0.12% of the excess of alternative minimum taxable
income for the taxable year (determined without regard to net operating losses
and the deduction for the environmental tax) over $2.0 million.
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, 1998, First Federal's pre-1988 reserves for tax purposes
totaled approximately $9.52 million.
The tax returns of First Federal have been audited or closed without
audit through the tax year ended December 31, 1994. The tax returns for The
Leader have been closed through their tax year ended September 30, 1994. 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.
<PAGE>
In computing its tax under the net worth method, the Company may
exclude 100% of its investment in the capital stock of First Federal after the
Conversion, as reflected on the balance sheet of the Company, in computing its
taxable net worth as long as it owns at least 25% of the issued and outstanding
capital stock of First Federal. The calculation of the exclusion from net worth
is based on the ratio of the excludable investment (net of any appreciation or
goodwill included in such investment) to total assets multiplied by the net
value of the stock. As a holding company, the Company may be entitled to various
other 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 the purposes. Generally, to qualify as a qualifying holding
company, a large portion of a corporations 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.
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
1999 tax year, the tax rate is 1.4% 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, 1998, First Federal conducted its business from its
main office at 601 Clinton Street, Defiance, Ohio, and eleven other full service
branches in northwestern Ohio. At December 31, 1998, The Leader conducted its
business from leased office space at 1015 Euclid Avenue, Cleveland, Ohio. The
Insurance Center of Defiance conducted its business from leased office space at
507 5th Street, Defiance, Ohio.
First Defiance maintains its headquarters in the main office of First
Federal at 601 Clinton Street, Defiance, Ohio.
<PAGE>
The following table sets forth certain information with respect to the
office and other properties of the Company at December 31, l998. See Note 8 to
the Consolidated Financial Statements.
<TABLE>
<CAPTION>
Net book value
Description/address Leased/owned of property Deposits
- ---------------------------------------------------------------------------------------------------------
(Dollars in thousands)
<S> <C> <C> <C>
Main Office
601 Clinton Street Owned $ 6,031 $183,805
Defiance, OH
Branch Offices
204 E. High Street Owned 1,209 80,049
Bryan, OH
211 S. Fulton Street Owned 857 42,332
Wauseon, OH
625 Scott Street Owned 1,729 64,378
Napoleon, OH
1050 East Main Street Owned 649 18,370
Montpelier, OH
926 East High Street Owned 120 7,073
Bryan, OH
1333 Woodlawn Owned 91 14,765
Napoleon, OH
825 N. Clinton Street Owned 420 8,889
Defiance, OH
Inside Super K-Mart Leased 153 3,974
190 Stadium Dr.
Defiance, OH
905 N. Williams St. Owned 1,179 7,358
Paulding, OH
201 E. High St. Owned 636 2,986
Hicksville, OH
Main Office, The Leader
1015 Euclid Avenue Leased 36 N/A
Cleveland, OH
Main Office, Insurance
Center of Defiance
507 5th Street Leased 3 N/A
Defiance, OH
========================================
$13,113 $433,979
========================================
</TABLE>
<PAGE>
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 l998.
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The information required herein is incorporated by reference from page
40 of First Defiance's Annual Report to Stockholders for fiscal 1998 ("Annual
Report"), which is included herein as Exhibit 13.
Item 6. Selected Financial Data
The information required herein is incorporated by reference from pages
6 through 7 of the Annual Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information required herein is incorporated by reference from pages
8 through 16 of the Annual Report.
Item 7a. Quantitative and Qualitative Disclosure About Market Risk
The information required herein is incorporated by reference from pages
12 and 13 of the Annual Report.
Item 8. Financial Statements and Supplementary Data
The financial statements and report of independent auditors required
herein are incorporated by reference from pages 17 through 40 of the Annual
Report.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
Not applicable.
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required herein is incorporated by reference from pages
6 through 13 of the definitive proxy statement dated March 22, 1999. Otherwise,
the requirements of this Item 10 are not applicable.
Item 11. Executive Compensation
The information required herein is incorporated by reference from page
13 of the definitive proxy statement dated March 22, 1999.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required herein is incorporated by reference from page
3 of the definitive proxy statement dated March 22, 1999.
Item 13. Certain Relationships and Related Transactions
The information required herein is incorporated by reference from page
20 of the definitive proxy statement dated March 22, 1999.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) Financial Statements
The following financial statements and report of independent auditors
are incorporated herein by reference from pages 17 through 40 of the Annual
Report:
Report of Independent Auditors
Consolidated Statements of Financial Condition as of December 31, 1998
and 1997
Consolidated Statements of Income for the years ended December 31,
1998, 1997 and 1996
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996
Notes to Consolidated Financial Statements
(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.
<PAGE>
(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 Form of Code of Regulations *
3.2 Bylaws *
4.1 Specimen Stock Certificate *
10.1 1996 Stock Option Plan **
10.2 1996 Management Recognition Plan and Trust ***
10.3 1993 Management Recognition Plan and Trust *
10.4 1993 Stock Incentive Plan *
10.5 1993 Directors' Stock Option Plan *
10.6 Employment Agreement with Don C. Van Brackel *
13 Annual Report to Shareholders and Notice of
Annual Meeting of
Shareholders and Proxy Statement ****
21.1 List of Subsidiaries of the Company ****
23.1 Consent of Independent Auditors ****
* Incorporated herein by reference to the like numbered exhibit in the
Registrant's Form S-1 (File No. 33-93354).
** Incorporated herein by reference to Appendix A to the 1996 Proxy
Statement.
*** Incorporated herein by reference to Appendix B to the 1996 Proxy
Statement.
**** Included herein.
(b) Reports on Form 8-K
1. On October 30, 1998, First Defiance Financial Corp. ("First
Defiance") filed a current report on Form 8-K, dated October 30,
1998, reporting, pursuant to Item 5 of such form, entering into an
Agreement of Merger and Plan of Reorganization with the Insurance
Center of Defiance, Inc. ("the Agency"), and Ohio Corporation. The
Agreement provides for the formation by First Defiance of a
subsidiary that will be merged into the Agency, resulting in the
acquisition of the Agency by First Defiance. First Defiance also
announced on October 30, 1998, its intention to repurchase up to
15% of its outstanding shares, or 1,226,704 shares, in the open
market commencing no earlier than November 5, 1998.
<PAGE>
2. On December 24, 1998, First Defiance filed a current report Form
8-K, dated December 24, 1998, reporting, pursuant to Item 5 of
such Form, the consummation of the acquisition of the Insurance
Center of Defiance. In payment for the Agency, First Defiance
issued 146,135 common shares to the Agency shareholders.
(c) See (a)(3) above for all exhibits filed herewith or incorporated herein
by reference to documents previously filed and the Exhibit Index.
(d) There are no other financial statements and financial statement
schedules which were excluded from the Annual Report to Stockholders
which are required to be included herein.
<PAGE>
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 30, 1999 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 30, 1999.
Signature Title
--------- -----
/s/ William J. Small
- -------------------- Chairman of the Board, President and
William J. Small CEO
- ------------------- Director, Executive Vice President,
P. Scott Carson President and COO, First Federal Savings
and Loan
/s/ John C. Wahl
- ---------------- Executive Vice President and CFO
John C. Wahl
/s/ Don C. Van Brachel
- ----------------------- Director, Vice Chairman
Don C. Van Brachel
/s/ Stephen L. Boomer Director
- ---------------------
Stephen L. Boomer
/s/ Dr. Douglas A. Burgei Director
- -------------------------
Dr. Douglas A. Burgei
<PAGE>
Signature Title
--------- -----
/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
1998 Annual Report
First Defiance
Finacial Corp.
<PAGE>
Table of Contens
<TABLE>
<S> <C>
Letter from the Chairman 1-4
Locations 5
Selected Consolidated Information 6-7
Management's Discussion & Analysis 8-16
Audited Consolidated Financial Statements 17-39
Report of Independent Auditors 40
Stock Information 40
</TABLE>
Financial Highlights
<TABLE>
<CAPTION>
Years ended December 31
($ in thousands, except per share data) 1998 1997 1996
- ------------------------------------------------------------------------------------------
At Period End:
<S> <C> <C> <C>
Assets $785,399 $579,698 $543,411
Loans, net 568,484 441,912 415,925
Deposits and Borrowers Escrow Balances 511,313 395,983 383,139
Stockholders' equity 93,710 106,884 116,565
Book value per share 12.37 12.53 12.31
Stockholders' equity to total assets 11.93% 18.44% 21.45%
Average Balances:
Assets $698,922 $560,709 $528,863
Loans 521,968 428,550 399,949
Deposits 409,254 382,574 381,444
Stockholders' equity 103,892 115,231 127,280
Summary of Operating Results:
Net interest income $ 22,110 $ 22,471 $ 21,798
Provision for loan losses 7,769 1,613 1,020
Non-interest income 17,528 1,627 1,328
Non-interest expense* 26,940 14,093 13,497
Net income* 3,111 5,407 5,775
Basic earnings per share* 0.42 0.65 0.60
Diluted earnings per share* 0.40 0.62 0.59
Return on average equity* 2.99% 4.69% 4.54%
Return on average assets* 0.45% 0.96% 1.09%
</TABLE>
*1996 operating results exclude the effect of a one-time $2.461 million charge
to recapitalize the Savings Association Insurance Fund. Net of tax the charge
was $1.624 million, or $.17 per share (both basic and diluted). Net income for
1996 including the charge was $4.151 million, basic and diluted EPS were $.43
and $.42, respectively, return on average equity was 3.26% and return on
average assets was .78%.
<PAGE>
William J. Small [GRAPHIC OMITTED-- photo
Chairman of the Board, President of Willam J. Small]
and Chief Executive Officer
First Defiance Corp.
Dear Shareholders
It is a great privilege for me to provide this report on the achievements
and the challenges of First Defiance Financial Corp. for the year ended December
31, 1998 as well as what I believe are tremendous opportunities for 1999 and
beyond.
1998 ACCOMPLISHMENTS
During 1998 we grew through acquisition, through geographic expansion, and
through expansion of our product line offerings.
On July 1, 1998 we completed the $34.9 million acquisition of The Leader
Mortgage Company. The Leader, based in Cleveland, is a full service mortgage
banking company which has developed a niche servicing loans originated under
first-time home-buyer bond programs which are sponsored by various state and
local governmental units. For the six months from July 1 to December 31, 1998,
The Leader originated a total of $604 million in loans, of which $574 million
were under bond programs. At December 31, 1998, The Leader is servicing a total
of 85,900 loans with a combined outstanding balance of $5.1 billion.
The acquisition of The Leader was attractive to us because the acquisition
would be accretive to earnings for 1998, even though it was a cash transaction
that required the use of purchase accounting. The Leader's results to date have
generally exceeded our expectations and for the six months ended December 31,
1998, The Leader earned income after tax of $1.43 million. After factoring in
First Defiance's after tax cost of financing the acquisition, The Leader still
contributed net income of $747,000, or $.10 per share.
We also liked The Leader's risk profile. Because most of the loans they
service are under first-time home-buyer programs, they are generally at rates
which are below market and less likely to pre-pay.
1
<PAGE>
In fact, the pre-payments experienced by The Leader during our six months of
ownership were approximately 11.1%, which is generally lower than pre-payments
for conventional mortgages which are in the 15-20 percent and higher range in
this rate environment. The lower pre-payment speeds make our investment in
mortgage servicing rights less volatile than the industry as a whole.
In addition to the acquisition of The Leader, at the end of December, we
acquired the Insurance Center of Defiance, a property and casualty and life
insurance agency which does business in the Defiance Ohio area under the name
the Stauffer-Mendenhall Agency. This acquisition was small, but it gives us an
entry into a new line of business. In addition to gaining the Agency's revenues,
it gives us the opportunity to retain a larger amount of the commissions from
credit-life policies marketed to our customers. It also gives us the potential
opportunity to cross-sell insurance and non-deposit investment products to both
First Federal customers as well as the borrowers for whom The Leader services
mortgages.
<PAGE>
In our core business at First Federal Savings and Loan, we hired Greg
Allen in June 1998. Greg, who has recently assumed the position of Chief Lending
Officer, joined us with 11 years of experience and he has had an immediate
impact. Under his direction, our commercial loan portfolio has grown from $35.9
million when he came on board in June (it was $29.8 million at December 31,
1997) to $70.1 million at December 31, 1998, a 95.3% increase in six months
time. In addition to originating a significant number of loans himself, Greg has
also improved the loan origination process. In addition to Greg, we hired two
experienced lenders to start a loan production office in Findlay, Ohio.
[GRAPHIC OMITTED -- of
Total Assets, In Millions
At December 31]
That loan office has been so successful that on February 16 of this year,
we opened a full-service branch facility in Findlay. A permanent structure is
currently being constructed and is slated for completion by September of 1999.
We also completed construction on a pair of new facilities in early 1998 in
Hicksville and Paulding, Ohio.
We recognize that the rapid growth in commercial lending has significantly
changed First Federal's risk profile. In response to that increased risk, we
have hired a credit analyst to analyze each commercial loan before it is made.
We also have engaged a reputable consultant to perform a detailed loan review on
a semi-annual basis.
Over the years, one of the missing ingredients in our menu of services has
been trust services. We remedied that deficiency in 1998 when we applied for and
received trust powers from the Office of Thrift Supervision, our primary
regulator. In July, we hired Mark Gazarek to start our department from scratch.
Mark has nearly 20 years of trust experience and is off to a tremendous start.
Although our trust systems were not in place until the middle of December, we
already have $6.2 million of assets under management. Also, the possession of
trust powers will allow us to be the loan-file custodian for the loan-servicing
portfolios of both First Federal and The Leader, which will save us nearly
$200,000 annually in costs we have been paying to third parties.
2
<PAGE>
FINANCIAL RESULTS
While the achievements listed above made us a better, more diverse company
in 1998, they were overshadowed at the end of the year by a large adjustment we
made to increase our allowance for loan losses. In December 1998, we increased
our allowance by approximately $5.4 million to $9.8 million on a consolidated
basis. The adjustment reduced our net income for the year by $3.6 million after
tax, or $.46 per diluted share. For the year, First Defiance reported net income
of $3.1 million, or $.40 per diluted share, compared to 1997 net income of $5.4
million, or $.62 per share.
Late in the fourth quarter, an internal review of the consumer loan
portfolio indicated some weaknesses and we hired an outside consultant to
perform an extensive review of consumer loans. As a result of that review,
management determined that the consumer loan portfolio, which had a balance at
year-end of $83.4 million, required approximately $3.6 million of additional
reserves. The problems with the consumer loan portfolio were the result of a
lack of adherence to written underwriting standards. We have taken the following
steps to address the problem.
[GRAPHIC OMITTED -- of
Quarterly
Earnings &
Dividends]
o We centralized our indirect auto loan underwriting and approval,
which were previously performed through First Federal's branch
network. We have hired experienced underwriters and revised lending
authority. Since those changes were implemented, the volume of our
consumer originations has decreased significantly.
o We have made a number of personnel changes and have revised
compensation strategies.
o We have identified the loans in our portfolio which have potential
underwriting deficiencies. Those loans are receiving immediate
collection action if a payment is missed.
o We are utilizing the services of a third party to review adherence
to our underwriting guidelines on a monthly basis.
In addition to the adjustment to the consumer loan allowance, we recorded
fourth quarter adjustments totaling $1.8 million before tax to reflect further
deterioration of the mobile home portfolio, increases in projected loss rates on
classified assets, and increases in the required allowance to reflect the growth
in the commercial loan portfolio. We believe these adjustments to our allowances
were both prudent and necessary and appropriately reflect the risk inherent in
the loan portfolios. We had a thorough review performed on the commercial
portfolio during the fourth quarter and no unreserved credit problems were
identified.
Absent the large adjustment to the allowance, 1998 was a very strong year
for First Defiance. Net interest income decreased, as expected for the reasons
explained in management's discussion and analysis; but the decline was more than
offset by increases in non-interest income, primarily the servicing income from
The Leader.
<PAGE>
From a capital management standpoint, we took advantage of the decline in
our stock price in 1998 to repurchase a total of 1.2 million shares of First
Defiance stock during the year at an average price of $15.12. This represents
more than 14 percent of the shares outstanding at the beginning of the
3
<PAGE>
year. Since May 1996, we have repurchased a total of 3.7 million shares, or 33.5
percent of the shares outstanding at the beginning of 1996. We believe stock
repurchases continue to be an effective capital management option and, through
the first two-and-a-half months of 1999, have repurchased an additional 451,000
shares at an average price of $13.50.
OUR STRATEGY
While 1999 holds many challenges, it also holds a number of opportunities.
The Leader continues to expand into new states and recently received new
servicing contracts for bond programs in Indiana, Oklahoma and Washington State.
Also, we believe The Leader's expertise in originating and servicing FHA and VA
loans can be applied to First Federal's business in the more conventional loan
markets. The Leader also has ambitious goals to expand its activities beyond
first-time homebuyer programs by increasing its retail and wholesale mortgage
loan originations in 1999, focusing on both conventional and FHA/VA programs.
We also plan to continue to grow our commercial lending business, expand
the insurance operations outside of the city of Defiance, and begin generating
fee income through our trust department.
We have an outstanding management staff to implement this strategy. P.
Scott Carson joined First Federal late in 1998 and, as planned, was named
President and Chief Operating Officer of First Federal effective January 1,
1999. Scott has 28 years of commercial and consumer banking experience, most
recently with Trumbull Financial Corporation in Warren, Ohio. James Hook is
President and Chief Executive Officer of The Leader. Jim has 30 years of
experience with The Leader and is an invaluable resource. We also look forward
to working with Steve Grosenbacher, who is President and CEO of the Insurance
Center of Defiance.
[GRAPHIC OMMITTED -- of
Common
Shares
Repurchased]
I also want to take this opportunity to honor my predecessor, Don C. Van
Brackel, who stepped down as First Defiance's President, Chairman and CEO on
December 31, 1998. Don is a man with tremendous vision. He was instrumental in
both the conversion of First Federal Savings and Loan to a mutual holding
company in 1993 and the formation of First Defiance in 1995 as well as the
acquisition of both The Leader and the Insurance Center of Defiance. I am
grateful that Don has remained as vice chairman of the board of directors. I
plan to seek his counsel often.
My goal as Chief Executive Officer is to build on the vision created by
Don Van Brackel, and I am committed to building the value of your investment in
First Defiance Financial Corp.
Thank you for your continued support.
Yours truly,
/s/ William J. Small
--------------------
William J. Small
Chairman, President, C.E.O.
4
<PAGE>
FIRST DEFIANCE FINANCIAL CORP. LOCATIONS
FIRST DEFIANCE FIRST FEDERAL FINDLAY LOAN
FINANCIAL CORP. SAVING AND LOAN PRODUCTION OFFICE
2113 Tiffin
FIRST DEFIANCE FINANCIAL FIRST FEDERAL LOCATIONS Suite 101
CORP. HEADQUARTERS BRYAN DOWNTOWN Findlay, OH 45839
601 Clinton St. 204 East High Street 419-422-4422
Defiance, OH 43512 Bryan, Ohio 43506
www.fdef.com 419-636-3118 HICKSVILLE
419-782-5015 201 East High Street
BRYAN EAST Hicksville, OH 43526
926 East High Street 419-542-5626
Bryan, Ohio 43506
419-636-5653 MONTPELIER
1050 East Main Street
DEFIANCE DOWNTOWN Montpelier, OH 43543
601 Clinton Street 419-485-5591
Defiance, OH 43512
[GRAPHICS OMMITTED -- 419-782-5015 NAPOLEON DOWNTOWN
depicting 2 maps of 625 Scott Street Napoleon,
branch locations] DEFIANCE NORTH OH 43545 419-592-3060
825 North Clinton Street
Defiance, OH 43512 NAPOLEON WOODLAWN
419-782-6626 1333 Woodlawn Avenue
Napoleon, OH 43545
DEFIANCE SUPER K-MART 419-599-2727
190 Stadium Drive
Defiance, OH 43512 PAULDING
419-782-5252 905 North Williams Street
Paulding, OH 45879
FINDLAY 419-399-9748
3900 N. Main
Findlay, OH 45840 WAUSEON
419-472-1981 211 South
Fulton Street
Wauseon, OH 43567
419-335-7911
THE LEADER MORTGAGE COMPANY
www.first-fed.com
[GRAPHIC OMMITTED --
[GRAPHICS OMMITTED -- of SMA Insurance]
U.S. map depicting
Bond Program Penetration] Stauffer-Mendenhall Agency
INSURANCE CENTER
OF DEFIANCE
507 5th Street
Defiance, OH 43512
419-784-5431
[GRAPHIC OMMITTED -- of
The Leader
Mortgage Company]
THE LEADER
MORTGAGE COMPANY
1015 Euclid Avenue
Cleveland, Ohio 44115
216-696-8000
5
<PAGE>
First Defiance Financial Corp. and Subsidiaries
Selected Consolidated Financial Information
($ in thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
Selected Consolidated Financial Condition Data: At December 31
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets $785,399 $579,698 $543,411 $525,550 $471,461
Loans receivable held-to-maturity 448,574 441,824 415,366 381,444 354,937
Loans receivable held-for-sale 119,910 88 559 3,759 -
Allowance for loan losses 9,789 2,686 2,217 1,817 1,733
Non-performing assets 14,371 1,906 2,239 945 865
Securities available-for-sale 47,554 82,436 77,407 93,041 65,604
Securities held-to-maturity 13,541 20,953 25,937 26,073 30,632
Mortgage servicing rights 76,452 188 121 - -
Deposits and borrowers' escrow balances 511,313 395,983 383,139 382,414 376,311
FHLB advances 168,142 71,665 40,821 6,842 23,741
Stockholders' equity 93,710 106,884 116,565 133,506 68,396
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Selected Consolidated Operating Results: Years ended December 31
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total interest income $49,056 $43,858 $41,257 $38,565 $35,260
Total interest expense 26,946 21,387 19,459 20,289 16,928
Net interest income 22,110 22,471 21,798 18,276 18,332
Provision for loan losses 7,769 1,613 1,020 374 465
Non-interest income 17,528 1,627 1,328 1,035 1,001
Non-interest expense 1 26,940 14,093 15,958 10,560 9,930
Income before income taxes 4,929 8,392 6,148 8,377 8,938
Income taxes 1,818 2,985 1,997 2,856 2,985
Net income 1 3,111 5,407 4,151 5,521 5,953
Basic earnings per share 1,2 0.42 0.65 0.43 0.54 0.58
Diluted earnings per share 1,2 0.40 0.62 0.42 0.53 0.58
Cash dividends declared per share 2 0.37 0.33 0.29 0.28 0.28
</TABLE>
[GRAPHIC OMMITTED -- depicting [GRAPHIC OMMITTED -- depicting
Net Interest Income 1998 Assets Breakdown]
Year Ended December 31
In Millions]
[GRAPHIC OMMITTED -- depicting
1997 Assets Breakdown]
6
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
Selected Financial Ratios and Other Data:
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Performance Ratios:
Return on average assets 1 0.45% 0.96% 0.78% 1.13% 1.28%
Return on average equity 1 2.99% 4.69% 3.26% 6.14% 8.87%
Interest rate spread 3 3.25% 3.39% 3.22% 3.01% 3.50%
Net interest margin 3 3.62% 4.24% 4.31% 3.87% 4.06%
Ratio of operating expense to average total assets 1 3.85% 2.51% 3.02% 2.16% 2.13%
Quality Ratios:
Non-performing assets to total assets at end of period 5 1.83% 0.33% 0.41% 0.24% 0.28%
Allowance for loan losses to non-performing assets 5 68.12% 140.92% 99.02% 192.28% 200.35%
Allowance for loan losses to total loans receivable 1.69% 0.60% 0.52% 0.47% 0.48%
Capital Ratios:
Equity to total assets at end of period 11.93% 18.44% 21.45% 25.40% 14.51%
Tangible equity to tangible assets at end of period 10.41% 18.44% 21.45% 25.40% 14.40%
Average equity to average assets 14.86% 20.55% 24.07% 18.36% 14.40%
Book value per share $12.37 $12.53 $12.31 $12.16 $6.23
Ratio of average interest-earning assets to average
interest-bearing liabilities 108.43% 121.45% 128.53% 120.41% 114.99%
Dividend payout ratio 4 88.10% 50.77% 67.44% 51.85% 48.28%
</TABLE>
1 Non-interest expense for 1996 includes a one-time charge of $2.461 million
to recapitalize the Savings Association Insurance Fund (SAIF). Without the
SAIF charge, net income for 1996 would have been $5.775 million, or $.60
basic earnings per share ($.59 on a diluted basis), return on average
assets would have been 1.09%, return on equity would have been 4.54% and
the ratio of operating expense to average total assets would have been
2.55%.
2 Per share amounts for 1994 have been restated to reflect the 1995
reorganization. Earnings per share for 1994-1996 have been restated for FASB
Statement 128.
3 Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average rate on
interest-bearing liabilities. Net interest margin represents net interest
income as a percentage of average interest-earning assets.
4 Dividend payout ratio was calculated using basic earnings per share.
5 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.
<PAGE>
[GRAPHIC OMMITTED -- depicting [GRAPHIC OMMITTED -- depicting
Deposit and Borrowers' Equity to Assets Ratio
Escrow Balances At December 31
At December 31
In $millions]
7
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations
First Defiance Financial Corp. ("First Defiance" or "the Company") is a unitary
thrift holding company which conducts business through its thrift subsidiary
First Federal Savings and Loan, Defiance, Ohio ("First Federal") through its
mortgage banking subsidiary, The Leader Mortgage Company, Cleveland, Ohio ("The
Leader"), which it acquired in July 1998, and the Insurance Center of Defiance,
a property and casualty and life insurance agency which it acquired in December
1998.
First Federal is a federally chartered savings and loan that provides financial
services to communities based in Northwest Ohio where it operates 12
full-service branches, including a branch in Findlay, Ohio that opened in
February 1999. First Federal provides a broad range of financial services
including checking accounts, savings accounts, certificates of deposit,
individual retirement accounts, real estate mortgage loans, commercial loans,
consumer loans and home equity loans. Effective October 1998 First Federal
applied for and was granted trust powers; and, in December 1998, it began
offering trust services to businesses and individuals.
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 government 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 or other agency
securities are issued to the bond trustees under the programs. As of December
31, 1998, The Leader services approximately 82,000 loans with a total balance of
$4.8 billion (85,900 loans with a balance of $5.1 billion including
subservicing). Of these loans, 60,500 are bond program loans with balances of
$3.7 billion. Because the loans under the first-time homebuyer programs are
issued at below market rates, they generally have significantly lower
pre-payments than conventional mortgage loans. The Leader also collects a
significant amount of ancillary fees, including late charges and credit life
insurance commissions.
Because the Insurance Center acquisition occurred at the end of December 1998,
results do not include any operations of that entity.
Financial Condition
The July 1, 1998 acquisition of The Leader changed the statement of condition of
First Defiance from what was reported at the end of 1997. Total assets at
December 31, 1998 were $785.4 million, an increase of 35.5% from the December
31, 1997 total of $579.7 million. The addition of The Leader increased mortgage
loans by $119.8 million, $103.6 million of which are considered available for
sale. It also increased mortgage servicing rights by $76.0 million and goodwill
by $11.1 million. On the liability side, First Defiance acquired $179.8 million
of bank debt when The Leader was acquired on July 1, 1998. Bank debt assumed
consisted of $125.5 million of mortgage warehouse financing to fund the loans
available for sale and $54.3 million of term credit financing used to fund
mortgage servicing rights. By December 31, 1998, First Defiance replaced the
existing bank debt with lower cost advances from the Federal Home Loan Bank
("FHLB"). Also, The Leader placed the principal and interest payments from their
customers, as well as the tax and insurance escrow payments, on deposit at First
Federal. The balance of those P&I payments and escrow funds at December 31, 1998
were $77.9 million. Throughout 1998, P&I payments and escrow funds had an
average balance of $82.7 million.
<PAGE>
Excluding The Leader, the balance of mortgage loans receivable declined by
approximately $27.5 million due to a bulk sale of approximately $30 million of
seasoned mortgage loans during the 1998 third quarter. First Defiance also sold
the majority of its mobile home loan portfolio, which declined from $25.4
million at the end of 1997 to only $3.1 million at the end of 1998. Those
declines were offset by a $40.4 million increase in commercial loans during
1998, to $70.1 million at December 31, 1998. Automobile loans also increased
during 1998, from $69.1 million at December 31, 1997 to $75.2 million at
December 31, 1998. During that same time period, home equity and improvement
loans increased to $18.2 million from $16.9 million. Management believes that
commercial loan balances will continue to grow at a rapid pace during 1999, due
to the addition of three experienced commercial lenders and an increased
emphasis on this type of lending. In the consumer loan portfolio, stricter
adherence to underwriting guidelines as a result of increased charge-off
activity in 1998 will likely result in a contraction in that portfolio, perhaps
by as much as 30% in 1999.
The Leader was acquired for a cash price of $34.9 million, which was funded with
FHLB advances. As noted earlier, FHLB advances have also been used to replace
The Leader's bank financing. Certain of those advances were subsequently repaid
using the proceeds from called investment securities and from the sales of the
mobile home and seasoned mortgage loans. Total advances at December 31, 1998
were $168.1 million compared to $71.7 million at the end of 1997. The maturities
on those advances range from overnight to 10 years.
First Defiance also had growth in deposits for the year of $38.7 million, to
$434.0 million at December 31, 1998 from $395.3 million at December 31, 1997.
The most significant growth was in checking accounts, which increased to $53.8
million at December 31, 1998 from $32.4 million at December 31, 1997. During
that same time period, savings and money market accounts grew by $4.2 million
while certificates of deposit increased by $13.1 million. In addition to
deposits, First Defiance also has the use of The Leader's escrow deposits and
advance principal and interest payments. As noted above, that balance was $77.9
million at December 31, 1998.
Investment securities, which include both available for sale securities and held
to maturity securities, decreased by $42 million to $61.4 million from $103.4
million. The decrease is due primarily to scheduled maturities and the early
call of virtually all callable agency securities. The reduction in the
investment portfolio was used to fund loan growth and to repay FHLB advances.
8
<PAGE>
Results of Operations
General - First Defiance reported net income of $3.1 million for the year ended
December 31, 1998 compared to $5.4 million and $4.2 million for the years ended
December 31, 1997 and December 31, 1996 respectively. Net income for 1998 was
negatively impacted by a $5.4 million pre-tax fourth quarter adjustment to the
reserve for loan losses. (See discussion on Provision for Loan Losses.) The 1996
net income was adversely impacted by a one-time assessment of $2.5 million to
recapitalize the Savings Association Insurance Fund ("SAIF"). The after-tax
impact of the SAIF charge was a reduction in net income in 1996 of $1.6 million.
Without the SAIF charge, First Defiance's net income for 1996 would have been
$5.8 million.
On a diluted per share basis, First Defiance's net income was $.40, $.62 and
$.42 for the years ended December 31, 1998, 1997 and 1996 respectively ($.59 for
1996 after adding back the SAIF assessment). Earnings per share have been
favorably impacted in both 1998 and 1997 by a reduction in average shares
outstanding as a result of a number of share repurchase programs. On a diluted
basis, the average shares outstanding has declined from 9.6 million in 1996 to
8.4 million in 1997 and 7.5 million in 1998. Since May 1996, a total of 3.7
million shares have been repurchased under stock repurchase programs, including
1.2 million in 1998.
<PAGE>
Net interest income was $22.1 million for the year ended December 31, 1998,
compared to $22.5 million and $21.8 million for the years ended December 31,
1997 and 1996 respectively. Net interest margin was 3.62%, 4.24% and 4.31% for
the years ended December 31, 1998, 1997 and 1996, respectively. The decrease in
net interest margin in 1998 is primarily a result of The Leader using, on
average, approximately $51.8 million of financing to acquire mortgage servicing
rights, which are a non-interest earning asset. The Company has effectively
exchanged net interest margin for an increase in mortgage servicing income,
which is included in non-interest income. The yield on interest earning assets
was 7.96% for the year ended December 31, 1998, a decrease from the years ended
December 31, 1997 and 1996 when the yields on interest earning assets were 8.24%
and 8.12% respectively. The decline in yields between 1998 and 1997 is due
primarily to the addition of The Leader's mortgage loans available for sale
during the second half of 1998. Those loans, which had an average balance of
$131.5 million for the six month period between July 1, 1998 and December 31,
1998, are generally originated under first time homebuyer programs and carried
an average interest rate of 6.47% for that six month period. The Company's cost
of funds for the year ended December 31, 1998 was 4.71% compared to 4.85% for
the year ended December 31, 1997 and 4.90% for the year ended December 31, 1996.
As a result, the interest rate spread declined to 3.25% for the year ended
December 31, 1998 compared to 3.39% for 1997 and 3.22% for 1996.
The provision for loan losses for the year ended December 31, 1998 was $7.8
million, compared to $1.6 million for 1997 and $1.0 million for 1996.
The addition of The Leader significantly impacts the comparability of both
non-interest income and non-interest expense because of the revenues and costs
associated with a mortgage banking operation. For the year ended December 31,
1998, non-interest income was $17.5 million compared to only $1.6 million for
1997 and $1.3 million for 1996. Non-interest expense for the year ended December
31, 1998 was $26.9 million compared to $14.1 million for 1997 and $16.0 million
for 1996, although the 1996 amount includes the $2.5 million SAIF assessment.
Without the SAIF assessment, non-interest expense for 1996 would have been $13.5
million.
Income for The Leader for the six months it was included in First Defiance's
results was $1.4 million; and the net earnings of First Defiance after factoring
in the after-tax cost of funding the acquisition were increased by $747,000, or
$.10 per share.
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 $5.2 million, or 11.9%, from $43.9 million
for the year ended December 31, 1997 to $49.1 million for the year ended
December 31, 1998. The increase was due to a $93.5 million increase in the
average balance of loans outstanding for 1998 when compared to 1997. The yield
on those loans declined to 8.31% in 1998 versus 8.70% in 1997. The increase in
loans receivable was primarily attributable to the acquisition of The Leader's
loans available for sale. Those loans averaged $131.5 million for the six months
that The Leader was included in First Defiance's results and increased the
average balance outstanding for the year by $65.8 million. The inclusion of
those loans also caused the reduced yield because of the below market nature of
loans originated under the first-time homebuyer programs. Interest income was
favorably impacted by the increase in the average balance in commercial loans,
which was $42.5 million for 1998 compared to $28.3 million for 1997. The
increase in commercial loan balances occurred after the hiring of three
experienced commercial lenders and a commercial credit analyst during the second
half of 1998.
<PAGE>
In 1997, total interest income increased by $2.6 million, or 6.3%, from $41.3
million for the year ended December 31, 1996 to $43.9 million for the year ended
December 31, 1997. That increase was due to a $28.6 million increase in the
average balance of loans outstanding for 1997 when compared to 1996. The yield
on those loans increased slightly, to 8.70% in 1997 from 8.66% in 1996.
Interest earnings from the investment portfolio declined to $5.1 million in 1998
compared to $6.6 million in both 1997 and 1996. The decline in 1998 was due to a
decrease in the average balance of securities from $103.3 million in 1997 to
$81.3 million in 1998. The decline was primarily due to agency securities with
call provisions being called during the low rate environment, particularly
during the second half of 1998. The yield on the average portfolio balance in
1998 was 6.25%. In 1997, the investment portfolio had a yield of 6.35% on an
average balance of $103.3 million while in 1996 the investment portfolio had a
yield of 6.15% on an average balance of $107.7 million.
Interest expense increased by $5.5 million, or 26.0%, to $26.9 million in 1998
compared to $21.4 million for 1997. The large increase is primarily due to the
financing requirements of The Leader's operations. When it was acquired, The
Leader had debt arrangements with a consortium of banks that provided financing
for its mortgage loan warehouse and also for the acquisition of
9
<PAGE>
Results of Operations (continued)
mortgage servicing rights. Those debt agreements were replaced during December
1998 with financing from First Federal Savings and Loan, which was funded
through both deposits and FHLB advances. The average bank debt outstanding for
the six months that The Leader was included in First Defiance's results was
approximately $175.3 million. The net cost of those funds was approximately
5.06%, including a credit that The Leader was receiving for escrow funds on
deposit at the banks at a fed funds rate. Beginning in November, those escrow
balances were placed on deposit with First Federal.
Interest expense also increased because of an increase in the average balance of
deposits outstanding, which increased to $409.3 million in 1998 compared to
$382.6 million in 1997. The average cost of those deposits declined by 22 basis
points in 1998, to 4.48% from 4.70% in 1997. The average balance of FHLB
advances increased to $75.1 million in 1998 from $58.1 million in 1997. The
average cost of those advances declined to 5.56% from 5.84%. The balance in FHLB
advances increased substantially in December 1998, as they were used as the
primary source of funding to replace The Leader's bank debt.
In 1997, interest expense increased to $21.4 million from $19.5 million for the
year ended December 31, 1996. The increase was due to an increase in interest
expense on FHLB advances, which was $3.4 million for 1997 compared to $880,000
for 1996. The increase was due to an increase in the average balance of FHLB
advances outstanding during 1997 to $58.1 million, compared to only $15.9
million for 1996. The average cost of those advances in 1997 increased to 5.84%
from 5.56% for 1996. The cost of deposit liabilities decreased to $18.0 million
for the year ended December 31, 1997 compared to $18.6 million for 1996 due to a
17 basis point decrease in the average cost of those funds. The average balance
of deposits was essentially the same for both 1997 and 1996.
As a result of the foregoing, First Defiance's net interest income was $22.1
million for the year ended December 31, 1998 compared to $22.5 million for the
year ended December 31, 1997 and $21.8 million for the year ended December 31,
1996. Net interest margin for the year ended December 31, 1998 declined to 3.62%
from 4.24% for 1997 and 4.31% for 1996. The decline was due to the financing of
The Leader, particularly the financing of mortgage servicing rights and
goodwill, which are both non-interest earning assets. The balance of mortgage
servicing rights at December 31, 1998 was $76.5 million and the balance of
goodwill at that date was $13.3 million.
Provision for Loan Losses - First Defiance's provision for loan losses was $7.8
million for the year ended December 31, 1998, compared to $1.6 million and $1.0
million for the years ended December 31, 1997 and 1996, respectively. Provisions
for loan losses are charged to earnings to bring the total allowance for loan
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, industry
standards, 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 collectability of First Defiance's loan portfolio.
In 1998, four factors combined to require the large increase in the loan loss
provision: an increase in charge-offs and delinquencies within First Federal's
consumer loan portfolio, rapid growth in First Federal's commercial loan
portfolio, the disposition of First Federal's mobile home loan portfolio, and
the acquisition of The Leader Mortgage Company. The consolidated allowance for
loan losses at December 31, 1998 was $9.8 million, compared to $2.7 million at
December 31, 1997.
<PAGE>
During 1998, First Federal experienced increased levels of charge-offs of loans
in its $83.4 million consumer loan portfolio, which is comprised primarily of
automobile loans. In response to the level of charge-offs, management hired an
outside consultant to perform an extensive review of consumer loans. The outside
consultant tested approximately 10% of all loans originated after January 1,
1997. Based on the review, they recommended that a loss percentage of as much as
6.31% of the total portfolio was required for loans originated in 1997 or 1998.
Based on that recommendation, management increased the allowance for consumer
loans by approximately $3.6 million. Subsequent to that review, consumer loan
underwriting and approval, which were previously performed through First
Federal's branch network, have been centralized at the main office under
experienced underwriters with revised lending authority. The volume of consumer
loans originated has been significantly reduced since the changes were
implemented.
The growth in the commercial portfolio also has resulted in an increase in the
allowance for loan losses. Commercial loans outstanding have increased from
$29.8 million at the end of 1997 to $70.1 million at the end of 1998. The
allowance for losses on those commercial loans has increased from approximately
$830,000 at December 31, 1997 to $1.76 million at December 31, 1998. The
increase in the allowance for commercial loans is a result of the rapid growth
in the portfolio balance during 1998. Management engaged an outside third party
to assess the credit quality of all loan relationships in the portfolio with
balances greater than $250,000 during the fourth quarter of 1998 and no
unreserved credit quality problems were noted.
During 1998, First Federal sold $21 million of its $24 million mobile home loan
portfolio to an unrelated third party, realizing a gain of approximately
$240,000. The loans retained in the portfolio were not saleable at the time of
the loan sale because of a variety of factors, including delinquency and
locations of the mobile homes. Subsequent to that July 1998 sale, the market for
subprime type loan portfolios declined significantly, causing management to
reassess the value of its remaining mobile home loan portfolio. Based on the
reassessment, it was determined to reserve 40% against the remaining mobile home
loan balances not already classified as doubtful or loss. This adjustment
resulted in increasing the mobile home loan loss allowance to $1.3 million at
December 31, 1998 compared to $360,000 at December 31, 1997.
The allowance for loan losses also increased because of an increase in
delinquent balances classified as doubtful or loss by management. At December
31, 1998, a total of $2.4 million, $856,000 and $1.1 million were classified as
10
<PAGE>
substandard, doubtful and loss respectively compared to $4.7 million, $589,000
and $498,000 respectively at December 31, 1997. First Federal had previously
reserved loans classified as substandard and doubtful at 10% and 30%
respectively. However, based on recent loss experience on loans, those
percentages have been increased to 20% and 50% respectively. Loans classified as
loss are 100% reserved.
There also was a slight increase in the provision for loan losses as a result of
the acquisition of The Leader. Most of the loans that are originated or acquired
by The Leader have FHA or VA guarantees. As a result, the risk of loss on those
loans is limited to the legal costs associated with foreclosure on the loan,
which have averaged approximately $1,500 per loan in foreclosure. This is a cost
that The Leader incurs whether the loan is included in its own portfolio or
serviced for others. As a result, it is The Leader's general practice to
repurchase loans that are in foreclosure out of the GNMA pool in order to avoid
having to advance principal and interest payments to the investors for those
loans, as is required under its agreement with GNMA. The Leader reserves for the
foreclosure losses when the loan is repurchased out of the GNMA pool. Management
also records an estimated loss reserve to provide for potential losses as loans
become delinquent based on The Leader's historical loss experience on similar
loans. A provision related to those loans totaling $351,000 was recorded by The
Leader for the six months that its results were included in First Defiance's
financial statements.
The acquisition of The Leader has resulted in an increase in the Company's
reported non-performing loans that include loans in The Leader's foreclosure
reserve. The balance of those loans was $11.0 million at December 31, 1998,
76.6% of First Defiance's total non-performing assets. However, that balance is
comprised of FHA insured and VA guaranteed loans whose payment is substantially
assured by the federal government.
The increase in the provision for loan losses between 1996 and 1997 is
attributed to the overall growth in the loan portfolio during 1997 and the
emphasis on consumer and commercial lending, which have more credit risk than
mortgage lending. Also, total charge-offs increased in 1997, to $1.1 million
compared to $620,000 for 1996. Total charge-offs recorded in 1998 were $1.9
million.
Non-interest Income - First Defiance's non-interest income increased by $15.9
million to $17.5 million for the year ended December 31, 1998 from $1.6 million
for the year ended December 31, 1997. Non-interest income for the year ended
December 31, 1996 was $1.3 million. The Leader's impact on non-interest income
was dramatic. As previously noted, 1998 consolidated net income includes the
results of The Leader from July 1, 1998. During that six-month period, The
Leader recognized $12.1 million of loan servicing fees, primarily the fees
collected for servicing loans for others. It also recognized $2.0 million of
gains from the sale of mortgage loans during that same period.
Excluding The Leader's results, non-interest income increased to $3.3 million in
1998, a 200% increase over 1997 amounts. Most of the increase was the result of
increased loan sales by First Federal during 1998. Total gains on sale of loans
(excluding The Leader) were $1.4 million in 1998 compared to only $116,000 for
1997. One million dollars of the gains resulted from sales of mortgage loans,
including a $785,000 gain in the third quarter of 1998 from the sale of $30.7
million of seasoned mortgage loans. First Federal also realized a $240,000 gain
from its sale of a large portion of its mobile home loan portfolio. In 1997,
First Defiance realized $116,000 in gains from sales of mortgage loans compared
to $209,000 from mortgage loan sales in 1996.
<PAGE>
The Company also had a significant increase in service fees, which increased to
$1.4 million in 1998 compared to $1.0 million in 1997. The increase in fee
income was due to several factors, including a $143,000 increase in
non-sufficient fund ("NSF") fees on checking accounts and increases in ATM and
debit card fees. The Company had similar increases between 1996 and 1997 when
service fees increased $211,000.
Non-interest Expense - Total non-interest expense for 1998 was $26.9 million
compared to $14.1 million for the year ended December 31, 1997 and $16.0 million
for the year ended December 31, 1996 ($13.5 million excluding the SAIF
assessment). As with non-interest income, the addition of The Leader in July
1998 significantly increased the consolidated level of non-interest expense. For
the six months from July 1 to December 31, 1998, The Leader's total non-interest
expense was $12.2 million. That total includes $3.8 million in compensation and
benefits, $490,000 in occupancy costs, $5.3 million in amortization of mortgage
servicing rights and $1.1 million in amortization of goodwill and other
acquisition costs, including non-compete and employment agreements. The purchase
of The Leader resulted in goodwill of approximately $11 million which is being
amortized over 20 years while non-compete and employment agreements total
approximately $4.5 million and are being amortized over periods ranging from two
to five years.
Excluding The Leader, non-interest expense for First Defiance for 1998 would
have been $14.7 million. Excluding the results of The Leader, occupancy expense
increased by $665,000 due to the addition of the Hicksville and Paulding
branches and a full year of depreciation expense on major renovations completed
in early to mid-1997; data processing costs increased by $200,000 due to the
enhancement of certain systems; amortization of mortgage servicing rights
increased by $240,000 due to an increase in loans serviced for others; and state
franchise tax increased by $116,000. These increases were offset by a net
$740,000 decline in compensation and benefits expense and a $118,000 decline in
mobile home loan servicing expenses. Compensation and benefits decreased due to
a $446,000 reduction in ESOP expense; the termination of First Federal's defined
benefit pension plan, which reduced expense by $475,000; and a reduction in
year-end bonuses, including the elimination of year-end bonuses for First
Defiance's management because of 1998 operating results. Also, the discretionary
contribution to the Company's 401(k) plan was not made because the Board of
Directors determined that the 1998 operating results did not warrant such a
contribution. Those adjustments more than offset increased compensation related
to staffing increases, including a full year with branches in Paulding and
Hicksville, the expansion of the commercial loan department beginning in
mid-1998, and the hiring of trust department personnel between July and October.
The acquisition of the Insurance Center of Defiance as of the end of December
1998 resulted in an additional $2.4 million of goodwill which will be amortized
over a 15 year period.
11
<PAGE>
The increase in non-interest expense from 1996 to 1997 was primarily due to a
$1.0 million increase in compensation and benefits expense and a $596,000
increase in occupancy costs. The increase in compensation was due to a $288,000
increase in ESOP expense due to a higher share value of First Defiance stock and
a $518,000 increase in overall compensation due to increased staffing at First
Defiance headquarters and at the branch level. Occupancy costs increased in 1997
compared to 1996 because of the completion of major renovations at the Defiance
headquarters and at other branch facilities that increased depreciation expense
by $366,000. Also in 1997, First Defiance made substantial improvements to its
computer hardware, network equipment and communications links which increased
depreciation expense by $95,000. The increases in compensation and occupancy
expense in 1997 were offset by substantial decreases in SAIF deposit insurance
premiums and Ohio franchise taxes. SAIF premiums, excluding the special 1996
SAIF assessment, decreased to $194,000 for 1997 compared to $872,000 in 1996.
The decrease in premiums resulted from the reduction in the annual assessment
from approximately 23 basis points per $100 of insured deposits to 6.4 basis
points per $100 of insured deposits. Ohio franchise tax for 1997 was $1.1
million compared to $1.7 million for the year ended December 31, 1996.
Income Taxes - Income tax amounted to $1.8 million in 1998 compared to $3.0
million in 1997 and $2.0 million in 1996. The effective tax rates for the three
years were 36.9%, 35.6% and 32.5% respectively. The increase in the effective
tax rate from 1997 to 1998 is the result of the addition of non-deductible
goodwill. The increase from 1996 to 1997 was due primarily to the inclusion in
1997 of a provision for Ohio income taxes, which are assessed at the holding
company level and were not material in 1996. (See Note 13 to the Consolidated
Financial Statements.)
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, nor does it engage in any trading activities.
First Defiance monitors interest rate risk on a monthly basis through simulation
analysis that measures the impact changes in interest rates can have on net
interest income. The simulation technique analyzes the effect of a presumed 100
basis point shift in interest rates (which is consistent with management's
estimate of the range of potential interest rate fluctuations) and takes into
account prepayment speeds on amortizing financial instruments, loan and deposit
volumes and rates, non-maturity deposit assumptions and capital requirements.
The results of the simulation indicate that in an environment where interest
rates rise 100 basis points over a 12 month period, using 1999 projected amounts
as a base case, First Defiance's net interest income would increase by 1.5%.
Were interest rates to fall by 100 basis points during the same 12-month period,
the simulation indicates that net interest income would remain essentially
unchanged.
<PAGE>
The acquisition of The Leader provided First Defiance with a significant source
of non-interest income. The mortgage banking operations also serve as a
countermeasure against the decline in the value of mortgage loans during a
rising rate environment because increases in interest rates tend to increase the
value of mortgage servicing rights due to of the resulting decrease in
prepayment rates on the underlying loans. Conversely, in a decreasing interest
rate environment, the value of the mortgage servicing portfolio tends to
decrease due to increased prepayments on the underlying loans. However, because
The Leader's portfolio is comprised primarily of below market-rate loans, the
prepayments on the loans it services have been much lower than industry
averages. The Leader averaged 11.1% prepayments for the second half of 1998,
which is lower than prepayment speeds for the mortgage industry as a whole. The
simulation model used by First Defiance measures the impact of rising and
falling interest rates on net interest income only. The Company also monitors
the potential change in the value of its mortgage servicing portfolio given the
same 100 basis point shift in interest rates. At December 31, 1998, a 100 basis
point decrease in interest rates would require First Defiance to increase its
reserve for impairment of mortgage servicing rights by approximately $586,000.
First Defiance, through The Leader, has plans to significantly increase its
origination capabilities, on both a retail and wholesale basis beginning in
1999. Such increases will help hedge the balance of mortgage servicing rights.
In a declining interest rate environment, though the value of the mortgage
servicing portfolio will fall, the volume of loan originations generally will
increase. To protect themselves from the risk of changing interest rates,
mortgage banking companies frequently use off balance sheet financial
instruments to hedge the exposure of the mortgage loan pipeline. The Leader does
not need to hedge its mortgage loan pipeline because the trustees under the
various first-time homebuyer programs are required to fund the issuance of the
GNMA or other agency securities backed by the mortgages in The Leader's pipeline
at a guaranteed price. As The Leader develops a greater presence in the
conventional mortgage markets, however, it will be required to utilize programs
to hedge its positions.
First Defiance also has increased its lending activities in the commercial loan
area. 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 commercial portfolio increased to $70.1 million,
which is split between $29.0 million of fixed rate loans and $41.1 million of
adjustable rate loans at December 31, 1998. 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 is generally less than seven years.
First Defiance also has significant balances of consumer loans which tend to
have a shorter duration than residential mortgage loans ($83.4 million at
December 31, 1998) and home equity loans ($14.3 million at December 31, 1998)
which fluctuate with changes in the prime lending rate. Also, to limit its
interest rate risk, First Federal has been selling fixed rate mortgage loans
with a maturity of 20 years or greater in the secondary market. Historically,
loans with maturities less than 20 years have been retained in portfolio
although First Federal began selling
12
<PAGE>
a portion of its 15 year fixed rate mortgage loans in the secondary market
beginning in January 1999. For the year ended December 31, 1998, First Federal
sold $50.8 million of loans in the secondary market including a bulk sale of
$30.7 million of seasoned loans sold during the 1998 third quarter. At December
31, 1998, First Federal's servicing portfolio totaled $62.2 million, compared to
only $17.8 million at December 31, 1997.
In addition to the simulation analysis, First Federal also utilizes the "net
portfolio value" ("NPV") methodology adopted by the Office of Thrift supervision
("OTS") First Federal's primary regulator. Under the NPV methodology, interest
rate risk exposure ("IRR") is assessed by reviewing the estimated changes in
First Federal's net interest income ("NII") and NPV that would hypothetically
occur if interest rates simultaneously rise or fall along the yield curve.
Projected values of NII and NPV at both higher and lower regulatory defined
scenarios are compared to base case values (no change in rates) to determine the
sensitivity to changing interest rates. Presented in the following table, as of
December 31, 1998, is an analysis of First Federal's estimated interest rate
risk as measured by changes in NPV for instantaneous and sustained parallel
shifts in interest rates up and down 300 basis points in 100 point increments.
Assumptions used in calculating the amounts in this table are those assumptions
utilized by the OTS in assessing the interest rate risk of the thrifts it
regulates. In the case of mortage servicing rights, First Federal utilized the
assumption from The Lender's in-house model. NPV is calculated by the OTS for
the purposes of interest rate risk assessment and should not be considered as an
indicator of value of First Federal.
<TABLE>
<CAPTION>
December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------------
Net Portfolio Value Net Portfolio Value as %
of Present Value of Assets
- ---------------------------------------------------------------------------------------------------------------------------
Change in Rates $Amount $Change %Change NPV Ratio Change
(Dollars in Thousands)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
+300 bp 60,931 (26,556) (30%) 8.08% (284) bp
+200 bp 75,598 (11,890) (14%) 9.75% (117) bp
+100 bp 86,505 (982) (1%) 10.91% (1) bp
0bp 87,487 -- -- 10.98% --
-100bp 74,111 (13,376) (15%) 9.31% (161) bp
-200bp 61,163 (26,324) (30%) 7.74% (318) bp
-300bp 63,782 (23,705) (27%) 7.96% (296) bp
</TABLE>
In the event of a 300 basis point change in interest rates based upon estimates
as of December 31, 1998, First Federal would experience a 30% decrease in NPV in
a rising rate environment and a 27% decrease in NPV 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. However, the value of mortgage servicing rights generally move
in the opposite direction of monetary assets, rising in a rising rate
environment and falling in a falling rate environment. Also, 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. The
large balance in mortgage servicing rights and the volatility of that asset has
a material impact on NPV in both a rising and falling rate environment.
<PAGE>
In evaluating First Federal's exposure to interest rate risk, certain
shortcomings inherent in the method of analysis presented in the foregoing table
must be considered. For example, although certain assets and liabilities may
have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
rates while interest rates on other types of financial instruments may lag
behind current changes in market rates. Furthermore, in the event of changes in
rates, prepayments and early withdrawal levels could differ significantly from
the assumptions in calculating the table and the results therefore may differ
from those presented.
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 related occurrences.
Diversifying loans and investments to prevent concentrations of risks is one
manner in which 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.
13
<PAGE>
Liquidity and Capital Resources
First Federal is required under applicable federal regulations to maintain
specified levels of "liquid" investments in qualifying types of United States
Treasury, agency and other investments having maturities of five years or less.
Current OTS regulations require that a savings institution maintain liquid
assets not less than 4% of its average daily balance of net withdrawable deposit
accounts and borrowings payable in one year or less. First Federal's liquidity
exceeded applicable requirements throughout 1998 and at December 31, 1998.
Cash was generated by First Defiance's operating activities during the years
ended December 31, 1998, 1997 and 1996, primarily as a result of net income. The
adjustments to reconcile net income to cash provided by 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 of mortgage servicing
rights and increases and decreases in other assets and liabilities. 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 1998
cash provided from the sale and maturity of investment securities totaled $62.6
million of which $21.0 million was reinvested in new securities. Principal
financing activities include the gathering of deposits and advance payments from
loan servicing customers and the utilization of FHLB advances. For the year
ended December 31, 1998, FHLB advances increased by $96.5 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, 1998, First Defiance had an aggregate of $71.4 million in
unfunded commitments to originate loans (including unused portions of lines of
credit and letters of credit) and no commitments to purchase securities. At the
same date, First Defiance had commitments to sell $22.0 million of loans. Also
as of December 31, 1998, the total amount of certificates of deposit that are
scheduled to mature by December 31, 1999 was $219.2 million. First Defiance
believes that it has adequate resources to fund commitments as they arise. It
can adjust the rate on savings certificates to retain deposits in changing
interest rate environments; it can sell or securitize mortgage or non-mortgage
loans; and it can turn to other sources of financing including FHLB advances.
Because the FHLB requires that the collateral must exceed 150% of the
outstanding advance balance, First Defiance may also from time-to-time be
required to utilize other sources of financing, including brokered certificates
of deposit and bank advances. In February 1999, First Defiance placed
approximately $42 million of certificates of deposits with maturities ranging
from three to six months through several CD brokers.
Stockholders' equity decreased by $13.2 million, or 12.3% at December 31, 1998
compared to December 31, 1997 due to the repurchase of 1.2 million shares of
First Defiance stock (14.0% of shares outstanding at the beginning of the year).
The shares in 1998 were repurchased at an average cost of $15.12 per share; and,
as a result, stockholders' equity was reduced by $18.1 million. First Defiance
made similar purchases of 966,000 shares of common stock during 1997.
<PAGE>
The equity reduction caused by the repurchase of First Defiance shares was
offset to a lesser degree by earnings retention, the vesting or issuance of
shares under the Company's Management Recognition Plan ("MRP") and Employee
Stock Ownership Plan ("ESOP"), unrealized securities gains, and the issuance of
stock under stock option programs. Net income for 1998 was $3.1 million, of
which $2.8 million was returned to shareholders in the form of declared
dividends ($.37 per share). The vesting of MRP shares and release of ESOP shares
increased equity by $837,000 and $776,000 respectively. Unrealized gains on
available for sale securities, net of tax, increased equity by $212,000. Stock
option exercises increased equity by approximately $642,000. The book value of
First Defiance's common stock was $12.37 at December 31, 1998, compared to
$12.53 at December 31, 1997. The decline in value is due to the repurchase of
shares at a cost greater than book value and a dividend payout ratio of 89% for
1998.
First Federal is subject to various capital requirements of the OTS. At December
31, 1998, First Federal had capital ratios that exceeded the minimum regulatory
requirements. For additional information about First Federal's capital
requirements, see Note 12 to the Consolidated Financial Statements.
Year 2000 Readiness
All companies, including First Defiance and its subsidiaries, currently face
many risks associated with the ability of computer systems to properly recognize
calendar dates beginning in the year 2000. This potential problem could cause
systems which utilize date sensitive information to either not function at all,
or to provide incorrect data or information. First Federal and The Leader have
developed separate action plans to address the Year 2000 problem.
First Federal outsources the majority of its data processing needs to BISYS,
Inc. Applications maintained by BISYS include savings, checking, mortgage loans
and consumer and commercial loans. BISYS has represented to its customers that
these applications have been updated to properly process transactions that
reflect dates in the year 2000, and First Federal has systematically tested all
of First Federal's BISYS applications for a variety of key dates in 1999, 2000
and beyond. The first testing cycle was completed in January 1999 with only
slight problems noted in the aging of certain information. Management believes
that the problems noted were a function of how BISYS processed data through its
test bank and not a result of data not being processed accurately. Further
testing will be performed to assure that all data is properly aged.
First Federal processes its general ledger on a system that is integrated with
the BISYS applications. The vendor has indicated that the current version of the
general ledger system, which also includes accounting for accounts payable,
fixed assets, and investments, is Year 2000 compliant. Testing of the general
ledger interface will be performed by management during the 1999 first quarter
in conjunction with other system testing.
First Federal's in-house computing environment consists of a Wide Area Network
("WAN") system that links together its 12 branches and is interfaced with the
BISYS applications. All
14
<PAGE>
hardware associated with the WAN has been tested and is Year 2000 compliant.
First Federal replaced approximately 12 personal computers that were not Year
2000 compliant at a cost of less than $50,000. Those replacement computers were
capitalized.
In addition to BISYS, First Federal is dependent on a number of other third
parties to provide various processing functions. Management is in the process of
testing the interchange of data among and between these various third party
providers that include the Federal Reserve Bank of Cleveland, the Federal Home
Loan Bank of Cincinnati, the MAC ATM network, and various Automated Clearing
House ("ACH") providers.
Because its data processing functions are outsourced, the cost of Year 2000
remediation has not been material to First Federal. In addition to the cost of
replacing non-compliant personal computers, BISYS is assessing a fee to cover
the cost of the test bank established to provide for the appropriate testing.
Testing itself is being performed by individuals responsible for the various
applications and is being coordinated by First Federal's internal auditor and
Sr. Vice President of Operating Systems. The cost of the individuals has not
been quantified, however the three primary individuals involved have devoted
approximately 60% of their time for approximately six months during the testing
phase. First Federal's total out of pocket expense recognized in conjunction
with Year 2000 compliance was less than $100,000 in 1998 and are expected to be
less than $100,000 in 1999.
While First Federal outsources the majority of its applications, The Leader
processes its critical applications on an in-house system. All of The Leader's
hardware and software, both internally developed and purchased from third party
vendors, have been upgraded and tested. Management believes it is functioning
properly and will continue to function properly in the Year 2000. The Company's
most mission critical systems, the loan servicing system and the wholesale bond
system, have been modified to process dates in the Year 2000 and are fully
operational.
The Leader is also dependent on a variety of third parties that provide software
or interface information with The Leader's system. The Leader will be
participating in a Year 2000 readiness test which is being coordinated by the
Mortgage Bankers of America. As part of that test, The Leader will have the
opportunity to conduct data interchange testing with HUD, Fannie Mae, Freddie
Mac and GNMA. The MBA testing will be conducted between March and June 1999.
The estimated total cost of Year 2000 compliance by The Leader is approximately
$600,000 including the cost of hardware and software upgrades, programming
costs, and retention bonuses to key staff members involved in the Year 2000
project. Approximately 60% of the cost has been expended to date with the
majority of those costs being equipment upgrades. The portion of the costs
associated with hardware acquisitions is being capitalized while internal
programming costs and retention payments are being expensed. Estimated Year 2000
expense for The Leader for 1999 is not anticipated to exceed $300,000.
<PAGE>
In addition to the mission critical systems identified by both First Federal and
The Leader, both entities have certain non-information technology systems that
may contain imbedded technology that is date dependent. Examples of such systems
include security systems, heating and cooling systems, telephone systems,
sprinkler systems, and elevators. To the extent possible, both First Federal and
The Leader have attempted to assess the risks associated with these systems. The
only significant system that management has identified as needing to be replaced
is the phone system at The Leader, which also includes the Interactive Voice
Response Unit and the Voice Mail components. Management is in the process of
evaluating options from various vendors and expects to have a replacement phone
system in place by June 30, 1999. The estimated cost of the replacement phone
system is included in The Leader's estimate of $600,000 in total Year 2000
costs.
The Company is attempting to limit the potential impact of the Year 2000 by
monitoring the progress of its own Year 2000 projects and those of its critical
external relationships. While management believes that all critical Year 2000
issues will be resolved, it cannot guarantee that all such issues will be
resolved. Any critical unresolved Year 2000 issues could have a material adverse
effect on the Company's results of operations, liquidity or financial condition.
In addition to Year 2000 remediation efforts, the Company has begun to develop
contingency/recovery plans aimed at ensuring the continuity of critical
functions. As part of this process, management is developing an assessment of
reasonably likely failure scenarios for its critical systems. Once this
assessment is completed, the Company will develop plans that are designed to
reduce the impact on the Company, and provide methods of returning to normal
operations, if one or more of those scenarios occur. A variety of automated and
manual fallback plans are under consideration, including the use of electronic
spreadsheets, resetting system dates, and manual workarounds. The Company
estimates that contingency planning will be substantially complete by September
1999.
Readiness for the Year 2000 is also a concern for First Defiance's customers,
particularly its commercial lending customers. Management is assessing the
status of Year 2000 readiness for all commercial lending customers. The ability
to be Year 2000 compliant is one consideration taken into account during the
loan underwriting process. Also, to the extent possible, management is
considering the risk associated with not being Year 2000 compliant when
evaluating the adequacy of the allowance for loan losses for individual
commercial loan customers.
Forward Looking Information
Forward looking statements in this report are made in reliance upon the safe
harbor provisions of the private Securities Litigation Reform Act of 1995. The
statements in this report which are not historical fact are forward looking
statements and they include, among other statements, projections about growth or
reduction in loan balances in the Financial Condition section, and projections
about interest rate risk 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 condition, 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
15
<PAGE>
Forward Looking Information (continued)
actual results to differ materially from management's expectation regarding
future performance.
Statements made herein about the implementation of First Defiance's Year 2000
remediation, the costs expected to be associated with those efforts and the
results that First Defiance expects to achieve also constitute forward looking
information. As noted above, there are many uncertainties involved in the Year
2000 issue, including the extent to which First Defiance will be able to
successfully remediate systems and adequately provide for contingencies that may
arise, as well as the broader scope of the Year 2000 issues as it may affect
third parties that are not controlled by First Defiance. Accordingly, the costs
and results of First Defiance's Year 2000 program and the extent of any impact
on First Defiance's operations could vary materially from those stated herein.
16
<PAGE>
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
<TABLE>
<CAPTION>
December 31
1998 1997
- ----------------------------------------------------------------------------------------------
Assets (In thousands)
- ----------------------------------------------------
<S> <C> <C>
Cash and cash equivalents:
Cash and amounts due from depository institutions $ 16,137 $ 8,149
Interest-bearing deposits 4,369 848
------------------------------------------
20,506 8,997
Investment securities:
Available-for-sale, carried at fair value 47,554 82,436
Held-to-maturity, carried at amortized cost
(approximate fair value $13,753 and
$21,730 at December 31, 1998 and
1997, respectively) 13,541 20,953
------------------------------------------
61,095 103,389
Loans receivable, net of allowance of $9,789 and
$2,686 at December 31, 1998 and 1997, respectively 448,574 441,824
Loans held for sale
(approximate fair value $120,097 and $89
at December 31, 1998 and 1997, respectively) 119,910 88
Mortgage servicing rights 76,452 188
Accrued interest receivable 3,605 3,479
Federal Home Loan Bank stock 10,826 3,764
Premises and equipment 19,057 16,799
Deferred federal income taxes - 415
Real estate, mobile homes and other
assets held for sale 1,517 541
Goodwill, net of accumulated amortization of $282 13,333 -
Other assets 10,524 214
------------------------------------------
Total assets $785,399 $579,698
------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
December 31
1998 1997
- ----------------------------------------------------------------------------------------------
Liabilities and stockholders' equity
- ----------------------------------------------------
<S> <C> <C>
Liabilities:
Deposits $433,979 $395,322
Advances from the Federal Home Loan Bank 168,142 71,665
Accrued expenses and other liabilities 9,387 5,166
Deferred taxes 2,847 -
Advance payments by borrowers
for taxes and insurance 77,334 661
------------------------------------------
Total liabilities 691,689 472,814
Stockholders' equity:
Preferred stock, no par value per share:
5,000 shares authorized; no shares issued
Common stock, $.01 par value per share:
20,000 shares authorized; 7,575 and
8,528 shares outstanding, respectively 76 85
Additional paid-in capital 58,681 65,726
Stock acquired by ESOP (4,089) (4,534)
Deferred compensation (843) (1,388)
Accumulated other comprehensive income,
net of tax of $83 and $25, respectively 162 (50)
Retained earnings 39,723 47,045
------------------------------------------
Total stockholders' equity 93,710 106,884
------------------------------------------
Total liabilities and stockholders' equity $785,399 $579,698
------------------------------------------
</TABLE>
See accompanying notes.
17
<PAGE>
<TABLE>
<CAPTION>
First Defiance Financial Corp.
Consolidated Statements of Income
- --------------------------------------------------------------------------------------------------
Years ended December 31
1998 1997 1996
-------------------------------------------------
Interest income: (In thousands, except per share amounts)
<S> <C> <C> <C>
Loans $43,369 $37,302 $34,635
Investment securities 5,082 6,458 6,430
Other 605 98 192
-------------------------------------------------
Total interest income 49,056 43,858 41,257
Interest expense:
Deposits 18,340 17,992 18,579
Federal Home Loan Bank advances
and other 4,171 3,395 880
Notes payable 4,435 - -
-------------------------------------------------
Total interest expense 26,946 21,387 19,459
-------------------------------------------------
Net interest income 22,110 22,471 21,798
Provision for loan losses 7,769 1,613 1,020
-------------------------------------------------
Net interest income after
provision for loan losses 14,341 20,858 20,778
Non-interest income:
Mortgage banking income 12,071 84 14
Service fees and other charges 1,314 952 810
Gain on sale of loans 3,405 116 209
Federal Home Loan Bank stock dividends 334 242 207
Net gain on sale of available-for-sale securities - 103 26
Other 404 130 62
-------------------------------------------------
17,528 1,627 1,328
<PAGE>
Years ended December 31
1998 1997 1996
-------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C>
Non-interest expense:
Compensation and benefits 10,985 7,905 6,900
Occupancy 2,394 1,241 645
Deposit insurance premiums 243 194 3,333
Franchise tax 1,273 1,101 1,721
Data processing 981 780 721
Mobile home loan servicing 339 457 433
Mortgage servicing rights amortization 5,385 17 2
Goodwill and other intangibles ammortization 1,068 - -
Other 4,272 2,398 2,203
-------------------------------------------------
26,940 14,093 15,958
-------------------------------------------------
Income before income taxes 4,929 8,392 6,148
Income taxes 1,818 2,985 1,997
-------------------------------------------------
Net income $ 3,111 $ 5,407 $ 4,151
-------------------------------------------------
Earnings per share:
Basic $ .42 $ .65 $ .43
-------------------------------------------------
Diluted $ .40 $ .62 $ .42
-------------------------------------------------
Dividends declared per share $ .37 $ .33 $ .29
-------------------------------------------------
</TABLE>
See accompanying notes.
18
<PAGE>
First Defiance Financial Corp.
Consolidated Statements of Stockholders' Equity
For the years ended December 31, 1998, 1997 and 1996
(In thousands)
<TABLE>
<CAPTION>
Stock Acquired By Net Unrealized
----------------- Gains
Common Stock Additional Management (Losses) on Total
------------------ Paid-In Recognition Available-For- Retained Stockholders'
Shares Amount Capital ESOP Plan Sale Securities Earnings Equity
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 10,977 $110 $83,458 $(5,702) $ (97) $(152) $55,890 $ 133,507
Comprehensive income:
Net income 4,151 4,151
Change in net unrealized losses,
net of income taxes of $125 (245) (245)
---------------
Total comprehensive income 3,906
ESOP shares released 133 609 742
Amortization of deferred compensation of 742 742
Management Recognition Plan
Shares issued under stock option plan 13 60 60
Acquisition of common stock for
Management Recognition Plan (2,818) (2,818)
Acquisition of common stock (1,519) (15) (9,980) (6,819) (16,814)
for treasury
Dividends declared (2,760) (2,760)
--------------------------------------------------------------------------------------------
Balance at December 31, 1996 9,471 95 73,671 (5,093) (2,173) (397) 50,462 116,565
Comprehensive income:
Net Income 5,407 5,407
Change in net unrealized gains, net of
income taxes of $178 347 347
---------------
Total comprehensive income 5,754
ESOP shares released 288 559 847
Amortization of deferred compensation of
Management Recognition Plan 113 785 898
Shares issued under stock option plan 23 160 160
Acquisition of common stock (966) (10) (8,506) (6,031) (14,547)
for treasury
Dividends declared (2,793) (2,793)
--------------------------------------------------------------------------------------------
Balance at December 31, 1997 8,528 85 65,726 (4,534) (1,388) (50) 47,045 106,884
<PAGE>
Stock Acquired By Net Unrealized
----------------- Gains
Common Stock Additional Management (Losses) on Total
------------------ Paid-In Recognition Available-For- Retained Stockholders'
Shares Amount Capital ESOP Plan Sale Securities Earnings Equity
--------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Comprehensive income:
Net income 3,111 3,111
Change in net unrealized gains, net of
income taxes of $108 212 212
---------------
Total comprehensive income 3,323
ESOP shares released 331 445 776
Amortization of deferred compensation of
Management Recognition Plan 292 545 837
Shares issued in acquisition 146 2 2,090 2,092
Shares issued under stock option plan 96 1 641 642
Acquisition of common stock (1,195) (12) (10,399) (7,662) (18,073)
for treasury
Dividends declared (2,771) (2,771)
--------------------------------------------------------------------------------------------
Balance at December 31, 1998 7,575 $ 76 $58,681 $(4,089) $(843) $162 $39,723 $93,710
--------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
19
<PAGE>
First Defiance Financial Corp.
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996
-------------------------------------------------
Operating activities (In Thousands)
- ----------------------------------------------------
<S> <C> <C> <C>
Net income $ 3,111 $ 5,407 $ 4,151
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 7,769 1,613 1,020
Provision for depreciation 1,278 736 257
Amortization of deferred compensation
expense 545 785 743
Amortization of mortgage servicing rights 5,385 17 2
Amortization of goodwill 282 - -
Release of ESOP shares 776 847 742
(Gain) loss on sale of office properties
and equipment (2) (3) 45
Net securities gains - (103) (26)
Gain on sale of loans (3,405) (116) (209)
Net securities amortization 73 41 10
Deferred federal income tax credit (1,785) (43) (203)
Decrease (increase) in interest receivable and
other assets 29 (513) (127)
Proceeds from sale of loans 677,925 8,358 13,541
Servicing rights on loans sold with
servicing retained (12,428) (84) (123)
Originations of loans held for sale (623,241) (7,771) (10,132)
Net repurchase of loans held for sale (3,143) - -
(Decrease) increase in accrued interest
and other expenses (1,597) 2,414 90
-------------------------------------------------
Net cash provided by operating activities 51,572 11,585 9,781
Investing activities
- ----------------------------------------------------
Proceeds from maturities of
available-for-sale securities 56,155 13,231 19,614
Proceeds from sale of available-for-sale securities - 22,220 27,247
Purchases of available-for-sale securities (20,967) (39,838) (36,748)
Proceeds from maturities of
held-to-maturity securities 7,354 4,929 5,302
Proceeds from sale of real estate, mobile
homes and other assets held for sale 1,805 1,519 1,336
Proceeds from sale of office properties
and equipment and investment properties 19 3 2
Purchase of mortgage servicing rights (3,417) - -
Acquisition of The Leader Mortgage Co.,
net of cash received (30,142) - -
Acquisition of The Insurance Center of Defiance,
net of cash received (45) - -
Purchases of Federal Home Loan Bank stock (7,062) (731) (203)
Purchases of premises and equipment (2,595) (5,280) (6,273)
Net increase in mortgage and other loans (53,171) (29,864) (36,372)
-------------------------------------------------
Net cash used in investing activities (52,066) (33,811) (26,095)
</TABLE>
20
<PAGE>
First Defiance Financial Corp.
Consolidated Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996
-------------------------------------------------
(In Thousands)
Financing activities
- ----------------------------------------------------
<S> <C> <C> <C>
Net increase in deposits and advance payments
by borrowers for taxes and insurance 115,329 12,797 746
Net increase in Federal Home Loan
Bank short-term advances 2,510 31,804 35,220
Proceeds from Federal Home Loan Bank
long-term advances 95,000 - -
Repayment of Federal Home Loan Bank
long-term advances (1,033) (960) (1,242)
Repayment of long term notes (54,101) - -
Decrease in mortgage warehouse loans (125,490) - -
Purchase of common stock for treasury (18,073) (14,547) (16,815)
Contribution to Management Recognition
Plan for purchase of common stock - - (2,817)
Cash dividends paid (2,781) (2,783) (2,771)
Proceeds from exercise of stock options 642 160 60
-------------------------------------------------
Net cash provided by financing activities 12,003 26,471 12,381
-------------------------------------------------
Increase (decrease) in cash and cash equivalents 11,509 4,245 (3,933)
Cash and cash equivalents at beginning of period 8,997 4,752 8,685
-------------------------------------------------
Cash and cash equivalents at end of period $20,506 $ 8,997 $4,752
-------------------------------------------------
Supplemental cash flow information
- ----------------------------------------------------
Interest paid $28,041 $20,194 $19,652
-------------------------------------------------
Income taxes paid $ 2,567 $ 2,739 $ 2,364
-------------------------------------------------
Transfers from loans to real estate, mobile homes
and other assets held for sale $ 2,109 $ 1,793 $ 1,430
-------------------------------------------------
Noncash operating activities
- ----------------------------------------------------
Change in deferred taxes on net unrealized
gains or losses on available-for-sale securities $ 108 $ 178 $ (125)
-------------------------------------------------
Noncash investing activities
- ----------------------------------------------------
Change in net unrealized gain (loss) on
available-for-sale securities $ 320 $ 525 $ (370)
-------------------------------------------------
Acquisition of The Insurance Center of Defiance
for stock $ 2,092 $ - $ -
-------------------------------------------------
Noncash financing activities
- ----------------------------------------------------
Cash dividends declared but not paid $ 710 $ 720 $ 758
-------------------------------------------------
</TABLE>
See accompanying notes.
21
<PAGE>
First Defiance Financial Corp.
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
December 31, 1998
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
Savings and Loan, Defiance Ohio ("First Federal") and The Insurance Center of
Defiance ("Insurance Center") 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 six counties in which its offices are
located and in contiguous Putnam County. First Federal's traditional banking
activities include originating and servicing residential, commercial and
consumer loans and providing a broad range of depository 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 under various
Government National Mortgage Association ("GNMA") bonds.
The Insurance Center is an insurance agency that does business in the Defiance,
Ohio area under the name of the Stauffer- Mendenhall Agency. The
Stauffer-Mendenhall Agency offers property and casualty and life insurance
products.
2. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. 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. Basic earnings per share excludes 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 $488,000 and $75,000, respectively, at
December 31, 1998.
<PAGE>
Investment Securities
Management determines the appropriate classification of debt securities at the
time of purchase and evaluates such designation as of each balance sheet date.
Debt securities are classified as held-to-maturity when First Defiance has the
positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest
income using the interest method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported in a
separate component of stockholders' equity until realized.
Realized gains and losses, and 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 on-balance sheet derivative securities as
part of the overall asset and liability management process. Such derivative
securities are disclosed in Note 3 and include agency step-up, REMIC and CMO
investments. Such investments are not classified as high risk at December 31,
1998 and do not present risk significantly different than other mortgage-backed
or agency securities. First Defiance does not invest in off-balance sheet
derivative 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 at least 1% of its net home
mortgage loans, 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
carried at the lower of cost or estimated fair value in the aggregate.
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
22
<PAGE>
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.
Management's determination of the adequacy of the allowance for loan losses is
based on an evaluation of the portfolio, past loan loss experience, current
economic conditions, volume, growth and composition of the loan portfolio, and
other relevant factors. The allowance is increased by provisions for loan losses
charged against earnings and decreased by charge-offs (net of recoveries).
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 cost of an individual mortgage servicing
rights stratum over its fair value, and is recognized through a valuation
allowance.
Fair values for individual stratum are based on the present value of estimated
future cash flows using a discount rate (9.2%) commensurate with the risks
involved. Estimates of fair value include assumptions about prepayment (170%
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, Mobile Homes 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 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.
<PAGE>
Income Taxes
Deferred income taxes reflect the temporary tax consequences on future years of
differences between the tax bases and financial statement amounts of assets and
liabilities at each year-end.
Deferred tax assets and liabilities are reflected at currently enacted income
tax rates applicable to the period in which the deferred tax assets or
liabilities are expected to be realized or settled. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes.
An effective tax rate of 34% 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 has been recorded as goodwill.
Goodwill relating to The Leader acquisition is being amortized over a
twenty-year period. Goodwill relating to the Insurance Center 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.
Reporting Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 130, Reporting Comprehensive
Income. This statement establishes standards for reporting the components of
comprehensive income and requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
included in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income includes net income as well as
certain items that are reported directly within a separate component of
stockholders' equity and bypass net income. First Defiance adopted the
provisions of this statement in 1998. These disclosure requirements had no
impact on financial position or results of operations.
Disclosures about Segments of an Enterprise and Related Information
In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information. The provisions of this statement require
disclosure of financial and descriptive information about an enterprise's
operating segments in annual and interim financial reports issued to
shareholders. This statement defines an operating segment as a component of an
enterprise that engages in business activities that generate revenue and incur
expense, whose operating results are reviewed by the chief operating decision
maker in the determination of resource allocation and performance, and for which
discrete financial information is available. The Company adopted the provisions
of this statement for 1998 annual reporting. These disclosure requirements had
no impact on financial position or results of operations.
23
<PAGE>
2. Statement of Accounting Policies (continued)
Accounting for Derivative Instruments and Hedging Activities
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. The provisions of this statement require
that derivative instruments 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 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 required to
be recognized in
The provisions of this statement become effective for quarterly and annual
reporting beginning January 1, 2000. Although the statement allows for early
adoption in any quarterly period after June 1998, First Defiance has no plans to
adopt the provisions of SFAS No. 133 prior to the effective date. The impact of
adopting the provisions of this statement on First Defiance's financial
position, results of operations and cash flow subsequent to the effective date
is not currently estimable and will depend on the financial position of the
Company and the nature and purpose of the derivative instruments in use by
management at that time.
Reclassifications
Certain reclassifications of 1997 and 1996 information have been made to conform
with the 1998 presentation.
3. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C>
Numerator for basic and diluted
eanings per share - net income $3,111 $ 5,407 $ 4,151
-------------------------------------------------
Denominator:
Denominator for basic earnings
per share - weighted-average shares 7,491 8,360 9,610
Effect of dilutive securities:
Employee stock options 223 252 137
Unvested Management Recognition
Plan stock 97 94 25
-------------------------------------------------
Dilutive potential common shares 320 346 162
-------------------------------------------------
Denominator for diluted earnings
per share - adjusted weighted-
average shares 7,811 8,706 9,772
-------------------------------------------------
Basic earnings per share $ .42 $ .65 $ .43
-------------------------------------------------
Diluted earnings per share $ .40 $ .62 $ .42
-------------------------------------------------
</TABLE>
24
<PAGE>
4. Investment Securities
The following is a summary of available for-sale and held-to-
maturity securities
<TABLE>
<CAPTION>
Gross Gross
December 31,1998 Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Available-for-Sale Securities
U. S. Treasury securities and
obligations of U. S. Government
corporations and agencies $ 7,021 $50 $ 8 $ 7,063
Commercial paper 5,961 5 - 5,966
Corporate bonds 11,073 124 1 11,196
Adjustable rate mortgage-backed
security mutual funds 8,981 - 247 8,734
REMIC 2,827 44 - 2,871
Collateralized mortgage obligations 6,194 266 22 6,438
Obligations of state and political
subdivisions 5,252 46 12 5,286
--------------------------------------------------------------
Totals $47,309 $535 $290 $47,554
--------------------------------------------------------------
Held-to-Maturity Securities
FHLMC certificates $ 5,258 $ 79 $ 27 $ 5,310
FNMA certificates 5,346 48 95 5,299
GNMA certificates 1,927 43 2 1,968
Obligations of states and
political subdivisions 1,010 166 - 1,176
--------------------------------------------------------------
Totals $13,541 $336 $ 124 $13,753
--------------------------------------------------------------
<PAGE>
December 31,1997 Amortized Unrealized Unrealized Fair
Available-for-Sale Securities Cost Gains Losses Value
--------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Available-for-Sale Securities
U. S. Treasury securities and
obligations of U. S. Government
corporations and agencies $58,851 $152 $ 152 $ 58,851
Corporate bonds 10,094 19 - 10,113
Adjustable rate mortgage-backed
security mutual funds 8,982 - 145 8,837
REMIC 2,963 24 17 2,970
Collateralized mortgage obligations 1,076 39 - 1,115
Obligations of state and political
subdivisions 545 5 - 550
--------------------------------------------------------------
Totals $ 82,511 $239 $ 314 $ 82,436
--------------------------------------------------------------
Held-to-Maturity Securities
FHLMC certificates $ 8,798 $197 $ 26 $ 8,969
FNMA certificates 8,310 95 119 8,286
GNMA certificates 2,607 97 1 2,703
Obligations of states and political
subdivisions 1,238 174 - 1,412
--------------------------------------------------------------
Totals $20,953 $563 $146 $ 21,370
--------------------------------------------------------------
</TABLE>
<PAGE>
The amortized cost and fair value of securities at December 31, 1998 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.
25
<PAGE>
<TABLE>
<CAPTION>
Available-for-Sale Held-to-Maturity
------------------------------------------------
Amortized Amortized
Cost Fair Value Cost Fair Value
------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Due in one year or less $17,421 $17,426 $ 112 $ 115
Due after one year through five years 8,558 8,677 1,891 1,943
Due after five years through ten years 10,669 10,770 700 789
Due after ten years 1,680 1,947 10,838 10,906
------------------------------------------------
38,328 38,820 13,541 13,753
Adjustable rate mortgage-backed security
mutual funds 8,981 8,734 - -
------------------------------------------------
Totals $47,309 $47,554 $13,541 $13,753
------------------------------------------------
</TABLE>
5. 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, 1998, First Defiance's outstanding commitments to fund
long-term mortgage loans amounted to approximately $14,136,000 which were
comprised of approximately 88% fixed rate and 12% adjustable rate loans with
rates ranging from 6.375% to 9.50%. First Defiance's commitment to sell long
term mortgage loans amounted to $22,000,000 as of December 31, 1998. First
Defiance's maximum exposure to credit loss for loan commitments (unfunded loans,
unused lines of credit and letters of credit) was $71,921,000 at December 31,
1998.
Unpaid balances of mortgage and installment loans with contractual payments
delinquent 90 days or more totaled $12,854,000 at December 31, 1998 and
$1,365,000 at December 31, 1997. 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 $427,000 at December 31, 1998 and
$537,000 at December 31, 1997 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 1998 and 1997 was $427,000 and $1.3 million,
respectively. The total allowance for loan losses related to these loans was
$277,000 and $327,000 at December 31, 1998 and 1997, respectively.
Loans having carrying values of $2.1 million and $1.8 million were transferred
to real estate, mobile homes and other assets held for sale in 1998 and 1997,
respectively.
<PAGE>
6. Loans Receivable
First Defiance is not committed to lend additional funds to debtors whose loans
have been modified.
<TABLE>
<CAPTION>
December 31
--------------------------------------
1998 1997
--------------------------------------
(In thousands)
<S> <C> <C>
Loans receivable consist of the following
at December 31:
Mortgage loans:
Secured by one-to-four-family residences $245,206 $255,340
Secured by other properties 27,454 26,526
Construction loans 8,258 10,148
Other mortgage loans 2,745 2,996
--------------------------------------
283,663 295,010
Other loans:
Automobile 75,166 69,131
Mobile home 3,117 25,424
Commercial 70,109 29,758
Home equity and improvement 18,168 16,940
Other 12,002 11,980
--------------------------------------
178,562 153,233
--------------------------------------
Total mortgage and other loans 462,225 448,243
Deduct:
Undisbursed loan funds 3,250 3,087
Net deferred loan origination fees and costs 612 646
Allowance for loan losses 9,789 2,686
--------------------------------------
Totals $448,574 $441,824
--------------------------------------
</TABLE>
26
<PAGE>
Changes in the allowance for mortgage and
other loans losses were as follows:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Balance at beginning of year $ 2,686 $ 2,217 $ 1,817
Charge-offs (2,080) (1,341) (775)
Recoveries 220 197 155
------------------------------------------------
Net charge-offs (1,860) (1,144) (620)
Acquired allowance of The Leader 1,194 - -
Provision charged to income 7,769 1,613 1,020
------------------------------------------------
Balance at end of year $ 9,789 $ 2,686 $ 2,217
------------------------------------------------
</TABLE>
Interest income on mortgage and other
loans is as follows
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Mortgage loans $ 28,695 $23,259 $ 22,272
Other loans 14,674 14,043 12,363
------------------------------------------------
Totals $ 43,369 $37,302 $ 34,635
------------------------------------------------
</TABLE>
<PAGE>
7. Mortgage Banking
The activity in Mortgage Servicing
Rights ("MSRs") summarized as follows:
<TABLE>
Year ended December 31
------------------------------------------------
1998 1997 1996
(In thousands)
<S> <C> <C> <C>
Balance at beginning of period $ 188 $121 $ -
Acquired in purchase of The Leader 65,804 - -
Loans sold, servicing retained 12,428 84 123
Purchased 3,417 - -
Amortization (5,385) (17) (2)
------------------------------------------------
Balance at end of period $76,452 $188 $121
------------------------------------------------
Accumulated amortization of MSRs aggregates approximately $5.4 million, $19,000
and $2,000 at December 31, 1998, 1997 and 1996, respectively.
At December 31, 1998, the estimated fair value of the servicing rights was $98.9
million, as determined using a mortgage servicing rights valuation model.
The Company's servicing portfolio (excluding subserviced loans) is comprised of
the following:
December 31
1998 1997
------------------------------------------------
Number of Principal Number of Principal
Loans Outstanding Loans Outstanding
------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
GNMA 57,204 $3,375,844
FNMA 11,058 684,107
FHLMC 2,273 82,500 281 $17,844
Other VA, FHA, and conventional loans 12,235 713,418 - -
------------------------------------------------
Totals 82,770 $4,855,869 281 $17,844
------------------------------------------------
</TABLE>
27
<PAGE>
7. Mortgage Banking (continued)
The components of mortgage banking income, net of amortization are as
follows:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Loan servicing fee income $10,697 $ 84 $ 14
Late charges 1,374 - -
------------------------------------------------
Total mortgage banking income 12,071 84 14
Gain on sale of loans 3,405 116 209
Amortization of mortgage servicing rights (5,385) (17) (2)
-----------------------------------------------
Totals $10,091 $183 $221
------------------------------------------------
</TABLE>
8. Premises and Equipment
Premises and equipment are sumaarized as Follows:
<TABLE>
<CAPTION>
December 31
1998 1997
------------------------------------------------
Cost: (In thousands)
<S> <C> <C>
Land $ 2,281 $ 1,890
Buildings 12,974 11,437
Leasehold improvements 276 236
Furniture, fixtures and equipment 7,493 5,580
Construction in process 408 1,174
------------------------------------------------
23,432 20,317
Less allowances for depreciation
and amortization 4,375 3,518
------------------------------------------------
$19,057 $16,799
------------------------------------------------
</TABLE>
Interest capitalized on construction projects amounted to approximately $11,600
and $83,500 for the years ended December 31, 1998 and 1997, respectively.
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, 1998.
<PAGE>
9. Deposits
The following schedule sets forth interest expense by type of savings deposit:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
------------------------------------------------
(In thousands)
<S> <C> <C> <C>
Checking and money market accounts $ 1,770 $ 1,400 $ 1,119
Savings accounts 1,096 1,625 2,036
Certificates 15,486 15,051 15,639
------------------------------------------------
18,352 18,076 18,794
Less interest capitalized (12) (84) (215)
------------------------------------------------
Totals $18,340 $17,992 $18,579
------------------------------------------------
</TABLE>
At December 31, 1998, accrued interest payable amounted to $725,000 which was
comprised of $645,000, $78,000 and $2,000 for certificates, checking and money
market accounts, and savings accounts, respectively.
28
<PAGE>
A summary of deposit balances is as follows:
<TABLE>
<CAPTION>
December 31
1998 1997
------------------------------------------------
(In thousands)
<S> <C> <C>
Savings accounts $ 54,624 $ 59,404
Checking accounts 53,778 32,414
Money Market demand accounts 33,914 24,926
Certificates of deposit 291,663 278,578
------------------------------------------------
$ 433,979 $395,322
------------------------------------------------
</TABLE>
A summary of deposit balances is as follows:
<TABLE>
<CAPTION>
December 31, 1998
----------------------
(In thousands)
<S> <C>
1999 $219,160
2000 60,991
2001 6,016
2002 450
2003 3,423
2004 and thereafter 1,623
----------------------
Total $291,663
----------------------
</TABLE>
At December 31, 1998 and 1997 deposits of $63.7 and $33.0 million, respectively,
were in excess of the $100,000 Federal Deposit Insurance Corporation limit. At
December 31, 1998 and 1997, $7.7 and $1.0 million, respectively, in investment
securities were pledged as collateral against public deposits for certificates
in excess of $100,000.
The Deposit Insurance Funds Act of 1996 provided for a special assessment to be
calculated for depository institutions with deposits insured by the Savings
Association Insurance Fund ("SAIF"). The SAIF assessment of $2,460,977 was
assessed and recorded in 1996.
10. 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, 1998, the total available for collateral
amounted to approximately $320.9 million. Collateral must exceed borrowings by
150%. The total level of borrowing is also limited to 25% of total assets. First
Federal has a maximum potential to acquire advances of approximately $214.0
million from the FHLB.
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. Additionally, as of December 31, 1998 there were $95.0 million
outstanding under various long-term FHLB advance programs.
Under one such program, $25.0 million was outstanding with a ten-year maturity
and is callable at the option of the FHLB after one year and on each quarter
thereafter. Under a second long-term advance program, First Defiance has $10.0
million outstanding for a ten-year term, callable at the option of the FHLB on
the advance's five-year anniversary. Under a third program, First Defiance has
$25.0 million outstanding for a five-year term, callable at the option of the
FHLB on the two-year anniversary. The remaining $35.0 million of long-term
advances has a two year term and no call provisions. The total FHLB long-term
advances bear a weighted average interest rate of 4.93% at December 31, 1998.
<PAGE>
Future minimum payments by fiscal year are as follows:
<TABLE>
<CAPTION>
(In thousands)
<S> <C>
1999 $ 5,471
2000 40,141
2001 3,812
2002 3,239
2003 28,005
Thereafter 44,810
----------------------
Total Minimum Payments 125,478
Less amounts representing interest 26,981
----------------------
Totals $ 98,497
----------------------
</TABLE>
29
<PAGE>
10. Advances from Federal Home Loan Bank (continued)
First Defiance also utilizes short-term advances from the FHLB to meet cash flow
needs and for short-term investment purposes. There were $69.6 million in
short-term advances outstanding at December 31, 1998 ($67.2 million at December
31, 1997). First Defiance borrows short-term advances under a variety of
programs at FHLB. At December 31, 1998, $68.0 million was outstanding under
First Defiance's REPO Advance line of credit. The total available under the REPO
line is $150.0 million. Amounts are generally borrowed under the REPO line on an
overnight basis. The $1.6 million of other advances are borrowed under the
FHLB's short-term fixed or LIBOR based programs. Information concerning
short-term advances is summarized as follows:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997
---------------------------------
(In thousand, except percentages)
<S> <C> <C>
Average balance during the year $49,462 $53,039
Maximum month-end balance during the year 69,645 70,135
Average interest rate during the year 5.43% 5.77%
</TABLE>
11. 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.
The plan is not currently funded. The following table summarizes benefit
obligation and plan asset activity for the plan:
<PAGE>
<TABLE>
<CAPTION>
December 31
1998 1997
---------------------------------
(In thousands)
<S> <C> <C>
Change in fair value of plan assets:
Balance at beginning of measurement period $ - $ -
Employer contribution 35 38
Participant contribution 3 2
Benefits paid (38) (40)
---------------------------------
Balance at end of measurement period - -
Change in benefit obligation:
Balance at beginning of measurement period 787 691
Service cost 40 50
Interest costs 55 51
Participant contribution (3) (2)
Actuarial losses 11 37
Benefits paid (38) (40)
---------------------------------
Balance at end of measurement period 852 787
---------------------------------
Funded status 852 787
Unrecognized prior service cost (55) (59)
Unrecognized net gain 17 20
---------------------------------
Accrued postretirement benefit obligation included in accrued interest
and other expenses in consolidated statement of financial condition $814 $748
---------------------------------
</TABLE>
30
<PAGE>
Net periodic postretirement benefit cost includes the
following componets:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
-----------------------------------
(In thousands)
<S> <C> <C> <C>
Service cost-benefits attributable to service during
the period $ 40 $ 50 $44
Interest cost on accumulated postretirement benefit obligation 55 51 47
Net amortization and deferral 11 37 -
-----------------------------------
Net periodic postretirement benefit cost $106 $138 $ 91
-----------------------------------
</TABLE>
For measurement purposes, 4.25%, 5.0% and 8.5% annual rates of increase in the
per capita cost of covered health care benefits were assumed for 1998, 1997 and
1996. 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, 1998 by $162,200 and the
aggregate of the service and interest cost for the year then ended by $23,000.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 6.5% for 1998 and 7.25% for 1997 and 1996.
12. 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.
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, 1998 and 1997, First Federal meets all capital adequacy
requirements to which it is subject.
<PAGE>
The most recent notification from the Office of Thrift Supervision categorized
First Federal as well capitalized under the regulatory framework. There are no
conditions or events since that notification that management believes have
changed First Federal's ranking.
The following schedule presents First Federal's regulatory capital ratios:
<TABLE>
<CAPTION>
Regulatory Capital Standards
-----------------------------------------------------
Actual Required
Amount Ratio Amount Ratio
-----------------------------------------------------
(In thousands, except percentages)
<S> <C> <C> <C> <C>
As of December 31, 1998:
Tangible Capital $ 52,265 6.80% $ 11,537 1.5%
Core Capital 52,265 6.80 30,766 4.0%
Risk-Based Capital 82,187 14.82 44,363 8.0%
As of December 31, 1997:
Tangible Capital $80,284 13.65% $ 8,821 1.5%
Core Capital 80,284 13.65 17,642 3.0
Risk-Based Capital 82,473 21.55 30,613 8.0
</TABLE>
13. Income Taxes
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996
-------------------------------------
(In thousands)
<S> <C> <C> <C>
Current:
Federal $ 3,584 $2,812 $2,200
State 19 216 -
Deferred (credit) (1,785) (43) (203)
-------------------------------------
$ 1,818 $2,985 $1,997
-------------------------------------
</TABLE>
31
<PAGE>
13. Income Taxes (continued)
The provision for income taxes differs form that
computed at the statutory corportate tax rate as follows:
<TABLE>
<CAPTION>
Years ended December 31
1998 1997 1996
-------------------------------------
(In thousands)
<S> <C> <C> <C>
Tax expense at statutory rate $1,676 $2,853 $2,090
Increases (decreases) in taxes from:
Goodwill amortization 96 - -
State income tax - net
of federal tax benefit 13 143 -
Tax exempt interest income (84) (36) (39)
Other 117 25 (54)
-------------------------------------
Totals $1,818 $2,985 $1,997
-------------------------------------
</TABLE>
<PAGE>
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:
<TABLE>
<CAPTION>
December 31
1998 1997
--------------------------------
(In thousands)
<S> <C> <C>
Deferred federal income tax assets:
Net unrealized losses on available-for-sale securities $ - $ 25
Allowance for loan losses 3,907 321
Pension costs - 131
Postretirement benefit costs 277 261
Deferred compensation and management
recognition plans 530 493
State income tax 29 73
Other 190 80
--------------------------------
Total deferred federal income tax assets 4,933 1,384
Deferred federal income tax liabilities:
Net unrealized gains on available-for-sale securities 83 -
Mortgage servicing rights 6,272 -
FHLB stock dividends 727 614
Deferred loan origination fees and costs (net) 333 222
Other 365 133
--------------------------------
Total deferred federal income tax liabilities 7,780 969
--------------------------------
Net deferred federal income tax (liability) asset $(2,847) $ 415
--------------------------------
</TABLE>
No valuation allowance was required at December 31, 1998 or 1997.
Retained earnings at December 31, 1998 include financial statement tax bad debt
reserves of $10.4 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
1996 and 1997 (which was met). At December 31, 1998, First Federal had $1.037
million 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.
<PAGE>
14. Employee Benefit Plans
Employees of First Federal are eligible to participate in the First Federal
Savings and Loan 401(k) Employee Savings Plan ("First Federal 401(k)")if they
meet certain age and service requirements. Under the First Federal 401(k), First
Federal matches 50% of the participants' contributions, to a maximum of 3% of
compensation. The First Federal 401(k) also provides for a discretionary First
Federal contribution in addition to the First Federal matching contribution. For
the year ended December 31, 1998, First Federal's matching contribution was
$92,400 and there was no discretionary company contribution. Prior to 1998,
32
<PAGE>
the First Federal 401(k) had been frozen, and there were no contributions to the
plan for either 1997 or 1996.
The Leader sponsors The Leader Mortgage Company Savings and Investment Plan and
Trust ("The Leader 401(k)"). All employees of The Leader who meet certain age
and eligibility requirements are eligible to participate. The Leader matches
employee contributions to The Leader 401(k) 100% up to federally proscribed
limits. Matching contributions to The Leader 401(k) from July 1, 1998 to
December 31, 1998 amounted to $123,900.
First Federal also has established an Employee Stock Ownership Plan ("ESOP")
covering all employees of First Federal Savings and Loan age 21 or older who
have at least one year of credited service. Contributions to the ESOP are made
by First Federal and are determined by First Federal'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, 1998 was
$4,678,332. 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 First Federal's contributions to the ESOP, dividends on unallocated shares
and earnings on ESOP assets.
As principal and interest payments on the loan are paid, shares are released
from collateral and committed for allocation to active employees, based on the
proportion of debt service paid in the year. Shares held by the ESOP which have
not been released for allocation are reported as stock acquired by the ESOP plan
in the statement of financial condition. As shares are released, First Federal
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 $579,000, $1,025,000 and $735,000
for 1998, 1997 and 1996, respectively. As of December 31, 1998, 401,852 ESOP
shares have been released for allocation of which 389,655 were allocated to
participants. The 461,744 unreleased shares have a fair value of $6.6 million at
December 31, 1998.
<PAGE>
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.
A total of 251,931 of the shares acquired in 1996 have been granted as of
December 31, 1998, not including 41,277 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 $545,177, $785,000 and $742,000 in
1998, 1997 and 1996 respectively.
First Federal had previously sponsored a defined benefit pension plan that
covered substantially all First Federal employees. During 1997, First Federal
amended the plan to eliminate all benefits for future service in connection with
a termination of the plan, which occurred in 1998. In conjunction with the
termination of the plan, all accumulated plan benefits became fully vested and
were distributed to participants in August, 1998.
Net periodic pension cost recognized for the years ended December 31, 1997 and
1996 included the following components:
<TABLE>
<CAPTION>
Year ended December 31
1997 1996
----------------------------------
(In thousands, except percentages)
<S> <C> <C>
Service cost--benefits earned during the period $354 $311
Interest cost on projected benefit obligation 291 244
Actual (return) loss on plan assets (6) 66
Net amortization and deferral 10 (54)
----------------------------------
Net periodic pension cost $649 $567
----------------------------------
Weighted average discount rate 6% 5.75%
Rate of increase in future compensation levels - 4%
Expected long-term rate of return on plan assets 5% 5.5%
</TABLE>
33
<PAGE>
15. Stock Option Plans
First Defiance has established incentive stock option plans for its directors
and its employees and has reserved 1,033,485 shares of common stock for issuance
under the plans. A total of 773,204 shares are reserved for employees and
260,281 shares are reserved for directors. As of December 31, 1998, 929,247
options (709,209 for employees and 220,038 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 321,785 options granted
under the 1993 plan that are currently exercisable while there are 607,462
options granted under the 1996 plan that vest at 20% per year beginning in 1997.
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 plan and on the earlier of the scheduled expiration
date or twelve months after the retirement date for the 1996 plan.
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.
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:
<TABLE>
<CAPTION>
December 31
1998 1997 1996
-------------------------------------------
<S> <C> <C> <C>
Risk free interest rate 5.92% 6.23% 6.62%
Dividend yield 2.70% 2.68% 2.66%
Volatility factors of expected market price of stock 0.282% 0.319% 0.341%
Weighted average expected life 8.15 years 7.5 years 7.35 years
Weighted average grant date fair value of
options granted $3.38 $2.83 $3.83
</TABLE>
<PAGE>
Based upon the above assumptions, pro forma net
income and earnings per share are as followes:
<TABLE>
<CAPTION>
December 31
1998 1997 1996
-------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C>
Pro forma net income $ 2,815 $ 5,015 $ 3,783
-------------------------------------------
Pro forma earnings per share:
Basic $.38 $.60 $.39
-------------------------------------------
Diluted $.36 $.58 $.39
-------------------------------------------
</TABLE>
The pro forma effects for 1998, 1997, and 1996 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.
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.
34
<PAGE>
The following table summarizes stock
option activity for 1998 and 1997:
<TABLE>
<CAPTION>
1998 1997
------------------------------------------------------------------------------
Range of Range of
Option Option Option Option
Shares Prices Shares Prices
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at January 1 870,140 $ 4.63 to $13.00 894,339 $ 4.63 to $10.6875
Granted 183,702 $12.25 to $15.50 75,961 $12.625 to $13.00
Exercised (95,933) $ 4.63 to $13.00 (23,325) $ 4.63 to $10.6875
Expired or canceled (28,662) $ 4.63 to $13.00 (76,835) $10.50
------------------------------------------------------------------------------
Outstanding at December 31 929,247 $ 4.63 to $15.50 870,140 $ 4.63 to $13.00
------------------------------------------------------------------------------
Exercisable to:
1998 18,009 $10.50
1999 30,581 $ 4.63 to $13.00 43,975 $ 4.63
2002 56,590 $ 4.63 60,450 $ 4.63
2003 124,214 $ 4.63 163,963 $ 4.63
2004 21,590 $ 6.95 21,590 $ 6.95
2006 445,104 $10.375 to $10.6875 486,192 $10.375 to $10.6875
2007 68,966 $10.625 to $13.00 75,961 $12.625 to $13.00
2008 182,202 $12.25 to $15.50
------------------------------------------------------------------------------
929,247 $ 4.63 to $15.50 870,140 $ 4.63 to $13.00
------------------------------------------------------------------------------
Available for future grant at
December 31 8,305 163,345
------------------------------------------------------------------------------
</TABLE>
16. Parent Company And Regulatory Restrictions
Dividends paid by the First Defiance subsidiaries are subject to various legal
and regulatory restrictions. In 1998, a subsidiary declared $20.0 million in
dividends to the parent company. The subsidiaries can initiate dividend payments
in 1999, without prior regulatory approval, of $18.9 million, plus an additional
amount equal to their net profits for 1999, as defined by statute, up to the
date of any such dividend declaration.
Condensed parent company financial statements, which include transactions with
subsidiaries, follow:
<PAGE>
<TABLE>
<CAPTION>
December 31
Statements of Financial Condition 1998 1997
----------------------------------
(In thousands)
<S> <C> <C>
Assets
Cash and cash equivalents $ 775 $ 671
Investment in subsidiaries 66,440 80,322
Subordinated debt receivable from
First Federal Savings and Loan 22,400 30,000
Loan receivable from First Federal Employee
Stock Ownership Plan 4,678 4,972
Other assets 103 205
----------------------------------
Total assets $ 94,396 $116,170
----------------------------------
Liabilities and Stockholders' Equity
Accrued liabilities $ 686 $ 9,286
Stockholders' equity 93,710 106,884
----------------------------------
Total liabilities and stockholders' equity $ 94,396 $116,170
----------------------------------
</TABLE>
35
<PAGE>
16. Parent Company And Regulatory Restrictions (continued)
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
---------------------------------------------
(In thousands)
<S> <C> <C> <C>
Statements of Income
Interest income $ - $ 191 $ 955
Interest on subordinated debt 1,063 2,475 -
Interest on loan to ESOP 419 454 499
Gain on sale of investments - 59 26
Noninterest expense (350) (290) (583)
---------------------------------------------
Income before income taxes and equity
in earnings of subsidiaries 1,132 2,889 897
Income tax expense 399 1,124 363
---------------------------------------------
Income before equity in earnings of subsidiaries 733 1,765 534
Equity in earnings of subsidiaries 2,378 3,642 3,617
---------------------------------------------
Net income $3,111 $5,407 $4,151
---------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Year ended December 31
1998 1997 1996
---------------------------------------------
(In thousands)
<S> <C> <C> <C>
Statements of Cash Flows
Operating activities
Net income $ 3,111 $ 5,407 $ 4,151
Adjustments to reconcile net income
to net cash provided by operating activities:
Gain on sale of securities - (58) (26)
Deferred federal income taxes (credit) (86) 10 (37)
Equity in earnings of subsidiaries (2,378) (3,642) (3,617)
Dividends received from subsidiary 20,000 - 30,000
Change in other assets and liabilities (8,175) 8,374 74
---------------------------------------------
Net cash provided by operating activities 12,472 10,091 30,545
Investing activities
Loan to subsidiary (20,000) - (30,000)
Proceeds from sale of
available-for-sale securities - 7,052 27,247
Principal payments received for
subordinated debt 27,600 - -
Purchase Insurance Center of Defiance (50) - -
Principal payments received on ESOP loan 294 466 459
Purchase of available-for-sale securities - (112) (8,602)
---------------------------------------------
Net cash provided by (used in) investing activities 7,844 7,406 (10,896)
Financing activities
Stock options exercised 642 160 60
Purchase of common stock for treasury (18,073) (14,547) (16,815)
Cash dividends paid (2,781) (2,783) (2,771)
---------------------------------------------
Net cash used in financing activities (20,212) (17,170) (19,526)
---------------------------------------------
Net increase in cash and cash equivalents 104 327 123
Cash and cash equivalents at beginning of year 671 344 221
---------------------------------------------
Cash and cash equivalents at end of year $ 775 $ 671 $ 344
---------------------------------------------
Noncash financing activities - cash
dividends declared but not paid $ 710 $ 720 $ 758
---------------------------------------------
</TABLE>
36
<PAGE>
17. 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, 1998 and 1997. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instrument. 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.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
------------------------------------------------------------------
Carrying Estimated Carrying Estimated
Value Fair Values Value Fair Values
------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Assets
Cash and cash equivalents $ 20,506 $ 20,506 $ 8,997 $ 8,997
Investment securities 61,095 61,307 103,389 103,806
Loans, net 568,484 573,396 441,911 443,232
------------------------------------------------------------------
650,085 $655,209 554,297 $556,035
Other assets 135,314 -------- 25,401 --------
-------- --------
Total assets $785,399 $579,698
-------- --------
Liabilities and
stockholders' equity
Deposits $433,979 $434,199 $395,322 $395,451
Advances from Federal Home
Loan Bank 168,142 168,143 71,665 71,665
Advance payments by borrowers
for taxes and insurance 77,334 77,334 661 661
------------------------------------------------------------------
679,455 $679,676 467,648 $467,777
Other liabilities 12,234 -------- 5,165 --------
-------- --------
691,689 472,813
Stockholders' equity 93,710 106,885
-------- --------
Total liabilities and
stockholders' equity $785,399 $579,698
-------- --------
</TABLE>
<PAGE>
18. Acquisitions
On July 1, 1998, First Federal completed the acquisition of The Leader, in a
cash transaction. At the date of acquisition, The Leader had assets of $197.3
million and equity of $14.0 million. The cash price of $34.9 million, including
$2 million held in escrow for indemnifiable claims, exceeded the fair value of
net assets acquired by approximately $11.3 million, which was recorded as
goodwill.
On December 24, 1998, First Defiance completed the acquisition of the Insurance
Center in a stock transaction valued at $2.1 million. The acquisition has been
accounted for as a purchase. First Defiance could be subject to additional
contingent consideration of up to $400,000 if certain earnings criteria are met.
Unaudited pro forma revenues, net income, basic and diluted earnings per share
for the years ended December 31, 1998 and 1997 had the purchase business
combinations been completed on January 1, 1997 were as follows:
<TABLE>
<CAPTION>
Year ended December 31
1998 1997
----------------------------------------
(In thousands, except per share amounts)
<S> <C> <C>
Revenues $85,386 $79,937
Net income $ 3,449 $ 4,075
Basic net income per share $ .46 $ .49
Diluted net income per share $ .44 $ .47
</TABLE>
37
<PAGE>
The Company expects to achieve operating cost savings primarily through the
utilization of lower cost sources of funding, the use of The Leader's custodial
escrow balances to reduce First Federal's cost of funds, consolidation of back
office functions, and the elimination of redundant expenses. The operating cost
savings are expected to be achieved in various amounts at various times during
the years subsequent to the acquisition of The Leader and the Insurance Center
and not ratably over, or at the beginning or end of, such periods. No adjustment
has been reflected in the pro forma disclosures to reflect these anticipated
cost savings. Net assets acquired in the acquisitions are as follows:
(In thousands)
Assets:
Loans held for sale $116,672
Mortgage servicing rights 65,804
Loans receivable 14,800
Goodwill 13,615
Cash 4,431
Other assets 12,037
Liabilities assumed:
Warehouse and term notes 179,958
Other 10,691
---------
$36,710
---------
19. 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 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 2. 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.
<PAGE>
The parent unit is comprised of inter-segment income eliminations and
unallocated expenses. Selected segment information is included in the following
table for 1998 only, as this was the first year First Defiance had two distinct
segments.
<TABLE>
<CAPTION>
Retail Mortgage
Consolidated Parent Banking Banking
----------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Total interest income $ 49,056 $ (510) $ 44,688 $ 4,878
Total interest expense 26,946 (1,992) 24,685 4,253
----------------------------------------------------------------
Net interest income 22,110 1,482 20,003 625
Provision for loan losses 7,769 - 7,418 351
----------------------------------------------------------------
Net interest income after provision 14,341 1,482 12,585 274
Non-interest income (expense) 17,528 (144) 3,410 14,262
Non-interest expense 26,940 206 14,536 12,198
----------------------------------------------------------------
Income before income taxes 4,929 1,132 1,459 2,338
Income taxes 1,818 399 513 906
----------------------------------------------------------------
Net income $ 3,111 $ 733 $ 946 $ 1,432
----------------------------------------------------------------
Total assets $ 785,399 $ (231,950) $ 785,282 $ 232,067
----------------------------------------------------------------
</TABLE>
38
<PAGE>
20. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly
consolidated results of operations:
<TABLE>
<CAPTION>
Three months ended
1998 March 31 June 30 September 30 December 31
--------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $11,342 $11,322 $12,976 $ 13,416
Interest expense 5,527 5,589 7,985 7,845
--------------------------------------------------------------
Net interest income 5,815 5,733 4,991 5,571
Provision for loan losses 448 239 1,039 6,043
--------------------------------------------------------------
Net interest income (loss) after
provision for loan losses 5,367 5,494 3,952 (472)
Non-interest income 484 585 8,875 7,584
Non-interest expense 3,559 3,763 10,247 9,371
--------------------------------------------------------------
Income (loss) before income taxes 2,292 2,316 2,580 (2,259)
Income taxes (credit) 784 771 919 (656)
--------------------------------------------------------------
Net income (loss) $ 1,508 $ 1,545 $ 1,661 $ (1,603)
--------------------------------------------------------------
Earnings (loss) per share:
Basic $ .20 $ .21 $ .22 $ (.22)
--------------------------------------------------------------
Diluted $ .19 $ .20 $ .21 $ (.22)
--------------------------------------------------------------
Average shares outstanding:
Basic 7,606 7,464 7,513 7,370
--------------------------------------------------------------
Diluted 7,985 7,814 7,786 7,658
--------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Three months ended
1997 March 31 June 30 September 30 December 31
--------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Interest income $ 10,601 $ 10,754 $ 11,296 $11,207
Interest expense 4,966 5,184 5,589 5,648
--------------------------------------------------------------
Net interest income 5,635 5,570 5,707 5,559
Provision for loan losses 365 282 514 452
--------------------------------------------------------------
Net interest income after
provision for loan losses 5,270 5,288 5,193 5,107
Gain on sale of securities 7 6 63 27
Non-interest income 329 351 383 461
Non-interest expense 3,254 3,378 3,487 3,974
--------------------------------------------------------------
Income before income taxes 2,352 2,267 2,152 1,621
Income taxes 795 746 769 675
--------------------------------------------------------------
Net income $ 1,557 $ 1,521 $ 1,383 $ 946
--------------------------------------------------------------
Earnings per share:
Basic $ .18 $ .18 $ .17 $ .12
--------------------------------------------------------------
Diluted $ .17 $ .17 $ .16 $ .11
--------------------------------------------------------------
Average shares outstanding:
Basic 8,597 8,622 8,357 7,946
--------------------------------------------------------------
Diluted 8,911 8,937 8,724 8,334
--------------------------------------------------------------
</TABLE>
39
<PAGE>
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, 1998 and 1997, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 1998. 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.
<PAGE>
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the consolidated results of
it's operations and cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
---------------------
Ernst & Young LLP
Toledo, Ohio
January 21, 1999
Stock Information
First Defiance's Common Stock is traded on the NASDAQ Stock Market(R) under the
symbol "FDEF." The range of high and low sales prices and closing stock data for
First Defiance's Common Stock, along with information on declared cash dividends
is as follows:
<TABLE>
<CAPTION>
1998 1997
---------------------------------------------------------
High Low High Low
---------------------------------------------------------
<S> <C> <C> <C> <C>
Quarter Ended
March 31 $15.875 $14.625 $14.625 $11.75
June 30 15.875 14.00 14.75 12.375
September 30 14.625 11.50 16.00 14.25
December 31 15.00 11.00 16.25 14.75
<CAPTION>
Dividend Declared per
Share of Common Stock 1998 1997
---------------------------------------------------------
<S> <C> <C>
March $0.09 $0.08
June 0.09 0.08
September 0.09 0.08
December 0.10 0.09
---------------------------------------------------------
</TABLE>
<PAGE>
As of March 5, 1999 there were approximately 1,848 registered holders of Common
Stock.
Dividends are subject to determination and declaration by the Board of
Directors, which will take into account First Defiance's financial condition,
results of operations, tax considerations, industry standards, economic
conditions, and regulatory restrictions which affect the payment of dividends
and other factors. The Board of Directors of First Defiance has adopted, subject
to the considerations described above, a cash dividend policy at a rate of 40
cents per share, per annum, payable quarterly.
In addition to certain federal income tax considerations, regulations of the OTS
impose limitations on the payment of dividends and other capital distributions
by savings associations. Under such regulations, a savings association that,
immediately prior to, and on a pro forma basis after giving effect to, a
proposed capital distribution, has total capital (as defined by OTS regulation)
that is equal to or greater than the amount of its fully phased-in capital
requirement is generally permitted without OTS approval (but subsequent to 30
day notice to the OTS of the planned dividend) to make capital distributions
during a calendar year in the amount of up to 100% of its net earnings to date
during the year plus an amount equal to one-half of the amount by which its
total capital to assets ratio exceeded its fully phase-in capital to assets
ratio at the beginning of the year.
40
<PAGE>
Board of Directors
[Graphic -- photo
(top row left to right) depicting Board
Dr. Douglas A. Burgei of Directors]
P. Scott Carson
Thomas A. Voigt
William J. Small
(bottom row left to right)
Steven L. Boomer
Don C. Van Brackel
Gerald W. Monnin
Dr. John U. Fauster III
(not present)
Dr. Marvin J. Ludwig
Peter A. Diehl
William J. Small, 1, 3, 8
Chairman of the Board, President
and Chief Executive Officer
First Defiance Financial Corp.
Age 48, Director since 1998
Don C. Van Brackel, 1, 4, 5, 6, 8
Vice Chairman of the Board
First Defiance Financial Corp.
Age 60, Director since 1979
P. Scott Carson, 1, 3, 8
Executive Vice President, First Defiance
Financial Corp. and President and
Chief Executive Officer, First Federal
Savings and Loan
Age 55, Director since 1998
Stephen L. Boomer, 2, 6, 7
President, Arps Dairy, Defiance, Ohio
Age 48, Director since 1994
Douglas A. Burgei, D.V.M., 3, 5, 7
Veterinarian, Napoleon, Ohio
Age 44, Director since 1995
Peter A. Diehl, 2, 4, 7
President and Chief Executive Officer,
Diehl, Inc., Defiance, Ohio
Age 48, Director since 1998
John U. Fauster, III, D.D.S., 2, 5, 7
Dentist, Defiance, Ohio
Age 61, Director since 1975
Marvin J. Ludwig, PhD, 2, 4, 6, 8
President Emeritus, The Defiance College,
Defiance, Ohio
Age 72, Director since 1979
<PAGE>
Gerald W. Monnin, 4, 5, 6, 8
President and Chief Executive Officer,
Northwest Controls, Defiance, Ohio
Age 60, Director since 1997
Thomas A. Voigt, 4, 5, 6
Vice President, General Manager,
Bryan Publishing Company, Bryan, Ohio
Age 56, Director since 1995
1. Permanent member of Executive
Committee. Other directors serve on
Executive Committee on a rotating basis.
2. Audit Committee
3. Investment Committee
4. Compensation Committee
5. Long Range Planning Committee
6. MRP-Stock Option Committee
7. Governance Committee
8. The Leader Mortgage Board Committee
OFFICERS
FIRST DEFIANCE
FINANCIAL CORP.
William J. Small
Chairman, President and Chief Executive
Officer, Joined Company 1994
Don C. Van Brackel
Vice Chairman, Officer since 1992
P. Scott Carson
Executive Vice President, Joined
Company 1998
John C. Wahl
Executive Vice President and Chief
Financial Officer and Treasurer
Age 38, Joined Company 1994
FIRST FEDERAL
SAVINGS AND LOAN
William J. Small
Chairman and Chief Executive Officer
Don C. Van Brackel
Vice Chairman
P. Scott Carson
President and Chief Operating Officer
Gregory R. Allen
Executive Vice President,
Chief Lending Officer
Age 35, Joined Company 1998
<PAGE>
Mark D. Gazarek
Executive Vice President, Trust Services
Age 41, Joined Company 1998
Jeffrey D. Vereecke
Executive Vice President, Operations
Age 37, Joined Company 1984
John C. Wahl
Executive Vice President, Finance and
Chief Financial Officer
John W. Boesling
Senior Vice President and Secretary
Age 51, Joined Company 1971
Patricia A. Cooper
Senior Vice President, Operating Systems
Age 53, Joined Company 1964
THE LEADER
MORTGAGE COMPANY
William J. Small
Chairman
James L. Hook, CMB
President and Chief Executive Officer
Age 61, Joined Company 1968
Alvin A. Siegal, CMB
Chairman Emeritus
Age 76, Joined Company 1960
Lawrence A. Ball
Executive Vice President,
Chief Information Officer
Age 51, Joined Company 1971
Sheldon Brodsky
Executive Vice President,
Chief Financial Officer
Age 56, Joined Company 1987
Joel A. Brotman
Executive Vice President, Loan Production
Age 55, Joined Company 1998
L. Robert Gentile
Executive Vice President, Housing
Finance Production
Age 43, Joined Company 1984
Robert H. Thompson
Executive Vice President, Loan Administration
Age 57, Joined Company 1993
INSURANCE CENTER
OF DEFIANCE
Stephen P. Grosenbacher
President
Age 46, Joined Company 1975
<PAGE>
Lawrence H. Woods
Vice President
Age 42, Joined Company 1980
Timothy S. Whetstone
Secretary
Age 39, Joined Company 1994
<PAGE>
OTHER STOCKHOLDER INFORMATION
ADDITIONAL FINANCIAL INFORMATION
Additional copies of this annual report, First Defiance Financial Corp. Form
10-K, filed with the Securities and Exchange Commission, dividend reinvestment
plan information, et. al., are available without charge to interested
stockholders upon request to:
John C. Wahl
Executive Vice President,
Chief Financial Officer
First Defiance Financial Corp.
601 Clinton St.
Defiance, OH 43512-0248
ANNUAL MEETING
OF STOCKHOLDERS
The annual meeting of stockholders of First Defiance Financial Corp. will be
held on Tuesday, April 20, 1999, 1 p.m. EDT at the office of First Federal
Savings and Loan, 601 Clinton Street, Defiance, OH, 43512.
STOCKHOLDER ACCOUNT MAINTENANCE
Communications concerning the transfer of shares, lost certificates, dividends,
dividend reinvestment, receipt of multiple dividend checks, duplicate mailings
or change of address should be directed to:
Registrar and Transfer Company
First Defiance Financial Corp.
Transfer Agent
10 Commerce Drive
Cranford, NJ 07016-3572
Telephone: (800) 368-5948
DIVIDEND REINVESTMENT PLAN
Stockholders may automatically reinvest their dividends in additional First
Defiance Financial Corp. Common Stock through the Dividend Reinvestment Plan,
which also provides for purchase by voluntary cash contributions. For additional
information, please write or telephone Registrar and Transfer Company.
DIVIDEND POLICY
Cash dividends are declared quarterly and have been paid since First Defiance's
predecessor company went public in 1993. As of March 5, 1999, the annual
indicated dividend rate is $.40 per share.
INTERNET ADDRESS
First Defiance's home page on the World Wide Web is located at www.fdef.com.
Recent financial data, historical information, and links to the SEC EDGAR data
base are available at this site. Information about First Federal's products and
services are described at the First Federal website which is www.first-fed.com.
<PAGE>
STOCKHOLDERS
OF RECORD
As of March 5, 1999, there were 1,848 stockholders of record.
SECURITIES LISTED First Defiance Financial Corp's common stock trades on the
Nasdaq Stock Market(R) under the symbol FDEF
AUDITORS
Ernst & Young LLP
One Seagate
Toledo, Ohio
GENERAL COUNSEL
Vorys, Sater, Seymour and Pease
Suite 2100 Atrium Two
221 E. Fourth St.
Cincinnati, OH 45201
TRANSFER AGENT
AND REGISTRAR
Registrar and Transfer Company
Cranford, New Jersey
MAJOR MARKET MAKERS
Everen Securities
Tucker Anthony, Inc.
Sandler O'Neill & Partners
Friedman Billings Ramsey & Co.
Keefe, Bruyette & Woods, Inc.
Herzog, Heine, Geduld, Inc.
ABN AMRO Securities (USA) Inc.
601 Clinton St.
Defiance, OH 43512
www.fdef.com
NASDAQ SYMBOL: FDEF
Exhibit 21.1
List of Subsidiaries of First Defiance Financial Corp.
First Federal Savings and Loan
First Defiance Service Company
Insurance Center of Defiance
Exhibit 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of First Defiance Financial Corp. of our report dated January 21, 1999, included
in the 1998 Annual Report to Shareholders of First Defiance Financial Corp.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8) pertaining to the 1993 Stock Incentive Plan and the 1993 Directors'
Stock Option Plan of First Defiance Financial Corp. of our report dated January
21, 1999, with respect to the consolidated financial statements of First
Defiance Financial Corp. incorporated by reference in the Annual Report (Form
10-K) for the year ended December 31, 1998.
/s/Ernst & Young LLP
--------------------
Ernst & Young LLP
Toledo, Ohio
March 24, 1999
<TABLE> <S> <C>
<ARTICLE> 9
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 16,137
<INT-BEARING-DEPOSITS> 4,369
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 47,554
<INVESTMENTS-CARRYING> 13,541
<INVESTMENTS-MARKET> 13,753
<LOANS> 578,273
<ALLOWANCE> 9,789
<TOTAL-ASSETS> 785,399
<DEPOSITS> 433,979
<SHORT-TERM> 69,645
<LIABILITIES-OTHER> 89,568
<LONG-TERM> 98,497
0
0
<COMMON> 76
<OTHER-SE> 93,634
<TOTAL-LIABILITIES-AND-EQUITY> 785,399
<INTEREST-LOAN> 43,369
<INTEREST-INVEST> 5,082
<INTEREST-OTHER> 605
<INTEREST-TOTAL> 49,056
<INTEREST-DEPOSIT> 18,340
<INTEREST-EXPENSE> 26,946
<INTEREST-INCOME-NET> 22,110
<LOAN-LOSSES> 7,769
<SECURITIES-GAINS> 0
<EXPENSE-OTHER> 26,940
<INCOME-PRETAX> 4,929
<INCOME-PRE-EXTRAORDINARY> 3,111
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,111
<EPS-PRIMARY> 0.42
<EPS-DILUTED> 0.40
<YIELD-ACTUAL> 3.62
<LOANS-NON> 12,854
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 2,686
<CHARGE-OFFS> 2,080
<RECOVERIES> 220
<ALLOWANCE-CLOSE> 9,789
<ALLOWANCE-DOMESTIC> 9,789
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
