UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 ------------------------------------------------- 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 000-24925 -------------------------------------------------------- COMBANC, INC. -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 34-1853493 -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 229 E. Second St., P. O. Box 429, Delphos, Ohio 45833 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (419) 695-1055 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) 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 is an accelerated filer (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 practicable date: 2,211,014 shares of the ComBanc's common stock (no par value) were outstanding as of October 11, 2004. TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets 3 Condensed Consolidated Statements of Operations 4 Condensed Consolidated Statements of Cash Flows 6 Notes to Condensed Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition 9 and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 16 Item 4. Controls and Procedures 16 PART II. OTHER INFORMATION Item 1. Legal Proceedings 17 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18 Exhibits 31.1 and 31.2 Rule 13a-14(a)/15d-14(a) certifications 20 Exhibits 32.1 and 32.2 Section 1350 certifications 22 2 COMBANC, INC. AND SUBSIDIARY DELPHOS, OHIO ------------- CONDENSED CONSOLIDATED BALANCE SHEETS ------------------------------------- ($ in thousands) September 30, December 31, ASSETS 2004 2003 ------ ----------------- ---------------- (unaudited) Cash and Due from Banks $ 8,076 $ 8,297 Federal Funds Sold 12,573 9,708 ----------------- ---------------- Cash and Cash Equivalents 20,649 18,005 Investment Securities - Available for Sale 55,238 55,052 Loans Held for Resale 262 - Loans 122,816 128,756 Allowance for Loan Losses (3,834) (3,825) ----------------- ---------------- Net Loans 118,982 124,931 Premises and Equipment 4,259 4,432 Federal Reserve and Federal Home Loan Bank Stock 2,067 2,012 Interest Receivable 844 760 Other Assets 2,320 2,541 ----------------- ---------------- Total Assets $ 204,621 $ 207,733 ================= ================ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits Noninterest Bearing $ 16,462 $ 15,758 Interest Bearing 153,497 156,474 ----------------- ---------------- Total Deposits 169,959 172,232 Short Term Borrowings 7,124 7,540 Long Term Debt 3,411 4,649 Interest Payable 440 392 Other Liabilities 506 362 ----------------- ---------------- Total Liabilities 181,440 185,175 ----------------- ---------------- Commitments and Contingent Liabilities - - Shareholders' Equity - Common Stock - No Par Value 5,000,000 shares authorized, 2,376,000 issued and 2,211,014 outstanding 1,237 1,237 Capital Surplus 1,513 1,513 Retained Earnings 22,655 22,034 Accumulated Other Comprehensive Income 493 491 Treasury Stock - 164,986 shares at cost (2,717) (2,717) ----------------- ---------------- Total Shareholders' Equity 23,181 22,558 ----------------- ---------------- Total Liabilities and Shareholders' Equity $ 204,621 $ 207,733 ================= ================ The accompanying notes are an integral part of the condensed consolidated financial statements 3 COMBANC, INC. AND SUBSIDIARY DELPHOS, OHIO ------------- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ----------------------------------------------- ($ in thousands, except per share data) For the Three Months Ended September 30, ----------------------------------- (unaudited) 2004 2003 ---------------- ---------------- Interest Income: ---------------- Loans Receivable $ 1,891 $ 2,058 Investments Securities Taxable 398 362 Tax-Exempt 116 139 Federal Funds Sold 40 22 ---------------- ---------------- Total Interest Income 2,446 2,582 ---------------- ---------------- Interest Expense: ----------------- Deposits 609 701 Short-Term Borrowings 31 27 Long-Term Debt 48 70 ---------------- ---------------- Total Interest Expense 688 798 ---------------- ---------------- Net Interest Income 1,758 1,784 Provision for Loan Losses - 430 ---------------- ---------------- Net Interest Income after Provision for Loan Losses 1,758 1,354 Other Income: ------------- Service Charges on Deposit Accounts 143 138 Net Realized Gains on Sales of Available-for- sale Securities (3) - Gain on Sale of Loans 33 173 Other Income 79 200 ---------------- ---------------- Total Other Income 252 511 ---------------- ---------------- Other Expenses: --------------- Salaries and Employee Benefits 1,113 710 Net Occupancy 102 98 Equipment Expenses 90 85 Data Processing Fees 101 97 Advertising 22 28 Printing and Office Supplies 20 25 Legal and Professional Fees 300 79 Dues and Memberships 57 69 State Taxes 74 58 Other Expense 300 194 ---------------- ---------------- Total Other Expenses 2,179 1,443 ---------------- ---------------- Income/(Loss) - before Income Tax (169) 422 ------------- Income Tax Expense/(Credit) (81) 113 ---------------- ---------------- Net Income/(Loss) $ (88) $ 309 ----------------- ================ ================ Earnings/(Loss) Per Share $ (0.04) $ 0.14 Cash Dividends Per Share $ 0.00 $ 0.10 The accompanying notes are an integral part of the condensed consolidated financial statements 4 COMBANC, INC. AND SUBSIDIARY DELPHOS, OHIO ------------- CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ----------------------------------------------- ($ in thousands, except per share data) For the Nine Months Ended September 30, ------------------------------------ (unaudited) 2004 2003 ---------------- ---------------- Interest Income: ---------------- Loans Receivable $ 5,827 $ 6,509 Investments Securities Taxable 1,234 1,216 Tax-Exempt 350 432 Federal Funds Sold 88 70 Deposits with Financial Institutions 1 1 ---------------- ---------------- Total Interest Income 7,500 8,228 ---------------- ---------------- Interest Expense: ----------------- Deposits 1,834 2,314 Short-Term Borrowings 79 57 Long-Term Debt 162 278 ---------------- ---------------- Total Interest Expense 2,075 2,649 ---------------- ---------------- Net Interest Income 5,425 5,579 Provision for Loan Losses 60 2,340 ---------------- ---------------- Net Interest Income after Provision for Loan Losses 5,365 3,239 Other Income: ------------- Service Charges on Deposit Accounts 412 407 Net Realized Gains on Sales of Available-for- sale Securities 12 - Gain on Sale of Loans 115 458 Other Income 390 518 ---------------- ---------------- Total Other Income 929 1,383 ---------------- ---------------- Other Expenses: --------------- Salaries and Employee Benefits 2,834 2,364 Net Occupancy 297 291 Equipment Expenses 259 256 Data Processing Fees 301 276 Advertising 92 131 Printing and Office Supplies 87 97 Legal and Professional Fees 536 199 Dues and Memberships 193 193 State Taxes 207 177 Other Expense 725 565 ---------------- ---------------- Total Other Expenses 5,531 4,549 ---------------- ---------------- Income - before Income Tax Expense 763 73 ------ Income Tax Expense/(Credit) 142 (125) ---------------- ---------------- Net Income $ 621 $ 198 ---------- ================ ================ Earnings Per Share $ 0.28 $ 0.09 Cash Dividends Per Share $ 0.00 $ 0.34 The accompanying notes are an integral part of the condensed consolidated financial statements 5 COMBANC, INC. AND SUBSIDIARY DELPHOS, OHIO ------------- CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ----------------------------------------------- ($ in thousands) For the Nine Months September 30, ----------------------------------- 2004 2003 --------------- ---------------- (unaudited) Cash Flows from Operating Activities: Net Income $ 621 $ 198 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities - Depreciation and amortization 298 297 Provision for Loan Loss 60 2,340 Investment Securities Gains (12) - Federal Home Loan Bank stock Dividends (55) (52) Investment securities amortization (accretion), Net 334 334 Proceeds From Sale of Loans Held For Sale 10,403 38,902 Originations of Loans Held For Sale (10,550) (38,051) Gain From Sale of Loans (115) (458) Net Change in Interest receivable (84) 55 Interest payable 48 (68) Other assets 220 (1,175) Other liabilities 143 33 --------------- ---------------- Net Cash Provided by Operating Activities 1,311 2,355 --------------- ---------------- Cash Flows from Investing Activities: Purchases of Securities Available for Sale/FHLB Stock (20,104) (23,452) Proceeds from Maturities of Securities Available for Sale 16,848 23,980 Proceeds from Sales of Securities Available for Sale 2,752 - Net Change in Loans 5,889 6,552 Purchases of Premises and Equipment (125) (114) --------------- ---------------- Net Cash Provided by Investing Activities 5,260 6,966 --------------- ---------------- Cash Flows from Financing Activities: Net change in Noninterest-bearing, Interest-bearing Demand and Savings Deposits (304) (702) Certificates and Other Time Deposits (1,969) (8,392) Short-term Borrowings (416) 2,029 Repayment of Long-term Debt (1,238) (2,761) Dividends Paid - (752) --------------- ---------------- Net Cash Used in Financing Activities (3,927) (10,578) --------------- ---------------- Net Change in Cash and Cash Equivalents 2,644 (1,257) Cash and Cash Equivalents - Beginning of Year 18,005 16,925 --------------- ---------------- End of Period $ 20,649 $ 15,668 =============== ================ The accompanying notes are an integral part of the condensed consolidated financial statements 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 2004 Note 1, Basis of Presentation Certain information and note disclosures normally included in the Company's annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Form 10-K annual report for 2003 filed with the Securities and Exchange Commission. The significant accounting policies followed by ComBanc, Inc. (Company) and its wholly-owned subsidiary, The Commercial Bank (Bank), for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. All adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods reported, consisting only of normal recurring adjustments, have been included in the accompanying unaudited condensed consolidated financial statements. The results of operations for the nine months ended September 30, 2004 and for the three months ended September 30, 2004 are not necessarily indicative of those expected for the remainder of the year. The Condensed Consolidated Balance Sheet at December 31, 2003 has been taken from audited consolidated financial statements at that date. Note 2, Earnings Per Share Earnings per share on the income statement has been computed on the basis of weighted-average number of shares of common stock outstanding. The weighted-average shares outstanding for the nine months ending September 30, 2004 and September 30, 2003 were 2,211,014. Note 3, Commitments and Contingent Liabilities Outstanding commitments to originate loans were $20,549,000 and $20,770,000 at September 30, 2004 and December 31, 2003, respectively. Note 4, Allowance for Loan Losses Credit risk is the risk of loss from a customer default on a loan. The Bank has in place a process to identify and manage its credit risk. The process includes initial credit review and approval, periodic monitoring to measure compliance with credit agreements and internal credit policies, monitoring changes in the risk ratings of loans and leases, identification of problem loans and special procedures for the collection of problem loans. The risk of loss is difficult to quantify and is subject to fluctuations in values and general economic conditions and other factors. THE DETERMINATION OF THE ALLOWANCE FOR LOAN LOSSES IS A CRITICAL ACCOUNTING POLICY WHICH INVOLVES ESTIMATES AND MANAGEMENT'S JUDGMENT ON A NUMBER OF FACTORS SUCH AS NET CHARGE-OFFS, DELINQUENCIES IN THE LOAN PORTFOLIO AND GENERAL ECONOMIC CONDITIONS. The Bank considers the allowance for loan losses of $3,834,000 adequate to cover losses inherent in the loan portfolios as of September 30, 2004. However, no assurance can be given that the Bank will not, in any particular period, sustain loan losses that are sizeable in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, 7 including economic conditions and the Bank's on-going credit review process, will not require significant increases in the allowance for loan losses. Among other factors, a protracted economic slowdown and/or a decline in commercial or residential real estate values in the Bank's markets may have an adverse impact on the adequacy of the allowance for loan losses by increasing credit risk and the risk of potential loss. Note 5, Merger Agreement The Company and the Bank entered into an Agreement and Plan of Merger dated as of August 4, 2004 by and among First Defiance Financial Corp., First Federal Bank of the Midwest, the Company and the Bank (the "Agreement and Plan of Merger"). A copy of the Agreement and Plan of Merger was attached as an exhibit to the Company's Current Report on Form 8-K, which was filed with the SEC on August 5, 2004. The agreement and plan have been filed with the Securities and Exchange Commission and may be viewed on the website maintained by the SEC at http://www.sec.gov. 8 PART I - FINANCIAL INFORMATION Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS The Company has made, and may continue to make, various forward-looking statements with respect to interest rate sensitivity analysis, credit quality and other financial and business matters for 2004 and, in certain instances, subsequent periods. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements for periods subsequent to 2003 are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from forward-looking statements. In addition to those factors previously disclosed by the Company and those factors identified elsewhere herein, the following factors could cause actual results to differ materially from such forward looking statements: the extent and timing of actions of the Federal Reserve, changes in economic conditions, continued pricing pressures on loan and deposit products, actions of competitors, customer's acceptance of the Company's products and services, the extent and timing of legislative and regulatory actions and reforms, changes in accounting principals, technological changes and increased technology costs, downturn in demand for loan and deposit products, and changes in the interest rate environment that reduce interest margins. The Company's forward-looking statements speak only as the date on which such statements are made. By making any forward-looking statements, the Company assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. ENTITY STATUS On April 13, 1998, The Commercial Bank became a wholly-owned subsidiary of the newly formed ComBanc, Inc., a one-bank holding company. Since ComBanc's only significant asset is the investment in The Commercial Bank, the following discussion will focus on the operations of The Commercial Bank. CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The Company's significant accounting policies are described in detail in the notes to the Company's consolidated financial statements for the year ended December 31, 2003. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company's financial condition and results, and they require management to make estimates that are difficult, subjective, or complex. Allowance for Credit Losses- The allowance for credit losses provides coverage for probable losses inherent in the Company's loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management's estimates of specific and expected losses, including volatility of default probabilities, 9 rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs. The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan's observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan's effective interest rate. Regardless of the extent of the Company's analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer's financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company's evaluation of imprecision risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment. Mortgage Servicing Rights- Mortgage servicing rights ("MSRs") associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets. FINANCIAL CONDITION We are currently subject to the terms of the Written Agreement, dated December 18, 2003, among the Company, the Bank, the Federal Reserve Bank of Cleveland and the Ohio Division of Financial Institutions. We are also currently subject to the terms of the Agreement and Plan of Merger dated as of August 4, 2004 by and among First Defiance Financial Corp., First Federal bank of the Midwest, ComBanc, Inc. and The Commercial Bank. Total Delinquent and Nonaccrual Loans as of September 30, 2004 stood at $3,615,000 as compared to $6,948,000 as of December 31, 2003. This decrease represents a 48.0% improvement since December 31, 2003. Total delinquency reduction can be credited to the continued emphasis on workout programs and a steady improvement in the local economy. 10 TABLE 1: Analysis of Delinquencies Dollars in Thousands 9/30/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000 Past due 30 to 89 days and still accruing $ 2,002 $ 2,758 $ 6,672 $ 9,863 $ 4,502 Past due 90 days or more and still accruing 17 680 798 2,810 2,587 Nonaccrual 1,596 3,510 8,456 3,455 542 ---------------------------------------------------------------------------- Total delinquencies $ 3,615 $ 6,948 $ 15,926 $ 16,128 $ 7,631 ============================================================================ Total Delinquencies as a percentage of total loans 2.94% 5.40% 11.37% 10.31% 4.50% Total assets decreased $3,112,000 or 1.5% from $207,733,000 at December 31, 2003 to $204,621,000 at September 30, 2004. This change is the result of a $5.9 million decrease in the loan portfolio while there was a $2.6 million increase in cash and cash equivalents. This reduction was offset through a decrease of $2.3 million in total deposits, a decrease of $1.2 million in long term debt, and a $0.4 million decrease in short term borrowings, while there was a $0.6 million increase in total shareholders' equity during the first nine months of 2004. Total gross loans decreased 4.4% or $5,678,000 from December 31, 2003 to $123,078,000 at September 30, 2004. The breakdown of the loan portfolio is detailed in table 2 below. A significant change in the portfolio includes a decrease in construction and land development loans. This decrease is the result of the completion of a large construction loan and being converted to an amortized commercial real estate loan. Another significant change includes 1-4 family secured by first lien mortgages. These loans decreased by $2,002,000 due to additional refinancing and the Bank selling the loans to the secondary market. As can be seen in Table 2, secondary market lending to FHLMC has dropped off significantly to net growth of $136,000 in the first three quarters of 2004. The decrease in sales to FHLMC is due to the increase of interest rates on the long end of the yield curve by approximately 50 basis points. These loans will continue to generate service fee income at .25% per year over the life of the loan, which currently amounts to approximately $161,000 annually. Another significant change in the portfolio includes a $1,702,000 decrease in consumer loans. This decrease is due to management's continued desire to decrease consumer loans due to the amount of risk that they carry. Commercial loans have decreased $1,032,000 or 8.2% from December 31, 2003 to September 30, 2004 due to the management's continued desire to decrease commercial loans not secured by real estate due to the amount of risk that they carry. TABLE 2: Analysis of Loan Portfolio Composition Dollars in Thousands 11 Loan Type 9/30/2004 12/31/2003 Difference % --------- ---------- ---------- -------- Construction/Land Development $ 6,161 $ 7,305 $ (1,144) -15.66% R/E Secured by Farmland 5,029 4,598 431 9.37% Revol Open-end 1-4 Family LOC 4,965 5,294 (329) -6.21% 1-4 Secured by first 33,110 35,112 (2,002) -5.70% 1-4 Secured by Junior 567 550 17 3.09% R/E Secured by Multi Family R/E 3,068 3,179 (111) -3.49% R/E Secured by Nonfarm, Nonres 47,903 46,977 926 1.97% Ag Loans 2,075 2,449 (374) -15.27% Commercial Loans 11,575 12,607 (1,032) -8.19% Municipal Loans 746 1,100 (354) -32.18% Master Card Loans 525 566 (41) -7.24% Other Consumer 12 7 5 71.43% Consumer Loans 7,291 8,993 (1,702) -18.93% Overdrafts 51 19 32 168.42% -------- -------- -------- ------ Total Loans 123,078 128,756 (5,678) -4.41% Loan Loss Reserve 3,834 3,825 9 0.24% -------- -------- -------- ------ Total Net Loans $119,244 $124,931 $ (5,687) -4.55% ======== ======== ======== ====== Serviced FHLMC Mortgages 63,596 63,460 136 0.21% -------- -------- -------- ------ Total Loans Serviced $182,840 $188,391 $ (5,551) -2.95% ======== ======== ======== ====== The Allowance for Loan Losses at September 30, 2004 was 3.1% of total loans compared to 3.0% at December 31, 2003. This $9,000 increase from December 31, 2003 is the result of a $60,000 provision and net charge-offs of $51,000, increasing the Allowance for Loan Loss from $3,825,000 at December 31, 2003 to $3,834,000 at September 30, 2004. Table 3 below illustrates an analysis of the Allowance for Loan and Lease Losses over the past five years. TABLE 3: Analysis of Changes in Allowance for Loan and Lease Losses Dollars in Thousands For the Nine Months Ended For the Years Ended --------- --------------------------------------------------------- 9/30/2004 12/31/2003 12/31/2002 12/31/2001 12/31/2000 --------- ---------- ---------- ---------- ---------- Balance of Allowance at Beginning of Year $3,825 $2,050 $1,815 $1,331 $1,832 ------ ------ ------ ------ ------ Loans Actually Charged Off - Real Estate - Construction -- 141 -- -- -- Real Estate - Mortgage 218 444 317 -- -- Commercial, Financial and Agricultural 13 1,706 811 281 96 Installment and Credit Card 81 284 307 548 890 ------ ------ ------ ------ ------ 312 2,575 1,435 829 986 ------ ------ ------ ------ ------ Recoveries of Loans Previously Charged Off - Real Estate - Construction 34 -- -- -- -- Real Estate - Mortgage 34 -- -- 11 -- Commercial, Financial and Agricultural 156 75 599 458 10 Installment and Credit Card 37 95 96 54 55 ------ ------ ------ ------ ------ 261 170 695 523 65 ------ ------ ------ ------ ------ Net Charge-Offs (Recoveries) 51 2,405 740 306 921 ------ ------ ------ ------ ------ Addition to Allowance Charged to Expense 60 4,180 975 790 420 ------ ------ ------ ------ ------ Balance of Allowance at Period-End $3,834 $3,825 $2,050 $1,815 $1,331 ====== ====== ====== ====== ====== Ratio of Net Charge-Offs to Avg. Loans Outstanding 0.04% 1.79% 0.51% 0.18% 0.55% Ratio of Allowance for Credit Losses to Total Loans 3.12% 2.97% 1.46% 1.15% 0.79% Total deposits decreased $2,273,000 or 1.3% from December 31, 2003 to September 30, 2004. Table 4 below shows a breakdown of deposits by type at both September 30, 2004 and December 31, 2003. 12 Management attributes the decrease in total deposits to the Bank's slightly less competitive interest rates being offered on certificates of deposit. Less competitive interest rates are being offered due to the abundance of liquidity that the Bank currently maintains. TABLE 4: Deposit Balances by Type (Dollars in Thousands) Deposit Type 9/30/2004 12/31/2003 Difference % Non-interest Bearing DDA $ 16,462 $ 15,758 $ 704 4.47% NOW Accounts 25,109 25,017 92 0.37% MMKT Savings 11,917 12,139 (222) -1.83% Savings 32,216 33,093 (877) -2.65% Time Deposits 84,255 86,225 (1,970) -2.28% --------- --------- -------- ------- Total Deposits $ 169,959 $ 172,232 $ (2,273) -1.32% ========= ========= ======== ======= Short-term borrowings, which are repurchase agreements, decreased $416,000 from December 31, 2003 to September 30, 2004. Long-term debt or borrowings with an original maturity of greater than one year from the Federal Home Loan Bank decreased $1,238,000 or 26.7% from December 31, 2003 to September 30, 2004. This decrease is due to a maturing advance, the prepayment of an advance with a prepayment option and regular principal amortization. Due to the excessive amount of liquidity, management chose not to borrow additional funds from FHLB. Total shareholders equity increased $623,000 from December 31, 2003 to September 30, 2004. Included in the overall increase was an increase in retained earnings of $621,000, which was solely comprised of net income and an increase of $2,000 in Accumulated Other Comprehensive Income, which is the unrealized gain/loss on the available-for-sale securities portfolio net of federal income tax. No Treasury Stock was repurchased in the first three quarters of 2004. RESULTS OF OPERATIONS Nine Months Ended September 30, 2004 compared to Nine Months Ended September 30, 2003 Net income for the first three quarters of 2004 was $621,000 or $0.28 per share. This represents an increase of $0.19 per share compared to the first three quarters of 2003. Annualized Return on average assets was 0.40% for the first three quarters of 2004, up from 0.13% for the first three quarters of 2003. Annualized return on average equity increased to 3.61% for the first three quarters of 2004 from 1.11% for the first three quarters of 2003. The most significant income statement changes between the nine months ended September 30, 2004 and the nine months ended September 30, 2003 were as follows: - The provision for loan losses has decreased $2,280,000 in the first three quarters of 2004, from $2,340,000 in the first three quarters of 2003 to $60,000 in the first three quarters of 2004. At year end 2003, management chose to have a complete loan review of the portfolio by an external consultant. At that time, all classified assets were allocated for in the allowance for loan losses charged to 2003 earnings. At September 30, 2004, management believes the allowance for loan losses is sufficient to cover all known losses. As a result, only $60,000 was charged to provision for loan losses in the first three quarters of 2004. - Total noninterest income decreased $454,000 in the first three quarters of 2004 compared to 2003. This decrease is the result of a $343,000 decrease in gain on sale of loans sold to 13 FHLMCand a $174,000 decrease in the capitalization of mortgage service rights, while there was a $21,000 increase in service fee income on FHLMC loans and an $18,000 increase in investment center revenue. As interest rates rise, sales of loans to FHLMC will continue to decrease. - Total noninterest expense increased $982,000 in the first three quarters of 2004 compared to the first three quarters of 2003. This is the result of a $337,000 increase in legal and professional fees which is due to additional expense incurred to address the Written Agreement, the Definitive Agreement with First Defiance, shareholder litigation and related matters. There was also an increase in Salaries and Employee Benefits in the amount of $470,000, which is the result of a $155,000 increase in employee health insurance, an increase of $103,000 in post-retirement benefits, a $95,000 increase in employee salaries and a $98,000 increase in retirement expense. Other expense increased $160,000 due to a $57,000 increase in FDIC assessments, which is a direct result of the Written Agreement, a $64,000 increase in other expense, due to the loss on the sale of other real estate owned in the amount of $70,000, and an $18,000 increase in mortgage service right impairments. - Net interest income decreased $154,000 or 2.8% in the first three quarters of 2004 compared to the first three quarters of 2003. Included in the decrease is a decrease in loan interest and fees which is the direct result of a decrease in loan balances of $9,690,000 since September 30, 2003. The decrease in loan balances is due to the large volume of 1 to 4 family residential loans sold to the secondary market in 2003 and management pricing higher risk commercial and consumer loans above the competition and allowing those loans to leave the institution. Three Months Ended September 30, 2004 compared to Three Months Ended September 30, 2003 There was a net operating loss in the amount of $88,000 for the third quarter of 2004 or $(0.04) per share. This represents a decrease of $0.18 per share compared to the third quarter of 2003. Annualized Return on average assets was (0.17%) for the third quarter of 2004, down from .58% for the third quarter of 2003. Annualized return on average equity decreased to (1.54%) for the third quarter of 2004 from 5.21% for the third quarter of 2003. The most significant income statement changes between the three months ended September 30, 2004 and the three months ended September 30, 2003 were as follows: - The provision for loan losses has decreased $430,000 in the third quarter of 2004. There was no provision recorded in the third quarter of 2004. The lower provision was due in part to the Company's experience in the first three quarters of 2004, which showed net charge-offs of $51,000. Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to the level deemed appropriate by management based on the following factors: historical experience; the volume and type of lending conducted by ComBanc, Inc.; the amount of non-performing assets, including loans which meet the FASB Statement No. 114 definition of impaired; the amount of assets graded by management as substandard, doubtful, or loss; industry standards; general economic conditions, particularly as they relate to ComBanc, Inc's market area; and other factors related to the collectibility of ComBanc, Inc's loan portfolio. As of September 30, 2004, management believes the balance of the allowance for loan losses is appropriate. - Total noninterest income decreased $259,000 in the third quarter of 2004 as compared to the third quarter of 2003. Included in the decrease is a $140,000 decrease in gain on sale of loans to FHLMC. There was also a $121,000 decrease in other income. This decrease is solely comprised of a $121,000 decrease in the capitalization of mortgage service rights. 15, 20, and 30 year interest rates decreased in the third quarter causing prepayment speeds to increase, therefore, causing the value of mortgage service rights to decrease. 14 - Total noninterest expense increased $736,000 in the third quarter of 2004 versus the third quarter of 2003. Included in the increase is an increase of $403,000 in salaries and employee benefits. Of the $403,000 increase, there was an $187,000 increase in group insurance, a $103,000 increase in post-retirement benefits, a $60,000 increase in employee salaries and a $53,000 increase in employee retirement benefits. There was a $221,000 increase in legal and professional fees which is the result of additional expense incurred to address the Written Agreement, the Definitive Agreement with First Defiance, shareholder litigation and related matters. Also included in the$736,000 increase is a $106,000 increase in other expense. Of the $106,000 increase, $60,000 is attributable to an increase in FDIC assessments, as the result of the Written Agreement, and $57,000 is the result of the third quarter 2004 mortgage service right impairment, which is the direct result of the decrease in long-term interest rates. Management believes that the $57,000 impairment will be recaptured by December 31, 2004. REGULATORY CAPITAL The Federal Reserve Board's risk-based capital guidelines addressing the capital adequacy of bank holding companies and banks (collectively, "banking organizations") include a definition of capital and a framework for calculating risk-weighted assets and off-balance sheet items to broad risk categories, as well as minimum ratios to be maintained by banking organizations. A banking organization's risk-based capital ratios are calculated by dividing its qualifying capital by its risk-weighted assets. Under the risk-based capital guidelines, there are two categories of capital: core capital ("Tier 1") and supplemental capital ("Tier 2") collectively referred to as Total Capital. Tier 1 Capital includes common stockholders' equity, qualifying perpetual preferred stock and minority interest in equity accounts of consolidated subsidiaries. Tier 2 capital includes perpetual preferred stock (to the extent ineligible for Tier 1), hybrid capital instruments (i.e., perpetual debt and mandatory convertible securities) and limited amounts of subordinated debt, intermediate-term preferred stock and the allowance for credit losses. The Federal Reserve Board's leverage constraint guidelines establish a minimum ratio of Tier 1 Capital to quarterly average total assets ("Leverage Ratio"). The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") established five capital tiers for banks. Pursuant to that statute the federal bank regulatory agencies have defined the five capital tiers for banks. Under these regulations, a bank is defined to be well capitalized, the highest tier, if it maintains a Tier 1 Capital ratio of at least 6 percent, a Total Capital ratio of at least 10 percent and a Leverage Ratio of at least 5 percent. At September 30, 2004 ComBanc, Inc. maintained a Tier I capital ratio of 18.37%, a total capital ratio of 19.64% and a Tier I leverage ratio of 11.00%. Based on the respective regulatory capital ratios at September 30, 2004, and based on the definitions in the regulations issued by the Federal Reserve Board and the other federal bank regulatory agencies setting forth the general capital requirements mandated by FDICIA, the Bank is well capitalized. LIQUIDITY The liquidity of a banking institution reflects its ability to provide funds to meet loan requests, to accommodate possible outflows in deposits and to take advantage of interest rate market opportunities. Funding of loan requests, providing for liability outflows, and management of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and investments with specific types of deposits and borrowings. Bank liquidity is thus normally considered in terms of the nature and mix of the banking institution's sources and uses of funds. Liquid assets 15 consist of cash and due from banks, federal funds sold, and securities available for sale. At September 30, 2004 the Bank's liquid assets amounted to $75,887,000 or 37.1% of total assets compared with 35.2% at December 31, 2003. Management considers its liquidity to be adequate to meet its normal funding requirements. Item 3 -- Quantitative and Qualitative Disclosures about Market Risk There have been no material changes in the Company's quantitative and qualitative market risks since December 31, 2003. As discussed in the 2003 Annual Report on Form 10-K, ComBanc, Inc's ability to maximize net income is dependent on management's ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of ComBanc, Inc. are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have a significant impact on the net income of the Company. ComBanc, Inc does not use off balance sheet derivatives to enhance its risk management, nor does it engage in trading activities beyond the sale of mortgage loans. ComBanc, Inc. monitors its exposure to interest rate risk on a monthly basis through simulation analysis which measures the impact changes in interest rates can have on net income. The simulation technique analyzes the effect of a presumed 200 basis point shift in interest rates and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, nonmaturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 200 basis points over a 12 month period, using September 2004 amounts as a base case, ComBanc, Inc's net interest income would be impacted by less than the board mandated guidelines of 15%. Item 4 -- Controls and Procedures Under the supervision and with the participation of our management, including the Chief Executive Officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e) and Exchange Act Rule 15d -- 15(e) as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and principal financial officer have concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed in reports the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. There were no changes in our internal control over financial reporting during the period covered by this report that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting. 16 PART II - OTHER INFORMATION Item 1 - Legal Proceedings As described in the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004, on June 2, 2004, Paul D. Harter, a shareholder of ComBanc, Inc., filed an action in the Court of Common Pleas for Allen County, Ohio (the "Court") against the Board of Directors of ComBanc, Inc. (Paul D. Harter V. Board of Directors, ComBanc, Inc. et al. Case No. CV20040531). On May 28, 2004, Mr. Harter submitted written consents of shareholders requesting the Company to call a special shareholders meeting "to determine by shareholder vote whether current members of the Board should be removed and replaced." Mr. Harter filed the action seeking to compel the Company to call a special meeting. On September 1, 2004, ComBanc and Harter entered into a Settlement Agreement and Release which resolved the dispute, and on September 8, 2004, Harter dismissed the lawsuit with prejudice. Additionally, the Bank, at any given time, is involved in a number of lawsuits initiated by the Bank as a plaintiff, intending to collect upon delinquent accounts, to foreclose upon real property, or to seize and sell personal property pledged as security for any such account. At September 30, 2004, the Bank was involved in a number of such cases as a party-plaintiff, and occasionally, as a party-defendant due to its joinder as a lien holder, either by mortgage or by judgment lien. In the ordinary case, the Bank's security and value of its lien is not threatened, except through bankruptcy or loss of value of the collateral should sale result in insufficient proceeds to satisfy the judgment. Item 6 - Exhibits and Reports on Form 8-K (a) Exhibit 11. Statement regarding computation of earnings per share is contained in Part I, Item 2. Exhibits 31.1 and 31.2 Rule 13a-14(a)/15d-14(a) Certifications Exhibits 32.1 and 32.2 Section 1350 Certifications (b) I. A report on Form 8-K, reported under Items 12 and 7, was filed with the SEC on July 16, 2004, which included Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003, Condensed Consolidated Statements of Income For the Three Months Ended June 30, 2004 and June 30, 2003 and Condensed Consolidated Statements of Cash Flows For the Six Months June 30, 2004 and June 30, 2003. II. A second report on Form 8-K, reported under Items 5 and 7, was filed with the SEC on August 5, 2004, which included as exhibits, a News Release dated August 4, 2004 and an Agreement and Plan of Merger dated as of August 4, 2004 by and among First Defiance Financial Corp., First Federal Bank of the Midwest, ComBanc, Inc. and The Commercial Bank. 17 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMBANC, INC. Date: October 27, 2004 /s/ Paul G. Wreede ------------------ Paul G. Wreede President, CEO, and Director Date: October 27, 2004 /s/ Jason R. Thornell --------------------- Jason R. Thornell VP/Controller 18 EXHIBIT INDEX Exhibit No. Description ----------- ----------- a) Exhibit 11. Statement regarding computation of earnings per share is contained in Part I, Item 2. Exhibits 31.1 and 31.2 Rule 13a-14(a)/15d-14(a) Certifications Exhibits 32.1 and 32.2 Section 1350 Certifications