PREMIER FINANCIAL CORP - Quarter Report: 2011 June (Form 10-Q)

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the Quarterly Period Ended June 30, 2011

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

Commission file number 0-26850

First Defiance Financial Corp.

(Exact name of registrant as specified in its charter)


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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

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


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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value – 9,724,471 shares outstanding at August 5, 2011.

FIRST DEFIANCE FINANCIAL CORP.

INDEX


		Page Number
PART I.-FINANCIAL INFORMATION

Item 1.	Consolidated Condensed Financial Statements (Unaudited):

	Consolidated Condensed Statements of Financial Condition - June 30, 2011 and December 31, 2010		2

	Consolidated Condensed Statements of Income - Three and six months ended June 30, 2011 and 2010		4

	Consolidated Condensed Statements of Changes in Stockholders’ Equity - Six months ended June 30, 2011 and 2010		5

	Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2011 and 2010		6

	Notes to Consolidated Condensed Financial Statements		8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		46

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		69

Item 4.	Controls and Procedures		69

PART II-OTHER INFORMATION:

Item 1.	Legal Proceedings		70

Item 1A.	Risk Factors		70

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		70

Item 3.	Defaults upon Senior Securities		70

Item 4.	(Removed and Reserved)		70

Item 5.	Other Information		70

Item 6.	Exhibits		70

	Signatures		72

PART 1-FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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


	June 30, 2011		December 31, 2010
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions	$	28,817	$	24,977
Interest-bearing deposits		185,000		144,187

		213,817		169,164
Securities:
Available-for-sale, carried at fair value		211,702		165,252
Held-to-maturity, carried at amortized cost (fair value $791 and $865 at June 30, 2011 and December 31, 2010, respectively)		770		839

		212,472		166,091
Loans held for sale		12,697		18,127
Loans receivable, net of allowance of $40,530 at June 30, 2011 and $41,080 at December 31, 2010, respectively		1,408,480		1,478,423
Accrued interest receivable		6,208		6,374
Federal Home Loan Bank stock		20,655		21,012
Bank owned life insurance		35,453		34,979
Premises and equipment		40,445		41,743
Real estate and other assets held for sale		7,388		9,591
Goodwill		57,556		57,556
Core deposit and other intangibles		5,464		6,128
Mortgage servicing rights		9,839		9,477
Deferred taxes		4,507		5,805
Other assets		10,709		11,047

Total assets	$	2,045,690	$	2,035,517

(continued)

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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


	June 30, 2011			December 31, 2010
Liabilities and stockholders’ equity
Liabilities:
Deposits	$	1,573,500		$	1,575,419
Advances from the Federal Home Loan Bank		96,863			116,885
Securities sold under repurchase agreements		50,847			56,247
Subordinated debentures		36,083			36,083
Advance payments by borrowers		1,074			937
Other liabilities		18,184			9,615

Total liabilities		1,776,551			1,795,186

Stockholders’ equity:

Preferred stock, $.01 par value per share: 37,000 shares authorized and issued with a liquidation preference of $37,231, net of discount		36,549			36,463
Preferred stock, $.01 par value per share:
4,963,000 shares authorized; no shares issued		—			—
Common stock, $.01 par value per share:
25,000,000 shares authorized; 12,739,496 and 12,739,496 shares issued and 9,724,471 and 8,117,770 shares outstanding, respectively		127			127
Common stock warrant		878			878
Additional paid-in capital		135,547			140,845
Accumulated other comprehensive income (loss), net of tax of $1,096 and $(184), respectively		2,031			(342	)
Retained earnings		141,386			134,988
Treasury stock, at cost, 3,015,025 and 4,621,726 shares respectively		(47,379	)		(72,628	)

Total stockholders’ equity		269,139			240,331

Total liabilities and stockholders’ equity	$	2,045,690		$	2,035,517

See accompanying notes

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Income

(UNAUDITED)

(Amounts in Thousands, except per share data)


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
Interest Income
Loans	$	19,841		$	22,477		$	40,065		$	44,874
Investment securities:
Taxable		1,162			1,078			2,191			2,068
Non-taxable		606			491			1,175			953
Interest-bearing deposits		140			69			241			130
FHLB stock dividends		224			234			459			453

Total interest income		21,973			24,349			44,131			48,478
Interest Expense
Deposits		3,263			5,126			6,857			10,524
FHLB advances and other		768			1,220			1,674			2,438
Subordinated debentures		286			327			612			650
Notes payable		140			115			270			220

Total interest expense		4,457			6,788			9,413			13,832

Net interest income		17,516			17,561			34,718			34,646
Provision for loan losses		2,405			5,440			5,238			12,329

Net interest income after provision for loan losses		15,111			12,121			29,480			22,317
Non-interest Income
Service fees and other charges		2,747			3,397			5,364			6,555
Insurance commission income		1,449			1,309			3,104			2,417
Mortgage banking income		1,906			985			3,194			2,792
Gain on sale of non-mortgage loans		195			50			299			87
Gain on sale or call of securities		—			—			49			6
Other-than-temporary impairment (OTTI) losses on investment securities
Total impairment losses on investment securities		—			(71	)		(13	)		(145	)
Losses recognized in other comprehensive income		—			—			11			4

Net impairment loss recognized in earnings		—			(71	)		(2	)		(141	)
Trust income		174			132			322			254
Income from Bank Owned Life Insurance		237			212			474			423
Gain on life insurance		—			—			—			268
Other non-interest income		130			(223	)		(21	)		(103	)

Total non-interest income		6,838			5,791			12,783			12,558
Non-interest Expense
Compensation and benefits		7,451			6,589			15,285			13,047
Occupancy		1,792			1,701			3,644			3,529
FDIC insurance premium		677			929			1,590			1,975
State franchise tax		542			516			1,084			1,079
Data processing		979			1,174			2,040			2,370
Acquisition related charges		135			37			135			37
Amortization of intangibles		320			345			664			783
Other non-interest expense		3,190			3,754			7,271			7,057

Total non-interest expense		15,086			15,045			31,713			29,877

Income before income taxes		6,863			2,867			10,550			4,998
Federal income taxes		2,113			808			3,140			1,432

Net Income	$	4,750		$	2,059		$	7,410		$	3,566

Dividends accrued on preferred shares	$	(463	)	$	(462	)	$	(925	)	$	(925	)
Accretion on preferred shares	$	(44	)	$	(42	)	$	(86	)	$	(82	)

Net income applicable to common shares	$	4,243		$	1,555		$	6,399		$	2,559

Earnings per common share (Note 7)
Basic	$	0.44		$	0.19		$	0.71		$	0.32
Diluted	$	0.43		$	0.19		$	0.70		$	0.31
Dividends declared per share (Note 6)	$	—		$	—		$	—		$	—
Average common shares outstanding (Note 7)
Basic		9,724			8,118			9,006			8,118
Diluted		9,902			8,193			9,171			8,169

See accompanying notes

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Changes in Stockholders’ Equity

(UNAUDITED)

(Amounts in Thousands)


	Preferred Stock		Common Stock		Common Stock Warrant		Treasury Stock			Additional Paid-In Capital			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Total Stockholders’ Equity
Balance at January 1, 2011	$	36,463	$	127	$	878	$	(72,628	)	$	140,845		$	(342	)	$	134,988		$	240,331
Comprehensive income:
Net income		—		—		—		—			—			—			7,410			7,410
Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $1,280		—		—		—		—			—			2,373			—			2,373

Total comprehensive income																				9,783
Stock options exercised		—		—		—		4			—			—			(1	)		3
Stock option expense		—		—		—		—			76			—			—			76
Capital stock issuance - 1,600,800		—		—		—		25,156			(5,297	)		—			—			19,859
Purchase of treasury stock, restricted share award - 4,738		—		—		—		75			(75	)		—			—			—
Purchase of treasury stock, Directors - 913		—		—		—		14			(2	)		—			—			12
Preferred Stock Dividends		—		—		—		—			—			—			(925	)		(925	)
Accretion on preferred shares		86		—		—		—			—			—			(86	)		—

Balance at June 30, 2011	$	36,549	$	127	$	878	$	(47,379	)	$	135,547		$	2,031		$	141,386		$	269,139


Balance at January 1, 2010	$	36,293	$	127	$	878	$	(72,631	)	$	140,677		$	(158	)	$	128,900		$	234,086
Comprehensive income:
Net income		—		—		—		—			—			—			3,566			3,566
Change in net unrealized gains and losses on available-for-sale securities, net of income taxes of $871		—		—		—		—			—			1,618			—			1,618

Total comprehensive income																				5,184
Stock option expense		—		—		—		—			90			—			—			90
Stock options exercised								3									—			3
Preferred stock dividends		—		—		—		—			—			—			(925	)		(925	)
Accretion on preferred shares		82		—		—		—			—			—			(82	)		—

Balance at June 30, 2010	$	36,375	$	127	$	878	$	(72,628	)	$	140,767		$	1,460		$	131,459		$	238,438

See accompanying notes

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(UNAUDITED)

(Amounts in Thousands)


	Six Months Ended June 30,
	2011			2010
Operating Activities
Net income	$	7,410		$	3,566
Items not requiring (providing) cash
Provision for loan losses		5,238			12,329
Depreciation		1,720			1,722
Amortization of mortgage servicing rights, net of impairment recoveries		309			1,086
Amortization of core deposit and other intangible assets		664			783
Net amortization of premiums and discounts on loans and deposits		502			545
Amortization of premiums and discounts on securities		(111	)		229
Change in deferred taxes		18			(1,077	)
Proceeds from the sale of loans held for sale		99,997			111,243
Originations of loans held for sale		(100,625	)		(115,369	)
Gain from sale of loans		(2,125	)		(2,463	)
OTTI losses on investment securities		2			141
Gain from sale or call of securities		(49	)		(6	)
Loss on sale or write-down of real estate and other assets held for sale		803			1,037
Stock option expense		76			90
Income from bank owned life insurance		(474	)		(423	)
Loss on sale of premises and equipment		—			1
Gain on life insurance		—			(268	)
Changes in:
Accrued interest receivable		166			(122	)
Other assets		567			(1,982	)
Other liabilities		5,844			283

Net cash provided by (used in) operating activities		19,932			11,345

Investing Activities
Proceeds from maturities of held-to-maturity securities		69			84
Proceeds from maturities, calls and pay-downs of available-for-sale securities		19,636			17,473
Proceeds from sale of real estate and other assets held for sale		5,030			7,405
Proceeds from the sale of available-for-sale securities		1,982			28
Proceeds from sale of non-mortgage loans		4,425			6,204
Purchases of available-for-sale securities		(61,532	)		(37,049	)
Proceeds from bank owned life insurance		—			728
Proceeds from sale of office properties and equipment		12			—
Proceeds from Federal Home Loan Bank stock redemption		357			—
Purchases of portfolio mortgage loans		(10,696	)		—
Purchases of premises and equipment, net		(663	)		(505	)
Net cash paid for group benefits line of business		—			(1,500	)
Net decrease in loans receivable		74,341			21,321

Net cash provided by investing activities		32,961			14,190

Financing Activities
Net (decrease) increase in deposits and advance payments by borrowers		(1,767	)		60
Repayment of Federal Home Loan Bank advances		(20,022	)		(20,021	)
Decrease in securities sold under repurchase agreements		(5,400	)		(3,696	)
Net cash received from common stock issuance		19,859			—
Proceeds from exercise of stock options		3			3


Proceeds from treasury stock purchase		12			—
Cash dividends paid on preferred stock		(925	)		(925	)

Net cash provided by (used in) financing activities		(8,240	)		(24,579	)

Increase (decrease) in cash and cash equivalents		44,653			956
Cash and cash equivalents at beginning of period		169,164			121,116

Cash and cash equivalents at end of period	$	213,817		$	122,072


Supplemental cash flow information:
Interest paid	$	9,572		$	13,942

Income taxes paid	$	700		$	2,650

Transfers from loans to real estate and other assets held for sale	$	3,630		$	9,172

Transfers from loans held for sale to loans	$	7,213		$	—

See accompanying notes.

FIRST DEFIANCE FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

(Unaudited)

1. Basis of Presentation

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

First Federal is primarily engaged in attracting deposits from the general public through its offices and using those and other available sources of funds to originate loans primarily in the counties in which its offices are located. First Federal’s traditional banking activities include originating and servicing residential, commercial and consumer loans and providing a broad range of depository, trust and wealth management services. First Insurance is an insurance agency that does business in the Defiance, Archbold, Bryan and Bowling Green, Ohio areas offering property and casualty, and group health and life insurance products.

The consolidated condensed statement of financial condition at December 31, 2010 has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K.

The accompanying consolidated condensed financial statements as of June 30, 2011 and for the three and six month periods ended June 30, 2011 and 2010 have been prepared by First Defiance without audit and do not include information or footnotes necessary for the complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance’s 2010 Annual Report on Form 10-K for the year ended December 31, 2010. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results that may be expected for the entire year.

2. Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Significant areas where First Defiance uses estimates are the valuation of certain investment securities, the determination of the allowance for loan losses, the valuation of mortgage servicing rights and goodwill, the determination of unrecognized income tax benefits, and the determination of post-retirement benefits.

Earnings Per Common Share

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

Newly Issued But Not Yet Effective Accounting Standards

In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring, updated to amend previous guidance with respect to troubled debt restructurings. This updated guidance is designed to assist creditors with determining whether or not a restructuring constitutes a troubled debt restructuring. In particular, additional guidance has been added to help creditors determine whether a concession has been granted and whether a debtor is experiencing financial difficulties. Both of these conditions are required to be met for a restructuring to constitute a troubled debt restructuring. The amendments in the update are effective for the first interim period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. The provisions of this update are not expected to have a material impact on the Company’s financial position, results or operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. The amendments in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The amendments of this update are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU No. 2011-05, Amendments to Topic 220, Comprehensive Income. Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. The amendments of this ASU should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.

Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require any transition disclosures. The provisions of this update are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

3. Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss) (“OCI”). OCI includes unrealized gains and losses on securities available-for-sale and the net unrecognized actuarial losses and unrecognized prior services costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items reported in OCI are reported net of tax. Following is a summary of OCI for the three and six months ended June 30, 2011 and 2010:


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	*(In thousands)*						*(In thousands)*
Net income	$	4,750		$	2,059		$	7,410		$	3,566
Change in securities available-for-sale (AFS):
Unrealized holding gains on securities AFS arising during the period		2,494			1,689			3,700			2,354
Reclassification adjustment for (gains) losses realized in income		—			—			(49	)		(6	)
Other-than-temporary impairment losses on securities AFS realized in income		—			71			2			141


Net unrealized gains		2,494			1,760			3,653			2,489

Income tax effect		(874	)		(615	)		(1,280	)		(871	)

Other comprehensive income		1,620			1,145			2,373			1,618

Comprehensive income	$	6,370		$	3,204		$	9,783		$	5,184

The following table summarizes the changes within each classification of accumulated other comprehensive income for the six months ended June 30, 2011 and 2010:


	Unrealized gains (losses) on available for sale securities		Postretirement Benefit			Accumulated other comprehensive income (loss), net
	*(In thousands)*
Balance at December 31, 2010	$	32	$	(374	)	$	(342	)
Other comprehensive income, net		2,373		—			2,373

Balance at June 30, 2011	$	2,405	$	(374	)	$	2,031


	Unrealized gains (losses) on available for sale securities		Postretirement Benefit			Accumulated other comprehensive income (loss), net
	*(In thousands)*
Balance at December 31, 2009	$	468	$	(626	)	$	(158	)
Other comprehensive income, net		1,618		—			1,618

Balance at June 30, 2010	$	2,086	$	(626	)	$	1,460

4. Fair Value

FASB ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

FASB ASC Topic 820 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on the best information available. In that regard, FASB ASC Topic 820 established a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

•

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

•

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by a correlation or other means.

•

Level 3: Unobservable inputs for determining fair value of assets and liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Available for sale securities - Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service which uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include federal agency preferred stock securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, corporate bonds, U.S. treasury bonds and municipal securities. The Company classifies its pooled trust preferred collateralized debt obligations as Level 3. The portfolio consists of collateralized debt obligations backed by pools of trust preferred securities issued by financial institutions and insurance companies. Based on the lack of observable market data, the Company estimated fair values based on the observable data available and reasonable unobservable market data. The Company estimated fair value based on a discounted cash flow model which used appropriately adjusted discount rates reflecting credit and liquidity risks. The Company used an independent third party which is described further in Note 8.

Impaired loans - The fair value of impaired loans with specific allocations of the allowance for loan loss is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in impaired loans being valued using Level 3 inputs.

Mortgage servicing rights - Mortgage servicing rights are reported at fair value utilizing Level 2 inputs. MSRs are valued by a third party consultant using a proprietary cash flow valuation model.

Mortgage banking derivative - The fair value of mortgage banking derivatives are based on derivative valuation models using market data inputs as of the valuation date (Level 2).

Real estate held for sale - Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell.

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

Assets and Liabilities Measured on a Recurring Basis


June 30, 2011	Level 1 Inputs		Level 2 Inputs			Level 3 Inputs		Total Fair Value
	*(In Thousands)*
Available for sale securities: Obligations of U.S. Government corporations and agencies	$	—	$	14,554		$	—	$	14,554
U.S. treasury bonds		—		2,008			—		2,008
Mortgage-backed – residential		—		59,721			—		59,721
REMICs		—		3,359			—		3,359
Collateralized mortgage obligations		—		61,587			—		61,587
Trust preferred stock		—		—			1,538		1,538
Preferred stock		203		—			—		203
Corporate bonds		—		3,826			—		3,826
Obligations of state and political subdivisions		—		64,906			—		64,906
Mortgage banking derivative – asset		—		429			—		429
Mortgage banking derivative – liability		—		(26	)		—		(26	)

December 31, 2010	Level 1 Inputs		Level 2 Inputs			Level 3 Inputs		Total Fair Value
	*(In Thousands)*
Available for sale securities: Obligations of U.S. Government corporations and agencies	$	—	$	11,985		$	—	$	11,985
Mortgage-backed – residential		—		40,576			—		40,576
REMICs		—		3,541			—		3,541
Collateralized mortgage obligations		—		51,057			—		51,057
Trust preferred stock		—		—			1,498		1,498
Preferred stock		48		—			—		48
Corporate bonds				3,797					3,797
Obligations of state and political subdivisions		—		52,750			—		52,750
Mortgage banking derivative – asset		—		265			—		265

The table below presents a reconciliation and income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2011 and 2010:


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

Ending balance, June 30, 2011	$	1,538


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

Ending balance, June 30, 2011	$	1,538


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands)
Beginning balance, January 1, 2010	$	1,589
Total gains or losses (realized/unrealized)
Included in earnings		(141	)
Included in other comprehensive income (presented gross of taxes)		87
Amortization		6
Sales		(25	)
Transfers in and/or out of Level 3		—

Ending balance, June 30, 2010	$	1,516


	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands)
Beginning balance, April 1, 2010	$	1,579
Total gains or losses (realized/unrealized)
Included in earnings		(71	)
Included in other comprehensive income (presented gross of taxes)		5
Amortization		3
Transfers in and/or out of Level 3		—

Ending balance, June 30, 2010	$	1,516

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

Assets and Liabilities Measured on a Non-Recurring Basis


June 30, 2011	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	*(In Thousands)*
Impaired loans
Residential Loans	$	—	$	—	$	1,713	$	1,713
Commercial Loans						5,381		5,381
Multi Family Loans						79		79
CRE loans						19,739		19,739

Total Impaired loans						26,912		26,912
Mortgage servicing rights		—		9,839		—		9,839
Real estate held for sale
Residential Loans						1,094		1,094
CRE loans						373		373

Total Real Estate held for sale						1,467		1,467

December 31, 2010	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	*(In Thousands)*
Impaired loans
Residential Loans	$		$		$	2,541	$	2,541
Commercial Loans						7,236		7,236
Multi Family Loans						962		962
CRE loans						16,835		16,835

Total Impaired loans						27,574		27,574
Mortgage servicing rights		—		9,477		—		9,477
Real estate held for sale		—		—		3,449		3,449

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $26,912,000, with a valuation allowance of $18,426,000 at June 30, 2011. A provision expense of $3,067,000 for the three months and $5,479,000 for the six months ended June 30, 2011 were included in earnings.

Mortgage servicing rights which are carried at the lower of cost or fair value had a fair value of $9,839,000 at June 30, 2011, resulting in a valuation allowance of $638,000. A recovery of $316,000 for the three months and $487,000 for the six months ended June 30, 2011 were included in earnings.

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

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $27,574,000, with a valuation allowance of $16,595,000 at

December 31, 2010. A provision expense of $17,972,000 for the year ended December 31, 2010 was included in earnings.

Mortgage servicing rights are carried at the lower of cost or fair value had a fair value of $9,477,000 at December 31, 2010, resulting in a valuation allowance of $1,125,000. A recovery of $353,000 was included in the earnings for the year ended December 31, 2010.

Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell. The change in fair value of real estate held for sale was $3,196,000 for the year ended December 31, 2010 and was recorded directly as an adjustment to current earnings through non-interest expense.

In accordance with FASB ASC Topic 825, the table below is a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of June 30, 2011 and December 31, 2010. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

Much of the information used to arrive at “fair value” is highly subjective and judgmental in nature and therefore the results may not be precise. Subjective factors include, among other things, estimated cash flows, risk characteristics and interest rates, all of which are subject to change. With the exception of investment securities, the Company’s financial instruments are not readily marketable and market prices do not exist. Since negotiated prices for the instruments, that are not readily marketable depend greatly on the motivation of the buyer and seller, the amounts that will actually be realized or paid per settlement or maturity of these instruments could be significantly different.

The carrying amount of cash and cash equivalents, term notes payable and advance payments by borrowers for taxes and insurance, as a result of their short-term nature, is considered to be equal to fair value.

Investment securities fair value has been based on current market quotations. If market prices are not available, fair value has been estimated based upon the quoted price of similar instruments or based on observable and unobservable data. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

The fair value of loans which reprice within 90 days is equal to their carrying amount. For other loans, the estimated fair value is calculated based on discounted cash flow analysis, using interest rates currently being offered for loans with similar terms. The allowance for loan losses is considered to be a reasonable adjustment for credit risk.

FASB ASC Topic 825 requires that the fair value of demand, savings, NOW and certain money market accounts be equal to their carrying amount. The Company believes that the fair value of these deposits may be greater or less than that prescribed by FASB ASC Topic 825.

The carrying value of subordinated debentures and deposits with fixed maturities is estimated based on interest rates currently being offered on instruments with similar characteristics and maturities. FHLB advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using

interest rates currently being quoted for similar characteristics and maturities. The cost or value of any call or put options is based on the estimated cost to settle the option at June 30, 2011.


	June 30, 2011				December 31, 2010
	Carrying Value		Estimated Fair Values		Carrying Value		Estimated Fair Values
	*(In Thousands)*
Assets:
Cash and cash equivalents	$	213,817	$	213,817	$	169,164	$	169,164
Investment securities		212,472		212,493		166,091		166,117
Federal Home Loan Bank Stock		20,655		N/A		21,012		N/A
Loans, net, including loans held for sale		1,421,177		1,436,663		1,496,550		1,498,990
Mortgage banking derivative asset		429		429		265		265
Accrued interest receivable		6,208		6,208		6,374		6,374

		1,874,758	$	1,869,610		1,859,456	$	1,840,910

Other assets		170,932				176,061

Total assets	$	2,045,690			$	2,035,517


Liabilities and stockholders’ equity:
Deposits	$	1,573,500	$	1,579,610	$	1,575,419	$	1,582,539
Advances from Federal Home Loan Bank		96,863		101,176		116,885		121,504
Securities sold under repurchase agreements		50,847		50,847		56,247		55,443
Subordinated debentures		36,083		40,311		36,083		32,258
Accrued interest payable		565		565		724		724
Mortgage banking derivative liability		26		26		—		—
Advance payments by borrowers for taxes and insurance		1,074		1,074		937		937

		1,758,958	$	1,773,609		1,786,295	$	1,793,405

Other liabilities		17,593				8,891

Total liabilities		1,776,551				1,795,186
Stockholders’ equity		269,139				240,331

Total liabilities and stockholders’ equity	$	2,045,690			$	2,035,517

5. Stock Compensation Plans

First Defiance has established incentive stock option plans for its directors and employees. On March 15, 2010, the Board adopted, and the shareholders approved at the 2010 Annual Shareholders Meeting, the First Defiance Financial Corp. 2010 Equity Incentive Plan (the “2010 Equity Plan”). The 2010 Equity Plan replaces all existing plans. All awards currently outstanding under the prior plans will remain in effect in accordance with their respective terms. Any new awards will be made under the 2010 Equity Plan. The 2010 Equity Plan allows for issuance of up to 350,000 option or restricted share awards.

As of June 30, 2011, 406,150 options (384,150 for employees and 22,000 for directors) have been granted and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year except for the 2009 grant to the Company’s executive officer’s, which vest 40% in 2011 and then 20% annually, subject to certain other limitations required by the Emergency Economic Stabilization Act of 2008. All options expire ten years from date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

The fair value of each option award is estimated on the date of grant using the Black-Scholes model. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. There were no options granted during the six months ended June 30, 2011 or 2010.

Following is activity under the plans during the six months ended June 30, 2011:

Options
Outstanding

Weighted
Average
Exercise Price

Weighted
Average
Remaining
Contractual
Term (in years)

Aggregate
Intrinsic
Value

Options outstanding, January 1, 2011

415,000

19.17

Forfeited or cancelled

(8,600

)

20.41

Exercised

(250

)

9.22

Granted

—

Options outstanding, June 30, 2011

406,150

19.15

4.31

381,835

Vested or expected to vest at June 30, 2011

406,150

19.15

4.31

381,835

Exercisable at June 30, 2011

320,790

20.33

3.52

176,618

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


	Six Months Ended June 30,
	2011		2010
Cash received from option exercises	$	3,000	$	3,000
Tax benefit realized from option exercises		—		—
Intrinsic value of options exercised		1,000		1,000

As of June 30, 2011, there was $173,000 of total unrecognized compensation costs related to unvested stock options granted under the Company Stock Option Plans. The cost is expected to be recognized over a weighted-average period of 2.2 years.

In March 2011, First Defiance granted restricted stock awards (“RSA”) under the 2010 Equity Plan, which provides for the issuance of shares to directors, officers and employees. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date. The fair value of the stock was determined using the closing price of First Defiance common stock on the date of the grant. The restricted stock shares fully vest on the second anniversary of the grant date.


Unvested Shares	Shares		Weighted-Average Grant Date Fair Value Per Share
Unvested at January 1, 2011		—	$	—
Granted		4,738		14.00
Vested		—		—
Forfeited		—		—

Unvested at June 30, 2011		4,738	$	14.00

As of June 30, 2011, there was $56,000 of total unrecognized compensation cost related to unvested shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of 1.68 years.

As of June 30, 2011, 340,262 options/restricted shares remain available for future grants.

6. Dividends on Common Stock

No common stock dividends were declared by First Defiance in the first or second quarters of 2011 or 2010.

As a result of its participation in the Capital Purchase Program (“CPP”), First Defiance is prohibited without prior approval of the U.S. Treasury, from paying a quarterly cash dividend of more than $0.26 per share until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party. Further, First Defiance has agreed with its primary regulator to obtain approval of cash dividends prior to declaration.

7. Earnings Per Common Share

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


	Three months ended June 30,				Six months ended June 30,
	2011		2010		2011		2010
Numerator for basic and diluted earnings per common share – Net income applicable to common shares	$	4,243	$	1,555	$	6,399	$	2,559
Denominator:
Denominator for basic earnings per common share – weighted average common shares, including participating securities		9,724		8,118		9,006		8,118
Effect of warrants		161		71		151		49
Effect of employee stock options		17		4		14		2


Denominator for diluted earnings per common share share		9,902		8,193		9,171		8,169


Basic earnings per common share	$	0.44	$	0.19	$	0.71	$	0.32


Diluted earnings per common share	$	0.43	$	0.19	$	0.70	$	0.31

There were 262,850 and 343,550 shares under option granted to employees and directors excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and six months ended June 30, 2011. There were 421,230 and 423,551 shares under option granted to employees and directors excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and six months ended June 30, 2010.

8. Investment Securities

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


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
At June 30, 2011
Available-for-Sale Securities:

Obligations of U.S. government corporations and agencies	$	14,565	$	63	$	(74	)	$	14,554
U.S. treasury bonds		2,001		7		—			2,008
Mortgage-backed securities – residential		58,153		1,646		(78	)		59,721
REMICs		3,254		105		—			3,359
Collateralized mortgage obligations		59,894		1,727		(34	)		61,587
Trust preferred securities and preferred stock		3,789		169		(2,217	)		1,741
Corporate bonds		3,806		25		(5	)		3,826
Obligations of state and political subdivisions		62,537		2,504		(135	)		64,906

Totals	$	207,999	$	6,246	$	(2,543	)	$	211,702


Held-to-Maturity Securities*:
FHLMC certificates	$	88	$	6	$	—		$	94
FNMA certificates		235		5		—			240
GNMA certificates		79		3		—			82
Obligations of state and political subdivisions		368		7		—			375

Totals	$	770	$	21	$	—		$	791


At December 31, 2010
Available-for-Sale Securities:

Obligations of U.S. government corporations and agencies	$	11,980	$	80	$	(75	)	$	11,985
Mortgage-backed securities – residential		39,561		1,244		(229	)		40,576
REMICs		3,378		163		—			3,541
Collateralized mortgage obligations		49,862		1,364		(169	)		51,057
Trust preferred securities and preferred stock		3,787		13		(2,254	)		1,546
Corporate bonds		3,782		15		—			3,797
Obligations of state and political subdivisions		52,853		779		(882	)		52,750

Totals	$	165,203	$	3,658	$	(3,609	)	$	165,252

Held-to-Maturity Securities*:
FHLMC certificates	$	95	$	7	$	—		$	102
FNMA certificates		259		6		—			265
GNMA certificates		86		3		—			89
Obligations of state and political subdivisions		399		10		—			409

Totals	$	839	$	26	$	—		$	865

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

The amortized cost and fair value of the investment securities portfolio at June 30, 2011 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because

borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities (“MBS”), collateralized mortgage obligations (“CMO”) and REMICs, which are not due at a single maturity date, have not been allocated over the maturity groupings. These securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

Available-for-Sale

Held-to-Maturity

Amortized
Cost

Fair
Value

Amortized
Cost

Fair
Value

(In Thousands)

Due in one year or less

2,133

2,155

Due after one year through five years

11,530

11,602

Due after five years through ten years

23,172

23,950

248

249

Due after ten years

49,863

49,328

—

MBS/CMO/REMIC

121,301

124,667

402

416

207,999

211,702

770

791

Investment securities with a carrying amount of $129.3 million at June 30, 2011 were pledged as collateral on public deposits, securities sold under repurchase agreements and FHLB advances.

As of June 30, 2011, the Company’s investment portfolio consisted of 358 securities, 35 of which were in an unrealized loss position.

The following table summarizes First Defiance’s securities that were in an unrealized loss position at June 30, 2011:


	Duration of Unrealized Loss Position
	Less than 12 Months					12 Month or Longer					Total
	Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss			Fair Value		Unrealized Losses
	*(In Thousands)*
At June 30, 2011
Available-for-sale securities:
Obligations of U.S. govt. corps. and agencies	$	5,927	$	(74	)	$	—	$	—		$	5,927	$	(74	)
Mortgage-backed -residential		5,609		(78	)		—		—			5,609		(78	)
Collateralized mortgage obligations and REMICs		6,087		(34	)		—		—			6,087		(34	)
Trust preferred stock and preferred stock		—		—			1,538		(2,217	)		1,538		(2,217	)
Corporate bonds		943		(5	)		—		—			943		(5	)
Obligations of state and political subdivisions		5,202		(64	)		1,859		(71	)		7,061		(135	)

Total temporarily impaired securities	$	23,768	$	(255	)	$	3,397	$	(2,288	)	$	27,165	$	(2,543	)

With the exception of Trust Preferred Securities, the above securities all have fixed interest rates, and all securities have defined maturities. Their fair value is sensitive to movements in market interest rates. First Defiance has the ability and intent to hold these investments for a time necessary to recover the amortized cost without impacting its liquidity position and it is not more than likely that the Company will be required to sell the investments before anticipated recovery.

There were no realized gains from the sales of investment securities in the second quarter of 2011 and first quarter of 2010. Realized gains from the sales of investment securities totaled $49,000 ($32,000 after tax) for the first six months of 2011 compared to realized gains of $6,000 ($4,000 after tax) for the first six months of 2010.

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

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

In the second quarter of 2011, management determined there was no OTTI compared to OTTI of $71,000 for the same period in 2010. For the first six months of 2011, the Company recorded OTTI write-downs of $2,200 compared to $141,000 for the same period in 2010.

The Company held nine CDOs at June 30, 2011. Four of those CDOs were written down in full prior to January 1, 2010. The remaining five CDOs have a total amortized cost of $3.8 million at June 30, 2011. Of these, three, with a total amortized cost of $1.8 million, were identified as OTTI in prior periods. The final two CDOs, with a total amortized cost of $2.0 million, continue to pay principal and interest payments in accordance with the contractual terms of the securities and no credit loss impairment has been identified in management’s analysis. Therefore, these two CDO investments have not been deemed by management to be OTTI.

Given the conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, the Company’s CDOs will be classified within Level 3 of the fair

value hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

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

The Company’s CDO valuations were supported by analysis prepared by an independent third party. Their approach to determining fair value involved several steps: 1) detailed credit and structural evaluation of each piece of collateral in the CDO; 2) collateral performance projections for each piece of collateral in the CDO (default, recovery and prepayment/amortization probabilities) and 3) discounted cash flow modeling.

Trust Preferred CDOs Discount Rate Methodology

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

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

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

The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions. For collateral that has already deferred, the Company assumed a recovery of 10% of par for

banks, thrifts or other depository institutions and 15% for insurance companies. Although there is a possibility that the deferring collateral will become current at some point in the future, First Defiance has conservatively assumed that it will continue to defer and gradually will default.

The following table details the seven securities with other-than-temporary impairment, their lowest credit rating at June 30, 2011 and the related credit losses recognized in earnings for the three month period ended March 31, 2011 and June 30, 2011 (In Thousands):


	Preferred Term VI		TPREF Funding II		Alesco VIII		Preferred Term Security XXVII		Trapeza CDO I		Alesco Preferred Funding VIII		Alesco Preferred Funding IX

	Rated Ca		Rated Caa3		Rated Ca		Rated C		Rated Ca		Not Rated		Not Rated		Total
Cumulative OTTI related to credit loss at January 1, 2011	$	80	$	318	$	1,000	$	76	$	857	$	453	$	465	$	3,249

Addition – Qtr 1		—		—		—		2		—		—		—		2

Cumulative OTTI related to credit loss at March 31, 2011	$	80	$	318	$	1,000	$	78	$	857	$	453	$	465	$	3,251


Addition – Qtr 2		—		—		—		—		—		—		—		—

Cumulative OTTI related to credit loss at June 30, 2011	$	80	$	318	$	1,000	$	78	$	857	$	453	$	465	$	3,251

The amount of OTTI recognized in accumulated other comprehensive income (“AOCI”) was $822,000 for the above securities at June 30, 2011. There was $820,000 recognized in AOCI at December 31, 2010.

The following table provides additional information related to the five CDO investments for which a balance remains as of June 30, 2011 (dollars in thousands):


CDO	Class		Amortized Cost		Fair Value		Unrealized Loss			OTTI Losses 2011			Lowest Rating		Current Number of Banks and Insurance Companies		Actual Deferrals and Defaults as a % of Current Collateral			Expected Deferrals and Defaults as a % of Remaining Performing Collateral			Excess Sub-ordination as a % of Current Performing Collateral

Preferred Term VI		Mezz	$	185	$	49	$	(136	)	$	—			Ca		5		64.62	%		—	%		—	%

TPREF Funding II		B		677		293		(384	)		—			Caa3		17		38.81	%		27.17			—

I-Preferred Term Sec I		B-1		1,000		532		(468	)		—			CCC		15		16.80	%		13.18	%		26.41	%

Dekania II CDO		C-1		990		505		(485	)		—			CCC		34		3.73	%		11.79	%		31.27	%

Preferred Term Sec XXVII		C-1		903		159		(744	)		(2	)		C		33		28.14	%		23.73	%		—


Total			$	3,755	$	1,538	$	(2,217	)	$	(2	)

There was no OTTI recorded in the second quarter of 2011. The increase in OTTI in the first quarter of 2011 was the result of deterioration in the performance of the underlying collateral. Specifically, depreciation was driven by both realized credit events (i.e. defaults and deferrals) and weakening credit fundamentals in some of the performing collateral, which led to an increased probability of default going forward. Excluding the Preferred Term VI, the Company’s assumed average lifetime default rate increased slightly to 30.2% at the end of the second quarter 2011 from a rate of 29.9% at the end of the second quarter 2010 but declined slightly from 30.3% at the end of the first quarter 2011.

The table below presents a roll-forward of the credit losses relating to debt securities recognized in earnings for the three and six month periods ended June 30, 2011 and 2010 (in thousands):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2011		2010		2011		2010
Beginning balance	$	476	$	330	$	474	$	2,521
Additions for amounts related to credit loss for which an OTTI was not previously recognized		—		54		—		76
Reductions for amounts realized for securities sold during the period		—		—		—		(2,261	)
Reductions for amounts related to securities for which the Company intends to sell or that it will be more than likely than not that the Company will be required to sell prior to recovery of amortized cost basis		—		—		—		—
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security		—		—		—		—
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized		—		17		2		65


Ending balance	$	476	$	401	$	476	$	401

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011			2010
	*(In thousands)*				*(In thousands)*
Proceeds	$	—	$	—	$	1,982	$28
Gross realized gains		—		—		49	3
Gross realized losses		—		—		—	—

9. Loans

Loans receivable consist of the following (in thousands):


	June 30, 2011			December 31, 2010
Real Estate:
Secured by 1-4 family residential	$	213,034		$	205,938
Secured by multi-family residential		109,794			120,534
Secured by non-residential real estate		625,418			646,478
Construction		23,893			30,340

		972,139			1,003,290
Other Loans:
Commercial		336,598			369,959
Home equity and improvement		127,962			133,593
Consumer Finance		20,384			22,848

		484,944			526,400

Total loans		1,457,083			1,529,690
Deduct:
Undisbursed loan funds		(7,257	)		(9,267	)
Net deferred loan origination fees and costs		(816	)		(920	)
Allowance for loan loss		(40,530	)		(41,080	)

Totals	$	1,408,480		$	1,478,423

Changes in the allowance for loan losses were as follows (in thousands):


	Three Months ended June 30,				Six Months ended June 30,
	2011		2010		2011		2010
Balance at beginning of period	$	40,798	$	38,980	$	41,080	$	36,547
Provision for loan losses		2,405		5,440		5,238		12,329
Charge-offs:
Residential		893		1,135		1,440		1,461
Commercial real estate		1,517		1,243		3,791		4,434
Commercial		107		3,153		442		3,888
Home equity and improvement		310		156		511		555
Consumer finance		20		16		31		41

Total charge-offs		2,847		5,703		6,215		10,379
Recoveries		174		135		427		355

Net charge-offs		2,673		5,568		5,788		10,024

Ending allowance	$	40,530	$	38,852	$	40,530	$	38,852

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

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


Quarter Ended June 30, 2011	1-4 Family Residential Real Estate			Construction			Multi- Family Residential Real Estate			Commercial Real Estate			Commercial			Home Equity and Improvement			Consumer			Total
Allowance for loans individually evaluated
Beginning Specific Allocations	$	1,776		$	—		$	250		$	10,697		$	4,319		$	36		$	—		$	17,078
Charge-Offs		(716	)		—			(364	)		(624	)		—			—			—			(1,704	)
Recoveries		—			—			—			—			—			—			—			—
Provisions		550			—			260			2,121			121			—			—			3,052

Ending Specific Allocations	$	1,610		$	—		$	146		$	12,194		$	4,440		$	36		$	—		$	18,426

Allowance for loans collectively evaluated
Beginning General Allocations	$	4,387		$	70		$	1,933		$	10,510		$	5,199		$	1,414		$	207		$	23,720
Charge-Offs		(177	)		—			—			(529	)		(107	)		(310	)		(20	)		(1,143	)
Recoveries		13			—			—			101			24			21			15			174
Provisions		97			(23	)		(126	)		168			(1,266	)		478			25			(647	)

Ending General Allocations	$	4,320		$	47		$	1,807		$	10,250		$	3,850		$	1,603		$	227		$	22,104

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


Year-to-Date June 30, 2011	1-4 Family Residential Real Estate			Construction			Multi- Family Residential Real Estate			Commercial Real Estate			Commercial			Home Equity and Improvement			Consumer			Total
Allowance for loans individually evaluated
Beginning Specific Allocations	$	1,741		$	13		$	230		$	10,213		$	4,362		$	36		$	—		$	16,595
Charge-Offs		(861	)		—			(364	)		(2,401	)		(206	)		—			—			(3,832	)
Recoveries		—			—			—			—			—			—			—			—
Provisions		730			(13	)		280			4,382			284			—			—			5,663

Ending Specific Allocations	$	1,610		$	—		$	146		$	12,194		$	4,440		$	36		$	—		$	18,426

Allowance for loans collectively evaluated
Beginning General Allocations	$	4,215		$	60		$	1,917		$	9,995		$	6,509		$	1,492		$	297		$	24,485
Charge-Offs		(579	)		—			—			(1,026	)		(236	)		(511	)		(31	)		(2,383	)
Recoveries		18			—			—			312			32			21			44			427
Provisions		666			(13	)		(110	)		969			(2,455	)		601			(83	)		(425	)

Ending General Allocations	$	4,320		$	47		$	1,807		$	10,250		$	3,850		$	1,603		$	227		$	22,104

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of June 30, 2011:

(In Thousands)


	1-4 Family Residential Real Estate		Construction		Multi- Family Residential Real Estate		Commercial Real Estate		Commercial		Home Equity & Improvement		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,610	$	—	$	146	$	11,789	$	4,330	$	36	$	—	$	17,911
Collectively evaluated for impairment		4,320		47		1,807		10,250		3,850		1,603		227		22,104
Acquired with deteriorated credit quality		—		—		—		405		110		—		—		515

Total ending allowance balance	$	5,930	$	47	$	1,953	$	22,444	$	8,290	$	1,639	$	227	$	40,530

Loans:
Loans individually evaluated for impairment	$	6,317	$	—	$	225	$	39,576$		14,012	$	302	$	—	$	60,432
Loans collectively evaluated for impairment		207,114		23,906		109,717		586,567		323,174		128,226		20,429		1,399,133
Loans acquired with deteriorated credit quality		77		—		—		1,353		677		—		—		2,107

Total ending loans balance	$	213,508	$	23,906	$	109,942	$	627,496	$	337,863	$	128,528	$	20,429	$	1,461,672

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2010:

(In Thousands)


	1-4 Family Residential Real Estate		Construction		Multi- Family Residential Real Estate		Commercial Real Estate		Commercial		Home Equity & Improvement		Consumer		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,741	$	13	$	230	$	9,843	$	4,252	$	36	$	—	$	16,115
Collectively evaluated for impairment		4,215		60		1,917		9,995		6,509		1,492		297		24,485
Acquired with deteriorated credit quality		—		—		—		370		110		—		—		480

Total ending allowance balance		$5,956		$73		$2,147		$20,208		$10,871		$1,528		$297		$41,080


Loans:
Loans individually evaluated for impairment	$	8,994	$	64	$	1,333	$	41,290$		17,189	$	317	$	—		$ 69,187
Loans collectively evaluated for impairment		197,296		30,275		119,444		605,882		353,386		133,881		22,942		1,463,106
Loans acquired with deteriorated credit quality		84		—		—		1,388		729		—		—		2,201

Total ending loans balance	$	206,374	$	30,339	$	120,777	$	648,560	$	371,304	$	134,198	$	22,942	$	1,534,494

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


	June 30, 2011		December 31, 2010
	*(in thousands)*
Non-accrual loans	$	34,528	$	41,040
Loans over 90 days past due and still accruing		—		—
Troubled debt restructuring, still accruing		6,242		6,001

Total non-performing loans		40,770	$	47,041
Real estate and other assets held for sale		7,388		9,591

Total non-performing assets	$	48,158	$	56,632

Three Months Ended June 30,

Six Months Ended June 30,

2011

2010

2011

2010

(in thousands)

Average of impaired loans during the period

64,957

62,886

66,951

61,416

Interest income recognized during the period

560

514

1,095

1,050

Cash-basis interest income recognized

528

433

1,019

885

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


	Three Months Ended June 30, 2011						Six Months Ended June 30, 2011
	Average Balance		Interest Income Recognized		Cash Basis Income Recognized		Average Balance		Interest Income Recognized		Cash Basis Income Recognized
Residential Owner Occupied	$	2,550	$	20	$	18	$	2,842	$	40	$	38
Residential Non Owner Occupied		4,093		38		36		4,639		71		74

Total Residential Real Estate		6,643		58		54		7,481		111		112
Construction		30		—		—		41		—		—
Multi-Family		778		11		8		962		23		19
CRE Owner Occupied		10,029		86		90		10,273		201		184
CRE Non Owner Occupied		21,050		262		245		21,142		496		448
Agriculture Land		1,907		11		12		2,174		22		23
Other CRE		8,114		36		24		7,910		49		37

Total Commercial Real Estate		41,100		395		371		41,499		768		692
Commercial Working Capital		4,595		24		23		4,854		47		50
Commercial Other		11,504		68		69		11,804		140		140

Total Commercial		16,099		92		92		16,658		187		190
Consumer		—		—		—		—		—		—
Home Equity and Home Improvement		307		4		3		310		7		7

Total Impaired Loans	$	64,957	$	560	$	528	$	66,951	$	1,096	$	1,020

The Company has no outstanding commitments to lend additional funds to borrowers whose loans have been modified in a troubled debt restructuring.

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2011: (In Thousands)


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With no allowance recorded:
Residential Owner Occupied	$	1,091	$	1,093	$	—
Residential Non Owner Occupied		2,214		2,220		—

Total Residential Real Estate		3,305		3,313		—
Construction		—		—		—
Multi-Family Residential Real Estate		—		—		—
CRE Owner Occupied		2,496		2,504		—
CRE Non Owner Occupied		3,919		3,945		—
Agriculture Land		1,472		1,474		—
Other CRE		960		960		—

Total Commercial Real Estate		8,847		8,883		—
Commercial Working Capital		2,179		2,184		—
Commercial Other		2,669		2,682		—

Total Commercial		4,848		4,866		—
Consumer		—		—		—
Home Equity and Home Improvement		18		19		—

Total loans with no allowance recorded	$	17,018	$	17,081	$	—


With an allowance recorded:
Residential Owner Occupied	$	1,298	$	1,300	$	663
Residential Non Owner Occupied		1,780		1,781		947

Total Residential Real Estate		3,078		3,081		1,610
Construction		—		—		—
Multi-Family Residential Real Estate		225		225		146
CRE Owner Occupied		6,415		6,423		2,124
CRE Non Owner Occupied		17,690		17,774		7,562
Agriculture Land		308		309		163
Other CRE		7,520		7,540		2,345

Total Commercial Real Estate		31,933		32,046		12,194
Commercial Working Capital		2,033		2,034		1,749
Commercial Other		7,788		7,790		2,691

Total Commercial		9,821		9,824		4,440
Consumer		—		—		—
Home Equity and Home Improvement		281		282		36

Total loans with an allowance recorded	$	45,338	$	45,458	$	18,426

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

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010: (In Thousands)


	Unpaid Principal Balance		Recorded Investment		Allowance for Loan Losses Allocated
With no allowance recorded:
Residential Owner Occupied	$	1,679	$	1,685	$	—
Residential Non Owner Occupied		3,300		3,311		—

Total Residential Real Estate		4,979		4,996		—
Construction		—		—		—
Multi-Family Residential Real Estate		137		139		—
CRE Owner Occupied		4,530		4,534		—
CRE Non Owner Occupied		6,909		6,921		—
Agriculture Land		2,394		2,401		—
Other CRE		1,639		1,645		—

Total Commercial Real Estate		15,472		15,501		—
Commercial Working Capital		1,713		1,718		—
Commercial Other		4,435		4,454		—

Total Commercial		6,148		6,172		—
Consumer		—		—		—
Home Equity and Home Improvement		35		35		—

Total loans with no allowance recorded	$	26,771	$	26,843	$	—


With an allowance recorded:
Residential Owner Occupied	$	800	$	803	$	259
Residential Non Owner Occupied		3,185		3,195		1,482

Total Residential Real Estate		3,985		3,998		1,741
Construction		64		64		13
Multi-Family Residential Real Estate		1,193		1,194		230
CRE Owner Occupied		6,436		6,451		2,860
CRE Non Owner Occupied		13,743		13,789		5,554
Agriculture Land		315		316		163
Other CRE		6,554		6,558		1,636

Total Commercial Real Estate		27,048		27,114		10,213
Commercial Working Capital		3,658		3,660		1,763
Commercial Other		7,940		7,968		2,599

Total Commercial		11,598		11,628		4,362
Consumer		—		—		—
Home Equity and Home Improvement		281		282		36

Total loans with an allowance recorded	$	44,169	$	44,280	$	16,595

The following table presents the aging of the recorded investment in past due loans as of June 30, 2011 by class of loans: (In Thousands)


	Current		30-59 days		60-89 days		Non Accrual		TDR		Total Past Due & TDR
Residential Owner Occupied	$	118,418	$	1,439	$	675	$	2,884	$	1,029	$	6,027
Residential Non Owner Occupied		84,348		1,444		29		1,770		1,472		4,715

Total residential real estate		202,766		2,883		704		4,654		2,501		10,742
Construction		23,846		—		—		60		—		60
Multi-Family		109,692		—		—		250		—		250
CRE Owner Occupied		191,946		516		483		7,459		803		9,261
CRE Non Owner Occupied		304,107		579		4,253		4,755		1,804		11,391
Agriculture Land		70,542		243		—		922		160		1,325
Other Commercial Real Estate		30,732		1,676		272		5,736		508		8,192

Total Commercial Real Estate		597,327		3,014		5,008		18,872		3,275		30,169
Commercial Working Capital		134,525		—		121		2,276		—		2,397
Commercial Other		192,655		69		3		8,035		180		8,287

Total Commercial		327,180		69		124		10,311		180		10,684
Consumer		20,247		150		14		18		—		182
Home Equity / Home Improvement		125,462		1,978		415		371		301		3,065

Total Loans	$	1,406,520	$	8,094	$	6,265	$	34,536	$	6,257	$	55,152

The following table presents the aging of the recorded investment in past due loans as of December 31, 2010 by class of loans: (In Thousands)


	Current		30-59 days		60-89 days		Non Accrual		TDR		Total Past Due & TDR
Residential Owner Occupied	$	106,249	$	298	$	1,420	$	1,933	$	1,775	$	5,426
Residential Non Owner Occupied		86,680		842		393		5,295		1,489		8,019

Total residential real estate		192,929		1,140		1,813		7,228		3,264		13,445
Construction		30,275		—		—		64		—		64
Multi-Family		119,606		257		228		686		—		1,171
CRE Owner Occupied		204,590		607		718		5,764		671		7,760
CRE Non Owner Occupied		308,278		247		518		7,519		142		8,426
Agriculture Land		73,650		108		176		1,971		166		2,421
Other Commercial Real Estate		36,378		—		85		5,793		1,179		7,057

Total Commercial Real Estate		622,896		962		1,497		21,047		2,158		25,664
Commercial Working Capital		148,116		—		10		3,287		—		3,297
Commercial Other		209,328		413		1,595		8,264		291		10,563

Total Commercial		357,444		413		1,605		11,551		291		13,860
Consumer		22,642		233		53		14		—		300
Home Equity / Home Improvement		130,281		2,738		335		527		317		3,917

Total Loans	$	1,476,073	$	5,743	$	5,531	$	41,117	$	6,030	$	58,421

Specific reserves in the amount of $2.8 million and $2.3 million have been allocated to customers whose loan terms have been modified in troubled debt restructurings as of June 30, 2011 and December 31, 2010, respectively. First Defiance is not committed to lend additional funds to customers whose loans have been modified.

Credit Quality Indicators

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

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

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

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

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

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of June 30, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (In Thousands)


Category	Pass		Special Mention		Substandard		Doubtful		Not Graded		Total
Residential Owner Occupied	$	7,068	$	960	$	5,404	$	—	$	111,013	$	124,445
Residential Non Owner Occupied		67,847		3,336		11,260		—		6,620		89,063

Total residential real estate		74,915		4,296		16,664		—		117,633		213,508
Construction		17,253		114		340		—		6,199		23,906
Multi Family		105,689		1,581		1,430		86		1,156		109,942
CRE Owner Occupied		170,767		6,020		24,236		—		184		201,207
CRE Non Owner Occupied		268,421		8,582		38,324		—		171		315,498
Agriculture Land		67,683		922		3,262		—		—		71,867
Other CRE		23,783		1,279		12,631		—		1,231		38,924

Total Commercial Real Estate		530,654		16,803		78,453		—		1,586		627,496
Commercial Working Capital		114,423		8,550		13,949		—		—		136,922
Commercial Other		167,643		8,395		24,886		18		—		200,942

Total Commercial		282,066		16,945		38,835		18		—		337,864
Consumer		—		—		81		18		20,330		20,429
Home Equity/Improvement		—		—		1,434		—		127,093		128,527

Total	$	1,010,577	$	39,739	$	137,237	$	122	$	273,997	$	1,461,672

As of December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows: (In Thousands)


Category	Pass		Special Mention		Substandard		Doubtful		Not Graded		Total
Residential Owner Occupied	$	6,462	$	1,055	$	5,302	$	794	$	98,063	$	111,676
Residential Non Owner Occupied		71,339		4,131		12,279		106		6,843		94,698

Total residential real estate		77,801		5,186		17,581		900		104,906		206,374
Construction		22,794		363		64		—		7,118		30,339
Multi Family		111,042		7,089		787		661		1,198		120,777
CRE Owner Occupied		174,468		12,308		25,081		295		198		212,350
CRE Non Owner Occupied		270,243		12,603		33,663		—		195		316,704
Agriculture Land		68,842		2,536		4,693		—		—		76,071
Other CRE		26,685		2,654		12,903		—		1,193		43,435

Total Commercial Real Estate		540,238		30,101		76,340		295		1,586		648,560
Commercial Working Capital		113,962		26,206		11,245		—		—		151,413
Commercial Other		181,506		14,138		24,247		—		—		219,891

Total Commercial		295,468		40,344		35,492		—		—		371,304
Consumer		—		—		60		56		22,826		22,942
Home Equity/Improvement		—		—		852		546		132,800		134,198

Total	$	1,047,343	$	83,083	$	131,176	$	2,458	$	270,434	$	1,534,494

10. Mortgage Banking

Net revenues from the sales and servicing of mortgage loans consisted of the following:


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	*(in thousands)*						*(in thousands)*
Gain from sale of mortgage loans	$	1,100		$	1,212		$	1,826		$	2,376
Mortgage loans servicing revenue (expense):
Mortgage loans servicing revenue		832			754			1,677			1,502
Amortization of mortgage servicing rights		(342	)		(410	)		(796	)		(836	)
Mortgage servicing rights valuation adjustments		316			(571	)		487			(250	)

		806			(227	)		1,368			416

Net revenue from sale and servicing of mortgage loans	$	1,906		$	985		$	3,194		$	2,792

The unpaid principal balance of residential mortgage loans serviced for third parties was $1.3 billion for June 30, 2011 and $1.2 billion for June 30, 2010.

Activity for capitalized mortgage servicing rights and the related valuation allowance follows for the three and six months ended June 30, 2011 and 2010:


	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	*(in thousands)*						*(in thousands)*
Mortgage servicing assets:
Balance at beginning of period	$	10,510		$	10,440		$	10,602		$	10,436
Loans sold, servicing retained		309			418			671			848
Amortization		(342	)		(410	)		(796	)		(836	)

Carrying value before valuation allowance at end of period		10,477			10,448			10,477			10,448
Valuation allowance:
Balance at beginning of period		(954	)		(1,157	)		(1,125	)		(1,478	)
Impairment recovery (charges)		316			(871	)		487			(250	)

Balance at end of period		(638	)		(1,728	)		(638	)		(1,728	)

Net carrying value of MSRs at end of period	$	9,839		$	8,720		$	9,839		$	8,720

Fair value of MSRs at end of period	$	9,839		$	8,720		$	9,839		$	8,720

Amortization of mortgage servicing rights is computed based on payments and payoffs of the related mortgage loans serviced. Estimates of future amortization expense are not easily estimable.

11. Deposits

A summary of deposit balances is as follows (in thousands):


	June 30, 2011		December 31, 2010
Non-interest-bearing checking accounts	$	225,869	$	216,699
Interest-bearing checking and money market accounts		578,867		555,434
Savings accounts		155,021		144,491
Retail certificates of deposit less than $100,000		444,431		465,774
Retail certificates of deposit greater than $100,000		146,655		151,258
Brokered or national certificates of deposit		22,657		41,763

	$	1,573,500	$	1,575,419

12. Borrowings

First Defiance’s debt, Federal Home Loan Bank (“FHLB”) advances and junior subordinated debentures owed to unconsolidated subsidiary trusts are comprised of the following:


	June 30, 2011		December 31, 2010
	*(in thousands)*
FHLB Advances:
Single maturity fixed rate advances	$	35,000	$	35,000
Putable advances		44,000		54,000
Strike-rate advances		17,000		27,000
Amortizable mortgage advances		863		885

Total	$	96,863	$	116,885


Junior subordinated debentures owed to unconsolidated subsidiary trusts	$	36,083	$	36,083

The putable advances can be put back to the Company at the option of the FHLB on a quarterly basis. $14.0 million of the putable advances with a weighted average rate of 2.69% are not yet callable by the FHLB. The call dates for these advances range from July 14, 2011 to September 12, 2011 and the maturity dates range from February 11, 2013 to March 12, 2018. The FHLB has the option to call the remaining $30.0 million of putable advances with a weighted average rate of 4.76%. The maturity dates of these advances range from October 28, 2013 to January 14, 2015. The strike-rate advances are putable at the option of the FHLB only when the three month LIBOR rates exceed the agreed upon strike-rate in the advance contract which ranges from 7.5% to 8.0%. The three month LIBOR rate at June 30, 2011 was 0.25%. The weighted average rate of the strike-rate advances is 3.61% and the maturity dates range from October 15, 2012 to February 25, 2013.

In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (Trust Affiliate II) that issued $15 million of Guaranteed Capital Trust Securities (Trust Preferred

Securities). In connection with this transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) to Trust Affiliate II. The Company formed Trust Affiliate II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a fixed rate equal to 6.441% for the first five years and a floating interest rate based on three-month LIBOR plus 1.50% points, repricing quarterly, thereafter.

The Company also sponsored an affiliated trust, First Defiance Statutory Trust I (Trust Affiliate I), that issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Junior Debentures held by Trust Affiliate I are the sole assets of the trust. The Company is not considered the primary beneficiary of this Trust (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.38%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate I was 1.63% and 1.67% on June 30, 2011 and December 31, 2010 respectively.

The Trust Preferred Securities issued by Trust Affiliates I and II are subject to mandatory redemption, in whole or part, upon repayment of the Subordinated Debentures. The Company has entered into agreements that fully and unconditionally guarantee the Trust Preferred Securities subject to the terms of the guarantees. The Trust Preferred Securities and Subordinated Debentures issued by Trust Affiliate I mature on December 15, 2035 but may be redeemed by the issuer at par after October 28, 2010. The Trust Preferred Securities issued by Trust Affiliate II mature on June 15, 2037, but may be redeemed at the Company’s option at any time on or after June 15, 2012, or at any time upon certain events.

Interest on both issues of trust preferred securities may be deferred for a period of up to five years at the option of the issuer.

13. Commitments, Guarantees and Contingent Liabilities

Loan commitments are made to accommodate the financial needs of First Federal’s customers; however, there are no long-term, fixed-rate loan commitments that result in market risk. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. They primarily are issued to facilitate customers’ trade transactions.

Both arrangements have credit risk, essentially the same as that involved in extending loans to customers, and are subject to the Company’s normal credit policies. Collateral (e.g., securities, receivables, inventory and equipment) is obtained based on Management’s credit assessment of the customer.

The Company’s maximum obligation to extend credit for loan commitments (unfunded loans and unused lines of credit) and standby letters of credit outstanding as of the periods stated below were as follows (in thousands):


	June 30, 2011				December 31, 2010
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
Commitments to make loans	$	35,414	$	55,767	$	26,382	$	48,801
Unused lines of credit		29,890		198,432		34,735		193,092
Standby letters of credit		0		21,882		0		21,533

Total	$	65,304	$	276,081	$	61,117	$	263,426

Commitments to make loans are generally made for periods of 60 days or less.

In addition to the above commitments, First Defiance had commitments to sell $20.1 million and $34.7 million of loans to Freddie Mac, Fannie Mae, Federal Home Loan Bank of Cincinnati or BB&T Mortgage at June 30, 2011 and December 31, 2010, respectively.

14. Income Taxes

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for years before 2007. The Company currently operates primarily in the states of Ohio and Michigan, which tax financial institutions based on their equity rather than their income.

15. Derivative Financial Instruments

Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors are considered derivatives. It is the Company’s practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. These mortgage banking derivatives are not designated in hedge relationships. First Federal had approximately $11.9 million and $24.9 million of interest rate lock commitments at June 30, 2011 and December 31, 2010, respectively. There were $20.1 million and $34.7 million of forward commitments for the future delivery of residential mortgage loans at June 30, 2011 and December 31, 2010, respectively.

The fair value of these mortgage banking derivatives are reflected by a derivative asset. The table below provides data about the carrying values of these derivative instruments:

June 30, 2011

December 31, 2010

Assets

(Liabilities)

Assets

(Liabilities)

Carrying
Value

Derivative
Net Carrying
Value

Carrying
Value

Derivative
Net Carrying
Value

(In Thousands)

Derivatives not designated as hedging instruments

Mortgage Banking Derivatives

429

403

265

—

265

The table below provides data about the amount of gains and losses recognized in income on derivative instruments not designated as hedging instruments:

Three Months Ended June 30,

Six Months Ended June 30,

2011

2010

2011

2010

(In Thousands)

Derivatives not designated as hedging instruments

Mortgage Banking Derivatives – Gain (Loss)

210

104

The above amounts are included in mortgage banking income with gain on sale of mortgage loans. During the first quarter of 2011, management determined that a group of loans, previously classified as held for sale, were no longer sellable and were transferred back into the portfolio. As a result, a $90,000 loss related to a fair value adjustment on those loans was recorded in the first quarter of 2011.

16. Common Stock Offering

During the first quarter of 2011, the Company completed its previously announced underwritten public common stock offering by issuing 1,600,800 shares of the Company’s common stock, including 208,800 shares issued pursuant to the exercise of the underwriter’s over-allotment option, at a price of $13.25 per share for gross proceeds of $21.2 million. The net proceeds to the Company after deducting underwriting discounts and commissions and offering expenses were $19.9 million.

17. Subsequent Event

On July 1, 2011, the Company acquired the business of Payak-Dubbs Insurance Agency, Inc., an independent property and casualty insurance agency with two office locations based in Maumee, Ohio and Oregon, Ohio for a cash price of $4.8 million. Disclosure of pro forma results of this acquisition is not material to the Company’s consolidated financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General - First Defiance is a unitary thrift holding company that conducts business through its two wholly owned subsidiaries, First Federal and First Insurance. First Federal is a federally chartered savings bank that provides financial services through 33 full service banking centers in communities based in northwest Ohio, northeast Indiana, and southeastern Michigan. First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust services. First Insurance sells a variety of property and casualty, group health and life, and individual health and life insurance products and investment and annuity products. Insurance products are sold through First Insurance’s offices in Defiance, Archbold, Bryan and Bowling Green, Ohio while investment and annuity products are sold through registered investment representatives located at certain First Federal banking center locations.

Business Strategy - First Defiance’s primary objective is to be a high performing community banking organization, well regarded in its market areas. First Defiance accomplishes this through emphasis on local decision making and empowering its employees with tools and knowledge to serve its customers’ needs. First Defiance believes in a “Customer First” philosophy that is strengthened by its Trusted Advisor initiative. First Defiance also has a tagline of “Bank with the people you know and trust” as an indication of its commitment to local, responsive, personalized service. First Defiance believes this strategy results in greater customer loyalty and profitability through core relationships. First Defiance is focused on diversification of revenue sources and increased market penetration in areas where the growth potential exists for a balance between acquisition and organic growth. The primary segments of First Defiance’s business strategy are commercial banking, consumer banking, including the origination and sale of single family residential loans, enhancement of fee income, wealth management and insurance sales, each united by a strong customer service culture throughout the organization. In 2011, management intends to continue to focus on asset quality, core deposit growth, expense control as well as other opportunities to further service our customers.

Commercial and Commercial Real Estate Lending - Commercial and commercial real estate lending have been an ongoing focus and a major component of First Federal’s success. First Federal provides primarily commercial real estate and commercial business loans with an emphasis on owner occupied commercial real estate and commercial business lending with a focus on the deposit balances that accompany these relationships. First Federal’s client base tends to be small to middle market customers with annual gross revenues generally between $1 million and $50 million. First Federal’s focus is also on securing multiple guarantors in addition to collateral where possible. These customers require First Federal to have a high degree of knowledge and understanding of their business in order to provide them with solutions to their financial needs. First Federal’s Customer First philosophy and culture complements this need of its clients. First Federal believes this personal service model differentiates First Federal from its competitors, particularly the larger regional institutions. First Federal offers a wide variety of products to support commercial clients including remote deposit capture and other cash management services. First Federal also believes that the small business customer is a strong market for First Federal. First Federal participates in many of the Small Business Administration

lending programs. Maintaining a diversified portfolio with an emphasis on monitoring industry concentrations and reacting to changes in the credit characteristics of industries is an ongoing focus.

Consumer Banking - First Federal offers customers a full range of deposit and investment products including demand, NOW, money market, certificates of deposit, CDARS and savings accounts. First Federal offers a full range of investment products through the wealth management department and a wide variety of consumer loan products, including residential mortgage loans, home equity loans, installment loans and education loans. First Federal also offers online banking services, which include online bill pay along with debit cards.

Fee Income Development - Generation of fee income and the diversification of revenue sources are accomplished through the mortgage banking operation, insurance subsidiary and the wealth management department as First Defiance seeks to reduce reliance on retail transaction fee income.

Deposit Growth - First Federal’s focus has been to grow core deposits with an emphasis on total relationship banking with both our retail and commercial customers. First Federal has initiated a pricing strategy that considers the whole relationship of the customer. First Federal will continue to focus on increasing its market share in the communities it serves by providing quality products with extraordinary customer service, business development strategies and branch expansion. First Federal will look to grow its footprint in areas believed to further complement its overall market share and complement its strategy of being a high performing community bank.

Asset Quality - Maintaining a strong credit culture is of the utmost importance to First Federal. First Federal has maintained a strong credit approval and review process that has allowed the Company to maintain a credit quality standard that balances the return with the risks of industry concentrations and loan types. First Federal is primarily a collateral lender with an emphasis on cash flow performance, while obtaining additional support from personal guarantees and secondary sources of repayment. First Federal has focused its attention on loan types and markets that it knows well and in which it has historically been successful. First Federal strives to have loan relationships that are well diversified in both size and industry, and monitor the overall trends in the portfolio to maintain its industry and loan type concentration targets. First Federal maintains a problem loan remediation process that focuses on detection and resolution. First Federal maintains a strong process of internal control that subjects the loan portfolio to periodic internal reviews as well as independent third party loan review.

Expansion Opportunities - First Defiance believes it is well positioned to take advantage of acquisitions or other business opportunities in its market areas, including FDIC-assisted transactions. First Defiance believes it has a track record of successfully accomplishing both acquisitions and de novo branching in its market area. This track record puts the Company in a solid position to enter or expand its business. First Defiance has successfully integrated acquired banking institutions in the past with the most recent acquisition completed in 2008. First Defiance will continue to be disciplined as well as opportunistic in its approach to future acquisitions and de novo branching with a focus on its primary geographic market area, which it knows well and has been competing in for a long period of time.

Investments - First Defiance invests in U.S. Treasury and federal government agency obligations, obligations of municipal and other political subdivisions, mortgage-backed securities which are issued by federal agencies, corporate bonds, and collateralized mortgage obligations (“CMOs”) and real estate mortgage investment conduits (“REMICs”). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB ASC Topic 320.

Securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the security to maturity. Held-to-maturity securities are stated at amortized cost and had a recorded value of $770,000 at June 30, 2011. Securities not classified as held-to-maturity are classified as available-for-sale, which are stated at fair value and had a recorded value of $211.7 million at June 30, 2011. The available-for-sale portfolio consists of obligations of U.S. Government corporations and agencies ($14.6 million), U.S. treasury bonds ($2.0 million), certain municipal obligations ($64.9 million), CMOs and REMICs ($65.0 million), corporate bonds ($3.8 million), mortgage backed securities ($59.7 million) and trust preferred and preferred stock ($1.7 million).

In accordance with ASC Topic 320, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income.

Lending - In order to properly assess the collateral dependent loans included in its loan portfolio, the Company has established policies regarding the monitoring of the collateral underlying such loans. The Company requires an appraisal that is less than one year old for all new collateral dependent real estate loans, and all renewed collateral dependent real estate loans where new money is extended. The appraisal process is handled by the Credit Department, which selects the appraiser and orders the appraisal. First Defiance’s loan policy prohibits the account officer from talking or communicating with the appraiser to insure that the appraiser is not influenced by the account officer in any way in making their determination of value.

First Federal generally does not require updated appraisals for performing loans unless new money is requested by the borrower.

When a collateral dependent loan is downgraded to classified status, First Federal reviews the most current appraisal on file and if necessary, based on First Federal’s assessment of the appraisal, such as age, market, etc., First Federal will discount this amount to a more appropriate current value based on inputs from lenders and realtors. This amount may then be discounted further by First Federal’s estimation of the carrying and selling costs. Finally, First Federal assesses whether there is any collateral short fall, considering guarantor support, and determines if a reserve is necessary.

When a collateral dependent loan moves to non-performing status, First Federal generally gets a new third party appraisal and adjusts the reserve as necessary based upon the new appraisal and an estimate of costs to liquidate the collateral. All properties that are moved into the Other Real

Estate Owned (“OREO”) category are supported by current appraisals, and the OREO is carried at the appraised value less First Federal’s estimate of the liquidation costs.

First Federal does not adjust any appraisals upward without written documentation of this valuation change from the appraiser. When setting reserves on classified loans, appraisal values may be discounted downward based upon First Federal’s experience with liquidating similar properties.

All loans over 90 days past due and or on non-accrual as well as all troubled debt restructured loans are classified as non-performing loans. Non-performing status automatically occurs in the month in which the 90 day delinquency occurs. For Troubled Debt Restructured loans, the loans are put into non-performing status in the month in which the restructure occurs.

As stated above, once a collateral dependent loan is identified as non-performing, First Federal generally gets an appraisal. Troubled debt restructured collateral dependent loans receive an appraisal as part of the restructure credit decision.

Appraisals are received within approximately 60 days after they are requested. The First Federal Loan Loss Reserve Committee reviews each new appraisal and makes any necessary adjustment to the reserve at its meeting prior to the end of each quarter.

Any partially charged-off collateral dependent loans are considered non-performing, and as such, would need to show an extended period of time with satisfactory payment performance as well as cash flow coverage capability supported by current financial statements before First Federal will consider an upgrade to performing status. If the loan maintains a rate at restructuring that is lower than the market rate for similar credits, the loan will remain classified as a troubled debt restructuring until such time as it is paid off or restructured at prevailing rates and terms. First Federal may consider moving the loan to an accruing status after six months of satisfactory payment performance.

For loans where First Federal determines that an updated appraisal is not necessary, other means are used to verify the value of the real estate, such as recent sales of similar properties on which First Federal had loans as well as calls to appraisers, brokers, realtors, and investors. First Federal monitors and tracks its reserves quarterly to determine accuracy. Based on these results, changes may occur in specific reserves assigned. The recent analysis indicates that First Federal is within its target range of the ultimate losses on liquidated loans being on average within 10% of the specific reserves established for these loans.

Loan modifications constitute a troubled debt restructuring if First Federal, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. For loans that are considered troubled debt restructurings, First Federal either computes the present value of expected future cash flows discounted at the original loan’s effective interest rate or, as a practical expedient, it may measure impairment based on the observable market price of the loan or the fair value of the collateral even though troubled debt restructurings are not expected to be deemed collateral dependent. The difference between the carrying value and fair value of the loan is recorded as a valuation allowance.

Earnings - The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, FHLB advances, and other borrowings. The Company’s non-interest income is mainly derived from service fees and other charges, mortgage banking income, and insurance commissions. First Defiance’s earnings also depend on the provision for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense.

Common Stock Offering

Participation in the U.S. Treasury Capital Purchase Program

On December 5, 2008, as part of the CPP, the Company entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “Purchase Agreement”) with the U.S. Treasury, pursuant to which the Company sold $37.0 million shares of newly authorized Fixed Rate Cumulative Perpetual Preferred Stock, par value $0.01 per share and liquidation value $1,000 per share (“Senior Preferred Shares”) and also issued warrants (the “Warrants”) to the U.S. Treasury to acquire an additional 550,595 of common shares having an exercise price of $10.08 per share. The Warrants have a term of 10 years.

The Senior Preferred Shares qualify as Tier 1 capital and will pay cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Senior Preferred Shares may be redeemed by the Company after three years. The Senior Preferred Shares are not subject to any contractual restrictions on transfer, except that the U.S. Treasury or any its transferees may not affect any transfer that, as a result of such transfer, would require the Company to become subject to the periodic reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934.

Pursuant to the terms of the Purchase Agreement, the ability of the Company to declare or pay dividends or distributions on, or purchase, redeem or otherwise acquire for consideration, its common shares will be subject to restrictions, including a restriction against increasing dividends from the last quarterly cash dividend per share of $0.26 declared on the common stock prior to October 14, 2008. The redemption, purchase or other acquisition of trust preferred securities of the Company or its affiliates also will be restricted. These restrictions will terminate on the earlier of (a) the third anniversary of the date of issuance of the Senior Preferred Shares and (b) the date on which the Senior Preferred Shares have been redeemed in whole or the U.S. Treasury has transferred all of the Senior Preferred Shares to third parties, except that, after the third anniversary of the date of issuance of the Senior Preferred Shares, if the Senior Preferred Shares

remain outstanding at such time, the Company may not increase its common dividends per share without obtaining consent of the U.S. Treasury.

The Purchase Agreement also subjects the Company to certain of the executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 (the “EESA”). As a condition to the closing of the transaction, the Company’s Senior Executive Officers (as defined in the Purchase Agreement) (the “Senior Executive Officers”), (i) voluntarily waived any claim against the U.S. Treasury or the Company for any changes to such officer’s compensation or benefits that are required to comply with the regulation issued by the U.S. Treasury under the CPP and acknowledged that the regulation may require modification of the compensation, bonus, incentive and other benefit plans, arrangements and policies and agreements as they relate to the period the U.S. Treasury owns the Senior Preferred Shares of the Company; and (ii) entered into a letter agreement with the Company amending the Benefit Plans with respect to such Senior Executive Officers as may be necessary, during the period that the U.S. Treasury owns the Senior Preferred Shares, as necessary to comply with Section 111(b) of the EESA.

The Company intends to redeem the Senior Preferred Shares and the Warrants as soon as it is prudent to do so. However, there are three factors the Company will continue to consider when evaluating redemption: (a) evidence of a sustained economic recovery, (b) the Company’s sustained profitable performance with growth in earnings, and (c) additional clarity of any new regulatory capital thresholds. The Company anticipates that it will redeem the Senior Preferred Shares and the Warrants within five years from the date of issuance, December 5, 2013, utilizing existing funds at that time.

Forward-Looking Information

Certain statements contained in this quarterly report are not historical facts, including but not limited to statements that can be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “anticipate”, or “continue” or the negative thereof or other variations thereon or comparable terminology are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21B of the Securities Act of 1934, as amended. Actual results could differ materially from those indicated in such statements due to risks, uncertainties and changes with respect to a variety of market and other factors.

Changes in Financial Condition

At June 30, 2011, First Defiance’s total assets, deposits and stockholders’ equity amounted to $2.05 billion, $1.57 billion and $269.1 million, respectively, compared to $2.04 billion, $1.58 billion and $240.3 million, respectively, at December 31, 2010.

Net loans receivable (excluding loans held for sale) declined $69.9 million to $1.41 billion from $1.48 billion at December 31, 2010. The variances in loans receivable between June 30, 2011 and December 31, 2010 include decreases in commercial real estate loans (down $31.8 million), commercial loans (down $33.4 million), home equity and improvement loans (down $5.6 million), construction loans (down $6.4 million), consumer loans (down $2.5 million) while one to four family residential real estate increased $7.1 million. Included in net loans receivable are $10.7 million of one to four family residential real estate loans purchased in the first quarter of 2011. Also

included in net loans receivable are $7.2 million of mortgage loans transferred from loans held for sale in the first quarter of 2011. These loans were identified by management as having rates too low to sell into the secondary market.

The investment securities portfolio increased $46.4 million to $212.5 million at June 30, 2011 from $166.1 million at December 31, 2010. The increase is the result of $61.5 million of securities being purchased during the first six months of 2011, offset by $8.2 million of securities maturing or being called in the period, principal pay downs of $11.5 million in CMOs and mortgage-backed securities, and $1.9 million of securities being sold. There was an unrealized gain in the investment portfolio of $3.7 million at June 30, 2011 compared to an unrealized gain of $49,000 at December 31, 2010.

Deposits decreased from $1.58 billion at December 31, 2010 to $1.57 billion as of June 30, 2011. Of the $1.9 million decrease, retail time deposits decreased $25.9 million to $591.1 million and broker/national certificates of deposit decreased $19.1 million to $22.7 million. These decreases were mostly offset by increases in interest-bearing demand deposits and money market accounts of $23.4 million to $578.9 million, savings accounts of $10.5 million to $155.0 million and non-interest-bearing demand deposits of $9.2 million to $225.9 million.

FHLB advances decreased $20.0 million to $96.9 million at June 30, 2011 from $116.9 million at December 31, 2010. The decrease is the result of paying off a $10.0 million putable advance and a $10.0 million strike-rate advance, both at maturity, in the first quarter of 2011.

Stockholders’ equity increased from $240.3 million at December 31, 2010 to $269.1 million at June 30, 2011. First Defiance completed an underwritten public common stock offering in the first quarter of 2011 by issuing 1,600,800 shares of the Company’s common stock. As a result of the common stock offering, total equity increased a net $19.9 million. The other increases resulted from net income of $7.4 million and a $2.4 million unrealized gain on available-for-sale securities partially offset by $925,000 of accrued dividends on preferred stock.

Average Balances, Net Interest Income and Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in thousands of dollars and rates, and the net interest margin. The table reports interest income from tax-exempt loans and investment on a tax-equivalent basis. All average balances are based upon daily balances (dollars in thousands).


	Three Months Ended June 30,
	2011							2010
	Average Balance		Interest(1)		Yield/ Rate(2)			Average Balance		Interest(1)		Yield/ Rate(2)
Interest-earning assets:
Loans receivable	$	1,431,792	$	19,874		5.57	%	$	1,551,396	$	22,514		5.82	%
Securities		195,790		2,099		4.36			156,263		1,838		4.78
Interest-earning deposits		210,050		140		0.27			116,271		69		0.24
FHLB stock and other		21,004		224		4.28			21,376		234		4.39

Total interest-earning assets		1,858,636		22,337		4.83			1,845,306		24,655		5.36
Non-interest-earning assets		206,464							215,619

Total assets	$	2,065,100						$	2,060,925


Interest-bearing liabilities:
Deposits	$	1,363,700	$	3,263		0.96	%	$	1,404,202	$	5,126		1.46	%
FHLB advances		96,934		768		3.18			126,910		1,220		3.86
Notes payable		56,796		140		0.99			47,986		115		0.96
Subordinated debentures		36,230		286		3.17			36,228		327		3.62

Total interest-bearing liabilities		1,553,660		4,457		1.15			1,615,326		6,788		1.69
Non-interest bearing deposits		228,086		—					193,618		—

Total including non-interest bearing demand deposits		1,781,746		4,457		1.00			1,808,944		6,788		1.51
Other non-interest-bearing liabilities		16,810							14,905

Total liabilities		1,798,556							1,823,849
Stockholders’ equity		266,544							237,076

Total liabilities and stock-holders’ equity	$	2,065,100						$	2,060,925

Net interest income; interest rate spread			$	17,880		3.68	%			$	17,867		3.67	%

Net interest margin (3)						3.86	%						3.89	%

Average interest-earning assets to average interest-bearing liabilities						120	%						114	%

(1)

Interest on certain tax-exempt loans and securities is not taxable for federal income tax purposes. In order to compare the tax-exempt yields on these assets to taxable yields, the interest earned on these assets is adjusted to a pre-tax equivalent amount based on the marginal corporate federal income tax rate of 35%.

(2)	Annualized

(3)	Net interest margin is net interest income divided by average interest-earning assets.


	Six Months Ended June 30,
	2011							2010
	Average Balance		Interest(1)		Yield/ Rate(2)			Average Balance		Interest(1)		Yield/ Rate(2)
Interest-earning assets:
Loans receivable	$	1,444,764	$	40,131		5.62	%	$	1,555,901	$	44,950		5.83	%
Securities		183,439		4,007		4.46			148,955		3,549		4.86
Interest-earning deposits		194,564		241		0.25			112,355		130		0.23
FHLB stock and other		21,008		459		4.42			21,376		453		4.27

Total interest-earning assets		1,843,775		44,838		4.92			1,838,587		49,082		5.38
Non-interest-earning assets		210,969							216,129

Total assets	$	2,054,744						$	2,054,716


Interest-bearing liabilities:
Deposits	$	1,366,853	$	6,857		1.01	%	$	1,398,073	$	10,524		1.52	%
FHLB advances		102,342		1,674		3.31			134,334		2,438		3.66
Notes payable		55,438		270		0.98			46,133		220		0.96
Subordinated debentures		36,230		612		3.42			36,229		650		3.62

Total interest-bearing liabilities		1,560,863		9,413		1.22			1,614,768		13,832		1.72
Non-interest bearing deposits		224,348		—					188,906		—

Total including non-interest bearing demand deposits		1,785,211		9,413		1.07			1,803,674		13,832		1.55
Other non-interest-bearing liabilities		15,498							14,759

Total liabilities		1,800,709							1,818,433
Stockholders’ equity		254,035							236,283

Total liabilities and stock-holders’ equity	$	2,054,744						$	2,054,716

Net interest income; interest rate spread			$	35,425		3.70	%			$	35,250		3.66	%

Net interest margin (3)						3.89	%						3.87	%

Average interest-earning assets to average interest-bearing liabilities						118	%						114	%

(1)

(2)	Annualized

(3)	Net interest margin is net interest income divided by average interest-earning assets.

Results of Operations

Three Months Ended June 30, 2011 and 2010

On a consolidated basis, First Defiance’s net income for the quarter ended June 30, 2011 was $4.8 million compared to net income of $2.1 million for the comparable period in 2010. Net income applicable to common shares was $4.2 million for the second quarter of 2011 compared to $1.6 million for the comparable period in 2010. On a per share basis, basic and diluted earnings per common share for the three months ended June 30, 2011 were $0.44 and $0.43, respectively, compared to basic and diluted earnings per common share of $0.19 for the quarter ended June 30, 2010.

Net Interest Income.

First Defiance’s net interest income is determined by its interest rate spread (i.e. the difference between the yields on its interest-earning assets and the rates paid on its interest-bearing liabilities) and the relative amounts of interest-earning assets and interest-bearing liabilities.

As demand for new lending opportunities has remained soft through the second quarter of 2011, the Company invested some of its liquidity in investment securities.

Net interest income was $17.5 million for the quarter ended June 30, 2011 compared to $17.6 million for the same period in 2010. The tax-equivalent net interest margin was 3.86% for the quarter ended June 30, 2011 compared to 3.89% for the same period in 2010. The decrease in margin between the 2010 and 2011 second quarters is mainly due to the cost of interest-bearing liabilities and non-interest bearing demand deposits decreasing by 51 basis points, to 1.00% for the quarter ended June 30, 2011, from 1.51% for the same period in 2010. This was offset by a decline in the yield on interest earning assets of 53 basis points, to 4.83% for the quarter ended June 30, 2011, from 5.36% for the same period in 2010.

Total interest income decreased by $2.3 million or 9.8% to $22.0 million for the quarter ended June 30, 2011 from $24.3 million for the same period in 2010. The decrease in interest income was due to a decline in asset yields, mainly as a result of a drop in yields on loans receivable which declined 25 basis points to 5.57% at June 30, 2011. Interest income from loans decreased to $19.8 million for the quarter ended June 30, 2011 compared to $22.5 million for the same period in 2010 which represents a decline of 11.7%.

Interest expense decreased by $2.3 million in the second quarter of 2011 compared to the same period in 2010, to $4.5 million from $6.8 million. This decrease was due to a 54 basis point decline in the average cost of interest-bearing liabilities in the second quarter of 2011. Interest expense related to interest-bearing deposits was $3.3 million in the second quarter of 2011 compared to $5.1 million for the same period in 2010. Expenses on FHLB advances and other borrowings were $768,000 and $140,000 respectively in the second quarter of 2011 compared to $1.2 million and $115,000 respectively for the same period in 2010. Interest expense recognized by the Company related to subordinated debentures was $286,000 in the second quarter of 2011 compared to $327,000 for the same period in 2010.

Provision for Loan Losses.

The allowance for loan losses represents management’s assessment of the estimated probable credit losses in the loan portfolio at each balance sheet date. Management analyzes the adequacy of the allowance for loan losses regularly through reviews of the loan portfolio. Consideration is given to economic conditions, changes in interest rates and the effect of such changes on collateral values and borrower’s ability to pay, changes in the composition of the loan portfolio and trends in past due and non-performing loan balances. The allowance for loan losses is a material estimate that is susceptible to significant fluctuation and is established through a provision for loan losses based on management’s evaluation of the inherent risk in the loan portfolio. In addition to extensive in-house loan monitoring procedures, the Company utilizes an outside party to conduct an independent loan review of all commercial loan and commercial real estate loan relationships that exceed $750,000 of aggregate exposure over a twelve month period. Management utilizes the results of this outside loan review to assess the effectiveness of its internal loan grading system as well as to assist in the assessment of the overall adequacy of the allowance for loan losses associated with these types of loans.

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio in the normal course of business. The allowance for loan loss is made up of two basic components. The first component is the specific allowance in which the Company sets aside reserves based on the analysis of individual credits. The second component is the general reserve. The general reserve is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolios based on quantitative and qualitative factors. Due to the uncertainty of risks in the loan portfolio, the Company’s judgment on the amount of the allowance necessary to absorb loans losses is approximate. See Note 9 - Loans for the allocation of the specific and general components of the allowance by signification loan types.

In establishing specific reserves, First Federal analyzes all loans on its classified and special mention lists at least quarterly and makes judgments about the risk of loss based on the cash flow of the borrower, the value of any collateral and the financial strength of any guarantor in determining the amount of impairment of individual loans and the specific reserve to be recorded.

For the purpose of the general reserve analysis, the loan portfolio is stratified into nine different loan pools based on loan type and by market area to allocate historic loss experience. The loss experience factor applied to the non-impaired loan portfolio was based upon historical losses of the most recent rolling eight quarters ending June 30, 2011.

The stratification of the loan portfolio resulted in a quantitative general allowance of $12.4 million at June 30, 2011 compared to $14.0 million at December 31, 2010. The decrease in the quantitative general allowance was the result of certain aging charge-offs rolling off managements analysis decreasing the commercial historical loss factors coupled with the decline in commercial loans.

In addition to the quantitative analysis, a qualitative analysis is performed each quarter to provide additional general reserves on the non-impaired loan portfolio for various factors that have a bearing on its loss content, including but not limited to the following:

•

Changes in international, national and local economic and business conditions and developments, including the condition of various market segments

•

Changes in the nature and volume of the loan portfolio

•

Changes in the trends of the volume and severity of past due and classified loans; and changes in trends in the volume of non-accrual loans, troubled debt restructurings and other loan modifications

•

The existence and effect of any concentrations of credit and changes in the level of such concentrations

•

Changes in the value of underlying collateral for collateral dependent loans

•

Changes in the political and regulatory environment

•

Changes in lending policies and procedures, including underwriting standards and collection, charge-off and recovery practices

•

Changes in the experience, ability and depth of lending management and staff

•

Changes in the quality and breadth of the loan review process

The qualitative analysis at June 30, 2011 indicated a general reserve of $9.7 million compared with $10.5 million at December 31, 2010. Management believes that the overall economy and operating environment has stabilized in our markets but still stress that high unemployment and declining real estate values in the Midwest remain a concern. All 14 counties that represent the footprint of the Company have seen improvements in their unemployment rates from December 31, 2010, with six being below the national average of 9.3% at June 30, 2011. May 2011 was the latest census information available for Ohio and Michigan.

As a result of the quantitative and qualitative analyses, along with the change in specific reserves, the Company’s provision for loan losses for the second quarter of 2011 was $2.4 million, compared to $5.4 million for the same period in 2010. The allowance for loan losses was $40.5 million and $41.1 million and represented 2.80% and 2.70% of loans, net of undisbursed loan funds and deferred fees and costs, as of June 30, 2011 and December 31, 2010, respectively. The provision of $2.4 million was offset by charge offs of $1.7 million against specific reserves and $1.1 million against general reserves and recoveries of $174,000 resulting in a slight decrease to the overall allowance for loan loss at June 30, 2011. In management’s opinion, the overall allowance for loan losses of $40.5 million as of June 30, 2011 is adequate.

Management also assesses the value of real estate owned as of the end of each accounting period and recognizes write-downs to the value of that real estate in the income statement if conditions dictate. In the second quarter of 2011, First Defiance recorded OREO write-downs that totaled $259,000 compared to write-downs of $607,000 for the same period in 2010. These write-downs are primarily due to decreasing the liquidation values in order to spur interest in our market areas

to sell these properties. These amounts are included in other non-interest expense. Management believes that the values recorded at June 30, 2011 for real estate owned and repossessed assets represent the realizable value of such assets.

Total classified loans increased to $137.4 million at June 30, 2011, compared to $133.1 million at December 31, 2010. At June 30, 2011, a total of $49.2 million of loans are classified as substandard for which a specific reserve is required. A total of $88.1 million in additional credits were classified as substandard at June 30, 2011 for which no reserve is required because of factors such as the level of collateral or the strength of guarantors. First Defiance also has classified $122,000 of loans doubtful at June 30, 2011. By contrast, at December 31, 2010, a total of $47.5 million of loans were classified as substandard for which a specific reserve is required. A total of $83.2 million in additional credits were classified as substandard at December 31, 2010 for which no reserve is required because of factors such as the level of collateral or the strength of guarantors. First Defiance also had classified $2.4 million of loans doubtful at December 31, 2010.

First Defiance’s ratio of allowance for loan losses to non-performing loans was 99.4% at June 30, 2011 compared with 87.3% at December 31, 2010. Management monitors collateral values of all loans included on the watch list that are collateral dependent and believes that allowances for those loans at June 30, 2011 are appropriate.

At June 30, 2011, First Defiance had total non-performing assets of $48.2 million, compared to $56.6 million at December 31, 2010. Non-performing assets include loans that are 90 days past due, troubled debt restructured loans and real estate owned and other assets held for sale. Non-performing assets at June 30, 2011 and December 31, 2010 by category were as follows:

Table 1 – Nonperforming Assets


	June 30, 2011			December 31, 2010
	*(In thousands)*
Non-performing loans:
Single-family residential	$	4,368		$	7,161
Construction		60			64
Non-residential and multi-family residential real estate		19,404			21,737
Commercial		10,307			11,547
Consumer finance		18			14
Home equity and improvement		371			517
Troubled debt restructured loans, accruing		6,242			6,001

Total non-performing loans		40,770			47,041
Real estate owned and repossessed assets		7,388			9,591

Total non-performing assets	$	48,158		$	56,632

Allowance for loan losses as a percentage of total loans*		2.80	%		2.70	%
Allowance for loan losses as a percentage of non-performing assets		84.16	%		72.54	%
Allowance for loan losses as a percentage of non-performing loans		99.41	%		87.33	%
Total non-performing assets as a percentage of total assets		2.35	%		2.78	%
Total non-performing loans as a percentage of total loans*		2.81	%		3.10	%

*	Total loans are net of undisbursed loan funds and deferred fees and costs.

The decrease in non-performing loans between December 31, 2010 and June 30, 2011 is primarily in single-family residential, non-residential and multi-family residential real estate, and commercial loans. The combined balance of these types of non-performing loans was $6.4 million lower at June 30, 2011 compared to December 31, 2010.

Non-performing loans in the single-family residential, non-residential and multi-family and commercial loan categories represent 2.05%, 2.64% and 3.06% of the total loans in those categories respectively at June 30, 2011 compared to 3.48%, 2.83% and 3.12% respectively for the same categories at December 31, 2010. With the level of non-performing loans decreasing, quarter over quarter, management believes that the current allowance for loan losses is appropriate and that the provision for loan losses recorded in the second quarter of 2011 is consistent with both charge-off experience and the risk inherent in the overall credits in the portfolio.

First Federal’s Asset Review Committee meets monthly to review the status of work-out strategies for all criticized relationships, which include all non-accrual loans. Based on such factors as anticipated collateral values in liquidation scenarios, cash flow projections, assessment of net worth of guarantors and all other factors which may mitigate risk of loss, the Asset Review Committee makes recommendations regarding required allowances and proposed charge-offs which are approved by the Senior Loan Committee (in the case of charge-offs) or the Loan Loss Reserve Committee (in the case of specific allowances).

The following table details net charge-offs and nonaccrual loans by loan type. For the three months ended and as of June 30, 2011, commercial real estate, which represented 50.46% of total loans, accounted for 52.97% of net charge-offs and 56.20% of nonaccrual loans, and commercial loans, which represented 23.10% of total loans, accounted for 3.11% of net charge-offs and 29.85% of nonaccrual loans. For the three months ended and as of June 30, 2010, commercial real estate, which represented 49.85% of total loans, accounted for 22.33% of net charge-offs and 56.32% of nonaccrual loans, and commercial loans, which represented 22.97% of total loans, accounted for 55.99% of net charge-offs and 21.69% of nonaccrual loans.

Table 2 – Net Charge-offs and Non-accruals by Loan Type


	For the Three Months Ended June 30, 2011						As of June 30, 2011
	Net Charge-offs			% of Total Net Charge-offs			Nonaccrual Loans		% of Total Non- Accrual Loans
		*(in thousands)*						*(in thousands)*
Residential	$	880			32.92	%	$	4,368		12.65	%

Construction		—			0.00	%		60		0.17	%
Commercial real estate		1,416			52.97	%		19,404		56.20	%
Commercial		83			3.11	%		10,307		29.85	%
Consumer		5			0.19	%		18		0.05	%
Home equity and improvement		289			10.81	%		371		1.08	%

Total	$	2,673			100.00	%	$	34,528		100.00	%


	For the Three Months Ended June 30, 2010						As of June 30, 2010
	Net Charge-offs			% of Total Net Charge-offs			Nonaccrual Loans		% of Total Non- Accrual Loans
		*(in thousands)*						*(in thousands)*
Residential	$	1,101			19.78	%	$	6,457		20.30	%

Construction		—			0.00	%		254		0.80	%
Commercial real estate		1,243			22.33	%		17,912		56.32	%
Commercial		3,118			55.99	%		6,898		21.69	%
Consumer		(12	)		(0.22	%)		17		0.05	%
Home equity and improvement		118			2.12	%		266		0.84	%

Total	$	5,568			100.00	%	$	31,804		100.00	%

Table 3 – Allowance for Loan Loss Activity


	For the Quarter Ended
	2nd 2011		1st 2011		4th 2010		3rd 2010		2nd 2010
	*(Dollars in Thousands)*
Allowance at beginning of period	$	40,798	$	41,080	$	41,343	$	38,852	$	38,980
Provision for credit losses		2,405		2,833		5,652		5,196		5,440
Charge-offs:
Residential		893		547		467		1,164		1,135
Commercial real estate		1,517		2,273		4,806		688		1,243
Commercial		107		335		388		842		3,153
Consumer finance		20		12		55		28		16
Home equity and improvement		310		201		363		148		156

Total charge-offs		2,847		3,368		6,079		2,870		5,703
Recoveries		174		253		164		165		135

Net charge-offs		2,673		3,115		5,915		2,705		5,568

Ending allowance	$	40,530	$	40,798	$	41,080	$	41,343	$	38,852

The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at the dates indicated.

Table 4 – Allowance for Loan Loss Allocation by Loan Category


	June 30, 2011					March 31, 2010					December 31, 2010					September 30, 2010					June 30, 2010
	Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category
Residential	$	5,930		14.62	%	$	6,163		14.76	%	$	5,956		13.46	%	$	6,161		13.69	%	$	6,585		13.72	%
Construction		47		1.64	%		70		1.65	%		73		1.98	%		189		2.03	%		214		2.73	%
Commercial real estate		24,397		50.46	%		23,390		50.42	%		22,355		50.14	%		22,294		49.82	%		19,939		49.86	%
Commercial		8,290		23.10	%		9,518		23.06	%		10,871		24.19	%		10,679		23.89	%		10,381		22.97	%
Consumer		227		1.40	%		207		1.41	%		297		1.49	%		527		1.74	%		494		1.83	%
Home equity and improvement		1,639		8.78	%		1,450		8.70	%		1,528		8.74	%		1,493		8.83	%		1,239		8.89	%

	$	40,530		100.00	%	$	40,798		100.00	%	$	41,080		100.00	%	$	41,343		100.00	%	$	38,852		100.00	%

Key Asset Quality Ratio Trends

Table 5 – Key Asset Quality Ratio Trends


	2nd Qtr 2011			1st Qtr 2011			4th Qtr 2010			3rd Qtr 2010			2nd Qtr 2010
Allowance for loan losses / loans*		2.80	%		2.77	%		2.70	%		2.67	%		2.47	%
Allowance for loan losses to net charge-offs		1,526.30	%		1,309.73	%		694.51	%		1,528.39	%		697.77	%
Allowance for loan losses / non-performing assets		84.16	%		74.56	%		72.54	%		72.17	%		72.68	%
Allowance for loan losses / non-performing loans		99.41	%		89.53	%		87.33	%		89.56	%		95.41	%
Non-performing assets / loans plus REO*		3.31	%		3.70	%		3.70	%		3.67	%		3.37	%
Non-performing assets / total assets		2.35	%		2.65	%		2.78	%		2.81	%		2.62	%
Net charge-offs / average loans (annualized)		0.75	%		0.85	%		1.58	%		0.70	%		1.44	%

*	Total loans are net of undisbursed funds and deferred fees and costs.

Non-Interest Income.

Total non-interest income increased $1.0 million in the second quarter of 2011 to $6.8 million from $5.8 million for the same period in 2010.

Service Fees. Service fees and other charges decreased by $650,000 or 19.1% in the 2011 second quarter compared to the same period in 2010. The decrease can be attributed to regulation changes which resulted in lower NSF fee income.

First Federal’s overdraft privilege program generally provides for the automatic payment of modest overdraft limits on all accounts deemed to be in good standing when the account is accessed using paper-based check processing, a teller withdrawal, a point-of-sale terminal, an ACH transaction, or an ATM. To be in good standing, an account must be brought to a positive balance within a 30-day period. Overdraft limits are established for all customers without discrimination using a risk assessment approach for each account classification. The approach includes a systematic review and evaluation of the normal deposit flows made to each account classification to establish reasonable and prudent negative balance limits that would be routinely repaid by normal, expected and reoccurring deposits. The risk assessment by portfolio approach assumes a minimal degree of undetermined credit risk associated with unidentified individual

accounts that are overdrawn for 30 or more days. Accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence and the fee charged for an item that is paid is equal to the fee charged for a non-sufficient fund item that is returned.

Overdrawn balances, net of allowance for losses, are reflected as loans on First Defiance’s balance sheet. The fees charged for this service are established based both on the return of processing costs plus a profit, and on the level of fees charged by competitors in the Company’s market area for similar services. These fees are considered to be compensation for providing a service to the customer and therefore deemed to be noninterest income rather than interest income. Fee income recorded for the quarters ending June 30, 2011 and 2010 related to the overdraft privilege product, net of adjustments to the allowance for uncollectible overdrafts, were $1.5 million and $2.0 million, respectively. Accounts charged off are included in noninterest expense. The allowance for uncollectible overdrafts was $123,000 at June 30, 2011, $83,000 at December 31, 2010 and $78,000 at June 30, 2010.

Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans increased $921,000 to $1.9 million for the second quarter of 2011 compared to $985,000 for the same period of 2010. Gains realized from the sale of mortgage loans declined in the second quarter of 2011 to $1.1 million from $1.2 million in the second quarter of 2010. Mortgage loan servicing revenue increased $78,000 in the second quarter of 2011 compared to the second quarter of 2010. The increase in servicing revenue was coupled with expense decreases of $68,000 for the amortization of mortgage servicing rights in the second quarter of 2011. The Company recorded a positive change in the valuation adjustment of $316,000 on mortgage servicing rights in the second quarter of 2011 compared to a negative change in the valuation adjustment of $571,000 in the second quarter of 2010. The positive MSR valuation adjustment is a reflection of the increase in the fair value of certain sectors of the Company’s portfolio of MSR’s. The interest rate environment that gives rise to decreased mortgage origination activity also typically causes decreases in MSR amortization and impairment, creating a natural hedge in the mortgage banking line of business.

Insurance and Investment Sales Commissions. Income from the sale of insurance and investment products increased $140,000 in the second quarter of 2011 to $1.4 million from $1.3 million in the same period of 2010. In May 2010, First Insurance acquired a group medical benefits business line from Andres O’Neil & Lowe Insurance Agency. This acquired group medical benefits business line added approximately $218,000 in revenue in the second quarter of 2011 compared to approximately $79,000 in the same period of 2010.

Loss on Sale or Write-Down of Securities. Non-interest income also includes investment securities gains or losses. In the second quarter of 2011, First Defiance did not recognize any other-than-temporary impairment (“OTTI”) charges. In the second quarter of 2010, First Defiance recognized OTTI charges of $71,000 for certain impaired investment securities, where in management’s opinion, the value of the investment will not be fully recovered. The OTTI charge related to two Trust Preferred Collateralized Debt Obligation (“CDO”) investments with a remaining book value of $1.6 million.

Other non-interest income. Other non-interest income increased $353,000 in the second quarter of 2011 from a loss of $223,000 in the same period in 2010. This increase was the result of recording

net gains of $38,000 from the sale of real estate owned properties in the second quarter of 2011, compared to net losses of $207,000 for the same period in 2010.

Non-Interest Expense.

Non-interest expense increased to $15.1 million for the second quarter of 2011 compared to $15.0 million for the same period in 2010.

Compensation and Benefits. Compensation and benefits increased to $7.5 million for the quarter ended June 30, 2011 from $6.6 million for the same period in 2010. The increase is mainly attributable to the Company freezing pay in 2010, coupled with no bonuses being paid in the second quarter of 2010 because certain targets were not met. The Company increased compensation late in the first quarter of 2011 and accrued for bonus payments based on 2011 performance.

FDIC Insurance Premiums. FDIC expense decreased to $677,000 in the second quarter of 2011, from $929,000 in the same period of 2010 due to changes made by the FDIC in the method of calculating assessment rates under the Dodd-Frank Act.

Other Non-Interest Expenses. Other non-interest expenses decreased to $3.2 million for the quarter ended June 30, 2011 from $3.8 million for the same period in 2010. The majority of the decrease between the 2011 and 2010 second quarters was the decline of credit, collection and real estate owned expenses of $189,000.

The efficiency ratio, considering tax equivalent interest income and excluding securities gains and losses, for the second quarter of 2011 was 61.03% compared to 63.40% for the second quarter of 2010.

Income Taxes.

First Defiance computes federal income tax expense in accordance with ASC Topic 740, Subtopic 942, which resulted in an effective tax rate of 30.80% for the quarter ended June 30, 2011 compared to 28.18% for the same period in 2010. The tax rate is lower than the statutory 35% tax rate for the Company mainly because of investments in tax-exempt securities. The earnings on tax-exempt securities are not subject to federal income tax.

Six Months Ended June 30, 2011 and 2010

On a consolidated basis, First Defiance’s net income for the six months ended June 30, 2011 of $7.4 million compared to income of $3.6 million for the comparable period in 2010. Net income applicable to common shares was $6.4 million for the six months ended June 30, 2011 compared to $2.6 million for the comparable period in 2010. On a per share basis, basic and diluted earnings per common share for the six months ended June 30, 2011 were $0.71 and $0.70, respectively, compared to basic and diluted earnings per common share of $0.32 and $0.31, respectively, for the six months ended June 30, 2010.

Net Interest Income.

Net interest income was $34.7 million for the six months ended June 30, 2011 compared to $34.6 million for the same period in 2010. For the six month period ended June 30, 2011, total interest

income was $44.1 million, a $4.3 million decrease from the same period in 2010. Despite average earning assets increasing $5.2 million in the first six months of 2011, the average yield declined 46 basis points as a result of a lower rate environment.

Interest expense decreased by $4.4 million to $9.4 million for the six months ended June 30, 2011 compared to $13.8 million in the first half of 2010. The average balance of interest-bearing deposits decreased by $31.2 million between the first halves of 2010 and 2011, resulting in a decline in the average cost of interest-bearing deposits for the six months ending June 30, 2011, to 1.01%, a 51 basis point decrease from the 1.52% average cost in the first half of 2010. This decline is the result of the continued low rate environment which has given management opportunities to re-price on the liability side.

Provision for Loan Losses.

The provision for loan losses was $5.2 million for the six months ended June 30, 2011, compared to $12.3 million during the six months ended June 30, 2010. The year over year decrease was primarily the result of the stabilization of net charge-offs, as well as improvements in overall credit. Charge-offs for the first half of 2011 were $6.2 million and recoveries of previously charged off loans totaled $427,000 for net charge-offs of $5.8 million. By comparison, $10.4 million of charge-offs were recorded in the same period of 2010 and $355,000 of recoveries were realized for net charge-offs of $10.0 million.

Non-Interest Income.

Total non-interest income increased to $12.8 million for the six months ended June 30, 2011 from $12.6 million recognized in the same period of 2010.

Service Fees. Service fees and other charges decreased by $1.2 million or 18.2% in the six months ended June 30, 2011 compared to the same period in 2010. The decrease can be attributed to regulation changes which resulted in lower NSF fee income.

Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans increased 14.4% to $3.2 million for the six months ended June 30, 2011 from $2.8 million for the same period of 2010. Gains realized from the sale of mortgage loans decreased $550,000 to $1.8 million for the first half of 2011 from $2.4 million during the same period of 2010. Mortgage loan servicing revenue increased $175,000 in the first half of 2011 compared to the same period of 2010. The decrease in gains were partially offset by expense decreases of $40,000 for the amortization of mortgage servicing rights in the first half of 2011 when compared to 2010. The Company recorded a positive valuation adjustment of $487,000 in the first half of 2011 compared to a negative adjustment of $250,000 in the first half of 2010.

Insurance and Investment Sales Commission. Insurance and investment sales commission income increased $687,000, to $3.1 million for the six months ended June 30, 2011, from $2.4 million during the same period of 2010. This is the result of receiving more contingent commission income in the first half of 2011 compared to the first half of 2010. In 2011, $329,000 was received compared to $104,000 in 2010. In May 2010, First Insurance acquired a group medical benefits business line from Andres O’Neil & Lowe Insurance Agency. This

acquired group medical benefits business line added approximately $426,000 in revenue in the first six months of 2011 compared to approximately $79,000 in the same period of 2010.

Loss on Securities. Non-interest income was increased in the first half of 2011 by $47,000 as First Defiance recognized $2,000 of other-than-temporary impairment charges for certain impaired investment securities offset by the gain on sale of $49,000 from available for sale securities. In the first half of 2010, $141,000 of OTTI charges were recorded on impaired investments partially offset by $6,000 in gains recorded from the sale of available for sale securities.

Non-Interest Expense.

Non-interest expense increased to $31.7 million for the first six months of 2011 compared to $29.9 million for the same period in 2010.

Compensation and Benefits. Compensation and benefits increased to $15.3 million for the first six months ended June 30, 2011 from $13.0 million for the same period in 2010. The increase is mainly attributable to the Company freezing pay in 2010, coupled with no bonuses being paid in the first six months of 2010 because certain targets were not met. The Company increased compensation late in the first quarter of 2011, paid bonuses for the first quarter of 2011 and accrued for bonus payments based on 2011 second quarter performance.

FDIC Insurance Premiums. FDIC expense decreased to $1.6 million in the first six months of 2011, from $2.0 million in the same period of 2010 due to the changes made by the FDIC in the method of calculating assessment rates under the Dodd-Frank Act.

Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles and other) decreased by $230,000 to $11.1 million for the first six months of 2011 from $11.3 million for the same period in 2010. The significant decrease between the first six months of 2011 and 2010 of expenses are related to data processing expenses that decreased $330,000 for the first six months of 2011 compared to the same period of 2010 resulting from the efficiencies gained from the new core system that was converted late in the fourth quarter of 2010.

The efficiency ratio for the first half of 2011 was 65.85% compared to 62.32% for the same period of 2009.

Liquidity

As a regulated financial institution, First Federal is required to maintain appropriate levels of “liquid” assets to meet short-term funding requirements.

First Defiance had $22.7 million of cash provided by operating activities during the first six months of 2011. The Company’s cash used in operating activities resulted from the origination of loans held for sale mostly offset by the proceeds on the sale of loans.

At June 30, 2011, First Defiance had $91.2 million in outstanding loan commitments and loans in process to be funded generally within the next six months and an additional $250.2 million committed under existing consumer and commercial lines of credit and standby letters of credit.

Also at that date, First Defiance had commitments to sell $20.1 million of loans held-for-sale. First Defiance believes that it has adequate resources to fund commitments as they arise and that it can adjust the rate on savings certificates to retain deposits in changing interest rate environments. If First Defiance requires funds beyond its internal funding capabilities, advances from the FHLB of Cincinnati and other financial institutions are available.

Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has established a Liquidity Policy that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements. This policy designates our Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO reviews liquidity on a monthly basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by the Company’s Chief Financial Officer and Controller.

ALCO uses an economic value of equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of First Federal’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The likelihood of a decrease in rates as of June 30, 2011 was considered to be remote given the current interest rate environment and therefore, was not included in this analysis. The results of this analysis are reflected in the following tables for the six months ended June 30, 2011 and the year-ended December 31, 2010.


June 30, 2011 Economic Value of Equity
Change in Rates	$ Amount		$ Change			% Change
	*(Dollars in Thousands)*
+400 bp		283,982		(16,411	)		(5.46	%)
+ 300 bp		288,269		(12,124	)		(4.04	%)
+ 200 bp		293,319		(7,074	)		(2.35	%)
+ 100 bp		297,775		(2,618	)		(0.87	%)
0 bp		300,393		—			—


December 31, 2010 Economic Value of Equity
Change in Rates	$ Amount		$ Change			% Change
	*(Dollars in Thousands)*
+400 bp		264,330		(13,549	)		(4.88	%)
+ 300 bp		269,417		(8,462	)		(3.05	%)
+ 200 bp		272,867		(5,012	)		(1.80	%)
+ 100 bp		276,234		(1645	)		(0.590	%)
0 bp		277,879		—			—

Capital Resources

Capital is managed at the bank and on a consolidated basis. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, liquidity and operational risks inherent in our business, as well as flexibility needed for future growth and new business opportunities.

Capital Purchase Plan Capital

During 2008, we received $37 million of equity capital by issuing 37,000 shares of Preferred Stock to the U.S. Department of Treasury, and a ten-year warrant to purchase up to 555,000 shares of our common stock, par value $0.01 per share, at an exercise price of $10.08 per share. The proceeds received were allocated to the preferred stock and additional paid-in-capital.

We intend to repay our CPP capital as soon as it is prudent to do so. However, there are three factors we will continue to consider as we evaluate repayment: (a) evidence of a sustained economic recovery in our market area, (b) sustained profitable performance with growth in earnings, and (c) additional clarity of any new regulatory capital thresholds. It is currently our expectation that we will we have completed the repayment of the CPP funds within the five year window from receipt, which ends at the later part of 2013 without an additional equity offering.

Capital Adequacy

First Federal is required to maintain specified amounts of capital pursuant to regulations promulgated by the OTS. The capital standards generally require the maintenance of regulatory capital sufficient to meet a tangible capital requirement, a core capital requirement, and a risk-based capital requirement. The following table sets forth First Federal’s compliance with each of the capital requirements at June 30, 2011 (in thousands).


	Core Capital						Risk-Based Capital
	Adequately Capitalized			Well Capitalized			Adequately Capitalized			Well Capitalized
Regulatory capital	$	222,178		$	222,178		$	242,107		$	242,107
Minimum required regulatory capital		79,132			98,914			126,921			158,651

Excess regulatory capital	$	143,046		$	123,264		$	115,186		$	83,456

Regulatory capital as a percentage of assets (1)		11.23	%		11.23	%		15.26	%		15.26	%
Minimum capital required as a percentage of assets		4.00	%		5.00	%		8.00	%		10.00	%

Excess regulatory capital as a percentage of assets		7.23	%		6.23	%		7.26	%		5.26	%

(1)	Core capital is computed as a percentage of adjusted total assets of $2.0 billion. Risk-based capital is computed as a percentage of total risk-weighted assets of $1.6 billion.

Critical Accounting Policies

First Defiance has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. The significant accounting policies of First Defiance are described in the footnotes to

the consolidated financial statements included in the Company’s Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. Those policies which are identified and discussed in detail in the Company’s Annual Report on Form 10-K include the Allowance for Loan Losses, Valuation of Securities, and the Valuation of Mortgage Servicing Rights. There have been no material changes in assumptions or judgments relative to those critical policies during the first six months of 2011.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As discussed in detail in the 2010 Annual Report on Form 10-K, First Defiance’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 First Defiance are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance 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.

First Defiance 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 100 basis point shift in interest rates (which is consistent with management’s estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 100 basis points over a 12 month period, using June 30, 2011 amounts as a base case, First Defiance’s net interest income would be impacted by less than the board mandated guidelines of 10%.

Item 4. Controls and Procedures

Disclosure controls are procedures designed to ensure that information required to be disclosed in the Company’s reports filed under the Exchange Act, such as this report, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls are also designed to ensure that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, as ours are designed to do, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2011. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. No changes occurred in the Company’s internal controls over financial reporting during the quarter ended June 30, 2011 that materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.

FIRST DEFIANCE FINANCIAL CORP.

PART II-OTHER INFORMATION

Item 1.

Legal Proceedings

First Defiance is not engaged in any legal proceedings of a material nature.

Item 1A.

Risk Factors

There are no material changes from the risk factors set forth under Part I, Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

First Defiance did not have any common stock repurchases during the first quarter of 2011, but has 93,124 shares that may be purchased under a plan announced by the Board of Directors on July 18, 2003. Participation in the CPP prohibits the Company from repurchasing any of its common shares without the prior approval of the U.S. Treasury until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party.

Item 3.

Defaults upon Senior Securities

Not applicable.

Item 4.

Removed and Reserved

Item 5.

Other Information

Not applicable.

Item 6.

Exhibits

Exhibit 3.1 Articles of Incorporation (1)

Exhibit 3.2 Code of Regulations (1)

Exhibit 3.3 Bylaws (1)

Exhibit 3.4 Amendment to Articles of Incorporation (2)

Exhibit 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act

Exhibit 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act

Exhibit 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act

Exhibit 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act

Exhibit 101 Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Condensed Balance Sheets, (ii) the Consolidated Condensed Statements of Income, (iii) the Consolidated Condensed Statements of Changes in Equity, (iv) the Consolidated Condensed Statements of Cash Flows, and (v) the Notes to Consolidated Condensed Financial Statements tagged as blocks of text and in detail. (3)

(1)	Incorporated herein by reference to the like numbered exhibit in the Registrant’s Form S-1 (File No. 33-93354)

(2)	Incorporated herein by reference to exhibit 3 in Form 8-K filed December 8, 2008 (Film No. 081236105)

(3)	As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.

FIRST DEFIANCE FINANCIAL CORP.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.


	First Defiance Financial Corp. (Registrant)

Date: August 8, 2011	By:	/s/ William J. Small
		William J. Small
		Chairman, President and Chief Executive Officer

Date: August 8, 2011	By:	/s/ Donald P. Hileman
		Donald P. Hileman
		Executive Vice President and Chief Financial Officer (Principal Financial Officer)