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Section 1: 10-Q (FORM 10-Q)

 

 

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 September 30, 2019

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class Trading Symbol Name of each exchange on which registered
Common Stock, Par Value $0.01 Per Share FDEF The NASDAQ Stock Market

 

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 has submitted electronically, every Interactive Data File required to be submitted 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 such files). Yes x  No ¨

 

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

 

Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ Smaller reporting company ¨
  Emerging growth company ¨

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

 

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 – 19,729,215 shares outstanding at October 31, 2019.

 

 

 

 

 

FIRST DEFIANCE FINANCIAL CORP.

 

INDEX

 

    Page Number
     
PART I - FINANCIAL INFORMATION  
     
Item 1. Consolidated Condensed Financial Statements (Unaudited): Consolidated Condensed Statements of Financial Condition – September 30, 2019 and December 31, 2018 2
     
  Consolidated Condensed Statements of Income - Three and Nine months ended September 30, 2019 and 2018 4
     
  Consolidated Condensed Statements of Comprehensive Income – Three and Nine months ended September 30, 2019 and 2018 5
     
  Consolidated Condensed Statements of Changes in Stockholders’ Equity – Nine months ended September 30, 2019 and 2018 6
     
  Consolidated Condensed Statements of Cash Flows - Nine months ended September 30, 2019 and 2018 7
     
  Notes to Consolidated Condensed Financial Statements 8
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 51
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 76
     
Item 4. Controls and Procedures 77
     
PART II - OTHER INFORMATION:  
     
Item 1. Legal Proceedings 78
     
Item 1A. Risk Factors 78
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 78
     
Item 3. Defaults upon Senior Securities 78
     
Item 4. Mine Safety Disclosures 78
     
Item 5. Other Information 79
     
Item 6. Exhibits 79
     
  Signatures 80

 

1

 

 

 

PART I-FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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

 

 

   September 30,
2019
   December 31,
2018
 
Assets          
Cash and cash equivalents:          
Cash and amounts due from depository institutions  $56,994   $55,962 
Federal funds sold   55,000    43,000 
    111,994    98,962 
Securities:          
Available-for-sale, carried at fair value   290,054    294,076 
Held-to-maturity, carried at amortized cost (fair value $481 and $526 at September 30, 2019 and December 31, 2018, respectively)   481    526 
    290,535    294,602 
Loans held for sale   22,909    6,613 
Loans receivable, net of allowance of $30,250 at September 30, 2019 and $28,331 at December 31, 2018, respectively   2,635,050    2,511,708 
Mortgage servicing rights   9,859    10,119 
Accrued interest receivable   11,386    9,641 
Federal Home Loan Bank stock   11,915    14,217 
Bank owned life insurance   75,088    67,660 
Premises and equipment   39,911    40,670 
Real estate and other assets held for sale   -    1,205 
Goodwill   100,069    98,569 
Core deposit and other intangibles   4,052    4,391 
Other assets   37,956    23,365 
Total assets  $3,350,724   $3,181,722 

 

(continued)

 

2

 

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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

 

 

   September 30,
2019
   December 31,
2018
 
Liabilities and stockholders’ equity          
Liabilities:          
Deposits  $2,760,615   $2,620,882 
Advances from the Federal Home Loan Bank   85,095    85,189 
Subordinated debentures   36,083    36,083 
Securities sold under repurchase agreements   2,851    5,741 
Advance payments by borrowers   5,504    3,652 
Deferred taxes   1,459    264 
Other liabilities   41,071    30,322 
Total liabilities   2,932,678    2,782,133 
           
Stockholders’ equity:          
Preferred stock, $.01 par value per share: 37,000 shares authorized; no shares issued   -    - 
Preferred stock, $.01 par value per share: 4,963,000 shares authorized; no shares issued   -    - 
Common stock, $.01 par value per share: 50,000,000 shares authorized; 25,371,086 and 25,398,992  shares issued and 19,728,590 and 20,171,392 shares outstanding at September 30, 2019 and December 31, 2018, respectively   127    127 
Additional paid-in capital   161,577    161,593 
Accumulated other comprehensive income (loss), net of tax of $1,356 and $(468), respectively   5,101    (2,148)
Retained earnings   320,998    295,588 
Treasury stock, at cost, 5,642,496 shares at September 30, 2019 and 5,227,600 shares at December 31, 2018   (69,757)   (55,571)
Total stockholders’ equity   418,046    399,589 
Total liabilities and stockholders’ equity  $3,350,724   $3,181,722 

 

See accompanying notes.

 

3

 

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Income

(UNAUDITED)

(Amounts in Thousands, except per share data)

 

 

   Three Months Ended  

 

Nine Months Ended

 
   September 30,   September 30, 
   2019   2018   2019   2018 
Interest Income                    
Loans  $33,284   $29,371   $97,158   $83,557 
Investment securities:                    
Taxable   1,134    1,207    3,788    3,445 
Non-taxable   818    870    2,507    2,522 
Interest-bearing deposits   312    275    857    945 
FHLB stock dividends   135    240    533    698 
Total interest income   35,683    31,963    104,843    91,167 
Interest Expense                    
Deposits   6,029    3,753    16,615    9,508 
FHLB advances and other   431    342    1,011    943 
Subordinated debentures   329    334    1,043    934 
Notes payable   2    5    23    19 
Total interest expense   6,791    4,434    18,692    11,404 
Net interest income   28,892    27,529    86,151    79,763 
Provision for loan losses   1,327    1,376    1,821    704 
Net interest income after provision for loan losses   27,565    26,153    84,330    79,059 
Non-interest Income                    
Service fees and other charges   4,027    3,335    10,335    9,762 
Insurance commissions   3,263    3,254    10,994    11,024 
Mortgage banking income   2,822    1,877    6,800    5,632 
Gain on sale of non-mortgage loans   105    33    215    300 
Gain on sale or call of securities   11    76    11    76 
Trust income   511    514    1,510    1,588 
Income from Bank Owned Life Insurance   783    399    1,702    1,365 
Other non-interest income   320    434    1,574    1,092 
Total non-interest income   11,842    9,922    33,141    30,839 
Non-interest Expense                    
Compensation and benefits   14,061    12,882    42,544    39,016 
Occupancy   2,206    2,154    6,751    6,251 
FDIC insurance premium   (255)   255    276    817 
Financial institutions tax   555    531    1,667    1,593 
Data processing   1,728    2,161    6,292    6,349 
Acquisition related charges   540    -    540    - 
Amortization of intangibles   264    319    839    998 
Other non-interest expense   4,104    3,984    13,395    13,178 
Total non-interest expense   23,203    22,286    72,304    68,202 
Income before income taxes   16,204    13,789    45,167    41,696 
Federal income taxes   3,033    2,483    8,315    7,544 
Net Income  $13,171   $11,306   $36,852   $34,152 
                     
Earnings per common share (1)                    
Basic  $0.67   $0.55   $1.86   $1.68 
Diluted  $0.66   $0.55   $1.85   $1.67 
Dividends declared per share (1)  $0.19   $0.17   $0.57   $0.47 
Average common shares outstanding (1)                    
Basic   19,790    20,400    19,862    20,373 
Diluted   19,875    20,467    19,943    20,465 

 

See accompanying notes.

 

4

 

 

FIRST DEFIANCE FINANCIAL CORP.

 

Consolidated Condensed Statements of Comprehensive Income

(UNAUDITED)

(Amounts in Thousands)

 

 

   Three Months Ended   Nine Months Ended 
   September 30,   September 30, 
   2019   2018   2019   2018 
Net income  $13,171   $11,306   $36,852   $34,152 
                     
Other comprehensive income (loss):                    
Unrealized gains (losses) on securities available for sale   1,192    (2,058)   9,084    (6,487)
Reclassification adjustment for securities gains                    
Included in net income(1)   (11)   (76)   (11)   (76)
Income tax expense (benefit)   (247)   448    (1,906)   1,378 
Net of tax amount   934    (1,686)   7,167    (5,185)
                     
Change in unrealized gain/(loss) on postretirement benefit:                    
Reclassification adjustment for deferred tax on defined benefit postretirement medical plan   -    -    82    - 
Net of tax amount   -    -    82    - 
                     
Total other comprehensive income (loss)   934    (1,686)   7,249    (5,185)
                     
Comprehensive income  $14,105   $9,620   $44,101   $28,967 

 

(1) Amounts are included in gains on sale or call of securities on the consolidated condensed statements of income. Income tax expense associated with the reclassification adjustments, included in federal income taxes, for the three months ended September 30, 2019 and 2018 was $2 and $16, respectively. Income tax expense associated with the reclassification adjustments, included in federal income taxes, for the nine months ended September 30, 2019 and 2018 was $2 and $16, respectively.

 

See accompanying notes.

 

5

 

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statement of Changes in Stockholders’ Equity

(UNAUDITED)

(Amounts in Thousands, except share data)

 

                   Accumulated             
       Common       Additional   Other           Total 
   Preferred   Stock   Common   Paid-In   Comprehensive   Retained   Treasury   Stockholders’ 
   Stock   Shares(1)   Stock   Capital   Income   Earnings   Stock   Equity 
Balance at December 31, 2018  $          -    20,171,392   $127   $161,593   $(2,148)  $295,588   $(55,571)  $399,589 
Net income                            11,482         11,482 
Other comprehensive income                       3,717              3,717 
Deferred compensation plan                  (22)             42    20 
Stock based compensation expenses                  11                   11 
Shares issued under stock option plan, net of 178 repurchased and retired        17,822         (22)        (5)   212    185 
Restricted share activity under stock incentive plans net of 25,195 repurchased and retired        38,890         (751)             440    (311)
Shares issued from direct stock sales        1,065         19              12    31 
Shares repurchased        (515,977)                       (15,147)   (15,147)
Common stock dividends declared                            (3,788)        (3,788)
Balance at March 31, 2019  $-    19,713,192   $127   $160,828   $1,569   $303,277   $(70,012)  $395,789 
Net income                            12,199         12,199 
Other comprehensive income                       2,598              2,598 
Deferred compensation plan                  (12)             29    17 
Stock based compensation expenses                  255                   255 
Shares issued under stock option plan, net of 0 repurchased and retired        1,200         (9)             15    6 
Restricted share activity under stock incentive plans net of 2,533 repurchased and retired        12,304         129         (153)   98    74 
Shares issued from direct stock sales        934         14              11    25 
Common stock dividends declared                            (3,747)        (3,747)
Balance at June 30, 2019  $-    19,727,630   $127   $161,205   $4,167   $311,576   $(69,859)  $407,216 
Net income                            13,171         13,171 
Other comprehensive income                       934              934 
Deferred compensation plan                  (12)             31    19 
Stock based compensation expenses                  6                   6 
Restricted share activity under stock incentive plans net of 0 repurchased and retired                  362              59    421 
Shares issued from direct stock sales        960         15              12    27 
Common stock dividends declared                            (3,748)        (3,748)
Balance at September 30, 2019  $-    19,728,590   $127   $161,576   $5,101   $320,999   $(69,757)  $418,046 

 

                   Accumulated             
       Common       Additional   Other           Total 
   Preferred   Stock   Common   Paid-In   Comprehensive   Retained   Treasury   Stockholders’ 
   Stock   Shares(1)   Stock   Capital   Income   Earnings   Stock   Equity 
Balance at December 31, 2017  $      -    20,312,082   $127   $160,940   $217   $262,900   $(50,898)  $373,286 
Net income                            11,737         11,737 
Other comprehensive loss                       (2,810)             (2,810)
Adoption of ASU 2018-02 – See Note 2                       47    (47)        - 
Stock based compensation expenses                  84                   84 
Shares issued under stock option plan, net of 1,224 repurchased and retired        11,276         (33)        (36)   125    56 
Restricted share activity under stock incentive plans net of 17,818 repurchased and retired        39,696         (458)        (81)   426    (113)
Shares issued from direct stock sales        744         14              7    21 
Common stock dividends declared                            (3,047)        (3,047)
Balance at March 31, 2018  $-    20,363,798   $127   $160,547   $(2,546)  $271,426   $(50,340)  $379,214 
Net income                            11,109         11,109 
Other comprehensive loss                       (689)             (689)
Stock based compensation expenses                  88                   88 
Shares issued under stock option plan, net of 7,648 repurchased and retired        27,352         (60)        (234)   349    55 
Restricted share activity under stock incentive plans net of 0 repurchased and retired        4,104         253         (120)   40    173 
Shares issued from direct stock sales        924         19              10    29 
Common stock dividends declared                            (3,059)        (3,059)
Balance at June 30, 2018  $-    20,396,178   $127   $160,847   $(3,235)  $279,122   $(49,941)  $386,920 
Net income                            11,306         11,306 
Other comprehensive loss                       (1,686)             (1,686)
Stock based compensation expenses                  122                   122 
Restricted share activity under stock incentive plans net of 0 repurchased and retired        4,500         192              45    237 
Shares issued from direct stock sales        783         18              8    26 
Common stock dividends declared                            (3,468)        (3,468)
Balance at September 30, 2018  $-    20,401,461   $127   $161,179   $(4,921)  $286,960   $(49,888)  $393,457 

 

(1)      Share data has been adjusted to reflect a 2-for-1 stock split on July 12, 2018

 

See accompanying notes.

 

6

 

 

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(UNAUDITED)

(Amounts in Thousands)

 

   Nine Months Ended 
   September 30, 
   2019   2018 
Operating Activities          
Net income  $36,852   $34,152 
Items not requiring (providing) cash:          
Provision for loan losses   1,821    704 
Depreciation   3,137    2,688 
Amortization of mortgage servicing rights, net of impairment charges/recoveries   1,714    918 
Amortization of core deposit and other intangible assets   839    998 
Net accretion of premiums and discounts on loans and deposits   (599)   (238)
Amortization of premiums and discounts on securities   1,073    905 
Change in deferred taxes   (637)   224 
Proceeds from the sale of loans held for sale   201,571    161,185 
Originations of loans held for sale   (213,649)   (160,655)
Gain from sale of loans   (5,887)   (4,044)
Gain from sale or call of securities   (11)   (76)
Loss on sale or write down of property plant and equipment   10    13 
Gain/loss on sale / write-down of real estate and other assets held for sale   178    529 
Stock option expense   272    294 
Restricted stock /expense   184    297 
Income from bank owned life insurance including income from death benefits in excess of cash surrender value   (1,702)   (1,365)
Excess tax benefit on stock compensation plans   (108)   (162)
Changes in:          
Accrued interest receivable   (1,745)   (2,552)
Other assets   (5,783)   (2,985)
Other liabilities   1,705    2,188 
Net cash provided by operating activities   19,235    33,018 
           
Investing Activities          
Proceeds from maturities of held-to-maturity securities   42    45 
Proceeds from maturities, calls and pay-downs of available-for-sale securities   29,913    19,916 
Proceeds from the sale of available-for-sale securities   783    1,944 
Proceeds from sale of premises and equipment, real estate and other assets held for sale   1,173    482 
Proceeds from sale of non-mortgage loans   15,944    28,277 
Purchases of available-for-sale securities   (18,652)   (51,535)
Proceeds from Federal Home Loan stock redemption   2,302    1,775 
Net cash paid for acquisition   (1,600)   - 
Proceeds from sale of bank owned life insurance   -    17,689 
Purchases of premises and equipment, net   (2,388)   (2,911)
Investment in bank owned life insurance   (6,600)   - 
Proceeds from bank owned life insurance death benefit   874    336 
Net increase in loans receivable   (140,439)   (136,083)
Net cash used by investing activities   (118,648)   (120,065)
           
Financing Activities          
Net increase in deposits and advance payments by borrowers   141,585    88,184 
Repayment of Federal Home Loan Bank advances   (35,094)   (34,059)
Proceeds from Federal Home Loan Bank advances   35,000    50,000 
Decrease in securities sold under repurchase agreements   (2,890)   (21,857)
Net cash paid for repurchase of common stock   (15,147)   - 
Proceeds from exercise of stock options   191    111 
Proceeds from direct stock sales   83    75 
Cash dividends paid on common stock   (11,283)   (9,574)
Net cash provided by financing activities   112,445    72,880 
Increase in cash and cash equivalents   13,032    (14,167)
Cash and cash equivalents at beginning of period   98,962    113,693 
Cash and cash equivalents at end of period  $111,994   $99,526 
           
Supplemental cash flow information:          
Interest paid  $18,459   $11,335 
Income taxes paid  $7,350   $6,950 
Initial recognition of right-of-use asset  $8,808   $- 
Initial recognition of lease liability  $9,339   $- 
          
Transfers from loans to real estate and other assets held for sale  $146   $1,141 
Securities purchased but not yet settled  $-   $577 

 

See accompanying notes.

 

7

 

 

FIRST DEFIANCE FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements (UNAUDITED)

September 30, 2019 and 2018

 

 

1.     Basis of Presentation

 

First Defiance Financial Corp. (“First Defiance” or the “Company”) is a unitary thrift holding company that conducts business through its three wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal” or the “Bank”), First Insurance Group of the Midwest, Inc. (“First Insurance”), and First Defiance Risk Management Inc. (“First Defiance Risk Management”). All significant intercompany transactions and balances are eliminated in consolidation.

 

First Federal is primarily engaged in community banking. It attracts deposits from the general public through its offices and website, and uses those and other available sources of funds to originate residential real estate loans, commercial real estate loans, commercial loans, home improvement and home equity loans and consumer loans. In addition, First Federal invests in U.S. Treasury and federal government agency obligations, obligations of the State of Ohio and its political subdivisions, mortgage-backed securities that are issued by federal agencies, including real estate mortgage investment conduits (“REMICs”) and residential collateralized mortgage obligations (“CMOs”), and corporate bonds. First Federal’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”). First Federal is a member of the Federal Home Loan Bank (“FHLB”) System.

 

First Insurance is an insurance agency that conducts business throughout First Federal’s markets. The Maumee and Oregon, Ohio, offices were consolidated into a new office in Sylvania, Ohio, in January 2018. First Insurance offers property and casualty insurance, life insurance and group health insurance.

 

First Defiance Risk Management is a wholly-owned insurance company subsidiary of the Company that insures the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to help minimize the risk allocable to each participating insurer.

 

The consolidated condensed statement of financial condition at December 31, 2018, has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”).

 

The accompanying consolidated condensed financial statements as of September 30, 2019, and for the three and nine month periods ended September 30, 2019 and 2018 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 (“GAAP”). These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the 2018 Form 10-K. 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 nine month periods ended September 30, 2019, are not necessarily indicative of the results that may be expected for the entire year.

 

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On June 22, 2018, the Company announced a stock split in the form of a share distribution of one common share for each outstanding common share. The stock split was distributed on July 12, 2018, to shareholders of record as of July 2, 2018. All share and per share data in this Quarterly Report on Form 10-Q has been adjusted and is reflective of the stock split.

 

2.     Significant Accounting Policies

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

 

Earnings Per Common Share

 

Basic earnings per common share is computed by dividing net income 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, restricted stock awards and stock grants.

 

Goodwill and Other Intangibles

 

Goodwill resulting from business combinations prior to January 1, 2009, represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Company has selected November 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on First Defiance’s balance sheet.

 

Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank, insurance and branch acquisitions. They are initially recorded at fair value and then amortized on an accelerated basis over their estimated lives, which range from five years for non-compete agreements to 10 to 20 years for core deposit and customer relationship intangibles.

 

Accounting Standards Adopted in 2019

 

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). The guidance in the update supersedes the requirements in ASC Topic 840, Leases. The guidance is intended to increase transparency and comparability among organizations by recognizing right-of-use assets and lease liabilities on the balance sheet. For public companies, this update was effective for interim and annual periods beginning after December 15, 2018. The Company adopted this guidance in the first quarter of 2019. Upon adoption, the Company elected a practical expedient which allows existing leases to retain their classification as operating leases. The Company has elected to account for lease and related non-lease components as a single lease component. The Company has also elected to not recognize right-of-use assets and lease liabilities arising from short-term leases, which are twelve months or less. Implementation of the guidance resulted in the recording of a right-of-use asset and lease liability on the balance sheet; however it does not have a material impact on the Company's other consolidated financial statements. See additional disclosures in Note 10.

 

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Accounting Standards Updates

 

In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments.” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance delays recognition of credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. As a result, entities will recognize improvements to estimated credit losses immediately in earnings rather than as interest income over time, as they do today. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. As a result of this ASU, the Company could experience an increase in its allowance. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). Interagency guidance issued in December 2018 allows for a three-year phase-in of the cumulative-effect adjustment for regulatory capital reporting purposes. The Company continues its implementation efforts through its established Company-wide implementation committee along with a third-party software vendor to assist in the implementation process. The committee’s review indicates the Company has maintained sufficient historical loan data to support the requirement of this pronouncement and is currently evaluating the various loss methodologies to determine their correlations to the Company’s loan segments historical performance. The Company is currently running parallel computations in 2019 and continues to evaluate the impact of adoption of this ASU.

 

3.     Fair Value

 

FASB ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) 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.

 

10

 

 

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.

 

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 2 include U.S. federal government agencies, mortgage-backed securities, corporate bonds and municipal securities.

 

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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 commercial real estate generally use three methods to derive value: cost, sales or market comparison and income approach.  The cost method bases value on 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 investor’s 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 from 0% to 30% to account for 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 but are not limited to:  physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

 

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).

 

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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

 

September 30, 2019  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total Fair
Value
 
   (In Thousands) 

Available for sale securities:

Obligations of U.S. federal government corporations and agencies

  $         -   $2,531   $            -   $2,531 
Mortgage-backed - residential   -    82,080    -    82,080 
REMICs   -    2,087    -    2,087 
Collateralized mortgage obligations-residential   -    90,708    -    90,708 
Preferred Stock   1    -    -    1 
Corporate bonds   -    12,970    -    12,970 
Obligations of state and political subdivisions   -    99,677    -    99,677 
Mortgage banking derivative - asset   -    1,657    -    1,657 
Mortgage banking derivative - liability   -    -    -    - 

 

December 31, 2018   Level 1
Inputs
    Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 
    (In Thousands) 

Available for sale securities:

Obligations of U.S. federal government corporations and agencies

  $              -   $2,503   $              -   $2,503 
Mortgage-backed - residential   -    74,710    -    74,710 
REMICs   -    2,709    -    2,709 
Collateralized mortgage obligations-residential   -    101,461    -    101,461 
Corporate bonds   -    12,806    -    12,806 
Obligations of state and political subdivisions   -    99,887         99,887 
Mortgage banking derivative - asset   -    367    -    367 
Mortgage banking derivative -liability   -    73    -    73 

 

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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

 

 September 30, 2019   Level 1
Inputs
    Level 2
Inputs
    Level 3
Inputs
    Total Fair
Value
 
    (In Thousands)  
Impaired loans                                
Other Commercial real estate   $            -     $           -     $ 24     $ 24  
Total impaired loans     -       -       24       24  
Mortgage servicing rights     -       288       -       288  

 

December 31, 2018  Level 1
Inputs
   Level 2
Inputs
   Level 3
Inputs
   Total Fair
Value
 
   (In Thousands) 
Impaired loans                    
Commercial real estate  $               -   $-   $1,456   $1,456 
Commercial               -    -    319    319 
Total impaired loans   -    -    1,775    1,775 
Mortgage servicing rights   -    629    -    629 
Real estate held for sale                    
Commercial real estate   -    -    705    705 
Total real estate held for sale   -    -    705    705 

 

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2019, the significant unobservable inputs used in the fair value measurements were as follows:

 

   Fair
Value
   Valuation Technique  Unobservable Inputs  Range of
Inputs
   Weighted Average 
   (Dollars in Thousands) 
Impaired Loans- Applies to all loan classes  $24   Appraisals which utilize sales comparison, net income and cost approach  Discounts for collection issues and changes in market conditions   15%    15%

 

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For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2018, the significant unobservable inputs used in the fair value measurements were as follows:

 

   Fair
Value
   Valuation Technique  Unobservable Inputs  Range of Inputs   Weighted Average 
   (Dollars in Thousands) 
Impaired Loans- Applies to all loan classes  $1,775   Appraisals which utilize sales comparison, net income and cost approach  Discounts for collection issues and changes in market conditions   10-13%    10.86%
                      
Real estate held for sale – Applies to all classes  $705   Appraisals which utilize sales comparison, net income and cost approach  Discounts for changes in market conditions    20%    20%

 

In accordance with FASB ASC Topic 825, the Fair Value Measurements tables are a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of September 30, 2019, and December 31, 2018. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

 

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.

 

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The carrying amount of cash and cash equivalents and notes payable, 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 FHLB stock due to restrictions placed on its transferability.

 

The Company adopted the amendments to ASU 2016-01 relating to the loan portfolio in the first quarter of 2018 and an exit price income approach is now used to determine the fair value. The loans were valued on an individual basis, with consideration given to the loans underlying characteristics, including account types, remaining terms (in months), annual interest rates or coupons, interest types, past delinquencies, timing of principal and interest payments, current market rates, loss exposures, and remaining balances. The model utilizes a discounted cash flow approach to estimate the fair value of the loans using assumptions for the coupon rates, remaining maturities, prepayment speeds, projected default probabilities, losses given defaults, and estimates of prevailing discount rates. The discounted cash flow approach models the credit losses directly in the projected cash flows. The model applies various assumptions regarding credit, interest, and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications. The estimated fair value of impaired loans is based on the fair value of the collateral, less estimated cost to sell, or the present value of the loan’s expected future cash flows (discounted at the loan’s effective interest rate). All impaired loans are classified as Level 3 within the valuation hierarchy.

 

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 value.

 

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, checking 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 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 a 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 September 30, 2019.

 

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   Carrying   Fair Value Measurements at September 30, 2019
(In Thousands)
 
   Value   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and cash equivalents  $111,994   $111,994   $111,994   $-   $                     - 
Investment securities   290,535    290,535    1    290,534    - 
Federal Home Loan Bank Stock   11,915    N/A    N/A    N/A    N/A 
Loans, net, including loans held for sale   2,657,959    2,675,786    -    23,417    2,652,369 
Accrued interest receivable   11,386    11,386    12    1,576    9,798 
                          
Financial Liabilities:                         
Deposits  $2,760,615   $2,758,523   $604,129   $2,154,394   $- 
Advances from Federal Home Loan Bank   85,095    85,339    -    85,339    - 
Securities sold under repurchase agreements   2,851    2,851    -    2,851    - 
Subordinated debentures   36,083    33,102    -    -    33,102 

 

   Carrying   Fair Value Measurements at December 31, 2018
(In Thousands)
 
   Value   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and cash equivalents  $98,962   $98,962   $98,962   $-   $- 
Investment securities   294,602    294,602    -    294,602    - 
FHLB Stock   14,217    N/A    N/A    N/A    N/A 
Loans, net, including loans held for sale   2,518,321    2,501,096    -    6,865    2,494,231 
Accrued interest receivable   9,641    9,641    18    1,168    8,455 
                          
Financial Liabilities:                         
Deposits  $2,620,882   $2,613,965   $607,198   $2,006,767   $- 
Advances from FHLB   85,189    84,281    -    84,281    - 
Securities sold under repurchase agreements   5,741    5,741    -    5,741    - 
Subordinated debentures   36,083    28,854    -    -    28,854 

 

4.     Stock Compensation Plans

 

First Defiance has established equity based compensation plans for its directors and employees. On February 27, 2018, the Board adopted, and the shareholders approved at the 2018 Annual Shareholders Meeting, the First Defiance Financial Corp. 2018 Equity Incentive Plan (the “2018 Equity Plan”). The 2018 Equity Plan replaced all existing plans, although the Company’s former equity plans remain in existence to the extent there were outstanding grants thereunder at the time the 2018 Equity Plan was approved. 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 2018 Equity Plan. The 2018 Equity Plan allows for issuance of up to 900,000 common shares through the award of options, stock grants, restricted stock units (“RSU”), stock appreciation rights or other stock-based awards.

 

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As of September 30, 2019, 20,200 options to acquire First Defiance shares were outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted vest 20% per year. 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.

 

The Company approved a Short-Term Incentive Plan (“STIP”) and a Long-Term Equity Incentive Plan (“LTIP”) for selected members of management.

 

Under the 2018 and 2019 STIPs, the participants could earn between 10% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The final amount of benefits under the STIPs is determined as of December 31 of the same year and paid out in cash in the first quarter of the following year. The participants are required to be employed on the day of payout in order to receive the payment.

 

Under each LTIP, the participants could earn between 20% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three-year period. The Company granted 41,676 and 69,014 RSUs to the participants in the 2018 and 2019 LTIPs, respectively, effective January 1 in the year the award was made, which represents the maximum target award. The amount of benefit under each LTIP will be determined individually at the end of the 36 month performance period ending December 31. The benefits earned under each LTIP will be paid out in equity in the first quarter following the end of the performance period. The participants are required to be employed on the day of payout in order to receive the payment. A total of 48,363 RSUs were issued to the participants of the 2016 LTIP in the first quarter of 2019 for the three year performance period ended December 31, 2018.

 

In the nine months ended September 30, 2019, the Company also granted to employees 13,916 RSUs and 24,651 shares of restricted stock. Of the 24,651 restricted shares granted, 5,258 were issued to directors and have a one-year vesting period. The remaining 19,393 were issued to employees and have a three-year vesting period. The fair value of all granted restricted shares was determined by the stock price on the date of the grant.

 

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 three or nine months ended September 30, 2019, or September 30, 2018.

 

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Following is stock option activity under the plans during the nine months ended September 30, 2019:

 

  

 

 

 

Options
Outstanding

  

 

 

Weighted
Average
Exercise Price

   Weighted
Average
Remaining
Contractual
Term (in years)
  

 

Aggregate
Intrinsic
Value

(in 000’s)

 
Options outstanding, January 1, 2019   39,400   $14.00           
Forfeited or cancelled   -    -           
Exercised   (19,200)   10.15           
Granted   -    -           
Options outstanding, September 30, 2019   20,200   $17.66    5.02   $228 
Vested or expected to vest at September 30, 2019   20,200   $17.66    5.02   $228 
Exercisable at September 30, 2019   14,500   $17.48    4.70   $166 

 

Proceeds, related tax benefits realized from options exercised and intrinsic value of options exercised were as follows (in thousands):

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2019   2018   2019   2018 
Proceeds of options exercised  $              -   $          -   $191   $111 
Related tax benefit recognized   -    -    4    28 
Intrinsic value of options exercised   -    -    390    1,034 

 

As of September 30, 2019, there was $20,000 of total unrecognized compensation cost 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 1.1 years.

 

At September 30, 2019, 160,196 RSUs and 48,919 restricted stock grants were unvested. Compensation expense related to RSUs and STIP is recognized over the performance period based on the achievements of targets as established under the plan documents. A total expense of $559,000 and $1.5 million was recorded during the three and nine months ended September 30, 2019 compared to an expense of $470,000 and $1.4 million for the three and nine months ended September 30, 2018. There was approximately $801,000 and $961,000 included within other liabilities at September 30, 2019 and December 31, 2018, respectively, related to the STIP.

 

       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, 2019   144,586   $23.94    30,372   $28.48 
Granted   82,930    25.61    78,922    22.25 
Vested   (54,771)   20.13    (60,375)   21.17 
Forfeited   (12,549)   25.64    -    - 
Unvested at  September 30, 2019   160,196   $25.72    48,919   $27.18 

 

The maximum amount of compensation expense that may be recorded for the 2019 STIP and the active LTIPs at September 30, 2019, is approximately $4.8 million. However, the estimated expense expected to be recorded as of September 30, 2019, based on the performance measures in the plans, is $4.0 million of which $1.5 million is unrecognized at September 30, 2019, and will be recognized over the remaining performance periods.

 

19

 

 

5.            Dividends on Common Stock

 

First Defiance declared and paid a $0.19 per common stock dividend in the first, second and third quarters of 2019 and declared and paid a $0.15 per common stock dividend in the first and second quarters of 2018 and a $0.17 per common stock dividend in the third quarter of 2018.

 

6.            Earnings Per Common Share

 

Basic earnings per share are calculated using the two-class method. The two-class method is an earnings allocation formula under which earnings per share is calculated from common stock and participating securities according to dividends declared and participation rights in undistributed earnings. Under this method, all earnings distributed and undistributed, are allocated to participating securities and common shares based on their respective rights to receive dividends. Unvested share-based payment awards that contain non-forfeitable rights to dividends are considered participating securities (i.e., unvested restricted stock), not subject to performance based measures.

 

The following table sets forth the computation of basic and diluted earnings per common share:

 

   Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2019   2018   2019   2018 
   (In Thousands, except per share data) 
Basic Earnings Per Share:                    
Net income available to common shareholders  $13,171   $11,306   $36,852   $34,152 
Less: Income allocated to participating securities   1    1    3    3 
Net income allocated to common shareholders   13,170    11,305    36,849    34,149 
                     
Weighted average common shares outstanding including participating securities(1)   19,801    20,409    19,873    20,382 
Less: Participating securities   11    9    11    9 
Average common shares(1)   19,790    20,400    19,862    20,373 
                     
Basic earnings per common share  $0.67   $0.55   $1.86   $1.68 
                     
Diluted Earnings Per Share:                    
Net income allocated to common shareholders  $13,170   $11,305   $36,849   $34,149 
Weighted average common shares outstanding for basic earnings per common share(1)   19,790    20,400    19,862    20,373 
Add: Dilutive effects of stock options   85    67    81    92 
Average shares and dilutive potential common shares(1)   19,875    20,467    19,943    20,465 
                     
Diluted earnings per common share  $0.66   $0.55   $1.85   $1.67 

 

(1)Share and per share data in above table has been adjusted for a 2-for-1 stock split on July 12, 2018.

 

There were no shares excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2019 and September 30, 2018, as no shares were anti-dilutive during these time periods.

 

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7.            Investment Securities

 

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

 

  

 

Amortized
Cost

   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
  

 

 

Fair Value

 
   (In Thousands) 
At September 30, 2019                    
Available-for-Sale Securities:                    
Obligations of U.S. government corporations and agencies  $2,519   $12   $-   $2,531 
Mortgage-backed securities – residential   80,965    1,233    (118)   82,080 
REMICs   2,072    15    -    2,087 
Collateralized mortgage obligations   89,802    997    (91)   90,708 
Preferred stock   -    1    -    1 
Corporate bonds   12,902    86    (18)   12,970 
Obligations of state and political subdivisions   95,326    4,351    -    99,677 
Total Available-for-Sale  $283,586   $6,695   $(227)  $290,054 

 

   Amortized
Cost
  

Gross
Unrecognized
Gains

   Gross
Unrecognized
Losses
   Fair Value 
   (In Thousands) 

Held-to-Maturity Securities*:

                    
FHLMC certificates  $6   $                     -   $                    -   $6 
FNMA certificates   23    -    -    23 
GNMA certificates   8    -    -    8 
Obligations of state and political subdivisions   444    -    -    444 
Total Held-to Maturity  $481   $-   $-   $481 

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
   Cost   Gains   Losses   Value 
   (In Thousands) 
At December 31, 2018                    
Available-for-sale                    
Obligations of U.S. government corporations and agencies  $2,519   $2   $(18)  $2,503 
Mortgage-backed securities - residential   76,165    111    (1,566)   74,710 
REMICs   2,712    4    (7)   2,709 
Collateralized mortgage obligations - residential   103,026    124    (1,689)   101,461 
Corporate bonds   12,910    44    (148)   12,806 
Obligations of state and political subdivisions   99,349    1,258    (720)   99,887 
Total Available-for-Sale  $296,681   $1,543   $(4,148)  $294,076 

 

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       Gross   Gross     
   Amortized   Unrecognized   Unrecognized   Fair 
   Cost   Gains   Losses   Value 
   (In Thousands) 
Held-to-Maturity                    
FHLMC certificates  $8   $                  -   $                    -   $8 
FNMA certificates   31    -    -    31 
GNMA certificates   12    -    -    12 
Obligations of states and political subdivisions   475    -    -    475 
Total Held-to-Maturity  $526   $-   $-   $526 

 

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

 

The amortized cost and fair value of the investment securities portfolio at September 30, 2019, 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  $5,091   $5,097   $-   $- 
Due after one year through five years   17,766    17,953    -    - 
Due after five years through ten years   32,514    33,359    444    444 
Due after ten years   55,376    58,770    -    - 
MBS/CMO/REMIC   172,839    174,875    37    37 
   $283,586   $290,054   $481   $481 

 

Investment securities with a carrying amount of $160.9 million at September 30, 2019, were pledged as collateral on public deposits, securities sold under repurchase agreements and the Federal Reserve discount window.

 

As of September 30, 2019, the Company’s investment portfolio consisted of 432 securities, 37 of which were in an unrealized loss position.

 

22

 

 

The following tables summarize First Defiance’s securities that were in an unrealized loss position at September 30, 2019, and December 31, 2018:

 

   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   Losses 
   (In Thousands) 
At September 30, 2019                              
Available-for-sale securities:                              
Mortgage-backed securities-residential   3,407    (20)   10,162    (98)   13,569    (118)
Collateralized mortgage obligations   15 414    (42)   5,850    (49)   21,264    (91)
Corporate bonds   1,998    (2)   873    (16)   2,871    (18)
Total temporarily impaired securities  $20,819   $(64)  $16,885   $(163)  $37,704   $(227)

 

   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   Losses 
   (In Thousands) 
At December 31, 2018                              
Available-for-sale securities:                              
Obligations of U.S. government corporations and agencies  $-   $-   $500   $(18)  $500   $(18)
Mortgage-backed securities-residential   11,589    (71)   48,665    (1,495)   60,254    (1,566)
REMIC’s   -    -    857    (7)   857    (7)
Collateralized mortgage obligations   11,613    (53)   70,585    (1,636)   82,198    (1,689)
Corporate Bonds   5,752    (148)   -    -    5,752    (148)
Obligations of state and political subdivisions   11,974    (69)   16,492    (651)   28,466    (720)
Total temporarily impaired securities  $40,928   $(341)  $137,099   $(3,807)  $178,027   $(4,148)

 

There were net realized gains of $11,000 ($9,000 after tax) from the sales and calls of investment securities for the three and nine months ended September 30, 2019, while there were net realized gains of $76,000 ($60,000 after tax) for the three and nine months ended September 30, 2018.

 

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, Investments-Debt and Equity Securities. 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.

 

With the exception of corporate bonds, 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.

 

For the three and nine month period of 2019 and 2018, management determined there was no OTTI.

 

23

 

 

 

8.   Loans

 

Loans receivable consist of the following:

 

   September 30,
2019
   December 31,
2018
 
   (In Thousands) 
Real Estate:          
           
Secured by 1-4 family residential  $330,369   $322,686 
Secured by multi-family residential   275,944    278,358 
Secured by commercial real estate   1,154,975    1,126,452 
Construction   308,061    265,772 
    2,069,349    1,993,268 
Other Loans:          
Commercial   537,806    509,577 
Home equity and improvement   123,871    128,152 
Consumer finance   36,644    34,405 
    698,321    672,134 
Total loans   2,767,670    2,665,402 
Deduct:          
Undisbursed loan funds   (100,260)   (123,293)
Net deferred loan origination fees and costs   (2,110)   (2,070)
Allowance for loan loss   (30,250)   (28,331)
Totals  $2,635,050   $2,511,708 

 

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

 

The following table discloses allowance for loan loss activity for the quarters ended September 30, 2019 and 2018 by portfolio segment (In Thousands):

 

Quarter Ended September 30, 2019  1-4 Family
Residential
Real Estate
   Multi-
Family
Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial   Home Equity
and
Improvement
   Consumer
Finance
   Total 
Beginning Allowance  $2,793   $3,102   $12,149   $887   $7,888   $1,763   $352   $28,934 
Charge-Offs   (74)   0    0    0    (25)   (12)   (80)   (191)
Recoveries   6    6    55    0    30    77    6    180 
Provisions   213    51    832    216    (5)   (76)   96    1,327 
Ending Allowance  $2,938   $3,159   $13,036   $1,103   $7,888   $1,752   $374   $30,250 

 

Quarter Ended September 30, 2018  1-4 Family
Residential
Real Estate
   Multi-
Family
Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial   Home Equity
and
Improvement
   Consumer
Finance
   Total 
Beginning Allowance  $2,682   $2,913   $11,253   $737   $7,455   $2,032   $249   $27,321 
Charge-Offs   (136)   0    (1,048)   0    (528)   (36)   (25)   (1,773)
Recoveries   27    38    182    0    413    47    8    715 
Provisions   251    61    1,281    (122)   (179)   28    56    1,376 
Ending Allowance  $2,824   $3,012   $11,668   $615   $7,161   $2,071   $288   $27,639 

 

24

 

 

The following table discloses allowance for loan loss activity for the year-to-date periods ended September 30, 2019 and 2018 by portfolio segment (In Thousands):

 

Year-to-date Period Ended
September 30, 2019
  1-4 Family
Residential
Real Estate
   Multi-
Family
Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial   Home Equity
and
Improvement
   Consumer
Finance
   Total 
Beginning Allowance  $2,881   $3,101   $12,041   $682   $7,281   $2,026   $319   $28,331 
Charge-Offs   (257)   0    (15)   0    (225)   (109)   (255)   (861)
Recoveries   176    42    408    0    136    161    36    959 
Provisions   138    16    602    421    696    (326)   274    1,821 
Ending Allowance  $2,938   $3,159   $13,036   $1,103   $7,888   $1,752   $374   $30,250 

 

Year-to-date Period Ended
September 30, 2018
  1-4 Family
Residential
Real Estate
   Multi-
Family
Residential
Real Estate
   Commercial
Real Estate
   Construction   Commercial   Home Equity
and
Improvement
   Consumer
Finance
   Total 
Beginning Allowance  $2,532   $2,702   $10,354   $647   $7,965   $2,255   $228   $26,683 
Charge-Offs   (230)   0    (1,357)   0    (709)   (194)   (128)   (2,618)
Recoveries   85    40    392    0    2,200    132    21    2,870 
Provisions   437    270    2,279    (32)   (2,295)   (122)   167    704 
Ending Allowance  $2,824   $3,012   $11,668   $615   $7,161   $2,071   $288   $27,639 

 

25

 

 

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 September 30, 2019 (In Thousands):

 

   1-4 Family   Multi Family                         
   Residential   Residential   Commercial           Home Equity   Consumer     
   Real Estate   Real Estate   Real Estate   Construction   Commercial   & Improvement   Finance   Total 
Allowance for loan losses:                                        
Ending allowance balance attributable to loans:                                        
Individually evaluated for impairment  $185   $2   $61   $-   $65   $62   $-   $375 
Collectively evaluated for impairment   2,753    3,157    12,975    1,103    7,823    1,690    374    29,875 
Acquired with deteriorated credit quality   -    -    -    -    -    -    -    - 
Total ending allowance balance  $2,938   $3,159   $13,036   $1,103   $7,888   $1,752   $374   $30,250 
                                         
Loans:                                        
Loans individually evaluated for impairment  $7,337   $173   $21,544   $-   $7,543   $857   $16   $37,470 
Loans collectively evaluated for impairment   322,455    275,934    1,136,877    207,633    532,154    123,871    36,775    2,635,699 
Loans acquired with deteriorated credit quality   998    292    627    -    14    -    -    1,931 
Total ending loans balance  $330,790   $276,399   $1,159,048   $207,633   $539,711   $124,728   $36,791   $2,675,100 

 

26

 

 

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, 2018 (In Thousands):

 

   1-4 Family   Multi Family                         
   Residential   Residential   Commercial           Home Equity   Consumer     
   Real Estate   Real Estate   Real Estate   Construction   Commercial   & Improvement   Finance   Total 
Allowance for loan losses:                                        
Ending allowance balance attributable to loans:                                        
Individually evaluated for impairment  $175   $3   $95   $-   $79   $242   $1   $595 
Collectively evaluated for impairment   2,706    3,098    11,946    682    7,202    1,784    318    27,736 
Acquired with deteriorated credit quality   -    -    -    -    -    -    -    - 
Total ending allowance balance  $2,881   $3,101   $12,041   $682   $7,281   $2,026   $319   $28,331 
                                         
Loans:                                        
Loans individually evaluated for impairment  $6,774   $1,347   $26,334   $-   $10,477   $963   $45   $45,940 
Loans collectively evaluated for impairment   315,385    277,105    1,102,355    142,096    500,730    128,065    34,486    2,500,222 
Loans acquired with deteriorated credit quality   1,012    296    846    -    177    -    -    2,331 
Total