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| FDEF > SEC Filings for FDEF > Form 10-Q on 10-Aug-2009 | All Recent SEC Filings |
10-Aug-2009
Quarterly Report
General
First Defiance Financial Corp. ("First Defiance" or "the Company") is a unitary thrift holding company which conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance"). First Federal is a federally chartered savings bank that provides financial services through 35 full-service branches in communities based in northwest Ohio, northeast Indiana, and southeastern Michigan. On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc. ("Pavilion"), which added eight banking centers in southeast Michigan, expanding the Company's reach to markets adjacent to its existing branch network. First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust services. First Insurance sells a variety of property and casualty, group health and life, and individual health and life insurance products and investment and annuity products. Insurance products are sold through First Insurance's offices in Defiance and Bowling Green, Ohio while investment and annuity products are sold through registered investment representatives located at certain First Federal banking center locations.
First Defiance invests in U.S. Treasury and federal government agency obligations, obligations of municipal and other political subdivisions, mortgage-backed securities which are issued by federal agencies, corporate bonds, and collateralized mortgage obligations ("CMOs") and real estate mortgage investment conduits ("REMICs"). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities.
Securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the security to maturity. Held-to-maturity securities are stated at amortized cost and had a recorded value of $831,000 at June 30, 2009. Securities not classified as held-to-maturity are classified as available-for-sale, which are stated at fair value and had a recorded value of $133.0 million at June 30, 2009. The available-for-sale portfolio consists of obligations of U.S. Government corporations and agencies ($17.5 million), certain municipal obligations ($43.7 million), CMOs and REMICs ($35.4 million), mortgage backed securities ($34.1 million) and trust preferred stock ($2.3 million).
In accordance with FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income.
The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, Federal Home Loan Bank advances, and other borrowings. The Company's non-interest income is mainly derived from service fees and other charges, mortgage banking income, and insurance commissions. First Defiance's earnings also depend on the provision
for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense.
Participation in the U.S. Treasury Capital Purchase Program
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 ("EESA"), which creates the Troubled Asset Relief Program ("TARP") and provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. The Capital Purchase Program ("CPP") was announced by the U.S. Treasury on October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will purchase up to $250 billion of senior preferred shares on standardized terms from qualifying financial institutions. The purpose of the CPP is to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.
The CPP is voluntary and requires a participating institution to comply with a number of restrictions and provisions, including standards for executive compensation and corporate governance and limitations on share repurchases and the declaration and payment of dividends on common shares. The standard terms of the CPP require that a participating financial institution limit the payment of dividends to the most recent quarterly amount prior to October 14, 2008, which is $0.26 per share in the case of First Defiance. This dividend limitation will remain in effect until such time that the preferred shares are no longer outstanding.
Eligible financial institutions could generally apply to issue senior preferred shares to the U.S. Treasury in aggregate amounts between 1% to 3% of the institution's risk-weighted assets. In the case of First Defiance, an application was approved by the U.S. Treasury and on December 5, 2008, First Defiance issued $37.0 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share ("Senior Preferred Shares"). The Senior Preferred Shares constitute Tier 1 capital and rank senior to First Defiance's common shares. The Senior Preferred Shares pay cumulative dividends at a rate of 5% per annum for the first five years and will reset to a rate of 9% per annum after five years.
As part of its participation in the CPP, First Defiance also issued a warrant to the U.S. Treasury to purchase 550,595 common shares having an exercise price of $10.08 per share. The initial exercise price for the warrant and the market price for determining the number of common shares subject to the warrant was determined by reference to the market price of the common shares on the date of the investment by the U.S. treasury in the Senior Preferred Shares (calculated on a 20-day trailing average). The warrant has a term of 10 years.
Forward-Looking Information
Certain statements contained in this quarterly report are not historical facts, including but not limited to statements that can be identified by the use of forward-looking terminology such as "may", "will", "expect", "anticipate", or "continue" or the negative thereof or other variations thereon or comparable terminology are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21B of the Securities Act of 1934, as amended. Actual results could differ materially from those indicated in such statements due to risks, uncertainties and changes with respect to a variety of market and other factors.
Changes in Financial Condition
At June 30, 2009, First Defiance's total assets, deposits and stockholders' equity amounted to $2.02 billion, $1.55 billion and $232.7 million, respectively, compared to $1.96 billion, $1.47 billion and $229.2 million, respectively, at December 31, 2008.
Net loans receivable (excluding loans held for sale) decreased $8.0 million to $1.58 billion at June 30, 2009 compared to $1.59 billion at December 31, 2008. The decrease in loans receivable between December 31, 2008 and June 30, 2009 included decreases in one-to-four family residential real estate loans (down $13.8 million), home equity and improvement loans (down $10.0 million), construction loans (down $28.3 million), and consumer loans (down $2.9 million) while commercial loans increased $25.9 million and non-residential and multi-family loans increased $13.0 million.
The investment securities portfolio increased $15.4 million to $133.8 million at June 30, 2009 from $118.5 million at December 31, 2008. The increase is the result of $30.0 million of securities being purchased during the first six months of 2009 partially offset by $1.8 million of securities being matured or called in the period, principal pay downs of $8.4 million in CMOs and mortgage-backed securities, and $3.5 million of securities being sold. The unrealized loss in the investment portfolio decreased $143,000 to $1.5 million at June 30, 2009 from $1.7 million at December 31, 2008.
Deposits increased from $1.47 billion at December 31, 2008 to $1.55 billion as of June 30, 2009. Of the $83.2 million increase, interest-bearing demand deposits and money market accounts increased $81.7 million to $456.2 million, savings accounts increased $3.7 million to $135.8 million, non-interest bearing checking accounts increased $4.0 million to $180.0 million and broker/national certificates of deposit increased $8.6 million to $47.1 million. These increases were slightly offset by a decline in retail time deposits of $14.8 million to $734.0 million.
The FHLB advances decreased $9.1 million to $147.0 million at June 30, 2009 from $156.1 million at December 31, 2008. The decrease is attributable to a $9.1 million decrease in overnight advances due in large part from the growth in deposits.
Stockholders' equity increased from $229.2 million at December 31, 2008 to $232.7 million at June 30, 2009. The increase is primarily the result of recording net income of $6.3 million partially offset by $2.1 million of cash dividends declared on common stock and $930,000 of accrued dividends on preferred stock.
Average Balances, Net Interest Income and Yields Earned and Rates Paid
The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in thousands of dollars and rates, and the net interest margin. The table reports interest income from tax-exempt loans and investment on a tax-equivalent basis. All average balances are based upon daily balances.
Three Months Ended June 30,
2009 2008
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
Interest-earning assets:
Loans receivable $ 1,592,513 $ 23,116 5.82 % $ 1,544,409 $ 24,536 6.39 %
Securities 130,663 1,739 5.26 121,506 1,648 5.42
Interest-earning deposits 83,720 33 0.16 2,616 15 2.31
FHLB stock and other 21,376 229 4.30 20,867 254 4.90
Total interest-earning assets 1,828,272 25,117 5.50 1,689,398 26,453 6.29
Non-interest-earning assets 199,488 208,767
Total assets $ 2,027,760 $ 1,898,165
Interest-bearing liabilities:
Deposits $ 1,377,317 $ 6,859 2.00 % $ 1,252,165 $ 7,522 2.42 %
FHLB advances and other 146,951 1,279 3.49 164,811 1,545 3.77
Notes payable 43,122 136 1.27 53,724 468 3.50
Subordinated debentures 36,242 369 4.08 36,225 456 5.06
Total interest-bearing liabilities 1,603,632 8,643 2.16 1,506,925 9,991 2.67
Non-interest bearing deposits 175,216 - 171,101 -
Total including non-interest bearing
demand deposits 1,778,848 8,643 1.95 1,678,026 9,991 2.39
Other non-interest-bearing liabilities 17,515 24,294
Total liabilities 1,796,363 1,702,320
Stockholders' equity 231,397 195,845
Total liabilities and stock- holders'
equity $ 2,027,760 $ 1,898,165
Net interest income; interest rate
spread $ 16,474 3.34 % $ 16,462 3.62 %
Net interest margin (3) 3.61 % 3.91 %
Average interest-earning assets to
average interest-bearing liabilities 114 % 112 %
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(1) Interest on certain tax-exempt loans and securities is not taxable for Federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average interest-earning assets.
Six Months Ended June 30,
2009 2008
Average Yield/ Average Yield/
Balance Interest(1) Rate(2) Balance Interest(1) Rate(2)
Interest-earning assets:
Loans receivable $ 1,594,553 $ 46,521 5.88 % $ 1,435,438 $ 47,363 6.64 %
Securities 124,988 3,460 5.51 119,112 3,323 5.60
Interest-earning deposits 64,227 47 0.15 8,352 113 2.72
FHLB stock and other 21,376 468 4.42 19,738 497 5.06
Total interest-earning assets 1,805,144 50,496 5.61 1,582,640 51,296 6.52
Non-interest-earning assets 201,229 189,161
Total assets $ 2,006,373 $ 1,771,801
Interest-bearing liabilities:
Deposits $ 1,362,747 $ 14,042 2.08 % $ 1,181,938 $ 16,193 2.76 %
FHLB advances and other 147,021 2,598 3.56 155,666 3,200 4.13
Notes payable 41,327 293 1.43 39,841 662 3.34
Subordinated debentures 36,247 795 4.41 36,253 984 5.46
Total interest-bearing liabilities 1,587,342 17,728 2.25 1,413,698 21,039 2.99
Non-interest bearing deposits 170,548 - 147,872 -
Total including non-interest bearing
demand deposits 1,757,890 17,728 2.03 1,561,570 21,039 2.71
Other non-interest-bearing liabilities 17,735 26,462
Total liabilities 1,775,625 1,588,032
Stockholders' equity 230,748 183,769
Total liabilities and stock- holders'
equity $ 2,006,373 $ 1,771,801
Net interest income; interest rate
spread $ 32,768 3.36 % $ 30,257 3.53 %
Net interest margin (3) 3.66 % 3.84 %
Average interest-earning assets to
average interest-bearing liabilities 114 % 112 %
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(1) Interest on certain tax-exempt loans and securities is not taxable for Federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%.
(2) Annualized
(3) Net interest margin is net interest income divided by average interest-earning assets.
Results of Operations
Three Months Ended June 30, 2009 and 2008
On a consolidated basis, First Defiance's net income for the quarter ended June 30, 2009 was $2.90 million compared to income of $2.74 million for the comparable period in 2008. Net income applicable to common shares was $2.39 million for the second quarter of 2009. On a per share basis, basic and diluted earnings per common share for the three months ended June 30, 2009 were both $0.29, compared to basic and diluted earnings per common share of $0.34 for the quarter ended June 30, 2008.
Net Interest Income.
The Company'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. Net interest income is the Company's largest source of revenue, representing 65.9% of total revenue during the second quarter of 2009. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.
The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The federal funds rate, which is the cost of immediately overnight funds and established by the Federal Reserve Board's Open Market Committee, began 2008 at 4.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 0.25%. During the second quarter of 2009, the federal funds rate did not change ending the quarter at 0.25%. The federal funds rate drives the Company's prime rate, which is used to price a substantial balance of loans in the commercial and home equity portfolios. The prime interest rate began 2008 at 7.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 3.25%. During the second quarter of 2009, the prime interest rate did not change ending the quarter at 3.25%. First Defiance effectively managed the impact of the change in the prime rate by reducing its deposit rates and by changing the mix of its interest-bearing liabilities.
Net interest income was $16.2 million for the second quarter of 2009 compared to $16.2 million in the second quarter of 2008. For the second quarter of 2009, total interest income was $24.8 million, a $1.4 million decrease from the second quarter of 2008. The decline in total interest income is the result of the decline in loan yields from period to period.
Interest expense was $8.6 million for the second quarter of 2009 compared to $10.0 million in the second quarter of 2008. The majority of the decrease in interest expense occurred in interest-bearing deposits, where despite average balances increasing $125.2 million to $1.38 billion for the second quarter of 2009, the cost of that funding decreased 0.42% between the 2008 and 2009 second quarters, to 2.00% from 2.42%.
Net interest margin for the quarter ended June 30, 2009 was 3.61%, a 0.30% decline from the 2008 second quarter margin of 3.91%. The Company's interest rate spread declined as well to 3.34% in the 2009 second quarter compared to 3.62% in the same 2008 quarterly period. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. In this low rate environment, management's attention will be to focus on a disciplined pricing strategy to strengthen the net interest margin for the remainder of 2009.
Provision for Loan Losses.
The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's best estimate, is necessary to absorb probable credit losses within the existing loan portfolio. The provision for loan losses was $4.0 million in the second quarter of 2009 compared to $2.8 million for the second quarter of 2008. The period over period increase was primarily due to the deterioration of a number of large credits in the commercial portfolio as well as increases in reserves on loans with existing reserves based on declining collateral values. Charge-offs for the second quarter of 2009 were $3.9 million and recoveries of previously charged off loans totaled $86,000 for net charge-offs of $3.8 million. By comparison, $894,000 of charge-offs were recorded in the 2008 second quarter and $81,000 of recoveries were realized for net charge-offs of $813,000. As a percentage of average loans, annualized net charge-offs were 0.96% for the second quarter of 2009 compared to 0.21% in the same period in 2008.
Non-performing assets, which include non-accrual loans, accruing restructured loans and real estate owned, increased to $48.9 million at June 30, 2009 from $20.9 million at June 30, 2008 and from $41.3 million at December 31, 2008. Non-performing assets and asset quality ratios for First Defiance were as follows at June 30, 2009 and December 31, 2008:
June 30, December 31,
2009 2008
(in thousands)
Non-accrual loans $ 35,528 $ 28,017
Restructured loans, accruing 4,845 6,250
Total non-performing loans $ 40,373 $ 34,267
Real estate owned (REO) 8,567 7,000
Total non-performing assets $ 48,940 $ 41,267
Allowance for loans losses as a percentage of total
loans 1.60 % 1.52 %
Allowance for loan losses as a percentage of
non-performing assets 52.80 % 59.59 %
Allowance for loan losses as a percentage of
non-performing loans 64.00 % 71.77 %
Total non-performing assets as a percentage of total
assets 2.42 % 2.11 %
Total non-performing loans as a percentage of total
loans 2.47 % 2.10 %
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Of the $35.5 million in non-accrual loans, $5.5 million were 1-4 family residential loans, $29.3 million were commercial or commercial real estate loans and $0.7 million were home equity or consumer loans.
First Federal Bank's Asset Review Committee meets monthly to review the status of work-out strategies for all criticized relationships, which include all non-accrual loans. Based on such factors as anticipated collateral values in liquidation scenarios, cash flow projections, assessment of net worth of guarantors and all other factors which may mitigate risk of loss, the Asset Review Committee makes recommendations regarding required allowances and proposed charge-offs which are approved by the Senior Loan Committee (in the case of charge-offs) or the Loan Loss Reserve Committee (in the case of specific allowances). At June 30, 2009 the specific allowance for loan losses recorded against the $29.3 million of non-accrual commercial and commercial real estate loans totaled $6.1 million. In management's opinion, the allowance for loan losses is appropriate. The allowance for loan losses at June 30, 2009 was $25.8 million compared to $24.6 million at December 31, 2008.
Non-Interest Income.
Total non-interest income increased to $8.4 million in the second quarter of 2009, compared with $6.2 million in the same period in 2008.
Service Fees. Service fees and other charges decreased by $91,000 or 2.7% in the 2009 second quarter compared to the same period in 2008. The decrease can be attributed to customers retaining more cash reserves in their checking and saving accounts resulting in less NSF fees transactions.
First Defiance's overdraft privilege program generally provides for the automatic payment of modest overdraft limits on all accounts deemed to be in good standing when the account is accessed using paper-based check processing, a teller withdrawal, a point-of-sale terminal, an ACH transaction, or an ATM. To be in good standing, an account must be brought to a positive balance within a 30-day period. Overdraft limits are established for all customers without discrimination using a risk assessment approach for each account classification. The approach includes a systematic review and evaluation of the normal deposit flows made to each account classification to establish reasonable and prudent negative balance limits that would be routinely repaid by normal, expected and reoccurring deposits. The risk assessment by portfolio approach assumes a minimal degree of undetermined credit risk associated with unidentified individual accounts that are overdrawn for 30 or more days. Accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence and the fee charged for an item that is paid is equal to the fee charged for a non-sufficient fund item that is returned.
Overdrawn balances, net of allowance for losses, are reflected as loans on First Defiance's balance sheet. The fees charged for this service are established . . .
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