Item 1. Description of Business
General
FFD Financial Corporation ("FFD"), an Ohio corporation formed in 1996, is
a savings and loan holding company which owns all of the issued and outstanding
common shares of First Federal Community Bank, a federal savings bank ("First
Federal").
First Federal has conducted business in Tuscarawas County, Ohio since it
was incorporated in 1898 as an Ohio savings and loan association under the name
"Dover Building & Loan Company." First Federal obtained a federal savings and
loan charter in 1937 under the name "First Federal Savings & Loan Association."
In 1983, First Federal changed to a federal savings bank charter under the name
"First Federal Savings Bank of Dover, " and in August 2001, First Federal
adopted its present name. First Federal presently conducts its business from
its main office in Dover, Ohio, branches in Dover, New Philadelphia and
Sugarcreek, Ohio, and a limited service office in Coshocton, Ohio. The
Sugarcreek, Ohio location was converted from a limited service office to a
branch office in September 2007.
FFD is subject to regulation and examination by the Office of Thrift
Supervision of the United States Department of the Treasury (the "OTS") and the
United States Securities and Exchange Commission (the "SEC"). First Federal is
subject to supervision and regulation by the OTS and the Federal Deposit
Insurance Corporation (the "FDIC"). First Federal's deposits are FDIC insured
up to applicable limits.
First Federal's business involves attracting deposits from individual and
business customers and using these deposits to originate loans to individuals
and businesses in its primary market area, which consists of Tuscarawas and
contiguous counties in Ohio. First Federal provides deposit products including
checking, savings, money market and individual retirement accounts and
certificates of deposit, and originates residential and home equity loans,
construction loans, nonresidential real estate loans, business loans, and
consumer loans. Loan funds are obtained primarily from deposits and loan
repayments. First Federal also obtains advances from the Federal Home Loan Bank
("FHLB") of Cincinnati when other sources of funds are inadequate to fund loan
demand. First Federal also invests in U.S. Government agency obligations,
interest-bearing deposits in other financial institutions, mortgage-backed
securities and other investments permitted by applicable law. Additionally,
First Federal provides access to its products and services via the Internet at
www.onlinefirstfed.com.
Interest on loans, mortgage-backed securities and investments is First
Federal's primary source of income. First Federal's principal expense is
interest paid on deposit accounts and borrowings. Operating results are
dependent to a significant degree on First Federal's net interest income, which
is the difference between interest earned on loans, mortgage-backed securities
and other investments and interest paid on deposits and borrowings. Like most
thrift institutions, First Federal's interest income and interest expense are
significantly affected by general economic conditions and by the policies of
various regulatory authorities.
Lending Activities
General. First Federal's principal lending activities are the origination
of real estate loans secured by one- to four-family residential properties,
nonresidential real estate loans, and commercial loans in First Federal's
primary market area. To a lesser extent, First Federal also originates loans
secured by multifamily properties containing five units or more, construction
loans, and various types of consumer loans.
Loan Portfolio Composition. The following table presents certain
information regarding the composition of First Federal's loan portfolio at the
dates indicated:
At June 30,
------------------------------------------------------------
2007 2006 2005
------------------ ------------------ -----------------
Percent Percent Percent
of total of total of total
loans Amount loans Amount loans Amount
----- ------ ----- ------ ----- ------
(Dollars in thousands)
One- to four-family (1) $ 66,018 42.3% $ 64,102 44.1% $ 60,470 45.2%
Multifamily (1) 8,325 5.3 10,120 7.0 9,082 6.8
Nonresidential and land (1) 58,139 37.3 48,337 33.3 42,763 31.9
Commercial - secured 16,601 10.6 16,408 11.3 16,388 12.2
Commercial - unsecured 124 0.1 273 0.2 279 0.2
Consumer 6,857 4.4 5,969 4.1 4,896 3.7
-------- -------- --------
Total loans 156,064 100.0% 145,209 100.0% 133,878 100.0%
===== ===== =====
Deferred loan origination costs 157 153 139
Undisbursed portion of loans in
process (2,009) (1,647) (2,770)
Allowance for loan losses (930) (752) (766)
-------- -------- --------
Loans receivable, net $153,282 $142,963 $130,481
======== ======== ========
------------------
(1) Includes construction loans.
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Loan Maturity Schedule. The following table sets forth certain
information as of June 30, 2007, regarding the dollar amount of loans maturing
in First Federal's portfolio based on their contractual terms to maturity.
Demand loans and loans having no stated schedule of repayments and no stated
maturity are reported as due in one year or less.
Due during the year ending Due 4-5 Due 6-10 Due more
June 30, years years than 10
-------------------------- after after years
2008 2009 2010 6/30/07 6/30/07 6/30/07 Total
------- ------- ------ ------- ------- ------- ---------
(In thousands)
Residential real estate $10,061 $ 3,762 $4,036 $ 8,970 $28,786 $18,728 $ 74,343
(1)
Nonresidential and land 3,054 3,280 3,523 7,849 25,311 15,122 58,139
Commercial loans 10,593 6,132 - - - - 16,725
Consumer loans 1,811 1,983 2,152 911 - - 6,857
-------- ------- ------- --------- ----------- ----------- ----------
Total loans $25,519 $15,157 $9,711 $17,730 $54,097 $33,850 $156,064
======= ======= ====== ======= ======= ======= ========
-------------------
(1) Includes one- to four-family and multifamily loans.
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2
The following table sets forth the dollar amount of all loans due after
June 30, 2008 which have fixed interest rates and which have floating or
adjustable interest rates:
Due after June 30, 2008
-----------------------
(In thousands)
Fixed rate of interest $ 22,670
Adjustable rate of interest 107,875
--------
$130,545
========
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One- to Four-Family Residential Real Estate Loans. First Federal makes
permanent conventional loans secured by first mortgages on existing one- to
four-family residences, primarily single-family residences, located in its
primary market area. First Federal also originates home equity loans secured by
mortgages on one- to four-family residential real estate. The aggregate amount
of First Federal's one- to four-family residential real estate loans was $66.0
million, or 42.3% of total loans, at June 30, 2007.
First Federal offers adjustable-rate mortgage loans ("ARMs") for terms up
to 30 years. The interest rate adjustment periods on the ARMs are one year,
three years or five years. Typically, most of First Federal's ARMs are
one-year. The rates on ARMs are tied to the average monthly mortgage contract
rate for previously occupied homes published by the Federal Housing Finance
Board. The maximum allowable adjustment at each adjustment date is 2%. A
limited number of First Federal's ARMs have a maximum adjustment of 6% over the
term of the loan.
Adjustable-rate mortgage loans decrease First Federal's interest rate
risk but involve other risks, primarily credit risk, because as interest rates
rise, the payment by the borrower increases to the extent permitted by the
terms of the loan, thereby increasing the potential for default. At the same
time, the marketability of the underlying property may be adversely affected by
higher interest rates. First Federal believes that these risks have not had a
material adverse effect to date.
First Federal originates fixed-rate loans with terms of up to 30 years,
although the majority of First Federal's fixed-rate loans are sold in the
secondary market, usually with servicing retained.
To a lesser extent, First Federal makes loans for the construction of
residential real estate. These loans are typically structured as permanent
loans with adjustable or fixed rates of interest and terms from 15 to 30 years.
Construction loans are made to owner-occupants for the construction of
single-family homes by a general contractor and to developers for the
construction of single-family homes.
Construction loans generally involve greater underwriting and default
risks than loans secured by mortgages on existing properties. First Federal
advances loan funds upon the security of the project under construction, which
is more difficult to value before the completion of construction. Because of
the uncertainties inherent in estimating construction costs, if a default on a
construction loan occurs and foreclosure follows, First Federal must take
control of the project and attempt either to arrange for completion of
construction or dispose of the unfinished project.
Regulations limit the amount that First Federal may lend in relation to
the appraised value of the real estate securing the loan, as determined by an
appraisal at the time of loan origination. Lending policies of First Federal
limit the maximum ("Loan-to-Value Ratio" or "LTVs") loan amount without private
mortgage insurance to 80% of the lesser of the appraised value or the purchase
price of the property. However, First Federal makes one-to four-family real
estate loans in excess of 80% LTVs. For owner occupied properties, loan to
value ratios of 100%, 95% and 80% are available for single family, duplex and
three to four family respectively with private mortgage insurance. First
Federal also has adjustable rate loans for owner occupied properties with LTV's
up to 89% and an affordable housing loan program under which it originates a
small number of adjustable rate loans with LTVs of up to 95% without private
mortgage insurance. For non-owner occupied properties loan to value ratios of
90% and 75% are available for 1-2 family and 3-4 family respectively with
private mortgage insurance for fixed rate loans. For non-owner occupied
properties maximum loan to value of 85% on adjustable rate loans without
private mortgage insurance.
3
Included in one- to four-family loans are lines of credit secured by a
mortgage on the borrower's principal residence. Typically, home equity lines of
credit, when added to any prior indebtedness secured by the real estate, do not
exceed 89% of the estimated value of the real estate. For borrowers with high
credit ratings, First Federal also originates a small number of home equity
lines of credit up to 95%. First Federal's home equity loans have terms of up
to 15 years. Premier lines of credit to certain limited high net worth
borrowers are made for amounts which may exceed the estimated value of the
underlying real estate. The interest rates charged by First Federal on home
equity loans adjust monthly and are tied to the base rate on corporate loans,
posted by at least 75% of the nation's 30 largest banks, as reported in The
Wall Street Journal. At June 30, 2007, First Federal's one- to four-family
residential real estate loan portfolio included $14.2 million in home equity
loans.
Multifamily Residential Real Estate Loans. First Federal originates loans
secured by multifamily properties containing five or more units. The majority
of these loans are made with adjustable interest rates and a maximum LTV of 85%
for terms of up to 20 years.
Multifamily lending is generally considered to involve a higher degree of
risk because the loan amounts are larger and the borrower typically depends
upon income generated by the project to cover operating expenses and debt
service. The profitability of a project can be affected by economic conditions,
government policies and other factors beyond the control of the borrower. First
Federal attempts to reduce the risk associated with multifamily lending by
evaluating the borrower's creditworthiness and the projected income from the
project and by obtaining personal guarantees on loans made to corporations,
partnerships and limited liability companies.
At June 30, 2007, loans secured by multifamily properties totaled
approximately $8.3 million, or 5.3% of total loans.
Nonresidential Real Estate and Land Loans. First Federal makes loans
secured by nonresidential real estate such as retail stores, office buildings
and other commercial properties, with terms of up to 20 years and a maximum LTV
of 85%. First Federal also makes loans secured by improved and unimproved lots
for the construction of single-family residences. Unimproved lot loans have
terms of up to five years and a maximum LTV of 65%. Improved lot loans have
terms of up to five years and a maximum LTV of 80%.
Nonresidential real estate lending is generally considered to involve a
higher degree of risk than residential lending due to the relatively larger
loan amounts and the effects of general economic conditions on the successful
operation of income-producing properties. If, for example, leases are not
obtained or renewed, the cash flow on the property may be reduced and the
borrower's ability to repay may be impaired. First Federal has endeavored to
reduce such risk by evaluating the borrower's credit history and past
performance, the location of the real estate, the quality of the management
constructing and operating the property, the debt service ratio, the quality
and characteristics of the income stream generated by the property, personal
guarantees and appraisals supporting the property's valuation.
First Federal also originates loans for the construction of
nonresidential real estate. These loans are typically structured as permanent
loans with adjustable or fixed rates of interest and terms up to 20 years and
generally involve greater underwriting and default risks than do loans secured
by mortgages on existing properties. Because of the uncertainties inherent in
estimating construction costs, in the event a default on a construction loan
occurs and foreclosure follows, First Federal must take control of the project
and attempt either to arrange for completion of construction or dispose of the
unfinished project.
At June 30, 2007, First Federal had a total of $58.1 million, or 37.3% of
total loans, invested in nonresidential real estate and land loans. Federal
regulations limit the amount of nonresidential mortgage and land loans which
First Federal may make to 400% of its capital. At June 30, 2007, nonresidential
mortgage and land loans totaled 321% of First Federal's capital.
Commercial Loans. First Federal makes commercial loans to businesses in
its primary market area which are secured by inventory, accounts receivable,
machinery, personal guarantees or other assets of the borrower. The LTV ratios
for commercial loans depend upon the nature of the underlying collateral, but
generally commercial loans are made with LTVs of not more than 85% and have
adjustable interest rates with terms up to 7 years.
4
Commercial loans generally entail significantly greater risk than real
estate lending. The repayment of commercial loans is typically dependent on the
income stream and successful operation of a business, which can be affected by
general economic conditions.
At June 30, 2007, First Federal had approximately $16.7 million, or 10.7%
of total loans, invested in commercial loans. OTS regulations limit the amount
of First Federal's commercial loans to 20% of First Federal's total assets,
provided that amounts in excess of 10% may only be used for small business
loans. At June 30, 2007, First Federal complied with this limit.
Consumer Loans. First Federal makes various types of consumer loans,
including unsecured loans and loans secured by savings accounts, motor vehicles
and boats. Consumer loans are made at fixed or adjustable rates of interest.
Unsecured loans are made with terms of up to two years. Motor vehicle loans are
made with terms of up to five and a half years. Consumer loans may entail
greater credit risk than residential mortgage loans. The risk of default on
consumer loans increases during periods of recession, high unemployment and
other adverse economic conditions, and often the underlying collateral, such as
a vehicle, declines in value over time.
At June 30, 2007, First Federal had approximately $6.9 million, or 4.4%
of First Federal's total loans, invested in consumer loans.
Loan Solicitation and Processing. Loan originations are developed from a
number of sources, including continuing business with depositors, borrowers and
real estate developers, newspaper, television, and radio advertisements,
solicitations by First Federal's lending staff, automobile and boat dealers,
word of mouth and walk-in customers.
Loan applications for real estate loans are taken by First Federal's loan
personnel. First Federal typically obtains a credit report, verification of
income and other documentation concerning the borrower's creditworthiness. An
appraisal or evaluation of the fair market value of the real estate which will
be given as security for the loan is prepared by a staff appraiser or a
certified appraiser approved by the Board of Directors. For construction loans,
the appraiser also evaluates the building plans, construction specifications
and estimates of construction costs, and First Federal evaluates the
feasibility of the proposed construction project and the experience and record
of the builder. Upon the completion of the appraisal or evaluation and the
receipt of information on the borrower's credit history, the loan application
is reviewed in accordance with First Federal's underwriting guidelines.
Loan applications for non-residential real estate loans are taken by
First Federal's loan personnel. First Federal typically obtains information
from the business entity and any guarantors that will include, as applicable,
personal and/or entity credit reports, tax returns, financial statements, and
other documentation concerning creditworthiness. An appraisal or evaluation of
the fair market value of the real estate which will be given as security for
the loan is prepared by a staff appraiser or a fee appraiser approved by the
Board of Directors. For construction loans, the appraiser also evaluates the
building plans, construction specifications and estimates of construction
costs, and First Federal evaluates the feasibility of the proposed construction
project and the builder's experience and record. Upon the completion of the
appraisal or evaluation and the receipt of information on the credit history of
the borrower, the loan application is reviewed in accordance with First
Federal's underwriting guidelines.
Under First Federal's current loan guidelines, if a residential or
nonresidential real estate loan application is approved, First Federal usually
obtains title insurance on the real estate which will secure the mortgage loan.
In the past, First Federal used an attorney's opinion for single-family loans.
First Federal requires borrowers to carry satisfactory fire and casualty
insurance and, if applicable, flood insurance, and to name First Federal as an
insured mortgagee.
Loan applications for commercial loans are taken by First Federal's loan
personnel. First Federal typically obtains information from the business entity
and any guarantors that will include, as applicable, personal and/or entity
credit reports, tax returns, financial statements, and other documentation
concerning creditworthiness. Documentation, an appraisal or an evaluation of
the fair market value of the collateral which will be given as security for the
loan is typically obtained. This can take the form of officer inspection, book
value, aging schedules, borrowing base reports, or appraisals prepared by a
staff appraiser or an industry field expert or dealer. Upon the completion of
the appraisal or evaluation and the receipt of information on the credit
history of the borrower, the loan application is reviewed in accordance with
First Federal's underwriting guidelines.
5
Loan applications for consumer loans are taken by First Federal's loan
personnel, with the exception of some auto loan applications taken by the auto
dealer and provided to First Federal. Underwriting guidelines require that a
credit report, verification of income and other documents concerning the
borrower's creditworthiness are obtained. An appraisal or evaluation of the
fair market value of the collateral, which will be given as security for the
loan, is typically obtained. Consumer loans are underwritten on the basis of
the borrower's credit history and an analysis of the borrower's income and
expenses, ability to repay the loan and the value of the collateral, if any.
Loan Originations, Purchases and Sales. Currently, First Federal
originates both adjustable-rate and fixed-rate loans for its portfolio. First
Federal sells a majority of its fixed-rate real estate loans to Freddie Mac,
and First Federal services the loan in exchange for a servicing fee. During the
year ended June 30, 2007, First Federal sold approximately $10.4 million in
loans, including approximately $8.9 million to Freddie Mac and $1.5 million in
servicing released loans to other secondary market purchasers, and sold
approximately $1.3 million in loan participations to other financial
institutions.
OTS regulations limit the aggregate amount that a savings association may
lend to any one borrower to 15% of the association's total capital for
risk-based capital purposes plus, any loan loss reserves not already included
in total capital (the "Lending Limit Capital"). A savings association may loan
to one borrower an additional amount not to exceed 10% of the association's
Lending Limit Capital if the additional amount is fully secured by certain
forms of "readily marketable collateral." Real estate is not considered
"readily marketable collateral." In applying this limit, the regulations
require that loans to certain related or affiliated borrowers be aggregated. In
addition, the OTS may permit exceptions to the lending limit on a case-by-case
basis under certain circumstances.
Based on the 15% limit, First Federal was able to lend approximately $2.7
million to one borrower at June 30, 2007. The largest amount First Federal had
outstanding to one borrower at June 30, 2007, was $2.3 million.
Loan Origination and Other Fees. First Federal receives loan origination
fees and other fee income from its lending activities, including late payment
charges, application fees and fees for other miscellaneous services. Loan
origination fees and other fees are a volatile source of income, varying with
the volume of lending, loan repayments and general economic conditions. All
nonrefundable loan origination fees and certain direct loan origination costs
are deferred and recognized as an adjustment to yield over the life of the
related loan.
Delinquent Loans, Nonperforming Assets and Classified Assets. First
Federal endeavors to maintain a high level of asset quality through sound
underwriting and efficient collection practices. To discourage late payments,
First Federal charges a late fee of 5% of the principal and interest amount
after 15 days for fixed-rate and ARM loans and 30 days for some older ARMs.
When a loan is 15 days or more delinquent, the borrower is sent a delinquency
notice. When a loan is 60 days delinquent, First Federal usually contacts the
borrower by telephone. When a loan becomes 90 days delinquent, it is generally
referred to an attorney for foreclosure or collection, unless the Board of
Directors authorizes alternative payment arrangements to eliminate the
arrearage. First Federal bases a decision as to whether and when to initiate
foreclosure or collection proceedings on such factors as the amount of the
outstanding loan in relation to the original indebtedness, the extent of the
delinquency and the borrower's ability and willingness to cooperate in curing
the delinquency. Additional measures may be taken to accelerate the collection
process for commercial or consumer loans.
If a foreclosure or repossession occurs, the real estate or other
collateral is sold at public sale and may be purchased by First Federal. Real
estate acquired by First Federal as a result of foreclosure proceedings is
classified as real estate owned ("REO") until it is sold. When First Federal
acquires a property, or any other collateral, it initially records the property
or collateral at the lower of cost or fair value, less estimated selling costs.
First Federal records a loss provision if the collateral's fair value
substantially declines below the value determined at the recording date. In
determining the lower of cost or fair value at acquisition, costs relating to
development and improvement are capitalized. Costs relating to holding real
estate acquired through foreclosure, net of rental income, are charged against
earnings as incurred. First Federal had no REO at June 30, 2007.
6
The following table reflects the amount of delinquent loans as of the
dates indicated:
June 30, 2007 June 30, 2006 June 30, 2005
----------------------------- ----------------------------- ----------------------------
Percent Percent Percent
of total of total of total
Number Amount loans Number Amount loans Number Amount loans
------ ------ -------- ------ ------ -------- ------ ------ --------
(Dollars in thousands)
Loans delinquent for:
30 - 59 days 27 $ 455 0.29% 22 $ 368 0.25% 13 $ 210 0.16%
60 - 89 days 12 307 0.20% 14 506 0.35% 15 484 0.36%
90 days and over 12 806 0.52% 17 492 0.34% 16 685 0.51%
-- ------ ---- -- ------ ---- -- ------ ----
Total delinquent loans 51 $1,568 1.01% 53 $1,366 0.94% 44 $1,379 1.03%
== ====== ==== == ====== ==== == ====== ====
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Nonperforming assets include nonaccruing loans, real estate acquired by
foreclosure or by deed-in-lieu of foreclosure, and repossessed assets. First
Federal stops accruing interest on all real estate loans that are delinquent 90
days or more, and interest accrual may stop before a loan is 90 days delinquent
if, in the opinion of management, the collateral value is not adequate to cover
the outstanding principal and interest. First Federal places a loan on
nonaccrual status when delinquent 90 days or, in management's judgment, the
collection of interest contractually past due is unlikely.
7
The following table sets forth information with respect to First
Federal's nonaccruing, impaired and nonperforming loans and nonperforming
assets at the dates indicated.
At June 30,
------------------------------
2007 2006 2005
------- ------ ------
(Dollars in thousands)
Impaired nonperforming loans $ 639 $ 108 $ 440
Impaired performing loans 90 780 533
------- ------ ------
Total impaired loans 729 888 973
Other nonperforming loans 77 383 243
------- ------ ------
Total nonperforming and impaired loans 806 1,271 1,216
Real estate acquired through foreclosure - - -
------- ------ ------
Total nonperforming and impaired assets $ 806 $1,271 $1,216
======= ====== ======
Total nonperforming and impaired loans as
a percent of total loans 0.52% 0.88% 0.91%
Allowance for loan losses as a percent of
nonperforming and impaired loans 115.38% 59.17% 62.99%
Total nonperforming and impaired assets to
total assets 0.47% 0.79% 0.82%
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For the year ended June 30, 2007, interest income of $43,000 would have
been recorded on nonaccruing loans had they been accruing pursuant to
contractual terms.
OTS regulations require that each thrift institution classify its own
assets on a regular basis. Problem assets are classified as "substandard,"
"doubtful" or "loss." "Substandard" assets have one or more defined weaknesses
and are characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. "Doubtful" assets
have the same weaknesses as "substandard" assets, with the additional
characteristics that (i) the weaknesses make collection or liquidation in full
on the basis of currently existing facts, conditions and values questionable
and (ii) there is a high possibility of loss. An asset classified as "loss" is
considered uncollectible and of such little value that its continuance as an
asset of the institution is not warranted. If an asset, or portion thereof, is
classified as loss, the association must either establish a specific allowance
for losses in the amount of 100% of the portion of the asset classified as loss
or charge-off such amount. OTS regulations also contain a "special mention"
category, consisting of assets which do not currently expose an institution to
a sufficient degree of risk to warrant classification but which possess credit
deficiencies or potential weaknesses deserving management's close attention. At
June 30, 2007, First Federal had $2.4 million in special mention assets.
The aggregate amounts of First Federal's classified assets at the dates
indicated were as follows:
At June 30,
----------------------------------------
2007 2006 2005
------ ------ ------
(In thousands)
Classified assets:
Substandard $1,391 $ 993 $1,041
Doubtful 137 184 108
------ ------ ------
Total $1,528 $1,177 $1,149
====== ====== ======
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8
Federal examiners are authorized to classify an association's assets. If
the association does not agree with an examiner's classification of an asset,
it may appeal the determination to the OTS Regional Director. First Federal had
no disagreements with the examiners regarding the classification of assets at
the time of its last examination.
Allowance for Loan Losses. First Federal maintains an allowance for loan
losses based upon a number of relevant factors, including growth and changes in
the composition of the loan portfolio, trends in the level of delinquent and
problem loans, loan charge-offs, current and anticipated economic conditions in
First Federal's primary lending area, past loss experience and probable losses
arising from specific problem assets.
The single largest component of First Federal's loan portfolio consists
of one- to four-family residential real estate loans. Substantially all of
these loans are secured by property in First Federal's primary lending area,
consisting of Tuscarawas and contiguous counties in Ohio, which has a fairly
stable economy. First Federal's practice of making loans primarily in its local
market area has contributed to a historically low charge-off rate.
Substantially all of First Federal's other real estate loans are also secured
by properties in First Federal's primary lending area. First Federal has not
experienced any significant charge-offs from these other real estate loan
categories in recent years. Consumer loans are a small portion of First
Federal's total loans. Some consumer loans are unsecured and others are secured
by collateral that declines in value, which entails a higher degree of risk
than real estate loans.
Large loans are reviewed periodically to identify potential problems
at an early date. While the Board of Directors believes that it uses the best
information available to determine the allowance for loan losses, unforeseen
market conditions could result in material adjustments, and net earnings could
be significantly adversely affected, if circumstances differ substantially from
the assumptions used in making the final determination.
The following table sets forth an analysis of First Federal's
allowance for loan losses for the periods indicated:
Year ended June 30,
----------------------------------
2007 2006 2005
---- ---- ----
(Dollars in thousands)
Balance at beginning of period $752 $766 $779
Charge-offs (100) (184) (24)
Recoveries 3 10 -
Provision for losses on loans 275 160 11
---- ---- ----
Balance at end of period $930 $752 $766
==== ==== ====
Ratio of net charge-offs to average
loans outstanding during the period 0.07% 0.13% 0.02%
Ratio of allowance for loan losses to
total loans 0.60% 0.52% 0.57%
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9
The following table sets forth the allocation of First Federal's
allowance for loan losses by type of loan at the dates indicated:
At June 30,
-----------------------------------------------------------------------------------
2007 2006 2005
----------------------- ------------------------- -------------------------
Percent of Percent of Percent of
loans in each loans in each loans in each
category to category to category to
Amount total loans Amount total loans Amount total loans
------ ------------- ------ ------------- ------ -------------
(Dollars in thousands)
Balance at year end
applicable to:
Real estate loans $291 84.9% $285 84.4% $205 83.9%
Commercial loans 501 10.7 463 11.5 557 12.4
Consumer loans 138 4.4 4 4.1 4 3.7
---- ----- ---- ----- ---- -----
Total $930 100.0% $752 100.0% $766 100.0%
==== ===== ==== ===== ==== =====
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Because the loan loss allowance is based on estimates, it is monitored
quarterly and adjusted as necessary.
Investment Activities
First Federal is permitted to invest in certain commercial paper,
corporate debt securities rated in one of the four highest rating categories by
one or more nationally recognized statistical rating organizations, and other
investments permitted by federal regulations.
First Federal maintains a portfolio of mortgage-backed securities in the
form of Freddie Mac, Ginnie Mae and Fannie Mae participation certificates.
Mortgage-backed securities generally entitle First Federal to receive a portion
of the cash flows from an identified pool of mortgages. Freddie Mac, Ginnie Mae
and Fannie Mae securities are guaranteed by the issuing agency as to principal
and interest. Although mortgage-backed securities generally yield less than
individual loans originated by First Federal, management believes they are a
prudent investment alternative, especially at times when loan origination
levels are low.
10
The following table sets forth information regarding First Federal's
investment securities and mortgage-backed securities at the dates indicated:
At June 30,
-------------------------------------------------------------------------------------------------------
2007 2006 2005
--------------------------------- --------------------------------- ---------------------------------
Amortized % of Market % of Amortized % of Market % of Amortized % of Market % of
cost total Value total cost total value total cost total value total
--------- ----- ------ ----- --------- ----- ------ ----- --------- ----- ------ -----
(Dollars in thousands)
Investment securities
designated as available
for sale:
U.S. Government and
agency obligations $3,499 90.6% $3,448 90.4% $3,500 86.2% $3,353 85.6% $3,500 82.9% $3,485 82.8%
Mortgage-backed securities
designated as held to
maturity 97 2.5 98 2.6 130 3.2 131 3.4 220 5.2 225 5.3
Mortgage-backed securities
designated as available
for sale 266 6.9 267 7.0 429 10.6 431 11.0 500 11.9 500 11.9
------ ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total mortgage-backed
securities 363 9.4 365 9.6 559 13.8 562 14.4 720 17.1 725 17.2
------ ----- ------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total investment securities
and mortgage-backed
securities $3,862 100.0% $3,813 100.0% $4,059 100.0% $3,915 100.0% $4,220 100.0% $4,210 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
|
The maturities of First Federal's U. S. Government and agency obligations
and mortgage-backed securities at June 30, 2007, are indicated in the following
table:
After one year After five After ten
Less than one year through five years through ten years years Total
------------------ ------------------ ------------------ ------------------ --------------------------------
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Weighted-
value yield value yield value yield value yield value average yield
--------- ------- --------- ------- --------- ------- --------- ------- --------- -------------
(Dollars in thousands)
U.S. Government and
agency obligations $ - -% $ - -% $2,456 4.20% $ 992 5.00% $3,448 4.43%
Mortgage-backed
securities 2 7.06 15 8.51 8 12.81 339 6.77 364 6.97
--- ---- --- ---- ------ ----- ------ ---- ------ ----
$ 2 7.06% $15 8.51% $2,464 4.23% $1,331 5.45% $3,812 4.67%
=== ==== === ==== ====== ===== ====== ==== ====== ====
|
11
Deposits and Borrowings
Deposits. Deposits have traditionally been First Federal's primary source
of funds for use in lending and other investment activities. Deposits are
attracted principally from within First Federal's primary market area through
the offering of a broad selection of deposit instruments, including negotiable
order of withdrawal ("NOW") accounts, passbook savings accounts, health savings
accounts, individual retirement accounts ("IRAs") and certificate of deposit
("CDs") accounts. Interest rates paid, maturity terms, service fees and
withdrawal penalties for the various types of accounts are established
periodically by First Federal's management based on liquidity requirements,
growth goals and interest rates paid by competitors. First Federal does not use
brokers to attract deposits. First Federal's lending activities have also
contributed to deposit growth due to its focus on developing relationships with
commercial borrowers.
At June 30, 2007, First Federal's CDs totaled $77.3 million, or 55.3% of
total deposits. Of this amount, approximately $53.1 million mature within one
year. Based on past experience and First Federal's prevailing pricing
strategies, management believes that a substantial percentage of these CDs will
renew with First Federal at maturity. If there is a significant deviation from
historical experience, First Federal can utilize borrowings from the FHLB as an
alternative to this source of funds.
The following table sets forth the dollar amount of deposits in the
various types of accounts offered by First Federal at the dates indicated:
At June 30,
-------------------------------------------------------------------------
2007 2006 2005
--------------------- --------------------- ---------------------
Percent Percent Percent
of total of total of total
Amount deposits Amount deposits Amount deposits
------ -------- ------ -------- ------ --------
(Dollars in thousands)
Transaction accounts:
Demand deposit accounts $ 9,984 7.1% $10,114 8.3% $ 9,386 8.4%
NOW and money market accounts (1) 28,785 20.6 16,546 13.5 13,998 12.6
Passbook savings accounts (2) 23,840 17.0 32,987 27.1 32,253 28.9
-------- ----- -------- ----- -------- -----
Total transaction accounts 62,609 44.7 59,647 48.9 55,637 49.9
CDs:
0.50 - 1.00% $ - - $ - - 493 0.4
1.01 - 2.00% 16 0.0 1,119 0.9 5,762 5.2
2.01 - 4.00% 10,895 7.8 25,535 20.6 35,409 31.8
4.01 - 6.00% 66,402 47.5 35,618 29.5 14,194 12.7
-------- ----- -------- ----- -------- -----
Total CDs (3) 77,313 55.3 62,272 51.1 55,858 50.1
-------- ----- -------- ----- -------- -----
Total deposits $139,922 100.0% $121,919 100.0% $111,495 100.0%
======== ===== ======== ===== ======== =====
-------------------
(1) The weighted-average interest rates on NOW and money market accounts were 2.36% at June 30, 2007, 0.84% at
June 30, 2006 and 0.38% at June 30, 2005.
(2) The weighted-average interest rates on passbook accounts were 1.87% at June 30, 2007, 1.16% at June 30, 2006
and 1.14% at June 30, 2005.
(3) The weighted-average rates on all CDs were 4.77% at June 30, 2007, 4.03% at June 30, 2006 and 3.30% at June
30, 2005.
|
12
The following table shows rate and maturity information for First
Federal's CDs at June 30, 2007:
Amount Due
------------------------------------------------
Over Over
Up to 1 year to 3 years to
Rate 1 year 3 years 5 years Total
---- ------ --------- ---------- -----
(In thousands)
1.01 - 2.00% $ - $ 16 $ - $ 16
2.01 - 4.00% 8,181 2,714 - 10,895
4.01 - 6.00% 44,917 19,778 1,707 66,402
------- ------- ------ -------
Total $53,098 $22,508 $1,707 $77,313
======= ======= ====== =======
|
The following table presents the amount of First Federal's CDs of
$100,000 or more by the time remaining until maturity at June 30, 2007:
Maturity Amount
-------- ------
(In thousands)
Three months or less $ 3,745
Over 3 months to 6 months 6,165
Over 6 months to 12 months 6,724
Over 12 months 6,968
-------
Total $23,602
=======
|
Borrowings. First Federal's primary alternative source of funds is FHLB
advances. First Federal is a member of the FHLB of Cincinnati and must maintain
an investment in the capital stock of that FHLB in an amount equal to the
greater of (i) 1% of the aggregate outstanding principal amount of First
Federal's residential mortgage loans, home purchase contracts and similar
obligations at the beginning of each year, and (ii) 5% of its outstanding
advances from the FHLB. First Federal complied with this requirement at June
30, 2007, with an investment in stock of the FHLB of Cincinnati of $2.3
million.
FHLB advances are secured by collateral in one or more of the following
categories: fully-disbursed, whole first mortgage loans on improved residential
property or securities representing a whole interest in such loans; securities
issued, insured, or guaranteed by the U.S. Government or an agency thereof;
deposits in any FHLB; or other real estate related collateral acceptable to the
FHLB, if such collateral has a readily ascertainable value and the FHLB can
perfect its security interest in the collateral. At June 30, 2007, First
Federal had $13.1 million of outstanding FHLB advances.
The following table sets forth certain information as to First Federal's
FHLB advances at the dates indicated:
At June 30,
-------------------------------------
2007 2006 2005
---- ---- ----
(Dollars in thousands)
FHLB advances $13,055 $18,428 $17,880
Weighted-average interest rate 4.90% 5.22% 4.32%
|
13
The following table sets forth the maximum balance, the average balance
and the weighted-average interest rate of First Federal's FHLB advances during
the periods indicated:
Year ended June 30,
-------------------------------------
2007 2006 2005
---- ---- ----
(Dollars in thousands)
Maximum balance $18,428 $23,018 $17,938
Average balance $14,295 $17,683 $13,882
Weighted-average interest rate 5.31% 4.55% 4.35%
|
FFD entered into a Business Loan Agreement on March 20, 2006, with The
Huntington National Bank permitting borrowings by FFD up to an aggregate
principal amount of $2,500,000. At June 30, 2007, FFD had no borrowings
outstanding under this line of credit.
Competition
First Federal competes for deposits with other savings associations,
commercial banks, credit unions, brokerage firms and with the issuers of
commercial paper and other securities, such as shares in money market mutual
funds. The primary factors in competing for deposits are interest rates and
convenience of office location. In making loans, First Federal competes with
other savings associations, commercial banks, consumer finance companies,
credit unions, leasing companies, mortgage companies and other lenders. First
Federal competes for loan originations primarily through the interest rates and
loan fees offered and through the efficiency and quality of services provided.
Competition is affected by, among other things, the general availability of
lendable funds, general and local economic conditions, current interest rate
levels and other factors which are not readily predictable.
Subsidiaries
First Federal owns all of the outstanding shares of Dover Service
Corporation ("DSC"). DSC was originally incorporated for the primary purpose of
holding shares in First Federal's data processing provider, Intrieve,
Incorporated ("Intrieve"). In April 2005, Intrieve was acquired by Harland
Financial Solutions, Inc. As a result, DSC received cash of approximately
$344,000 for its Intrieve shares. DSC received an additional $35,000 in
holdback proceeds in fiscal 2006. The proceeds from the sale of Intrieve shares
are held by DSC in a savings account in First Federal, which is DSC's only
asset. The net book value of First Federal's investment in DSC at June 30,
2007, was approximately $15,000.
Personnel
At June 30, 2007, First Federal had 48 full-time equivalent employees.
First Federal believes that relations with its employees are good. First
Federal offers health, disability and life insurance benefits. None of First
Federal's employees is represented by a collective bargaining unit.
REGULATION
General
As a savings and loan holding company, FFD is subject to regulation,
examination and oversight by the OTS and is required to submit periodic reports
to the OTS concerning its activities and financial condition. As an Ohio
corporation, FFD is subject to provisions of the Ohio Revised Code applicable
to corporations generally. As a publicly-traded company, FFD is also subject to
regulation by the SEC.
As a federal savings association, First Federal is subject to regulatory
oversight by the OTS and, because its deposits are FDIC insured, First Federal
is subject to examination and regulation by the FDIC. First Federal must file
periodic reports with the OTS concerning its activities and financial
condition. Examinations are conducted periodically by the OTS and the FDIC to
determine whether First Federal is in compliance with various regulatory
requirements and is operating in a safe and sound manner.
14
Office of Thrift Supervision Regulations
General. The OTS is responsible for the regulation and supervision of all
federally-chartered savings associations and all other savings associations
that have FDIC insured deposits. The OTS issues regulations governing the
operation of savings associations, regularly examines such associations and
imposes assessments on savings associations based on their asset size to cover
the costs of general supervision and examination. The OTS also may initiate
enforcement actions against savings associations and certain persons affiliated
with them for violations of laws or regulations or for engaging in unsafe or
unsound practices. Under certain circumstances, the OTS may appoint a
conservator or receiver for a savings association.
Savings associations are subject to regulatory oversight under various
consumer protection and fair lending laws. These laws govern, among other
things, truth-in-lending and truth-in-savings disclosures, equal credit
opportunity, fair credit reporting and community reinvestment. Community
reinvestment regulations evaluate how well and to what extent an association
lends and invests in its designated service area, with particular emphasis on
low- to moderate-income communities and borrowers in those areas. Failure to
abide by federal laws and regulations governing community reinvestment could
limit the ability of an association to open a new branch or engage in a merger.
Regulatory Capital Requirements. OTS regulations require First Federal to
meet certain minimum capital requirements. All savings associations must have
tangible capital of 1.5% of adjusted total assets, core capital of 4% of
adjusted total assets (except for associations with the highest examination
rating and acceptable levels of risk) and risk-based capital equal to 8% of
risk-weighted assets. At June 30, 2007, First Federal exceeded these
requirements with tangible capital of 10.0%, core capital of 10.0% and total
risk-based capital of 13.2%.
The OTS has adopted regulations governing prompt corrective action to
address capital deficient and otherwise troubled savings associations. At each
successively lower defined capital category, an association is subject to more
restrictive operations and limits, and the OTS has less flexibility in
determining how to resolve the problems of the institution. In addition, the
OTS generally can downgrade an association's capital category if the
association is deemed to be engaging in an unsafe or unsound practice or it is
deemed to be in an unsafe or unsound condition. An undercapitalized association
is subject to increased monitoring and asset growth restrictions and is
required to obtain prior approval for acquisitions, branching and engaging in
new lines of business. In addition, each company controlling an
undercapitalized association must guarantee that the association will comply
with its capital plan until the association has been adequately capitalized on
average during each of four preceding calendar quarters and must provide
adequate assurances of performance. Except under limited circumstances,
critically undercapitalized institutions must be placed in conservatorship or
receivership within 90 days of reaching that capitalization level. First
Federal's capital at June 30, 2007, met the standards for the highest category,
a "well-capitalized" institution.
Limitations on Capital Distributions. The OTS imposes various
restrictions or requirements on the ability of savings associations to make
capital distributions. Federal law prohibits a savings association from making
a capital distribution if, after the distribution or payment, the association
would be undercapitalized. Capital distributions include payments of cash
dividends, stock repurchases and certain other acquisitions by an association
of its shares and payments to stockholders of another association in an
acquisition of such other association.
A subsidiary of a savings and loan holding company must file a notice or
an application with the OTS before it can pay a dividend. An application must
be filed if (i) the proposed distribution would cause the savings association's
total distributions for the calendar year to exceed its net income for that
year to date plus its retained net income for the preceding two years; (ii) the
savings association will not be at least adequately capitalized following the
capital distribution; or (iii) the proposed distribution would violate a
prohibition contained in any applicable statute, regulation or agreement
between the savings association and the OTS or the FDIC, or violate a condition
imposed on the savings association in an OTS-approved application or notice. If
a savings association subsidiary of a holding company is not required to file
an application, it must file a notice with the OTS.
Qualified Thrift Lender Test. If a savings association fails to meet one
of the two tests in order to be a qualified thrift lender ("QTL"), the
association and its holding company become subject to certain operating and
regulatory restrictions. The first test requires a savings association to
maintain a specified level of investments in assets that are designated as
qualifying thrift investments ("QTIs"). Generally, QTIs are assets related to
domestic residential real estate
15
and manufactured housing and include credit card, student and small business
loans and stock issued by a FHLB, Freddie Mac or Fannie Mae. The second test
permits a savings association to qualify as a QTL if at least 60% of such
institution's assets consist of specified types of property, including cash,
loans secured by residential real estate or deposits, educational loans and
certain governmental obligations. The OTS may grant exceptions to the QTL tests
under certain circumstances. At June 30, 2007, First Federal was a QTL.
Transactions with Insiders and Affiliates. Loans to executive officers,
directors and principal shareholders and their related interests must conform
to the lending limit, and the total of such loans cannot exceed the
association's Lending Limit Capital. Most loans to directors, executive
officers and principal shareholders must be approved in advance by a majority
of the "disinterested" directors of the association, with any "interested"
director not participating. All loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
in comparable transactions with the general public or as offered to all
employees in a company-wide benefit program. Loans to executive officers are
subject to additional restrictions. First Federal complied with such
restrictions at June 30, 2007.
All transactions between savings associations and their affiliates must
comply with Sections 23A and 23B of the Federal Reserve Act and the Federal
Reserve Board's Regulation W. An affiliate of a savings association is any
company or entity that controls, is controlled by, or is under common control
with, the savings association. FFD is an affiliate of First Federal. Generally,
Sections 23A and 23B and Regulation W (i) limit the extent to which a savings
association or its subsidiaries may engage in "covered transactions" with any
one affiliate up to an amount equal to 10% of the institution's capital stock
and surplus, (ii) limit the aggregate of all covered transactions with all
affiliates up to an amount equal to 20% of the capital stock and surplus, and
(iii) require that all such transactions be on terms substantially the same, or
at least as favorable to the association, as those provided in transactions
with a non-affiliate. The term "covered transaction" includes making loans and
extending credit, purchasing assets, accepting securities issued by an
affiliate as collateral, issuing a guarantee and other similar types of
transactions. In addition, a savings association may not make any loan or other
extension of credit to an affiliate unless the affiliate is engaged only in
activities permissible for a bank holding company and may not purchase or
invest in securities of any affiliate except shares of a subsidiary. First
Federal complied with these requirements and restrictions at June 30, 2007.
Federal Deposit Insurance Corporation
First Federal's deposit accounts are insured by the FDIC up to applicable
limits. The FDIC has examination authority over all insured depository
institutions, including First Federal, and has authority to initiate
enforcement actions if the FDIC does not believe the OTS has taken appropriate
action to safeguard safety and soundness and the deposit insurance fund.
The FDIC is required to maintain designated levels of reserves and may
increase assessment rates if necessary to restore the ratio of reserves to
insured deposits to its target level within a reasonable time and may decrease
such rates if such target level has been met. The FDIC has established a
risk-based assessment system for its members, and assessments vary based on the
risk the institution poses to the deposit insurance fund. The risk level is
determined based on the institution's capital level and the FDIC's level of
supervisory concern about the institution.
The Deposit Insurance Reform Act of 2005 and its companion bill, the
Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the
"Deposit Insurance Reform Acts"), resulted in the merger of the Bank Insurance
Fund ("BIF") and the SAIF into the combined Deposit Insurance Fund ("DIF"). The
Deposit Insurance Reform Acts provide for several additional changes to the
deposit insurance system, including the following: (i) increasing the deposit
insurance limit for retirement accounts from $100,000 to $250,000; (ii)
adjusting the deposit insurance limits (currently $100,000 for accounts other
than retirement accounts) every five years based on an inflation index, with
the first adjustment to be effective on January 1, 2011; (iii) providing
pass-through deposit insurance for the deposits of employee benefit plans (but
prohibiting undercapitalized depository institutions from accepting employee
benefit plan deposits); (iv) allocating an aggregate of $4.7 billion of
one-time credits to offset the premiums of depository institutions based on
their assessment bases at the end of 1996; (v) establishing rules for awarding
cash dividends to depository institutions, based on their relative
contributions to the DIF and its predecessor funds, when the DIF reserve ratio
reaches certain levels; and (vi) revising the rules and procedures for
risk-based premium assessments.
16
FRB Reserve Requirements
FRB regulations currently require that savings associations maintain
reserves of 3% of net transaction accounts (primarily NOW accounts) up to $45.8
million (subject to an exemption of up to $8.5 million), and of 10% of net
transaction accounts in excess of $45.8 million. At June 30, 2007, First
Federal complied with its reserve requirements.
Holding Company Regulation
As a unitary savings and loan holding company, FFD generally has no
restrictions on its activities. If, however, the OTS determines that there is
reasonable cause to believe that the continuation of an activity by a holding
company constitutes a serious risk to the financial safety, soundness or
stability of its subsidiary savings association, the OTS may impose
restrictions it deems necessary to address such risk, including limiting (i)
payment of dividends by the savings association, (ii) transactions between the
savings association and its affiliates, and (iii) any activities of the savings
association that might create a serious risk that the liabilities of the
holding company and its affiliates may be imposed on the savings association.
If the savings association subsidiary of a holding company fails to meet the
QTL test, then the holding company would become subject to the activities
restrictions applicable to multiple holding companies. At June 30, 2007, First
Federal qualified as a QTL.
Federal law generally prohibits a savings and loan holding company from
controlling any other savings association or savings and loan holding company,
or from acquiring or retaining more than 5% of the voting shares of a savings
association or holding company which is not a subsidiary, without prior OTS
approval. Under certain circumstances, a holding company is permitted to
acquire, with OTS approval, up to 15% of the previously unissued voting shares
of an undercapitalized savings association for cash without such savings
association being deemed to be controlled by the holding company.
Ohio Corporation Law
Merger Moratorium Statute. Chapter 1704 of the Ohio Revised Code
regulates certain takeover bids affecting public corporations with significant
ties to Ohio. The statute prohibits, with some exceptions, mergers,
combinations and certain other sales, distributions, dividends, or other
transactions between an Ohio corporation and any person who has the right to
exercise, alone or with others, 10% or more of the voting power of such
corporation (an "Interested Shareholder"), for three years following the date
on which such person first becomes an Interested Shareholder. Such a
transaction is permitted only if, prior to the time the person first becomes an
Interested Shareholder, the Board of Directors has approved the purchase of
shares that resulted in such person first becoming an Interested Shareholder.
After the initial three-year moratorium, such a transaction may not occur
unless (i) one of the specified exceptions applies (ii) the holders of
two-thirds of the voting shares, and a majority of the voting shares not
beneficially owned by the Interested Shareholders, approve the transaction at a
meeting called for such purpose; or (iii) the transaction meets certain
statutory criteria designed to ensure that the issuing public corporation's
remaining shareholders receive fair consideration for their shares.
Control Share Acquisition Statute. Section 1701.831 of the Ohio Revised
Code (the "Control Share Acquisition Statute") requires that, with certain
exceptions, acquisitions of shares which would result in the acquiring
shareholder owning 20%, 33 1/3%, or 50% of the outstanding shares of an Ohio
corporation (a "Control Share Acquisition") must be approved in advance by (i)
the holders of a majority of the outstanding voting shares of the corporation
represented at a meeting at which a quorum is present, and (ii) a majority of
the portion of the outstanding voting shares represented at the meeting,
excluding the voting shares owned by the acquiring shareholder, by certain
other persons who acquire or transfer voting shares after public announcement
of the acquisition or by certain officers of the corporation or directors of
the corporation who are employees of the corporation.
Regulation of Acquisitions of Control of FFD and First Federal
Federal law generally requires regulatory approval of acquisitions at
specified levels. Under applicable federal law and regulations, no person,
directly or indirectly, or acting in concert with others, may acquire control
of First Federal or FFD without 60 days' prior notice to the OTS. "Control" is
generally defined as having more than 25% ownership or voting power; however,
ownership or voting power of more than 10% may be deemed "control" if certain
17
factors exist. If the acquisition of control is by a company, the acquiror must
obtain OTS approval of the acquisition. In addition, OTS approval must be
obtained for any merger involving FFD or First Federal.
Federal Taxation
FFD and First Federal are each subject to the federal tax laws and
regulations which apply to corporations generally. In addition to the regular
income tax, FFD and First Federal may be subject to the alternative minimum tax
which is imposed at a minimum tax rate of 20% on "alternative minimum taxable
income" (which is the sum of a corporation's regular taxable income, with
certain adjustments, and tax preference items), less any available exemption.
In addition, 75% of the amount by which a corporation's "adjusted current
earnings" exceeds its alternative minimum taxable income computed without
regard to preference items and prior to reduction by net operating losses, is
included in alternative minimum taxable income. Net operating losses can offset
no more than 90% of alternative minimum taxable income. The alternative minimum
tax is imposed to the extent it exceeds the corporation's regular income tax.
Payments of alternative minimum tax may be used as credits against regular tax
liabilities in future years.
Certain thrift institutions, such as First Federal, are allowed
deductions for bad debts under methods more favorable than those granted to
other taxpayers. Qualified thrift institutions may compute deductions for bad
debts using either the specific charge-off method of Section 166 of the Code or
the experience method of Section 593 of the Code. The "experience" method is
also available to small banks. Under the experience method, a thrift
institution is generally allowed a deduction for an addition to its bad debt
reserve equal to the greater of (i) an amount based on its actual average
experience for losses in the current and five preceding taxable years, or (ii)
an amount necessary to restore the reserve to its balance as of the close of
the base year. Thrift institutions that are treated as small banks are allowed
to utilize the experience method applicable to such institutions, while thrift
institutions that are treated as large banks are required to use only the
specific charge off method.
A thrift institution required to change its method of computing reserves
for bad debt will treat such change as a change in the method of accounting,
initiated by the taxpayer and having been made with the consent of the
Secretary of the Treasury. Section 481(a) of the Code requires certain amounts
to be recaptured with respect to such change. Generally, the amounts to be
recaptured will be determined solely with respect to the "applicable excess
reserves" of the taxpayer. The amount of the applicable excess reserves will be
taken into account ratably over a six-taxable year period, commencing with the
first taxable year beginning after 1995, subject to the residential loan
requirement described below. In the case of a thrift institution that is
treated as a large bank, the amount of the institution's applicable excess
reserves generally is the excess of (i) the balances of its reserve for losses
on qualifying real property loans (generally loans secured by improved real
estate) and its reserve for losses on nonqualifying loans (all other types of
loans) as of the close of its last taxable year beginning before January 1,
1996, over (ii) the balances of such reserves as of the close of its last
taxable year beginning before January 1, 1988 (i.e., the "pre-1988 reserves").
In the case of a thrift institution that is treated as a small bank, like First
Federal, the amount of the institution's applicable excess reserves generally
is the excess of (i) the balances of its reserve for losses on qualifying real
property loans and its reserve for losses on nonqualifying loans as of the
close of its last taxable year beginning before January 1, 1996, over (ii) the
greater of the balance of (a) its pre-1988 reserves or (b) what the thrift's
reserves would have been at the close of its last year beginning before January
1, 1996, had the thrift always used the experience method.
The balance of the pre-1988 reserves is subject to the provisions of
Section 593(e), which require recapture in the case of certain excessive
distributions to shareholders. The pre-1988 reserves may not be utilized for
payment of cash dividends or other distributions to a shareholder (including
distributions in dissolution or liquidation) or for any other purpose (except
to absorb bad debt losses). Distribution of a cash dividend by a thrift
institution to a shareholder is treated as made: first, out of the
institution's post-1951 accumulated earnings and profits; second, out of the
pre-1988 reserves; and third, out of such other accounts as may be proper. To
the extent a distribution by First Federal to FFD is deemed paid out of its
pre-1988 reserves under these rules, the pre-1988 reserves would be reduced and
First Federal's gross income for tax purposes would be increased by the amount
which, when reduced by the income tax, if any, attributable to the inclusion of
such amount in its gross income, equals the amount deemed paid out of the
pre-1988 reserves. As of June 30, 2007, First Federal's pre-1988 reserves
totaled approximately $1.65 million. See Notes A and J to the Consolidated
Financial Statements for additional information.
18
First Federal's tax returns have been audited or closed without audit
through 2002. In the opinion of management, any examination of open returns
would not result in a deficiency which could have a material adverse effect on
First Federal's financial condition.
Ohio Taxation
FFD is subject to the Ohio corporation franchise tax, which, as applied
to FFD, is a tax measured by both net earnings and net worth. The rate of tax
is the greater of (i) 5.1% on the first $50,000 of computed Ohio taxable income
and 8.5% of computed Ohio taxable income in excess of $50,000 or (ii) 0.4% of
taxable net worth.
In computing its tax under the net worth method, FFD may exclude 100% of
its investment in the capital stock of First Federal, as reflected on the
balance sheet of FFD in computing its taxable net worth as long as it owns at
least 25% of the issued and outstanding capital stock of First Federal. The
calculation of the exclusion from net worth is based on the ratio of the
excludable investment (net of any appreciation or goodwill included in such
investment) to total assets multiplied by the net value of the stock. As a
holding company, FFD may be entitled to various other deductions in computing
taxable net worth that are not generally available to operating companies.
FFD may elect to be a "qualifying holding company" and as such be exempt
from the net worth tax. A corporation franchise tax based solely on net
earnings would still apply. To be exempt, FFD must satisfy all of the
requirements of the applicable statute, including making related member
adjustments that could affect the taxable net worth of First Federal. FFD made
such an election for fiscal 2007.
First Federal is a "financial institution" for Ohio tax purposes. As
such, it is subject to the Ohio corporate franchise tax on "financial
institutions," which is imposed at a rate of 1.3% of the taxable book net
worth. As a "financial institution," First Federal is not subject to any tax
based upon net income or net profits imposed by the State of Ohio.
Ohio imposes a commercial activity tax on gross receipts in excess of
$150,000; however, gross receipts of financial institutions and their holding
companies are exempt from this tax.
