XNAS:FDEF Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period Ended June 30, 2012

OR

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from ___________to__________

 

Commission file number 0-26850

 

First Defiance Financial Corp.

(Exact name of registrant as specified in its charter)

 

Ohio   34-1803915
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)

 

601 Clinton Street, Defiance, Ohio   43512
(Address of principal executive office)   (Zip Code)

 

Registrant's telephone number, including area code: (419) 782-5015

 

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 whether the registrant submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer ¨ Accelerated filer x
  Non-accelerated filer ¨ 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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value – 9,728,749 shares outstanding at August 3, 2012.

 

 
 

 

FIRST DEFIANCE FINANCIAL CORP.

 

INDEX

 

    Page Number
PART I.-FINANCIAL INFORMATION  
     
Item 1. Consolidated Condensed Financial Statements (Unaudited):  
  Consolidated Condensed Statements of Financial  
  Condition – June 30, 2012 and December 31, 2011 2
     
  Consolidated Condensed Statements of Income -  
  Three and six months ended June 30, 2012 and 2011 4
     
  Consolidated Condensed Statements of Comprehensive  
  Income – Three and six months ended June 31, 2012 and 2011 5
     
  Consolidated Condensed Statements of Changes in  
  Stockholders’ Equity – Six months ended June 30, 2012 and 2011 6
     
  Consolidated Condensed Statements of Cash Flows  
  - Six months ended June 30, 2012 and 2011 7
     
  Notes to Consolidated Condensed Financial Statements 8
     
Item 2. Management's Discussion and Analysis of Financial  
  Condition and Results of Operations 47
     
Item 3. Quantitative and Qualitative Disclosures about  
  Market Risk 69
     
Item 4. Controls and Procedures 69
     
PART II-OTHER INFORMATION:  
     
Item 1. Legal Proceedings 70
     
Item 1A. Risk Factors 70
     
Item 2. Unregistered Sales of Equity Securities  
  and Use of Proceeds 70
     
Item 3. Defaults upon Senior Securities 70
     
Item 4. Mine Safety Disclosures 70
     
Item 5. Other Information 70
     
Item 6. Exhibits 70
     
  Signatures 72

  

1
 

 

PART I-FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(Amounts in Thousands, except share and per share data)

 

 

   

   June 30,
2012
   December 31,
2011
 
   (Unaudited)     
Assets          
Cash and cash equivalents:          
Cash and amounts due from depository institutions  $31,517   $31,931 
Federal funds sold   72,000    143,000 
    103,517    174,931 
Securities:          
Available-for-sale, carried at fair value   278,829    232,919 
Held-to-maturity, carried at amortized cost
(fair value $611 and $672 at June 30, 2012 and December 31, 2011, respectively)
   600    661 
    279,429    233,580 
Loans held for sale   13,125    13,841 
Loans receivable, net of allowance of $26,409 at June 30, 2012 and $33,254 at December 31, 2011, respectively   1,474,228    1,453,822 
Accrued interest receivable   6,063    6,142 
Federal Home Loan Bank stock   20,655    20,655 
Bank owned life insurance   41,347    35,908 
Premises and equipment   40,825    40,045 
Real estate and other assets held for sale   3,538    3,628 
Goodwill   61,525    61,525 
Core deposit and other intangibles   5,427    6,151 
Mortgage servicing rights   8,274    8,690 
Deferred taxes   -    629 
Other assets   9,663    8,643 
Total assets  $2,067,616   $2,068,190 

 

(continued)

 

2
 

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

(Amounts in Thousands, except share and per share data)

 

 

  

   June 30,
2012
   December 31,
2011
 
   (Unaudited)     
Liabilities and stockholders’ equity          
Liabilities:          
Deposits  $1,613,611   $1,596,241 
Advances from the Federal Home Loan Bank   81,819    81,841 
Subordinated debentures   36,083    36,083 
Securities sold under repurchase agreements   50,527    60,386 
Advance payments by borrowers   989    1,402 
Deferred taxes   1,376    - 
Other liabilities   33,341    14,110 
Total liabilities   1,817,746    1,790,063 
           
Stockholders’ equity:          
           
Preferred stock, $.01 par value per share: 37,000 shares authorized; 1,000 and 37,000 issued with a liquidation preference of $998 and $37,231, respectively, net of discount   992    36,641 
Preferred stock, $.01 par value per share:          
4,963,000 shares authorized; no shares issued        
Common stock, $.01 par value per share:          
25,000,000 shares authorized; 12,739,496 and 12,739,496  shares issued and 9,728,749 and 9,726,243 shares outstanding, respectively   127    127 
Common stock warrant   878    878 
Additional paid-in capital   136,025    135,825 
Accumulated other comprehensive income, net of tax of $2,509 and $2,153, respectively   4,660    3,997 
Retained earnings   154,500    148,010 
Treasury stock, at cost, 3,010,747 and 3,013,253 shares respectively   (47,312)   (47,351)
Total stockholders’ equity   249,870    278,127 
           
Total liabilities and stockholders’ equity  $2,067,616   $2,068,190 

 

See accompanying notes

 

3
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Income

(UNAUDITED)

(Amounts in Thousands, except share and per share data)

 

 

  

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Interest Income                    
Loans  $18,197   $19,841   $36,847   $40,065 
Investment securities:                    
Taxable   1,268    1,162    2,380    2,191 
Non-taxable   726    606    1,397    1,175 
Interest-bearing deposits   114    140    206    241 
FHLB stock dividends   214    224    443    459 
Total interest income   20,519    21,973    41,273    44,131 
Interest Expense                    
Deposits   2,116    3,263    4,485    6,857 
FHLB advances and other   750    768    1,501    1,674 
Subordinated debentures   310    286    641    612 
Notes payable   97    140    201    270 
Total interest expense   3,273    4,457    6,828    9,413 
Net interest income   17,246    17,516    34,445    34,718 
Provision for loan losses   4,097    2,405    7,600    5,238 
Net interest income after provision for loan losses   13,149    15,111    26,845    29,480 
Non-interest Income                    
Service fees and other charges   2,687    2,747    5,358    5,364 
Insurance and investment commission income   2,192    1,449    4,727    3,104 
Mortgage banking income   2,258    1,906    4,704    3,194 
Gain on sale of non-mortgage loans   33    195    42    299 
Gain on sale or call of securities   382    -    425    49 
Other-than-temporary impairment (OTTI) losses on investment securities                    
Total impairment losses on investment securities   -    -    -    (13)
Losses recognized in other comprehensive income   -    -    -    11 
Net impairment loss recognized in earnings   -    -    -    (2)
Trust income   169    174    323    322 
Income from Bank Owned Life Insurance   219    237    439    474 
Other non-interest income   54    130    396    (21)
Total non-interest income   7,994    6,838    16,414    12,783 
Non-interest Expense                    
Compensation and benefits   8,049    7,451    16,514    15,285 
Occupancy   1,760    1,792    3,548    3,644 
FDIC insurance premium   672    677    1,341    1,590 
State franchise tax   512    542    1,026    1,084 
Data processing   1,169    979    2,337    2,040 
Acquisition related charges   -    135    -    135 
Amortization of intangibles   349    320    724    664 
Other non-interest expense   3,021    3,190    6,302    7,271 
Total non-interest expense   15,532    15,086    31,792    31,713 
Income before income taxes   5,611    6,863    11,467    10,550 
Federal income taxes   1,690    2,113    3,393    3,140 
Net Income  $3,921   $4,750   $8,074   $7,410 
                     
Dividends accrued on preferred shares  $(435)  $(463)  $(897)  $(925)
Accretion on preferred shares  $(305)  $(44)  $(351)  $(86)
Net income applicable to common shares  $3,181   $4,243   $6,826   $6,399 
                     
Earnings per common share (Note 7)                    
Basic  $0.33   $0.44   $0.70   $0.71 
Diluted  $0.32   $0.43   $0.68   $0.70 
Dividends declared per share (Note 6)  $0.05   $-   $0.10   $- 
Average common shares outstanding (Note 7)                    
Basic   9,729    9,724    9,728    9,006 
Diluted   9,985    9,902    9,980    9,171 

 

See accompanying notes

 

4
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Comprehensive Income

(UNAUDITED)

(Amounts in Thousands)

 

 

  

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Net Income  $3,921   $4,750   $8,074   $7,410 
                     
Other comprehensive income:                    
Unrealized gains/losses on securities                    
Unrealized holding gains on securities arising during the period   1,493    2,494    1,444    3,700 
Reclassification adjustment for (gains) losses  realized in income   (382)   -    (425)   (49)
Other-than-temporary impairment losses on  securities realized in income   -    -    -    2 
Net unrealized gains   1,111    2,494    1,019    3,653 
Income tax effect   (388)   (874)   (356)   (1,280)
Other comprehensive income   723    1,620    663    2,373 
                     
Comprehensive income  $4,644   $6,370   $8,737   $9,783 

 

5
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Changes in Stockholders’ Equity

(UNAUDITED)

(Amounts in Thousands)

 

 

  

                   Accumulated             
           Common   Additional   Other           Total 
   Preferred   Common   Stock   Paid-In   Comprehensive   Retained   Treasury   Stockholders’ 
   Stock   Stock   Warrant   Capital   Income (Loss)   Earnings   Stock   Equity 
                                         
Balance at January 1, 2012  $36,641   $127   $878   $135,825   $3,997   $148,010   $(47,351)  $278,127 
Net income   -    -    -    -    -    8,074    -    8,074 
Change in net unrealized gains and losses on available-for-sale securities                       663              663 
Stock option expense   -    -    -    59    -    -    -    59 
200 shares issued under stock option plan with no income tax benefit   -    -    -    -    -    (1)   3    2 
Restricted share activity under Stock Incentive Plans   -    -    -    141    -    -    29    170 
419 shares issued direct purchases   -    -    -    -    -    -    7    7 
Preferred Stock Dividends accrued   -    -    -    -    -    (897)   -    (897)
Accretion on preferred shares   351    -    -    -    -    (351)   -    - 
16,560 shares purchased in U.S. Treasury auction   (16,560)   -    -    -    -    618    -    (15,942)
19,440 shares purchased in open market   (19,440)   -    -    -    -    24    -    (19,416)
Common stock dividends declared   -    -    -    -    -    (977)   -    (977)
Balance at June 30, 2012  $992   $127   $878   $136,025   $4,660   $154,500   $(47,312)  $249,870 
                                         
Balance at January 1, 2011  $36,463   $127   $878   $140,845   $(342)  $134,988   $(72,628)  $240,331 
Net income   -    -    -    -    -    7,410    -    7,410 
Change in net unrealized gains and losses                                        
on available-for-sale securities   -    -    -    -    2,373    -    -    2,373 
Stock option expense   -    -    -    76    -    -    -    76 
250 shares issued under stock option plan, with no income tax benefit   -    -    -    -    -    (1)   4    3 
1,600,800 shares issued capital stock   -    -    -    (5,297)   -    -    25,156    19,859 
Restricted share activity under Stock Incentive Plans   -    -    -    (75)   -    -    75    - 
913 shares issued direct purchases   -    -    -    (2)   -    -    14    12 
Preferred Stock Dividends accrued   -    -    -    -    -    (925)   -    (925)
Accretion on preferred shares   86    -    -    -    -    (86)   -    - 
Balance at June 30, 2011  $36,549   $127   $878   $135,547   $2,031   $141,386   $(47,379)  $269,139 

 

6
 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(UNAUDITED)

(Amounts in Thousands)

 

 

   

   Six Months Ended 
   June 30, 
   2012   2011 
Operating Activities          
Net income  $8,074   $7,410 
Items not requiring (providing) cash          
Provision for loan losses   7,600    5,238 
Depreciation   1,689    1,720 
Amortization of mortgage servicing rights, net of impairment recoveries   1,973    309 
Amortization of core deposit and other intangible assets   724    664 
Net amortization of premiums and discounts on loans and deposits   301    502 
Amortization of premiums and discounts on securities   381    (111)
Loss on sale or disposals of property, plant and equipment   19    - 
Change in deferred taxes   1,649    18 
Proceeds from the sale of loans held for sale   230,291    99,997 
Originations of loans held for sale   (226,130)   (100,625)
Gain from sale of loans   (5,044)   (2,125)
OTTI losses on investment securities   -    2 
Gain from sale or call of securities   (425)   (49)
Loss on sale or write-down of real estate and other assets held for sale   295    803 
Stock option expense   59    76 
Restricted stock expense   170    - 
Income from bank owned life insurance   (439)   (474)
Changes in:          
Accrued interest receivable   79    166 
Other assets   (1,020)   567 
Other liabilities   2,536    5,844 
Net cash provided by (used in) operating activities   22,782    19,932 
           
Investing Activities          
Proceeds from maturities of held-to-maturity securities   61    69 
Proceeds from maturities, calls and pay-downs of available-for-sale securities   31,789    19,636 
Proceeds from sale of real estate and other assets held for sale   1,766    5,030 
Proceeds from the sale of available-for-sale securities   6,416    1,982 
Proceeds from sale of non-mortgage loans   363    4,425 
Purchases of available-for-sale securities   (83,056)   (61,532)
Proceeds from sale of office properties and equipment   -    12 
Proceeds from Federal Home Loan Bank stock redemption   -    357 
Purchase of bank-owned life insurance   (5,000)   - 
Purchases of portfolio mortgage loans   -    (10,696)
Purchases of premises and equipment, net   (2,488)   (663)
Net (increase) decrease in loans receivable   (30,607)   74,341 
Net cash provided by investing activities   (80,756)   32,961 
           
Financing Activities          
Net increase (decrease) in deposits and advance payments by borrowers   16,965    (1,767)
Repayment of Federal Home Loan Bank advances   (22)   (20,022)
Decrease in securities sold under repurchase agreements   (9,859)   (5,400)
Net cash received from common stock issuance   -    19,859 
Cash paid for redemption of preferred stock   (18,539)   - 
Proceeds from exercise of stock options   2    3 
Proceeds from treasury stock purchases   7    12 
Cash dividends paid on common stock   (977)   - 
Cash dividends paid on preferred stock   (1,017)   (925)
Net cash provided by (used in) financing activities   (13,440)   (8,240)
Increase (decrease) in cash and cash equivalents   (71,414)   44,653 
Cash and cash equivalents at beginning of period   174,931    169,164 
Cash and cash equivalents at end of period  $103,517   $213,817 
           
Supplemental cash flow information:          
Interest paid  $6,884   $9,572 
Income taxes paid  $-   $700 
Transfers from loans to real estate and other assets held for sale  $1,971   $3,630 
           
Transfers from loans held for sale to loans  $-   $7,213 
           
Redemption of preferred shares not yet settled  $16,929   $- 

 

See accompanying notes.

 

7
 

 

FIRST DEFIANCE FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

(Unaudited at June 30, 2012 and 2011)

 

 

  

1.   Basis of Presentation

 

First Defiance Financial Corp. (“First Defiance” or the “Company”) 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 Group of the Midwest, Inc. (“First Insurance”). All significant intercompany transactions and balances are eliminated in consolidation.

 

First Federal is primarily engaged in attracting deposits from the general public 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, Archbold, Bryan, Bowling Green, Maumee and Oregon, Ohio areas, offering property and casualty, and group health and life insurance products.

 

The consolidated condensed statement of financial condition at December 31, 2011 has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K.

 

The accompanying consolidated condensed financial statements as of June 30, 2012 and for the three and six month periods ended June 30, 2012 and 2011 have been prepared by First Defiance without audit and do not include information or footnotes necessary for the complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance's 2011 Annual Report on Form 10-K for the year ended December 31, 2011. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results for the three and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the entire year.

 

2. Significant Accounting Policies

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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.

 

8
 

 

Earnings Per Common Share

 

Basic earnings per common share is computed by dividing net income applicable to common shares (net income less dividend requirements for preferred stock and accretion of preferred stock discount) by the weighted average number of shares of common stock outstanding during the period. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for the calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, warrants, restricted stock awards or units and stock grants.

 

 

9
 

 

3.   Fair Value

 

FASB ASC Topic 820 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.

 

FASB ASC Topic 820 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 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 that regard, FASB ASC Topic 820 established a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

·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 than 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.

 

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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 that uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include federal agency preferred stock securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, corporate bonds and municipal securities. The Company classifies its pooled trust preferred collateralized debt obligations as Level 3. The portfolio consists of collateralized debt obligations backed by pools of trust preferred securities issued by financial institutions and insurance companies. Based on the lack of observable market data, the Company estimated fair values based on the observable data available and reasonable unobservable market data. The Company estimated fair value based on a discounted cash flow model which used appropriately adjusted discount rates reflecting credit and liquidity risks. The Company used an independent third party which is described further in Note 7.

 

Impaired loans - Fair values for impaired collateral dependent loans are generally based on appraisals obtained from licensed real estate appraisers and in certain circumstances consideration of offers obtained to purchase properties prior to foreclosure.  Appraisals for collateral dependent impaired loans are ordered annually. These appraisals are ordered and reviewed independently by the Company’s credit administration department. Appraisals for commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach.  The cost method bases value in the cost to replace the current property.  Value of market comparison approach evaluates the sales price of similar properties in the same market area.  The income approach considers net operating income generated by the property and an investors required return.  Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available.  Comparable sales adjustments are based on known sales prices of similar type and similar use properties and duration of time that the property has been on the market to sell.  Such adjustments made in the appraisal process are typically significant and result in a Level 3 classification of the inputs for determining fair value.

 

Real Estate held for sale - Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are then reviewed monthly by members of the asset review committee for valuation changes and are accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which may utilize a single valuation approach or a combination of approaches including cost, comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments may be significant and typically result in a Level 3 classification of the inputs for determining fair value.

 

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company.  Once received, a member of the Company’s asset quality or collections department reviews the assumptions and approaches utilized in the appraisal.  Appraisal values are discounted between a range of 10% to 30% to account for various disposal costs and other factors that may impact the value of collateral. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used which include:  physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

 

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Mortgage servicing rights – On a quarterly basis, mortgage servicing rights are evaluated for impairment based upon the fair value of the rights as compared to the carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level based on a model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and are validated against available market data (Level 2).

 

Mortgage banking derivative - The fair value of mortgage banking derivatives are evaluated monthly based on derivative valuation models using quoted prices for similar assets adjusted for specific attributes of the commitments and other observable market data at the valuation date (Level 2).

 

The following table summarizes the financial assets measured at fair value on a recurring basis 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

 

June 30, 2012  Level 1
Inputs
   Level 2 
Inputs
   Level 3
 Inputs
   Total Fair
Value
 
   (In Thousands) 
Available for sale securities:                    
                     
Obligations of U.S. Government  corporations and agencies  $-   $24,794   $-   $24,794 
U.S. treasury bonds        2,006         2,006 
Mortgage-backed - residential   -    87,192    -    87,192 
REMICs   -    462    -    462 
Collateralized mortgage obligations   -    70,427    -    70,427 
Trust preferred stock   -    -    1,227    1,227 
Preferred stock   146    -    -    146 
Corporate bonds   -    8,610    -    8,610 
Obligations of state and political subdivisions   -    83,965    -    83,965 
Mortgage banking derivative - asset   -    1,431    -    1,431 
Mortgage banking derivative - liability   -    (434)   -    (434)

 

There were no transfers between levels 1 and 2 for the three and six months ended June 30, 2012 and 2011. 

 

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December 31, 2011  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total Fair
Value
 
   (In Thousands) 
Available for sale securities:                    
                     
Obligations of U.S. Government  corporations and agencies  $-   $17,085   $-   $17,085 
U.S. treasury bonds        2,010         2,010 
Mortgage-backed - residential   -    70,716    -    70,716 
REMICs   -    2,894    -    2,894 
Collateralized mortgage obligations   -    59,009    -    59,009 
Trust preferred stock   -    -    1,342    1,342 
Preferred stock   108    -    -    108 
Corporate bonds        8,252         8,252 
Obligations of state and political subdivisions   -    71,503    -    71,503 
Mortgage banking derivative - asset   -    865    -    865 
Mortgage banking derivative - liability        (258)        (258)

  

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 three and six months ended June 30, 2012 and 2011:

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, January 1, 2012  $1,342 
Total gains or losses (realized/unrealized)     
Included in earnings (realized)   80 
Included in other comprehensive income (presented gross of taxes)   70 
Amortization   - 
Redemption   (265)
Transfers in and/or out of Level 3   - 
Ending balance, June 30, 2012  $1,227 

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, April 1, 2012  $1,377 
Total gains or losses (realized/unrealized)     
Included in earnings (realized)   80 
Included in other comprehensive income (presented gross of taxes)   35 
Amortization   - 
Redemption   (265)
Transfers in and/or out of Level 3   - 
Ending balance, June 30, 2012  $1,227 

 

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Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, January 1, 2011  $1,498 
Total gains or losses (realized/unrealized)     
Included in earnings (unrealized)   (2)
Included in other comprehensive income (presented gross of taxes)   38 
Amortization   4 
Transfers in and/or out of Level 3   - 
Ending balance, June 30, 2011  $1,538 

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In Thousands)
Beginning balance, April 1, 2011  $1,566 
Total gains or losses (realized/unrealized)     
Included in earnings (unrealized)   - 
Included in other comprehensive income (presented gross of taxes)   (28)
Amortization   - 
Transfers in and/or out of Level 3   - 
Ending balance, June 30, 2011  $1,538 

 

The following table summarizes the financial assets measured at fair value on a non-recurring basis segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

Assets and Liabilities Measured on a Non-Recurring Basis

 

June 30, 2012  Level 1 Inputs   Level 2 Inputs   Level 3 Inputs   Total Fair
Value
 
   (In Thousands) 
Impaired loans                    
Residential Loans  $-   $-   $786   $786 
Commercial Loans   -    -    -    - 
Multi Family Loans   -    -    -    - 
CRE loans   -    -    525    525 
Total Impaired loans   -    -    1,311    1,311 
Mortgage servicing rights   -    8,274    -    8,274 
Real estate held for sale                    
Residential Loans   -    -    -    - 
CRE loans   -    -    1,081    1,081 
Total Real Estate held for sale   -    -    1,081    1,081 

 

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December 31, 2011  Level 1 Inputs   Level 2 Inputs   Level 3 Inputs   Total Fair
Value
 
   (In Thousands) 
Impaired loans                    
Residential Loans  $-   $-   $1,092   $1,092 
Commercial Loans   -    -    1,268    1,268 
Multi Family Loans   -         103    103 
CRE loans   -    -    8,449    8,449 
Total Impaired loans   -    -    10,912    10,912 
Mortgage servicing rights   -    8,690    -    8,690 
Real estate held for sale                    
Residential Loans   -    -    28    28 
CRE loans   -    -    1,600    1,600 
Total Real Estate held for sale   -    -    1,628    1,628 

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $1,311,000, with a valuation allowance of $765,000 at June 30, 2012. A recovery of provision expense of $576,000 for the three months ended June 30, 2012 was included in earnings. Provision expense of $4,187,000 for the six months ended June 30, 2012 was included in earnings.

 

Mortgage servicing rights which are carried at the lower of cost or fair value had a fair value of $8,274,000 at June 30, 2012 resulting in a valuation allowance of $1,785,000. A charge of $177,000 for the three months and $256,000 for the six months ended June 30, 2012 was included in earnings.

 

Real estate held for sale is determined using Level 3 inputs which include appraisals and adjusted for estimated costs to sell. The change in fair value of real estate held for sale was $126,000 for the three months and $263,000 for the six months ended June 30, 2012 which was recorded directly as an adjustment to current earnings through non-interest expense.

 

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $10,912,000, with a valuation allowance of $7,200,000 at December 31, 2011. A provision expense of $3,067,000 for the three months and $5,479,000 for the six months ended June 30, 2011 were included in earnings.

 

Mortgage servicing rights which are carried at the lower of cost or fair value had a fair value of $8,690,000 at December 31, 2011, resulting in a valuation allowance of $1,529,000. A recovery of $316,000 for the three months and $487,000 for the six months ended June 30, 2011 were included in earnings.

 

Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell. The change in fair value of real estate held for sale was $259,000 for the three months and $551,000 for the six months ended June 30, 2011, which was recorded directly as an adjustment to current earnings through non-interest expense.

 

In accordance with FASB ASC Topic 825, the following table is a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of June 30, 2012 and December 31, 2011. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

 

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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, 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 and are classified as Level 1.

 

It was not practicable to determine the fair value of Federal Home Loan Bank (“FHLB”) stock due to restrictions placed on its transferability.

 

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, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as previously described. The allowance for loan losses is considered to be a reasonable adjustment for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based on binding contracts and quotes from third party investors resulting in a Level 2 classification.

 

The fair value of accrued interest receivable is equal to the carrying amounts resulting in a Level 2 or Level 3 classification which is consistent with its underlying asset.

 

The fair value of non-interest bearing deposits are considered equal to the amount payable on demand at the reporting date (i.e. carrying value) and are classified as Level 1. The fair value of savings, NOW and certain money market accounts are equal to their carrying amounts and are a Level 2 classification. Fair values of fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

 

The fair values of securities sold under repurchase agreements are equal to their carrying amounts resulting in a Level 2 classification. The carrying value of subordinated debentures and deposits with fixed maturities is estimated based on discounted cash flow analyses based on interest rates currently being offered on instruments with similar characteristics and maturities resulting in a Level 3 classification.

 

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 resulting in a Level 2 classification. The cost or value of any call or put options is based on the estimated cost to settle the option at June 30, 2012.

 

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       Fair Value Measurements at June 30, 2012
(In Thousands)
 
   Carrying
Value
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and cash equivalents  $103,517   $103,517   $103,517   $-   $- 
Investment securities   279,429    279,440    146    278,067    1,227 
Federal Home Loan Bank Stock   20,655    N/A    N/A    N/A    N/A 
Loans, net, including loans held for sale   1,487,343    1,508,825    -    13,559    1,495,266 
Accrued interest receivable   6,063    6,063    -    969    5,094 
                          
Financial Liabilities:                         
Deposits  $1,613,611   $1,619,854   $261,211   $1,358,643   $- 
Advances from Federal Home Loan Bank   81,819    84,679    -    84,679    - 
Securities sold under repurchase agreements   50,527    50,527    -    50,527    - 
Subordinated debentures   36,083    38,577    -    -    38,577 

 

   December 31, 2011 
   Carrying   Estimated 
   Value   Fair Values 
Assets:          
Cash and cash equivalents  $174,931   $174,931 
Investment securities   233,580    233,591 
Federal Home Loan Bank Stock   20,655    N/A 
Loans, net, including loans held for sale   1,467,663    1,494,573 
Mortgage banking derivative asset   865    865 
Accrued interest receivable   6,142    6,142 
    1,903,836   $1,910,102 
Other assets   164,354      
Total assets  $2,068,190      
           
Liabilities and stockholders’ equity:          
Deposits  $1,596,241   $1,603,111 
Advances from Federal Home Loan Bank   81,841    85,196 
Securities sold under repurchase agreements   60,386    60,386 
Subordinated debentures   36,083    31,814 
Accrued interest payable   446    446 
Mortgage banking derivative liability   258    258 
Advance payments by borrowers for taxes and insurance   1,402    1,402 
    1,776,399   $1,782,613 
Other liabilities   13,664      
Total liabilities   1,790,063      
Stockholders’ equity   278,127      
Total liabilities and stockholders’ equity  $2,068,190      

 

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4.  Stock Compensation Plans

 

First Defiance has established equity based compensation plans for its directors and employees. On March 15, 2010, the Board adopted, and the shareholders approved at the 2010 Annual Shareholders Meeting, the First Defiance Financial Corp. 2010 Equity Incentive Plan (the “2010 Equity Plan”). The 2010 Equity Plan replaces all existing plans. All awards currently outstanding under prior plans will remain in effect in accordance with their respective terms. Any new awards will be made under the 2010 Equity Plan. The 2010 Equity Plan allows for issuance of up to 350,000 common shares through the award of options, stock grants, restricted stock units (“RSU”), stock appreciation rights or other stock-based awards.

 

As of June 30, 2012, 317,600 options have been granted pursuant to the 2010 equity plan and previous plans and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year except for the 2009 grant to the Company’s executive officers, which vested 40% in 2011 and then 20% annually, subject to certain other limitations required by the Emergency Economic Stabilization Act of 2008. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

 

On August 15, 2011, the Company approved a 2011 Short-Term (“STIP”) and a 2011 Long-Term (“LTIP”) Equity Incentive Plan for selected members of management. The Plans are effective January 1, 2011 and provide for cash and/or equity benefits if certain performance targets are achieved.

 

On March 9, 2012, the Company approved a 2012 STIP and a 2012 LTIP for selected members of management. The Plans are effective January 1, 2012 and provide for cash and/or equity benefits if certain performance targets are achieved. Awards issued under these plans will reduce the amount of awards available to be issued under the 2010 Equity Plan.

 

Under both STIPs the participants may earn up to 25% to 45% of their salary for potential payout based on the achievement of certain corporate and/or market area performance targets during the calendar year. The final value of the awards to be made under the 2012 STIP will be determined at December 31 of each year and will be paid out in cash and/or equity, as elected by the participant, in accordance with the following vesting schedule: 50% in the first quarter after the calendar year, 25% on the one-year anniversary, and 25% on the second-year anniversary. The participants are required to be employed on the day of payout in order to receive an award.

 

Under both LTIPs the participants may earn up to 25% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets either over a two or three year period. The final amount of benefit under the 2011 LTIP will be determined at December 31, 2012 and the final amount of benefit under the 2012 LTIP will be determined on December 31, 2014. The benefits earned under the plans will be paid out in cash and/or equity, as elected by the participant, in the first quarter following the close of the performance period. The participants are required to be employed on the day of payout in order to receive the payment.

 

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The fair value of each option award is estimated on the date of grant using the Black-Scholes model. 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. There were no options granted during the six months ended June 30, 2012 or 2011.

 

Following is activity under the plans during the six months ended June 30, 2012:

 

Stock options  Options
Outstanding
   Weighted
Average
Exercise Price
   Weighted
Average
Remaining
Contractual
Term (in years)
   Aggregate
Intrinsic
Value      
(in 000’s)
 
Options outstanding, January 1, 2012   317,800   $20.35           
Forfeited or cancelled   -    -           
Exercised   200    9.22           
Granted   -    -           
Options outstanding, June 30, 2012   317,600   $20.35    4.44   $498 
Vested or expected to vest at June 30, 2012   317,600   $20.35    4.44   $498 
Exercisable at June 30, 2012   269,060   $21.74    4.06   $275 

 

As of June 30, 2012, there was $80,000 of total unrecognized compensation costs related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 1.7 years.

 

At June 30, 2012, 5,681 stock grants and 50,028 RSU’s were outstanding. Compensation expense is recognized over the performance period based on the achievements of targets as established with the plan documents. Total expense of $296,000 was recorded during the six months ended June 30, 2012 and approximately $296,000 is included within other liabilities at June 30, 2012 related to the STIPs and LTIPs.

 

   Restricted Stock Units   Stock Grants 
       Weighted-Average       Weighted-Average 
       Grant Date       Grant Date 
Unvested Shares  Shares   Fair Value   Shares   Fair Value 
                 
Unvested at January 1, 2012   27,108   $11.97    4,738   $14.00 
Granted   27,714    15.86    1,887    17.46 
Vested   -    -    (944)   17.46 
Forfeited   (4,794)   11.97    -    - 
Unvested at June 30, 2012   50,028   $14.13    5,681   $14.57 

 

The maximum amount of compensation expense that may be recorded for the 2012 STIP and both LTIPs at June 30, 2012 is approximately $1.3 million. However, the estimated expense expected to be recorded as of June 30, 2012 based on the performance measures in the plans, is $880,000 of which $500,000 is unrecognized at June 30, 2012 and will be recognized over the remaining performance period.

 

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5.  Dividends on Common Stock

 

First Defiance declared and paid a $0.05 per common stock dividend in the first and second quarter of 2012. There was no common stock dividend declared or paid in the first or second quarter of 2011.

 

As a result of its participation in the Capital Purchase Program (“CPP”), First Defiance was prohibited without prior approval of the U.S. Treasury, from paying a quarterly cash dividend of more than $0.26 per share until the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party. This prohibition ended when the U.S. Treasury sold all of its preferred stock on June 19, 2012. Further, First Defiance has agreed in its Memorandum of Understanding with the Federal Reserve to obtain the approval of the Federal Reserve prior to the declaration of dividends.

 

6.  Earnings Per Common Share

 

The following table sets forth the computation of basic and diluted earnings per common share (in thousands except per share data):

 

   Three months ended
June 30,
   Six months ended
June 30,
 
   2012   2011   2012   2011 
Numerator for basic and diluted earnings per common share – Net income applicable to common shares  $3,181   $4,243   $6,826   $6,399 
Denominator:                    
Denominator for basic earnings per common share – weighted average common shares, including participating securities   9,729    9,724    9,728    9,006 
Effect of warrants   211    161    210    151 
Effect of restricted stock units   24    -    21    - 
Effect of employee stock options   21    17    21    14 
                     
Denominator for diluted earnings per common share    9,985    9,902    9,980    9,171 
Basic earnings per common share  $0.33   $0.44   $0.70   $0.71 
                     
Diluted earnings per common share  $0.32   $0.43   $0.68   $0.70 

 

There were 256,643 shares under option granted to employees excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and six months ended June 30, 2012. Shares under option of 262,850 and 343,550 were excluded from the diluted earnings per common share calculations as they were anti-dilutive for the three and six months ended June 30, 2011.

 

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7.   Investment Securities

 

The following is a summary of available-for-sale and held-to-maturity securities (in thousands):

 

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
At June 30, 2012                    
Available-for-Sale Securities:                    
                     
Obligations of U.S. government corporations and agencies  $24,663   $131   $-   $24,794 
U.S. treasury bonds   2,000    6    -    2,006 
Mortgage-backed securities – residential   84,750    2,442    -    87,192 
REMICs   461    1    -    462 
Collateralized mortgage obligations   68,551    1,901    (25)   70,427 
Trust preferred securities and preferred stock   3,604    111    (2,342)   1,373 
Corporate bonds   8,673    86    (149)   8,610 
Obligations of state and political subdivisions   77,871    6,143    (49)   83,965 
Totals  $270,573   $10,821   $(2,565)  $278,829 
                     
Held-to-Maturity Securities*:                    
FHLMC certificates  $75   $-   $-   $75 
FNMA certificates   181    6    -    187 
GNMA certificates   67    3    -    70 
Obligations of state and political subdivisions   277    2    -    279 
Totals  $600   $11   $-   $611 
                     
At December 31, 2011                    
Available-for-Sale Securities:                    
                     
Obligations of U.S. government corporations and agencies  $16,989   $96   $-   $17,085 
U.S. treasury bonds   2,000    10    -    2,010 
Mortgage-backed securities – residential   68,400    2,318    (2)   70,716 
REMICs   2,863    31    -    2,894 
Collateralized mortgage obligations   57,083    1,926    -    59,009 
Trust preferred securities and preferred stock   3,790    73    (2,413)   1,450 
Corporate bonds   8,629    -    (377)   8,252 
Obligations of state and political subdivisions   65,928    5,580    (5)   71,503 
Totals  $225,682   $10,034   $(2,797)  $232,919 
                     
Held-to-Maturity Securities*:                    
FHLMC certificates  $82   $1   $-   $83 
FNMA certificates   199    4    -    203 
GNMA certificates   72    3    -    75 
Obligations of state and political subdivisions   308    3    -    311 
Totals  $661   $11   $-   $672 

 

*     FHLMC, FNMA, and GNMA certificates are residential mortgage-backed securities.

21
 

 

The amortized cost and fair value of the investment securities portfolio at June 30, 2012 are shown below by contractual maturity. 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 (“MBS”), collateralized mortgage obligations (“CMO”) and REMICs, which are not due at a single maturity date, have not been allocated over the maturity groupings. These securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

 

   Available-for-Sale   Held-to-Maturity 
   Amortized   Fair   Amortized   Fair 
   Cost   Value   Cost   Value 
   (In Thousands) 
Due in one year or less  $2,594   $2,605   $60   $62 
Due after one year through five years   13,034    13,078    -    - 
Due after five years through ten years   42,925    44,723    217    217 
Due after ten years   58,258    60,341    -    - 
MBS/CMO/REMIC   153,762    158,082    323    332 
   $270,573   $278,829   $600   $611 

 

Investment securities with a carrying amount of $141.4 million at June 30, 2012 were pledged as collateral on public deposits, securities sold under repurchase agreements and FHLB advances.

 

As of June 30, 2012, the Company’s investment portfolio consisted of 380 securities, 29 of which were in an unrealized loss position.

 

The following tables summarize First Defiance’s securities that were in an unrealized loss position at June 30, 2012 and December 31, 2011:

 

   Duration of Unrealized Loss Position     
   Less than 12 Months   12 Month or Longer   Total 
       Gross       Gross         
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Losses 
   (In Thousands) 
At June 30, 2012                        
Available-for-sale securities:                              
Mortgage-backed - residential  $2   $-   $-   $-   $2   $- 
Collateralized mortgage obligations and REMICs   5,265    (25)   -    -    5,265    (25)
Corporate bonds   933    (29)   1,796    (120)   2,729    (149)
Trust preferred stock and preferred stock   -    -    1,227    (2,342)   1,227    (2,342)
Obligations of state and political subdivisions   5,693    (47)   244    (2)   5,937    (49)
Total temporarily impaired securities  $11,893   $(101)  $3,267   $(2,464)  $15,160   $(2,565)

 

22
 

 

   Duration of Unrealized Loss Position     
   Less than 12 Months   12 Months or Longer   Total 
       Gross       Gross         
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Loss   Value   Loss   Value   Loses 
   (In Thousands) 
At December 31, 2011                              
Available-for-sale securities:                              
Mortgage-backed securities - residential  $2,030   $(2)  $-   $-   $2,030   $(2)
Obligations of state and political subdivisions   -    -    746    (5)   746    (5)
Trust preferred stock and preferred stock   -    -    1,342    (2,413)   1,342    (2,413)
Corporate bonds   8,252    (377)   -    -    8,252    (377)
Total temporarily impaired securities  $10,282   $(379)  $2,088   $(2,418)  $12,370   $(2,797)

 

With the exception of Trust Preferred Securities, 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 and it is not more than likely that the Company will be required to sell the investments before anticipated recovery.

 

Realized gains from the sales of investment securities totaled $382,000 ($248,000 after tax) in the second quarter of 2012 while there were no realized gains in the second quarter of 2011. Realized gains from the sales of investment securities totaled $425,000 ($276,000 after tax) for the first six months of 2012 compared to realized gains of $49,000 ($32,000 after tax) for the first six months of 2011.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment portfolio is evaluated for OTTI by segregating the portfolio into two general segments. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under FASB ASC Topic 320. Certain collateralized debt obligations (“CDOs”) are evaluated for OTTI under FASB ASC Topic 325, Investment – Other.

 

When OTTI occurs under either model, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected compared to the book value of the security and is recognized in earnings. The amount of OTTI related to other factors shall be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings shall become the new amortized cost basis of the investment.

 

23
 

 

For the first six months of 2012, management determined there was no OTTI. For the first six months of 2011, management determined there was OTTI on one CDO resulting in a write-down of $2,200 ($1,400 after tax).

 

The Company held eight CDOs at June 30, 2012. Four of those CDOs were written down in full prior to January 1, 2010. The remaining four CDOs have a total amortized cost of $3.6 million at June 30, 2012. Of these, two, with a total amortized cost of $1.6 million, were identified as OTTI in prior periods. The final two CDOs, with a total amortized cost of $2.0 million, continue to pay principal and interest payments in accordance with the contractual terms of the securities and no credit loss impairment has been identified in management’s analysis. Therefore, these two CDO investments have not been deemed by management to be OTTI. In June 2012, the Company was notified that its Preferred Term Security VI was redeemed through an auction process. The security was redeemed at full price with proceeds being received in July 2012. This security had previously identified OTTI of $80,000. The previous OTTI amount was recorded as a yield adjustment in interest income as of June 30, 2012 due to the increase in expected cash flows resulting from the auction.

 

Given the conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, 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.

 

As required under FASB ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.

 

The Company’s CDO valuations were supported by analysis 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.

 

Trust Preferred CDOs Discount Rate Methodology

 

First Defiance uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific CDO instruments. The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis. There is currently no active market for trust preferred CDOs, however, First Defiance looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market. The next step is to make a series of adjustments to reflect the differences that nevertheless exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific CDOs. Importantly, as part of the analysis described above, First Defiance considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

 

24
 

 

Fundamental to this evaluation is an assessment of the likelihood of CDO coverage test failures that would have the effect of diverting cash flow away from the relevant CDO bond for some period of time. Generally speaking, the Company adjusts indicative credit spreads upwards in the case of CDOs that have relatively weaker collateral and/or less cushion with respect to overcollateralization and interest coverage test ratios and downwards if the reverse is true. This aspect of the Company’s discount rate methodology is important because there is frequently a great difference in the risks present in CDO instruments that are otherwise very similar (i.e. CDOs with the same basic type of collateral, the same manager, the same vintage, etc., may exhibit vastly different performance characteristics). With respect to this last point, First Defiance notes that given today’s credit environment, characterized by high default and deferral rates, it is typically the case that deal-specific credit performance (determined on the basis of the credit characteristics of remaining collateral) is the best indicator of what a willing market participant would pay for an instrument.

 

The Company uses the same methodology for all of its CDOs and believes its valuation methodology is appropriate for all of its CDOs in accordance with FASB ASC Topic 320 as well as other related guidance.

 

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already deferred, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions and 15% for insurance companies. Although there is a possibility that the deferring collateral will become current at some point in the future, First Defiance has conservatively assumed that it will continue to defer and gradually will default.

 

The following table details the six securities with other-than-temporary impairment, their lowest credit rating at June 30, 2012 and the related credit losses recognized in earnings for the three month periods ended March 31, 2012 and June 30, 2012 (In Thousands):

 

25
 

 

     TPREF
Funding II
   Alesco
VIII
   Preferred
Term
Security
XXVII
   Trapeza
CDO I
   Alesco
Preferred
Funding
VIII
   Alesco
Preferred
Funding
IX
     
     Rated
Caa3
   Rated Ca   Rated C   Rated
Ca
   Not Rated   Not Rated   Total 
                               
Cumulative OTTI related to credit loss at January 1, 2012    $318   $1,000   $78   $857   $453   $465   $3,171 
                                      
Addition – Qtr 1     -    -    -    -    -    -    - 
                                      
Cumulative OTTI related to credit loss at March 31, 2012    $318   $1,000   $78   $857   $453   $465   $3,171 
                                      
Addition – Qtr 2     -    -    -    -    -    -    - 
                                      
Cumulative OTTI related to credit loss at June 30, 2012    $318   $1,000   $78   $857   $453   $465   $3,171 

 

The amount of OTTI recognized in accumulated other comprehensive income (“AOCI”) was $771,000 for the above securities at June 30, 2012. There was $822,000 recognized in AOCI at June 30, 2011.

 

The following table provides additional information related to the four CDO investments for which a balance remains as of June 30, 2012 (dollars in thousands):

 

CDO  Class   Amortized
Cost
   Fair
Value
   Unrealized
Loss
   OTTI
Losses
2012
   Lowest
Rating
  Current
Number of
Banks and
Insurance
Companies
   Actual
Deferrals
and
Defaults
as a % of
Current
Collateral
   Expected
Deferrals
and
Defaults as
a % of
Remaining
Performing
Collateral
   Excess
Sub-
ordination
as a % of
Current
Performing
Collateral
 
                                        
TPREF Funding II  B    677    223    (454)   -   Caa3   17    38.81%   16.32%   - 
                                                 
I-Preferred Term Sec I  B-1    1,000    434    (566)   -   CCC   14    17.24%   14.82%   27.62%
                                                 
Dekania II CDO  C-1    990    400    (590)   -   CCC   33    -%    14.09%   30.50%
                                                 
Preferred Term Sec XXVII  C-1    902    170    (732)   -   C   33    28.14%   24.88%   5.62%
                                                 
Total       $3,569   $1,227   $(2,342)  $-                        

  

The Company’s assumed average lifetime default rate declined from 30.2% at the end of the second quarter 2011 to a rate of 28.6% at the end of the second quarter 2012.

 

26
 

 

The table below presents a roll-forward of the credit losses relating to debt securities recognized in earnings for the three and six month periods ended June 30, 2012 and 2011 (in thousands):

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Beginning balance  $3,251   $3,251   $3,251   $3,249 
Additions for amounts related to credit loss for which an OTTI was not previously recognized   -    -    -    - 
                     
Reductions for amounts realized for securities sold/redeemed during the period   (80)   -    (80)   - 
                     
Reductions for amounts related to securities for which the Company intends to sell or that it will be more than likely than not that the Company will be required to sell prior to recovery of amortized cost basis   -    -    -    - 
                     
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security   -    -    -    - 
                     
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized   -    -    -    2 
                     
Ending balance  $3,171   $3,251   $3,171   $3,251 

 

The proceeds from the sales and calls of securities and the associated gains are listed below:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2012   2011   2012   2011 
   (In thousands)   (In thousands) 
Proceeds  $6,198   $-   $6,416   $1,982 
Gross realized gains   382    -    425    49 
Gross realized losses   -    -    -    - 

  

27
 

  

The following table summarizes the changes within each classification of accumulated other comprehensive income for the quarters ended June 30, 2012 and 2011:

 

   Unrealized gains
(losses) on
available for sale
securities
   Postretirement
Benefit
   Accumulated
other
comprehensive
income (loss),
net
 
   (In Thousands) 
Balance at December 31, 2011  $4,704   $(707)  $3,997 
Other comprehensive income (loss), net   663    -    663 
Balance at June 30, 2012  $5,367   $(707)  $4,660 

 

   Unrealized gains
(losses) on
available for sale
securities
   Postretirement
Benefit
   Accumulated
other
comprehensive
income (loss),
net
 
   (In Thousands) 
Balance at December 31, 2010  $32   $(374)  $(342)
Other comprehensive income (loss), net   2,373    -    2,373 
Balance at June 30, 2011  $2,405   $(374)  $2,031 

 

8.Loans

 

Loans receivable consist of the following (in thousands):

 

   June 30,
2012
   December 31,
2011
 
Real Estate:          
Secured by 1-4 family residential  $210,520   $203,401 
Secured by multi-family residential   120,869    126,246 
Secured by commercial real estate   654,657    649,746 
Construction   22,923    31,552 
    1,008,969    1,010,945 
Other Loans:          
Commercial   372,266    349,053 
Home equity and improvement   112,427    122,143 
Consumer Finance   17,127    18,887 
    501,820    490,083 
Total loans   1,510,789    1,501,028 
Deduct:          
Undisbursed loan funds   (9,439)   (13,243)
Net deferred loan origination fees and costs   (713)   (709)
Allowance for loan loss   (26,409)   (33,254)
Totals  $1,474,228   $1,453,822 

 

Loan segments have been identified by evaluating the portfolio based on collateral and credit risk characteristics.

 

28
 

 

The following table discloses allowance for loan loss activity for the quarter ended June 30, 2012 and June 30, 2011 by portfolio segment and impairment method ($ in thousands):

 

Quarter Ended June 30, 2012  1-4 Family
Residential
Real Estate
   Construction   Multi- Family
Residential
Real Estate
   Commercial
Real Estate
   Commercial   Home Equity
and
Improvement
   Consumer   Total 
Allowance for loans individually evaluated                                        
Beginning Specific Allocations  $505   $-   $155   $4,511   $13   $-   $-   $5,184 
Charge-Offs   (363)   -    (168)   (3,188)   (383)   -    -    (4,102)
Recoveries   -    -    -    16    76    -    -    92 
Provisions   125    -    13    (841)   294    -    -    (409)
Ending Specific Allocations  $267   $-   $-   $498   $-   $-   $-   $765 
Allowance for loans collectively evaluated                                        
Beginning General Allocations  $2,868   $73   $2,676   $11,689   $4,680   $1,485   $178   $23,649 
Charge-Offs   (221)   -    (149)   (1,944)   (103)   (254)   (13)   (2,684)
Recoveries   69    -    -    20    49    18    17    173 
Provisions   121    (27)   83    3,651    530    186    (38)   4,506 
Ending General Allocations  $2,837   $46   $2,610   $13,416   $5,156   $1,435   $144   $25,644 

 

Quarter Ended June 30, 2011  1-4 Family
Residential
Real Estate
   Construction   Multi- Family
Residential
Real Estate
   Commercial
Real Estate
   Commercial   Home Equity
and
Improvement
   Consumer   Total 
Allowance for loans individually evaluated                                        
Beginning Specific Allocations  $1,776   $-   $250   $10,697   $4,319   $36   $-   $17,078 
Charge-Offs   (716)   -    (364)   (624)   -    -    -    (1,704)
Recoveries   -    -    -    -    -    -    -    - 
Provisions   550    -    260    2,121    121    -    -    3,052 
Ending Specific Allocations  $1,610   $-   $146   $12,194   $4,440   $36   $-   $18,426 
Allowance for loans collectively evaluated                                        
Beginning General Allocations  $4,387   $70   $1,933   $10,510   $5,199   $1,414   $207   $23,720 
Charge-Offs   (177)   -    -    (529)   (107)   (310)   (20)   (1,143)
Recoveries   13    -    -    101    24    21    15    174 
Provisions   97    (23)   (126)   168    (1,266)   478    25    (647)
Ending General Allocations  $4,320   $47   $1,807   $10,250   $3,850   $1,603   $227   $22,104 

 

29
 

 

The following table discloses allowance for loan loss activity year to date as of June 30, 2012 and 2011 by portfolio segment and impairment method ($ in thousands):

 

Year to Date June 30, 2012  1-4 Family
Residential
Real Estate
   Construction   Multi- Family
Residential
Real Estate
   Commercial
Real Estate
   Commercial   Home Equity
and
Improvement
   Consumer   Total 
Allowance for loans individually evaluated                                        
Beginning Specific Allocations  $654   $-   $195   $5,400   $969   $-   $-   $7,218 
Charge-Offs   (718)   -    (406)   (6,055)   (2,377)   -    -    (9,556)
Recoveries   -    -    -    16    76    -    -    92 
Provisions   331    -    211    1,137    1,332    -    -    3,011 
Ending Specific Allocations  $267   $-   $-   $498   $-   $-   $-   $765 
Allowance for loans collectively evaluated                                        
Beginning General Allocations  $3,441   $63   $2,655   $12,240   $5,607   $1,856   $174   $26,036 
Charge-Offs   (604)   -    (149)   (3,335)   (775)   (465)   (54)   (5,382)
Recoveries   124    -    -    128    79    39    31    401 
Provisions   (124)   (17)   104    4,383    245    5    (7)   4,589 
Ending General Allocations  $2,837   $46   $2,610   $13,416   $5,156   $1,435   $144   $25,644 

 

Year-to-Date June 30, 2011  1-4 Family
Residential
Real Estate
   Construction   Multi- Family
Residential
Real Estate
   Commercial
Real Estate
   Commercial   Home Equity
and
Improvement
   Consumer   Total 
Allowance for loans individually evaluated                                        
Beginning Specific Allocations  $1,741   $13   $230   $10,213   $4,362   $36   $-   $16,595 
Charge-Offs   (861)   -    (364)   (2,401)   (206)   -    -    (3,832)
Recoveries   -    -    -    -    -    -    -    - 
Provisions   730    (13)   280    4,382    284    -    -    5,663 
Ending Specific Allocations  $1,610   $-   $146   $12,194   $4,440   $36   $-   $18,426 
Allowance for loans collectively evaluated                                        
Beginning General Allocations  $4,215   $60   $1,917   $9,995   $6,509   $1,492   $297   $24,485 
Charge-Offs   (579)   -    -    (1,026)   (236)   (511)   (31)   (2,383)
Recoveries   18    -    -    312    32    21    44    427 
Provisions   666    (13)   (110)   969    (2,455)   601    (83)   (425)
Ending General Allocations  $4,320   $47   $1,807   $10,250   $3,850   $1,603   $227   $22,104 

 

30
 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2012:

 

(In Thousands)

 

   1-4 Family       Multi- Family                     
   Residential       Residential   Commercial       Home Equity         
   Real Estate   Construction   Real Estate   Real Estate   Commercial   & Improvement   Consumer   Total 
Allowance for loan losses:                                        
                                         
Ending allowance balance attributable to loans:                                        
                                         
Individually evaluated for impairment  $267   $-   $-   $498   $-   $-   $-   $765 
                                         
Collectively evaluated for impairment   2,837    46    2,610    13,416    5,156    1,435    144    25,644 
                                         
Acquired with deteriorated credit quality   -    -    -    -    -    -    -    - 
                                         
Total ending allowance balance  $3,104   $46   $2,610   $13,914   $5,156   $1,435   $144   $26,409 
                                         
Loans:                                        
                                         
Loans individually evaluated for impairment  $7,334   $-   $442   $33,458   $6,053   $36   $-   $47,323 
                                         
Loans collectively evaluated for impairment   203,692    13,476    120,587    622,906    367,120    112,881    17,136    1,457,798 
                                         
Loans acquired with deteriorated credit quality   41    -    -    300    264    -    -    605 
                                         
Total ending loans balance  $211,067   $13,476   $121,029   $656,664   $373,437   $112,917   $17,136   $1,505,726 

 

31
 

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2011:

 

(In Thousands)

 

   1-4 Family       Multi- Family                     
   Residential       Residential   Commercial       Home Equity         
   Real Estate   Construction   Real Estate   Real Estate   Commercial   & Improvement   Consumer   Total 
Allowance for loan losses:                                        
                                         
Ending allowance balance attributable to loans:                                        
                                         
Individually evaluated for impairment  $654   $-   $195   $ 5,400   $969   $-   $-   $7,218 
                                         
Collectively evaluated for impairment   3,441    63    2,655    12,240    5,607    1,856    174    26,036 
                                         
Acquired with deteriorated credit quality   -    -    -              -         - 
                                         
Total ending allowance balance  $4,095   $63   $2,850   $17,640   $6,576   $1,856   $174   $33,254 
                                         
Loans:                                        
                                         
Loans individually evaluated for impairment  $4,537   $-   $1,435   $34,009   $6,773   $40   $-   $46,794 
                                         
Loans collectively evaluated for impairment   199,453    18,288    125,080    616,856    343,147    122,623    18,910    1,444,357 
                                         
Loans acquired with deteriorated credit quality   70    -    -    825    312    -    -    1,207 
                                         
Total ending loans balance  $204,060   $18,288   $126,515   $651,690   $350,232   $122,663   $18,910   $1,492,358 

 

32
 

 

The following table presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans. (In Thousands)

 

   Three Months Ended June 30, 2012   Six Months Ended June 30, 2012 
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
 
Residential Owner Occupied  $1,933   $17   $16   $1,956   $30   $28 
Residential Non Owner Occupied   5,395    33    32    4,888    71    71 
Total Residential Real Estate   7,328    50    48    6,844    101    99 
Construction   -    -    -    -    -    - 
Multi-Family   598    -    -    443    1    1 
CRE Owner Occupied   11,473    26    32    10,376    39    44 
CRE Non Owner Occupied   14,574    89    56    15,158    180    126 
Agriculture Land   1,049    -    -    1,157    14    14 
Other CRE   6,879    1    2    7,568    3    3 
Total Commercial Real Estate   33,975    116    90    34,259    236    187 
Commercial Working Capital   2,485    2    2    2,240    4    4 
Commercial Other   4,132    10    10    4,529    16    16 
Total Commercial   6,617    12    12    6,769    20    20 
Consumer   -    -    -    -    -    - 
Home Equity and Home Improvement   37    1    1    38    2    2 
Total Impaired Loans  $48,555   $179   $151   $48,353   $360   $309 

 

33
 

 

The following table presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans: (In Thousands)

 

   Three Months Ended June 30, 2011   Six Months Ended June 30, 2011 
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
   Average
Balance
   Interest
Income
Recognized
   Cash Basis
Income
Recognized
 
Residential Owner Occupied  $2,550   $20   $18   $2,842   $40   $38 
Residential Non Owner Occupied   4,093    38    36    4,639    71    74 
Total Residential Real Estate   6,643    58    54    7,481    111    112 
Construction   30    -    -    41    -    - 
Multi-Family   778    11    8    962    23    19 
CRE Owner Occupied   10,029    86    90    10,273    201    184 
CRE Non Owner Occupied   21,050    262    245    21,142    496    448 
Agriculture Land   1,907    11    12    2,174    22    23 
Other CRE   8,114    36    24    7,910    49    37 
Total Commercial Real Estate   41,100    395    371    41,499    768    692 
Commercial Working Capital   4,595    24    23    4,854    47    50 
Commercial Other   11,504    68    69    11,804    140    140 
Total Commercial   16,099    92    92    16,658    187    190 
Consumer   -    -    -    -    -    - 
Home Equity and Home Improvement   307    4    3    310    7    7 
Total Impaired Loans  $64,957   $560   $528   $66,951   $1,096   $1,020 

 

34
 

 

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2012: (In Thousands)

 

   Unpaid
Principal
Balance
   Recorded
Investment
   Allowance
for Loan
Losses
Allocated
 
With no allowance recorded:               
Residential Owner Occupied  $953   $955   $- 
Residential Non Owner Occupied   5,358    5,366    - 
Total Residential Real Estate   6,311    6,321    - 
Construction   -    -    - 
Multi-Family Residential Real Estate   442    442    - 
CRE Owner Occupied   11,342    11,340    - 
CRE Non Owner Occupied   14,144    14,207    - 
Agriculture Land   589    588    - 
Other CRE   6,600    6,600    - 
Total Commercial Real Estate   32,675    32,735    - 
Commercial Working Capital   2,298    2,298    - 
Commercial Other   4,015    4,019    - 
Total Commercial   6,313    6,317    - 
Consumer   -    -    - 
Home Equity and Home Improvement   36    36    - 
Total loans with no allowance recorded  $45,777   $45,851   $- 
                
With an allowance recorded:               
Residential Owner Occupied  $1,053   $1,054   $267 
Residential Non Owner Occupied   0    0    0 
Total Residential Real Estate   1,053    1,054    267 
Construction   -    -    - 
Multi-Family Residential Real Estate   -    -    - 
CRE Owner Occupied   834    834    375 
CRE Non Owner Occupied   171    171    111 
Agriculture Land   -    -    - 
Other CRE   18    18    12 
Total Commercial Real Estate   1,023    1,023    498 
Commercial Working Capital   -    -    - 
Commercial Other   -    -    - 
Total Commercial   -    -    - 
Consumer   -    -    - 
Home Equity and Home Improvement   -    -    - 
Total loans with an allowance recorded  $2,076   $2,077   $765 

 

Impaired loans have been recognized in conformity with FASB ASC Topic 310.

 

35
 

 

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2011: (In Thousands)

 

   Unpaid
Principal
Balance
   Recorded
Investment
   Allowance
for Loan
Losses
Allocated
 
With no allowance recorded:               
Residential Owner Occupied  $981   $984   $- 
Residential Non Owner Occupied   1,871    1,877    - 
Total Residential Real Estate   2,852    2,861    - 
Construction   -    -    - 
Multi-Family Residential Real Estate   1,138    1,137    - 
CRE Owner Occupied   5,868    5,879    - 
CRE Non Owner Occupied   8,408    8,421    - 
Agriculture Land   1,072    1,073    - 
Other CRE   5,607    5,605    - 
Total Commercial Real Estate   20,955    20,978    - 
Commercial Working Capital   1,391    1,393    - 
Commercial Other   3,444    3,453    - 
Total Commercial   4,835    4,846    - 
Consumer   -    -    - 
Home Equity and Home Improvement   39    40    - 
Total loans with no allowance recorded  $29,819   $29,862   $- 
                
With an allowance recorded:               
Residential Owner Occupied  $1,020   $1,020   $373 
Residential Non Owner Occupied   726    726    281 
Total Residential Real Estate   1,746    1,746    654 
Construction   -    -    - 
Multi-Family Residential Real Estate   298    298    195 
CRE Owner Occupied   2,284    2,284    589 
CRE Non Owner Occupied   8,589    8,596    3,235 
Agriculture Land   300    300    163 
Other CRE   2,676    2,676    1,413 
Total Commercial Real Estate   13,849    13,856    5,400 
Commercial Working Capital   358    358    192 
Commercial Other   1,879    1,881    777 
Total Commercial   2,237    2,239    969 
Consumer   -    -    - 
Home Equity and Home Improvement   -    -    - 
Total loans with an allowance recorded  $18,130   $18,139   $7,218 

 

36
 

 

The following table presents the aggregate amounts of non-performing assets, comprised of non-performing loans and real estate owned on the dates indicated:

 

   June 30,
2012
   December 31,
2011
 
   (in thousands) 
Non-accrual loans  $41,702   $39,328 
Loans over 90 days past due and still accruing   -    - 
Troubled debt restructuring, still accruing   3,581    3,380 
Total non-performing loans   45,283   $42,708 
Real estate and other assets held for sale   3,538    3,628 
Total non-performing assets  $48,821   $46,336 

 

The following table presents the aging of the recorded investment in past due and non accrual loans as of June 30, 2012 by class of loans: (In Thousands)

 

   Current   30-59
days
   60-89
days
   90+
days
   Total
Past
Due
   Total
Non
Accrual
 
                         
Residential Owner Occupied  $132,517   $1,667   $628   $1,043   $3,338   $1,413 
Residential Non Owner Occupied   72,451    830    478    1,453    2,761    3,940 
                               
Total residential real estate   204,968    2,497    1,106    2,496    6,099    5,353 
                               
Construction   13,476    -    -    -    -    - 
Multi-Family   120,992    -    -    37    37    754 
CRE Owner Occupied   292,880    -    578    3,018    3,596    11,459 
CRE Non Owner Occupied   247,262    696    614    3,573    4,883    9,127 
Agriculture Land   70,508    262    159    83    504    938 
Other Commercial Real Estate   31,653    559    60    4,759    5,378    6,711 
                               
Total Commercial Real Estate   642,303    1,517    1,411    11,433    14,361    28,235 
                               
Commercial Working Capital   159,697    217    -    1,087    1,304    2,448 
Commercial Other   208,166    573    1,575    2,122    4,270    4,455 
                               
Total Commercial   367,863    790    1,575    3,209    5,574    6,903 
Consumer   16,913    200    19    4    223    4 
Home Equity / Home Improvement   111,494    773    204    446    1,423    446 
                               
Total Loans  $1,478,009   $5,777   $4,315   $17,625   $27,717   $41,695 

 

37
 

 

The following table presents the aging of the recorded investment in past due and non accrual loans as of December 31, 2011 by class of loans: (In Thousands)

 

   Current   30-59
days
   60-89
days
   90+ days   Total
Past
Due
   Total Non
Accrual
 
                         
Residential Owner Occupied  $131,014   $1,573   $220   $1,996   $3,789   $2,490 
Residential Non Owner Occupied   67,516    563    410    768    1,741    1,397 
Total residential real estate   198,530    2,136    630    2,764    5,530    3,887 
                               
Construction   18,288    -    -    -    -    - 
Multi-Family   125,050    1,022    -    443    1,465    443 
CRE Owner Occupied   288,096    1,468    993    4,771    7,232    7,691 
CRE Non Owner Occupied   243,016    921    1,990    3,384    6,295    10,398 
Agriculture Land   70,490    -    -    456    456    1,275 
Other Commercial Real Estate   30,056    98    -    5,951    6,049    8,342 
Total Commercial Real Estate   631,658    2,487    2,983    14,562    20,032    27,706 
Commercial Working Capital   137,310    -    223    242    465    1,410 
Commercial Other   209,187    278    59    2,933    3,270    5,481 
Total Commercial   346,497    278    282    3,175    3,735    6,891 
Consumer   18,736    129    35    10    174    10 
Home Equity / Home Improvement   119,400    2,602    267    394    3,263    394 
                               
Total Loans  $1,458,159   $8,654   $4,197   $21,348   $34,199   $39,331 

 

Troubled Debt Restructurings

 

The Company has allocated $140,000 and $1.8 million, respectively, of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2012 and December 31, 2011. The Company had not committed to lend any additional amounts to customers with outstanding loans that are classified as troubled debt restructurings as of June 30, 2012 and had committed to lend additional amounts totaling up to $64,000 as of December 31, 2011.

 

During the three and six month periods ended June 30, 2012, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; a permanent reduction of the recorded investment in the loan; or some other modification deeming the loan a troubled debt restructuring.

 

During the six month period ending June 30, 2012, modifications were made to four loans to reduce the stated interest rate of the loans. The reduction for one loan was for the remaining maturity of the loan, which is in 14 years; the reduction for one loan was for 16 months, after which it will convert to an adjustable rate loan over an index at a market spread; the reduction for one loan was for the remaining maturity of the loan, which is in 25 ½ years, priced at a market spread over the 1-year T-bill; and the reduction for one loan was for 2 years, after which it will convert to an adjustable rate loan over an index at a market spread. There were four additional loans which involved a partial write-down along with new terms and two additional other loans where interest was capitalized and the term was extended.

 

38
 

 

The following table presents loans by class modified as troubled debt restructurings that occurred during the three and six month period ending June 30, 2012 (Dollars In Thousands): 

 

   Loans Modified as a TDR for the Three
Months Ended June 30, 2012
   Loans Modified as a TDR for the Six Months
Ended June 30, 2012
 
Troubled Debt Restructurings  Number of
Loans
   Recorded
Investment
(as of Period
End)
   Increase/(Decrease)
in the
Allowance
(as of Period
End)
   Number of
Loans
   Recorded
Investment
(as of Period
End)
   Increase/(Decrease)
in the
Allowance
(as of Period
End)
 
                         
Residential Owner Occupied   3   $412   $34    5   $559   $(20)
Residential Non Owner Occupied   -    -    -    1    82    - 
CRE Owner Occupied   -    -    -    2    922    - 
CRE Non Owner Occupied   -    -    -    -    -    - 
Agriculture Land   -    -    -    1    320    (7)
Other CRE   1    62    (2)   1    62    (2)
Commercial / Industrial   -    -    -    -    -    - 
Home Equity / Improvement   -    -    -    -    -    - 
Total   4   $474   $32    10   $1,945   $(29)

 

The troubled debt restructurings described above increased the allowance for loan losses by $32,000 for the quarter ended June 30, 2012, after $29,000 of charge-offs during the quarter ended June 30, 2012. During the six months ended June 30, 2012, the troubled debt restructurings described above decreased the allowance for loan losses by $29,000 after $742,000 of charge-offs.

 

There was one loan that defaulted during 2012 which had been modified within one year of the default date. A default for purposes of this disclosure is a troubled debt restructured loan in which the borrower is 90 days past due. This was a commercial working capital loan with a recorded investment of $580,000 at June 30, 2012. There was no allowance for loan loss impact as a result of this default.

 

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed in an internal loan committee meeting.

 

Credit Quality Indicators

 

Loans are categorized into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. Loans are analyzed individually by classifying the loans as to credit risk. This analysis includes all non-homogeneous loans, such as commercial and commercial real estate loans and certain homogenous mortgage, home equity and consumer loans. This analysis is performed on a quarterly basis. First Defiance uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

39
 

 

Not Graded. Loans classified as not graded are generally smaller balance residential real estate, home equity and consumer installment loans which are originated primarily by using an automated underwriting system. These loans are monitored based on their delinquency status and are evaluated individually only if they are seriously delinquent.

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of June 30, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (In Thousands)

 

Category  Pass   Special
Mention
   Substandard   Doubtful   Not
Graded
   Total 
                         
Residential Owner Occupied  $4,496   $53   $4,561   $-   $125,907   $135,017 
Residential Non Owner Occupied   57,172    2,580    10,060    -    6,238    76,050 
Total residential real estate   61,668    2,633    14,621    -    132,145    211,067 
                               
Construction   6,834    -    -    -    6,642    13,476 
                               
Multi Family   117,170    944    1,851    -    1,064    121,029