Annual Report
C om pan y Prof i l e
Safe Harbor Statement
Statements contained in this Annual Report may
First Defiance Financial Corp., headquartered in Defiance, Ohio, is the holding
company for First Federal Bank of the Midwest and First Insurance & Investments.
not be based on historical facts and are “forward-
First Federal Bank operates 36 full service branches and 47 ATMs in 15 counties in
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 vary materially
depending on risks and uncertainties inherent in
general and local banking and insurance conditions,
competitive factors specific to markets in which
the company and its subsidiaries operate, future
interest rate levels, legislative and regulatory
decisions or capital market conditions. The
company assumes no responsibility to update this
information. For more details, please refer to the
company’s SEC filings.
northwest Ohio, southeast Michigan and in Fort Wayne, Indiana. First Insurance
& Investments is a full-service insurance agency with offices in Defiance and
Bowling Green, Ohio.
Founded in 1920 as Northwest Savings, First Federal was chartered in 1935 as a
federal mutual savings and loan company. First Federal converted to a Mutual
Holding Company and issued its first stock to the public and employees in 1993.
In September 1995, First Federal converted to a full stock company, trading stock
on the NASDAQ national market under the ticker symbol FDEF. At the same
time, First Defiance Financial Corp. was founded as the holding company for
First Federal. The bank’s name was changed to First Federal Bank of the Midwest
in 1999, to reflect the desire to provide more comprehensive financial products
and services.
Since 2003, First Defiance has acquired three banking offices, opened four
de novo offices, acquired an insurance agency and completed acquisitions
of ComBanc, Inc., based in Delphos, Ohio; Genoa Savings and Loan, based near
Toledo in Genoa, Ohio; and Pavilion Bancorp, based in Adrian, Michigan.
2 0 0 8 F i nanc i a l H igh l igh t s
(In Thousands, Except Per Share Amounts)
Summary of
Operating Results
Net interest income
Provision for loan losses
Non-interest income
(excluding securities gains/losses)
Securities gains (losses)
Non-interest expense
(excluding non-recurring items)
Net income
Dividends accrued on
preferred shares
Accretion on
preferred shares
Net income applicable
to common shares
NM — % not meaningful
2008
$ 62,195
12,585
22,229
(3,160)
57,794
7,357
(134)
(11)
2007
$ 48,662
2,306
%
Change
27.8%
445.8%
22,109
0.54%
21
NM
48,113
20.1%
13,904
(47.1%)
–
–
–
–
Balance Sheet Data
2008
2007
%
Change
Total assets
$ 1,957,400 $ 1,609,404
21.6%
Loans, net
1,592,643
1,275,806
24.8%
Deposits
1,469,912
1,217,858
20.7%
Stockholders’ equity
229,159
165,954
38.1%
7,212
13,904
(48.1%)
Allowance for
loan losses
24,592
13,890
77.0%
Share Information:
2008
2007
%
Change
Key Ratios:
2008
2007
%
Change
Basic earnings
per common share
Basic core earnings
per common share
Diluted earnings
per common share
Diluted core earnings
per common share
Dividends
per common share
Tangible book value
per common share
Shares outstanding
at end of period
$ 0.91
$ 1.96
(53.6%)
Average net interest
margin
3.80%
3.55%
7.0%
1.01
0.91
1.00
0.95
1.96
(48.5%)
1.94
(53.1%)
1.94
(48.5%)
1.01
(5.9%)
Return on average assets
– core earnings
0.44%
0.90%
(51.1%)
Return on average equity
– core earnings
4.23%
8.48%
(50.1%)
15.67
17.79
(11.9%)
8,117
7,059
15.0%
Efficiency ratio
– core basis
66.43%
67.29%
1.3%
Diluted Earnings
Per Share
Total Assets
(in millions)
Deposits
(in millions)
Loans
(in millions)
Total Non-Interest
Income
(excluding security
gains, in millions)
$2.50
2.00
1.50
1.00
0.50
$2,000
$1,500
1,500
1,000
500
1,000
500
$1,600
1,400
1,200
1,000
800
600
400
200
$25.0
20.0
15.0
10.0
5.0
04 05 06 07 08
04 05 06 07 08
04 05 06 07 08
04 05 06 07 08
04 05 06 07 08
2
To our
shareholders:
be nice to think all of those challenges are behind us as we
move through 2009, but we all know there are plenty of difficulties
still to tackle. We are pleased to have turned in a profitable year despite
In my 30 years of banking, there has never
been a more challenging year than 2008. It would
numerous economic, legislative and regulatory distractions. And I am confident
that through diligence, discipline and an unwavering focus on our core community
banking strategy, First Defiance Financial Corp. is well-positioned to manage through
this unprecedented economic environment and find opportunities that contribute to
long-term success.
The recession that began to take shape in 2007 roared through 2008 like a tsunami and
overwhelmed the entire economy, not only in the U.S., but globally. Continued stress
in the housing market, a faltering Fannie Mae and Freddie Mac, high-profile bank
failures and the collapse of long-established investment firms brought a record level of
government involvement in the banking industry. New legislation and programs were
introduced in rapid succession, and the purpose and focus of many of these initiatives
changed just as rapidly. The failures of a handful of banks that were heavy subprime
lenders caused many people to fear for the safety of their deposits and prompted
Congress to increase FDIC insurance coverage. The placement of Fannie Mae and
Freddie Mac into conservatorship in September added to the concerns for the financial
stability of the country and virtually wiped out the value of their preferred investment
securities held by many banks, including ours.
Perhaps the most misunderstood and misrepresented program to come out of the
financial debacle of 2008 was the Troubled Asset Relief Program (TARP) that was
most commonly, and wrongly, referred to as the “Bank Bailout Bill.” The fact is, over
95% of the community banks in this country were, and remain, well-capitalized.
Initially conceived to create liquidity for financial institutions by acquiring problem
assets with no other available market, TARP quickly morphed into a capital program
3
for qualifying banks and a significant amount of the designated
by 8.1% and provided financing totaling $80 million to local
funds were directed toward the Capital Purchase Program (CPP).
commercial and commercial real estate clients, and $18 million in
The theory behind this change was to invest in banks that would
financing to area farmers. Our credit quality performance in this
in turn increase their lending to stimulate the economy. That’s
unusual economic environment was below our historic standards,
the principle under which First Defiance applied for and received
and we know it will continue to be challenged until the economy
$37 million in CPP investments in December 2008. This capital
begins to recover. However, we have further reinforced our
will further bolster our already-strong balance sheet and provide
prudent credit administration function and are confident in our
us with additional flexibility to serve our growing commercial
ability to manage asset quality.
and retail client base. We’ve been a leading lender to businesses
throughout our market area and have continued making loans
during this economic slowdown and period of tight credit. We’re
looking forward to utilizing this capital to further expand our
business lending and support local economies.
Focused On Our Core Business
In addition to responding to everything the economy, legislators,
and regulators dealt us in 2008, we devoted significant time and
energy to the acquisition of Pavilion Bancorp based in Adrian,
Michigan. This acquisition was announced in October 2007
and closed on March 14, 2008. The integration of the new offices
we acquired in this transaction has gone smoothly and although
the Michigan economy has been hit especially hard, we are
The crux of our business is providing high quality community
confident this market will fit well into our growth plans. With this
financial services on a conservative, responsible basis. As a
expansion, our footprint consists of four distinct market areas,
result, our core operation remained solid throughout the
developed to keep decision-making as close to the
year. We reached $1.96 billion in assets at December 31, 2008,
customer as possible.
solidifying our ranking as the largest locally owned community
bank in northwest Ohio. In an environment rattled by subprime
mortgage lending, we provided traditional loan options and
increased our mortgage volume by $57 million. We continued
the pace in commercial Remote Deposit Services growth. We
achieved the status of the #2 bank in Ohio and are #23 in the
nation in CDARS (Certificate of Deposit Account Registry
Service) account management. We increased commercial loans
First Defiance Financial Corp. is also focused on the future.
We believe that opportunities arise in extraordinary times and
that we are positioned to take advantage of those that offer
long-term strategic value for our company. We appreciate your
investment in and support of First Defiance Financial Corp. and
look forward to future growth and profitability for all of our
stakeholders.
Sincerely,
William J. Small
Chairman, President & CEO
4
Barbara A. Mitzel
Area Manager
Consumers Energy
Adrian, Michigan
5 & 6
James L. Rohrs
President & Chief Executive Officer
First Federal Bank
Executive Vice President
First Defiance Financial Corp.
1, 6 & 8
Samuel S. Strausbaugh
Co-President
Defiance Metal Products
Defiance, Ohio
2, 3, 6 & 8
Thomas A. Voigt
Vice President &
General Manager
Bryan Publishing Company
Bryan, Ohio
3, 4 & 5
First Defiance Financial Corp.
Board of Directors
William J. Small
Chairman, President &
Chief Executive Officer
First Defiance Financial Corp.
1, 6, 7 & 8
Stephen L. Boomer
Vice Chairman & Lead Director
First Defiance Financial Corp.
President, Arps Dairy
Defiance, Ohio
1, 2, 3, 4, 7 & 8
John L. Bookmyer
Chief Executive Officer
Pain Management Group
Findlay, Ohio
2 & 3
Douglas A. Burgei, D.V.M.
Veterinarian
Napoleon, Ohio
4, 5 & 6
Peter A. Diehl
Retired Business Owner
Defiance, Ohio
2, 3 & 5
Jean A. Hubbard
Business Manager &
Corporate Treasurer
The Hubbard Company
Defiance, Ohio
4 & 5
Dwain I. Metzger
Farmer
Elida, Ohio
4 & 5
Key For Board of Directors:
1. Executive Committee
2. Audit Committee
3. Compensation Committee
4. Corporate Governance Committee
5. Long Range Planning Committee
6. Investment Committee
7. Trust Committee
8. First Insurance & Investments Board
Gerald W. Monnin
Retired December 2008
First Insurance & Investments, Inc.
Donald P. Hileman
Chief Executive Officer
Steven P. Grosenbacher
Executive Vice President
Kenneth G. Keller
Executive Vice President
Group Health & Life
Timothy S. Whetstone
Executive Vice President
Secretary
Lawrence H. Woods
Executive Vice President
Property & Casualty
First Defiance Financial Corp.
Corporate Officers
William J. Small
Chairman, President &
Chief Executive Officer
John C. Wahl
Executive Vice President,
Chief Financial Officer &
Corporate Treasurer
Donald P. Hileman
Executive Vice President,
Interim Chief Financial
Officer
James L. Rohrs
Executive Vice President
First Federal Bank of the Midwest
William J. Small
Chairman
James L. Rohrs
President,
Chief Executive Officer
Gregory R. Allen
Executive Vice President,
Southern Market Area
President
Timothy K. Harris
Executive Vice President,
Eastern Market Area
President
Jeffrey D. Vereecke
Executive Vice President,
Northern Market Area
President
Dennis E. Rose, Jr.
Executive Vice President,
Operations
John C. Wahl
Executive Vice President,
Treasurer,
Chief Financial Officer
Brent L. Beard
Senior Vice President,
Controller
John H. Bick
Senior Vice President,
Asset Quality
John W. Boesling
Senior Vice President,
Secretary
Lisa R. Christy
Senior Vice President,
Certified Trust and
Financial Advisor
Patricia A. Cooper
Senior Vice President,
Bank Secrecy, Fraud and
Security
David J. Kondas
Senior Vice President,
Wealth Management
Kathleen A. Miller
Senior Vice President,
Information Technology
Richard J. Mitsdarfer
Senior Vice President,
Risk Management
Linda R. Moening
Senior Vice President,
Deposit Operations
John W. Boesling
Senior Vice President &
Corporate Secretary
Richard J. Mitsdarfer
Senior Vice President
Risk Management
Eric A. Morman
Senior Vice President,
Commercial Lending
Michael D. Mulford
Senior Vice President,
Credit Administration
Randall L. Rice
Senior Vice President,
Commercial Lending
Patrick S. Rothgery
Senior Vice President,
Retail Lending
Marybeth Shunck
Senior Vice President,
Retail Administration
Bradley D. Spitnale
Senior Vice President,
Western Market Area
President
Mary Beth K. Weisenburger
Senior Vice President,
Marketing
James R. Williams
Senior Vice President,
Commercial Lending
Paul N. Windisch
Senior Vice President,
Business Development
Community Advisory Boards
Adrian, Michigan
David Stutzman
Stutzman Farms
Dan Hupp
Dan’s Farm Supply
Emory Schmidt
Retired
Ed Engle
Rima Manufacturing
Defiance, Ohio
Rick Weaver
Poggemeyer Design
Mike Koester
Koester Corporation
Brad Mangas
BE Mangas Construction
Bryan Keller
Keller Logistics Group, Inc.
Delphos, Ohio
Eric Fritz
Delphos Ace Hardware,
Delphos Rental Corporation,
Bobcat of Lima
Richard Thompson
Thompson Seed Farm
Perry Wiltsie
Vanamatic Company
Findlay, Ohio
Duane Jebbett
Rowmark, Inc.
Michael Mallett
Corporate Research
International, Inc.
James Koehler
Country Club Acres, Inc.
Paul Kramer
Kramer Enterprises, Inc.
M. Michael Roberts
dmh Toyota-Lift
Dr. Alan Tong
Cascade Women’s Health
Fostoria, Ohio
Mark Baker
Roppe Holding Company
Frank Kinn
Business/Financial Consultant
Lynn Radabaugh
Maple Grove Quarry, Inc.
Tom Reineke
Reineke Ford
Dave Whitta
Whitta Construction, Inc.
Hicksville, Ohio
Larry Haver
Mayor of Hicksville
Michael Headley
H&W Automotive Parts, Inc.
Robert Ramus
Robert Ramus, DDS
Lima, Ohio
Tim DeHaven
DeHaven Garden Center
Robert J. Schulte, Jr.
HR Services
Greg Wannemacher
Wannemacher Enterprises
Jerry Johnson
Attorney
Don Fischer
Cappie Sportswear
Jerry Lewis
Speedy Arches
Napoleon, Ohio
Greg Beck
Beck ’s Construction
Kay Wesche
Henry County
Development Services
Susan Witt
Gerken Paving
Ottawa, Ohio
Kevin Ellerbrock
Kevin Ellerbrock Construction
Kenneth Konst
Farmer
Mike Ruhe
Retired Superintendent
Dean Walther
Optometrist
Paulding, Ohio
Joseph Burkard
Cook, Troth, Burkard
& Gorrell
William Shugars
Retired Superintendent
Michael Keezer
Custom Assembly
Wauseon, Ohio
Bill Fortier
Aquatek Water Conditioning
Kerry Ackerman
J&B Feed Company
Steven McElrath
BMW Services
Leon Mann
Retired
Williams County, Ohio
LeRoy Feather
Retired
Renee Isaac
Retired
Martin Sostoi
Attorney
James (Chip) Wood
Bryan Ford Lincoln Mercury,
Landmark Chevrolet
Chad Tinkel
Community Hospitals of
Williams County
Walter Bumb
Retired
Stacey Bock
Community Health
Professionals
5
SH A R E HOL DE R I N FOR M AT ION
Annual Meeting
The Annual Meeting of Shareholders of First Defiance Financial Corp.
will be held on Tuesday, April 21, 2009 at 1:00 p.m. in the conference
room at the First Federal Bank Operations Center at 25600 Elliott Road,
Defiance, Ohio 43512.
Investor Information
Shareholders, investors and analysts interested in additional
information about First Defiance Financial Corp. may contact
Investor Relations at the corporate office at (419) 782-5015.
Stock Transfer Agent
Shareholders with questions concerning the transfer of shares,
lost certificates, dividend payments, dividend reinvestment,
receipt of multiple dividend checks, duplicate mailings or
changes of address should contact:
Registrar and Transfer Company
First Defiance Financial Corp. Transfer Agent
10 Commerce Drive
Cranford, NJ 07016-3573
Telephone: 800-368-5948
Internet: www.rtco.com
Securities Listing
First Defiance Financial Corp. common stock trades on the NASDAQ
Global Select Market under the symbol FDEF.
As of March 6, 2009, there were approximately 2,615 stockholders of
record and 8,117,120 shares outstanding.
Price Range
Year Ended December 31, 2008
Year Ended December 31, 2007
High
First Quarter
$22.51
Second Quarter $20.00
Third Quarter
$17.66
Fourth Quarter $14.50
Low
$17.30
$15.90
$10.00
$6.00
High
First Quarter
$30.25
Second Quarter $30.00
Third Quarter
$29.64
Fourth Quarter $26.93
Low
$27.25
$26.71
$23.99
$20.58
Total Return Performance
150
125
100
75
50
First Defiance Financial Corp.
NASDAQ Composite
SNL Bank NASDAQ Index
SNL Midwest Thrift Index
25
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
Dividends Policy
Cash dividends on the common stock are declared quarterly and have
been paid since First Defiance and its predecessor, First Federal Savings
and Loan, went public in 1993. Dividends declared in 2008 totaled
$0.95 per share.
Dividend Reinvestment Plan
Shareholders may automatically reinvest 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 contact Registrar and
Transfer Company at 800-368-5948.
Auditors
Crowe Horwath LLP
330 East Jefferson Boulevard
South Bend, Indiana 46624
General Counsel
Vorys, Sater, Seymour & Pease LLP
Suite 2000 Atrium Two
221 East Fourth Street
Cincinnati, Ohio 45201
First Defiance Financial Corp.
601 Clinton Street
Defiance, OH 43512
www.fdef.com
419-782-5015
First Federal Bank of the Midwest
601 Clinton Street
Defiance, OH 43512
www.first-fed.com
419-782-5015
First Insurance & Investments
419 Fifth Street, Suite 1200
Defiance, OH 43512
www.firstii.com
419-784-5431
For investor relations information visit www.fdef.com
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, 2008
or
[
]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number
0-26850
_____________
FIRST DEFIANCE FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
_____________
OHIO
(State or other jurisdiction of incorporation or organization)
601 Clinton Street, Defiance, Ohio
(Address of principal executive offices)
34-1803915
(I.R.S. Employer Identification Number)
43512
(Zip code)
Registrant’s telephone number, including area code: (419) 782-5015
_______________
Common Stock, Par Value $0.01 Per Share
(Title of Class)
The Nasdaq Stock Market
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
_______________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ]
No [ X ]
Indicate by check mark if registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes [ ] No [ X ]
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ X ] Non-accelerated filer [ ] Smaller Reporting Company[ ]
(Do not check if smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]
No [ X ]
As of March 13, 2009, there were issued and outstanding 8,117,120 shares of the Registrant’s common stock.
The aggregate market value of the voting stock held by non-affiliates of the Registrant computed by reference to the average bid and
ask price of such stock as of June 30, 2008 was approximately $131.0 million
Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement for the 2009
Annual Shareholders’ Meeting
Documents Incorporated by Reference
First Defiance Financial Corp.
Annual report on Form 10-k
Table of Contents
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Submission of Matters to a Vote of Security Holders
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of
Operation
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements With Accountants on Accounting and Financial
Disclosures
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules
PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
SIGNATURES
Page
3
24
29
29
31
31
31
33
34
52
54
104
104
105
105
105
105
106
106
107
108
-2-
- 2 -
Item 1. Business
PART I
First Defiance Financial Corp. (“First Defiance” or “the Company”) is a unitary thrift holding
company that, through its subsidiaries, First Federal Bank of the Midwest (“First Federal”) and First
Insurance & Investments (“First Insurance”) (“the Subsidiaries”), focuses on traditional banking and
property and casualty, life and group health insurance products. The Company’s traditional banking
activities include originating and servicing residential, commercial, and consumer loans and providing a
broad range of depository services. The Company’s insurance activities consist primarily of commissions
relating to the sale of property and casualty, life and group health insurance and investment products.
The Company’s philosophy is to grow and prosper, building long-term relationships based on top
quality service, high ethical standards, and safe and sound assets. The Company operates as a locally
oriented, community-based financial services organization, augmented by experienced, centralized
support in select critical areas. The Company’s local market orientation is reflected in its market area
management and local advisory boards, which are comprised of local business persons, professionals and
other community representatives, that assist area management in responding to local banking needs.
The Company’s operating objectives include expansion, diversification within its markets, growth
of its fee based income, and growth internally and through acquisitions of financial institutions, branches
and financial services businesses. The Company seeks merger or acquisition partners that are culturally
similar and have experienced management and possess either significant market area presence or have the
potential for improved profitability through financial management, economies of scale and expanded
services. The Company regularly evaluates merger and acquisitions opportunities and conducts due
diligence activities related to possible transactions with other financial institutions. As a result, merger or
acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions
involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of a
premium over book and market values, and, therefore, some dilution of the Company’s tangible book
value and net income per common share may occur in any future transaction. During 2008, the Company
acquired Pavilion Bancorp, Inc (“Pavilion”). The branches of Pavilion’s subsidiary, Bank of Lenawee,
became branches of First Federal. During 2007, the Company acquired Huber, Harger, Welt and Smith
(“HHWS”), an insurance agency headquartered in Bowling Green, Ohio. HHWS was merged into First
Insurance. Details of these transactions are presented in Note 3 – Acquisitions in the Notes to the financial
statements.
At December 31, 2008, the Company had consolidated assets of $1.96 billion, consolidated
deposits of $1.47 billion, and consolidated stockholder’s equity of $229.2 million. The Company was
incorporated in Ohio in June of 1995. Its principal executive offices are located at 601 N. Clinton Street,
Defiance, Ohio 43512, and its telephone number is (419) 782-5015.
First Defiance's Internet site, www.fdef.com contains a hyperlink under the Investor Relations
section to EDGAR where the annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Securities Exchange Act of 1934 are available free of charge as soon as reasonably
practicable after First Defiance has filed the report with the SEC.
-3-
- 3 -
The Subsidiaries
The Company’s core business operations are conducted through the Subsidiaries:
First Federal Bank of the Midwest: First Federal is a federally chartered stock savings bank
headquartered in Defiance, Ohio. As of December 31, 2008, it conducts operations through 27 full service
banking center offices in Allen, Defiance, Fulton, Hancock, Henry, Lucas, Ottawa, Paulding, Putnam,
Seneca, Williams and Wood Counties in northwest Ohio, 1 full service banking center office in Allen
County in northeast Indiana, and 8 full service banking center offices in Hillsdale and Lenawee Counties
in southeast Michigan.
On January 21, 2005, First Defiance completed the acquisition of ComBanc, Inc. (“ComBanc”) and
its subsidiary, the Commercial Bank, Delphos, Ohio. That acquisition added four branch offices located
in Allen County, Ohio which is adjacent to First Defiance’s existing footprint. On April 8, 2005, First
Defiance completed the acquisition of the Genoa Savings and Loan Company, (“Genoa”) which added
three offices in the metropolitan Toledo, Ohio area.
First Federal is primarily engaged in community banking. It attracts deposits from the general
public through its offices and uses those and other available sources of funds to originate residential real
estate loans, non-residential real estate loans, commercial loans, home improvement and home equity
loans and consumer loans. In addition, First Federal invests in U.S. Treasury and federal government
agency obligations, obligations of the State of Ohio and its political subdivisions, mortgage-backed
securities which are issued by federal agencies, including REMICs and CMOs and corporate bonds. First
Federal’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). First Federal is a
member of the Federal Home Loan Bank (“FHLB”) System.
First Insurance & Investments: First Insurance & Investments (“First Insurance”) is a wholly
owned subsidiary of First Defiance. First Insurance is an insurance agency that conducts business in the
Defiance and Bowling Green, Ohio area. First Insurance offers property and casualty insurance, life
insurance, group health insurance, and investment products.
Securities
First Defiance’s securities portfolio is managed in accordance with a written policy adopted by the
Board of Directors and administered by the Investment Committee. The Chief Financial Officer, the Chief
Operating Officer, and the Chief Executive Officer of First Federal can each approve transactions up to
$1 million. Two of the three officers are required to approve transactions between $1 million and
$5 million. All transactions in excess of $5 million must be approved by the Board of Directors.
First Defiance’s investment portfolio includes 28 CMO and REMIC issues totaling $26.6 million,
all of which are fully amortizing securities. Management does not believe the risks associated with any of
its CMO or REMIC investments are significantly different from risks associated with other pass-through
mortgage-backed securities. First Defiance does not invest in off-balance sheet derivative securities.
Management determines the appropriate classification of debt securities at the time of purchase.
Debt securities are classified as held-to-maturity when First Defiance has the positive intent and ability to
hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not
-4-
- 4 -
classified as held-to-maturity and equity securities are classified as available-for-sale. Available-for-sale
securities are stated at fair value.
The carrying value of securities at December 31, 2008 by contractual maturity is shown below.
Expected maturities will differ from contractual maturities because issuers may have the right to call or
prepay obligations with or without call or prepayment penalties. For purposes of the maturity table,
mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity
groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-
backed securities may mature earlier than their weighted-average contractual maturities because of
principal prepayments.
Contractually Maturing
Total
Weighted
Under 1 Average
Year
Rate
1 - 5
Years
Weighted
Average
Rate
6-10
Years
Weighted
Weighted
Average Over 10 Average
Years
Rate
Rate
Amount Yield
Mortgage-backed
securities
REMICs and CMOs
U.S. government and
federal agency
obligations
Obligations of states and
political subdivisions (1)
Trust preferred stock
Total
Unamortized premiums/
(discounts)
Unrealized loss on
securities available
for sale
Total
$ 8,672
8,146
5.10% $ 18,085
17,804
4.92
5.03% $ 7,084
608
5.03
5.04%
4.79
$ 1,172
33
(Dollars in Thousands)
5.17% $ 35,013
5.00
26,591 4.99
5.06%
1,000
6.50
9,000
5.44
4,000
5.27
−
−
14,000
5.47
955 4.39
−
$ 18,773
6,605
−
$ 51,494
4.17
4,340
−
$ 16,032
4.34
24,476
8,241
$ 33,922
4.58
4.20
36,376
4.24
8,241 4.20
$ 120,221
(100)
(1,660)
$ 118,461
(1) Tax exempt yield based on effective tax rate of 35%. Actual coupon rate is approximately equal to the weighted average rate disclosed in the
table times 65%.
The carrying value of investment securities is as follows:
2008
December 31
2007
(In Thousands)
2006
Available-for-sale securities:
U. S. treasury and federal agency obligations
Obligations of state and political subdivisions
CMOs, REMICS and mortgage-backed securities
Trust preferred stock
Total
14,685
37,013
61,955
3,922
$ 117,575
24,918
28,819
49,991
8,642
$ 112,370
36,043
25,254
41,207
8,178
$ 110,682
Held-to-maturity securities:
Mortgage-backed securities
Obligations of state and political subdivisions
Total
$ 646
240
$ 886
$ 817
300
$ 1,117
$ 1,081
360
$ 1,441
For additional information regarding First Defiance’s investment portfolio refer to Note 5 –
Investment Securities to the consolidated financial statements.
-5-
- 5 -
Interest-Bearing Deposits
First Defiance had interest-earning deposits in the FHLB of Cincinnati and other financial
institutions amounting to $5.2 million and $1.4 million at December 31, 2008 and 2007, respectively. At
December 31, 2008 and 2007, the Company had $0 and $10.0 million, respectively in federal funds sold
held at other financial institutions.
Residential Loan Servicing Activities
Servicing mortgage loans for investors involves a contractual right to receive a fee for processing
and administering loan payments on mortgage loans that are not owned by the Company and are not
included on the Company’s balance sheet. This processing involves collecting monthly mortgage
payments on behalf of investors, reporting information to those investors on a monthly basis and
maintaining custodial escrow accounts for the payment of principal and interest to investors and property
taxes and insurance premiums on behalf of borrowers. At December 31, 2008, First Federal serviced
12,337 loans totaling $1.10 billion. The vast majority of the loans serviced for others are fixed rate
conventional mortgage loans.
As compensation for its mortgage servicing activities, the Company receives servicing fees, usually
0.25% per annum of the loan balances serviced, plus any late charges collected from delinquent
borrowers and other fees incidental to the services provided. In the event of a default by the borrower, the
Company receives no servicing fees until the default is cured.
The following table sets forth certain information regarding the number and aggregate principal
balance of the mortgage loans serviced by the Company, including both fixed and adjustable rate loans, at
various interest rates:
2008
December 31,
2007
2006
Number
of
Loans
Rate
Percentage
Percentage
Aggregate of Aggregate Number Aggregate of Aggregate Number Aggregate of Aggregate
Principal
Balance
Principal
Balance
Principal
Balance
Principal
Balance
Principal
Balance
Principal
Balance
of
Loans
of
Loans
Percentage
(Dollars in Thousands)
Less than 5.00%
5.00% - 5.99%
6.00% - 6.99%
7.00% - 7.99%
8.00% - 8.99%
9.00% and over
Total
1,089
5,111
5,302
749
70
16
$ 12,337
$ 88,681
453,548
502,811
52,884
2,931
465
$ 1,101,320
8.05%
41.18
45.66
4.80
0.27
0.04
100.00%
759
3,222
3,897
620
70
12
8,580
$ 57,448
249,600
363,018
41,918
3,164
339
$ 715,487
8.03%
34.89
50.74
5.86
0.44
0.04
100.00%
810
3,473
3,129
582
86
17
8,097
$ 65,938
280,779
278,651
36,158
3,476
437
$ 665,439
9.91%
42.20
41.87
5.43
0.52
0.07
100.00%
-6-
- 6 -
Loan servicing fees decrease as the principal balance on the outstanding loan decreases and as the
remaining time to maturity of the loan shortens. The following table sets forth certain information
regarding the remaining maturity of the mortgage loans serviced by the Company as of the dates shown.
2008
2007
2006
Number
of Loans
% of
Number
of Loans
Unpaid
Principal
Amount
Maturity
% of
Unpaid
Principal
Amount
Number
of Loans
% of
Number
of Loans
Unpaid
Principal
Amount
(Dollars in Thousands)
% of
Unpaid
Principal
Amount
Number
of Loans
% of
Number
of Loans
Unpaid
Principal
Amount
% of
Unpaid
Principal
Amount
1–5 years
6–10 years
11–15 years
16–20 years
21–25 years
More than 25
years
Total
941
2,312
1,795
634
2,097
7.63% $ 65,351
126,206
141,168
54,303
203,117
18.74
14.55
5.14
17.00
5.93%
11.46
12.82
4.93
18.44
546
1,041
1,991
830
590
6.36%
12.13
23.21
9.67
6.88
$ 35,049
48,412
134,243
68,412
49,132
4.90%
6.77
18.76
9.56
6.87
559
659
2,408
992
338
6.90% $ 40,545
26,342
8.14
163,796
29.74
81,262
12.25
28,604
4.17
6.09%
3.96
24.61
12.21
4.30
4,558
36.94
511,175
46.42
3,582
41.75
380,239
53.14
3,141
38.80
324,890
48.83
12,337
100.00% $1,101,320 100.00%
8,580
100.00% $ 715,487
100.00%
8,097
100.00% $ 665,439
100.00%
Lending Activities
General – A savings bank generally may not make loans to one borrower and related entities in an
amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an
additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured
by readily marketable 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, a savings bank may lend to one borrower up to
$500,000 “for any purpose”. At December 31, 2008, First Federal’s limit on loans-to-one borrower was
$32.9 million and its five largest loans (including available lines of credit) or groups of loans to one
borrower, including related entities, were $19.1 million, $16.0 million, $15.7 million, $15.1 million and
$13.5 million. All of these loans or groups of loans were performing in accordance with their terms at
December 31, 2008.
Loan Portfolio Composition – The net increase in net loans receivable over the prior year was
$316.8 million, $49.5 million, and $61.8 million in 2008, 2007, and 2006, respectively. First Defiance
acquired net loans of $232.5 million in the Pavilion acquisition in 2008. The loan portfolio contains no
foreign loans. The Company’s loan portfolio is concentrated geographically in its northwest Ohio,
northeast Indiana and southeast Michigan market areas. Management has identified lending for income
generating rental properties as an industry concentration. Total loans for income generating property
totaled $442.0 million at December 31, 2008, which represents 27% of the Company’s loan portfolio.
-7-
- 7 -
The following table sets forth the composition of the Company’s loan portfolio by type of loan at
the dates indicated.
Real estate:
Single family residential
Five or more family
residential
Nonresidential real estate
Construction
Total real estate loans
Other:
Consumer finance
Commercial
Home equity and improvement
Mobile home
Total non-real estate loans
Total loans
Less:
Loans in process
Deferred loan origination fees
Allowance for loan losses
Net loans
2008
2007
December 31
2006
2005
2004
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
(Dollars in Thousands)
$ 251,807
15.4% $ 231,921 17.9%
$ 250,808
20.1%
$ 275,497 23.2%
$ 187,775
20.9%
78,427
677,313
72,938
1,080,485
4.8
41.3
4.4
65.9
56,774
4.4
545,077 42.1
1.0
13,146
846,918 65.4
57,263
522,597
17,339
848,007
50,040
4.2
501,943 42.2
21,173
1.8
848,653 71.4
39,049
376,115
15,507
618,446
4.4
42.0
1.7
69.0
40,567
356,574
161,106
445
558,692
1,639,177
2.5
21.8
9.8
−
34.1
100.0%
37,401
2.9
283,072 21.8
9.9
128,080
342
−
448,895 34.6
1,295,813 100.0%
43,320
232,914
122,789
450
399,473
1,247,480 100.0%
54,657
4.6
171,289 14.4
9.5
113,000
.1
640
339,586 28.6
1,188,239 100.0%
20,892
1,050
24,592
$ 1,592,643
5,085
1,032
13,890
$ 1,275,806
6,409
1,182
13,579
$ 1,226,310
8,782
1,303
13,673
$ 1,164,481
5.1
15.8
10.1
−
31.0
100.0%
45,213
141,644
90,839
299
277,995
896,441
6,341
1,232
9,956
$ 878,912
4.6
41.9
1.4
68.0
3.5
18.7
9.8
−
32.0
In addition to the loans reported above, First Defiance had $11.0 million, $5.8 million, $3.4
million, $5.3 million and $2.3 million in loans classified as held for sale at December 31, 2008, 2007,
2006, 2005 and 2004, respectively. The fair value of such loans, which are all single-family residential
mortgage loans, approximated their carrying value for all years presented.
Contractual Principal, Repayments and Interest Rates – The following table sets forth certain
information at December 31, 2008 regarding the dollar amount of gross loans maturing in First Defiance’s
portfolio, based on the contractual terms to maturity. Demand loans, loans having no stated schedule of
repayments and no stated maturity and overdrafts are reported as due in one year or less.
Years After December 31, 2008
Due Less
than 1
Due 1-2
Due 3-5
$ 188,555
$ 68,009
$ 267,895
Due 5-10
(In Thousands)
$ 423,939
Due 10-15
Due 15+
Total
$ 59,302
$
72,785
$ 1,080,485
188,078
53,483
80,450
33,416
856
291
356,574
16,572
97
15,630
$ 408,932
14,400
115
10,586
$ 146,593
60,568
150
13,420
$ 422,483
8,357
83
755
$ 466,550
4,273
-
144
$ 64,575
56,936
−
32
161,106
445
40,567
$ 130,044 $ 1,639,177
Real estate
Non-real estate:
Commercial
Home equity and
improvement
Mobile home
Consumer finance
Total
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.
-8-
- 8 -
The following table sets forth the dollar amount of gross loans due after one year from
December 31, 2008 which have fixed interest rates or which have floating or adjustable interest rates.
Real estate
Commercial
Other
Fixed
Rates
Floating or
Adjustable
Rates
(In Thousands)
Total
$ 131,667
9,028
96,678
$ 237,373
$ 760,263
159,470
73,139
$ 992,872
$ 891,930
168,498
169,817
$1,230,245
Originations, Purchases and Sales of Loans – The lending activities of First Defiance are
subject to the written, non-discriminatory, underwriting standards and loan origination procedures
established by the Board of Directors and management. Loan originations are obtained from a variety of
sources, including referrals from existing customers, real estate brokers, developers, builders, and existing
customers; newspapers and radio advertising; and walk-in customers.
First Defiance’s loan approval process for all types of loans is intended to assess the borrower’s
ability to repay the loan, the viability of the loan, and the adequacy of the value of the collateral that will
secure the loan.
A commercial loan application is first reviewed and underwritten by one of the commercial loan
officers, who may approve credits within their lending limit. Another loan officer with limits sufficient to
cover the exposure must approve credits exceeding an individual’s lending limit. All credits which exceed
$100,000 in aggregate exposure must be presented for review or approval to the Senior Loan Committee
comprised of senior lending personnel. Credits which exceed $1,000,000 in aggregate exposure must be
presented for approval to the Executive Loan Committee, a committee of First Federal’s Board of
Directors.
Residential mortgage applications are accepted by retail lenders or branch managers, who utilize
an automated underwriting system to review the loan request. First Federal also receives mortgage
applications via an online residential mortgage origination system. A final approval of all residential
mortgage applications is made by a member of a centralized underwriting staff within their designated
lending limits. Loan requests in excess or outside an individual underwriter’s limit are approved by the
Senior Loan Committee and if necessary by the Executive Loan Committee.
Retail lenders and branch managers are authorized to originate and approve direct consumer loan
requests that are within policy guidelines and within the lender’s approved lending limit. Loans in excess
of the lender’s approved lending limit may be approved by retail lending managers up to their approved
lending limit. Loans in excess of the retail lending manager’s authorized lending limit or outside of policy
must be approved by Senior Loan Committee and if necessary by the Executive Loan Committee. Indirect
consumer loans originated by auto dealers are underwritten and approved by a designated underwriter in
accordance with company policy and lending limits.
First Defiance offers adjustable-rate loans in order to decrease the vulnerability of its operations
to changes in interest rates. The demand for adjustable-rate loans in First Defiance’s primary market area
has been a function of several factors, including customer preference, the level of interest rates, the
expectations of changes in the level of interest rates and the difference between the interest rates offered
-9-
- 9 -
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 7.0% of First Defiance’s total originations of one-to-four family
residential mortgage loans in 2008 compared to 4.0% and 6.0% during 2007 and 2006, respectively.
Adjustable-rate loans decrease the risks associated with changes in interest rates, but involve
other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent
permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the
marketability of the underlying property may be adversely affected by higher interest rates.
The following table shows total loans originated, loan reductions, and the net increase in First
Defiance’s total loans during the periods indicated:
2008
Years Ended December 31
2007
(In Thousands)
2006
Loan originations:
Single family residential
Multi-family residential
Non-residential real estate
Construction
Commercial
Home equity and improvement
Consumer finance
Total loans originated
Loans acquired in acquisitions
Loan reductions:
Loan pay-offs
Mortgage loans sold
Periodic principal repayments
Net increase in total loans
$ 262,338
44,853
225,520
20,167
341,657
40,786
24,751
960,072
236,759
$ 216,203
22,119
145,675
18,633
243,229
29,934
23,931
699,724
−
$ 162,499
71,671
168,909
24,026
174,081
40,498
42,162
683,846
−
387,475
181,459
284,324
853,258
$ 343,573
$
265,367
136,413
247,296
649,076
50,648
$
242,137
134,000
250,324
626,461
57,385
The gross loans acquired in the Pavilion acquisition in 2008 by category were as follows: Single
family residential – $50.0 million, multi-family residential – $6.0, non-residential real estate – $100.9
million, commercial – $49.2 million, home equity and improvement – $25.7 million and consumer
finance – $5.0 million.
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.
-10-
- 10 -
Delinquent Loans — The following table sets forth information concerning delinquent loans at
December 31, 2008, in dollar amount and as a percentage of First Defiance’s total loan portfolio. The
amounts presented represent the total outstanding principal balances of the related loans, rather than the
actual payment amounts that are past due.
30 to 59 Days
60 to 89 Days
90 Days and Over
Total
Amount Percentage Amount Percentage Amount Percentage Amount Percentage
(Dollars in Thousands)
Single – family residential
Nonresidential and Multi-
$ 2,818
0.17%
$ 1,911
0.12% $ 4,656
0.28% $ 9,384
0.57%
family residential
3,340
0.20
2,064
0.13
19,980
1.22
25,384
1.55
Home equity and
improvement
Consumer finance
Commercial
Total
3,559
484
1,283
$ 11,484
0.22
0.03
0.08
0.70%
465
76
388
$ 4,904
424
0.03
76
0.00
0.02
2,881
0.30% $ 28,017
4,449
0.03
635
0.00
0.18
4,552
1.71% $ 44,404
0.27
0.04
0.28
2.71%
Overall, the level of delinquencies at December 31, 2008 has increased from the levels at
December 31, 2007, when First Defiance reported that 1.39% of its outstanding loans were at least 30
days delinquent. The level of total loans 90 or more days delinquent has increased to 1.71% at December
31, 2008 from 0.71% at December 31, 2007. Overall, the level of loans that were 30 to 59 days past due
and 60 to 89 days past due increased from $5.5 million (0.43%) and $3.3 million (0.25%), respectively, at
December 31, 2007 to $11.5 million (0.70%) and $4.9 million (0.30%), respectively, at December 31,
2008. Management has assessed the collectability of all loans that are 90 days or more delinquent as part
of its procedures in establishing the allowance for loan losses.
Nonperforming Assets – All loans are reviewed on a regular basis and are placed on a non-
accrual status when, in the opinion of management, the collectability of additional interest is deemed
insufficient to warrant further accrual. Generally, First Defiance places all loans more than 90 days past
due on non-accrual status. When a loan is placed on nonaccrual status, total unpaid interest accrued to
date is reversed. Subsequent payments are either applied to the outstanding principal balance or recorded
as interest income, depending on the assessment of the ultimate collectability of the loan. First Defiance
considers that a loan is impaired when, based on current information and events, it is probable that it will
be unable to collect all amounts due (both principal and interest) according to the contractual terms of the
loan agreement. First Defiance measures impairment based on the present value of expected future cash
flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value
of the collateral, if collateral dependent. If the estimated recoverability of the impaired loan is less than
the recorded investment, First Defiance will recognize impairment by allocating a portion of the
allowance for loan losses.
Impaired loans acquired in the ComBanc, Genoa and Pavilion acquisitions have been accounted
for under the provisions of AICPA Statement of Position (“SOP”) 03-3 – Accounting for Certain Loans
or Debt Securities Acquired in a Transfer. Such loans were recorded at their fair value, which was
estimated based on the expected cash flow of the acquired loan. In the Genoa acquisition, 10 loan
relationships with a stated value of $1.5 million were recorded at $721,000. In the ComBanc acquisition,
12 loan relationships with a stated value of $3.4 million were recorded at $2.0 million. In the Pavilion
acquisition, 12 loan relationships with a stated value of $6.4 million were recorded at $4.4 million. At
December 31, 2008, 22 loan relationships remained with a contractual balance of $8.9 million and were
recorded at $5.8 million. If management expectations about the cash flow of those loans changes over
time, the difference will be recognized as a yield adjustment over the remaining life of the respective
-11-
- 11 -
loan. In 2008, $53,000 of impairment was recognized as a yield adjustment. There were no significant
changes in the expected cash flows of the remaining loan relationships in 2008.
Loans originated by First Federal having recorded investments of $13.4 million, $8.6 million,
and $4.2 million were considered impaired as of December 31, 2008, 2007 and 2006, respectively. These
amounts exclude large groups of small-balance homogeneous loans that are collectively evaluated for
impairment such as residential mortgage, consumer installment, and credit card loans. There was
$507,000 of interest received and recorded in income during 2008 related to impaired loans. There was
$338,000 and $111,000 recorded in 2007 and 2006 respectively. Unrecorded interest income based on the
loan’s contractual terms on these impaired loans and all non-performing loans in 2008, 2007 and 2006
was $2.9 million, $1.3 million, and $625,000, respectively. The average recorded investment in impaired
loans during 2008, 2007 and 2006 (excluding loans accounted for under SOP) was $15.1 million, $9.6
million and $4.4 million, respectively. The total allowance for loan losses related to these loans was $4.1
million, $1.4 million, and $969,000 at December 31, 2008, 2007 and 2006, respectively.
Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold.
First Defiance also repossesses other assets securing loans, consisting primarily of automobiles. When
such property is acquired it is recorded at fair value less cost to sell. 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 a write-down of the value is recorded with a
corresponding charge to operations if it is determined that the carrying value of property exceeds its
estimated net realizable value. During 2008, First Defiance recognized $144,000 of expense related to
write-downs in value of real estate acquired by foreclosure. The balance of real estate owned at December
31, 2008 was $7.0 million and other repossessed assets totaled $27,000.
As of December 31, 2008, First Defiance’s total non-performing loans amounted to $34.3 million
or 2.09% of total loans, compared to $9.2 million or 0.71% of total loans, at December 31, 2007. Non-
performing loans are loans which are more than 90 days past due or loans which have been restructured
and identified as troubled debt. The nonperforming loan balance includes $9.8 million of loans originated
by First Federal also considered impaired and $1.5 million of acquired loans accounted for under SOP.
-12-
- 12 -
The following table sets forth the amounts and categories of First Defiance’s non-performing
assets (excluding impaired loans not considered non-performing) and troubled debt restructurings at the
dates indicated.
2008
2007
December 31
2006
(Dollars in Thousands)
2005
2004
Nonperforming loans:
Single-family residential
Nonresidential and multi-family
residential real estate
Commercial
Mobile home
Consumer finance
Troubled debt restructurings
Total nonperforming loans
Real estate owned
Other repossessed assets
Total repossessed assets
$ 5,080
$ 2,608
$ 1,980
$ 2,648
$
419
19,980
2,881
−
76
6,250
34,267
6,973
27
7,000
5,917
675
−
17
−
9,217
2,410
50
2,460
4,977
272
−
54
−
7,283
2,321
71
2,392
1,917
287
−
100
−
4,952
315
89
404
1,014
450
−
10
−
1,893
49
49
98
Total nonperforming assets
$ 41,267
$ 11,677
$ 9,675
$ 5,356
$ 1,991
Total nonperforming assets as a
percentage of total assets of
continuing operations
Total nonperforming loans as a
percentage of total loans
Allowance for loan losses as a percent
of total nonperforming assets
2.11%
0.73%
0.63%
0.37%
0.18%
2.09%
0.71%
0.59%
0.42%
0.21%
59.59%
118.95%
140.35%
255.28% 500.05%
In addition to the $34.3 million of loans reported above and $11.3 million of loans considered
impaired (including loans accounted for under SOP 03-3), which are not included in the loans reported
above, there are approximately $55.6 million of performing loans where known information about
possible credit problems of the borrowers causes management to have doubts as to the ability of such
borrowers to comply with the present loan repayment terms and which may result in the inclusion of such
loans in non-performing loans at some future date. In analyzing these loans for the purpose of
determining the adequacy of the allowance for loan losses, management has determined that these loans
generally have significant collateral, strong guarantors, or both.
Allowance for Loan Losses – First Defiance maintains an allowance for loan losses to absorb
probable incurred credit losses in the loan portfolio. The balance of the allowance is based upon an
assessment of prior loss experience, the volume and type of lending conducted by First Defiance, industry
standards, past due loan amounts and trends, general economic conditions and other factors related to the
collectability of the loan portfolio. The Company principally uses its own loss experience in calculating
its loan loss provision. However, in those instances where the Company’s experience with certain types of
lending is new or recent and therefore historical losses are less meaningful, management will consider
such other factors as industry loss statistics, experience of other financial institutions operating in the
same geographic area, and inherent risks associated with the borrower in determining the required
allowance. In evaluating the adequacy of its allowance each quarter, management grades all loans in the
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commercial portfolio using a scale of one to ten. Loans graded in the three worst categories (substandard,
doubtful and loss) generally have specific allowances. Loans graded as substandard would generally have
allowances that range between zero and 20% based on management’s knowledge of the credit and other
local factors. Substandard loans that have no allowances generally exhibit negative financial
characteristics, such as poor cash flow or declining sales, but have offsetting credit strengths, such as an
abundance of collateral or the existence of a strong guarantor. Loans classified as doubtful generally have
an allowance of 50% and loans classified as loss have a 100% loan loss provision, unless other facts and
circumstances, such as strength of collateral or strength of guarantors warrant a different percentage.
Management also engages a third-party to review all loan relationships in excess of $250,000 and, among
other things, to independently assess management’s loan grades.
Loans charged-off are charged against the allowance when such loans meet the Company’s
established policy on loan charge-offs and the allowance itself is adjusted quarterly by recording a
provision for loan losses. As such, actual losses and losses provided for should be approximately the same
if the overall quality, composition and size of the portfolio remained static. To the extent that the portfolio
grows at a rapid rate or overall quality deteriorates, the provision generally will exceed charge-offs.
However, in certain circumstances, including in 2006, net charge-offs may exceed the provision for loan
losses when management determines that loans previously provided for in the allowance for loan losses
are uncollectible and should be charged off. Although management believes that it uses the best
information available to make such determinations, future adjustments to the allowances may be
necessary, and net earnings could be significantly affected, if circumstances differ substantially from the
assumptions used in making the initial determinations.
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At December 31, 2008, First Defiance’s allowance for loan losses amounted to $24.6 million
compared to $13.9 million at December 31, 2007. The following table sets forth the activity in First
Defiance’s allowance for loan losses during the periods indicated.
Allowance at beginning of year
Provision for credit losses
Allowance acquired in acquisitions
Charge-offs:
Single family residential real estate
Commercial real estate
Commercial
Consumer finance
Home equity and improvement
Total charge-offs
Recoveries
Net charge-offs
Ending allowance
2008
Years Ended December 31
2006
2005
2007
(Dollars in Thousands)
2004
$ 13,890
12,585
4,258
$ 13,579
2,306
−
$ 13,673
1,756
−
$ 9,956
1,442
3,027
$ 8,844
1,549
−
1,185
3,758
813
380
363
6,499
358
6,141
$ 24,592
256
1,803
99
161
81
2,400
405
1,995
$ 13,890
513
1,028
177
392
166
2,276
426
1,850
$ 13,579
182
226
267
354
25
1,054
302
752
$ 13,673
52
58
390
186
−
686
249
437
$ 9,956
Allowance for loan losses to total non-
performing loans at end of year
71.77% 150.70% 186.45% 276.11%
525.94%
Allowance for loan losses to total loans at end
of year
1.52%
1.08%
1.10%
1.16%
1.13%
Allowance for loan losses to net charge-offs
for the year
Net charge-offs for the year to average loans
400.39% 696.24% 734.00% 1,818.22% 2,278.26%
0.05%
0.07%
0.15%
0.16%
0.38%
The provision for credit losses, as well as charge-offs, has increased significantly from 2007 to
2008. Of the increase in credit losses during 2008, 25.28% of this can be attributed to the acquisition of
Pavilion. The level of charge-offs increased in 2007, 2006 and 2005 because of general growth in the
overall portfolio and deteriorating economic conditions, while in 2008 there were some large
relationships in the commercial real estate portfolio that were charged off due to the effect of the slowing
economy. Management is prepared for similar charge-off activity in 2009, and believes the level of
allowance for loan losses is sufficient to cover a higher level of charge-offs.
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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.”
2008
2007
Percent of
total loans
by category Amount
Percent of
total loans
by category
Amount
December 31,
2006
Percent of
total loans
by category Amount
Amount
(Dollars in Thousands)
2005
2004
Percent of
total loans
by category Amount
Percent of
total loans
by category
$ 3,678
19.8%
$ 2,112
17.9%
$ 2,077
20.1%
$ 1,484
23.2%
$
239
22.8%
13,436
46.1
7,750
47.5
8,551
46.5
8,965
21.8
3,420
21.8
2,244
18.7
2,287
46.4
14.4
6,538
2,454
46.3
15.8
12.3
100.0%
608
$ 13,890
12.8
100.0%
707
$13,579
14.7
100.0%
937
$ 13,673
16.0
100.0%
725
$ 9,956
15.1
100.0%
Single family
residential
Nonresidential and
Multi-family
residential real
estate
Other:
Commercial loans
Consumer and home
6,351
equity and
improvement loans 1,127
$ 24,592
Sources of Funds
General – Deposits are the primary source of First Defiance’s funds for lending and other
investment purposes. In addition to deposits, First Defiance derives funds from loan principal repayments.
Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are
significantly influenced by general interest rates and money market conditions. Borrowings from the
FHLB may be used on a short-term basis to compensate for reductions in the availability of funds from
other sources. They may also be used on a longer-term basis for general business purposes. During 2007,
First Defiance issued $15.0 million of trust preferred securities through an unconsolidated affiliated trust.
Proceeds from the offering were used for general corporate purposes including funding of dividends and
stock buybacks as well as bolstering regulatory capital at the First Federal level. First Defiance also
issued $20.0 million of similar trust preferred securities in 2005.
Deposits – First Defiance’s deposits are attracted principally from within First Defiance’s primary
market area through the offering of a broad selection of deposit instruments, including checking accounts,
money market accounts, regular savings accounts, and term certificate accounts.
Deposit account terms vary, with the principal differences being the minimum balance required, the time
periods the funds must remain on deposit, and the interest rate.
To supplement its funding needs, First Defiance also utilizes the national market for Certificates
of Deposit. Such deposits have maturities ranging from three months to one year. The total balance of
national certificates of deposit was $38.5 million at December 31, 2008. National CDs at December 31,
2007 totaled $408,000.
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Average balances and average rates paid on deposits are as follows:
2008
Amount
Rate
Years Ended December 31
2007
Amount
(Dollars in Thousands)
Rate
2006
Amount
Rate
Non-interest-bearing
demand deposits
Interest bearing
demand deposits
Savings deposits
Time deposits
Totals
$ 159,452
−
$ 104,200
−
$
95,044
−
381,627
135,374
714,362
$ 1,390,815
1.28%
1.02
3.51
2.25%
310,230
92,756
661,974
$ 1,169,160
2.67%
1.51
4.65
3.46%
289,214
76,775
640,479
$ 1,101,512
2.44%
0.36
4.05
3.02%
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, 2008 (in thousands):
Certificates of deposit maturing in quarter ending:
March 31, 2009
June 30, 2009
September 30, 2009
December 31, 2009
After December 31, 2009
Total certificates of deposit with
balances of $100,000 or more
$ 48,029
48,380
27,881
12,611
88,365
$ 225,266
The following table details the deposit accrued interest payable as of December 31:
Interest bearing demand deposits and
money market accounts
Savings Accounts
Certificates of deposit
2008
2007
(In Thousands)
$
60
−
1,327
$ 1,387
$
220
−
2,317
$ 2,537
For additional information regarding First Defiance’s deposits see Note 11 to the financial
statements.
Borrowings— First Defiance may obtain advances from the FHLB of Cincinnati by pledging
certain of its residential mortgage loans, non-residential loans and investment securities provided certain
standards related to creditworthiness have been met. Such advances are made pursuant to several credit
programs, each of which has its own interest rate and range of maturities.
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The following table sets forth certain information as to First Defiance’s FHLB advances and other
borrowings at the dates indicated.
2008
December 31
2007
(Dollars in Thousands)
2006
$ 146,967
3.65%
$ 128,236
4.97%
$ 129,128
5.01%
Long-term:
FHLB advances
Weighted average interest rate
Short-term:
FHLB advances
Weighted average interest rate
Securities sold under agreement to repurchase
$
Weighted average interest rate
0.54%
49,454
1.79%
$ 9,100
$ 11,300
4.28%
30,055
3.14%
$
$ 33,100
5.18%
30,424
2.98%
$
The following table sets forth the maximum month-end balance and average balance of First
Defiance’s Long-term FHLB advances and other borrowings during the periods indicated.
Long-term:
FHLB advances:
Maximum balance
Average balance
Weighted average interest rate
2008
Years Ended December 31
2007
(Dollars in Thousands)
2006
$ 153,153
146,054
4.17%
$ 129,022
128,622
5.05%
$ 152,164
141,836
4.89%
The following table sets forth the maximum month-end balance and average balance of First Defiance’s
short-term FHLB advances and other borrowings during the periods indicated.
Short-term:
FHLB advances:
Maximum balance
Average balance
Weighted average interest rate
Revolving credit agreements:
Maximum balance
Average balance
Weighted average interest rate
2008
Years Ended December 31
2007
(Dollars in Thousands)
2006
$
$
44,900
14,004
2.17%
45,800
7,772
5.23%
$
57,500
40,104
5.10%
$
23,200
14,416
4.45%
$
500
171
6.20%
$
-
80
5.13%
Securities sold under agreement to repurchase:
Maximum balance
Average balance
Weighted average interest rate
$
$
50,679
36,926
2.69%
30,055
23,739
3.04%
$
30,424
20,318
2.84%
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First Defiance borrows funds under a variety of programs at the FHLB. As of December 31,
2008, there were $147.0 million outstanding under various long-term FHLB advance programs. First
Defiance utilizes short-term advances from the FHLB to meet cash flow needs and for short-term
investment purposes. There were $9.1 million and $11.3 million in short-term advances outstanding at
December 31, 2008 and 2007, respectively. At December 31, 2008, $9.1 million was outstanding under
First Defiance’s cash management advance line of credit. The total available under the line is $15.0
million. Additionally, First Defiance has $100.0 million available under a REPO line of credit. Amounts
are generally borrowed under these lines on an overnight basis. First Federal’s total borrowing capacity at
the FHLB is limited by various collateral requirements. Eligible collateral includes mortgage loans, home
equity loans, non-mortgage loans, cash, and investment securities. At December 31, 2008, regardless of
amounts available on the REPO and Cash Management line, First Federal’s additional borrowing capacity
with the FHLB was $57.9 million due to these collateral requirements.
As a member of the FHLB of Cincinnati, First Federal must maintain a minimum investment in
the capital stock of that FHLB in an amount defined in the FHLB’s regulations. First Federal is permitted
to own stock in excess of the minimum requirement and is in compliance with the minimum requirement
with an investment in stock of the FHLB of Cincinnati of $19.4 million at December 31, 2008. First
Federal also acquired $2.0 million in stock of the FHLB of Indianapolis from the Pavilion acquisition.
This stock is required to be held for a minimum of five years from the date of acquisition at the FHLB of
Indianapolis.
Each FHLB is required to establish standards of community investment or service that its
members must maintain for continued access to long-term advances from the FHLB. The standards take
into account a member’s performance under the Community Reinvestment Act and its record of lending
to first-time homebuyers.
For additional information regarding First Defiance’s FHLB advances and other debt see Notes
12 and 14 to the financial statements.
Subordinated Debentures - In March 2007, the Company sponsored an affiliated trust, First
Defiance Statutory Trust II (“Trust Affiliate II”) that issued $15 million of Guaranteed Capital Trust
Securities (Trust Preferred Securities). In connection with the transaction, the Company issued $15.5
million of Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) to Trust
Affiliate II. Trust Affiliate II was formed for the purpose of issuing Trust Preferred Securities to third-
party investors and investing the proceeds from the sale of these capital securities solely in Subordinated
Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of
the trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly
at a fixed rate equal to 6.441% for the first five years and a floating rate of three-month LIBOR plus
1.50%, repricing quarterly, thereafter.
The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon
repayment of the Subordinated Debentures. The Company has entered into an agreement that fully and
unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust
Preferred Securities and Subordinated Debentures mature on June 15, 2037, but may be redeemed at the
Company’s option at any time on or after June 15, 2012, or at any time upon certain events.
In October 2005, the Company formed an affiliated trust, First Defiance Statutory Trust I (“Trust
Affiliate I”) that issued $20 million of Trust Preferred Securities. In connection with the transaction, the
Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was
formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the
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proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The
Subordinated Debentures held by Trust Affiliate I are the sole assets of the trust. Distributions on the
Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the
three-month LIBOR rate plus 1.38%, or 3.38% as of December 31, 2008. The rate was 6.37% at
December 31, 2007.
The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in
whole or in part, upon repayment of the Subordinated Debentures. The Company has entered into an
agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of
the guarantee. The Trust Preferred Securities and Subordinated Debentures may be redeemed by the
issuer at par after October 28, 2010. The Subordinated Debentures mature on December 15, 2035.
Due to the Company’s participation in the U.S. Treasury’s Capital Purchase Program, permission
must be obtained from the U.S. Treasury in order to call these securities.
Participation in the Capital Purchase Program
In December 2008, First Defiance participated in the U.S. Treasury’s Capital Purchase Program
(“CPP”). Under the CPP, First Defiance issued $37.0 million of First Defiance non-voting preferred stock
and a warrant to purchase 550,595 shares of Common Stock at an exercise price of $10.08 per share,
subject to certain anti-dilution and other adjustments. The $37.0 million of Preferred Stock issued by First
Defiance under the CPP will qualify as Tier 1 capital. The cash received from the preferred stock issuance
is reflected in the financing activities section in Item 8 of this Form 10-K of the Consolidated Statements
of Cash Flows. The general purpose of the funds were to maintain and create lending opportunities in our
market area.
Employees
First Defiance had 556 employees at December 31, 2008. None of these employees are represented
by a collective bargaining agent, and First Defiance believes that it enjoys good relations with its
personnel.
Competition
Competition in originating non-residential mortgage and commercial loans comes mainly from
commercial banks with banking center offices in the Company’s market area. Competition for the
origination of mortgage loans arises mainly from savings associations, commercial banks, and mortgage
companies. The distinction among market participants is based on a combination of price, the quality of
customer service and name recognition. The Company competes for loans by offering competitive interest
rates and product types and by seeking to provide a higher level of personal service to borrowers than is
furnished by competitors. First Federal has a significant market share of the lending markets in which it
conducts operations.
Management believes that First Federal’s most direct competition for deposits comes from local
financial institutions. The distinction among market participants is based on price and the quality of
customer service and name recognition. First Federal’s cost of funds fluctuates with general market
interest rates. During certain interest rate environments, additional significant competition for deposits
may be expected from corporate and governmental debt securities, as well as from money market mutual
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funds. First Federal competes for conventional deposits by emphasizing quality of service, extensive
product lines and competitive pricing.
Regulation
General – First Defiance and First Federal are subject to regulation, examination and oversight
by the OTS. Because the FDIC insures First Federal’s deposits, First Federal is also subject to
examination and regulation by the FDIC. First Defiance and First Federal must file periodic reports with
the OTS and examinations are conducted periodically by the OTS and the FDIC to determine whether
First Federal is in compliance with various regulatory requirements and is operating in a safe and sound
manner. First Federal is subject to various consumer protection and fair lending laws. These laws govern,
among other things, truth-in-lending disclosure, equal credit opportunity, and, in the case of First Federal,
fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations
governing community reinvestment could limit the ability of First Federal to open a new branch or
engage in a merger transaction. Community reinvestment regulations evaluate how well and to what
extent First Federal lends and invests in its designated service area, with particular emphasis on low-to-
moderate income communities and borrowers in such areas.
First Defiance is also subject to various Ohio laws which restrict takeover bids, tender offers and
control-share acquisitions involving public companies which have significant ties to Ohio.
Regulatory Capital Requirements – First Federal is required by OTS regulations to meet
certain minimum capital requirements. Current capital requirements call for tangible capital of 1.5% of
adjusted total assets, core capital of 4.0% of adjusted total assets, except for associations with the highest
examination rating and acceptable levels of risk, and risk-based capital of 8.0% of risk-weighted assets.
The OTS does not have defined capital requirements for unitary thrift holding companies.
The following table sets forth the amount and percentage level of regulatory capital of First
Federal at December 31, 2008, 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.
Tangible Capital
Requirement
Excess
Core Capital
Requirement
Excess
Total risked-based capital
Risk-based requirement
Excess
December 31, 2008
Amount
Percent
(In Thousands)
$
$
$
$
$
$
202,616
28,416
174,200
202,616
75,777
126,839
219,290
134,712
84,578
10.70%
1.50
9.20%
10.70%
4.00
6.70%
13.02%
8.00
5.02%
First Federal’s capital at December 31, 2008, meets the standards for a well-capitalized
institution. There are no conditions or events since the most recent notification from the OTS regarding
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those capital standards
categorizations of First Federal.
that management believes have changed any of
the well-capitalized
Dividends. First Defiance’s payment of dividends to its shareholder’s is generally funded by the
payment of dividends by the Subsidiaries. Dividends paid by First Federal to First Defiance are subject to
various regulatory restrictions. First Federal can initiate dividend payments equal to its net profits (as
defined by statute) for the current year plus the preceding two calendar years without prior regulatory
approval. First Federal paid $10.0 million in dividends in 2008 and no dividends were paid by First
Federal in 2007. As a result of its participation in the CPP, First Defiance is prohibited, without prior
approval from the U.S. Treasury, from paying a quarterly cash dividend of more than $0.26 per share
until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or
transferred to an unaffiliated third party.
Transactions with Insiders and Affiliates. Loans to executive officers, directors and principal
shareholders and their related interests must conform to the lending limits. Most loans to directors,
executive officers and principal shareholders must be approved in advance by a majority of the
“disinterested” members of board of directors of the association with any “interested” director not
participating. All loans to directors, executive officers and principal shareholders must be made on terms
substantially the same as offered in comparable transactions with the general public or as offered to all
employees in a company-wide benefit program. Loans to executive officers are subject to additional
restrictions. In addition, all related party transactions must be approved by the Company’s audit
committee pursuant to Nasdaq Rule 4350(h), including loans made by financial institutions in the
ordinary course of business. All transactions between savings associations and their affiliates must
comport with Sections 23A and 23B of the Federal Reserve Act (FRA) and the Federal Reserve Board’s
(FRB) Regulation W. An affiliate of a savings association is any company or entity that controls, is
controlled by or is under common control with the savings association. First Defiance is an affiliate of
First Federal.
Holding Company Regulation. First Defiance is a unitary thrift holding company and is subject
to OTS regulations, examination, supervision and reporting requirements. Federal law generally prohibits
a thrift holding company from controlling any other savings association or thrift holding company,
without prior approval of the OTS, or from acquiring or retaining more than 5% of the voting shares of a
savings association or holding company thereof, which is not a subsidiary. If First Defiance were to
acquire control of another savings institution, other than through a merger or other business combination
with First Federal, First Defiance would become a multiple thrift holding company and its activities
would thereafter be limited generally to those activities authorized by the FRB as permissible for bank
holding companies.
Deposit Insurance. First Federal is a member of the Deposit Insurance Fund (“DIF”), which is
administered by the FDIC. Deposit accounts at First Federal are insured by the FDIC, generally up to a
maximum of $100,000 for each separately insured depositor and up to a maximum of $250,000 for self-
directed retirement accounts. However, the FDIC increased the deposit insurance available on all deposit
accounts to $250,000, effective until December 31, 2009. The Bank has opted to participate in the FDIC’s
Transaction Account Guarantee Program. See “Temporary Liquidity Guarantee Program” below.
The FDIC imposes an assessment against all depository institutions for deposit insurance. This
assessment is based on the risk category of the institution. On October 7, 2008, as a result of decreases in
the reserve ratio of the DIF, the FDIC issued a proposed rule establishing a Restoration Plan for the DIF.
The rulemaking proposed that, effectively January 1, 2009, assessment rates would increase uniformly by
seven basis points for the first quarter of 2009 assessment period. The rulemaking proposed to alter the
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way in which the FDIC’s risk-based assessment system differentiates for risk and set new deposit
insurance assessment rates, effective April 1, 2009. Under the proposed rule, the FDIC would first
establish an institution’s initial base assessment rate. This initial base assessment rate would range,
depending on the risk category of the institution, from ten to forty-five basis points. The FDIC would then
adjust the initial base assessment (higher or lower) to obtain the total base assessment rate. The
adjustment to the initial base assessment rate would be based upon an institution’s levels of unsecured
debt, secured liabilities, and brokered deposits. The total base assessment rate would range from eight to
77.5 basis points of the institution’s deposits. On December 22, 2008, the FDIC published a final rule
raising the current deposit insurance assessment rates uniformly for all institutions by seven basis points
(to a range from twelve to fifty basis points) for the first quarter of 2009. However, the FDIC approved an
extension of the comment period on the parts of the proposed rulemaking that would become effective on
April 1, 2009. The FDIC expects to issue a second final rule early in 2009, to be effective April 1, 2009,
to change the way that the FDIC’s assessment system differentiates for risk and to set new assessment
rates beginning with the second quarter of 2009.
Insurance of deposits may be terminated by the FDIC upon finding that an institution has engaged
in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated
any applicable law, regulation, rule, order or condition imposed by the FDIC. Management does not
currently know of any practice, condition or violation that might lead to termination of the deposit
insurance.
Temporary Liquidity Guarantee Program. On October 14, 2008, the FDIC announced a new
program- the Temporary Liquidity Guarantee Program. This program has two components – The Debt
Guarantee Program and the Transaction Account Guarantee Program. The Debt Guarantee Program
guarantees newly issued senior unsecured debt of a participating organization, up to certain limits
established for each institution, issued between October 14, 2008 and June 30, 2009. The FDIC will pay
the unpaid principal and interest on an FDIC-guaranteed debt instrument upon the uncured failure of the
participating entity to make a timely payment of principal or interest in accordance with the terms of the
instrument. The guarantee will remain in effect until June 30, 2012. In return for the FDIC’s guarantee,
participating institutions will pay the FDIC a fee based on the amount and maturity of the debt. The
Company has opted to participate in the Debt Guarantee Program.
The Transaction Account Guarantee Program provides full deposits insurance coverage for non-
interest bearing transaction deposit accounts, regardless of dollar amount, until December 31, 2009. An
annualized ten basis point assessment on balances in noninterest-bearing transaction accounts that exceed
the existing deposit insurance limit of $250,000 will be assessed on a quarterly basis to insured depository
institutions that have not opted out of this component of the Temporary Liquidity Guarantee Program.
The Company has opted to participate in the Transaction Account Guarantee Program.
-23-
- 23 -
Item 1A. Risk Factors
An investment in the Company’s common stock is subject to risks inherent to the Company’s
business. The material risks and uncertainties that management believes affect the Company are described
below. Before making an investment decision, you should carefully consider the risks and uncertainties
described below together with all of the other information included or incorporated by reference in this
report. The risks and uncertainties described below are the not the only ones facing the Company.
Additional risks and uncertainties that management is not aware of or focused on or that management
currently deems immaterial may also impair the Company’s business operations.
If any of the following risks actually occur, the Company’s financial condition and results of
operations could be materially and adversely affected. If this were to happen, the market price of the
Company’s common stock could decline significantly, and you could lose all or part of your investment.
Economy
The Company operates its banking and insurance business units within the geographic area
comprised of the northwest corner of Ohio, northeast Indiana and southeast Michigan. Weaknesses in this
geographic market area could be caused by such factors as an increase in the unemployment rate, a
decrease in real estate values, or significant increases in interest rates. Any such weakness could have a
negative impact on First Defiance’s earnings and financial condition because:
• Demand for financial products and services may go down;
• Borrowers may be unable to make payments on their loans;
• The value of collateral securing loans may decline;
• The overall quality of the loan portfolio may decline; and
• Local market-area deposits may decline, impacting the Company’s cost of funding and its
liquidity.
Dramatic declines in the housing market beginning in the latter half of 2007, with falling home
prices and increasing foreclosures, unemployment and underemployment, have negatively impacted the
credit performance of mortgage loans and resulted in significant write-downs of asset values by financial
institutions. The resulting write-downs to assets of financial institutions have caused many financial
institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to
seek government assistance or bankruptcy protection.
Many lenders and institutional investors have reduced and, in some cases, ceased to provide funding
to borrowers, including to other financial institutions because of concern about the stability of the
financial markets and the strength of counterparties. It is difficult to predict how long these economic
conditions will exist, which of our markets, products or other businesses will ultimately be affected, and
whether management’s actions will effectively mitigate these external factors. Accordingly, the resulting
lack of available credit, lack of confidence in the financial sector, decreased consumer confidence,
increased volatility in the financial markets and reduced business activity could materially and adversely
affect the Company’s business, financial condition and results of operations.
-24-
- 24 -
As a result of the challenges presented by economic conditions, the Company may face the
following risks in connection with these events:
• Inability of borrowers to make timely repayments of their loans, or decreases in value of real
estate collateral securing the payment of such loans resulting in significant credit losses, which
could result in increased delinquencies, foreclosures and customer bankruptcies, any of which
could have a material adverse effect on our operating results.
• Increased regulation of the financial services industry, including heightened legal standards and
regulatory requirements or expectations. Compliance with such regulation will likely increase
costs and may limit the Company’s ability to pursue business opportunities.
• Further disruptions in the capital markets or other events, including actions by rating agencies and
deteriorating investor expectations, may result in an inability to borrow on favorable terms or at
all from other financial institutions.
• Increased competition among financial services companies due to the recent consolidation of
certain competing financial institutions and the conversion of certain investment banks to bank
holding companies, which may adversely affect the Company’s ability to market our products
and services.
• Further increases in FDIC insurance premiums due to the market developments which have
significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured
deposits.
The capital and credit markets have been experiencing volatility and disruption for more than a year.
In recent months, the volatility and disruption has reached unprecedented levels. In some cases, the
markets have produced downward pressure on stock prices and credit availability for certain issuers
seemingly without regard to those issuers’ underlying financial strength. If current levels of market
disruption and volatility continue or worsen, there can be no assurance that First Defiance will not
experience an adverse effect, which may be material, on the Company’s ability to access capital and on
our business, financial condition and results of operations.
The market price for First Defiance’s common shares has been volatile in the past, and several
factors could cause the price to fluctuate substantially in the future, including:
• announcements of developments related to our business;
• fluctuations in our results of operations;
• sales of substantial amounts of our securities into the marketplace;
• general conditions in our markets or the worldwide economy;
• a shortfall in revenues or earnings compared to securities analysts’ expectations;
• changes in analysts’ recommendations or projections; and
• our announcement of new acquisitions or other projects.
Interest Rate Risk
The earnings and financial condition of First Defiance are dependent to a large degree upon net
interest income, which is the difference between interest earned from loans and investments and interest
paid on deposits and borrowings. The narrowing of the spread between interest earned on loans and
investments and interest paid on deposits and borrowings could adversely affect our earnings and
financial condition.
-25-
- 25 -
Interest rates are highly sensitive to many factors including:
• The rate of inflation;
• Economic conditions;
• Federal monetary policies; and
• Stability of domestic and foreign markets.
Changes in market interest rates will also affect the level of prepayments on loans as well as the
payments received on mortgage backed securities, requiring the reinvestment at lower rates than the loans
or securities were paying.
First Federal originates a significant amount of residential mortgage loans for sale and for our
portfolio. The origination of residential mortgage loans is highly dependent on the local real estate market
and the level of interest rates. Increasing interest rates tend to reduce the origination of loans for sale and
consequently fee income, which we report as mortgage banking income. Conversely, decreasing interest
rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the
value of mortgage servicing rights on the loans sold to be lower than originally anticipated. If this
happens, the Company may be required to write down the value of our mortgage servicing rights faster
than anticipated, which will increase expense and lower earnings.
Credit Risk
First Defiance’s earnings and financial condition may be adversely affected if the Company fails
to adequately manage credit risk. The Company’s primary business is the origination and underwriting of
loans. This business requires the Company to take “credit risk” which is the risk of losing principal and
interest income because borrowers fail to repay their loans. The ability of borrowers to repay their loans
and the value of collateral securing such loans may be affected by a number of factors including:
• A slowdown in the local economy where the Company’s markets are located or the national
economy;
• A downturn in the business sectors in which the Company’s loan customers operate; and
• A rapid increase in interest rates.
Liquidity Risk
Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. The
liquidity of the Company is used to make loans and to repay deposit liabilities as they become due or are
demanded by customers. Liquidity policies and limits are established by the board of directors, with limits
monitored by the Asset/Liability committee.
First Defiance’s sources of liquidity include both local deposits and wholesale funding sources.
Wholesale funding sources include FHLB advances, Federal Funds purchased, securities sold under
repurchase agreements, brokered or other out-of-market certificate of deposit purchases, and a line of
credit with a commercial bank. Also, the Company maintains a portfolio of securities that can be used as a
secondary source of liquidity. Other sources of liquidity that may be available if necessary include the
sale or securitization of loans, the issuance of additional collateralized borrowings beyond those currently
utilized with the FHLB, the issuance of debt securities and the issuance of preferred or common securities
in public or private transactions.
-26-
- 26 -
The inability of the Company to access the above listed sources of liquidity when needed could
cause First Federal to be unable to meet customer needs, which could adversely impact its financial
condition, results of operations, cash flow, or regulatory capital levels. For further discussion, see the
“Liquidity and Capital Resources” section of Management’s Discussion and Analysis of Financial
Condition and Results of Operations included in Item 7 of this Form 10-K.
Competition
Competition in the Company’s market area may reduce First Defiance’s ability to originate loans
and attract and retain deposits. First Defiance faces competition both in originating loans and attracting
deposits. Competition is intense in the financial services industry. The Company competes in its market
area by offering superior service and competitive rates and products. The type of institutions First
Defiance competes with include large regional commercial banks, smaller community banks, savings
institutions, mortgage banking firms, credit unions, finance companies, brokerage firms, insurance
agencies and mutual funds. As a result of their size and ability to achieve economies of scale, certain of
First Defiance’s competitors can offer a broader range of products and services than the Company can
offer. To stay competitive in its market area, First Defiance may need to adjust the interest rates on its
products to match rates of its competition, which will have a negative impact on net interest margin. The
Company’s continued profitability depends on its ability to continue to effectively compete in its market
areas.
Operational Risks
First Defiance processes a large volume of transactions on a daily basis and is exposed to
numerous types of risks resulting from inadequate or failed internal processes, people and systems. These
risks include but are not limited to the risk of fraud by persons inside or outside the Company, the
execution of unauthorized transactions by employees, errors relating to transaction processing and
systems, and breaches of the internal control system and compliance requirements. The risk of loss also
includes the potential legal actions that could arise as a result of operational deficiencies or as a result of
noncompliance with applicable regulatory standards.
The Company has established and maintains a system of internal controls that provide
management with information on a timely basis and allows for the monitoring of compliance with
operational standards. While not foolproof, these systems have been designed to manage operational risks
at an appropriate, cost effective level. Procedures exist that are designed to ensure that policies relating to
conduct, ethics, and business practices are followed. Periodically losses from operational risks may occur,
including the effects of operational errors. Such losses are included in non-interest expense as incurred.
While management continually monitors the system of internal control, as well as data processing
systems and corporate-wide processes and procedures, there can be no assurance that future losses will
not occur.
First Defiance’s operations are also dependent on the existing infrastructure, including equipment
and facilities. Extended disruption of vital infrastructure as a result of fire, power loss, natural disaster,
telecommunications failures, computer hacking or viruses, terrorist activity or the domestic response to
such activity, or other events outside of the control of management could have a material adverse impact
on the financial services industry as a whole and on First Defiance’s business, results of operations, cash
flows and financial condition in particular. First Defiance has a business recovery plan but there are no
assurances that such plan will work as intended or that it will prevent significant interruptions to
operations.
-27-
- 27 -
Government Regulation
First Defiance’s business may be adversely affected by changes in the regulatory environment or
by changes in government policies as a whole. The earnings of financial institutions such as First
Defiance and First Federal are affected by the policies of the regulatory authorities, including the Federal
Reserve Board, which regulates the money supply, and the OTS, which regulates unitary thrift holding
companies such as First Defiance and savings banks such as First Federal.
Among the methods employed by the Federal Reserve Board to regulate the money supply are
open market operations in U.S. Government securities, changes in the discount rate on member bank
borrowings, and changes in the reserve requirement against member bank deposits. These tools are
utilized by the Federal Reserve in varying combinations to influence overall growth and distribution of
bank loans, investments and deposits and they have a significant impact on interest rates charged on loans
and paid on deposits. The influence of the monetary policies of the Federal Reserve Board is expected to
have a continuing and profound effect on the operating results of commercial and savings banks.
Policies, administration guidelines, and regulatory practices of the OTS and other banking
regulators have a significant impact on the operations of First Federal and First Defiance. It is possible
that certain of those regulations will negatively impact the Company’s operating results or financial
condition.
The Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3,
2008. As part of EESA, the U.S. Treasury established the Troubled Assets Relief Program, including the
CPP, to provide up to $700 billion of funding to eligible financial institutions through the purchase of
capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the
U.S. financial markets. Then, on February 17, 2009, President Obama signed the American Recovery and
Reinvestment Act (“ARRA”), as a sweeping economic recovery package intended to stimulate the
economy and provide for broad infrastructure, energy, health, and education needs. There can be no
assurance as to the actual impact that EESA or its programs, including the CPP, and ARRA or its
programs, will have on the national economy or financial markets. The failure of these significant
legislative measures to help stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our business, financial condition, results
of operations, access to credit or the trading price of our common shares.
There have been numerous actions undertaken in connection with or following EESA and ARRA by
the Federal Reserve Board, Congress, the U.S. Treasury, the FDIC, the SEC and others in efforts to
address the current liquidity and credit crisis in the financial industry that followed the sub-prime
mortgage market meltdown which began in late 2007. These measures include homeowner relief that
encourages loan restructuring and modification; the establishment of significant liquidity and credit
facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency
action against short selling practices; a temporary guaranty program for money market funds; the
establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper
issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking
sector. The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system.
EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If
the volatility in the markets continues and economic conditions fail to improve or worsen, our business,
financial condition and results of operations could be materially and adversely affected.
-28-
- 28 -
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
At December 31, 2008, First Federal conducted its business from its main office at 601 Clinton
Street, Defiance, Ohio, and thirty-five other full service banking centers in northwestern Ohio,
northeastern Indiana, and southeastern Michigan. First Insurance conducted its business from leased
office space at 419 5th Street, Suite 1200, Defiance, Ohio and 209 West Poe Road, Bowling Green, Ohio.
First Defiance maintains its headquarters in the main office of First Federal at 601 Clinton Street,
Defiance, Ohio. Back-office operation departments, including information technology, loan processing
and underwriting, deposit processing, accounting and risk management are headquartered in an operations
center located at 25600 Elliott Road, Defiance, Ohio.
The following table sets forth certain information with respect to the office and other properties of
the Company at December 31, 2008. See Note 9 to the Consolidated Financial Statements.
-29-
- 29 -
Description/address
Leased/
Owned
Net Book Value
of Property
Deposits
(In Thousands)
Main Office, First Federal
601 Clinton St., Defiance, OH
Operations Center
25600 Elliott Rd., Defiance, OH
Mobile Banking
1011 W. Beecher St., Adrian, MI
Branch Offices, First Federal
204 E. High St., Bryan, OH
211 S. Fulton St., Wauseon, OH
625 Scott St., Napoleon, OH
1050 East Main St., Montpelier, OH
926 East High St., Bryan, OH
1800 Scott St., Napoleon, OH
1177 N. Clinton St., Defiance, OH
905 N. Williams St., Paulding, OH
201 E. High St., Hicksville, OH
3900 N. Main St., Findlay, OH
11694 N. Countyline St., Fostoria, OH
1226 W. Wooster, Bowling Green, OH
301 S. Main St., Findlay, OH
405 E. Main St., Ottawa, OH
124 E. Main St., McComb, OH
7591 Patriot Dr., Findlay, OH
417 W Dussell Dr., Maumee, OH
230 E. Second St., Delphos, OH
105 S. Greenlawn Ave., Elida, OH
2600 Allentown Rd., Lima, OH
2285 N. Cole St., Lima, OH
22020 W. State Rt. 51, Genoa, OH
2760 Navarre Ave., Oregon, OH
3426 Navarre Ave., Oregon, OH
1077 Louisiana Ave., Perrysburg, OH
2565 Shawnee Rd., Lima, OH
7437 Coldwater Rd., Fort Wayne, IN
135 South Main St., Glandorf, OH
300 N. Main St., Adrian, MI
1701 W. Maumee St., Adrian, MI
211 W. Main St., Morenci, MI
539 S. Meridian, Hudson, MI
8 W. Carleton Rd., Hillsdale, MI
1449 W. Chicago Blvd., Tecumseh, MI
501 E. Chicago Blvd., Tecumseh, MI
First Insurance & Investments
419 5th Street, Suite 1200, Defiance, OH
209 West Poe Road, Bowling Green, OH
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned, Land Lease
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned, Land Lease
Owned
Owned
Owned
Owned
Owned
Owned, Land Lease
Owned
Owned
Owned
Leased
Leased
Owned
Owned
Owned
Owned
Leased
Owned
Leased
$
4,976
$ 258,681
6,150
224
838
577
1,241
425
90
1,507
1,116
895
442
1,144
738
1,149
1,251
398
230
1,259
1,036
1,203
376
899
455
994
252
752
1,204
1,662
147
0
857
172
190
658
161
1,618
16
N/A
N/A
110,825
56,858
65,134
34,282
6,623
24,904
34,566
37,052
21,406
44,622
25,057
70,803
36,544
72,652
21,701
27,531
37,964
90,160
33,176
33,439
8,996
39,852
22,075
0
21,750
14,802
15,595
4,737
58,147
43,145
24,836
29,953
12,307
9,523
20,214
Leased
Leased
166
21
$ 37,489
N/A
N/A
$ 1,469,912
-30-
- 30 -
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 Security Holders
No matters were submitted to a vote of securities holders during the fourth quarter of 2008.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
The Company’s common stock trades on The Nasdaq Global Select Market under the symbol
“FDEF.” As of March 6, 2009, the Company had 2,615 shareholders of record.
The table below shows the reported high and low sales prices of the common stock and cash
dividends declared per share of common stock during the periods indicated in 2007 and 2008.
Years Ending
December 31, 2008
Low
High
Dividend
High
December 31, 2007
Low
Dividend
Quarter ended:
March 31
June 30
September 30
December 31
$ 22.51
20.00
17.66
14.50
$ 17.30
15.90
10.00
6.00
$ .26
.26
.26
.17
$ 30.25
30.00
29.64
26.93
$ 27.25
26.71
23.99
20.58
$ .25
.25
.25
.26
As a result of participating in the CPP, First Defiance is prohibited, without prior approval of the
U.S. Treasury, from paying a quarterly cash dividend of more than $0.26 per share until the earlier of
December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an
unaffiliated third party.
First Defiance’s ability to pay dividends to its shareholders is primarily dependent on the ability
of the Subsidiaries to pay dividends to First Defiance. The OTS imposes various restrictions or
requirements on the ability of a subsidiary of a savings and loan holding company to make capital
distributions. Capital distributions include, without limitation, payments of cash dividends, repurchases
and certain other acquisitions by an association of its shares and payments to stockholders of another
association in an acquisition of such other association.
An application must be submitted and approval from the OTS must be obtained by a subsidiary of a
savings and loan holding company (i) if the proposed distribution would cause total distributions for the
calendar year to exceed net income for that year to date plus the savings association’s retained net income
for the preceding two years; (ii) if the savings association will not be at least adequately capitalized
following the capital distribution; or (iii) if the proposed distribution would violate a prohibition
contained in any applicable statute, regulation or agreement between the savings association and the OTS
(or the FDIC), or a condition imposed on the savings association in an OTS-approved application or
notice. If a savings association subsidiary of a holding company is not required to file an application, it
must file a notice of the proposed capital distribution with the OTS. First Federal paid $10.0 million in
dividends to First Defiance during 2008 and $0 in 2007.
-- 30 --
- 31 -
The line graph below compares the yearly percentage change in cumulative total shareholder return on
First Defiance common stock and the cumulative total return of the NASDAQ Composite Index, the SNL
NASDAQ Bank Index and the SNL Midwest Thrift Index. An investment of $100 on December 31, 2003,
and the reinvestment of all dividends are assumed. The performance graph represents past performance and
should not be considered to be an indication of future performance.
Index
First Defiance Financial Corp.
NASDAQ Composite
SNL Bank NASDAQ Index
SNL Midwest Thrift Index
Period Ending
12/31/03
100.00
100.00
100.00
100.00
12/31/04
114.89
108.59
114.61
110.43
12/31/05
111.38
110.08
111.12
107.91
12/31/06
128.94
120.56
124.75
122.48
12/31/07
97.33
132.39
97.94
103.45
12/31/08
36.59
78.72
71.13
91.93
Total Return Performance
160
140
120
100
80
60
40
20
0
e
u
l
a
V
x
e
d
n
I
First Defiance Financial Corp.
NASDAQ Composite
SNL Bank NASDAQ
SNL Midwest Thrift
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
First Defiance did not have any common stock repurchases during the 2008 fourth quarter, but has
93,124 shares that may be purchased under a plan announced by the Board of Directors on July 18, 2003.
Participation in the CPP prohibits the Company from repurchasing any of its common shares without the
prior approval of the U.S. Treasury until the earlier of December 5, 2011 or the date the U.S. Treasury’s
preferred stock is redeemed or transferred to an unaffiliated third party.
- 32 -
- 31 -
Item 6. Selected Financial Data
The following table is derived from the Company’s audited financial statements as of and for the
five years ended December 31, 2008. The following consolidated selected financial data should be read in
conjunction with Management’s Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and related notes included elsewhere in this Form
10-K. The operating results of the acquired companies are included with the Company’s results of
operations since their respective dates of acquisition.
Financial Condition:
Total assets
Investment securities
Loans held-to maturity, net
Allowance for loan losses
Nonperforming assets (1)
Deposits and borrowers’ escrow balances
FHLB advances
Stockholders’ equity
Share Information:
Basic earnings per share
Diluted earnings per share
Book value per common share
Tangible book value per common share
Cash dividends per common share
Weighted average diluted shares outstanding
Shares outstanding end of period
Operations:
Interest income
Interest expense
Net interest income
Provision for loan losses
Non-interest income
Non-interest expense
Income before tax
Federal income tax
Net Income
Performance Ratios:
Return on average assets
Return on average equity
Interest rate spread (2)
Net interest margin (2)
Ratio of operating expense to
average total assets
Efficiency ratio
Capital Ratios:
Equity to total assets at end of period
Tangible equity to tangible assets
at end of period
Average equity to average assets
Asset Quality Ratios:
Nonperforming assets to total assets
at end of period (1)
Allowance for loan losses to total
loans receivable
Net charge-offs to average loans
2008
$1,957,400
118,461
1,592,643
24,592
41,267
1,470,564
156,067
229,159
As of and For the Year Ended December 31
2006
(Dollars in Thousands, Except Per Share Data
2005
2007
2004
$1,609,404
113,487
1,275,806
13,890
11,677
1,218,620
139,536
165,954
$1,527,879
112,123
1,226,310
13,579
9,675
1,139,112
162,228
159,825
$ 1,461,082
114,854
1,164,481
13,673
5,356
1,070,106
180,960
151,216
$ 1,126,667
139,258
878,912
9,956
1,991
797,979
178,213
126,874
$
$
0.91
0.91
23.67
15.67
0.95
7,911
8,117
103,463
41,268
62,195
12,585
19,069
57,794
10,885
3,528
7,357
0.40%
3.85%
3.51%
3.80%
3.12%
67.74%
11.71%
6.72%
10.30%
$
1.96
1.94
23.51
17.79
1.01
7,178
7,059
98,751
50,089
48,662
2,306
22,130
48,113
20,373
6,469
13,904
0.90%
8.48%
3.17%
3.55%
3.11%
67.96%
$
$
2.22
2.18
22.38
16.99
0.97
7,163
7,142
93,065
44,043
49,022
1,756
19,624
43,839
23,051
7,451
15,600
1.04%
10.03%
3.36%
3.68%
2.93%
63.31%
1.75
1.69
21.34
15.81
0.90
7,096
7,085
76,174
28,892
47,282
1,442
15,925
43,942
17,823
5,853
11,970
0.88%
8.26%
3.63%
3.87%
3.22%
70.18%
1.77
1.69
20.20
17.19
0.82
6,371
6,280
54,731
20,381
34,350
1,548
13,996
31,200
15,598
4,802
10,796
1.01%
8.57%
3.37%
3.60%
2.98%
65.91%
10.31%
10.46%
10.35%
11.26%
8.00%
10.62%
8.15%
10.40%
7.88%
10.62%
9.74%
11.76%
2.11%
0.73%
0.63%
0.37%
1.52%
0.38%
1.08%
0.16%
1.10%
0.15%
1.16%
0.07%
0.18%
1.13%
0.05%
(1)
(2)
Nonperforming assets consist of non-accrual loans that are contractually past due 90 days or more; loans that are deemed impaired
under the criteria of FASB Statement No. 114; loans that have been restructured; and real estate, mobile homes and other assets
acquired by foreclosure or deed-in-lieu thereof.
Interest rate spread represents the difference between the weighted average yield on interest-earnings assets and the weighted
average rate on interest-bearing liabilities. Net interest margin represents net interest income as a percentage of average interest-
earnings assets. Interest income on tax-exempt securities and loans has been adjusted to a tax-equivalent basis using the statutory
federal income tax rate of 35%.
- 33 -
- 32 -
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements and Factors that Could Affect Future Results
Certain statements contained in this Annual Report on Form 10-K that are not statements of
historical fact constitute forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (“Act”), notwithstanding that such statements are not specifically
identified as such. In addition, certain statements may be contained in the Corporation’s future filings
with the SEC, in press releases, and in oral and written statements made by or with the approval of the
Corporation that are not statements of historical fact and constitute forward-looking statements within the
meaning of the Act. Examples of forward-looking statements include, but are not limited to:
(i) projections of revenues, expenses, income or loss, earnings or loss per common share, the payment or
nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives
and expectations of First Defiance or its management or Board of Directors, including those relating to
products or services; (iii) statements of future economic performance; and (iv) statements of assumptions
underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”,
“continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify
forward-looking statements but are not the exclusive means of identifying such statements.
Forward-looking statements involve risks and uncertainties that may cause actual results to differ
materially from those in such statements. Factors that could cause actual results to differ from those
discussed in the forward-looking statements include, but are not limited to:
�
Local, regional, national and international economic conditions and the impact they may have on
the Corporation and its customers and the Corporation’s assessment of that impact.
�
Volatility and disruption in national and international financial markets.
�
Government intervention in the U.S. financial system.
�
Changes in the level of non-performing assets and charge-offs.
�
Changes in estimates of future reserve requirements based upon the periodic review thereof under
relevant regulatory and accounting requirements.
�
The effects of and changes in trade and monetary and fiscal policies and laws, including the
interest rate policies of the Federal Reserve Board.
�
Inflation, interest rate, securities market and monetary fluctuations.
�
Political instability.
�
Acts of God or of war or terrorism.
�
The timely development and acceptance of new products and services and perceived overall
value of these products and services by users.
�
Changes in consumer spending, borrowings and savings habits.
�
Changes in the financial performance and/or condition of the Corporation’s borrowers.
�
Technological changes.
�
Acquisitions and integration of acquired businesses.
�
The ability to increase market share and control expenses.
�
Changes in the competitive environment among financial holding companies and other financial
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service providers.
service providers.
�
The effect of changes in laws and regulations (including laws and regulations concerning taxes,
The effect of changes in laws and regulations (including laws and regulations concerning taxes,
banking, securities and insurance) with which the Corporation and its subsidiaries must comply.
banking, securities and insurance) with which the Corporation and its subsidiaries must comply.
�
The effect of changes in accounting policies and practices, as may be adopted by the regulatory
The effect of changes in accounting policies and practices, as may be adopted by the regulatory
agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting
agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting
Standards Board and other accounting standard setters.
Standards Board and other accounting standard setters.
�
The costs and effects of legal and regulatory developments including the resolution of legal
The costs and effects of legal and regulatory developments including the resolution of legal
proceedings or regulatory or other governmental inquiries and the results of regulatory
proceedings or regulatory or other governmental inquiries and the results of regulatory
examinations or reviews.
examinations or reviews.
�
Greater than expected costs or difficulties related to the integration of new products and lines of
Greater than expected costs or difficulties related to the integration of new products and lines of
business.
business.
�
The Corporation’s success at managing the risks involved in the foregoing items.
The Corporation’s success at managing the risks involved in the foregoing items.
Forward-looking statements speak only as of the date on which such statements are made. The
Forward-looking statements speak only as of the date on which such statements are made. The
Corporation undertakes no obligation to update any forward-looking statement to reflect events or
Corporation undertakes no obligation to update any forward-looking statement to reflect events or
circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated
circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated
events.
events.
Recent Market Developments
Recent Market Developments
In response to the financial crises affecting the banking system and financial markets and the
In response to the financial crises affecting the banking system and financial markets and the
going concern threats to investment banks and other financial institutions, on October 3, 2008, the
growing concern threats to investment banks and other financial institutions, on October 3, 2008, the
Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. Pursuant to the EESA,
Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law. Pursuant to the EESA,
the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of
the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of
mortgages, mortgage-backed securities and certain other financial instruments from financial institutions
mortgages, mortgage-backed securities and certain other financial instruments from financial institutions
for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
On October 14, 2008, the Secretary of the Department of the Treasury announced that the
On October 14, 2008, the Secretary of the Department of the Treasury announced that the
Department of the Treasury will purchase equity stakes in a wide variety of banks and thrifts. Under the
Department of the Treasury will purchase equity stakes in a wide variety of banks and thrifts. Under the
program, known as the Troubled Asset Relief Program Capital Purchase Program (“CPP”), from the
program, known as the Troubled Asset Relief Program Capital Purchase Program (“CPP”), from the
$700 billion authorized by the EESA, the Treasury made $250 billion of capital available to U.S.
$700 billion authorized by the EESA, the Treasury made $250 billion of capital available to U.S.
financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock,
financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock,
the Treasury received, from participating financial institutions, warrants to purchase common stock with
the Treasury received, from participating financial institutions, warrants to purchase common stock with
an aggregate market price equal to 15% of the preferred investment. Participating financial institutions
an aggregate market price equal to 15% of the preferred investment. Participating financial institutions
were required to adopt the Treasury’s standards for executive compensation and corporate governance for
were required to adopt the Treasury’s standards for executive compensation and corporate governance for
the period during which the Treasury holds equity issued under the CPP. On December 5, 2008, First
the period during which the Treasury holds equity issued under the CPP. On December 5, 2008, First
Defiance issued to the U.S. Treasury 37,000 shares of First Defiance’s Fixed Rate Cumulative Perpetual
Defiance issued to the U.S. Treasury 37,000 shares of First Defiance’s Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, par value $0.01 per share, with a liquidation preference of $1,000 per share,
Preferred Stock, Series A, par value $0.01 per share, with a liquidation preference of $1,000 per share,
and a warrant to purchase 550,595 First Defiance common shares at an exercise price of $10.08 per share,
and a warrant to purchase 550,595 First Defiance common shares at an exercise price of $10.08 per share,
subject to certain anti-dilution and other adjustments.
subject to certain anti-dilution and other adjustments.
On November 21, 2008, the Board of Directors of the Federal Deposit Insurance Corporation
On November 21, 2008, the Board of Directors of the Federal Deposit Insurance Corporation
(“FDIC”) adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”).
(“FDIC”) adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”).
The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of
The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of
systemic risk by the Secretary of the Department of Treasury (after consultation with the President), as an
systemic risk by the Secretary of the Department of Treasury (after consultation with the President), as an
initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLG Program the
initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLG Program the
FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior
FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior
unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009
unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009
and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit
and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit
accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum
accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum
and Interest on Lawyers Trust Accounts (“IOLTA”) accounts held at participating FDIC - insured
and Interest on Lawyers Trust Accounts (“IOLTA”) accounts held at participating FDIC - insured
institutions through December 31, 2009. Coverage under the TLG Program was available for the first
institutions through December 31, 2009. Coverage under the TLG Program was available for the first
30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis
30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis
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points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for
deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding
$250,000. On December 5, 2008, the Corporation elected to participate in both guarantee programs.
The American Recovery and Reinvestment Act of 2009 signed into law on February 17, 2009 by the
President, is designed to jolt the ailing United States economy by providing government spending and tax cuts
for both individuals and businesses. Management is currently assessing the impact this legislation will have on
the Company’s financial statements.
The following section presents information to assess the financial condition and results of operations
of First Defiance. This section should be read in conjunction with the consolidated financial statements and
the supplemental financial data contained elsewhere in this Annual Report.
Overview
First Defiance is a unitary thrift holding company which conducts business through its subsidiaries, First
Federal Bank of the Midwest (“First Federal”) and First Insurance and Investments (“First Insurance”).
First Federal is a federally chartered stock savings bank that provides financial services to communities
based in northwest Ohio, northeast Indiana, and southeastern Michigan where it operates 36 full service
banking centers in 12 northwest Ohio counties, 1 northeast Indiana county, and 2 southeastern Michigan
counties.
On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc. and its wholly-
owned subsidiary, Bank of Lenawee, which was headquartered in Adrian, Michigan. First Defiance agreed to
purchase each outstanding share of Pavilion for 1.4209 shares of First Defiance common stock plus $37.50 in
cash. The cash portion of the acquisition was financed from existing sources of liquidity, including a line of
credit facility at First Defiance. For more details on the Pavilion acquisition, see Note 3 – Acquisitions in the
Notes to the Financial Statements.
First Federal provides a broad range of financial services including checking accounts, savings
accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity
loans and trust and wealth management services through its extensive branch network.
First Insurance sells a variety of property and casualty, group health and life, and individual health
and life insurance products. Insurance products are sold through First Insurance’s offices in Defiance and
Bowling Green, Ohio.
On February 28, 2007, First Defiance acquired Huber, Harger, Welt and Smith (“HHWS”), an
insurance agency headquartered in Bowling Green, Ohio for a purchase price comprised of 76,435 shares of
First Defiance common stock and future consideration to be paid in 2009 and 2010. Management has
determined goodwill of $1.7 million and identifiable intangible assets of $800,000 consisting of customer
relationship intangible of $620,000 and a non-compete intangible of $180,000. For more details on the
HHWS acquisition, see Note 3 – Acquisitions in the Notes to the Financial Statements.
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Financial Condition
Assets at December 31, 2008 totaled $1.96 billion compared to $1.61 billion at December 31,
2007, an increase of $347.8 million or 21.6%. The majority of First Defiance’s asset growth was due in
large part to the Pavilion acquisition which added approximately $288.0 million in assets. The increase in
assets was funded through growth in deposits, which increased by $252.1 million or 20.7%, to $1.47
billion at December 31, 2008 from $1.22 billion at December 31, 2007. For more details on the impact
the Pavilion acquisition had on the balance sheet, see Note 3 – Acquisitions in the Notes to the Financial
Statements.
Securities
The securities portfolio increased $5.0 million to $118.5 million at December 31, 2008. The
activity in the portfolio in 2008 included $31.8 million of purchases, $9.1 million of acquired securities,
$30.4 million of amortization and maturities and a net decrease of $2.5 million in market value on
available-for-sale securities.
Loans
Gross loans receivable increased by $327.5 million or 25.4% to $1.62 billion at December 31,
2008 from $1.29 billion at December 31, 2007. Through the acquisition of Pavilion, First Defiance
acquired gross loans (including purchase accounting adjustments) of $50.0 million in single family
residential loans, $6.0 million in multi-family residential loans, $100.9 million in non-residential real
estate loans, $49.2 million in commercial loans, $2.8 million in auto loans, $25.7 million in home equity
and improvement loans and $2.2 million in other loans. Excluding the Pavilion acquisition, gross loans
receivable increased by $84.2 million or 6.6% in 2008. For more details on the loan balances acquired in
the Pavilion acquisition, see Note 7 – Loans Receivable and/or Note 3 – Acquisitions in the Notes to the
Financial Statements.
The majority of First Defiance’s non-residential real estate and commercial loans are to small and
mid-sized businesses. The combined commercial, non-residential real estate and multi-family real estate
loan portfolios totaled $1.1 billion and $884.9 million at December 31, 2008 and 2007 respectively and
accounted for approximately 68.8% and 68.6% of First Defiance’s loan portfolio at the end of those
respective periods. First Defiance believes it has been able to establish itself as a leader in its market area
in the commercial and commercial real estate lending area by hiring experienced lenders and providing a
high level of customer service to its commercial lending clients.
The one-to-four family residential portfolio, including residential construction loans, totaled
$324.7 million at December 31, 2008, up from $245.1 million at the end of 2007. At the end of 2008
those loans comprised 20.1% of the total loan portfolio, up from 19.0% at December 31, 2007.
Home equity and home improvement loans grew to $161.1 million at December 31, 2008, up
from $128.1 million at the end of 2007. For both periods, home equity and improvement loans
represented 9.9% of total loans.
Consumer finance loans were just $41.0 million at December 31, 2008, up from $37.7 million at
the end of 2007. These loans comprised just 2.5% and 2.9% of the total portfolio at December 31, 2008
and 2007 respectively.
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Allowance for Loan Losses and Classified Assets
The allowance for loan losses represents management’s assessment of the estimated probable
credit losses in the loan portfolio at each balance sheet date. Management analyzes the adequacy of the
allowance for loan losses regularly through reviews of the loan portfolio. Consideration is given to
economic conditions, changes in interest rates and the effect of such changes on collateral values and
borrower’s ability to pay, changes in the composition of the loan portfolio, and trends in past due and
non-performing loan balances. The allowance for loan losses is a material estimate that is susceptible to
significant fluctuation and is established through a provision for loan losses based on management’s
evaluation of the inherent risk in the loan portfolio. In addition to extensive in-house loan monitoring
procedures, the Company utilizes an outside party to conduct an independent loan review of all
commercial loan and commercial real estate loan relationships that exceed $250,000 of aggregate
exposure. Management utilizes the results of this outside loan review to assess the effectiveness of its
internal loan grading system as well as to assist in the assessment of the overall adequacy of the
allowance for loan losses associated with these types of loans.
At December 31, 2008, the allowance for loan losses was $24.6 million compared to $13.9
million at December 31, 2007, an increase of $10.7 million or 77.0%. Those balances represented 1.52%
and 1.08% of outstanding loans as of December 31, 2008 and December 31, 2007 respectively. The
increase was mainly the result of the deterioration of economic conditions in 2008 that posed many
challenges for the banking industry. Real estate values have declined and some collateral dependent loans
no longer have enough collateral value to support the outstanding balance. Management has expanded its
credit monitoring functions in response to the deteriorated market conditions. Additional asset review
functions and more delinquent loan reporting requirements have been added to assist in this monitoring.
Management will continually review credit concentrations by the industry and has placed lower limits on
lending within certain types of loan categories. Management has also segmented the commercial real
estate portfolio to track the general performance of these segments to further refine the predictive process
of identifying potential problem loans. Of the $6.1 million of net charge-offs in 2008, $557,000 was
provided for in the allowance for loan losses at December 31, 2007.
Total classified loans increased to $85.8 million at December 31, 2008, compared to $51.2
million at December 31, 2007. At December 31, 2008, a total of $29.8 million of loans are classified as
substandard for which some level of reserve ranging between 5% and 100% of the outstanding balance is
required. A total of $49.5 million in additional credits were classified as substandard at December 31,
2008 for which no reserve is required because of factors such as the level of collateral or the strength of
guarantors. First Defiance also has classified $946,000 of assets doubtful at December 31, 2008. By
contrast, at December 31, 2007, a total of $16.7 million of loans were classified as substandard for which
some level of reserve was required and $34.5 million were classified as substandard which did not require
any reserve. $359,000 was classified as doubtful at December 31, 2007.
First Defiance’s ratio of allowance for loan losses to non-performing loans dropped from 150.7%
at the end of 2007 to 71.8% at December 31, 2008. Management monitors collateral values of all loans
included on the watch list that are collateral dependent and believes that allowances for those loans at
December 31, 2008 are appropriate.
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At December 31, 2008, First Defiance had total non-performing assets of $41.3 million,
compared to $11.7 million at December 31, 2007. Non-performing assets include loans that are 90 days
past due, restructured loans and all real estate owned and other foreclosed assets. Non-performing assets
at December 31, 2008 and 2007 by category were as follows:
Non-performing loans:
Single-family residential
Construction
Non-residential and multi-family residential real estate
Commercial
Consumer finance
Restructured loans, still accruing
Total non-performing loans
Real estate owned and repossessed assets
Total non-performing assets
December 31
2008
2007
(In thousands)
$5,008
72
19,980
2,881
76
6,250
34,267
7,000
$41,267
$2,608
266
5,651
675
17
-
9,217
2,460
$11,677
The increase in non-performing loans between December 31, 2007 and December 31, 2008 is
primarily in non-residential and multi-family real estate and commercial loans. The combined balance of
these types of non-performing loans was $16.5 million higher at December 31, 2008 compared to
December 31, 2007. Approximately $4.4 million of 2007 non-performing loans are still considered non-
performing loans at December 31, 2008 and no real estate owned at December 31, 2008 was in non-
performing non-residential real estate loans at December 31, 2007. The commercial and non-residential
real estate and multi-family real estate loans that are non-performing at December 31, 2008 are comprised
of seventy-seven relationships, with eleven relationships making up $14.6 million of the $22.9 million
total. The allowance for loan losses includes $3.8 million for those eleven relationships. By comparison,
at December 31, 2007, nineteen loans made up the $6.6 million of commercial and non-residential real
estate and multi-family real estate loans that were non-performing and the largest two loans comprised
$4.9 million of the total.
Non-performing loans in the single-family residential, non-residential and multi-family
residential real estate and commercial loan categories represent 1.48%, 2.94% and 1.63% of the total
loans in those categories respectively at December 31, 2008 compared to 0.73%, 0.98% and 0.24%
respectively for the same categories at December 31, 2007. While the level of non-performing loans has
increased, year over year, management believes that the current allowance for loan losses is appropriate
and that the provision for loan losses recorded in 2008 is consistent with both charge-off experience and
the strength of the overall credits in the portfolio.
Management also assesses the value of real estate owned as of the end of each accounting period
and recognizes write-downs to the value of that real estate in the income statement if conditions dictate. In
2008, First Defiance recorded OREO write-downs that totaled $144,000. These amounts were included in
other non-interest expense. Management believes that the values recorded at December 31, 2008 for real
estate owned and repossessed assets represent the realizable value of such assets.
First Defiance also utilizes a general reserve percentage for loans not otherwise classified which
ranges from 0.22% for mortgage loans to 1.05% for commercial and non-residential real estate loans. The
reserve percentage utilized for those loans is based on both historical losses in the Company’s portfolio,
national statistics on loss percentages provided by the FDIC, and empirical evidence regarding the
strength of the economy in the First Defiance’s general market area.
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Loans Acquired with Impairment
Certain loans acquired in the ComBanc, Genoa, and Pavilion acquisitions had evidence that the
credit quality of the loan had deteriorated since its origination and in management’s assessment at the
acquisition date it was probable that First Defiance would be unable to collect all contractually required
payments due. In accordance with American Institute of Certified Public Accountants Statement of
Position 03-3 – Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3),
these loans were recorded based on management’s estimate of the fair value of the loans. At the
acquisition date of January 21, 2005, loans with a contractual receivable of $3.4 million were acquired
from Combanc which were deemed impaired. Those loans were recorded at a net realizable value of $2.0
million. On April 8, 2005, loans with contractual receivable totals of $1.5 million were acquired from
Genoa which were deemed impaired. Those loans were recorded at a net realizable value of $721,000. On
March 14, 2008, loans with contractual receivable totals of $6.4 million were acquired from Pavilion and
were deemed impaired. Those loans were recorded at a net realizable value of $4.4 million.
As of December 31, 2008, the total contractual receivable for those loans was $8.9 million and
the recorded value was $5.8 million.
High Loan-to-Value Mortgage Loans
The majority of First Defiance’s mortgage loans are collateralized by one-to-four-family
residential real estate, have loan-to-value ratios of 80% or less, and are made to borrowers in good credit
standing. First Federal usually requires residential mortgage loan borrowers whose loan-to-value is
greater than 80% to purchase private mortgage insurance (PMI). Management also periodically reviews
and monitors the financial viability of its PMI providers.
First Federal does originate and retain a limited number of residential mortgage loans with loan-
to-value ratios that exceed 80% where PMI is not required if the borrower possesses other demonstrable
strengths. The loan-to-value ratios on these loans are generally limited to 85% and exceptions must be
approved by First Federal’s senior loan committee. Management monitors the balance of one-to-four
family residential loans, including home equity loans and committed lines of credit that exceed certain
loan to value standards (90% for owner occupied residences, 85% for non-owner occupied residences and
one-to-four family construction loans, 75% for developed land and 65% for raw land). Total loans that
exceed those standards at December 31, 2008 were $33.0 million, compared to $25.9 million at December
31, 2007. These loans are generally paying as agreed.
First Defiance does not make interest-only first-mortgage residential loans, nor does it have
residential mortgage loan products, or other consumer products that allow negative amortization.
Goodwill and Intangible Assets
Goodwill increased $19.8 million to $56.6 million at December 31, 2008, from $36.8 million at
December 31, 2007, the result of the Pavilion acquisition. No impairment of goodwill was recorded in
2008 or 2007. Core deposit intangibles and other intangible assets increased $4.8 million during 2008 to
$8.3 million from $3.6 million at the end of 2007. The Pavilion acquisition increased intangibles by $6.3
million in 2008, which was offset by the recognition of $1.5 million of amortization expense during the
year.
Deposits
Total deposits at December 31, 2008 were $1.47 billion compared to $1.22 billion at December
31, 2007, an increase of $252.1 million or 20.7%. Through the acquisition of Pavilion,, First Defiance
acquired deposits (including purchase accounting adjustments) of $43.8 million in non-interest-bearing
checking accounts, $41.5 million in interest-bearing checking accounts, $26.2 million in savings
accounts, and $97.9 million in certificates of deposit. Excluding the Pavilion acquisition, total deposits
grew $42.7 million in 2008. Non-interest bearing checking accounts grew by $54.5 million, money
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market and interest bearing checking accounts grew by $32.1 million, savings grew by $26.3 million, and
certificates of deposit increased by $101.1 million. Management periodically utilizes the national market
for certificates of deposit to supplement its funding needs. The balance of national CD’s increased to
$38.5 million at December 31, 2008, from $408,000 at December 31, 2007. For more details on the
deposit balances in general or those acquired in the Pavilion acquisition, see Note 11 – Deposits and/or
Note 3 – Acquisitions in the Notes to the Financial Statements.
Borrowings
FHLB advances totaled $156.1 million at December 31, 2008 compared to $139.5 million at
December 31, 2007. The balance at the end of 2008 includes $64.0 million of convertible advances with
rates ranging from 2.35% to 5.84%. These advances are all callable by the FHLB, at which point they
would convert to a three-month LIBOR advance if not paid off. Those advances have final maturity dates
ranging from 2010 to 2018. In addition, First Defiance has advances totaling $27 million that are callable
by the FHLB only if the three-month LIBOR rate exceeds a strike rate ranging from 7.5% to 8.0%. The
rate on those advances ranges from 3.48% to 5.14%. First Defiance also has $45.0 million of three-month
LIBOR-based advances with rates ranging from 2.19% to 4.52%. First Defiance also has $11.0 million of
fixed-rate advances with rates ranging from 2.60% to 4.10% and has $9.1 million of overnight advances
at December 31, 2008.
First Defiance also has $49.5 million of securities that have been sold at December 31, 2008 with
agreements to repurchase, compared to $30.1 million of repurchase funding at December 31, 2007.
In March 2007, the Company issued $15.5 million of Subordinated Debentures. These debentures
were issued to an unconsolidated affiliated trust that purchased them with the proceeds from a $15 million
issue of trust preferred securities to an outside party. The proceeds of the Subordinated Debentures were
used for general corporate purposes. The Subordinated Debentures have a fixed rate equal to 6.441% for
the first five years and a floating interest rate based on three-month LIBOR plus 1.50% thereafter. First
Defiance also has $20.6 million of subordinated debentures issued in 2005 which have a rate equal to
three-month LIBOR plus 1.38%, or 3.38% at December 31, 2008.
Capital Resources
Total shareholders’ equity increased $63.2 million to $229.2 million at December 31, 2008. This
increase is primarily the result of the Company’s $7.4 million of net income, $27.1 million of common
stock issued in conjunction with the acquisition of Pavilion (for more information on the Pavilion
acquisition, see the above caption – Overview), and $37.0 million of preferred stock issued to the U.S
Treasury (for more information relating to the preferred stock issuance, see the above caption - Recent
Market Developments). The increases were offset by $7.7 million of common dividends ($0.95 per share
declared) and the Company’s repurchase of its common stock. In 2003, the Company’s board of directors
authorized the repurchase of 640,000 shares. A total of 29,735 shares were repurchased in 2008 under that
program at an average cost of $21.36 per share, thus reducing stockholders’ equity by $635,000. A total
of 93,124 shares remain to be purchased under the authorization. Participation in the CPP prohibits the
Company from repurchasing its common shares without prior approval of the U.S. Treasury until the
earlier of December 5, 2011 or the date the Treasury’s preferred stock is redeemed or transferred to an
unaffiliated third party.
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Results of Operations
Summary
First Defiance reported net income of $7.4 million for the year ended December 31, 2008
compared to $13.9 million and $15.6 million for the years ended December 31, 2007 and 2006,
respectively. Net income applicable to common shares was $7.2 million in 2008. On a diluted per
common share basis, First Defiance earned $0.91 in 2008, $1.94 in 2007 and $2.18 in 2006.
The 2008 net income amount includes $1.1 million of acquisition related costs that were incurred
as part of the Pavilion acquisition. These costs included such items as the expense to terminate certain
contracts, retention bonuses with key employees, and other costs resulting from the acquisition or related
transition efforts. After tax, these costs amounted to $726,000, or $0.09 per share. Excluding these items,
core earnings were $8.1 million for the year ended December 31, 2008. On a diluted per share basis, core
earnings amounted to $1.00, $1.94 and $2.18 for the years ended December 31, 2008, 2007 and 2006,
respectively. Management believes that the presentation of the non-GAAP financial measures assists
when comparing results period-to-period in a meaningful and consistent manner and provides a better
measure of results for First Defiance’s ongoing operations. A reconciliation of GAAP earnings to core
earnings is as follows:
GAAP Net Income
One-time acquisition related charges
Tax effect
Core Operating Earnings
Basic earnings per common share:
GAAP
Core Operating Earnings
Diluted earnings per common share:
GAAP
Core Operating Earnings
$
$
$
$
$
$
2008
Year Ended December 31,
2007
(in thousands)
13,904
$
−
−
13,904
$
$
$
7,357
1,117
(391)
8,083
0.91
1.01
0.91
1.00
$
$
$
$
1.96
1.96
1.94
1.94
$
$
$
$
2006
15,600
−
−
15,600
2.22
2.22
2.18
2.18
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.
Net interest income was $62.2 million for the year ended December 31, 2008 compared to $48.7
million and $49.0 million for the years ended December 31, 2007 and 2006, respectively. The tax-
equivalent net interest margin was 3.80%, 3.55% and 3.68% for the years ended December 31, 2008,
2007 and 2006, respectively. The increase in margin between 2007 and 2008 is due to a widening of the
interest rate spread, which increased to 3.51% for the year ended December 31, 2008 compared to 3.17%
for 2007. The increase in spread between 2008 and 2007 was a result of the cost of interest bearing
liabilities between the two periods decreasing by 119 basis points (to 2.79% in 2008 from 3.98% in
2007), which is offset by interest-earning asset yields decreasing by 85 basis points (to 6.30% in 2008
from 7.15% in 2007). The Pavilion acquisition coupled with the average balance of non-interest bearing
deposits increasing $55.3 million in 2008 from 2007 contributed to the margin improvement.
The decrease in margin between 2007 and 2006 is due to a declining interest rate spread, which
decreased to 3.17% for the year ended December 31, 2007 compared to 3.37% for 2006. The decline in
spread between 2007 and 2006 occurred due to interest-earning asset yields increasing by just 20 basis
points (to 7.15% in 2007 from 6.95% in 2006) while the cost of interest bearing liabilities between the
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two periods increased by 40 basis points (to 3.98% in 2007 from 3.58% in 2006). The margin
compression caused by the narrowing interest rate spread was mitigated somewhat by a $9.2 million
increase in the average balance of non-interest bearing deposits in 2007 compared to 2006 and an $8.5
million increase in average shareholders’ equity between the two periods.
Total interest income increased by $4.7 million, or 4.8% to $103.5 million for the year ended
December 31, 2008 from $98.8 million for the year ended December 31, 2007. The increase in interest
income was due to an increase in the average balance in loans receivable, to $1.51 billion for the twelve
months of 2008 compared to $1.24 billion for 2007. Interest income from loans increased to $96.5 million
for 2008 compared to $90.9 million in 2007 which represented growth of 6.2%.
During the same period the average balance of investment securities increased to $118.0 million
for 2008 from $112.6 million for the year ended December 31, 2007. Interest income from the investment
portfolio increased $21,000 to stay relatively flat at $5.7 million in 2008 and 2007. The tax-equivalent
yield on the investment portfolio was 5.43% in 2008 compared to 5.68% in 2007. The investment
portfolio yield decreased despite a widening of the overall duration of investments, to 4.0 years at
December 31, 2008 from 3.7 years at December 31, 2007.
Interest expense decreased by $8.8 million in 2008 compared to 2007, to $41.3 million from
$50.1 million. This decrease was due to a 119 basis point decline in the average cost of interest-bearing
liabilities in 2008 which more than offset the $221.3 million increase in the average balance of those
liabilities in 2008. The balance of interest-bearing deposits increased by $166.4 million at December 31,
2008 compared to December 31, 2007. Interest expense related to interest-bearing deposits was $31.4
million in 2008 and $40.4 million in 2007. Expenses on FHLB advances and other interest bearing
funding sources were $6.4 million and $1.6 million respectively in 2008 and $6.9 million and $729,000
respectively in 2007. First Defiance issued $15.5 million of junior subordinated debentures in the first
quarter of 2007 in conjunction with a trust preferred offering by an unconsolidated affiliated subsidiary.
Interest expense recognized by the Company related to subordinated debentures was $1.9 million in 2008
compared to $2.1 million in 2007.
Total interest income increased by $5.7 million, or 6.1% to $98.8 million for the year ended
December 31, 2007 from $93.1 million for the year ended December 31, 2006. The increase in interest
income was due to an increase in the average balance in loans receivable, to $1.24 billion for the twelve
months of 2007 compared to $1.21 billion for 2006. In addition to the increase in loan balances, the
average tax-equivalent yield on loans increased to 7.32% for 2007 compared to 7.13% in 2006, a 19 basis
point improvement. Interest income from loans increased to $90.9 million for 2007 compared to $86.2
million in 2006 which represented growth of 5.4%.
During the same period the average balance of investment securities dropped to $112.6 million
for 2007 from $116.7 million for the year ended December 31, 2006. Interest income from the investment
portfolio increased $90,000 to $5.7 million in 2007 from $5.6 million in 2006. The increase is due to the
38 basis point increase in the tax-equivalent yield as lower yielding securities matured and higher yielding
securities were purchased in 2007. The tax-equivalent yield on the investment portfolio was 5.68% in
2007 compared to 5.30% in 2006. The investment portfolio yield increased despite a narrowing of the
overall duration of investments, to 3.7 years at December 31, 2007 from 4.1 years at December 31, 2006.
Interest expense increased by $6.1 million in 2007 compared to 2006, to $50.1 million from $44.0
million. This increase was due to a $28.4 million increase in the average balance of interest bearing
liabilities in 2007 compared to 2006 as well as a 40 basis point increase in the average cost of those
liabilities. The balance of interest-bearing deposits increased by $64.2 million at December 31, 2007
compared to December 31, 2006. Interest expense related to interest-bearing deposits was $40.4 million
in 2007 and $33.3 million in 2006. Expenses on FHLB advances and other interest bearing funding
sources were $6.9 million and $729,000 respectively in 2007 and $8.9 million and $577,000 respectively
in 2006. First Defiance issued $15.5 million of junior subordinated debentures in the first quarter of 2007
in conjunction with a trust preferred offering by an unconsolidated affiliated subsidiary and $20.6 million
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of similar debentures in an offering in October, 2005. Interest expense recognized by the Company
related to subordinated debentures was $2.1 million in 2007 compared to $1.3 million in 2006.
The following table shows an analysis of net interest margin on a tax equivalent basis for the years ended
December 31, 2008, 2007 and 2006:
Year Ended December 31,
Average
Balance
2008
Interest
(1)
Yield/
Rate (2)
(In Thousands)
2007
Interest
(1)
(Dollars in Thousands)
Yield/
Rate (2)
Average
Balance
Average
Balance
2006
Interest
(1)
Yield/
Rate (2)
$1,511,877
117,972
5,383
20,493
$96,627
6,548
123
1,062
6.39%
5.43%
2.28%
5.18%
$1,241,817
112,577
18,161
18,585
$90,913
6,414
924
1,226
7.32% $1,209,498 $86,237
6,217
116,718
5.68%
165
3,483
5.09%
1,042
17,926
6.60%
7.13%
5.30%
4.74%
5.81%
1,655,725
104,360
6.30% 1,391,140
99,477
7.15%
1,347,625
93,661
6.95%
Interest-Earning Assets:
Loans receivable
Securities
Interest-earning deposits
Dividends on FHLB stock
Total interest-earning
assets
Non-interest-earning
assets
196,620
Total Assets
$1,852,345
153,229
$1,544,369
148,136
$1,495,761
Interest-Bearing Liabilities:
Interest-bearing deposits
FHLB advances
Other borrowings
Subordinated debentures
Total interest-bearing
liabilities
Non-interest bearing
demand deposits
Total including non-
interest- bearing
demand deposits
Other non-interest
liabilities
Total Liabilities
Stockholders’ equity
Total liabilities and
stockholders’ equity
Net interest income;
interest rate spread (3)
Net interest margin (4)
Average interest-earning
assets to average interest-
bearing liabilities
$1,231,363 $31,354
6,375
160,407
50,962 1,632
36,242
1,907
2.55%
3.97%
3.20%
5.26%
$1,064,960 $40,356
6,889
136,484
23,841 729
32,435 2,115
3.79%
5.05%
3.06%
6.52%
$1,006,468
181,869
20,398
20,619
$33,273
8,885
577
1,308
3.31%
4.88%
2.86%
6.34%
1,478,974
41,268
2.79%
1,257,720
50,089
3.98%
1,229,354
44,043
3.58%
159,452
−
104,200
−
95,044
−
1,638,426
41,268
2.52%
1,361,920
50,089
3.68%
1,324,398
44,043
3.33
23,047
1,661,473
190,872
$ 1,852,345
18,391
1,380,311
164,058
$1,544,369
15,815
1,340,213
155,548
$1,495,761
$63,092
3.51%
$49,388
3.17%
$49,618
3.37%
3.80%
112.0%
3.55%
110.6%
3.68%
109.6%
(1)
Interest on certain tax exempt loans (amounting to $195,000, $87,000 and $48,000 in 2008, 2007 and 2006 respectively) and tax-exempt securities
($1.5 million, $1.3 million and $1.1 million in 2008, 2007 and 2006) is not taxable for Federal income tax purposes. The average balance of such
loans was $4.2 million, $1.8 million and $1.0 million in 2008, 2007 and 2006 while the average balance of such securities was $32.5 million, $27.3
million and $25.2 million in 2008, 2007 and 2006 respectively. In order to compare the tax-exempt yields on these assets to taxable yields, the
interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%.
(2)
At December 31, 2008, the yields earned and rates paid were as follows: loans receivable, 6.21%; securities,4.98%; FHLB stock, 5.00%; total
interest-earning assets, 6.21%; deposits, 1.98%; FHLB advances,3.80%; other borrowings,4.69%; total interest-bearing liabilities, 2.15%; and
interest rate spread, 4.07%.
(3)
(4)
Interest rate spread is the difference in the yield on interest-earning assets and the cost of interest-bearing liabilities.
Net interest margin is net interest income divided by average interest-earning assets.
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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 tax-equivalent interest income
and interest expense during the periods indicated. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume
(change in volume multiplied by prior year rate), (ii) change in rate (change in rate multiplied by
prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both
rate and volume has been allocated proportionately to the change due to rate and the change due to
volume.
Year Ended December 31,
Increase
(decrease)
due to
rate
2008 vs. 2007
Increase
(decrease)
due to
volume
Total
increase
(decrease)
Increase
(decrease)
due to
rate
2007 vs. 2006
Increase
(decrease)
due to
volume
Total
increase
(decrease)
$(12,472)
(168)
$ 18,186
302
$ 5,714
134
$ 2,341
423
$ 2,335
(226)
$ 4,676
197
(352)
(281)
(449)
117
(801)
(164)
13
145
746
39
759
184
$(13,273)
$ 18,156
$ 4,883
$ 2,922
$ 2,894
$ 5,816
$(14,640)
(1,605)
36
(438)
$ 5,638
1,091
867
230
$ (9,002)
(514)
903
(208)
$ 5,069
286
49
37
$ 2,014
(2,282)
103
770
$ 7,083
(1,996)
152
807
$(16,647)
$ 7,826
$ (8,821)
$ 5,441
$
605
$ 6,046
Interest-Earning Assets
Loans
Securities
Interest-earning
deposits
FHLB stock
Total interest-earning
assets
Interest-Bearing Liabilities
Deposits
FHLB advances
Term notes
Subordinated Debentures
Total interest- bearing
liabilities
Increase (decrease) in net interest income
$ 13,704
$
(230)
Provision for Loan Losses – First Defiance’s provision for loan losses was $12.6 million for the
year ended December 31, 2008 compared to $2.3 million and $1.8 million for the years ended December
31, 2007 and 2006 respectively.
Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a
level deemed appropriate by management to absorb probable losses incurred in the loan portfolio. Factors
considered by management include identifiable risk in the portfolios; historical experience; the volume
and type of lending conducted by First Defiance; the amount of non-performing assets, including loans
which meet the FASB Statement No. 114 definition of impaired; the amount of assets graded by
management as substandard, doubtful, or loss; general economic conditions, particularly as they relate to
First Defiance’s market areas; and other factors related to the collectability of First Defiance’s loan
portfolio. See also Allowance for Loan Losses in Management’s Discussion and Analysis and Note 7 to
the audited financial statements.
Non-interest Income – Non-interest income decreased by $3.0 million or 13.8% in 2008 to $19.1
million from $22.1 million for the year ended December 31, 2007. That followed an increase of $2.5
million or 12.8% in 2007 from $19.6 million in 2006. Service fees and other charges increased to $13.3
million for the year ended December 31, 2008 from $10.8 million for 2007 and $9.3 million for 2006; an
increase of $2.5 million or 23.0% from 2007 to 2008 and an increase of $1.5 million, or 16.0% from 2006
to 2007. The growth in fee income in 2008 is primarily related to the additional accounts acquired in the
Pavilion acquisition. The growth in 2007 was primarily related to checking account charges, the result of
the implementation of an overdraft product in March of 2006.
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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 based both on the return of processing
costs plus a profit, and on the level of fees charged by competitors in the Company’s market area for
similar services. These fees are considered to be compensation for providing a service to the customer and
therefore deemed to be non-interest income rather than interest income. Fee income recorded for the years
ending December 31, 2008 and 2007 related to the overdraft privilege product, net of adjustments to the
allowance for uncollectible overdrafts, were $8.4 million and $7.4, respectively. Accounts charged off are
included in non-interest expense. The period over period increase is due to the increased usage of the
program by customers coupled with the additional accounts acquired in the Pavilion acquisition. The
allowance for losses was established June 30, 2006 with a balance of $156,000. The allowance for losses
was $125,000 at December 31, 2008 and $133,000 at December 31, 2007.
Non-interest income also includes investment securities gains or losses. In 2008, First Defiance
realized a $3.2 million loss on securities compared to a $21,000 gain in 2007 and a $2,000 loss in 2006.
In 2008, First Defiance recognized other-than-temporary impairment (“OTTI”) charges for certain
impaired investment securities, where in management’s opinion, the value of the investment will not be
recovered. In the third quarter of 2008, a $1.9 million OTTI charge was recorded relating to the perpetual
preferred securities issued by Fannie Mae and Freddie Mac. The OTTI was determined by management as
a result of the action taken by the United States Treasury Department and the Federal Housing Finance
Agency on September 7, 2008, which placed Fannie Mae and Freddie Mac into conservatorship. First
Defiance invested $1.0 million each in preferred stock of Fannie Mae and Freddie Mac in January of
2008 and as of September 30, 2008, that stock had a combined market value of $151,000. The combined
market value as of December 31, 2008 was $49,000 but management believes that the decline in market
value from September 30, 2008 is not OTTI. Also in 2008, management recorded $1.3 million of OTTI
on its investment in the equity notes of three trust preferred collateralized debt obligations (“CDOs”) as a
result of management’s analysis of the securities. At December 31, 2008, the market value of those
CDOs, which had a total original cost of $2.0 million, had been written down to $419,000. There was
only a minor amount of sales activity in the investment portfolio in 2008 and 2007.
Mortgage banking income includes gains from the sale of mortgage loans, fees for servicing
mortgage loans for others, and an offset for amortization of mortgage servicing rights, and adjustments
for impairment in the value of mortgage servicing rights. Mortgage banking income totaled $3.0 million,
$3.6 million and $3.4 million in 2008, 2007 and 2006 respectively. The $622,000 decline in 2008 from
2007 was primarily attributable to the impairment charge of $2.7 million on the mortgage servicing rights
and the increase of $618,000 in amortization of mortgage servicing rights primarily due to the material
decline in long-term mortgage rates during the month of December, which caused an increase in
prepayment assumptions. The decline is 2008 was offset by a $831,000 increase in mortgage servicing
fees resulting from a $385.8 million increase in the portfolio of mortgage loans serviced for others and
gains from sale of mortgage loans, which increased $1.8 million in 2008 from 2007. The interest rate
environment that produces increased mortgage origination activity also typically causes increases in
mortgage servicing rights amortization and impairment, creating somewhat of a natural hedge in the
mortgage banking line of business. The $223,000 of growth in 2007 over 2006 was primarily attributable
to a $130,000 increase in mortgage servicing fees resulting from a $50.1 million increase in the portfolio
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of mortgage loans serviced for others and gains from sale of mortgage loans, which increased $167,000 in
2007 from 2006. The balance of the impairment allowance stands at $2.8 million at the end of 2008. See
Note 8 to the financial statements.
Insurance and investment commission income increased by $218,000 or 4.1% in 2008, primarily
due to increases in revenue from employee benefits and property and casualty commissions in 2008.
These increases were partially offset by a $31,000 decrease in contingent commission. Insurance and
investment commission income increased by $747,000 or 16.5% in 2007, primarily due to the February
2007 acquisition of HHWS located in Bowling Green, Ohio. Commission income associated with that
agency acquisition totaled $1.0 million in 2007. Insurance commissions also were favorably impacted by
an $80,000 increase in contingent commission income in 2007 ($275,000 if you include the contingent
commission received by the HHWS Agency, which is included in their $1.0 million 2007 commissions).
Contingent commissions are bonus payments received by First Defiance’s insurance subsidiary for
effective underwriting. These increases were offset by a $450,000 decline in commissions from the sale
of investment products. This decline is the result of a change in strategy in this line of business, to
providing more fee-based investment advice, versus selling primarily commission-based products.
Non-interest Expense – Total non-interest expense for 2008 was $57.8 million compared to
$48.1 million for the year ended December 31, 2007 and $43.8 million for the year ended December 31,
2006. The 2008 total includes $1.1 million of acquisition related charges. Non-interest expense, excluding
the acquisition related charges in 2008 was $56.7 million.
Compensation and benefits increased by $3.6 million in 2008 compared to 2007, to $28.8 million
from $25.2 million. A portion of the increase in compensation was due to having nine and a half months
of compensation and benefits costs associated with the Pavilion acquisition in 2008. The balance of the
increase in compensation and benefits resulted from year-over-year merit increases and an increase in
staff to support the operations of the Company. Occupancy costs for 2008 increased to $7.5 million from
$6.1 million in 2007, with over half of that increase associated with the Pavilion acquisition. Data
processing costs increased $834,000 in 2008 from 2007 directly related to the Pavilion acquisition. First
Defiance’s other non-interest expense category also increased to $15.7 million in 2008 from $12.9 million
in 2007. The most significant reason for the increase in that category was a $813,000 increase in
amortization expense of intangibles relating to the core deposit and customer relationship intangible in
conjunction with the Pavilion acquisition and a $727,000 expense associated with losses related to a
former investment advisor which was recorded after the denial of coverage under the Company’s fidelity
bond. Other items which caused the increase in this expense category include higher levels of advertising
(up $166,000), credit and collection expenses (up $402,000) and state franchise tax (up $372,000).
The increase in non-interest expense in 2007 from 2006 was primarily due to the following:
compensation and benefits increased by $1.4 million in 2007 compared to 2006, to $25.2 million from
$23.8 million. A portion of the increase in compensation was due to having ten months of compensation
and benefits costs associated with the HHWS acquisition in 2007. The balance of the increase in
compensation and benefits resulted from general staffing increases, including staffing for the Fort Wayne,
Indiana banking center which opened in August 2007, and cost of living pay increases. Occupancy costs
for 2007 increased to $6.1 million from $5.1 million in 2006, with nearly half of that increase associated
with clean-up costs and repairs necessary in First Federal’s downtown Findlay and Ottawa Ohio banking
centers. These offices were severely damaged by the worst flooding of Ohio’s Blanchard River in nearly a
century. Total flood related costs were approximately $497,000 which included clean up expenses, the
cost to repair or replace computer equipment, heating and air conditioning units, drywall, window
coverings and carpeting. In addition to occupancy costs, $87,000 of other costs associated with the
flooding were recorded in 2007, mainly the loss on disposal of fixed assets destroyed in the flood at the
two impacted banking offices. First Defiance’s other non-interest expense category also increased to
$12.9 million in 2007 from $11.2 million in 2006. The most significant reason for the increase in that
category was a $709,000 increase in expenses associated with Other Real Estate Owned, including
$698,000 of write-downs in property values. Other items which caused the increase in this expense
category include higher levels of advertising (up $399,000), fraud losses and other related deposit account
losses (up $175,000) and overdraft protection fees (up $120,000).
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Income Taxes – Income taxes amounted to $3.5 million in 2008 compared to $6.5 million in
2007 and $7.5 million in 2006. The effective tax rates for those years were 32.4%, 31.8%, and 32.3%
respectively. The tax rate is lower than the statutory 35% tax rate for the Company mainly because of
investments in tax-exempt securities. The earnings on tax-exempt securities are not subject to federal
income tax. See note 18 to the financial statements for further details.
Concentrations of Credit Risk
Financial institutions such as First Defiance generate income primarily through lending and
investing activities. The risk of loss from lending and investing activities includes the possibility that
losses may occur from the failure of another party to perform according to the terms of the loan or
investment agreement. This possibility is known as credit risk.
Lending or investing activities that concentrate assets in a way that exposes the Company to a material
loss from any single occurrence or group of occurrences increases credit risk. Diversifying loans and
investments to prevent concentrations of risks is one manner a financial institution can reduce potential losses
due to credit risk. Examples of asset concentrations would include multiple loans made to a single borrower
and loans of inappropriate size relative to the total capitalization of the institution. Management believes
adherence to its loan and investment policies allows it to control its exposure to concentrations of credit risk at
acceptable levels. First Defiance’s loan portfolio is concentrated geographically in its northwest Ohio,
northeast Indiana, and southeastern Michigan market areas. Management has also identified lending for
income-generating rental properties as an industry concentration. Total loans for income generating property
totaled $442.0 million at December 31, 2008, which represents 27.2% of the Company’s loan portfolio.
Management believes it has the skill and experience to manage any risks associated with this type of lending.
Loans in this category are generally paying as agreed without any unusual or unexpected levels of
delinquency. The delinquency rate in this category, which is any loan 30 days or more past due, was 2.01% at
December 31, 2008. There are no other industry concentrations that exceed 10% of the Company’s loan
portfolio.
Liquidity and Capital Resources
The Company’s primary source of liquidity is its core deposit base, raised through First Federal’s branch
network, along with wholesale sources of funding and its capital base. These funds, along with investment
securities, provide the ability to meet the needs of depositors while funding new loan demand and existing
commitments.
Cash generated from operating activities was $21.9 million, $18.7 million and $21.7 million in 2008,
2007 and 2006 respectively. The adjustments to reconcile net income to cash provided by or used in
operations during the periods presented consist primarily of proceeds from the sale of loans (less the
origination of loans held for sale), the provision for loan losses, depreciation expense, the origination,
amortization and impairment of mortgage servicing rights, 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
operating and financing activities, as well as proceeds from payment on existing loans and proceeds from
maturities of investment securities. On March 14, 2008, First Defiance completed the acquisition of Pavilion,
which was purchased with a combination of stock and cash, First Defiance realized a decrease in cash of $23.9
million. In 2007, First Defiance completed the acquisition of HHWS, financed with the issuance of First
Defiance shares of common stock, and realized an increase in cash of $190,000.
In considering the more typical investing activities, during 2008, $30.2 million was generated from
the maturity of available-for-sale investment securities, while $114.7 million was used to fund loan growth
and $31.8 million was used to purchase available-for-sale investment securities. During 2007, $25.4 million
and $2.5 million was generated from the maturity or sale of available-for-sale investment securities,
respectively, while $67.7 million was used to fund loan growth and $28.9 million was used to purchase
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available-for-sale investment securities. During 2006, $16.6 million and $3.1 million was generated from the
maturity or sale of available-for-sale investment securities, respectively, while $73.1 million was used to fund
loan growth and $17.6 million was used to purchase available-for-sale investment securities.
Principal financing activities include the gathering of deposits, the utilization of FHLB advances, and the
sale of securities under agreements to repurchase such securities and borrowings from other banks. In
addition, First Defiance also purchased common stock for its treasury. For 2008, total deposits increased by
$43.1 million, excluding the deposits acquired in the Pavilion acquisition, including $5.0 million of growth in
retail deposits. The amount of deposits acquired from out of market sources increased in 2008 by $38.1
million. For 2007, total deposits increased by $79.4 million, including $96.6 million of growth in retail deposit
balances. The amount of deposits acquired from out of market sources declined in 2007 by $17.2 million. For
2006, total deposits increased by $69.3 million, including $88.3 million of growth in retail deposit balances.
The amount of deposits acquired from out of market sources declined in 2006 by $19.4 million. Also in 2008,
short-term advances from the FHLB decreased by $2.2 million and there were no borrowings on lines of
credit from other banks. Securities sold under repurchase arrangements increased by $7.2 million. In 2007,
short-term advances from the FHLB decreased by $21.8 million and there were no borrowings on lines of
credit from other banks. Also securities sold under repurchase arrangements decreased by $369,000. In 2006,
Short-term advances from the FHLB increased by $4.6 million and there were no borrowings on lines of
credit from other banks. Also securities sold under repurchase arrangements increased by $4.7 million. In
2007, First Defiance issued $15.5 million of subordinated debentures to an unconsolidated affiliated trust and
that trust issued $15 million of trust preferred stock to outside investors. In 2008, First Defiance issued $37.0
million of preferred stock to the U.S. Treasury. 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, 2008, First Defiance had the following commitments to fund deposit, advance and
borrowing obligations:
Contractual Obligations
Maturity Dates by Period at December 31, 2008
Total
Less than
1 year
1-3 years
(In Thousands)
$322,695
−
83,879
−
−
206
774
$407,554
4-5 years
After 5
years
$4,650
−
58,605
−
−
140
332
$63,727
$970
−
18,672
36,083
−
−
2,927
$58,652
Certificates of deposit
FHLB overnight advances
FHLB fixed advances including interest (1)
Subordinated debentures
Securities sold under repurchase agreements
Unrecognized tax benefits
Lease obligations
Total contractual obligations
(1) Includes principal payments of $146,967 and interest payments of $20,189
$787,215
9,100
167,156
36,083
49,454
444
4,507
$1,053,959
$458,900
9,100
6,000
−
49,454
98
474
$524,026
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- 48 -
At December 31, 2008, First Defiance had the following commitments to fund loan or line of credit
obligations:
Commitments
Residential real estate
loans in process
Commercial loans in process
One-to-four family mortgage loan
originations
Multifamily originations
Other real estate originations
Nonmortgage loan originations
Consumer lines of credit
Commercial lines of credit
Total loan commitments
Total
Amounts
Committed
Amount of Commitment Expiration by Period
Less than 1
year
1-3 years
(In Thousands)
4-5 years
After 5
years
$28,796
10,592
8,414
4,313
37,414
3,294
117,731
138,096
348,650
$18,410
5,913
$ 10,386
4,679
8,414
4,313
31,461
3,294
13,041
124,483
209,329
−
−
4,339
−
19,835
12,284
51,523
$ −
−
−
−
1,614
−
23,212
329
25,155
$ −
−
−
−
−
−
61,643
1,000
62,643
Standby letters of credit
18,927
8,661
10,000
166
100
Total Commitments
$367,577
$217,990
$61,523
$25,321
$62,743
In addition to the above commitments, at December 31, 2008, First Defiance had commitments to sell
$72.9 million of loans to Freddie Mac, Fannie Mae, Federal Home Loan Bank of Cincinnati or BB&T
Mortgage.
To meet its obligations, management can adjust the rate of savings certificates to retain deposits in
changing interest rate environments; it can sell or securitize mortgage and non-mortgage loans; and it can turn
to other sources of financing including FHLB advances, the Federal Reserve Bank, and brokered certificates
of deposit. At December 31, 2008 First Defiance had $57.9 million capacity under its agreements with the
FHLB.
First Defiance is subject to various capital requirements of the OTS. At December 31, 2008, First Federal
had capital ratios that exceeded the standard to be considered “well capitalized”. For additional information
about First Federal’s capital requirements, see Note 17 – Regulatory Matters to the Consolidated December
31, 2008 Financial Statements.
Critical Accounting Policies
First Defiance has established various accounting policies which govern the application of accounting
principles generally accepted in the United States in the preparation of its financial statements. The significant
accounting policies of First Defiance are described in the footnotes to the consolidated financial statements.
Certain accounting policies involve significant judgments and assumptions by management, which have a
material impact on the carrying value of certain assets and liabilities; management considers such accounting
policies to be critical accounting policies. The judgments and assumptions used by management are based on
historical experience and other factors, which are believed to be reasonable under the circumstances. Because
of the nature of the judgments and assumptions made by management, actual results could differ from these
judgments and estimates, which could have a material impact on the carrying value of assets and liabilities and
the results of operations of First Defiance.
Allowance for Loan Losses: First Defiance believes the allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in preparation of its consolidated
financial statements. In determining the appropriate estimate for the allowance for loan losses, management
considers a number of factors relative to both specific credits in the loan portfolio and
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macro-economic factors relative to the economy of the United States as a whole and the economy of the
northwest Ohio, northeast Indiana and southeast Michigan regions in which the Company does business.
Factors relative to specific credits that are considered include a customer’s payment history, a
customer’s recent financial performance, an assessment of the value of collateral held, knowledge of the
customer’s character, the financial strength and commitment of any guarantors, the existence of any customer
or industry concentrations, changes in a customer’s competitive environment, and any other issues that may
impact a customer’s ability to meet his obligations.
Economic factors that are considered include levels of unemployment and inflation, specific plant or
business closings in the Company’s market area, the impact of strikes or other work stoppages, the impact of
weather or environmental conditions, especially relative to agricultural borrowers and other matters that may
have an impact on the economy as a whole.
In addition to the identification of specific customers who may be potential credit problems,
management considers its historical losses, the results of independent loan reviews, an assessment of the
adherence to underwriting standards, the loss experience being reported by other financial institutions
operating in the Company’s market area, and other factors in providing for loan losses that have not been
specifically classified. While management believes its allowance for loan losses is conservatively determined
based on the above factors, it does not believe the allowances to be excessive or unnecessary. Refer to the
section titled “Allowance for Loan Losses” and Note 2, Statement of Accounting Policies for a further
description of the Company’s estimation process and methodology related to the allowance for loan losses.
Valuation of Mortgage Servicing Rights: First Defiance believes the valuation of mortgage servicing
rights is a critical accounting policy that requires significant estimates in preparation of its consolidated
financial statements. First Defiance recognizes as separate assets the value of mortgage servicing rights, which
are acquired through loan origination activities. First Defiance does not purchase any mortgage servicing
rights.
Key assumptions made by management relative to the valuation of mortgage servicing rights include
the stratification policy used in valuing servicing, assumptions relative to future prepayments of mortgages,
the potential value of any escrow deposits maintained or ancillary income received as a result of the servicing
activity and discount rates used to value the present value of a future cash flow stream. In assessing the value
of the mortgage servicing rights portfolio, management utilizes a third party that specializes in valuing
servicing portfolios. That third party reviews key assumptions with management prior to completing the
valuation. Prepayment speeds are determined based on projected median prepayment speeds for 15 and 30
year mortgage backed securities. Those speeds are then adjusted up or down based on the size of the loan. The
discount rate used in this analysis is the pretax yield generally required by purchasers of bulk servicing rights
as of the valuation date. The value of mortgage servicing rights is especially vulnerable in a falling interest
rate environment. Refer also to the section entitled Mortgage Servicing Rights and Note 2 - Statement of
Accounting Policies, and Note 8 - Mortgage Banking, for a further description of First Defiance’s valuation
process, methodology and assumptions along with sensitivity analyses.
Valuation of Securities: First Defiance believes the valuation of certain securities is a critical
accounting policy that requires significant estimates in preparation of its consolidated financial
statements. This is pertaining to the Company’s investment in certain trust preferred debt obligations
securities (“CDOs”). As required by SFAS 115, when a decline in fair value below cost is deemed to be
other-than-temporary, the unrealized loss must be recognized as a charge to earnings. The fair value of
these CDOs, which are backed by trust preferred securities issued by banks, thrifts and insurance
companies, have a fair value of $3.9 million. The market for these securities at December 31, 2008 is not
active and markets for similar securities are also not active. The inactivity was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which CDOs trade and then by a
significant decrease in the volume of trades relative to historical levels. The new issue market is also
inactive as no new CDOs have been issued since 2007. There are currently very few market participants
who are willing and or able to transact for these securities.
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The market values for these securities (and any securities other than those issued or guaranteed by
the U.S. Treasury) are very depressed relative to historical levels. Thus in today’s market, a low market
price for a particular bond may only provide evidence of stress in the credit markets in general versus
being an indicator of credit problems with a particular issue.
Given the conditions in the debt markets today and the absence of observable transactions in the
secondary and new issue markets, management has determined: 1) The few observable transactions and
market quotations that are available are not reliable for purposed of determining fair value at December
31, 2008; 2) An income valuation approach technique (present value technique) that maximizes the use of
relevant observable inputs and minimizes the use of observable inputs will be equally or more
representative of fair value than the market approach valuation used at the prior measurement dates and 3)
The Company’s CDOs will be classified within Level 3 of the fair value hierarchy because management
determined that significant adjustments were required to determine fair value at the measurement date.
The Company’s CDO valuations were prepared by an independent third party. Their approach
to determining fair value involved several steps: 1) Detailed credit and structural evaluation of each piece
of collateral in the CDO; 2) Collateral performance projections for each piece of collateral in the CDO
(default, recovery and prepayment/amortization probabilities) and 3) Discounted cash flow modeling.
Item 7a: Quantitative and Qualitative Disclosures About Market Risk
Asset/Liability Management
A significant portion of the Company’s revenues and net income is derived from net interest
income and, accordingly, the Company strives to manage its interest-earning assets and interest-bearing
liabilities to generate an appropriate contribution from net interest income. Asset and liability
management seeks to control the volatility of the Company’s performance due to changes in interest rates.
The Company attempts to achieve an appropriate relationship between rate sensitive assets and rate
sensitive liabilities. First Defiance does not presently use off balance sheet derivatives to enhance its risk
management.
First Defiance monitors interest rate risk on a monthly basis through simulation analysis that
measures the impact changes in interest rates can have on net interest income. The simulation technique
analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with
management’s estimate of the range of potential interest rate fluctuations) and takes into account
prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity
deposit assumptions and capital requirements. The results of the simulation indicate that in an
environment where interest rates rise 100 basis points over a 12 month period, First Defiance’s net
interest income would increase by just 1.82% over the base case scenario. It should be noted that other
areas of First Defiance’s income statement, such as gains from sales of mortgage loans and amortization
of mortgage servicing rights are also impacted by fluctuations in interest rates but are not considered in
the simulation of net interest income.
The majority of First Defiance’s lending activities are in non-residential real estate and
commercial loan areas. While such loans carry higher credit risk than residential mortgage lending, they
tend to be more rate sensitive than residential mortgage loans. The balance of First Defiance’s non-
residential and multi-family real estate loan portfolio was $755.7 million, which was split between $158.2
million of fixed-rate loans and $597.5 million of adjustable-rate loans at December 31, 2008. The
commercial loan portfolio increased to $356.6 million, which is split between $149.0 million of fixed-rate
loans and $207.6 million of adjustable-rate loans at December 31, 2008. Certain of the loans classified as
adjustable have fixed rates for an initial term that may be as long as five years. The maturities on fixed-
rate loans are generally less than 7 years. First Defiance also has significant balances of home equity and
improvement loans ($161.1 million at December 31, 2008), of which $78.4 million fluctuate with changes
in the prime lending rate. Approximately $87.7 million of home equity and improvement loans have fixed
rates but the maturities on those loans range from three to five years. First Defiance also has consumer
loans ($41.0 million at December 31, 2008) which tend to have a shorter duration than residential
- 52 -
- 51 -
mortgage loans. Also, to limit its interest rate risk, (as well as to provide liquidity) First Federal sells a
majority of its fixed-rate mortgage originations into the secondary market.
In addition to the simulation analysis, First Federal also prepares an “economic value of equity”
(“EVE”) analysis. This analysis calculates the net present value of First Federal’s assets and liabilities in
rate shock environments that range from –300 basis points to +300 basis points. The likelihood of a
decrease in interest rates as of December 31, 2008 was considered to be remote given the current interest
rate levels and therefore, was not included in this analysis. The results of this analysis are reflected in the
following table.
December 31, 2008
Economic Value of Equity
Change in Rates
$ Amount
$ Change
% Change
Economic Value of Equity as % of
Present Value of Assets
Ratio
Change
+ 300 bp
+ 200 bp
+ 100 bp
0 bp
(Dollars in Thousands)
250,485
261,652
271,860
279,785
(29,300)
(18,133)
(7,925)
–
(10.47%)
(6.48%)
(2.83%)
–
13.49%
13.83%
14.12%
14.28%
(79) bp
(45) bp
(16) bp
–
Based on the above analysis, in the event of a 200 basis point increase in interest rates as of
December 31, 2008, First Federal would experience a 6.48% decrease in its economic value of equity.
During periods of rising rates, the value of monetary assets declines. Conversely, during periods of falling
rates, the value of monetary assets increases. It should be noted that the amount of change in value of
specific assets and liabilities due to changes in rates is not the same in a rising rate environment as in a
falling rate environment. Based on the EVE analysis, the change in the economic value of equity in both
rising and falling rate environments is relatively low because both its assets and liabilities have relatively
short durations and the durations are fairly closely matched. The average duration of its assets at
December 31, 2008 was 1.69 years while the average duration of its liabilities was 1.54 years.
In evaluating First Federal’s exposure to interest rate risk, certain shortcomings inherent in each
of the methods of analysis presented must be considered. For example, although certain assets and
liabilities may have similar maturities or periods to repricing, they may react in different degrees to
changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates while interest rates on other types of financial instruments
may lag behind current changes in market rates. Furthermore, in the event of changes in rates,
prepayments and early withdrawal levels could differ significantly from the assumptions in calculating
the table and the results therefore may differ from those presented.
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Item 8. Financial Statements and Supplementary Data
Management’s Report on Internal Control Over Financial Reporting
Management of First Federal Bank of the Midwest is responsible for establishing and maintaining effective
internal control over financial reporting presented in conformity with U.S. generally accepted accounting
principles and for regulatory reporting in conformity with FFIEC’s Instructions on Consolidated Reports of
Condition and Income (“Call Report Instructions”), which is designed to provide reasonable assurance to the
Bank’s management and board of directors regarding the preparation of reliable published financial
statements. There are inherent limitations in the effectiveness of any internal control, including the possibility
of human error and the circumvention or overriding of controls. Accordingly, even effective internal control
can provide only reasonable assurance with respect to financial statement preparation. Further, because of
changes in conditions, the effectiveness of internal control may vary over time.
Management assessed the institution’s internal control over financial reporting presented in conformity with
U.S. generally accepted accounting principles as of December 31, 2008. This assessment was based on criteria
for effective internal control over financial reporting described in “Internal Control-Integrated Framework”
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this
assessment, Management believes that as of December 31, 2008, First Federal Bank of the Midwest
maintained effective internal control over financial reporting presented in conformity with U.S. generally
accepted accounting principles and Call Report Instructions based on those criteria.
Crowe Horwath LLP, the independent registered public accounting firm that audited the consolidated
financial statements of the Company included in this Annual Report on Form 10-K, has issued an
attestation report on the effectiveness of the Company’s internal control over financial reporting as of
December 31, 2008. The report, which expresses an unqualified opinion on the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2008, is included below.
William J. Small Donald P. Hileman
Chairman, President and
Chief Executive Officer
Executive Vice President and
Interim Chief Financial Officer
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- 53 -
Report of Independent Registered Public Accounting Firm
We have audited the accompanying consolidated statements of financial condition of First Defiance
Financial Corp. (the Company) as of December 31, 2008 and 2007 and the related statements of income,
stockholders' equity and cash flows for each of the three years in the period ended December 31, 2008.
We also have audited First Defiance Financial Corp.’s internal control over financial reporting as of
December 31, 2008, based on criteria established in Internal Control – Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's
management is responsible for these financial statements, for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our
responsibility is to express an opinion on these financial statements and an opinion on the Company's
internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material respects. Our audits of the
financial statements included examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audits also included performing such
other procedures as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the
assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could
have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
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- 54 -
In our opinion, the financial statements referred to above present fairly, in all material respects, the
financial position of First Defiance Financial Corp. as of December 31, 2008 and 2007, and the results of
its operations and its cash flows for each of the three years in the period ended December 31, 2008 in
conformity with accounting principles generally accepted in the United States of America. Also in our
opinion, First Defiance Financial Corp. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2008, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Crowe Horwath LLP
Cleveland, Ohio
March 16, 2009
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- 55 -
First Defiance Financial Corp.
Consolidated Statements of Financial Condition
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions
Interest-bearing deposits
Securities available-for-sale, carried at fair value
Securities held-to-maturity, carried at amortized cost (fair value $917 and
$1,161 at December 31, 2008 and 2007 respectively)
Loans receivable, net of allowance of $24,592 and
$13,890 at December 31, 2008 and 2007, respectively
Loans held for sale
Mortgage servicing rights
Accrued interest receivable
Federal Home Loan Bank stock
Bank owned life insurance
Premises and equipment
Real estate and other assets held for sale
Goodwill
Core deposit and other intangibles
Deferred taxes
Other assets
Total assets
December 31
2008
(In Thousands)
2007
$ 40,980
5,172
$ 53,976
11,577
46,152
65,553
117,575
112,370
886
1,117
1,592,643
10,960
6,611
7,293
21,376
28,747
47,756
7,000
56,585
8,344
336
5,136
1,275,806
5,751
5,973
6,755
18,586
28,423
40,545
2,460
36,820
3,551
–
5,694
$ 1,957,400
$ 1,609,404
- 57 -
- 56 -
First Defiance Financial Corp
Consolidated Statements of Financial Condition (continued)
Liabilities and stockholders’ equity
Liabilities:
Deposits:
Noninterest-bearing
Interest-bearing
Total
Advances from the Federal Home Loan Bank
Short term borrowings and other interest-bearing liabilities
Subordinated debentures
Advance payments by borrowers
Deferred taxes
Other liabilities
Total liabilities
Commitments and Contingent (Note 6)
Stockholders’ equity:
Preferred stock, $.01 par value per share, including warrants and amortization
of discount: 37,000 shares authorized and issued with a liquidation
preference of $1,000 per share
Preferred stock discount
Preferred stock, no par value per share:
5,000,000 shares authorized; no shares issued
Common stock, $.01 par value per share:
20,000,000 shares authorized; 12,739,496 and 11,702,635 shares issued
and 8,117,120 and 7,059,202 shares outstanding, respectively
Common stock warrant
Additional paid-in capital
Stock acquired by ESOP
Accumulated other comprehensive income (loss),
net of tax of $(1,025) and $224, respectively
Retained earnings
Treasury stock, at cost, 4,622,376 and 4,643,433
shares respectively
Total stockholders’ equity
December 31
2008
2007
(In Thousands)
$ 176,063
1,293,849
1,469,912
156,067
49,454
36,083
652
–
16,073
$ 121,563
1,096,295
1,217,858
139,536
30,055
36,083
762
1,306
17,850
1,728,241
1,443,450
37,000
(867)
–
–
–
–
127
878
140,449
–
117
–
112,651
(202)
(1,904)
126,114
(415)
126,630
(72,638)
(72,827)
229,159
165,954
Total liabilities and stockholders’ equity
$ 1,957,400
$ 1,609,404
See accompanying notes.
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- 57 -
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Statements of Income
(Amounts in Thousands, except per share data)
Interest Income
Loans
Investment securities:
Taxable
Tax-exempt
Interest-bearing deposits
FHLB stock dividends
Total interest income
Interest Expense
Deposits
Federal Home Loan Bank advances and other
Subordinated debentures
Notes payable
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest Income
Service fees and other charges
Mortgage banking income
Insurance commissions
Gain on sale of non-mortgage loans
Gain (loss) on sale or write-down of securities
Trust income
Income from bank owned life insurance
Other noninterest income
Total noninterest income
Noninterest Expense
Compensation and benefits
Occupancy
Data processing
Acquisition related charges
Other noninterest expense
Total noninterest expense
Income before income taxes
Federal income taxes
Net Income
Dividends Accrued on Preferred Shares
Accretion on Preferred Shares
Net Income Applicable to Common Shares
Earnings per common share:
Basic
Diluted
Dividends declared per share
See accompanying notes
- 59 -
- 58 -
Years Ended December 31
2008
2007
2006
$
96,522
$
90,866
$
86,213
4,357
1,399
123
1,062
103,463
31,354
6,375
1,907
1,632
41,268
62,195
12,585
49,610
13,268
2,990
5,496
180
(3,160)
448
323
(476)
19,069
28,829
7,484
4,658
1,117
15,706
57,794
10,885
3,528
7,357
(134)
(11)
7,223
0.91
0.91
0.95
$
$
$
$
$
$
$
$
$
$
$
$
$
$
4,475
1,260
924
1,226
98,751
40,356
6,889
2,115
729
50,089
48,662
2,306
46,356
10,788
3,612
5,278
226
21
375
1,375
455
22,130
25,245
6,100
3,824
-
12,944
48,113
20,373
6,469
13,904
-
-
13,904
1.96
1.94
1.01
$
$
$
$
$
$
$
4,511
1,134
165
1,042
93,065
33,273
8,885
1,308
577
44,043
49,022
1,756
47,266
9,303
3,389
4,531
526
(2)
312
980
585
19,624
23,805
5,103
3,689
-
11,242
43,839
23,051
7,451
15,600
-
-
15,600
2.22
2.18
0.97
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Statement of Changes in Stockholders’ Equity
(In Thousands, except number of shares)
Preferred
Stock
Preferred
Stock
Discount
Common
Stock
Common
Stock
Warrant
Additiona
l
Paid-In
Treasury
Stock
Capital
Stock
Accumulated
Other
Total
Acquired
by
ESOP
Comprehensiv
e
Income (Loss)
Retained
Earnings
Stockholder’
s
Equity
$ 117
$ (68,493)
$ 108,626
$ (1,053)
$ (22)
$ 112,041
$ 151,216
Balance at January 1, 2006
Comprehensive income:
Net income
Change in net unrealized gains and
losses on available-for-sale securities,
net of income taxes of $(39)
Total comprehensive income
ESOP shares released
Adjustment to initially apply SFAS No.
158, net of tax of ($310)
Stock option expense
Amortization of deferred compensation
of Management Recognition Plan,
including income tax benefit of $4
203,595 shares issued under stock option
plan, including income tax benefit of $481
147,401 common shares acquired for treasury
Dividends declared
Balance at December 31, 2006
Adjustment to initially apply FIN 48
Balance at December 31, 2006 adjusted
Comprehensive income:
Net income
Change in net unrealized gains and losses
on available-for-sale securities, net
of income taxes of $248 (a)
Change in unrealized loss on postretirement
postretirement benefit, net of tax of ($110)
Total comprehensive income
ESOP shares released
Stock option expense
36,865 shares issued under stock option plan,
including income tax benefit of $64
76,435 shares issued in acquisition of HHWS
196,474 common shares acquired for treasury
Dividends declared
Balance at December 31, 2007
Comprehensive income:
Net income
Change in net unrealized gains and losses
on available-for-sale securities, net of
income taxes of ($790)
Change in unrealized loss on postretirement
benefit, net of tax of ($13)
Total comprehensive income
ESOP shares released
Stock option expense
52,486 shares issued under stock option plan,
including income tax benefit of $72
1,036,861 shares issued in acquisition of
Pavilion
31,429 common shares acquired for treasury
37,000 shares issued to U.S. Treasury CPP
Preferred stock dividends accrued
Issuance of common stock warrant
Accretion on preferred shares
Common stock dividends declared
Balance at December 31, 2008
-
-
-
-
-
-
-
-
-
117
-
-
-
-
-
-
-
-
-
117
-
-
-
-
-
-
10
-
-
-
-
$ 127
$
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
878
-
-
878
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
37,000
-
-
-
-
$ 37,000
-
-
(878)
-
-
11
-
(867)
$
-
-
-
-
-
-
901
-
268
4
3,046
(3,943)
-
(69,390)
486
-
-
110,285
-
-
-
-
-
563
1,163
(5,163)
-
(72,827)
-
-
-
-
-
824
-
(635)
-
-
-
-
-
951
260
68
1,087
-
-
112,651
-
-
-
351
266
63
27,118
-
-
-
-
-
425
-
-
-
-
-
-
(628)
426
-
-
-
-
-
(202)
-
-
-
202
-
-
-
-
-
-
15,600
15,600
(73)
-
(576)
-
-
-
-
-
(671)
-
-
-
-
-
(703)
-
(6,826)
120,112
(200)
(73)
15,527
1,326
(576)
268
4
2,829
(3,943)
(6,826)
159,825
(200)
159,625
-
13,904
13,904
459
(203)
-
-
-
-
-
-
(415)
-
-
-
-
(46)
-
-
(7,140)
126,630
459
(203)
14,160
1,377
260
585
2,250
(5,163)
(7,140)
165,954
-
7,357
7,357
(1,464)
(25)
-
-
-
-
-
-
-
-
-
-
(46)
-
-
(134)
-
(11)
(7,682)
$ 126,114
(1,464)
(25)
5,868
553
266
841
27,128
(635)
36,122
(134)
878
-
(7,682)
$ 229,159
-
$ (72,638)
-
$ 140,449
-
$ -
-
$ (1,904)
(a) Net of reclassification adjustments. Reclassification adjustments represent net unrealized gains (losses) as of December 31 of the prior year on securities
available-for-sale that were sold or called during the current year. The reclassification adjustment was ($7,000)(($5,000) after tax) in 2007.
See accompanying notes
- 59 -
- 60 -
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Statements of Cash Flows
(Amounts in Thousands)
Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses
Provision for depreciation
Net amortization of premium and discounts on loans,
securities, deposits and debt obligations
Amortization of mortgage servicing rights
Net impairment (recovery) of mortgage servicing rights
Amortization of intangibles
Gain on sale of loans
(Gain) loss on sale or disposals of property, plant and
equipment
Loss on sale or write-down of REO
FHLB stock dividends
Release of ESOP shares
(Gain) loss on sales or write-down of securities
Deferred federal income tax
Proceeds from sale of loans
Stock option expense
Origination of loans held for sale
Income from bank owned life insurance
Change in interest receivable and other assets
Change in accrued interest and other liabilities
Net cash provided by operating activities
Investing Activities
Proceeds from maturities of held-to-maturity securities
Proceeds from maturities of available-for-sale securities
Proceeds from sale of available-for-sale securities
Proceeds from sale of real estate and other assets held for sale
Proceeds from sale of office properties and equipment
Purchases of available-for-sale securities
Purchases of office properties and equipment
Investment in bank owned life insurance
Proceed from insurance death benefit
Net cash received in acquisitions
Net cash paid in Pavilion acquisition
Proceeds from sale of non-mortgage loans
Net increase in loans receivable
Net cash used in investing activities
Years Ended December 31,
2008
2007
2006
$ 7,357
$ 13,904
$ 15,600
12,585
3,803
752
1,266
2,676
1,458
(4,575)
-
434
(754)
553
3,160
(4,672)
180,072
266
(182,336)
(323)
2,407
(2,122)
22,007
230
30,416
-
2,796
27
(31,811)
(4,589)
-
-
-
(23,907)
10,707
(114,816)
(130,947)
2,306
2,986
140
648
36
646
(2,816)
108
805
-
1,377
(21)
(257)
127,674
260
(128,537)
(1,375)
(1,615)
2,444
18,713
324
25,359
2,521
2,923
18
(28,946)
(8,687)
(2,060)
338
190
-
12,234
(67,741)
(63,527)
1,756
2,738
532
612
(2)
720
(2,950)
(104)
-
(1,042)
1,326
2
870
140,828
268
(137,624)
(980)
(2,616)
1,804
21,738
358
16,649
3,073
2,229
213
(17,551)
(5,317)
-
-
-
-
4,929
(73,060)
(68,477)
- 60 -
- 61 -
FIRST DEFIANCE FINANCIAL CORP.
Consolidated Statements of Cash Flows (continued)
(Amounts in Thousands)
Financing Activities
Net increase in deposits
Repayment of Federal Home Loan Bank long-term advances
Net increase (decrease) in Federal Home Loan Bank short-term
advances
Net increase (decrease) in short-term line of credit
Proceeds from Federal Home Loan Bank long-term advances
Increase (decrease) in securities sold under repurchase agreements
Proceeds from issuance of subordinated debentures
Purchase of common stock for treasury
Cash dividends paid
Proceeds from issuance of preferred stock
Proceeds from exercise of stock options
Excess tax benefit from exercise of stock options
Net cash provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental cash flow information:
Interest paid
Income taxes paid
Stock option exercise price paid with common stock
Transfers from loans to other real estate owned and other
assets held for sale
Years Ended December 31,
2008
2007
42,925
(16,408)
(2,200)
-
29,000
7,153
-
(635)
(8,137)
37,000
769
72
89,539
79,590
(873)
(21,800)
-
-
(369)
15,464
(4,923)
(7,090)
-
281
64
60,344
(19,401)
65,553
$ 46,152
15,530
50,023
$ 65,553
$ 42,433
6,772
$
$ 33
$ 49,411
$ 5,576
$ 240
2006
69,291
(68,206)
4,600
-
45,000
4,676
-
(2,852)
(6,741)
-
1,257
481
47,506
767
49,256
$ 50,023
$ 43,197
$ 5,956
$ 1,091
$
6,060
$ 3,796
$ 4,217
First Defiance acquired all of the capital stock of Pavilion Bancorp, Inc. for $55.5 million in 2008.
In conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired
Purchase price
Liabilities assumed
See accompanying notes.
Pavilion
$
287,994
55,548
232,446
$
- 61 -
- 62 -
Notes to the Consolidated Financial Statements
1. Basis of Presentation
First Defiance Financial Corp. (First Defiance) is a unitary thrift holding company that conducts business
through its two wholly owned subsidiaries, First Federal Bank of the Midwest (First Federal) and First
Insurance & Investments (First Insurance). All significant intercompany transactions and balances are
eliminated in consolidation.
First Federal is primarily engaged in attracting deposits from the general public through its offices and
using those and other available sources of funds to originate loans primarily in the counties in which its
offices are located. First Federal’s traditional banking activities include originating and servicing
residential, commercial and consumer loans and providing a broad range of depository, trust and wealth
management services. First Insurance is an insurance agency that does business in the Defiance and
Bowling Green, Ohio areas offering property and casualty, and group health, and life insurance products.
2. Statement of Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally
accepted in the United States requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and accompanying notes. Actual results could
differ from those estimates. Significant areas where First Defiance uses estimates are the valuation of
certain investment securities, the determination of the allowance for loan losses, the valuation of
mortgage servicing rights and goodwill, the determination of unrecognized income tax benefits, and the
determination of post-retirement benefits.
Earnings Per Common Share
Basic earnings per common share is net income applicable to common shares divided by the weighted
average number of shares of common stock outstanding during the period. Diluted earnings per common
share include the dilutive effect of additional potential common shares issuable under stock options,
warrants and stock grants. Unreleased shares held by the Company’s Employee Stock Ownership Plan are
not included in average shares for purposes of calculating earnings per share. As shares are released for
allocation, they are included in the average shares outstanding. Also see note 19.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income. Other comprehensive
income includes unrealized gains and losses on available for sale investment securities and the net
unrecognized actuarial losses and unrecognized prior service costs associated with the Company’s
Defined Benefit Postretirement Medical Plan. All items included in other comprehensive income are
reported net of tax. See also notes 5 and 16.
Cash Flows
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 include required balances
on hand or on deposit at the FHLB and Federal Reserve of approximately $2,292,000 and $1,402,000,
respectively, at December 31, 2008 to meet regulatory reserve and clearing requirements. Net cash flows
- 62 -
- 63 -
are reported for customer loan and deposit transactions, interest bearing deposits in other financial
institutions, and repurchase agreements.
Investment Securities
Management determines the appropriate classification of debt securities at the time of purchase and
evaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity
when First Defiance has the positive intent and ability to hold the securities to maturity and are reported
at cost, adjusted for premiums and discounts that are recognized in interest income using the interest
method over the period to maturity.
Debt securities not classified as held-to-maturity and equity securities are classified as available-for-sale.
Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax,
reported in other comprehensive income until realized. Realized gains and losses on securities sold are
recognized on the trade date based on the specific identification method and are included in gains (losses)
or impairment of securities.
Interest income includes amortization of purchase premiums and discounts using the interest method over
the period to maturity. Securities with unrealized losses are reviewed quarterly to determine if impairment
is other-than-temporary. In performing this review management considers the length of time and extent
that fair value has been less than cost, the financial condition of the issuer, the impact of changes in
market interest rates on market value and the Company’s ability and intent to hold the security for a
period sufficient to allow for any anticipated recovery in fair value. If the fair value of a security is less
than amortized cost and the impairment is determined to be other-than-temporary, the security is written
down, establishing a reduced cost basis, and the related charge is recorded as a realized loss in the income
statement.
FHLB Stock
As a member of the FHLB System, First Federal is required to own stock of the FHLB of Cincinnati in an
amount principally equal to 0.15% of total assets plus an amount of at least 2% but no more than 4% of
its non-grandfathered mission asset activity (as defined in the FHLB’s regulations). First Federal is
permitted to own stock in excess of the minimum requirement. FHLB stock is a restricted equity security
that does not have a readily determinable fair value and is carried at cost. It is evaluated for impairment
based upon the ultimate recovery of par value. Both cash and stock dividends are reported as income. At
December 31, 2008, the balance at FHLB of Cincinnati was $19.3 million. First Federal acquired $2.0
million of stock from the Pavilion acquisition which is held at the FHLB of Indianapolis and is required
to be held for five years from the date of acquisition of March 14, 2008.
Loans Receivable
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or
payoff are reported at the principal amount outstanding, net of deferred loan fees and costs, purchase
premiums and discounts and the allowance for loan losses. Deferred fees net of deferred incremental loan
origination costs, are amortized to interest income generally over the contractual life of the loan using the
interest method.
Mortgage loans originated and intended for sale in the secondary market are classified as loans held for
sale and are carried at the lower of aggregate cost or market, as determined by outstanding commitments
from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to
earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying
value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains or losses on
sales of mortgage loans are based on the difference between the selling price and the carrying value of the
related loan sold.
- 63 -
- 64 -
Interest receivable is accrued on loans and credited to income as earned. The accrual of interest on loans
90 days delinquent or impaired is discontinued when, in management’s opinion, the borrower may be
unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Interest income is subsequently recognized only to the extent cash payments are
received. The accrual of interest on these loans is generally resumed after a pattern of repayment has been
established and the collection of principal and interest is reasonably assured.
Acquired Loans
Purchased loans which have evidence of credit deterioration since origination are recorded at the amount
paid or allocated fair value in a purchase business combination, such that there is no carryover of the
seller’s allowance for loan losses. After acquisition, losses are recognized by an increase in the allowance
for loan losses.
The Company acquires loans individually and in groups or portfolios. At acquisition, the Company
reviews each loan to determine whether there is evidence of deterioration of credit quality since
origination and if it is probable that it will be unable to collect all amounts due according to the loan’s
contractual terms. If both conditions exist, the Company determines whether each such loan is to be
accounted for individually or whether such loans will be assembled into pools of loans based on common
risk characteristics (credit score, loan type, and date of origination). The Company considers expected
prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other
cash flows (expected at acquisition) for each loan and subsequently aggregated pool of loans.
The Company determines the excess of the loan’s or pool’s scheduled contractual principal and
contractual interest payments over all cash flows expected at acquisition as an amount that should not be
accreted (nonaccretable difference). The remaining amount—representing the excess of the loan’s cash
flows expected to be collected over the amount paid—is accreted into interest income over the remaining
life of the loan or pool (accretable yield).
Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected,
and evaluates whether the present value of its loans determined using the effective interest rates has
decreased and if so, recognizes a loss. The present value of any subsequent increase in the loan’s or
pool’s actual cash flows or cash flows expected to be collected is used first to reverse any existing
valuation allowance for that loan or pool. For any remaining increases in cash flows expected to be
collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the
loan’s or pool’s remaining life.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by management to absorb
probable incurred losses in the loan portfolio and is based on the size and current risk characteristics of
the loan portfolio, an assessment of individual problem loans, actual loss experience, current economic
events in specific industries and geographical areas, and other pertinent factors including general
economic conditions. Determination of the allowance is inherently subjective as it requires significant
estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated
losses on pools of homogeneous loans based on historical loss experience and consideration of economic
trends, all of which may be susceptible to significant change. Allocations of the allowance may be made
for specific loans, but the entire allowance is available for any loan that, in management’s judgment,
should be charged off.
Loan losses are charged off against the allowance when in management’s estimation it is unlikely that the
loan will be collected, while recoveries of amounts previously charged off are credited to the allowance.
A provision for loan loss is charged to operations based on management’s periodic evaluation of the
- 64 -
- 65 -
factors previously mentioned, as well as other pertinent factors in order to maintain the allowance for loan
losses at the level deemed adequate by management. The determination of whether a loan is considered
past due or delinquent is based on the contractual payment terms.
A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial
real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the
allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows
using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the
collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real
estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified
for impairment disclosures.
Servicing Rights
Servicing rights are recognized separately when they are acquired through sales of loans. For sales of
mortgage loans prior to January 1, 2007, a portion of the cost of the loan was allocated to the servicing
right based on relative fair values. The Company adopted SFAS No. 156 on January 1, 2007, and for sales
of mortgage loans beginning in 2007, servicing rights are initially recorded at fair value with the income
statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable
mortgage servicing contracts, when available, or alternatively, is based on a valuation model that
calculates the present value of estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net servicing income, such as the cost
to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment
speeds and default rates and losses. The Company compares the valuation model inputs and results to
published industry data in order to validate the model results and assumptions. All classes of servicing
assets are subsequently measured using the amortization method which requires servicing rights to be
amortized into non-interest income in proportion to, and over the period of, the estimated future net
servicing income of the underlying loans.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to
carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk
characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a
valuation allowance for an individual grouping, to the extent that fair value is less than the carrying
amount. If the Company later determines that all or a portion of the impairment no longer exists for a
particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in
valuation allowances are reported with mortgage banking income on the income statement. The fair
values of servicing rights are subject to significant fluctuations as a result of changes in estimated and
actual prepayment speeds and default rates and losses.
Servicing fee income, which is reported on the income statement with mortgage banking income, is
recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the
outstanding principal, or a fixed amount per loan, and are recorded as income when earned. The
amortization of mortgage servicing rights is netted against loan servicing fee income. Servicing fees, net
of amortization of mortgage servicing rights (excluding valuation adjustments) totaled $1.3 million, $1.1
million and $963,000 for the years ended December 31, 2008, 2007 and 2006. Late fees and ancillary fees
related to loan servicing are not material. See Note 8.
Mortgage Banking Derivatives
Commitments to fund mortgage loans (interest rate locks) to be sold in the secondary market and forward
commitments for the future delivery of these mortgage loans are accounted for as derivatives not
qualifying for hedge accounting. Fair values of these mortgage derivatives are estimated based on
- 65 -
- 66 -
changes in mortgage interest rates from the date of commitments. Changes in the fair values of these
derivatives are included in mortgage banking income.
Bank Owned Life Insurance
The Company has purchased life insurance policies on certain key employees. In accordance with
Emerging Issues Task Force (“EITF”) 06-05, Company owned life insurance is recorded at the amount
that can be realized under the insurance contract at the balance sheet date, which is the cash surrender
value adjusted for other charges or other amounts dues that are probable at settlement.
Premises and Equipment and Long Lived Assets
Premises and equipment are carried at cost less accumulated depreciation and amortization computed
principally by the straight-line method over the following estimated useful lives:
Buildings and improvements
Furniture, fixtures and equipment
20 to 50 years
3 to 15 years
Long-lived assets to be held and those to be disposed of and certain intangibles are evaluated for
impairment using the guidance provided by Statement of Financial Accounting Standards (SFAS)
No. 144, Accounting for Long-Lived Assets to be Disposed of, relative to accounting for long-lived assets
and accounting for long-lived assets to be disposed of either through sale, abandonment, exchange or a
distribution to owners. See Note 9.
Goodwill and Other Intangibles
Goodwill results from business acquisitions and represents the purchase price over the fair value of
acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed annually for
impairment and any such impairment is recognized in the period identified. Identified purchased
intangibles, which consist of core deposit intangibles, customer relationship intangibles and non-compete
agreements, are recorded at cost or estimated fair value and amortized over their estimated lives, which
range from five years for non-compete agreements to 10 to 20 years for core deposit and customer
relationship intangibles. See Note 10.
Real Estate and Other Assets Held for Sale
Other assets held for sale are comprised of properties acquired through foreclosure proceedings or
acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of cost or fair value,
less estimated costs to dispose, at the time of foreclosure or insubstance foreclosure. Losses arising from
the acquisition of such property are charged against the allowance for loan losses at the time of
acquisition. If fair value declines subsequent to foreclosure, the property is written down against expense.
Costs after acquisition are expensed.
Stock Compensation Plans
Compensation cost is recognized for stock options issued to employees and directors, based on the fair
value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of
stock options. Compensation cost is recognized over the required service period, generally defined as the
vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis
over the requisite service period for the entire award.
- 66 -
- 67 -
Postretirement Benefits
The Company sponsors a defined benefit postretirement plan that provides medical benefits to eligible
retirees. Postretirement benefit expense is accrued based on the expected future cost of providing benefits
during the years service is rendered by the employee.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other
assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and
matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors,
especially in the absence of broad markets for particular items. Changes in assumptions or in market
conditions could significantly affect the estimates.
Operating Segments
Management considers the following factors in determining the need to disclose separate operating
segments: 1) The nature of products and services, which are all financial in nature. 2) the type and class of
customer for the products and services; in First Defiance’s case retail customers for retail bank and
insurance products and commercial customers for commercial loan, deposit, life, health and property and
casualty insurance needs. 3) The methods used to distribute products or provide services; such services
are delivered through banking and insurance offices and through bank and insurance customer contact
representatives. Retail and commercial customers are frequently targets for both banking and insurance
products. 4) The nature of the regulatory environment; both banking and insurance entities are subject to
various regulatory bodies and a number of specific regulations.
Quantitative thresholds of SFAS 131, Disclosures about Segments of an Enterprise and Related
Information are monitored. For the year ended December 31, 2008, the reported revenue for First
Insurance was 6.8% of total revenue for First Defiance. Total revenue includes net interest income (before
provision for loan losses) plus non-interest income. Net income for First Insurance for the year ended
December 31, 2008 was 9.4% of consolidated net income. Total assets of First Insurance at December 31,
2008 were 0.4% of total assets. First Insurance does not meet any of the quantitative thresholds of SFAS
131. Accordingly, all of the financial service operations are considered by management to be aggregated
in one reportable segment.
Dividend Restriction
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the
bank to the holding company. These restrictions pose no practical limit on the ability of the bank or
holding company to pay dividends at historical levels. See Note 17.
Loan Commitments and Related Financial Instruments
Financial instruments include off-balance sheet credit instruments, such as commitments to make loans
and commercial letters of credit, issued to meet customer financing needs. The face amount for these
items represents the exposure to loss, before considering customer collateral or ability to repay. Such
financial instruments are recorded when they are funded.
- 67 -
- 68 -
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are
recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be
reasonably estimated. Management does not believe there are any such matters that will have a material
effect on the financial statements.
Income Taxes
Income tax expense is the total of the current year income tax due or refundable and the change in
deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts
for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount
expected to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient
level of future taxable income and recoverable taxes paid in prior years. Although realization is not
assured, management believes it is more likely than not that all of the deferred tax assets will be realized.
An effective tax rate of 35% is used to determine after-tax components of other comprehensive income
(loss) included in the statements of stockholders’ equity.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”),
as of January 1, 2007. A tax position is recognized as a benefit only if it is more likely than not that the
tax position would be sustained in a tax examination, with a tax examination being presumed to occur.
The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being
realized on examination. For tax positions not meeting the more likely than not test, no tax benefit is
recorded. The Company adopted FIN 48 effective January 1, 2007, the effect of which resulted in
$200,000 being recorded as an adjustment to beginning retained earnings. See Note 18.
Business Combinations
Business combinations, which have been accounted for under the purchase method of accounting, include
the results of operations of the acquired business from the date of acquisition. Net assets of companies
acquired are recorded at their estimated fair value as of the date of acquisition.
Reclassifications
Some items in the prior year financial statements were reclassified to conform to the current presentation.
Advertising Costs
Advertising costs are expensed as incurred.
Adoption of New Accounting Standards
Fair Value Measurements
In September 2006, FASB issued Statement No. 157, Fair Value Measurements (“FAS 157”). This
Statement defines fair value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions
used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or
use of an asset. This statement was effective for the Company on January 1, 2008 and did not have a
significant impact on the Company’s consolidated financial position or results of operation. In February
2008, the FASB issued Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No. 157. This
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FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except
those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years
beginning after November 15, 2008, and interim periods within those fiscal years. The impact of adoption
was not material. In October 2008, FASB issued FSP 157-3, Determining the Fair Value of a Financial
Asset When the Market for That Asset Is Not Active. This FSP clarifies the application of FAS 157 in a
market that is not active and provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not active. The FSP was effective
immediately, and includes prior periods for which financial statements have not been issued, and
therefore the Company is subject to the provision of the FSP effective September 30, 2008. The
implementation of FSP 157-3 did not materially affect the Company’s fair value measurement.
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, FASB issued Statement No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities – Including an amendment of FASB Statement No. 115. This Statement permits
entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and
losses on items for which the fair value option has been elected are reported in earnings at each
subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain
exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire
instruments and not to portions of instruments. This statement was effective for the Company on January
1, 2008 and did not elect the fair value option for any financial assets or financial liabilities.
Accounting for Deferred Compensation
In February 2007, the FASB EITF finalized Issue No. 06-4, Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements (EITF 06-4).
This issue requires that a liability be recorded during the service period when a split-dollar life insurance
agreement continues after participants’ employment or retirement. The required liability will be based on
ether the post-employment benefit cost for the continuing life insurance or based on the future death
benefit depending on the contractual terms of the underlying agreement. This issue was effective for fiscal
years beginning after December 15, 2007. The impact of adoption was not material.
Written Loan Commitments Recorded at Fair Value Through Earnings
On November 5, 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin No.
109, Written Loan Commitments Recorded at Fair Value Through Earnings (“SAB 109”). SAB 109
supercedes SAB 105, Application of Accounting Principles to Loan Commitments, and indicates that the
expected net future cash flows related to the associated servicing of the loan should be included in the
measurement of all written loan commitments that are accounted for at fair value through earnings. SAB
109 was effective for derivative loan commitments issued or modified in fiscal quarters beginning after
December 15, 2007. The impact of adoption resulted in a $1.1 million increase to mortgage banking
income for the year ended December 31, 2008.
Newly Issued But Not Yet Effective Accounting Standards
SFAS No. 141, “Business Combinations (Revised 2007).” SFAS 141R replaces SFAS 141, “Business
Combinations,” and applies to all transactions and other events in which one entity obtains control over
one or more other businesses. SFAS 141R requires an acquirer, upon initially obtaining control of another
entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of
the acquisition date. Contingent consideration is required to be recognized and measured at fair value on
the date of acquisition rather than at a later date when the amount of that consideration may be
determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process
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required under SFAS 141 whereby the cost of an acquisition was allocated to the individual assets
acquired and liabilities assumed based on their estimated fair value. SFAS 141R requires acquirers to
expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and
liabilities assumed, as was previously the case under SFAS 141. Under SFAS 141R, the requirements of
SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in
order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be
recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in
which case, nothing should be recognized in purchase accounting and, instead, that contingency would be
subject to the probable and estimable recognition criteria of SFAS 5, “Accounting for Contingencies.”
SFAS 141R is expected to have a significant impact on the Company’s accounting for business
combinations closing on or after January 1, 2009.
SFAS No. 160, “Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB
Statement No. 51.” SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, “Consolidated
Financial Statements,” to establish accounting and reporting standards for the non-controlling interest in
a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest
in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the
consolidated entity that should be reported as a component of equity in the consolidated financial
statements. Among other requirements, SFAS 160 requires consolidated net income to be reported at
amounts that include the amounts attributable to both the parent and the non-controlling interest. It also
requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net
income attributable to the parent and to the non-controlling interest. SFAS 160 is effective for the
Company on January 1, 2009 and did not have a significant impact on the Company’s financial
statements.
SFAS No. 161, “Disclosures About Derivative Instruments and Hedging Activities, an Amendment of
FASB Statement No. 133.” SFAS 161 amends SFAS 133, “Accounting for Derivative Instruments and
Hedging Activities,” to amend and expand the disclosure requirements of SFAS 133 to provide greater
transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments
and related hedge items are accounted for under SFAS 133 and its related interpretations, and (iii) how
derivative instruments and related hedged items affect an entity’s financial position, results of operations
and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and
strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on
derivative instruments and disclosures about credit-risk-related contingent features in derivative
agreements. SFAS 161 is effective for the Company on January 1, 2009 and did not have a significant
impact on the Company’s financial statements.
3. Acquisitions
On March 14, 2008, First Defiance completed the acquisition of Pavilion, which is headquartered in
Adrian, Michigan. Each Pavilion shareholder received 1.4209 shares of First Defiance common stock and
$37.50 in cash for each share of Pavilion stock. In connection with this transaction, 1,036,861 shares of
First Defiance common stock were issued at a total value of $27.1 million. The common shares issued
were valued at $26.117 per share, representing the average of the closing bid and ask price as of the date
of the merger announcement plus two days prior and two days subsequent to the announcement. The total
cost of the transaction, including legal and investment banking fees, was $55.5 million. The assets and
liabilities of Pavilion were recorded on the balance sheet at their fair value as of the acquisition date. The
results of Pavilion’s operations have been included in the First Defiance’s consolidated statement of
income from the date of acquisition. Disclosure of pro forma results of this acquisition is not material to
the Company’s consolidated financial statements as the transaction closed in the first quarter of 2008.
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The following tables summarize the estimated fair values of the net assets acquired and the computation
of the purchase price and goodwill related to the Pavilion acquisition. The numbers in the following two
tables below have been adjusted through December 31, 2008.
Assets
Cash and cash equivalents
Investment securities
Loans, net of allowance for loan losses
Premises and equipment
Federal Home Loan Bank stock
Goodwill and other intangibles
Other assets
Total Assets
Liabilities
Deposits
Borrowings
Other liabilities
Total Liabilities
Net assets acquired
Purchase price
Pavilion’s carrying value of net assets acquired
Excess purchase price over Pavilion’s carrying
Value of net assets acquired
Purchase accounting adjustments
Portfolio loans
Premises and equipment
Mortgage servicing rights
Deposits
Deferred tax liabilities
Total net tangible assets
Core deposit and other intangibles
Acquisition Date
March 14, 2008
(In Thousands)
$
4,514
9,136
232,499
6,992
2,036
26,016
6,801
287,994
209,385
18,403
4,658
232,446
$
55,548
Acquisition Date
March 14, 2008
(In Thousands)
$
55,548
(28,228)
27,320
(6,632)
2,579
(1,010)
1,021
2,648
(1,394)
(6,251)
Goodwill
$
19,765
The estimated fair values of Pavilion’s acquired assets and liabilities, including identifiable intangible
assets, are preliminary and subject to refinement, as additional information becomes available. Any
subsequent adjustments to the fair value of assets and liabilities acquired, identifiable intangible assets, or
other purchase accounting adjustments will result in adjustments to goodwill.
During the twelve months ended December 31, 2008, First Defiance recognized $1,117,000 of acquisition
related charges, of which, $198,000 related to retention bonuses and $171,000 related to termination of
certain contracts. The remaining $663,000 includes items related to professional services, start-up costs of
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system conversions, supplies and other non-recurring costs associated with the completion of the
acquisition and the transition of operations. Management believes that that the acquisition related costs
have essentially been completed as of December 31, 2008.
On February 28, 2007, First Defiance acquired HHWS, an insurance agency headquartered in Bowling
Green, Ohio for a purchase price comprised of 76,435 shares of First Defiance common stock and future
consideration to be paid in cash in 2009 and 2010. As of December 31, 2007, management has reported
goodwill of $1.7 million and identifiable intangible assets of $800,000 consisting of customer relationship
intangible of $620,000 and a non-compete intangible of $180,000.
4. Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings per common share:
Numerator for basic and diluted earnings per
common share-net income less dividend for and
accretion of preferred stock
Denominator:
Denominator for basic earnings per common
share-weighted-average shares
Effect of dilutive securities:
Employee stock options
Warrants
Dilutive potential common shares
Denominator for diluted earnings per common
share-adjusted weighted-average shares
Basic earnings per common share
Diluted earnings per common share
2006
2007
2008
(In Thousands, Except Per Share Amounts)
$
7,212
$ 13,904
$ 15,600
7,889
7,085
7,028
22
8
30
93
-
93
7,919
0.91
0.91
$
$
7,178
1.96
1.94
$
$
$
$
135
-
135
7,163
2.22
2.18
Shares under option of 327,300 in 2008, 204,453 in 2007 and 149,053 in 2006 were excluded
from the diluted earnings per common share calculation as they were anti-dilutive.
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5. Investment Securities
The following fair value of available for sale securities and the related unrealized gains and losses
recognized in accumulated other comprehensive income (loss) were as follows:
Gross
Amortized Unrealized Unrealized
Gains
Losses
Gross
Cost
Fair
Value
At December 31, 2008
Obligations of U.S. government corporations
and agencies
Mortgage-backed securities
REMICs
Collateralized mortgage obligations
Trust preferred stock and preferred stock
Obligations of state and political
subdivisions
Totals
At December 31, 2007
(In Thousands)
$ 14,180
34,232
4,041
22,196
8,038
$
505
1,137
118
486
-
$
-
(3)
-
(252)
(4,116)
$ 14,685
35,366
4,159
22,430
3,922
36,581
$119,268
754
$ 3,000
(322)
$ (4,693)
37,013
$ 117,575
Obligations of U.S. government corporations
and agencies
Mortgage-backed securities
REMICs
Collateralized mortgage obligations
Trust preferred stock and preferred stock
Obligations of state and political
subdivisions
Totals
$
$ 24,565
26,453
3,064
20,103
9,374
354
289
41
173
29
$
(1)
(55)
-
(77)
(761)
$ 24,918
26,687
3,105
20,199
8,642
28,251
$111,810
568
$ 1,454
-
(894)
28,819
$ 112,370
$
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The amortized cost, unrecognized gains and losses, and fair value of securities held to maturity were as
follows:
Gross
Amortized Unrecognized Unrecognized
Gains
Losses
Gross
Cost
At December 31, 2008
FHLMC certificates
FNMA certificates
GNMA certificates
Obligations of states and political
subdivisions
Totals
At December 31, 2007
FHLMC certificates
FNMA certificates
GNMA certificates
Obligations of states and political
subdivisions
Totals
(In Thousands)
$
$
$
$
$
$
141
378
127
240
886
195
472
150
300
1,117
$
$
5
1
1
26
33
6
4
2
33
45
$
$
$
$
–
(2)
–
–
(2)
–
(1)
–
–
(1)
Fair
Value
146
377
128
266
917
201
475
152
$
$
$
333
1,161
$
The amortized cost and fair value of securities at December 31, 2008 by contractual maturity are shown
below. Expected maturities will differ from contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity
table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over
maturity groupings based on the weighted-average contractual maturities of the underlying collateral. The
mortgage-backed securities may mature earlier than their weighted-average contractual maturities because
of principal prepayments.
Available-for-Sale
Fair
Value
Amortized
Cost
Amortized
Held-to-Maturity
Fair
Value
Cost
Due in one year or less
Due after one year through
five years
Due after five years through
ten years
Due after ten years
$ 18,383
$
18,764
$
282
$
286
(In Thousands)
51,037
52,076
493
520
15,874
33,974
$ 119,268
16,416
30,319
$ 117,575
100
11
$ 886
100
11
$ 917
Investment securities with carrying amounts of $93.0 million and $78.2 million at December 31, 2008
and 2007, respectively, were pledged as collateral on public deposits, securities sold under repurchase
agreements and FHLB advances and for other purposes required or permitted by law.
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The following table summarizes First Defiance’s securities that were in an unrealized loss position at
December 31, 2008 and December 31, 2007:
Duration of Unrealized Loss Position
Less than 12 Months
Gross
Unrealized
Loss
Fair
Value
12 Months or Longer
Gross
Unrealized
Loss
Fair
Value
(In Thousands)
Total
Fair
Value
Unrealized
Loses
$
-
317
451
7,019
678
293
-
(3)
-
(192)
(889)
(2)
$
$
-
-
$
-
-
$
-
317
-
(3)
1,004
2,047
2,826
87
(252)
(130)
(3,227)
-
1,455
(252)
9,066
3,504
380
(322)
(4,116)
(2)
$
8,758
$ (1,086)
$ 5,964
$ (3,609)
$
14,722
$ (4,695)
At December 31, 2008
Available-for-sale securities:
Obligations of U.S. govt. corps.
and agencies
$
Mortgage-backed securities
Collateralized mortgage
obligations and REMICs
Obligations of state and political
subdivisions
Trust preferred stock
Held to maturity securities:
Mortgage-backed securities
Total temporarily impaired
securities
At December 31, 2007
Available-for-sale securities:
Obligations of U.S. govt. corps.
and agencies
$
Mortgage-backed securities
Collateralized mortgage
obligations and REMICs
Obligations of state and political
subdivisions
Trust preferred stock
Held to maturity securities:
Mortgage-backed securities
Total temporarily impaired
$
-
4
-
-
-
-
-
3,489
146
-
(307)
(1)
$ 1,999
8,170
$
8,688
20
1,418
102
$
(1)
(55)
(77)
−
(454)
-
$
1,999
8,174
8,688
20
4,907
248
(1)
(55)
(77)
-
(761)
(1)
securities
$
3,639
$
(308)
$ 20,397
$
(587)
$
24,036
$
(895)
With the exception of Trust Preferred Stock, the above securities all have fixed interest rates, and all
securities have defined maturities. Their fair value is sensitive to movements in market interest rates. First
Defiance has the ability and intent to hold these investments for a time necessary to recover the amortized
cost without impacting its liquidity position. Realized gains from the sales and calls of investment
securities totaled $22,000, $21,000, and $73,000 ($14,000, $14,000 and $47,000 after tax) in 2008, 2007
and 2006 respectively. In 2008, management deemed that the value of certain investments were other-
than-temporarily impaired which consisted of a combination of $1.9 million ($1.2 million after tax) write-
down of the Fannie Mae and Freddie Mac Stock and a $1.3 million ($833,000 after tax) write-down of
certain trust preferred collateralized debt obligations (“CDOs”). As required by SFAS 115, when a
decline in fair value below cost is deemed to be other-than-temporary, the unrealized loss must be
recognized as a charge to earnings. The Company owns $3.9 million of CDOs that are backed by trust
preferred securities issued by banks, thrifts and insurance companies. The market for these securities at
December 31, 2008 is not active and markets for similar securities are also not active. The inactivity was
evidenced first by a significant widening of the bid-ask spread in the brokered markets in which CDOs
trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue
market is also inactive as no new CDOs have been issued since 2007. There are currently very few market
participants who are willing and or able to transact for these securities.
The market values for these securities (and any securities other than those issued or guaranteed by
the U.S. Treasury) are very depressed relative to historical levels. Thus in today’s market, a low market
price for a particular bond may only provide evidence of stress in the credit markets in general versus
being an indicator of credit problems with a particular issue.
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Given the conditions in the debt markets today and the absence of observable transactions in the
secondary and new issue markets, management has determined: 1) The few observable transactions and
market quotations that are available are not reliable for purposed of determining fair value at December
31, 2008; 2) An income valuation approach technique (present value technique) that maximizes the use of
relevant observable inputs and minimizes the use of observable inputs will be equally or more
representative of fair value than the market approach valuation used at the prior measurement dates and 3)
The Company’s CDOs will be classified within Level 3 of the fair value hierarchy because management
determined that significant adjustments were required to determine fair value at the measurement date.
The Company’s CDO valuations were prepared by an independent third party. Their approach to
determining fair value involved several steps: 1) Detailed credit and structural evaluation of each piece of
collateral in the CDO; 2) Collateral performance projections for each piece of collateral in the CDO
(default, recovery and prepayment/amortization probabilities) and 3) Discounted cash flow modeling.
Sales and write-downs of available for sale securities were as follows:
Proceeds
Gross gains
Gross losses
Other-than-temporary impairment charges
$
2008
-
-
-
(3,182)
2006
2007
(In Thousands)
$ 2,521
21
-
-
$ 3,073
73
-
(75)
There were no security sales in 2008. Gross gains from calls of securities available for sale during the
year ended December 31, 2008 were $22,000 and gross losses of $0.
6. Commitments and Contingent Liabilities
Loan Commitments
Loan commitments are made to accommodate the financial needs of First Federal’s customers; however,
there are no long-term, fixed-rate loan commitments that result in market risk. Standby letters of credit
commit the Company to make payments on behalf of customers when certain specified future events
occur. They primarily are issued to facilitate customers’ trade transactions.
Both arrangements have credit risk, essentially the same as that involved in extending loans to customers,
and are subject to the Company’s normal credit policies. Collateral (e.g., securities, receivables, inventory
and equipment) is obtained based on Management’s credit assessment of the customer.
The Company’s maximum obligation to extend credit for loan commitments (unfunded loans and unused
lines of credit) and standby letters of credit outstanding on December 31 was as follows (in thousands):
2008
2007
Commitments to make loans
Unused lines of credit
Standby letters of credit
Total
Fixed Rate
22,710
44,535
67
67,312
$
$
Variable Rate
$
$
70,114
211,291
18,860
300,265
Fixed Rate
37,354
35,479
167
73,000
$
$
$
Variable Rate
54,189
153,129
8,981
216,299
$
Commitments to make loans are generally made for periods of 60 days or less.
In addition to the above commitments, at December 31, 2008 First Defiance had commitments to sell
$72.9 million of loans to Freddie Mac, Fannie Mae, Federal Home Loan Bank of Cincinnati or BB&T
Mortgage.
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Contingent Receivable
The Company recorded a receivable of approximately $800,000 in 2007 relating to claims from various
insurance carriers from incurred losses associated with a former employee. In 2008, $727,000 of this
receivable was recorded as an expense due to the denial of the insurance claim under the Company’s
fidelity bond. $73,000 of this receivable was recovered in 2008.
7. Loans Receivable
Loans receivable consist of the following at December 31:
Real estate loans:
Secured by single family residential
Secured by multi-family residential
Secured by non-residential real estate
Construction
Other loans:
Automobile
Commercial
Home equity and improvement
Other
Total loans
Deduct:
Undisbursed loan funds
Net deferred loan origination fees and costs
Allowance for loan losses
Totals
December 31
2008
2007
(In Thousands)
$ 251,807
78,427
677,313
72,938
1,080,485
$ 231,921
56,774
545,077
13,146
846,918
27,490
356,574
161,106
13,522
558,692
1,639,177
27,843
283,072
128,080
9,900
448,895
1,295,813
(20,892)
(1,050)
(24,592)
$ 1,592,643
(5,085)
(1,032)
(13,890)
$ 1,275,806
On March 14, 2008, First Defiance acquired gross loans (including purchase accounting adjustments) of
$50.0 million in single family residential loans, $6.0 million in multi-family residential loans, $100.9
million in non-residential real estate, $49.2 million in commercial loans, $2.8 million in auto loans, $25.7
million in home equity and improvement loans and $2.2 million in other loans. The associated acquired
reserve of those loans was $4.3 million.
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Changes in the allowance for loan losses were as follows:
2008
Years Ended December 31
2007
(In Thousands)
2006
Allowance at beginning of year
$ 13,890
$ 13,579
$ 13,673
Provision for credit losses
Acquired in acquisitions
Charge-offs
Recoveries
Net charge-offs
Ending allowance
12,585
4,258
(6,499)
358
(6,141)
$ 24,592
2,306
-
(2,400)
405
(1,995)
$ 13,890
1,756
-
(2,276)
426
(1,850)
$ 13,579
Individually impaired loans were as follows (in thousands):
Years Ended December 31
2008
2007
Year-end loans with no allocated allowance
for loan losses
Year-end loans with allocated allowance for loan losses
Total
Amount of the allowance for loan losses allocated
$
$
$
6,734
20,812
27,546
6,030
$
$
$
-
8,643
8,643
1,356
2008
Years Ended December 31
2007
(In Thousands)
2006
Average of individually impaired loans during the year
Interest income recognized during impairment
Cash-basis interest income recognized
$ 25,682
1,055
1,067
$
9,571
305
338
$
4,400
111
Nonaccrual loans and loans past due 90 days still on accrual were as follows (in thousands):
Loans past due over 90 days still on accrual
Nonaccrual loans
Troubled debt restructurings, still accruing
Total non-performing loans
Years Ended December 31
2008
2007
$
$
-
28,017
6,250
34,267
$
$
-
9,217
-
9,217
Impaired loans having recorded investments of $27.5 million at December 31, 2008 and $8.6 million at
December 31, 2007, have been recognized in conformity with FASB Statement No. 114, as amended by
FASB Statement No. 118. Nonaccrual loans disclosed above are net of impaired reserves of $1.9 million
and $612,000 at December 31, 2008 and 2007. Loans having carrying values of $6.1 million and $3.8
million were transferred to real estate and other assets held for sale in 2008 and 2007, respectively. At
December 31, 2008 and December 31, 2007, non-performing loans, which include loans with contractual
payments delinquent 90 days or more, were $34.3 million and $9.2 million respectively. There was
$119,000 and $16,000 of accrued interest recorded on impaired or non-performing loans at December 31,
2008 and December 31, 2007.
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First Defiance has classified $6.2 million in loans still accruing as troubled debt restructurings and is not
committed to lend additional funds to those debtors whose loans have been modified.
Certain loans acquired in the Pavilion Bancorp, ComBanc and Genoa acquisitions had evidence that the
credit quality of the loan had deteriorated since its origination and in management’s assessment at the
acquisition date it was probable that First Defiance would be unable to collect all contractually required
payments due. In accordance with American Institute of Certified Public Accountants Statement of
Position 03-3 – Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP”), these
loans have been recorded based on management’s estimate of the fair value of the loans.
These loans are not included with the impaired loan disclosures above. Details of these loans are as
follows:
Contractual
Amount
Receivable
Balance at December 31, 2005
Principal payments received
Loans charged off
Additional provision for loan loss
Loan accretion recorded
Balance at December 31, 2006
Principal payments received
Loans charged off
Additional provision for loan loss
Loan accretion recorded
Balance at December 31, 2007
Amount recorded for Pavilion Bancorp
Principal payments received
Loans charged off
Loan accretion recorded
Balance at December 31, 2008
$
$
4,626
(129)
(198)
(189)
−
4,110
(908)
(97)
(95)
−
3,010
6,362
(274)
(234)
−
8,864
Interest income on loans is as follows:
$
Impairment
Discount
(in thousands)
2,019
−
(198)
−
(138)
1,683
−
(97)
−
(233)
1,353
2,002
−
(234)
(53)
3,068
$
Recorded
Loan
Receivable
$ 2,607
(129)
−
(189)
138
2,427
(908)
−
(95)
233
1,657
4,360
(274)
−
53
$ 5,796
Commercial and non-residential real-
estate loans
Mortgage loans
Other loans
Totals
2008
Years Ended December 31
2007
(In Thousands)
2006
$
$
73,973
10,115
12,434
96,522
$
$
68,419
9,693
12,754
90,866
$
$
63,140
10,526
12,547
86,213
First Defiance’s loan portfolio is concentrated geographically in its northwest Ohio market area.
Management has also identified lending for income-generating rental properties as an industry
concentration. Total loans for income generating property totaled $442.0 million at December 31, 2008,
which represents 27% of the Company’s loan portfolio. The Company’s loans receivable are primarily to
borrowers in the Northwest Ohio, Northeast Indiana or Southeast Michigan areas.
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Loans to executive officers, directors, and their affiliates are as follows (in thousands):
Years Ended December 31
2008
2007
Beginning balance
New loans
Effect of changes in composition of related parties
Repayments
Ending Balance
$
$
5,610
4,623
656
(5,848)
5,041
$
$
4,384
5,952
-
(4,726)
5,610
8. Mortgage Banking
Net revenues from the sales and servicing of mortgage loans consisted of the following:
Gain from sale of mortgage loans
Mortgage loan servicing revenue (expense):
Mortgage loan servicing revenue
Amortization of mortgage servicing rights
Mortgage servicing rights valuation adjustments
$
2008
Years Ended December 31
2007
(In Thousands)
2,590
$
$
4,395
2,537
(1,266)
(2,676)
(1,405)
1,706
(648)
(36)
1,022
2006
2,424
1,575
(612)
2
965
Net revenue from sale and servicing of mortgage
loans
$
2,990
$
3,612
$
3,389
The unpaid principal balance of residential mortgage loans serviced for third parties was $1.1 billion at
December 31, 2008 compared to $715.5 million at December 31, 2007.
Activity for capitalized mortgage servicing rights and the related valuation allowance follows:
2008
Years Ended December 31
2007
(In Thousands)
2006
Mortgage servicing assets:
Balance at beginning of period
Loans sold, servicing retained
Fair value of servicing assets acquired from Pavilion
Amortization
$
6,089
1,450
3,130
(1,266)
$
$
5,609
1,128
-
(648)
5,145
1,076
-
(612)
Carrying value before valuation allowance
at end of period
9,403
6,089
5,609
Valuation allowance:
Balance at beginning of period
Impairment recovery (charges)
Balance at end of period
Net carrying value of MSRs at end of period
Fair value of MSRs at end of period
$
$
(116)
(2,676)
(2,792)
6,611
6,611
$
$
(80)
(36)
(116)
5,973
7,000
$
$
(82)
2
(80)
5,529
6,684
Amortization of mortgage servicing rights is computed based on payments and payoffs of the related
mortgage loans serviced. Estimates of future amortization expense are not easily estimable.
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The Company’s servicing portfolio is comprised of the following:
Investor
Fannie Mae
Freddie Mac
Other
Totals
December 31
2008
2007
Number of
Loans
Principal
Outstanding
Number of
Loans
Principal
Outstanding
(Dollars in Thousands)
4,275
7,959
103
12,337
$
413,078
678,485
9,757
$ 1,101,320
876
7,683
21
8,580
$
$
69,208
645,821
458
715,487
Significant assumptions at December 31, 2008 used in determining the value of MSRs include a weighted
average prepayment rate of 422 PSA and a weighted average discount rate of 9.00%.
A sensitivity analysis of the current fair value to immediate 10% and 20% adverse changes in those
assumptions as of December 31, 2008 is presented below. These sensitivities are hypothetical. Changes in
fair value based on a 10% variation in assumptions generally cannot be extrapolated because the
relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect
of a variation in a particular assumption on the fair value of the MSR is calculated independently without
changing any other assumption. In reality, changes in one factor may result in changes in another (for
example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could
result in changes in the discount rates), which might magnify or counteract the sensitivities.
Assumption:
Decline in fair value from increase in prepayment rate
Declines in fair value from increase in discount rate
$ 363
144
$ 801
253
10% Adverse
Change
20% Adverse
Change
(Dollars in Thousands)
9. Premises and Equipment
Premises and equipment are summarized as follows:
Cost:
Land
Land improvements
Buildings
Leasehold improvements
Furniture, fixtures and equipment
Construction in process
Less allowances for depreciation and amortization
December 31
2008
2007
(In Thousands)
$
$
6,936
1,248
38,926
808
22,474
1,655
72,047
24,291
47,756
$
$
5,337
1,025
34,943
416
19,131
227
61,079
20,534
40,545
Depreciation expense was $3.8 million, $3.0 million and $2.7 million for the years ended December 31,
2008, 2007 and 2006 respectively.
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Lease Agreements
The Company has entered into lease agreements covering First Insurance’s main office and Bowling
Green, Ohio office, four banking center locations, three land leases for which the Company owns the
banking centers, one land lease which is primarily used for parking, and numerous stand-alone Automated
Teller Machine sites with varying terms and options to renew.
Future minimum commitments under non-cancelable operating leases are as follows (in thousands):
2009
2010
2011
2012
2013
Thereafter
Total
$
$
474
410
364
190
142
2,927
4,507
Rentals under operating leases amounted to $444,000, $446,000, and $353,000, in 2008, 2007, and 2006,
respectively.
10. Goodwill and Intangible Assets
Goodwill
The change in the carrying amount of goodwill for the year is as follows:
Beginning balance
Goodwill acquired or adjusted during the year
Ending balance
Acquired Intangible Assets
December 31
2008
2007
(In Thousands)
$
$
36,820
19,765
56,585
$
$
35,090
1,730
36,820
Activity in intangibles for the years ended December 31, 2008 and 2007 was as follows:
Balance as of January 1, 2007
Intangible assets acquired
Amortization of intangible assets
Balance as of December 31, 2007
Intangible assets acquired
Amortization of intangible assets
Balance as of December 31, 2008
Gross
Carrying
Amount
$
5,051
800
−
5,851
6,251
-
$ 12,102
$
Accumulated
Amortization
(In Thousands)
(1,654)
−
(646)
(2,300)
−
(1,458)
(3,758)
$
Net
Value
$
$
3,397
800
(646)
3,551
6,251
(1,458)
8,344
Aggregate amortization expense was $1,458,000, $646,000 and $720,000 for 2008, 2007 and 2006
respectively.
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Estimated amortization expense for each of the next five years and thereafter (in thousands) is as follows:
2009
2010
2011
2012
2013
Thereafter
Total
11. Deposits
The following schedule sets forth interest expense by type of deposit:
$
$
1,456
1,284
1,150
1,009
872
2,573
8,344
2008
Years Ended December 31
2007
(In Thousands)
2006
Checking and money market accounts
Savings accounts
Certificates of deposit
Less interest capitalized
Totals
$
4,876
1,376
25,102
31,354
-
$ 31,354
$
8,273
1,404
30,786
40,463
(107)
$ 40,356
$
7,052
276
25,974
33,302
(29)
$ 33,273
Accrued interest payable on deposit accounts amounted to $1,387,000 and $2,537,000 at December 31,
2008 and 2007 respectively, which was comprised of $1,327,000 and $60,000 for certificates of deposit
and checking and money market accounts respectively at December 31, 2008 and $2,316,000 and
$221,000 for certificates of deposit and money market accounts respectively at December 31, 2007.
A summary of deposit balances is as follows:
Non-interest bearing checking accounts
Interest bearing checking and money market accounts
Savings deposits
Retail certificates of deposit less than $100,000
Retail certificates of deposit greater than $100,000
Brokered or national certificates of deposit
December 31
2008
2007
(In Thousands)
$
176,063
374,488
132,146
578,244
170,485
38,486
$ 1,469,912
$
121,563
342,367
105,873
509,720
137,927
408
$ 1,217,858
On March 14, 2008, $43.8 million of non-interest-bearing checking accounts, $41.5 million of interest-
bearing checking accounts, $26.2 million of savings accounts, and $97.9 million of certificates of deposit
were acquired in the Pavilion acquisition.
Scheduled maturities of certificates of deposit at December 31, 2008 are as follows (in thousands):
2009
2010
2011
2012
2013
2014 and thereafter
Total
$
$
458,900
226,643
96,052
2,552
2,098
970
787,215
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At December 31, 2008 and 2007, the Company had deposits of $429.7 million and $326.5 million,
respectively, with balances of $100,000 or more. At December 31, 2008 and 2007, $40.4 million and
$38.2 million, respectively, in investment securities were pledged as collateral against public deposits for
certificates in excess of $100,000 and an additional $52.7 million and $40.0 million of securities were
pledged at December 31, 2008 and December 31, 2007, respectively as collateral against deposits from
private entities in excess of $100,000.
12. Advances from Federal Home Loan Bank
First Federal has the ability to borrow funds from the FHLB. First Federal pledges its single-family
residential mortgage loan portfolio, certain investment securities, certain 1st mortgage home equity loans,
and certain multi-family or non-residential real estate loans as security for these advances. Advances
secured by investment securities must have collateral of at least 105% of the borrowing. Advances
secured by residential mortgages must have collateral of at least 125% of the borrowings. Advances
secured by multi-family or non-residential real estate loans securities must have 300% collateral
coverage. The total level of borrowing is also limited to 50% of total assets and at least 50% of the
borrowings must be secured by either one-to-four family residential mortgages or investment securities.
Total loans pledged to the FHLB at December 31, 2008 and December 31, 2007 were $677.8 million and
$517.1 million, respectively. First Federal has a maximum potential to acquire advances of approximately
$224.1 million from the FHLB at December 31, 2008.
At year-end, advances from the FHLB were as follows:
Principal Terms
December 31, 2008
Short-term borrowings
Single maturity fixed rate advances
Single maturity LIBOR based advances
Putable advances
Strike-rate advances
Amortizable mortgage advances
Advance
Amount
(in Thousands)
Range of Maturities
$
9,100 Overnight
10,000 October 2013
45,000 January 2011 to March 2011
64,000 September 2010 to March 2018
27,000 March 2011 to February 2013
967 December 2015
$ 156,067
December 31, 2007
Short-term borrowings
Single maturity fixed rate advances
Single maturity LIBOR based advances
Putable advances
Strike-rate advances
Amortizable mortgage advances
$ 11,300 Overnight
January 2011 to March 2011
10,000 December 2008
45,000
45,000 September 2010 to November 2013
27,000 March 2011 to February 2013
1,236 March 2008 to December 2015
$ 139,536
Weighted
Average
Interest
Rate
0.54%
2.60%
3.49%
4.50%
4.18%
4.10%
4.28%
4.94%
5.20%
5.25%
4.18%
3.78%
Putable advances are callable at the option of the FHLB on a quarterly basis. Strike rate advances are
callable at the option of the FHLB only when three-month LIBOR rates exceed the agreed upon strike
rate in the advance contract. Such strike rates range from 7.5% to 8.0%. When called, First Defiance has
the option of paying off these advances, or converting them to variable rate advances at the three month
LIBOR rate. First Defiance has three advances totaling $45 million outstanding at December 31, 2008
that were converted from callable advances. These advances can be paid in full without penalty at any
quarterly repricing date.
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Estimated future minimum payments by fiscal year based on maturity date are as follows (in thousands):
2009
2010
2011
2012
2013
Thereafter
Total minimum payments
Less amounts representing interest
Totals
$
6,000
15,803
68,076
14,720
43,885
18,672
167,156
20,189
$ 146,967
First Defiance also utilizes short-term advances from the FHLB to meet cash flow needs and for short-
term investment purposes. First Defiance borrows short-term advances under a variety of programs at
FHLB. At December 31, 2008 and December 31, 2007, $9.1 million and $11.3 million, respectively, were
outstanding under First Defiance’s Cash Management Advance line of credit. The total available under
this line is $15.0 million. In addition First Defiance has a $100.0 million REPO Advance line of credit
available. There were no borrowings against this line at December 31, 2008 and December 31, 2007.
Amounts are generally borrowed under the Cash Management and REPO lines on an overnight basis.
Amounts available under the various lines are also subject to the Company’s overall borrowing
limitations. Information concerning short-term advances is summarized as follows:
Years Ended December 31
2008
2007
Average daily balance during the year
Maximum month-end balance during the year
Average interest rate during the year
$
(In Thousands, Except Percentages)
7,772
45,800
5.23%
14,004
44,900
2.17%
$
13. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trust
In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (Trust
Affiliate II) that issued $15 million of Guaranteed Capital Trust Securities (Trust Preferred Securities). In
connection with the transaction, the Company issued $15.5 million of Junior Subordinated Deferrable
Interest Debentures (Subordinated Debentures) to Trust Affiliate II. The Company formed Trust Affiliate
II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds
from the sale of these capital securities solely in Subordinated Debentures of the Company. The
Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. Distributions on the
Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a fixed rate equal to 6.441%
for the first five years and a floating interest rate based on three-month LIBOR plus 1.5%, repricing
quarterly, thereafter.
The Trust Preferred Securities issued by Trust Affiliate II are subject to mandatory redemption, in whole
or part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement
that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the
guarantee. The Trust Preferred Securities and Subordinated Debentures mature on June 15, 2037, but may
be redeemed at the Company’s option at any time on or after June 15, 2012, or at any time upon certain
events.
The Company also sponsors an affiliated trust, First Defiance Statutory Trust I (Trust Affiliate I), that
issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the
Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was
formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the
proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The
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Junior Debentures held by Trust Affiliate I are the sole assets of the trust. Distributions on the Trust
Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-
month LIBOR rate plus 1.38%. The Coupon rate payable on the Trust Preferred Securities issued by
Trust Affiliate I was 3.38% and 6.37% as of December 31, 2008 and 2007 respectively.
The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in whole
or in part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement
that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the
guarantee. The Trust Preferred Securities and Junior Debentures mature December 15, 2035 but may be
redeemed by the issuer at par after October 28, 2010.
Due to the Company’s participation in the U.S. Treasury’s Capital Purchase Program, permission must be
obtained from the U.S. Treasury in order to call these securities.
A summary of all junior subordinated debentures issued by the Company to affiliates follows. These
amounts represent the par value of the obligations owed to these affiliates, including the Company’s
equity interest in the trusts. Junior subordinated debentures owed to the following affiliates were as
follows:
First Defiance Statutory Trust I due December 2035
First Defiance Statutory Trust II due June 2037
Total junior subordinated debentures owed to
unconsolidated subsidiary Trusts
December 31
2008
$
20,619
15,464
$
2007
20,619
15,464
$
36,083
$
36,083
Interest on both issues of Trust Preferred Securities may be deferred for a period of up to five years at the
option of the issuer.
14. Notes Payable and Other Short-term Borrowings
Total short term borrowings, revolving and term debt is summarized as follows:
Securities sold under agreement to repurchase
Amounts outstanding at year-end
Year-end interest rate
Average daily balance during year
Maximum month-end balance during the year
Average interest rate during the year
Revolving line of credit facilities to financial institutions
Average daily balance during year
Maximum month-end balance during the year
Average interest rate during the year
Years Ended December 31
2008
2007
(In Thousands, Except Percentages)
$ 49,454
$ 30,055
1.79%
36,926
50,679
2.69%
$ 14,416
23,200
4.45%
$
3.14%
23,739
30,055
3.04%
171
500
6.20%
As of December 31, 2008, First Defiance had the following line of credit facility available for short-term
borrowing purposes:
A $20 million fed funds line of credit with a financial institution. The line is unsecured and has an
interest rate of the institution’s fed funds rate. There were no amounts outstanding on the line at
December 31, 2008 and 2007. The maximum borrowed at any point in time under the line was
$20.0 million in 2008 and $6.8 million in 2007, and the average balance outstanding was
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$339,000 and $63,000 in 2008 and 2007, respectively. This line of credit expired on January 31,
2009.
During 2008, First Defiance had the following line of credit facilities expire in 2008:
A $15 million revolving line of credit facility with a financial institution. The facility was
unsecured and has an interest rate of fed funds rate plus 0.45%. This facility was not used in
2008 or 2007.
A $15 million fed funds line of credit with a financial institution. The line was unsecured and has
an interest rate of the institution’s fed funds rate. This facility was not used in 2008 or 2007.
A $22.0 million revolving line of credit with a financial institution. There was no amount
outstanding on the line at December 31, 2008 and 2007. The line was secured by the stock of
First Federal Bank and the interest rate is either the lender’s prime rate or LIBOR plus 1.50%,
whichever was selected by First Defiance. The maximum borrowed at any point in time under the
line was $22.0 million and $1.0 million in 2008 and 2007, and the average balance outstanding
was $14,077,000 and $108,000 in 2008 and 2007, respectively. This line of credit was paid off in
December 2008.
15. Other Non-Interest Expense
The following is a summary of other non-interest expense:
2008
Years Ended December 31,
2007
(In Thousands)
$
$
2006
$ 1,933
1,896
1,951
1,082
583
776
1,459
768
1,120
123
676
3,339
$ 15,706
1,840
1,729
1,579
135
831
679
646
643
549
492
274
3,547
$ 12,944
1,732
1,330
1,288
297
122
879
719
781
373
372
289
3,060
$ 11,242
Legal and other professional fees
Marketing
State franchise taxes
FDIC Insurance
REO expenses and write-downs
Printing and office supplies
Amortization of intangibles
Postage
Check charge-offs and fraud losses
Overdraft protection expense
Credit and collection expense
Other
Total other non-interest expense
16. Postretirement Benefits
First Defiance sponsors a defined benefit postretirement plan that is intended to supplement Medicare
coverage for certain retirees who meet minimum age requirements. First Federal employees who retired
prior to April 1, 1997 who completed 20 years of service after age 40 receive full medical coverage at no
cost. Such coverage continues for surviving spouses of those participants for one year, after which
coverage may be continued provided the spouse pays 50% of the average cost. First Federal employees
retiring after April 1, 1997 are provided medical benefits at a cost based on their combined age and years
of service at retirement. Surviving spouses are also eligible for continued coverage after the retiree is
deceased at a subsidy level that is 10% less than what the retiree is eligible for. First Federal employees
retiring before July 1, 1997 receive dental and vision care in addition to medical coverage. First Federal
employees who retire after July 1, 1997 are not eligible for dental or vision care, but those retirees and
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their spouses each receive up to $200 annually in a medical spending account. Funds in that account may
be used for payment of uninsured medical expenses.
First Federal employees who were born after December 31, 1950 are not eligible for the medical coverage
described above at retirement. Rather, a medical spending account of up to $10,000 (based on the
participant’s age and years of service) will be established to reimburse medical expenses for those
individuals. First Insurance employees who were born before December 31, 1950 can continue coverage
until they reach age 65, or in lieu of continuing coverage, can elect the medical spending account option,
subject to eligibility requirements. Employees hired or acquired after January 1, 2003 are eligible only for
the medical spending account option.
Adoption of Statement 158
On December 31, 2006, the Company adopted the recognition and disclosure provisions of Statement
158. The adjustment to accumulated other comprehensive income at adoption represented the net
unrecognized actuarial losses and unrecognized prior service costs, which were previously netted against
the plan’s funded status in the Company’s statement of financial position pursuant to the provisions of
Statement 106. These amounts will be subsequently recognized as net periodic pension cost pursuant to
the Company’s historical accounting policy for amortizing such amounts. Actuarial gains and losses are
recognized as a component of other comprehensive income. Those amounts will be subsequently
recognized as a component of net periodic cost on the same basis as the amounts recognized in
accumulated other comprehensive income at adoption of Statement 158.
The incremental effects of adopting the provisions of Statement 158 on the Company’s statement of
financial position at December 31, 2006 are presented in the following table. The adoption of Statement
158 had no effect on the Company’s consolidated statement of income for the year ended December 31,
2006, or for any prior period presented, and it will not affect the Company’s operating results in future
periods.
At December 31, 2006
Prior to Adopting
Statement 158
Effect of Adopting
Statement 158
As Reported at
December 31, 2006
Accrued Postretirement Liability
Deferred income tax liability
Accumulated other comprehensive income (loss)
$
1,232
(1,605)
(95)
$
(In Thousands)
886
310
(576)
$
2,118
(1,295)
(671)
Included in accumulated other comprehensive income at December 31, 2008 and 2007 are the following
amounts that have not yet been recognized in net periodic pension cost:
Unrecognized prior service cost
Unrecognized actuarial losses
Total recognized in Accumulated Other
Comprehensive Income
Income tax effect
Net amount recognized in Accumulated Other
Comprehensive Income
December 31
2008
2007
$
(In Thousands)
76
1,161
$
1,237
(433)
62
1,137
1,199
(420)
$
804
$
779
The prior service cost and actuarial loss included in other comprehensive income and expected to be
recognized in net postretirement benefit cost during the fiscal year-ended December 31, 2009 is $10,000
($6,500 net of tax) and $45,000 ($29,000 net of tax), respectively.
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Reconciliation of Funded Status and Accumulated Benefit Obligation
The plan is not currently funded. The following table summarizes benefit obligation and plan asset
activity for the plan measured as of December 31 each year:
Change in benefit obligation:
Benefit obligation at beginning of year
Service cost
Interest cost
Participant contribution
Plan amendments
Actuarial losses
Acquisition
Benefits paid
Benefit obligation at end of year
Change in fair value of plan assets:
Balance at beginning of year
Employer contribution
Participant contribution
Benefits paid
Balance at end of year
Funded status at end of year
December 31
2008
2007
(In Thousands)
$
$
2,393
57
159
37
25
74
271
(163)
2,853
–
126
37
(163)
–
(2,853)
$
$
2,118
49
125
42
–
357
–
(298)
2,393
–
256
42
(298)
–
(2,393)
Net periodic postretirement benefit cost includes the following components:
Service cost-benefits attributable to service during the period
Interest cost on accumulated postretirement benefit obligation
Net amortization and deferral
Net periodic postretirement benefit cost
Net loss during the year
Prior service cost added during the year
Amortization of prior service cost and actuarial losses
Total recognized in comprehensive income
Total recognized in net periodic postretirement benefit
cost and other comprehensive income
$
2008
57
159
61
277
74
25
(61)
38
Years Ended December 31
2007
(In Thousands)
$
49
125
44
218
357
−
(44)
313
$
$
315
$
531
$
2006
40
107
32
179
−
−
−
−
179
The following assumptions were used in determining the components of the postretirement benefit
obligation:
Weighted average discount rates:
Used to determine benefit obligations at December 31
Used to determine net periodic postretirement benefit cost for years
ended December 31
Assumed health care cost trend rates at December 31:
Health care cost trend rate assumed for next year
Rate to which the cost trend rate is assumed to decline (the ultimate
trend rate)
Year that rate reaches ultimate trend rate
2008
6.00%
6.00%
9.00%
4.00%
2019
2007
6.00%
5.75%
9.50%
4.00%
2019
The following benefits are expected to be paid over the next five years and in aggregate for the next five
years thereafter. Because the plan is unfunded, the expected net benefits to be paid and the estimated
Company contributions are the same amount. The Company has elected to opt for the Federal subsidy
approach in lieu of coverage under Medicare Part D.
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These amounts include an estimate of that tax-free Federal subsidy:
2009
2010
2011
2012
2013
2014 through 2018
Before Reflecting
Medicare Part D
Subsidy
Impact of Medicare
Part D Subsidy
(In Thousands)
$
186
202
211
223
231
1,346
$
(23)
(24)
(25)
(26)
(30)
(183)
After Reflecting
Medicare Part D
Subsidy
$
163
178
186
197
201
1,163
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care
plans. A one-percentage-point change in assumed health care cost trend rates would have the following
effect (in thousands):
One-Percentage-Point
Increase
Year Ended December 31
2008
2007
One-Percentage-Point
Decrease
Year Ended December 31
2007
2008
(In Thousands)
Effect on total of service and interest cost
Effect on postretirement benefit obligation
$
29
301
$
30
293
$
(24)
(259)
$ (25)
(249)
The Company expects to contribute $186,000 before reflecting expected Medicare retiree drug subsidy
payments in 2009.
17. Regulatory Matters
First Federal is subject to various regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a direct material effect on
the consolidated financial statements. Under capital adequacy 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, 2008 and 2007, First Federal meets all capital adequacy
requirements to which it is subject and the most recent notification from the Office of Thrift Supervision
(OTS) categorized First Federal as well capitalized under the regulatory framework. There are no
conditions or events since these notifications that management believes have changed any of the well-
capitalized categorizations of First Federal.
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The following schedule presents First Federal’s regulatory capital ratios:
Actual
Amount
Ratio
Required for Capital
Adequacy Purposes
Amount
Ratio
Required to be
Well Capitalized
Amount
Ratio
As of December 31, 2008
Tangible Capital
Tier 1 (Core) Capital
Tier 1 Capital to risk-weighted assets
Risk-Based Capital
As of December 31, 2007
Tangible Capital
Tier 1 (Core) Capital
Tier 1 Capital to risk-weighted assets
Risk-Based Capital
$
$
202,616
202,616
202,616
219,290
156,856
156,856
156,856
170,746
$
$
10.70%
10.70%
12.03%
13.02%
10.03%
10.03%
11.68%
12.71%
28,416
75,777
67,356
134,712
23,469
62,584
53,723
107,446
1.50%
4.00%
4.00%
8.00%
1.50%
4.00%
4.00%
8.00%
$
$
N/A
94,721
101,034
168,390
N/A
78,231
80,585
134,308
N/A
5.00%
6.00%
10.00%
N/A
5.00%
6.00%
10.00%
First Defiance is a unitary thrift holding company and is regulated by the OTS. The OTS does not have
defined capital requirements for unitary thrift holding companies.
Dividend Restrictions – As a result of its participation in the CPP, First Defiance is prohibited without
prior approval of the U.S. Treasury, from paying a quarterly cash dividend of more that $0.26 per share
until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or
transferred to an unaffiliated third party. In addition, dividends paid by First Federal to First Defiance are
subject to various regulatory restrictions. First Federal paid $10.0 million in dividends in 2008. No
dividends were paid in 2007. First Federal can initiate dividend payments equal to its net profits (as
defined by statute) for 2007 and 2008 plus 2009 net profits without prior regulatory approval. During
2009, the Bank could declare dividends of approximately $14.4 million to First Defiance. First Federal
must notify the Office of Thrift Supervision prior to the payment of any such dividend and it may apply
to the OTS to pay total dividends that exceed an amount equal to its 2007 to 2009 net profits. First
Insurance paid dividends of $1.8 million to First Defiance in 2008. No dividends were paid in 2007.
18. Income Taxes
The components of income tax expense are as follows:
Current:
Federal
State and local
Deferred
2008
Years Ended December 31
2007
(In Thousands)
2006
$
$
7,534
45
(4,051)
3,528
$
$
6,636
90
(257)
6,469
$
$
6,579
2
870
7,451
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The provision for income taxes differs from that computed at the statutory corporate tax rate as follows:
Tax expense at statutory rate (35%)
Increases (decreases) in taxes from:
State income tax – net of federal tax benefit
ESOP adjustments
Tax exempt interest income
Bank owned life insurance
Stock option expense under FAS 123(R)
Other
Totals
$
$
2008
Years Ended December 31
2007
(In Thousands)
7,130
$
$
3,810
2006
29
(30)
(530)
130
90
29
3,528
$
59
152
(472)
(511)
89
22
6,469
$
8,068
–
163
(414)
(367)
90
(89)
7,451
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:
Deferred federal income tax assets:
Allowance for loan losses
Postretirement benefit costs
Deferred compensation
Impaired loans
Impaired investments
Accrued vacation
Allowance for real estate held for sale losses
Deferred loan origination fees and costs
Net unrealized losses on available-for-sale securities
Other
Total deferred federal income tax assets
Deferred federal income tax liabilities:
FHLB stock dividends
Goodwill
Mortgage servicing rights
Fixed assets
Other intangible assets
Loan mark to market
Net unrealized gains on available-for-sale securities
Other
Total deferred federal income tax liabilities
Net deferred federal income tax asset (liability)
December 31
2008
2007
(In Thousands)
$
$
8,423
998
645
1,074
1,140
428
56
337
708
565
14,374
3,284
2,284
2,072
975
2,815
2,274
−
334
14,038
336
$
$
4,768
838
796
508
−
336
245
205
−
488
8,184
2,949
1,884
1,766
1,244
1,132
168
196
151
9,490
(1,306)
The realization of the Company’s deferred tax assets is dependent upon the Company’s ability to generate
taxable income in future periods and the reversal of deferred tax liabilities during the same period. The
Company has evaluated the available evidence supporting the realization of its deferred tax assets and
determined it is more likely than not that the assets will be realized and thus no valuation allowance was
required at December 31, 2008.
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Retained earnings at December 31, 2008 include approximately $11.0 million for which no tax provision
for federal income taxes has been made. This amount represents the tax bad debt reserve at December 31,
1987, which is the end of the Company’s base year for purposes of calculating the bad debt deduction for
tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb
bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability
on the above amount at December 31, 2008 was approximately $3.85 million.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in
thousands):
Balance at December 31, 2007
Additions based on tax positions related to the current year
Additions for tax positions of prior years
Reductions for tax positions of prior years
Reductions due to the statute of limitations
Settlements
Balance at December 31, 2008
$
$
498
86
−
−
(140)
−
444
As of December 31, 2008 the amount of unrecognized tax benefits that, if recognized, would favorably
affect the effective income tax rate in future periods totaled $296,000. The Company does not expect the
total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.
The total amount of interest and penalties recorded in the income statement, net of the related federal tax
benefit, for the year ended December 31, 2008 was $20,000, and the amount accrued for interest and
penalties (net of the related federal tax benefit) at December 31, 2008 was $89,000.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state
of Indiana. The Company is no longer subject to examination by taxing authorities for years before 2005.
The Company currently operates primarily in the state of Ohio, which taxes financial institutions based on
their equity rather than their income.
19. Employee Benefit Plans
ESOP Plan
First Defiance has established an Employee Stock Ownership Plan (ESOP) covering all employees of
First Defiance age 21 or older who have at least one year of credited service. Contributions to the ESOP
are made by First Defiance and are determined by First Defiance’s Board of Directors at their discretion.
The contributions may be made in the form of cash or First Defiance common stock. The annual
contributions may not be greater than the amount deductible for federal income tax purposes and cannot
cause First Federal to violate regulatory capital requirements.
To fund the plan, the ESOP borrowed funds from First Defiance for the purpose of purchasing shares of
First Defiance common stock. The ESOP acquired a total of 863,596 shares in 1993 and 1995. The loan
outstanding was paid off in June 2008 and had a balance of $493,000 at December 31, 2007. Principal
and interest payments on the loan were due in equal quarterly installments. The loan was collateralized by
the shares of First Defiance’s common stock and was repaid by the ESOP with funds from the Company’s
contributions to the ESOP, dividends on allocated and unallocated shares and earnings on ESOP assets.
As principal and interest payments on the loan were paid, shares were 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
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the ESOP plan in the statement of financial condition. As shares are released, First Defiance records
compensation expense equal to the average fair value of the shares over the period in which the shares
were earned. Also, the shares released for allocation are included in the average shares outstanding for
earnings per share computations. Dividends on allocated shares are recorded as a reduction of retained
earnings and dividends on unallocated shares reduce debt and accrued interest. ESOP compensation
expense was $116,000, $859,000, and $891,000, for 2008, 2007 and 2006, respectively.
Shares held by the ESOP at December 31 were as follows:
Beginning Balance
Allocation of shares to participants
Distribution of shares to
former participants
Ending Balance
Year Ended December 31, 2008
Allocated
515,618
34,828
Unallocated
34,828
(34,828)
Total
550,446
-
Year Ended December 31, 2007
Unallocated
83,618
(48,790)
Allocated
498,249
48,790
Total
581,867
-
(22,723)
527,723
-
-
(22,723)
527,723
(31,421)
515,618
-
34,828
(31,421)
550,446
There were no unallocated shares at December 31, 2008. Of the 34,828 unallocated shares at December
31, 2007, 12,197 were released during the 2007 fourth quarter for allocation in 2008. The 22,631
unreleased shares had a fair value of $498,000 at December 31, 2007.
410(k) Plan
Employees of First Defiance are eligible to participate in the First Defiance Financial Corp. 401(k)
Employee Savings Plan (First Defiance 401(k)) if they meet certain age and service requirements. Under
the First Defiance 401(k), First Defiance matches 50% of the participants’ contributions, to a maximum
of 3% of compensation. The First Defiance 401(k) also provides for a discretionary First Defiance
contribution in addition to the First Defiance matching contribution. First Defiance matching
contributions totaled $474,000, $409,000 and $355,000 for the years ended December 31, 2008, 2007 and
2006 respectively. There were no discretionary contributions in any of those years.
20. Stock Option Plans
First Defiance has established incentive stock option plans for its directors and its employees and has
reserved 1,727,485 shares of common stock for issuance under the plans. A total of 1,467,204 shares are
reserved for employees and 260,281 shares are reserved for directors. As of December 31, 2008, 439,800
options (427,800 for employees and 12,000 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 33,600 options granted under the 1996 plan that vest at 20% per year beginning in 1997 of
which 33,400 are fully vested and currently exercisable, 194,650 options granted under the 2001 plan
which vest at 20% per year beginning in 2002, of which 174,700 are fully vested and currently
exercisable and 211,550 options granted under the 2005 plan which vest at 20% per year beginning in
2006, of which 46,500 are fully vested and currently exercisable. All options expire ten years from date of
grant. Vested options of retirees expire on the earlier of the scheduled expiration date or five years after
the retirement date for the 1993, 2001 and 2005 plans and on the earlier of the scheduled expiration date
or twelve months after the retirement date for the 1996 plan.
The fair value of each option award is estimated on the date of grant using the Black-Scholes model using
the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the
Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting
termination behavior. The expected term of options granted is based on historical data and represents the
period of time that options granted are expected to be outstanding, which takes into account that the
options are not transferable. The risk-free interest rate for the expected term of the option is based on the
U.S. Treasury yield curve in effect at the time of the grant.
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The fair value of options granted was determined using the following weighted-average assumptions as of
grant date.
Risk-free interest rate
Expected term
Expected stock price volatility
Dividend yield
2008
Year Ended December 31
2007
4.84%
6.6 years
21.8%
4.26%
6.5 years
22.5%
6.08%
3.67%
The following table summarizes stock option activity for 2008:
Weighted
Average
Remaining
Contractual
Term (in years)
Weighted
Average
Exercise
Price
$ 20.79
17.15
14.64
24.06
$ 20.58
Options
Outstanding
418,339
95,000
(52,486)
(21,053)
439,800
5.90
$0
417,426
254,600
$ 20.49
$ 19.58
5.80
4.08
$0
$0
Outstanding at January 1, 2008
Granted
Exercised
Forfeited
Outstanding at December 31,
2008
Vested or expected to vest
at December 31, 2008
Exercisable at December 31, 2008
2006
5.16%
6.5 years
22.4%
3.62%
Aggregate
Intrinsic
Value
(in $000s)
Information related to the stock option plans follows:
Year Ended December 31.
2008
2006
2007
(in thousands, except per share amounts)
Intrinsic value of options exercised
Cash received from option exercises*
Tax benefit realized from option exercises
Weighted average fair value of options granted
* - Includes $33,000, $240,000, and $1,091,000 of option exercises paid by optionees in First Defiance
common stock in 2008, 2007 and 2006, respectively.
290
768
72
1.98
3,092
2,348
481
509
522
64
5.27
5.96
$
$
$
$
$
$
As of December 31, 2008, there was $549,000 of total unrecognized compensation cost related to
nonvested stock options granted under the Company Stock Option Plans. The cost is expected to be
recognized over a weighted-average period of 3.1 years.
As of December 31, 2008 and 2007, 146,850 and 223,950 shares, respectively, were available for grant
under the Company’s stock option plans. Options forfeited or cancelled under the 1996 plan are no longer
available for grant to other participants.
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21. Parent Company Statements
Condensed parent company financial statements, which include transactions with subsidiaries, follow:
Statements of Financial Condition
Assets
Cash and cash equivalents
Investment securities, available for sale, carried at fair value
Investment in subsidiaries
Loan receivable from First Defiance Employee Stock
Ownership Plan
Other assets
Total assets
Liabilities and stockholders’ equity:
Subordinated debentures
Accrued liabilities
Stockholders’ equity
Total liabilities and stockholders’ equity
Statements of Income
December 31
2008
2007
(In Thousands)
$
$
$
$
2,023
419
263,562
-
1,101
267,105
36,083
1,863
229,159
267,105
$
$
$
$
3,167
1,388
197,839
493
1,111
203,998
36,083
1,961
165,954
203,998
2008
Years Ended December 31
2007
(In Thousands)
2006
Dividends from subsidiaries
Interest on loan to ESOP
Interest expense
Gain (loss) on write-down of securities
Other income
Noninterest expense
Income (loss) before income taxes and equity in earnings of
subsidiaries
Income tax credit
Income (loss) before equity in earnings of subsidiaries
Undistributed equity in (distributions in excess of)
earnings of subsidiaries
Net income
$
11,750 $
10
(2,545)
(1,281)
35
(785)
7,184
(1,650)
8,834
- $
64
(2,124)
-
222
(698)
(2,536)
(867)
(1,669)
1,000
119
(1,310)
-
140
(653)
(704)
(577)
(127)
(1,477)
7,357 $
15,573
13,904 $
15,727
15,600
$
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Statements of Cash Flows
Operating activities:
Net income
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Distribution in excess of (undistributed equity in)
earnings of subsidiaries
Gain or (loss) on write-down of securities
Net amortization of premium on securities
Change in other assets and liabilities
Net cash provided by (used in) operating activities
Investing activities:
Investment in unconsolidated trust subsidiary
Cash paid for Pavilion Bancorp
Cash paid for Huber Harger Welt & Smith
Principal payments received on ESOP loan
Purchase of available-for-sale securities
Maturities of available-for-sale securities
Net cash (used in) provided by investing activities
Financing activities:
Proceeds from issuance of subordinated debt securities
Capital contribution to subsidiary
Stock options exercised
Excess tax benefit from exercise of stock options
Purchase of common stock for treasury
Cash dividends paid
Proceeds from issuance of preferred stock
Net cash used in financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
2008
Years Ended December 31
2007
(In Thousands)
2006
$
7,357
$ 13,904
$ 15,600
1,477
1,281
29
118
10,262
–
(27,968)
–
493
–
–
(27,475)
-
(13,000)
769
72
(635)
(8,137)
37,000
16,069
(1,144)
3,167
2,023
$
(15,573)
(15,727)
–
54
(435)
(2,050)
(464)
–
(175)
641
–
102
104
15,464
–
281
64
(4,923)
(7,090)
–
3,796
1,850
1,317
3,167
$
75
–
695
643
–
–
588
(500)
35
123
–
(1,000)
1,257
481
(2,852)
(6,741)
–
(8,855)
(8,089)
9,406
1,317
$
22. Fair Value
FAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants. A fair value measurement assumes that the
transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability
or, in the absence of a principal market, the most advantageous market for the asset or liability. The price
in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall
not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the
market for a period prior to the measurement date to allow for marketing activities that are usual and
customary for transactions involving such assets and liabilities; it is not a forced transaction. Market
participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii)
able to transact and (iv) willing to transact.
FAS 157 requires the use of valuation techniques that are consistent with the market approach, the income
approach and/or the cost approach. The market approach uses prices and other relevant information
generated by market transactions involving identical or comparable assets and liabilities. The income
approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to
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a single present amount on a discounted basis. The cost approach is based on the amount that currently
would be required to replace the service capacity of an asset (replacement cost). Valuation techniques
should be consistently applied. Inputs to valuation techniques refer to the assumptions that market
participants would use in pricing the asset or liability. Inputs may be observable, meaning those that
reflect the assumptions market participants would use in pricing the asset or liability developed based on
the best information available.
In Accordance with FAS 157, the Company groups its assets and liabilities measured at fair value in three
levels, based on the markets in which the assets and liabilities are traded and the reliability of the
assumptions used to determine the fair value. These levels are:
• Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that
the reporting entity has the ability to access at the measurement date.
• Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset
or liability, either directly or indirectly. These might include quoted prices for similar assets
or liabilities in active markets, quoted prices for identical or similar assets or liabilities in
markets that are not active, inputs other that quoted prices that are observable for the asset
or liability (such as interest rates, prepayment speeds, credit risks, etc.) or inputs that are
derived principally from or corroborated by market data by a correlation or other means.
• Level 3: Unobservable inputs for determining fair value of assets and liabilities that reflect
an entity’s own assumptions about the assumptions that market participants would use in
pricing the assets or liabilities.
A description of the valuation methodologies used for instruments measured at fair value, as well as the
general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Available for sale securities. Securities classified as available for sale are generally reported at fair value
utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing
service. The fair value measurements consider observable data that may include dealer quotes, market
spreads, cash flows and the bond’s terms and conditions, among other things. Securities in Level 1
include U.S. Treasury and other federal agency securities. Securities in Level 2 include U.S. Government
agencies, mortgage-backed securities, municipal securities. Securities in Level 3 include trust preferred
securities.
Impaired loans. Impaired loans are reported at the fair value of the underlying collateral, if repayment is
expected solely from collateral. Impaired loans are valued using Level 3 inputs.
Mortgage servicing rights. Mortgage servicing rights are reported at fair value utilizing Level 3 inputs.
MSRs are valued by a third party consultant using a proprietary cash flow valuation model.
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The following table summarizes the financial assets measured at fair value on a recurring and non-
recurring basis as of December 31, 2008, segregated by the level of the valuation inputs within the fair
value hierarchy utilized to measure fair value:
Assets and Liabilities Measured on a Recurring Basis
Level 1 Inputs
Level 2 Inputs
Level 3 Inputs
(In Thousands)
Total Fair
Value
Available for sale securities
$ 49
$ 113,653
$ 3,873
$ 117,575
The table below presents a reconciliation and income classification of gains and losses for all assets
measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the
year ended December 31, 2008:
Beginning balance, January 1, 2008
Total gains or losses (realized/unrealized)
Included in earnings
Included in other comprehensive income
(presented gross of taxes)
Purchases, issuances, and settlements
Transfers in and/or out of Level 3
Ending balance, December 31, 2008
Fair Value Measurements
Using Significant
Unobservable Inputs (Level 3)
$
8,642
(1,281)
(3,281)
(207)
-
3,873
$
Assets and Liabilities Measured on a Non-Recurring Basis
Level 1 Inputs
Level 2 Inputs
Level 3 Inputs
Total Fair Value
(In Thousands)
Impaired loans
Mortgage servicing rights
$ -
-
$ -
-
$
14,782
6,611
$ 14,782
6,611
Mortgage servicing rights which are carried at lower of cost or fair value were written down to fair value
of $6,611,000, resulting in a valuation allowance of $2,792,000. A charge of $2,676,000 was included in
earnings for the year ended December 31, 2008.
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral
dependent loans, derived from an appraisal or evaluation, had a carrying amount of $14,782,000, with a
recorded allowance of $6,030,000.
The following is a comparative condensed consolidated statement of financial condition based on
carrying amount and estimated fair values of financial instruments as of December 31, 2008 and 2007.
Statement of Financial Accounting Standards (SFAS) 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.
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Much of the information used to arrive at “fair value” is highly subjective and judgmental in nature and
therefore the results may not be precise. Subjective factors include, among other things, estimated cash
flows, risk characteristics and interest rates, all of which are subject to change. With the exception of
investment securities, the Company’s financial instruments are not readily marketable and market prices
do not exist. Since negotiated prices for the instruments, which are not readily marketable depend greatly
on the motivation of the buyer and seller, the amounts that will actually be realized or paid per settlement
or maturity of these instruments could be significantly different.
The carrying amount of cash and cash equivalents, warehouse and term notes payable and advance
payments by borrowers for taxes and insurance, as a result of their short-term nature, is considered to be
equal to fair value.
For investment securities, fair value has been based or current market quotations. If market prices are not
available, fair value has been estimated based upon the quoted price of similar instruments.
The fair value of loans which reprice within 90 days is equal to their carrying amount. For other loans, the
estimated fair value is calculated based on discounted cash flow analysis, using interest rates currently
being offered for loans with similar terms. The allowance for loan losses is considered to be a reasonable
adjustment for credit risk.
SFAS No. 107 requires that the fair value of demand, savings, NOW and certain money market accounts
be equal to their carrying amount. The Company believes that the fair value of these deposits may be
greater or less than that prescribed by SFAS No. 107.
The carrying value of Subordinated Debentures and deposits with fixed maturities is estimated based on
interest rates currently being offered on instruments with similar characteristics and maturities. FHLB
advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using
interest rates currently being quoted for similar characteristics and maturities. The cost or value of any
call or put options is based on the estimated cost to settle the option at December 31, 2008.
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Assets:
Cash and cash equivalents
Investment securities
Loans, net, including loans
held for sale
Other assets
Total assets
Liabilities and stockholders’ equity:
Deposits
Advances from Federal Home
Loan Bank
Subordinated debentures
Short term borrowings and other
interest bearing liabilities
Advance payments by borrowers
for taxes and insurance
Other liabilities
Total liabilities
Stockholders’ equity
Total liabilities and
stockholders’ equity
December 31, 2008
December 31, 2007
Carrying
Value
Estimated
Fair Values
Carrying
Value
Estimated
Fair Values
(In Thousands)
$
46,152
118,461
$
46,152
118,492
$
65,553
113,487
$
65,553
113,531
1,619,409
$ 1,784,053
1,603,603
1,768,216
189,184
$ 1,957,400
1,298,305
$ 1,477,389
1,281,557
1,460,597
148,807
$ 1,609,404
$ 1,469,912
$ 1,476,135
$ 1,217,858
$ 1,218,391
156,067
36,083
162,776
40,282
139,536
36,083
145,117
28,027
49,454
49,454
30,055
30,055
652
$ 1,729,299
652
1,712,168
16,073
1,728,241
229,159
762
$ 1,422,352
762
1,424,294
19,156
1,443,450
165,954
$1,957,400
$1,609,404
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23. Quarterly Consolidated Results of Operations (Unaudited)
The following is a summary of the quarterly consolidated results of operations:
Three Months Ended
March 31
June 30
September 30
December 31
(In Thousands, Except Per Share Amounts)
2008
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for
loan losses
Gain (loss) on sale or write-down
of securities
Noninterest income
Noninterest expense
Income before income taxes
Income taxes
Net income
$
$
24,639
11,048
13,591
1,058
26,237
9,991
16,246
2,797
$
12,533
13,449
(81)
6,096
13,476
5,072
1,653
3,419
$
(432)
6,582
15,515
4,084
1,349
2,735
$
Dividends accrued on preferred shares
Accretion on preferred shares
Net income applicable to common shares $
-
-
3,419
$
$
$
$
$
0.48
0.47
7,195
7,241
24,033
12,048
11,985
457
11,528
-
5,608
11,774
5,362
1,756
3,606
$
$
$
-
-
2,735
0.34
0.34
8,094
8,126
24,532
12,410
12,122
575
11,547
-
5,670
11,882
5,335
1,724
3,611
Earnings per common share:
Basic
Diluted
Average shares outstanding:
Basic
Diluted
2007
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for
$
loan losses
Gain on sale of securities
Noninterest income
Noninterest expense
Income before income taxes
Income taxes
Net income
Earnings per common share:
Basic
Diluted
Average shares outstanding:
Basic
Diluted
26,643
10,277
16,366
4,907
11,459
(2,051)
6,191
15,233
366
44
322
-
-
322
0.04
0.04
8,113
8,123
24,989
12,962
12,027
671
11,356
21
5,563
12,296
4,644
1,515
3,129
$
$
$
$
$
$
$
25,945
9,952
15,993
3,824
12,169
(596)
3,360
13,571
1,362
482
880
(134)
(11)
735
0.09
0.09
8,117
8,117
25,197
12,669
12,528
603
11,925
-
5,268
12,161
5,032
1,474
3,558
$
$
$
$
$
$
$
$
0.51
0.50
$
$
0.51
0.50
$
$
0.44
0.44
$
$
0.51
0.50
7,105
7,215
7,129
7,229
7,080
7,171
7,037
7,108
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24. 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 in 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.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial
Disclosure
None.
Item 9a: Controls and Procedures
First Defiance’s management carried out an evaluation, under the supervision and with the
participation of the chief executive officer and the interim chief financial officer, of the effectiveness of
First Defiance’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-
15(e) under the Exchange Act) as of December 31, 2008. Based upon that evaluation, the chief executive
officer along with the interim chief financial officer concluded that First Defiance’s disclosure controls
and procedures as of December 31, 2008, are effective.
The information set forth under “Management’s Report on Internal Control Over Financial
Reporting” and “Report of Independent Registered Public Accounting Firm” included in Item 8 above is
incorporated herein by reference.
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Changes in Internal Control Over Financial Reporting
There were no changes in First Defiance’s internal control over financial reporting (as such
term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter
ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect First
Defiance’s internal control over financial reporting.
Item 9b: Other Information
None
Item 10: Directors, Executive Officers and Corporate Governance
PART III
The information required herein is incorporated by reference from the sections captioned:
“Proposal 1 - Election of Directors”, “Executive Officers”, and “Section 16(a) Beneficial Ownership
Reporting Compliance” of the definitive proxy statement to be filed on or about March 25, 2009 (the
“Proxy Statement”).
First Defiance has adopted a Code of Ethics applicable to all officers, directors and employees
that complies with SEC requirements, and is available on its Internet site at www.fdef.com under the
Investor Relations tab.
Item 11: Executive Compensation
Information required by this item is set forth under the captions “Executive Compensation,”
“Director Compensation,” “Compensation Committee Report,” and “Compensation Committee Interlocks
and Insider Participation” of the Proxy Statement.
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
The information set forth under the caption “Beneficial Ownership” of the Proxy Statement is
incorporated herein by reference.
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Equity Compensation Plans
The following table provides information as of December 31, 2008 with respect to the shares of
First Defiance common stock that may be issued under First Defiance’s existing equity compensation
plans.
Number of securities to
be Issued Upon
Exercise of Outstanding
Options, Warrants and
Rights
Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights
Plan Category
Equity Compensation Plans Approved by
Security Holders
(a)
439,800
(b)
$20.58
Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column
(a))
(c)
147,005
Item 13: Certain Relationships and Related Transactions, and Director Independence
The information set forth under the captions “Composition of the Board” and “Related Person
Transactions” of the Proxy Statement is incorporated herein by reference.
Item 14: Principal Accountant Fees and Services
The information set forth under the caption “Independent Registered Public Accounting Firm”
of the Proxy Statement is incorporated herein by reference.
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Item 15: Exhibits, Financial Statement Schedules
PART IV
The following documents are filed as item 8 of this Form 10-K
(a) Report of Independent Registered Public Accounting Firm on Financial Statements (Crowe
Horwath LLP)
(b) Consolidated Balance Sheets – at December 31, 2008 and 2007
(c) Consolidated Statements of Earnings – Years Ended December 31, 2008, 2007 and 2006
(d) Consolidated Statements of Stockholders’ Equity and Comprehensive Income – Years Ended
December 31, 2008, 2007 and 2006
(e) Consolidated Statements of Cash Flows – Years Ended December 31, 2008, 2007 and 2006
(1) We are not filing separately financial statement schedules because of the absence of conditions
under which they are required or because the required information is included in the
consolidated financial statements or the related notes.
(2) The exhibits required by this item are listed in the Exhibit Index of this Form 10-K. The
management contracts and compensation plans or arrangements required to be filed as
exhibits to this Form 10-K are listed as Exhibits 10.1 through 10.12.
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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 16, 2009
By: /s/ Donald P. Hileman
Donald P. Hileman, Interim Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the Registrant and in the capacities indicated on March 16,
2009.
Signature
Title
/s/ William J. Small
William J. Small
/s/ Donald P. Hileman
Donald P. Hileman
/s/ James L. Rohrs
James L. Rohrs
/s/ Stephen L. Boomer
Stephen L. Boomer
/s/ John L. Bookmyer
John L. Bookmyer
/s/ Dr. Douglas A. Burgei
Dr. Douglas A. Burgei
/s/ Peter A. Diehl
Peter A. Diehl
/s/ Barb A. Mitzel
Barb A. Mitzel
/s/ Dwain I. Metzger
Dwain I. Metzger
/s/ Jean A. Hubbard
Jean A. Hubbard
/s/ Samuel S. Strausbaugh
Samuel S. Strausbaugh
/s/ Thomas A. Voigt
Thomas A. Voigt
Chairman of the Board, President and
Chief Executive Officer
Executive Vice President and
Interim Chief Financial Officer
Director, Executive Vice President
Director, Vice Chairman
Director
Director
Director
Director
Director
Director
Director
Director
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Exhibit Index
This report incorporates by reference the documents listed below that we have previously filed
with the SEC. The SEC allows us to incorporate by reference information in this document. The
information incorporated by reference is considered to be part of this document.
This information may be read and copied at the Public Reference Room of the SEC at 100 F
Street, N.E., Washington D.C. 20549. The SEC also maintains an internet web site that contains
reports, proxy statements, and other information about issuers, like First Defiance, who file
electronically with the SEC. The address of the site is http://www.sec.gov. The reports and other
information filed by First Defiance with the SEC are also available at the First Defiance Financial
Corp. web site. The address of the site is http://www.fdef.com. Except as specifically incorporated by
reference into this Annual Report on Form 10-K, information on those web sites is not part of this
report.
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- 109 -
Exhibit
Number
3.1
3.2
3.3
3.4
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
14
21
23.1
31.1
Description
Articles of Incorporation
Code of Regulations
Bylaws
Amendment to Articles of Incorporation
Agreement to furnish instruments and agreements defining
rights of holders of long-term debt
Form of Warrant for Purchase of Shares of Common Stock
1996 Stock Option Plan
Form of Incentive Stock Option Award Agreement
Form of Nonqualified Stock Option Award Agreement
1996 Management Recognition Plan and Trust
2001 Stock Option and Incentive Plan
1993 Stock Incentive Plan
Employment Agreement with William J. Small
Employment Agreement with James L. Rohrs
Employment Agreement with John C. Wahl
Employment Agreement with Gregory R. Allen
Description of Annual Bonus
2005 Stock Option and Incentive Plan
Letter Agreement, dated December 5, 2008, between First
Defiance and the U.S. Treasury
2008 Long Term Incentive Compensation Plan
Form of Contingent Award Agreement
Form of Stock Option Award Agreement
Amendment to all Employment Agreements for CPP
Code of Ethics
List of Subsidiaries of the Company
Consent of Crowe Horwath LLP
Certification of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
32.2
Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(1)
(1)
(1)
(11)
(4)
(15)
(2)
(3)
(3)
(2)
(5)
(1)
(6)
(7)
(8)
(9)
(16)
(10)
(12)
(13)
(14)
(4)
(4)
(16)
(16)
(4)
(4)
(4)
(4)
(4)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
(16)
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 like numbered exhibit in Registrant’s 2001 Form 10-K
Incorporated herein by reference to like numbered exhibit in Registrant’s 2004 Form 10-K
Included herein
Incorporated herein by reference to Appendix B to the 2001 Proxy Statement
Incorporated herein by reference to exhibit 10.1 in Form 8-K filed October 1, 2007
Incorporated herein by reference to exhibit 10.2 in Form 8-K filed October 1, 2007
Incorporated herein by reference to exhibit 10.3 in Form 8-K filed October 1, 2007
Incorporated herein by reference to exhibit 10.4 in Form 8-K filed October 1, 2007
Incorporated herein by reference to Appendix A to the 2005 Proxy Statement
Incorporated herein by reference to exhibit 3 in Form 8-K filed December 8, 2008
Incorporated herein by reference to exhibit 10 in Form 8-K filed December 8, 2008
Incorporated herein by reference to exhibit 10.1 in Form 8-K filed December 12, 2008
Incorporated herein by reference to exhibit 10.2 in Form 8-K filed December 12, 2008
Incorporated herein by reference to exhibit 4 in Form 8-K filed December 8, 2008
Incorporated herein by reference to like numbered exhibit in Registrant’s 2007 Form 10-K
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