PREMIER FINANCIAL CORP - Annual Report: 2016 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year Ended

December 31, 2016

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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 offices)		(Zip code)

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

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

Common Stock, Par Value $0.01 Per Share		The NASDAQ Stock Market
(Title of Class)		(Name of each exchange on which registered)

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

None

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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 “accelerated filer”, “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant computed by reference to the average bid and ask price of such stock as of June 30, 2016 was approximately $338.8 million.

As of February 20, 2017, there were issued and outstanding 8,985,385 shares of the Registrant’s common stock.

Documents Incorporated by Reference

Part III of this Form 10-K incorporates by reference certain information from the registrant’s definitive Proxy Statement for the 2017 Annual Shareholders’ Meeting.

First Defiance Financial Corp.

Annual Report on Form 10-K

Table of Contents

		Page
PART I
Item 1.	Business	3
Item 1A.	Risk Factors	23
Item 1B.	Unresolved Staff Comments	28
Item 2.	Properties	28
Item 3.	Legal Proceedings	30
Item 4.	Mine Safety Disclosures	30

PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	30
Item 6.	Selected Financial Data	33
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operation	34
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	54
Item 8.	Financial Statements and Supplementary Data	57
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	127
Item 9A.	Controls and Procedures	127
Item 9B.	Other Information	127

PART III
Item 10.	Directors, Executive Officers and Corporate Governance	127
Item 11.	Executive Compensation	127
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	128
Item 13.	Certain Relationships and Related Transactions, and Director Independence	128
Item 14.	Principal Accounting Fees and Services	128

PART IV
Item 15.	Exhibits, Financial Statement Schedules	129

SIGNATURES		130

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PART I

Item 1. Business

First Defiance Financial Corp. (“First Defiance” or “the Company”) is a unitary thrift holding company that, through its subsidiaries, First Federal Bank of the Midwest (“First Federal” or “the Bank”), First Insurance Group of the Midwest, Inc. (“First Insurance”), and First Defiance Risk Management Inc. (collectively, “the Subsidiaries”), focuses on traditional banking and property and casualty, life and group health insurance products.

The Company’s philosophy is to grow and prosper, building long-term relationships based on top quality service, high ethical standards and safe and sound assets. The Company operates as a locally oriented, community-based financial services organization, augmented by experienced, centralized support in select critical areas. The Company’s local market orientation is reflected in its market area management and local advisory boards, which are comprised of local business persons, professionals and other community representatives that assist area management in responding to local banking needs.

The Company’s operating objectives include expansion, diversification within its markets, growth of its fee-based income and growth organically and through acquisitions of financial institutions, branches and financial services businesses. The Company seeks merger or acquisition partners that are culturally similar, have experienced management and possess either significant market area presence or have the potential for improved profitability through financial management, economies of scale and expanded services. The Company regularly evaluates merger and acquisition opportunities and conducts due diligence activities related to possible transactions with other financial institutions. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur. Acquisitions typically involve the payment of premiums over book and market values and, therefore, some dilution of the Company’s tangible book value and net income per common share may occur in any future transaction.

On August 23, 2016, First Defiance announced the execution of a definitive agreement (the “Agreement”) to acquire Commercial Bancshares, Inc. (“Commercial Bancshares”) and its wholly-owned subsidiary, the Commercial Savings Bank. Each Commercial Bancshares shareholder will receive 1.1808 shares of First Defiance common stock (“First Defiance Shares”) or $51.00 in cash, subject to total consideration being paid 80% in First Defiance Shares and 20% in cash as provided in the Agreement. Based on the twenty-day average closing price of First Defiance Shares of $43.19 ending August 22, 2016, the transaction is valued at approximately $63.0 million in the aggregate, including a cash payment of approximately $1.5 million to cancel outstanding options. On December 31, 2016, Commercial Bancshares had $356 million in assets, $297 million in loans and $314 million in deposits at its seven banking offices. The transaction closed on February 24, 2017.

At December 31, 2016, the Company had consolidated assets of $2.48 billion, consolidated deposits of $1.98 billion, and consolidated stockholders’ equity of $293.0 million. The Company was incorporated in Ohio in June of 1995. Its principal executive offices are located at 601 Clinton Street, Defiance, Ohio 43512, and its telephone number is (419) 782-5015.

First Defiance's website, www.fdef.com, contains a hyperlink under the Investor Relations section to EDGAR, where the annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge as soon as reasonably practicable after First Defiance has filed the report with the United State Securities and Exchange Commission (“SEC”).

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The Subsidiaries

The Company’s core business operations are conducted through its Subsidiaries:

First Federal Bank of the Midwest: First Federal is a federally chartered stock savings bank headquartered in Defiance, Ohio. It conducts operations through twenty-seven full-service banking center offices in Allen, Defiance, Fulton, Hancock, Henry, Lucas, Ottawa, Paulding, Putnam, Seneca, Williams and Wood counties in northwest Ohio, two full-service banking center offices in Allen County in northeast Indiana, five full-service banking center offices in Lenawee County in southeast Michigan and one commercial loan production office in Hilliard, Ohio that was approved in August 2016 to become a full-service branch. The Hilliard location is expected to open as a full-service branch late in the first quarter of 2017.

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

First Insurance Group of the Midwest: First Insurance is a wholly owned subsidiary of First Defiance. First Insurance is an insurance agency that conducts business through offices located in the Defiance, Maumee, Oregon, Bryan, Lima and Bowling Green, Ohio areas. First Insurance offers property and casualty insurance, life insurance and group health insurance.

First Defiance Risk Management: First Defiance Risk Management was incorporated on December 20, 2012, as a wholly-owned insurance company subsidiary of the Company to insure the Company and the Subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.

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 Mission & Vision and Core Values initiatives. First Defiance also has a tagline of “Better Together” 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 elements 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.

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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, including 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, checking, money market, certificates of deposits, Certificate of Deposit Account Registry Service (“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, and installment loans. First Federal also offers online banking services, which include mobile banking and online bill-pay.

Fee Income Development - Generation of fee income and the diversification of revenue sources are accomplished through the mortgage banking operation, First Insurance 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’s pricing strategy considers the whole relationship of the customer. First Federal continues 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 directed its attention to 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 monitors 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. 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 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, as well as surrounding market areas.

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Securities

First Defiance’s securities portfolio is managed in accordance with a written policy adopted by the Board of Directors and administered by the Investment Committee. The Chief Financial Officer of First Federal, Controller of First Federal, and the Chief Administration Officer of First Federal can each approve transactions up to $3.0 million. Two of the three officers are required to approve transactions between $3.0 million and $5.0 million. All transactions in excess of $5.0 million must be approved by the Board of Directors.

First Defiance’s investment portfolio includes 61 CMO issues totaling $63.0 million, all of which are fully amortizing securities. Management does not believe the risks associated with any of its CMO investments are significantly different from risks associated with other pass-through mortgage-backed securities. First Defiance did not have any off-balance sheet derivative securities at December 31, 2016.

Management determines the appropriate classification of debt securities at the time of purchase. Debt securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value.

The carrying value of securities at December 31, 2016 by contractual maturity is shown below. Expected maturities will differ from contractual maturities because issuers 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, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

	Contractually Maturing																				Total
			Weighted					Weighted					Weighted					Weighted
	Under 1		Average			1 - 5		Average			6-10		Average			Over 10		Average
	Year		Rate			Years		Rate			Years		Rate			Years		Rate			Amount		Yield
	(Dollars in Thousands)
Mortgage-backed securities	$	8,737		3.20	%	$	32,915		3.14	%	$	23,769		3.07	%	$	14,639		3.03	%	$	80,060		3.11	%
CMOs		9,414		2.97			30,164		2.87			20,944		2.78			3,429		2.79			63,951		2.85
U.S. government and federal agency obligations		-		-			2,000		1.50			2,000		2.00			-		-			4,000		1.75
Obligations of states and political subdivisions (1)		578		1.56			9,923		3.69			36,202		3.72			39,345		3.43			86,048		3.58
Corporate bonds		-		-			10,020		1.79			2,899		2.06			-		-			12,919		1.85
Total	$	18,729				$	85,022				$	85,814				$	57,413				$	246,978
Unamortized premiums/ (discounts)																						3,422
Unrealized gain on securities available for sale																						776
Total																					$	251,176

(1)

Tax exempt yield based on effective tax rate of 35%. Actual coupon rate is approximately equal to the weighted average rate disclosed in the table times 65%.

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The carrying value of investment securities is as follows:

	December 31
	2016		2015		2014
	(In Thousands)
Available-for-sale securities:
Obligations of U.S. government corporations and agencies	$	3,915	$	2,994	$	980
Obligations of state and political subdivisions		88,043		90,389		88,532
CMOs, REMICS and mortgage-backed securities		146,019		138,074		142,816
Trust preferred stock and preferred stock		2		1		1
Corporate bonds		13,013		4,977		6,992
Total	$	250,992	$	236,435	$	239,321

Held-to-maturity securities:
Mortgage-backed securities	$	91	$	119	$	158
Obligations of state and political subdivisions		93		124		155
Total	$	184	$	243	$	313

For additional information regarding First Defiance’s investment portfolio, refer to Note 5 – Investment Securities to the Consolidated Financial Statements.

Interest-Bearing Deposits

The Company had $46.0 million and $41.0 million in overnight investments at the Federal Reserve at December 31, 2016 and 2015, respectively, which amount is included in interest-bearing deposits. First Defiance had interest-earning deposits in the FHLB of Cincinnati and other financial institutions amounting to $1.8 million and $1.6 million at December 31, 2016 and 2015, respectively.

Residential Loan Servicing Activities

Servicing mortgage loans for investors involves a contractual right to receive a fee for processing and administering loan payments on mortgage loans that are not owned by the Company and are not included on the Company’s balance sheet. This processing involves collecting monthly mortgage payments on behalf of investors, reporting information to those investors on a monthly basis and maintaining custodial escrow accounts for the payment of principal and interest to investors and property taxes and insurance premiums on behalf of borrowers. At December 31, 2016, First Federal serviced 14,350 loans totaling $1.37 billion. The vast majority of the loans serviced for others are fixed rate conventional mortgage loans. The Company primarily sells its loans to Freddie Mac, Fannie Mae and FHLB. At December 31, 2016, 64.82%, 34.31% and 0.81% of the Company’s sold loans were to Freddie Mac, Fannie Mae and FHLB, respectively.

As compensation for its mortgage servicing activities, the Company receives servicing fees, usually approximating 0.25% per annum of the loan balances serviced, plus any late charges collected from delinquent borrowers and other fees incidental to the services provided. In the event of a default by the borrower, the Company receives no servicing fees until the default is cured.

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The following table sets forth certain information regarding the number and aggregate principal balance of the mortgage loans serviced by the Company, including both fixed and adjustable rate loans, at various interest rates:

	December 31
	2016							2015							2014
					Percentage							Percentage							Percentage
	Number		Aggregate		of Aggregate			Number		Aggregate		of Aggregate			Number		Aggregate		of Aggregate
	of		Principal		Principal			of		Principal		Principal			of		Principal		Principal
Rate	Loans		Balance		Balance			Loans		Balance		Balance			Loans		Balance		Balance
	(Dollars in Thousands)

Less than 3.00%		2,191	$	225,328		16.42	%		1,836	$	188,916		14.06	%		1,807	$	194,998		14.48	%
3.00% -3.99%		6,279		682,157		49.72			5,606		603,875		44.94			4,985		544,117		40.41
4.00% -4.99%		3,551		332,023		24.20			3,924		379,917		28.28			3,952		386,949		28.73
5.00% - 5.99%		1,405		83,775		6.11			1,761		110,616		8.23			2,200		147,057		10.92
6.00% - 6.99%		749		41,055		2.99			922		50,937		3.79			1,086		62,379		4.63
7.00% and over		175		7,680		0.56			209		9,461		0.70			237		11,138		0.83
Total		14,350	$	1,372,018		100.00	%		14,258	$	1,343,722		100.00	%		14,267	$	1,346,638		100.00	%

Loan servicing fees decrease as the principal balance on the outstanding loan decreases and as the remaining time to maturity of the loan shortens.

The following table sets forth certain information regarding the remaining maturity of the mortgage loans serviced by the Company as of the dates shown.

	December 31
	2016										2015										2014
Maturity	Number of Loans		% of Number of Loans			Unpaid Principal Amount		% of Unpaid Principal Amount			Number of Loans		% of Number of Loans			Unpaid Principal Amount		% of Unpaid Principal Amount			Number of Loans		% of Number of Loans			Unpaid Principal Amount		% of Unpaid Principal Amount
	(Dollars in Thousands)

1–5 years		529		3.69	%	$	7,432		0.54	%		680		4.77	%	$	10,801		0.80	%		810		5.67	%	$	15,932		1.18	%
6–10 years		1,784		12.43			102,132		7.44			1,563		10.97			89,364		6.65			1,204		8.44			64,979		4.83
11–15 years		3,671		25.58			343,750		25.05			3,759		26.36			349,986		26.05			4,082		28.61			385,409		28.62
16–20 years		1,526		10.63			135,540		9.88			1,635		11.47			144,249		10.74			1,720		12.06			155,783		11.57
21–25 years		1,846		12.86			169,496		12.35			1,833		12.85			169,889		12.64			1,575		11.04			143,062		10.62
More than 25 years		4,994		34.81			613,668		44.74			4,788		33.58			579,433		43.12			4,876		34.18			581,473		43.18
Total		14,350		100.00	%	$	1,372,018		100.00	%		14,258		100.00	%	$	1,343,722		100.00	%		14,267		100.00	%	$	1,346,638		100.00	%

Lending Activities

General – A savings bank generally may not make loans to one borrower and related entities in an amount which exceeds 15% of its unimpaired capital and surplus, although loans in an amount equal to an additional 10% of unimpaired capital and surplus may be made to a borrower if the loans are fully secured by readily marketable collateral. Real estate is not considered “readily marketable collateral.” Certain types of loans are not subject to these limits. In applying these limits, loans to certain borrowers may be aggregated. Notwithstanding the specified limits, a savings bank may lend to one borrower up to $500,000 “for any purpose.” At December 31, 2016, First Federal’s limit on loans-to-one borrower was $40.3 million and its five largest loans (including available lines of credit) or groups of loans to one borrower, including related entities, were $23.6 million, $23.3 million, $23.1 million, $23.1 million and $22.9 million. All of these loans or groups of loans were performing in accordance with their terms at December 31, 2016.

Loan Portfolio Composition – The net increase in net loans receivable over the prior year was $137.8 million, $154.8 million and $66.5 million at December 31, 2016, 2015, and 2014, respectively. The loan portfolio contains no foreign loans. The Company’s loan portfolio is concentrated geographically in the northwest Ohio, northeast Indiana, central Ohio and southeast Michigan market areas. Management has identified lending for income generating rental properties as an industry concentration. Total loans for income generating property totaled $687.5 million at December 31, 2016, which represents 33.8% of the Company’s loan portfolio.

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The following table sets forth the composition of the Company’s loan portfolio by type of loan at the dates indicated.

	December 31
	2016					2015					2014					2013					2012
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
	(Dollars in Thousands)
Real estate:
1-4 family residential	$	207,550		10.2	%	$	205,330		11.0	%	$	206,437		12.2	%	$	195,752		12.2	%	$	200,826		13.0	%
Multi-family residential		196,983		9.7			167,558		9.0			156,530		9.3			148,952		9.2			122,275		7.9
Commercial real estate		843,579		41.5			780,870		41.8			683,958		40.6			670,666		41.6			675,110		43.7
Construction		182,886		9.0			163,877		8.7			112,385		6.7			86,058		5.3			37,788		2.5
Total real estate loans		1,430,998		70.4			1,317,635		70.5			1,159,310		68.8			1,101,428		68.3			1,035,999		67.1

Other:

Commercial		469,055		23.0			419,349		22.4			399,730		23.7			388,236		24.1			383,817		24.9
Home equity and improvement		118,429		5.8			116,962		6.2			111,813		6.6			106,930		6.6			108,718		7.0
Consumer finance		16,680		0.8			16,281		0.9			15,466		0.9			16,902		1.0			15,936		1.0
		604,164		29.6			552,592		29.5			527,009		31.2			512,068		31.7			508,471		32.9
Total loans		2,035,162		100.0	%		1,870,227		100.0	%		1,686,319		100.0	%		1,613,496		100.0	%		1,544,470		100.0	%
Less:
Undisbursed loan funds		93,355					66,902					38,653					32,290					18,478
Net deferred loan origination fees		1,320					1,108					880					758					735
Allowance for loan losses		25,884					25,382					24,766					24,950					26,711
Net loans	$	1,914,603				$	1,776,835				$	1,622,020				$	1,555,498				$	1,498,546

In addition to the loans reported above, First Defiance had $9.6 million, $5.5 million, $4.5 million, $9.1 million, and $22.1 million in loans classified as held for sale at December 31, 2016, 2015, 2014, 2013 and 2012, respectively. The fair value of such loans, which are all single-family residential mortgage loans, approximated their carrying value for all years presented.

Contractual Principal, Repayments and Interest Rates – The following table sets forth certain information at December 31, 2016 regarding the dollar amount of gross loans maturing in First Defiance’s portfolio, based on the contractual terms to maturity. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.

	Years After December 31, 2016
	Due Less than 1		Due 1-2		Due 3-5		Due 5-10		Due 10-15		Due 15+		Total
	(In Thousands)
Real estate	$	471,363	$	164,604	$	608,344	$	88,086	$	31,425	$	67,176	$	1,430,998
Other loans:
Commercial		316,760		50,152		94,636		7,507		-		-		469,055
Home equity and improvement		109,651		2,410		4,044		1,452		425		447		118,429
Consumer finance		6,726		3,531		6,194		223		6		-		16,680
Total	$	904,500	$	220,697	$	713,218	$	97,268	$	31,856	$	67,623	$	2,035,162

The schedule above does not reflect the actual life of the Company’s loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale clauses, which give First Defiance the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.

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The following table sets forth the dollar amount of gross loans due after one year from December 31, 2016 which have fixed interest rates or which have floating or adjustable interest rates.

			Floating or
	Fixed		Adjustable
	Rates		Rates		Total
	(In Thousands)

Real estate	$	289,578	$	670,057	$	959,635
Commercial		114,463		37,832		152,295
Other		17,602		1,130		18,732
	$	421,643	$	709,019	$	1,130,662

Originations, Purchases and Sales of Loans – The lending activities of First Federal are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Board of Directors and management. Loan originations are obtained from a variety of sources, including referrals from existing customers, real estate brokers, developers and builders, newspaper and radio advertising and walk-in customers.

First Federal’s loan approval process for all types of loans is intended to assess the borrower’s ability to repay the loan, the viability of the loan and the adequacy of the value of the collateral that will secure the loan.

A commercial loan application is first reviewed and underwritten by one of the commercial loan officers, who may approve credits within their lending limit. Another loan officer with limits sufficient to cover the exposure must approve credits exceeding an individual’s lending limit. All credits which exceed $100,000 in aggregate exposure must be presented for review or approval to the Senior Loan Committee comprised of senior lending personnel. Credits which exceed $2,000,000 in aggregate exposure must be presented for approval to the Executive Loan Committee.

Residential mortgage applications are accepted by retail lenders or branch managers, who utilize an automated underwriting system to review the loan request. First Federal also receives mortgage applications via an online residential mortgage origination system. A final approval of all residential mortgage applications is made by a member of a centralized underwriting staff within their designated lending limits. Loan requests in excess or outside an individual underwriter’s limit are approved by the Senior Loan Committee and, if necessary, by the Executive Loan Committee.

Retail lenders and branch managers are authorized to originate and approve direct consumer loan requests that are within policy guidelines and within the lender’s approved lending limit. Loans in excess of the lender’s approved lending limit may be approved by retail lending managers up to their approved lending limit. Loans in excess of the retail lending manager’s authorized lending limit or outside of policy must be approved by the Senior Loan Committee and, if necessary, by the Executive Loan Committee. Indirect consumer loans originated by auto dealers are underwritten and approved by a designated underwriter in accordance with Company policy and lending limits.

First Defiance offers adjustable-rate loans in order to decrease the vulnerability of its operations to changes in interest rates. The demand for adjustable-rate loans in First Defiance’s primary market area has been a function of several factors, including customer preference, the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates offered for fixed-rate loans and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate residential loans that can be originated at any time is largely determined by the demand for each in a competitive environment.

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Adjustable-rate loans represented 10.8% of First Defiance’s total originations of one-to-four family residential mortgage loans in 2016 compared to 10.3% and 11.9% during 2015 and 2014, respectively.

Adjustable-rate loans decrease the risks associated with changes in interest rates, but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.

The following table shows total loans originated, loan reductions, and the net increase in First Defiance’s total loans and loans held for sale during the periods indicated:

	Years Ended December 31
	2016		2015		2014
	(In Thousands)
Loan originations:
1-4 family residential	$	294,307	$	241,658	$	173,301
Multi-family residential		59,957		44,352		46,181
Commercial real estate		166,437		241,969		159,959
Construction		138,553		116,224		66,264
Commercial		389,037		465,543		524,073
Home equity and improvement		56,816		54,676		45,934
Consumer finance		10,426		10,235		10,632
Total loans originated		1,115,533		1,174,657		1,026,344
Loans purchased:		822		-		16,594
Loan reductions:
Loan pay-offs		232,302		265,311		219,446
Loans sold		282,589		231,067		176,381
Periodic principal repayments		432,445		493,383		578,873
		947,336		989,761		974,700
Net increase in total loans and loans held for sale	$	169,019	$	184,896	$	68,238

Asset Quality

First Defiance’s credit policy establishes guidelines to manage credit risk and asset quality. These guidelines include loan review and early identification of problem loans to ensure sound credit decisions. First Defiance’s credit policies and review procedures are meant to minimize the risk and uncertainties inherent in lending. In following the policies and procedures, management must rely on estimates, appraisals and evaluations of loans and the possibility that changes in these could occur because of changing economic conditions.

Delinquent Loans — The following table sets forth information concerning delinquent loans at December 31, 2016, in dollar amount and as a percentage of First Defiance’s total loan portfolio. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts that are past due.

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	30 to 59 Days					60 to 89 Days					90 Days and Over					Total
	Amount		Percentage			Amount		Percentage			Amount		Percentage			Amount		Percentage
	(Dollars in Thousands)

1-4 family residential real estate	$	221		0.01	%	$	1,142		0.06	%	$	608		0.03	%	$	1,971		0.10	%
Multi- family residential		-		0.00			-		0.00			-		0.00			-		0.00
Commercial real estate		159		0.01			16		0.00			2,072		0.10			2,247		0.11
Construction		-		0.00			-		0.00			-		0.00			-		0.00
Commercial		23		0.00			10		0.00			403		0.02			436		0.02
Home Equity and Improvement		1,115		0.05			174		0.01			254		0.02			1,543		0.08
Consumer Finance		85		0.01			69		0.00			78		0.00			232		0.01
Total	$	1,603		0.08	%	$	1,411		0.07	%	$	3,415		0.17	%	$	6,429		0.32	%

Overall, the level of delinquencies at December 31, 2016 decreased from the levels at December 31, 2015, when First Defiance reported that 0.64% of its outstanding loans were at least 30 days delinquent. The level of total loans 90 or more days delinquent has decreased to 0.17% at December 31, 2016 from 0.39% at December 31, 2015. The level of total loans 60-89 days delinquent decreased to 0.07% at December 31, 2016 from 0.13% at December 31, 2015. The level of loans that were 30 to 59 days past due decreased to 0.08% at December 31, 2016 from 0.12% at December 31, 2015. Management has assessed the collectability of all loans that are 90 days or more delinquent as part of its procedures in establishing the allowance for loan losses.

Nonperforming Assets – All loans are reviewed on a regular basis and are placed on non-accrual status when, in the opinion of management, the collectability of additional interest is not expected. Generally, First Defiance places all loans more than 90 days past due on non-accrual status. First Defiance also places loans on non-accrual when the loan is paying as agreed but the Company believes the financial condition of the borrower is such that this classification is warranted. When a loan is placed on non-accrual status, total unpaid interest accrued to date is reversed. Subsequent payments are generally applied to the outstanding principal balance but may be recorded as interest income, depending on the assessment of the ultimate collectability of the loan. First Defiance considers that a loan is impaired when, based on current information and events, it is probable that it will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan agreement. First Defiance measures impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral, if collateral dependent. If the estimated recoverability of the impaired loan is less than the recorded investment, First Defiance will recognize impairment by allocating a portion of the allowance for loan losses on cash flow dependent loans and by charging off the deficiency on collateral dependent loans.

Loans originated by First Federal having principal balances of $27.4 million, $41.9 million and $48.9 million were considered impaired as of December 31, 2016, 2015 and 2014, respectively. The decrease in impaired loans from 2014 to 2016 is due to a continued concerted effort by management and the lending staff to work specific credits out of the Bank or back to performing status. These amounts of impaired loans exclude large groups of small-balance homogeneous loans that are collectively evaluated for impairment such as residential mortgage, consumer installment and credit card loans, except for those classified as troubled debt restructurings. There was $1.7 million of interest received and recorded in income during 2016 related to impaired loans. There was $1.3 million and $1.6 million recorded in 2015 and 2014, respectively. Unrecorded interest income based on the loan’s contractual terms on these impaired loans and all non-performing loans in 2016, 2015 and 2014 was $1.2 million, $1.5 million, and $1.2 million, respectively. The average recorded investment in impaired loans during 2016, 2015 and 2014 (excluding loans accounted for under FASB ASC Topic 310 Subtopic 30) was $32.8 million, $51.8 million and $50.3 million, respectively. The total allowance for loan losses related to these loans was $0.8 million, $0.4 million, and $1.3 million at December 31, 2016, 2015 and 2014, respectively.

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Real estate acquired by foreclosure is classified as real estate owned until such time as it is sold. First Defiance also repossesses other assets securing loans, consisting primarily of automobiles. When such property is acquired it is recorded at fair value less cost to sell. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management and a write-down of the value is recorded with a corresponding charge to operations if it is determined that the carrying value of property exceeds its estimated net realizable value. During 2016, First Defiance recognized $74,000 of expense related to write-downs in value of real estate acquired by foreclosure. The balance of real estate owned at December 31, 2016 was $455,000.

As of December 31, 2016, First Defiance’s total non-performing loans amounted to $14.3 million or 0.74% of total loans (net of undisbursed loan funds and deferred fees and costs), compared to $16.3 million or 0.90% of total loans, at December 31, 2015. Non-performing loans are loans which are more than 90 days past due or on nonaccrual. The nonperforming loan balance for 2016 includes $11.3 million of loans that were originated by First Federal and also considered impaired compared to $13.4 million for 2015.

The following table sets forth the amounts and categories of First Defiance’s non-performing assets (excluding impaired loans not considered non-performing) and troubled debt restructurings at the dates indicated.

	December 31
	2016			2015			2014			2013			2012
	(Dollars in Thousands)
Nonperforming loans:

1-4 family residential real estate	$	2,928		$	2,610		$	3,332		$	3,273		$	3,602
Multi-family residential real estate		2,639			2,419			2,539			581			1,177
Commercial real estate		6,953			7,429			12,635			15,253			21,913
Commercial		1,007			3,078			4,993			8,327			5,661
Home Equity and Improvement		730			689			619			413			217
Consumer finance		91			36			12			-			-
Total nonperforming loans		14,348			16,261			24,130			27,847			32,570

Real estate owned		455			1,321			6,181			5,859			3,805
Total repossessed assets		455			1,321			6,181			5,859			3,805

Total nonperforming assets	$	14,803		$	17,582		$	30,311		$	33,706		$	36,375

Restructured loans, accruing	$	10,544		$	11,178		$	24,686		$	27,630		$	28,203

Total nonperforming assets as a percentage of total assets		0.60	%		0.77	%		1.39	%		1.58	%		1.78	%
Total nonperforming loans as a percentage of total loans*		0.74	%		0.90	%		1.47	%		1.76	%		2.14	%
Total nonperforming assets as a percentage of total loans plus REO*		0.76	%		0.97	%		1.83	%		2.12	%		2.38	%
Allowance for loan losses as a percent of total nonperforming assets		174.86	%		144.36	%		81.71	%		74.02	%		73.43	%

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

Allowance for Loan Losses – First Defiance maintains an allowance for loan losses to absorb probable incurred credit losses in the loan portfolio. The allowance for loan loss is made up of two components. The first is a general reserve, which is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolio based on quantitative and qualitative factors.

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The second component of the allowance for loan loss is the specific reserve in which the Company sets aside reserves based on the analysis of individual credits. In evaluating the adequacy of its allowance each quarter, management grades all loans in the commercial portfolio. See Management’s Discussion and Analysis – Allowance for Loan Losses for further discussion on management’s evaluation of the allowance for loan losses.

Loans are charged against the allowance when such loans meet the Company’s established policy on loan charge-offs and the allowance itself is adjusted quarterly by recording a provision for loan losses. As such, actual losses and losses provided for should be approximately the same if the overall quality, composition and size of the portfolio remained static along with a static loan environment. To the extent that the portfolio grows at a rapid rate or overall quality or the loan environment deteriorates, the provision generally will exceed charge-offs. However, in certain circumstances net charge-offs may exceed the provision for loan losses when management determines that loans previously provided for in the allowance for loan losses are uncollectible and should be charged off or as overall credit or the loan environment improves. Although management believes that it uses the best information available to make such determinations, future adjustments to the allowances may be necessary, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations.

At December 31, 2016, First Defiance’s allowance for loan losses totaled $25.9 million compared to $25.4 million at December 31, 2015. The following table sets forth the activity in First Defiance’s allowance for loan losses during the periods indicated.

	Years Ended December 31
	2016			2015			2014			2013			2012
	(Dollars in Thousands)

Allowance at beginning of year	$	25,382		$	24,766		$	24,950		$	26,711		$	33,254
Provision for credit losses		283			136			1,117			1,824			10,924
Charge-offs:
1-4 family residential real estate		(350	)		(282	)		(426	)		(643	)		(2,515	)
Commercial real estate and multi-family		(92	)		(468	)		(1,018	)		(2,475	)		(11,319	)
Commercial		(615	)		(68	)		(2,982	)		(1,230	)		(4,047	)
Consumer finance		(94	)		(53	)		(41	)		(94	)		(133	)
Home equity and improvement		(268	)		(350	)		(392	)		(757	)		(1,165	)
Total charge-offs		(1,419	)		(1,221	)		(4,859	)		(5,199	)		(19,179	)
Recoveries		1,638			1,701			3,558			1,614			1,712
Net (charge-offs) recoveries		219			480			(1,301	)		(3,585	)		(17,467	)
Ending allowance	$	25,884		$	25,382		$	24,766		$	24,950		$	26,711

Allowance for loan losses to total non-performing loans at end of year		180.40	%		156.09	%		102.64	%		89.60	%		82.01	%
Allowance for loan losses to total loans at end of year*		1.33	%		1.41	%		1.50	%		1.58	%		1.75	%
Net charge-offs (recoveries) for the year to average loans		-0.01	%		-0.03	%		0.08	%		0.23	%		1.18	%

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

The provision for credit losses decreased significantly in 2016 and 2015 from previous years due to improved credit quality of the loan portfolio. Management does not anticipate a net recovery position in 2017 and feels that the level of the allowance for loan losses at December 31, 2016 is sufficient to cover the estimated losses incurred but not yet recognized in the loan portfolio.

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The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at the dates indicated. For information about the percent of total loans in each category to total loans, see “Lending Activities-Loan Portfolio Composition.”

	December 31
	2016					2015					2014					2013					2012
			Percent of					Percent of					Percent of					Percent of					Percent of
			total loans					total loans					total loans					total loans					total loans
	Amount		by category			Amount		by category			Amount		by category			Amount		by category			Amount		by category
	(Dollars in Thousands)
1-4 family residential	$	2,627		10.2	%	$	3,212		11.0	%	$	2,494		12.2	%	$	2,847		12.2	%	$	3,506		13.0	%
Multi-family residential real estate		2,228		9.7			2,151		9.0			2,453		9.3			2,508		9.2			2,197		7.9
Commercial real estate		10,625		41.5			11,772		41.8			11,268		40.6			12,000		41.6			12,702		43.7
Construction		450		9.0			517		8.7			221		6.7			134		5.3			75		2.5
Commercial loans		7,361		23.0			5,192		22.4			6,509		23.7			5,678		24.1			6,325		24.9
Home equity and improvement loans		2,386		5.8			2,270		6.2			1,704		6.6			1,635		6.6			1,759		7.0
Consumer loans		207		0.8			171		0.9			117		0.9			148		1.0			147		1.0
	$	25,884		100.0	%	$	25,382		100.0	%	$	24,766		100.0	%	$	24,950		100.0	%	$	26,711		100.0	%

Sources of Funds

General – Deposits are the primary source of First Defiance’s funds for lending and other investment purposes. In addition to deposits, First Defiance derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings from the FHLB may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes. During 2007, First Defiance issued $15.0 million of trust preferred securities through an unconsolidated affiliated trust. Proceeds from the offering were used for general corporate purposes including funding of dividends and stock buybacks as well as bolstering regulatory capital at the First Federal level. First Defiance also issued $20.0 million of similar trust preferred securities in 2005.

Deposits – First Defiance’s deposits are attracted principally from within First Defiance’s primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts, and term certificate accounts. Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit, and the interest rate.

To supplement its funding needs, First Defiance also has the ability to utilize the national market for Certificates of Deposit. First Defiance has used these deposits in the past and could in the future if necessary. The total balance of national certificates of deposit was $0 at December 31, 2016 and 2015.

Average balances and average rates paid on deposits are as follows:

	Years Ended December 31
	2016					2015					2014
	Amount		Rate			Amount		Rate			Amount		Rate
	(Dollars in Thousands)
Non-interest-bearing demand deposits	$	441,731		-		$	388,257		-		$	350,677		-
Interest bearing demand deposits		798,266		0.17	%		742,856		0.16	%		733,637		0.17	%
Savings deposits		235,137		0.04			215,253		0.04			198,919		0.05
Time deposits		430,487		1.12			441,510		0.92			466,951		0.85
Totals	$	1,905,621		0.33	%	$	1,787,876		0.30	%	$	1,750,184		0.30	%

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The following table sets forth the maturities of First Defiance’s retail certificates of deposit having principal amounts $100,000 or greater at December 31, 2016 (In Thousands):

Retail certificates of deposit maturing in quarter ending:
March 31, 2017	$	17,854
June 30, 2017		16,394
September 30, 2017		15,125
December 31, 2017		8,322
After December 31, 2017		109,862
Total retail certificates of deposit with balances $100,000 or greater	$	167,557

The following table details the deposit accrued interest payable as of December 31:

	2016		2015
	(In Thousands)

Interest bearing demand deposits and money market accounts	$	23	$	18
Certificates of deposit		19		25
	$	42	$	43

For additional information regarding First Defiance’s deposits see Note 11 to the Consolidated Financial Statements.

Borrowings— First Defiance may obtain advances from the FHLB of Cincinnati by pledging certain of its residential mortgage loans, commercial real estate loans, multi-family loans, home equity loans and investment securities provided certain standards related to creditworthiness have been met. Such advances are made pursuant to several credit programs, each of which has its own interest rate and range of maturities.

The following table sets forth certain information as to First Defiance’s FHLB advances and other borrowings at the dates indicated.

	Years Ended December 31
	2016			2015			2014
	(Dollars in Thousands)
Long-term:
FHLB advances	$	103,943		$	59,902		$	21,544
Weighted average interest rate		1.42	%		1.62	%		2.38	%

Short-term:
Securities sold under agreement to repurchase	$	31,816		$	57,188		$	54,759
Weighted average interest rate		0.22	%		0.27	%		0.28	%

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The following table sets forth the maximum month-end balance and average balance of First Defiance’s long-term FHLB advances and other borrowings during the periods indicated.

	Years Ended December 31
	2016			2015			2014
	(Dollars in Thousands)
Long-term:
FHLB advances:
Maximum balance	$	103,943		$	59,902		$	22,520
Average balance		84,944			38,185			21,993
Weighted average interest rate		1.42	%		1.62	%		2.38	%

The following table sets forth the maximum month-end balance and average balance of First Defiance’s short-term FHLB advances and other borrowings during the periods indicated.

	Years Ended December 31
	2016			2015			2014
	(Dollars in Thousands)
Short-term:
FHLB advances:
Maximum balance	$	30,000		$	-		$	-
Average balance		861			41			-
Weighted average interest rate		0.39	%		0.18	%		-
Securities sold under agreement to repurchase:
Maximum balance	$	57,984		$	60,272		$	61,154
Average balance		52,821			54,632			54,541
Weighted average interest rate		0.26	%		0.28	%		0.29	%

First Defiance borrows funds under a variety of programs at the FHLB. As of December 31, 2016, there was $103.9 million outstanding under various long-term FHLB advance programs. First Defiance utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. At December 31, 2016 and 2015, no outstanding balances existed under First Defiance’s short-term Cash Management Advance Line of Credit or REPO line of credit. The total available under the Cash Management Advance Line is $15.0 million. Additionally, First Defiance has $100.0 million available under a REPO line of credit. Amounts are generally borrowed under these lines on an overnight basis. First Federal’s total borrowing capacity at the FHLB is limited by various collateral requirements. Eligible collateral includes mortgage loans, home equity loans, non-mortgage loans, cash, and investment securities. At December 31, 2016, other than amounts available on the REPO and Cash Management line, First Federal had additional borrowing capacity with the FHLB of $448.9 million as a result of these collateral requirements.

As a member of the FHLB of Cincinnati, First Federal must maintain a minimum investment in the capital stock of that FHLB in an amount defined in the FHLB’s regulations. First Federal is permitted to own stock in excess of the minimum requirement and was in compliance with the minimum requirement with an investment in stock of the FHLB of Cincinnati of $13.8 million at December 31, 2016 and 2015. First Federal holds stock of the FHLB of Indianapolis of $5,000 at December 31, 2016 and $9,000 at December 31, 2015.

Each FHLB is required to establish standards of community investment or service that its members must maintain for continued access to long-term advances from the FHLB. The standards take into account a member’s performance under the Community Reinvestment Act and its record of lending to first-time homebuyers.

For additional information regarding First Defiance’s FHLB advances and other debt see Notes 12 and 14 to the Consolidated Financial Statements.

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Subordinated Debentures - In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (“Trust Affiliate II”) that issued $15.0 million of Guaranteed Capital Trust Securities (“Trust Preferred Securities”). In connection with the transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (“Subordinated Debentures”) to Trust Affiliate II. Trust Affiliate II 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 Subordinated Debentures held by Trust Affiliate II are the sole assets of the trust. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.5%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate II was 2.46% and 2.01% as of December 31, 2016 and 2015 respectively.

The Trust Preferred Securities are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on June 15, 2037, but can be redeemed at the Company’s option at any time now.

In October 2005, the Company formed an affiliated trust, First Defiance Statutory Trust I (“Trust Affiliate I”) that issued $20.0 million of Trust Preferred Securities. In connection with the 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 Subordinated Debentures held by Trust Affiliate I are the sole assets of the trust. 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%, or 2.34% and 1.89% as of December 31, 2016 and 2015 respectively.

The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on December 15, 2035, but can be redeemed by the Company at any time now.

Employees

First Defiance had 581 employees at December 31, 2016. None of these employees are represented by a collective bargaining agent, and First Defiance believes that it maintains good relationships with its personnel.

Competition

Competition in originating commercial real estate and commercial loans comes mainly from commercial banks with banking center offices in the Company’s market area. Competition for the origination of mortgage loans arises mainly from savings associations, commercial banks, and mortgage companies. The distinction among market participants is based on a combination of price, the quality of customer service and name recognition. The Company competes for loans by offering competitive interest rates and product types and by seeking to provide a higher level of personal service to borrowers than is furnished by competitors. First Federal has a significant market share of the lending markets in which it conducts operations, except for central Ohio.

Management believes that First Federal’s most direct competition for deposits comes from local financial institutions. The distinction among market participants is based on price and the quality of customer service and name recognition. First Federal’s cost of funds fluctuates with general market interest rates. During certain interest rate environments, additional significant competition for deposits may be expected from corporate and governmental debt securities, as well as from money market mutual funds. First Federal competes for conventional deposits by emphasizing quality of service, extensive product lines and competitive pricing.

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Regulation

General – First Defiance and First Federal are subject to regulation, examination and oversight by the Office of the Comptroller of the Currency (“OCC”) and the Federal Reserve Board (“Federal Reserve”). Because the FDIC insures First Federal’s deposits, First Federal is also subject to examination and regulation by the FDIC. In addition, First Federal is subject to regulation and examination by the Consumer Financial Protection Bureau (the “CFPB”) established by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). First Defiance and First Federal must file periodic reports with the Federal Reserve and the OCC and examinations are conducted periodically by the Federal Reserve, OCC and the FDIC to determine whether First Defiance and First Federal are in compliance with various regulatory requirements and are operating in a safe and sound manner. First Federal is subject to various consumer protection and fair lending laws. These laws govern, among other things, truth-in-lending disclosure, equal credit opportunity, and, in the case of First Federal, fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations governing community reinvestment could limit the ability of First Federal to open a new branch or engage in a merger transaction. Community reinvestment regulations evaluate how well and to what extent First Federal lends and invests in its designated service area, with particular emphasis on low-to-moderate income communities and borrowers in such areas.

First Defiance is also subject to various Ohio laws which restrict takeover bids, tender offers and control-share acquisitions involving public companies which have significant ties to Ohio.

Regulatory Capital Requirements – The federal banking regulators have adopted risk-based capital guidelines for financial institutions and their holding companies, designed to absorb losses. The guidelines provide a systematic analytical framework, which makes regulatory capital requirements sensitive to differences in risk profiles among banking organizations, takes off-balance sheet exposures expressly into account in evaluating capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Capital levels as measured by these standards are also used to categorize financial institutions for purposes of certain prompt corrective action regulatory provisions.

In July 2013 the United States banking regulators issued final new capital rules applicable to smaller banking organizations which also implement certain provisions of the Dodd-Frank Act. The new minimum capital requirements became effective on January 1, 2015, whereas a new capital conservation buffer and deductions from common equity capital phase in from January 1, 2016, through January 1, 2019, and most deductions from common equity tier 1 capital are being phased in from January 1, 2015, through January 1, 2019.

The new rules include (a) a new common equity tier 1 (“CET1”) capital ratio of at least 4.5%, (b) a Tier 1 capital ratio of at least 6.0%, rather than the former 4.0%, (c) a minimum total capital ratio that remains at 8.0%, and (d) a minimum leverage ratio of 4%.

Common equity for the common equity tier 1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.

Tier 1 capital includes common equity as defined for the common equity tier 1 capital ratio, plus certain non-cumulative preferred stock and related surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered (but which are not permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.

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Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and limited amounts of the allowance for loan and lease losses, subject to new eligibility criteria, less applicable deductions.

The deductions from common equity tier 1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-servicing assets above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own capital instruments and investments in the capital of unconsolidated financial institutions (above certain levels). The deductions phase in through 2019.

Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance sheet, one of several risk weights is applied to different balance sheet and off-balance sheet assets, primarily based on the relative credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The new rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to executive officers if the company does not hold a capital conservation buffer of greater than 2.5% composed of common equity tier 1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. The capital conservation buffer phases in starting on January 1, 2016, at .625%.

The following table sets forth the amount and percentage level of regulatory capital of First Federal at December 31, 2016, and the amount by which it exceeded the minimum capital requirements in effect at that date. (Dollars in Thousands):

	Actual					Minimum Required for Adequately Capitalized					Minimum Required for Well Capitalized
	Amount		Ratio			Amount		Ratio(1)			Amount		Ratio
CET1 Capital (to Risk-Weighted Assets) (1)
Consolidated	$	234,809		10.45	%	$	101,108		4.5	%		N/A		N/A
First Federal	$	242,928		10.81	%	$	101,116		4.5	%	$	146,057		6.5	%

Tier 1 Capital (2)
Consolidated	$	269,809		11.24	%	$	95,975		4.0	%		N/A		N/A
First Federal	$	242,928		10.14	%	$	95,791		4.0	%	$	119,739		5.0	%

Tier 1 Capital (to Risk Weighted Assets) (1)
Consolidated	$	269,809		12.01	%	$	134,811		6.0	%		N/A		N/A
First Federal	$	242,928		10.81	%	$	134,822		6.0	%	$	179,763		8.0	%

Total Capital (to Risk Weighted Assets) (1)
Consolidated	$	295,693		13.16	%	$	179,748		8.0	%		N/A		N/A
First Federal	$	268,812		11.96	%	$	179,763		8.0	%	$	224,703		10.0	%

(1)

Excludes capital conservation buffer of 0.625% as of December 31, 2016.

(2)

Core capital is computed as a percentage of adjusted total assets of $2.40 billion for consolidated and $2.39 billion for the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.25 billion for consolidated and the Bank.

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Prompt Corrective Action - The federal banking agencies have established a system of “prompt corrective action” to resolve certain problems of undercapitalized institutions. This system is based on five capital level categories for insured depository institutions: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The federal banking agencies may (or in some cases must) take certain supervisory actions depending upon a bank's capital level. For example, the banking agencies must appoint a receiver or conservator for a bank within 90 days after it becomes "critically undercapitalized" unless the bank's primary regulator determines, with the concurrence of the FDIC, that other action would better achieve regulatory purposes. Banking operations otherwise may be significantly affected depending on a bank's capital category. For example, a bank that is not "well capitalized" generally is prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market, and the holding company of any undercapitalized depository institution must guarantee, in part, specific aspects of the bank's capital plan for the plan to be acceptable.

Effective January 1, 2015, in order to be "well-capitalized," a financial institution must have a common equity tier 1 capital ratio of 6.5%, a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital of at least 8% and a leverage ratio of at least 5%, and the institution must not be subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. As of December 31, 2016, First Federal met the ratio requirements in effect at that date to be deemed "well-capitalized." See Note 17 of the Notes to Consolidated Financial Statements which is incorporated herein by reference.

Dividends - Dividends paid by First Federal to First Defiance are subject to various regulatory restrictions. First Federal paid $22.0 million in dividends to First Defiance in 2016 and $29.0 million in 2015. First Federal can initiate dividend payments equal to its net profits (as defined by statute) for the last two fiscal years, plus any year to date net profits. First Insurance paid $1.2 million in dividends to First Defiance in 2016 and $900,000 in dividends in 2015. First Defiance Risk Management paid $1.0 million in dividends to First Defiance in 2016 and 2015.

First Defiance’s ability to pay dividends to its shareholders is primarily dependent on its receipt of dividends from the Subsidiaries. The Federal Reserve expects First Defiance to serve as a source of strength for First Federal and may require First Defiance to retain capital for further investment in First Federal, rather than pay dividends to First Defiance shareholders. Payment of dividends by First Federal may be restricted at any time at the discretion of its applicable regulatory authorities if they deem such dividends to constitute an unsafe or unsound banking practice. These provisions could have the effect of limiting First Defiance's ability to pay dividends on its common shares.

Transactions with Insiders and Affiliates - Loans to executive officers, directors and principal shareholders and their related interests must conform to the lending limits. Most loans to directors, executive officers and principal shareholders must be approved in advance by a majority of the “disinterested” members of board of directors of the association with any “interested” director not participating. All loans to directors, executive officers and principal shareholders must be made on terms substantially the same as offered in comparable transactions with the general public or as offered to all employees in a company-wide benefit program. Loans to executive officers are subject to additional restrictions. In addition, all related party transactions must be approved by the Company’s audit committee pursuant to NASDAQ Rule 5630, including loans made by financial institutions in the ordinary course of business. All transactions between savings associations and their affiliates must comply with Sections 23A and 23B of the Federal Reserve Act (“FRA”) and the Federal Reserve’s Regulation W. An affiliate of a savings association is any company or entity that controls, is controlled by, or is under common control with the savings association. First Defiance, First Defiance Risk Management and First Insurance are affiliates of First Federal.

Holding Company Regulation - First Defiance is a unitary thrift holding company and is subject to the Federal Reserve regulations, examination, supervision and reporting requirements. Federal law generally prohibits a thrift holding company from controlling any other savings association or thrift holding company, without prior approval of the Federal Reserve, or from acquiring or retaining more than 5% of the voting shares of a savings association or holding company thereof, which is not a subsidiary.

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Deposit Insurance - Substantially all of the deposits of First Federal are insured up to applicable limits by the Deposit Insurance Fund of the FDIC, and First Federal is assessed deposit insurance premiums to maintain the Deposit Insurance Fund. Insurance premiums for each insured institution are determined based upon the institution’s capital level and supervisory rating provided to the FDIC by the institution’s primary federal regulator and other information deemed by the FDIC to be relevant to the risk posed to the Deposit Insurance Fund by the institution. The assessment rate is then applied to the amount of the institution’s deposits to determine the institution’s insurance premium.

The deposit insurance assessment base is average assets less average tangible equity. The FDIC set a target size for the Deposit Insurance Fund at 2% of insured deposits and a lower assessment rate schedule when the fund reaches 1.15% and, in lieu of dividends, the FDIC rule provides for a lower rate schedule when the reserve ratio reaches 2% and 2.5%. On June 30, 2016, the Deposit Insurance Fund surpassed its target of 1.15%, decreasing the assessment base based on the final rules approved by the FDIC Board of Directors on February 7, 2011, and April 26, 2016. The change to the assessment base and assessment rates, as well as the Deposit Insurance Fund restoration time frame, has lowered First Defiance’s deposit insurance assessment.

In addition, the FDIC has proposed changing the deposit insurance premium assessment method for banks with less than $10 billion in assets that have been insured by the FDIC for at least five years. The proposed changes would revise the financial ratios method so that it would be based on a statistical model estimating the probability of failure of a bank over three years; update the financial measures used in the financial ratios method consistent with the statistical model; and eliminate risk categories for established small banks and using the financial ratios method to determine assessment rates for all such banks (subject to minimum or maximum initial assessment rates based upon a bank’s composite examination rating).

As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, federally-insured institutions. It also may prohibit any federally-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the Deposit Insurance Fund. The FDIC also has the authority to take enforcement actions against insured institutions. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement entered into with the FDIC. The management of First Federal does not know of any practice, condition or violation that might lead to termination of deposit insurance.

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Item 1A. Risk Factors

The risks listed below present risks that could have a material impact on the Company’s financial condition, results of operations, or business. The risks and uncertainties described below are the not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations.

Economic and financial market conditions may adversely affect First Defiance’s operations and financial condition.

First Defiance’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services First Defiance offers, is highly dependent upon the business environment in the markets where the Company operates, mainly in the State of Ohio and in the Great Lake Region. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, low unemployment, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy and other factors beyond First Defiance’s control may adversely affect its deposit levels and composition, demand for loans, the ability of its borrowers to repay their loans and the value of the collateral securing the loans it makes. Economic turmoil in Europe and Asia and changes in oil production in the Middle East affect the economy and stock prices in the United States, which can affect First Defiance’s earnings and capital and the ability of its customers to repay loans. Because First Defiance has a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property used as collateral and First Defiance’s ability to sell the collateral upon foreclosure.

First Defiance’s loan portfolio includes a concentration of commercial real estate loans and commercial loans, which involve risks specific to real estate value and the successful operations of these businesses.

At December 31, 2016, First Federal’s portfolio of commercial real estate loans totaled $1.0 billion, or approximately 51.1% of total loans. First Federal’s commercial real estate loans typically have higher principal amounts than residential real estate loans, and many of our commercial real estate borrowers have more than one loan outstanding. As a result, an adverse development on one loan can expose First Defiance to greater risk of loss on other loans. Additionally, repayment of the loans is generally dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. Economic conditions and events outside of the control of the borrower or lender could negatively impact the future cash flow and market values of the affected properties.

At December 31, 2016, First Federal’s portfolio of commercial loans totaled $469.1 million, or approximately 23.1% of total loans. Commercial loans generally expose First Defiance to a greater risk of nonpayment and loss than commercial real estate or residential real estate loans since repayment of such loans often depends on the successful operations and income stream of the borrowers. First Federal’s commercial loans are primarily made based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower such as accounts receivable, inventory, machinery or real estate. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. The collateral securing other loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any exists.

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First Defiance targets its business lending towards small and medium-sized businesses, many of which have fewer financial resources than larger companies and may be more susceptible to economic downturns. If general economic conditions negatively impact these businesses, First Defiance’s results of operations and financial condition may be adversely affected.

Increases to the allowance for loan losses may cause First Defiance’s earnings to decrease.

First Federal makes a number of assumptions and judgments about the collectability of its loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In determining the amount of the allowance for loan losses, First Federal relies on loan quality reviews, past loss experience, and an evaluation of economic conditions, among other factors. If its assumptions prove to be incorrect, First Federal’s allowance for loan losses may not be sufficient to cover actual losses, resulting in additions to the allowance. In addition, bank regulators periodically review First Federal’s allowance and may require First Federal to increase its allowance. Material additions to the allowance and any loan losses that exceed First Federal’s reserves would materially adversely affect First Defiance’s results of operations and financial condition.

Changes in interest rates can adversely affect First Defiance’s profitability.

First Defiance’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond First Defiance’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Open Market Committee. Changes in monetary policy, including changes in interest rates, could influence not only the interest First Defiance receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) First Defiance’s ability to originate loans and obtain deposits, (ii) the fair value of First Defiance’s financial assets and liabilities, and (iii) the average duration of certain assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, First Defiance’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on First Defiance’s results of operations and financial condition.

First Federal originates a significant amount of residential mortgage loans that it sells in the secondary market. The origination of residential mortgage loans is highly dependent on the local real estate market and the current interest rates. Increasing interest rates tend to reduce the origination of loans for sale and consequently fee income, which First Defiance reports as mortgage banking income. Conversely, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the value of mortgage servicing rights on the loans sold to be lower than originally anticipated. If this happens, First Defiance may be required to write down the value of its mortgage servicing rights faster than anticipated, which will increase expense and lower earnings. Accelerated repayments on loans and mortgage backed securities could result in the reinvestment of funds at lower rates than the loans or securities were paying.

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Laws and regulations may affect First Defiance’s results of operations.

The earnings of financial institutions are affected by the regulations and policies of various regulatory authorities, including the Federal Reserve, the OCC, the FDIC and the CFPB. The Federal Reserve has extensive supervisory authority over the Company, affecting a comprehensive range of matters relating to ownership and control of First Defiance’s shares, First Defiance’s acquisition of other companies and businesses, permissible activities for the Company to engage in, maintenance of adequate capital levels and other aspects of operations. These supervisory and regulatory powers are intended primarily for the protection of First Defiance’s depositors and borrowers and the deposit insurance fund, rather than First Defiance’s shareholders.

Comprehensive revisions to the regulatory capital framework were finalized by the Federal Reserve, the OCC, and the FDIC in 2013. The revised regulations change what qualifies as regulatory capital, raises minimum requirements, and introduces the concept of additional capital buffers. The need to maintain more and higher quality capital as well as greater liquidity going forward could limit our business activities, including lending, and our ability to expand, either organically or through acquisitions. In addition, the new liquidity standards could require us to increase our holdings of highly liquid short-term investments, thereby reducing our ability to invest in longer-term assets even if more desirable from a balance sheet management perspective.

The laws and regulations applicable to the banking industry could change at any time. The potential exists for new laws and regulations, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations. Increased regulation could increase First Defiance’s cost of compliance and reduce its income to the extent that they limit the manner in which First Defiance may conduct business, including its ability to offer new products, charge fees for specific products and services, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads.

First Defiance’s ability to meet cash flow needs on a timely basis at a reasonable cost may adversely affect net income.

First Defiance’s principal sources of liquidity are local deposits and wholesale funding sources such as FHLB advances, Federal Funds purchased, securities sold under repurchase agreements, and brokered or other out-of-market certificate of deposit purchases. Also, First Defiance maintains a portfolio of securities that can be used as a secondary source of liquidity. First Defiance’s access to funding sources in amounts adequate to finance or capitalize its activities or on terms that are acceptable could be impaired by factors that affect First Defiance directly or the financial services industry or economy in general, such as further disruptions in the financial markets or negative views and expectations about the prospects for the financial services industry.

Other possible sources of liquidity include the sale or securitization of loans, the issuance of additional collateralized borrowings beyond those currently utilized with the FHLB, the issuance of debt securities and the issuance of preferred or common securities in public or private transactions, or borrowings from a commercial bank. First Defiance does not currently have any borrowings from a commercial bank, but it has used them in the past.

Any decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, pay dividends to First Defiance’s shareholders, or fulfill obligations such as repaying First Defiance’s borrowings or meeting deposit withdrawal demands, any of which could have a material adverse impact on our liquidity, business, results of operations and financial condition.

Competition affects First Defiance’s earnings.

First Defiance’s continued profitability depends on its ability to continue to effectively compete to originate loans and attract and retain deposits. Competition for both loans and deposits is intense in the financial services industry. The Company competes in its market area by offering superior service and competitive rates and products. The type of institutions First Defiance competes with include large regional commercial banks, smaller community banks, savings institutions, mortgage banking firms, credit unions, finance companies, brokerage firms, insurance agencies and mutual funds. As a result of their size and ability to achieve economies of scale, certain of First Defiance’s competitors can offer a broader range of products and services than the Company can offer. To stay competitive in its market area, First Defiance may need to adjust the interest rates on its products to match rates of its competition, which could have a negative impact on net interest margin.

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The increasing complexity of First Defiance’s operations presents varied risks that could affect its earnings and financial condition.

First Defiance processes a large volume of transactions on a daily basis and is exposed to numerous types of risks related to internal processes, people and systems. These risks include, but are not limited to, the risk of fraud by persons inside or outside the Company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, breaches of data security and our internal control system and compliance with a complex array of consumer and safety and soundness regulations. First Defiance could also experience additional loss as a result of potential legal actions that could arise as a result of operational deficiencies or as a result of noncompliance with applicable laws and regulations.

First Defiance has established and maintains a system of internal controls that provides management with information on a timely basis and allows for the monitoring of compliance with operational standards. These systems have been designed to manage operational risks at an appropriate, cost effective level. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. Losses from operational risks may still occur, however, including losses from the effects of operational errors.

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of the Company’s computer systems or otherwise, could severely harm its business.

Potential misuse of funds or information by First Defiance’s employees or by third parties could result in damage to First Defiance’s customers for which First Defiance could be held liable, subject First Defiance to regulatory sanctions and otherwise adversely affect First Defiance’s financial condition and results of operations.

First Defiance’s employees handle a significant amount of funds, as well as financial and personal information. Although First Defiance has implemented systems to minimize the risk of fraudulent taking or misuse of funds or information, there can be no assurance that such systems will be adequate or that a taking or misuse of funds or information by employees, by third parties who have authorized access to funds or information, or by third parties who are able to access funds or information without authorization will never occur. First Defiance could be held liable for such an event and could also be subject to regulatory sanctions. First Defiance could also incur the expense of developing additional controls to prevent future such occurrences. Although First Defiance has insurance to cover such potential losses, First Defiance cannot provide assurance that such insurance will be adequate to meet any liability. In addition, any loss of trust or confidence placed in First Defiance by our clients could result in a loss of business, which could adversely affect our financial condition and results of operations.

First Defiance could suffer a material adverse impact from interruptions in the effective operation of, or security breaches affecting, First Defiance’s computer systems.

First Defiance relies heavily on information systems to conduct our business and to process, record, and monitor transactions. Risks to the system could result from a variety of factors, including the potential for bad acts on the part of hackers, criminals, employees and others. As one example, some banks have experienced denial of service attacks in which individuals or organizations flood the bank’s website with extraordinarily high volumes of traffic, with the goal and effect of disrupting the ability of the bank to process transactions. First Defiance is also at risk for the impact of natural disasters, terrorism and international hostilities on its systems or for the effects of outages or other failures involving power or communications systems operated by others. These risks also arise from the same types of threats to businesses with which First Defiance deals.

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Potential adverse consequences of attacks on First Defiance’s computer systems or other threats include damage to First Defiance’s reputation, loss of customer business, litigation and increased regulatory scrutiny, which might also result in financial loss and require additional efforts and expense to attempt to prevent such adverse consequences in the future.

If First Defiance forecloses on collateral property resulting in First Defiance’s ownership of the underlying real estate, First Defiance may be subject to the increased costs associated with the ownership of real property, resulting in reduced income.

A significant portion of First Defiance’s loan portfolio is secured by real property. During the ordinary course of business, First Defiance may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, First Defiance may be liable for remediation costs, as well as for personal injury and property damage.

In addition, when First Defiance forecloses on real property, the amount First Defiance realizes after a default is dependent upon factors outside of First Defiance’s control, including, but not limited to, economic conditions, neighborhood real estate values, interest rates, real estate taxes, operating expenses of the mortgaged properties, zoning laws, governmental rules, regulations and fiscal policies, and acts of God. Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of operating real property may exceed the rental income earned from such property, and First Defiance may have to sell the property at a loss. The foregoing expenditures could adversely affect First Defiance’s financial condition and results of operations.

First Defiance’s business strategy includes planned growth. First Defiance’s financial condition and results of operations could be negatively affected if First Defiance fails to grow or fails to manage its growth effectively.

First Defiance’s ability to grow successfully will depend on a variety of factors, including the continued availability of desirable business opportunities, its ability to integrate acquisitions and manage growth and First Defiance’s ability to raise capital. There can be no assurance that growth opportunities will be available.

First Defiance may acquire other financial institutions or parts of institutions in the future, open new branches, and consider new lines of business and new products or services. Expansions of its business would involve a number of expenses and risks, including:

the time and costs associated with identifying and evaluating potential acquisitions or expansions into new markets;

the potential inaccuracy of estimates and judgments used to evaluate the business and risks with respect to target institutions;

the time and costs of hiring local management and opening new offices;

the delay between commencing making acquisitions or engaging in new activities and the generation of profits from the expansion;

First Defiance’s ability to finance an expansion and the possible dilution to existing shareholders;

the diversion of management’s attention to the expansion;

management’s lack of familiarity with new market areas;

the integration of new products and services and new personnel into First Defiance’s existing business;

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the incurrence and possible impairment of goodwill associated with an acquisition and effects on First Defiance’s results of operations; and

the risk of loss of key employees and customers.

If First Defiance’s growth involves the acquisition of companies through merger, the success of the merger will depend on, among other things, First Defiance’s ability to combine the businesses in a manner that permits growth opportunities and cost efficiencies, and does not cause inconsistencies in standards, controls, procedures and policies that adversely affect the ability of First Defiance to maintain relationships with customers and employees or to achieve the anticipated benefits of the merger.

Failure to manage First Defiance’s growth effectively could have a material adverse effect on its business, future prospects, financial condition or results of operations and could adversely affect First Defiance’s ability to successfully implement its business strategy.

First Defiance’s ability to pay dividends is subject to regulatory limitations which, to the extent First Defiance requires such dividends in the future, may affect its ability to pay dividends or repurchase its stock.

As a savings and loan holding company, First Defiance is a separate legal entity from First Federal and does not have significant operations of its own. Dividends from First Federal provide a significant source of capital for First Defiance. The availability of dividends from First Federal is limited by various statutes and regulations. The federal banking regulators require that insured financial institutions and their holding companies should generally only pay dividends out of current operating earnings. It is possible, depending upon the financial condition of First Federal and other factors, that the OCC, as First Federal’s primary regulator, could assert that the payment of dividends or other payments by First Federal are an unsafe or unsound practice. In the event First Federal is unable to pay dividends to First Defiance, First Defiance may not be able to pay its obligations as they become due, repurchase its stock, or pay dividends on its common stock. Consequently, the potential inability to receive dividends from First Defiance could adversely affect First Defiance’s business, financial condition, results of operations or prospects.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

At December 31, 2016, First Federal conducted its business from its main office at 601 Clinton Street, Defiance, Ohio, and thirty-three other full-service banking centers in northwest Ohio, northeast Indiana and southeast Michigan. First Insurance conducted its business from leased office space at 511 Fifth Street, Defiance, Ohio; 209 West Poe Road, Bowling Green, Ohio; 204 East High Street, Bryan, Ohio; 1755 Indian Wood Circle, Maumee, Ohio; 4350 Navarre Ave, Oregon, Ohio and 2600 Allentown Road, Lima, Ohio.

In August 2016, First Federal received approval to transition its loan production office at 4501 Cemetery Road, Hilliard, Ohio to a full-service branch. The transition will be completed late in the first quarter of 2017. This office is owned.

First Defiance maintains its headquarters in the main office of First Federal at 601 Clinton Street, Defiance, Ohio. Back-office operation departments, including information technology, loan processing and underwriting, deposit processing, accounting and risk management are headquartered in an operations center located at 25600 Elliott Road, Defiance, Ohio.

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The following table sets forth certain information with respect to the offices and other properties of the Company at December 31, 2016. See Note 9 to the Consolidated Financial Statements.

	Leased/	Net Book Value
Description/address	Owned	of Property		Deposits
		(In Thousands)
Main Office, First Federal
601 Clinton St., Defiance, OH	Owned	$	3,225	$	230,654
Operations Center
25600 Elliott Rd., Defiance, OH	Owned		4,807		N/A
Mobile Banking
1011 W. Beecher St., Adrian, MI	Owned		170		N/A
Branch Offices, First Federal
204 E. High St., Bryan, OH	Owned		538		157,476
211 S. Fulton St., Wauseon, OH	Owned		345		75,865
625 Scott St., Napoleon, OH	Owned		877		79,074
1050 E. Main St., Montpelier, OH	Owned		225		43,705
1800 Scott St., Napoleon, OH	Owned		1,126		32,747
1177 N. Clinton St., Defiance, OH	Owned, Land Lease		730		41,753
905 N. Williams St., Paulding, OH	Owned		653		85,946
201 E. High St., Hicksville, OH	Owned		288		29,753
3900 N. Main St., Findlay, OH	Owned		813		56,206
1694 N. Countyline St., Fostoria, OH	Owned		561		53,499
1226 W. Wooster St., Bowling Green, OH	Owned		877		113,248
301 S. Main St., Findlay, OH	Owned		786		66,427
405 E. Main St., Ottawa, OH	Owned		279		92,914
124 E. Main St., McComb, OH	Owned		160		22,646
7591 Patriot Dr., Findlay, OH	Owned		1,029		45,127
417 W. Dussel Dr., Maumee, OH	Owned, Land Lease		707		76,061
230 E. Second St., Delphos, OH	Owned		862		98,143
105 S. Greenlawn Ave., Elida, OH	Owned		284		42,443
2600 Allentown Rd., Lima, OH	Owned		929		44,419
22020 W. State Rt. 51, Genoa, OH	Owned		736		33,705
3426 Navarre Ave., Oregon, OH	Owned		810		38,547
1077 Louisiana Ave., Perrysburg, OH	Owned		389		41,871
2565 Shawnee Rd., Lima, OH	Owned		1,253		39,393
1595 W. Dupont Rd., Fort Wayne, IN	Leased		-		19,549
135 S. Main St., Glandorf, OH	Leased		-		16,474
300 N. Main St., Adrian, MI	Owned		613		82,230
1701 W. Maumee St., Adrian, MI	Owned		190		47,233
211 W. Main St., Morenci, MI	Owned		165		30,416
539 S. Meridian Hwy., Hudson, MI	Owned		494		45,950
1449 W. Chicago Blvd., Tecumseh, MI	Owned		1,384		59,648
1200 N. Main St., Bowling Green OH	Owned		1,558		10,093
9909 Illinois Rd, Fort Wayne, IN	Owned		1,931		26,915
4501 Cemetery Rd, Hilliard, OH	Owned		966		270
2920 W. Central Ave., Toledo, OH	Owned		165		1,228

First Insurance Group
511 Fifth St., Defiance, OH	Leased		463		N/A
209 W. Poe Rd., Bowling Green, OH	Leased		-		N/A
204 E. High St., Bryan, OH	Leased		-		N/A
1755 Indian Wood Cir., Maumee, OH	Leased		-		N/A
4350 Navarre Ave., Oregon, OH	Leased		-		N/A
2600 Allentown Rd., Lima, OH	Leased		-		N/A
		$	31,388	$	1,981,628

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Item 3. Legal Proceedings

First Defiance is involved in routine legal proceedings that are incidental to and occur in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of First Defiance.

Item 4. Mine Safety Disclosures

Not applicable.

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common shares trade on The NASDAQ Global Select Market under the symbol “FDEF.” As of February 20, 2017, the Company had approximately 1,782 shareholders of record.

The table below shows the reported high and low sales prices of the common shares and cash dividends declared per common share during the periods indicated in 2016 and 2015.

	Year Ending
	December 31, 2016						December 31, 2015
	High		Low		Dividend		High		Low		Dividend

Quarter ended:
March 31	$	40.98	$	34.80	$	0.22	$	34.64	$	29.05	$	0.175
June 30		41.21		37.53		0.22		38.21		32.42		0.20
September 30		46.83		35.90		0.22		39.95		35.03		0.20
December 31		52.31		36.91		0.22		42.46		35.01		0.20

The line graph below compares the yearly percentage change in cumulative total shareholder return on First Defiance common shares and the cumulative total return of the NASDAQ Composite Index, the SNL NASDAQ Bank Index and the SNL Midwest Thrift Index. An investment of $100 on December 31, 2011, and the reinvestment of all dividends are assumed. The performance graph represents past performance and should not be considered to be an indication of future performance.

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	*Period Ending*
Index	12/31/11		12/31/12		12/31/13		12/31/14		12/31/15		12/31/16
First Defiance Financial Corp.		100.00		133.10		183.16		245.58		278.23		381.92
NASDAQ Composite		100.00		117.45		164.57		188.84		201.98		219.89
SNL Bank NASDAQ		100.00		119.19		171.31		177.42		191.53		265.56
SNL Midwest Thrift		100.00		129.30		159.45		182.24		223.15		268.71

The following table provides information regarding First Defiance’s purchases of its common shares during the fourth quarter period ended December 31, 2016:

Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares (or Approximate Dollar Value) that May Yet Be Purchased Under the Plans or Programs (1)
October 1 – October 31, 2016		-	$	-		-		377,500
November 1 – November 30, 2016		-		-		-		377,500
December 1 – December 31, 2016		122		50.74		-		377,500
Total		122	$	50.74		-		377,500

(1)

On January 29, 2016, the Company announced that its Board of Directors authorized another program for the repurchase of up to 5% of the outstanding common shares or 450,000 shares. There is no expiration date for the new repurchase program.

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The information set forth under the caption “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters - Equity Compensation Plans” of this Form 10-K is incorporated herein by reference.

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Item 6.

Selected Financial Data

The following table is derived from the Company’s audited financial statements as of and for the five years ended December 31, 2016. The following consolidated selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes included elsewhere in this Form 10-K. The operating results of acquired companies are included with the Company’s results of operations since their respective dates of acquisition.

	As of and For the Year Ended December 31
	2016			2015			2014			2013			2012
	(Dollars in Thousands, Except Per Share Data)
Financial Condition:
Total assets	$	2,477,597		$	2,297,676		$	2,178,952		$	2,137,148		$	2,046,948
Investment securities		251,176			236,678			239,634			198,557			194,609
Loans receivable, net		1,914,603			1,776,835			1,622,020			1,555,498			1,498,546
Allowance for loan losses		25,884			25,382			24,766			24,950			26,711
Nonperforming assets (1)		14,803			17,582			30,311			33,706			36,375
Deposits and borrowers’ escrow balances		1,984,278			1,838,811			1,763,122			1,737,311			1,668,945
FHLB advances		103,943			59,902			21,544			22,520			12,796
Stockholders’ equity		293,018			280,197			279,505			272,147			258,128
Share Information:
Basic earnings per share		3.21			2.87			2.55			2.28			1.86
Diluted earnings per share		3.19			2.82			2.44			2.19			1.81
Book value per common share		32.62			30.78			30.17			27.91			26.44
Tangible book value per common share (2)		25.59			23.79			23.25			21.22			19.63
Cash dividends per common share		0.88			0.775			0.625			0.40			0.20
Dividend payout ratio		27.41	%		27.00	%		24.51	%		17.45	%		10.75	%
Weighted average diluted shares outstanding		9,035			9,371			9,969			10,171			9,998
Shares outstanding end of period		8,983			9,102			9,235			9,720			9,729
Operations:
Interest income	$	87,383		$	80,836		$	76,248		$	74,781		$	80,943
Interest expense		8,440			6,781			6,559			7,170			11,937
Net interest income		78,943			74,055			69,689			67,611			69,006
Provision for loan losses		283			136			1,117			1,824			10,924
Non-interest income		34,030			31,803			31,641			30,778			34,374
Non-interest expense		71,093			67,889			66,758			65,052			65,780
Income before tax		41,597			37,833			33,455			31,513			26,676
Federal income tax		12,754			11,410			9,163			9,278			8,012
Net Income		28,843			26,423			24,292			22,235			18,664
Performance Ratios:
Return on average assets		1.20	%		1.19	%		1.12	%		1.08	%		0.90	%
Return on average equity		10.10	%		9.52	%		8.78	%		8.39	%		6.99	%
Interest rate spread (2)		3.61	%		3.71	%		3.57	%		3.65	%		3.64	%
Net interest margin (2)		3.74	%		3.81	%		3.68	%		3.76	%		3.81	%
Ratio of operating expense to
average total assets		2.97	%		3.05	%		3.09	%		3.16	%		3.19	%
Efficiency ratio (2)		62.20	%		63.01	%		65.32	%		64.81	%		63.93	%
Other Ratios:
Equity to total assets at end of period		11.83	%		12.19	%		12.83	%		12.73	%		12.61	%
Average equity to average assets		11.91	%		12.49	%		12.79	%		12.92	%		12.95	%
Asset Quality Ratios:
Nonperforming assets to total assets
at end of period (1)		0.60	%		0.77	%		1.39	%		1.58	%		1.78	%
Allowance for loan losses to total
loans*		1.33	%		1.41	%		1.50	%		1.58	%		1.75	%
Net charge-offs (recoveries) to average loans		-0.01	%		-0.03	%		0.08	%		0.23	%		1.18	%

(1)

Nonperforming assets include non-accrual loans that are contractually past due 90 days or more and real estate, mobile homes and other assets acquired by foreclosure or deed-in-lieu thereof.

(2)

Refer to Non-GAAP Financial Measures in Item 7- Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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

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Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and Factors that Could Affect Future Results

Certain statements contained in this Annual Report on Form 10-K that are not statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (“Act”), notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Corporation that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per common share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of First Defiance or its management or Board of Directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as “believes”, “anticipates”, “expects”, “intends”, “targeted”, “continue”, “remain”, “will”, “should”, “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

Local, regional, national and international economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact.

Volatility and disruption in national and international financial markets.

Government intervention in the U.S. financial system.

Changes in the level of non-performing assets and charge-offs.

Changes in estimates of future reserve requirements based upon the periodic review thereof under relevant regulatory and accounting requirements.

The effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve.

Inflation, interest rate, securities market and monetary fluctuations.

Political instability.

Acts of God or of war or terrorism.

The timely development and acceptance of new products and services and perceived overall value of these products and services by users.

Changes in consumer spending, borrowing and saving habits.

Changes in the financial performance and/or condition of the Company’s borrowers.

Technological changes including core system conversions.

Acquisitions and integration of acquired businesses.

The ability to increase market share and control expenses.

Changes in the competitive environment among financial holding companies and other financial service providers.

The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which the Company and the Subsidiaries must comply.

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The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.

The costs and effects of legal and regulatory developments including the resolution of legal proceedings or regulatory or other governmental inquiries and the results of regulatory examinations or reviews.

Greater than expected costs or difficulties related to the integration of new products and lines of business.

The Company’s success at managing the risks involved in the foregoing items.

Forward-looking statements speak only as of the date on which such statements are made. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

The following section presents information to assess the financial condition and results of operations of First Defiance. This section should be read in conjunction with the Consolidated Financial Statements and the supplemental financial data contained elsewhere in this Annual Report on Form 10-K.

Non-GAAP Financial Measures

This document contains GAAP financial measures and certain non-GAAP financial measures which are presented as management believes they are helpful in understanding the Company’s results of operations or financial position. Fully taxable-equivalent (“FTE”) is an adjustment to net interest income to reflect tax-exempt income on an equivalent before-tax basis. The following tables present a reconciliation of non-GAAP measures to their respective GAAP measures at December 31, 2016 and 2015.

Non-GAAP Financial Measures – Net Interest Income on an FTE basis, Net Interest Margin and Efficiency Ratio
($ in Thousands)	December 31, 2016			December 31, 2015
Net interest income (GAAP)	$	78,943		$	74,055
Add: FTE adjustment		1,830			1,905
Net interest income on a FTE basis (1)	$	80,773		$	75,960

Noninterest income – less securities gains/losses (2)	$	33,521		$	31,781
Noninterest expense (3)		71,093			67,889
Average interest-earning assets less average unrealized gains/losses on securities(4)		2,160,561			1,993,311
Average interest-earning assets		2,153,076			1,986,145
Average unrealized gains/losses on securities		7,485			7,166

Ratios:
Net interest margin (1) / (4)		3.74	%		3.81	%
Efficiency ratio (3) / (1) + (2)		62.20	%		63.01	%

Non-GAAP Financial Measures – Tangible Book Value

($ in Thousands, except per share data)	December 31, 2016			December 31, 2015
Total Shareholders’ Equity (GAAP)	$	293,018		$	280,197
Less: Goodwill		(61,798	)		(61,798	)
Intangible assets		(1,336	)		(1,871	)
Tangible common equity (1)	$	229,884		$	216,528

Common shares outstanding (2)		8,983			9,102

Tangible book value per share (1) / (2)	$	25.59		$	23.79

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Overview

First Defiance is a unitary thrift holding company that conducts business through the Subsidiaries, First Federal, First Insurance and First Defiance Risk Management.

First Federal is a federally chartered stock savings bank that provides financial services to communities based in northwest Ohio, northeast Indiana, and southeastern Michigan where it operates 34 full service banking centers in twelve northwest Ohio counties, one northeast Indiana county, and one southeastern Michigan county. First Federal operates one loan production office in one central Ohio county, which will become a full-service branch late in the first quarter of 2017.

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 and wealth management services through its extensive branch network.

First Insurance sells a variety of property and casualty, group health and life and individual health and life insurance products. First Insurance is an insurance agency that does business in the Defiance, Bryan, Bowling Green, Lima, Maumee and Oregon, Ohio areas.

First Defiance Risk Management is a wholly owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. First Defiance Risk Management was incorporated on December 20, 2012.

Financial Condition

Assets at December 31, 2016 totaled $2.48 billion compared to $2.30 billion at December 31, 2015, an increase of $179.9 million or 7.8%. Cash and cash equivalents increased $19.2 million to $99.0 million at December 31, 2016 from $79.8 million at December 31, 2015. The increase in assets was due to an increase in loans receivable, net of undisbursed loan funds and deferred fees and costs, of $138.3 million and an increase in securities of $14.5 million. These increases were funded by increases in total deposits of $145.5 million and advances from the Federal Home Loan Bank of $44.0 million as well as from cash and cash equivalents.

Securities

The securities portfolio increased $14.5 million to $251.2 million at December 31, 2016. The 2016 activity in the portfolio included $71.3 million of purchases, $882,000 of amortization,, $36.4 million of principal pay-downs and maturities, and $14.9 million of securities being sold. There was a net decrease of $5.4 million in the market value of available-for-sale securities. For additional information regarding First Defiance’s investment securities see Note 5 to the Consolidated Financial Statements.

Loans

Loans receivable, net of undisbursed loan funds and deferred fees and costs, increased $138.3 million to $1.94 billion at December 31, 2016. For more details on the loan balances, see Note 7 – Loans Receivable in the Notes to the Consolidated Financial Statements.

The majority of First Defiance’s commercial real estate and commercial loans are to small and mid-sized businesses. The combined commercial, commercial real estate and multi-family real estate loan portfolios totaled $1.51 billion and $1.37 billion at December 31, 2016 and 2015, respectively, and accounted for approximately 74.2% and 73.1% of First Defiance’s loan portfolio at the end of those respective periods. First Defiance believes it has been able to establish itself as a leader in its market area in the commercial and commercial real estate lending area by hiring experienced lenders and providing a high level of customer service to its commercial lending clients.

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The 1-4 family residential portfolio totaled $207.6 million at December 31, 2016, compared with $205.3 million at the end of 2015. At the end of 2016, those loans comprised 10.2% of the total loan portfolio, down from 11.0% at December 31, 2015.

Construction loans, which include one-to-four family and commercial real estate properties, increased to $182.9 million at December 31, 2016 compared to $163.9 million at December 31, 2015. These loans accounted for approximately 9.0% and 8.7% of the total loan portfolio at December 31, 2016 and 2015, respectively.

Home equity and home improvement loans increased to $118.4 million at December 31, 2016, from $117.0 million at the end of 2015. At the end of 2016, those loans comprised 5.8% of the total loan portfolio, down slightly from 6.3% at December 31, 2015.

Consumer finance and mobile home loans were $16.7 million at December 31, 2016 up slightly from $16.3 million at the end of 2015. These loans accounted for approximately 0.8% and 0.9% of the total loan portfolio at December 31, 2016 and 2015, respectively.

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 significant 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 a determination of value.

First Federal generally does not require updated appraisals for performing loans unless significant 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 appropriate, based on First Federal’s assessment of the appraisal, such as age, market, etc. First Federal will discount the appraisal 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 selling costs. In most instances, if the appraisal is more than twelve to fifteen months old, a new appraisal may be required. Finally, First Federal assesses whether there is any collateral short fall, taking into consideration guarantor support and liquidity, and determines if a charge off is necessary.

All loans over 90 days past due and/or on non-accrual are classified as non-performing loans. Non-performing status automatically occurs in the month in which the 90-day delinquency occurs. When a collateral dependent loan moves to non-performing status, First Federal generally gets a new third party appraisal and charges the loan down appropriately 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 lower of cost or fair value, which is determined based on 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 and charge offs on classified loans, appraisal values may be discounted downward based upon First Federal’s experience with liquidating similar properties.

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Appraisals are received within approximately 60 days after they are requested. The First Federal Loan Loss Reserve Committee reviews the amount of each new appraisal and makes any necessary charge off decisions 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. First Federal may consider moving the loan to accruing status after approximately 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 loan to value quarterly to determine accuracy and any necessary charge offs. Based on these results, changes may occur in the processes used.

Loan modifications constitute a troubled debt restructuring (“TDR”) 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 TDRs, First Federal either computes the present value of expected future cash flows discounted at the original loan’s effective interest rate or it may measure impairment based on the fair value of the collateral. For those loans measured for impairment utilizing the present value of future cash flows method, any discount is carried as a specific reserve in the allowance for loan and lease losses. For those loans measured for impairment utilizing the fair value of the collateral, any shortfall is charged off. As of December 31, 2016 and December 31, 2015, First Federal had $10.5 million and $11.2 million, respectively, of loans that were still performing and which were classified as TDRs.

Allowance for Loan Losses

The allowance for loan losses represents management’s assessment of the estimated probable incurred 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 commercial loan and commercial real estate loan relationships. The goal is to have approximately 55% to 60% of the portfolio reviewed annually. This includes all relationships over $5.0 million with new exposure greater than $2.0 million and a sample of other relationships greater than $5.0 million; loan relationships between $1.0 million and $5.0 million with new exposure greater than $750,000 and a sample of other relationships between $1.0 million and $5.0 million; and a sample of relationships less than $1.0 million. 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 allowance for loan loss is made up of two basic components. The first component of the allowance for loan loss is the specific reserve in which the Company sets aside reserves based on the analysis of individual impaired credits. In establishing specific reserves, the Company analyzes all substandard, doubtful and loss graded loans 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 guarantors. If the loan is impaired and cash flow dependent, then a specific reserve is established for the discount on the net present value of expected future cash flows. If the loan is impaired and collateral dependent, then any shortfall is usually charged off. The Company also considers the impacts of any Small Business Association or Farm Service Agency guarantees. The specific reserve was $809,000 at December 31, 2016 and $437,000 at December 31, 2015.

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The second component is a general reserve, which is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the losses incurred in the portfolio based on quantitative and qualitative factors. For purposes of the general reserve analysis, the loan portfolio is stratified into nine different loan pools based on loan type to allocate historic loss experience. The loss experience factor is then applied to the non-impaired loan portfolio. Beginning June 30, 2015, the Company refined the methodology to its allowance for loan loss calculation pertaining to the general reserve component for non-impaired loans. There was no change to the calculation of the component for reserves on impaired loans. Within the general reserve, the determination of the historical loss component was modified from using a three-year average annual loss rate to a loss migration measurement. The loss migration measurement implemented June 30, 2015, utilized an average of four (4) four-year loss migration periods for each loan portfolio segment with differentiation between loan risk grades. Prior to June 30, 2015, the approach to this component quantified the historical loss by calculating a rolling twelve quarter average annual loss rate for each portfolio segment, without differentiation between loan risk grades. Beginning December 31, 2016 the historical loss calculation was changed from using a an average of four (4) four-year loss migration periods to using an average of all four-year loss migration periods to the present beginning with data from the second quarter 2011. Management believes this enhancement is consistent with the rationale of the previous measurement but provides a more precise calculation of historical losses by incorporating more data points for the average loss ratio and including periods that provide a more complete coverage of the full business cycle. Management believes that capturing the risk grade changes and cumulative losses over the life cycle of a loan more accurately depicts management’s estimate of historical losses as well as being more reflective of the ongoing risks in the loan portfolio. These modifications resulted in a change in the general reserves between the loan portfolio segments but did not have a material impact on the overall allowance for loan losses.

The stratification of the loan portfolio and the loss migration measurement described above resulted in a decrease to the quantitative general allowance to $8.7 million at December 31, 2016 from $9.8 million at December 31, 2015.

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. The overall qualitative factors are based on nine sub-factors. The nine sub-factors have been aggregated into three qualitative factors: economic, environment and risk.

ECONOMIC

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

Changes in the value of underlying collateral for collateral dependent loans.

ENVIRONMENT

Changes in the nature and volume in the loan portfolio.

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

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

Changes in the quality and breadth of the loan review process.

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

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RISK

Changes in the trends of the volume and severity of delinquent and classified loans, and changes in the volume of non-accrual loans, trouble debt restructuring, and other loan modifications.

Changes in the political and regulatory environment.

The qualitative analysis at December 31, 2016 indicated a general reserve of $16.4 million compared with $15.2 million at December 31, 2015. Management reviews the overall economic, environmental and risk factors quarterly and determines appropriate adjustments to these sub-factors based on that review.

The economic factors for all loan segments were increased in 2016 due to the uncertain global economic conditions and related market volatility which presented higher than normal risks to the U.S. economy.

The environmental factors have increased in 2016 in the commercial real estate and commercial loan segments due to the significant growth in balances achieved amidst highly competitive conditions on pricing and terms and balances generated in our metro markets. There was also a continued increase in the volume of loans greater than $10 million and an increase in loans to our most significant borrowers. The environmental factors for residential, consumer, home equity and construction loans were decreased during 2016 due to the stability and maturity of the lending staff.

The risk factors in all loan segments except consumer were decreased in 2016 due to the continued decrease in the level of non-accrual loans, troubled debt restructurings and OREO since December 31, 2015.

First Defiance’s general reserve percentages for main loan segments not otherwise classified ranged from 0.50% for construction loans to 1.71% for home equity and improvement loans.

As a result of the quantitative and qualitative analysis, along with the change in specific reserves, the Company’s provision for loan losses for 2016 was $283,000 compared to $136,000 for 2015. The allowance for loan losses was $25.9 million at December 31, 2016 and $25.4 million at December 31, 2015 and represented 1.33% and 1.41% of loans, net of undisbursed loan funds and deferred fees and costs, respectively. The decrease in the quantitative reserves and the lower level of charge offs was offset by the increase in the qualitative reserve and specific reserve. The provision was offset by charge offs of $1.4 million and recoveries of $1.6 million resulting in an increase to the overall allowance for loan loss of $502,000. In management’s opinion, the overall allowance for loan losses of $25.9 million as of December 31, 2016 is adequate.

Management also assesses the value of OREO 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 2016, First Defiance recorded OREO write-downs that totaled $74,000. These amounts were included in other non-interest expense. Management believes that the values recorded at December 31, 2016 for OREO and repossessed assets represent the realizable value of such assets.

Total classified loans decreased significantly to $27.5 million at December 31, 2016, compared to $49.1 million at December 31, 2015.

First Defiance’s ratio of allowance for loan losses to non-performing loans was 180.4% at December 31, 2016 compared with 156.1% at December 31, 2015. Management monitors collateral values of all loans included on the watch list that are collateral dependent and believes that allowances for those loans at December 31, 2016 are appropriate.

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At December 31, 2016, First Defiance had total non-performing assets of $14.8 million, compared to $17.6 million at December 31, 2015. Non-performing assets include loans that are 90 days past due, real estate owned and other assets held for sale.

The decrease in non-performing assets between December 31, 2016 and December 31, 2015 is in commercial loans and real estate owned. The balance of commercial non-performing loans was $2.1 million lower at December 31, 2016 compared to December 31, 2015. The balance of OREO was $866,000 lower at December 31, 2016 compared to December 31, 2015.

Non-performing loans in the single-family residential, commercial real estate and commercial loan categories represent 1.41%, 0.92% and 0.21% of the total loans in those categories respectively at December 31, 2016 compared to 1.27%, 1.04% and 0.73% respectively for the same categories at December 31, 2015. Management believes that the current allowance for loan losses is appropriate and that the provision for loan losses recorded in 2016 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 proposed charge-offs which are approved by the Senior Loan Committee or the Loan Loss Reserve Committee.

For the twelve months ended and as of December 31, 2016, commercial real estate, which represented 51.15% of total loans, accounted for a net recovery of 379.45% and 66.85% of nonaccrual loans, and commercial loans, which represented 23.01% of total loans, accounted for 127.85% of net charge offs and 7.02% of nonaccrual loans. For the twelve months ended and as of December 31, 2015, commercial real estate, which represented 50.71% of total loans, accounted for a net recovery of 93.33% and 60.56% of nonaccrual loans, and commercial loans, which represented 22.42% of total loans, accounted for 54.79% of net recoveries and 18.93% of nonaccrual loans.

Table 1 – Net Charge-offs and Non-accruals by Loan Type

	For the Twelve Months Ended December 31, 2016						As of December 31, 2016
	Net			% of Total Net
	Charge-offs			Charge-offs			Nonaccrual		% of Total Non-
	(Recoveries)			(Recoveries)			Loans		Accrual Loans
	(In Thousands)						(In Thousands)
Residential	$	184			84.02	%	$	2,928		20.41	%
Construction		-			0.00	%		-		0.00	%
Commercial real estate		(831	)		(379.45	)%		9,592		66.85	%
Commercial		280			127.85	%		1,007		7.02	%
Consumer finance		30			13.70	%		91		0.63	%
Home equity and improvement		118			53.88	%		730		5.09	%
Total	$	(219	)		(100.00	)%	$	14,348		100.00	%

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	For the Twelve Months Ended December 31, 2015						As of December 31, 2015
	Net			% of Total Net			Nonaccrual		% of Total Non-
	Charge-offs			Charge-offs			Loans		Accrual Loans
	(In Thousands)						(In Thousands)
Residential	$	69			14.38	%	$	2,610		16.05	%
Construction		-			0.00	%		-		0.00	%
Commercial real estate		(448	)		(93.33	)%		9,848		60.56	%
Commercial		(263	)		(54.79	)%		3,078		18.93	%
Consumer finance		-			0.00	%		36		0.22	%
Home equity and improvement		162			33.74	%		689		4.24	%
Total	$	(480	)		(100.00	)%	$	16,261		100.00	%

The following table sets forth information concerning the allocation of First Defiance’s allowance for loan losses by loan categories at December 31, 2016 and 2015.

Table 2 – Allowance for Loan Loss Allocation by Loan Category

	December 31, 2016					December 31, 2015
			Percent of					Percent of
			total loans					total loans
	Amount		by category			Amount		by category
	(Dollars in Thousands)
1-4 family residential	$	2,627		10.2	%	$	3,212		11.0	%
Multi-family residential real estate		2,228		9.7			2,151		9.0
Commercial real estate		10,625		41.5			11,772		41.8
Construction		450		9.0			517		8.7
Commercial loans		7,361		23.0			5,192		22.4
Home equity and improvement loans		2,386		5.8			2,270		6.2
Consumer loans		207		0.8			171		0.9
	$	25,884		100.0	%	$	25,382		100.0	%

Loans Acquired with Impairment

Certain loans acquired had evidence that the credit quality of the loan had deteriorated since its origination and, in management’s assessment at the acquisition date, it was probable that First Defiance would be unable to collect all contractually required payments due. In accordance with FASB ASC Topic 310 Subtopic 30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, these loans were recorded based on management’s estimate of the fair value of the loans.

As of December 31, 2016, the total contractual receivable for those loans was $66,000 and the recorded value was $11,000.

High Loan-to-Value Mortgage Loans

The majority of First Defiance’s mortgage loans are collateralized by one-to-four-family residential real estate, have loan-to-value ratios of 80% or less, and are made to borrowers in good credit standing. First Federal usually requires residential mortgage loan borrowers whose loan-to-value is greater than 80% to purchase private mortgage insurance (“PMI”). Management also periodically reviews and monitors the financial viability of its PMI providers.

First Federal originates and retains a limited number of residential mortgage loans with loan-to-value ratios that exceed 80% where PMI is not required if the borrower possesses other demonstrable strengths. The loan-to-value ratios on these loans are generally limited to 85% and exceptions must be approved by First Federal’s senior loan committee. Management monitors the balance of one-to-four family residential loans, including home equity loans and committed lines of credit that exceed certain loan to value standards (90% for owner occupied residences, 85% for non-owner occupied residences and one-to-four family construction loans, 75% for developed land and 65% for raw land). Total loans that exceed those standards described above at December 31, 2016 totaled $42.8 million, compared to $46.3 million at December 31, 2015. These loans are generally paying as agreed.

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First Defiance does not make interest-only first-mortgage residential loans, nor does it have residential mortgage loan products or other consumer products that allow negative amortization.

Goodwill and Intangible Assets

Goodwill was $61.8 million at December 31, 2016 and December 31, 2015. Core deposit intangibles and other intangible assets decreased to $1.3 million at December 31, 2016 compared to $1.9 million at December 31, 2015. During 2016, changes to the core deposit intangibles and other intangibles were due to the recognition of $535,000 of amortization expense. No impairment of goodwill was recorded in 2016 or 2015.

Deposits

Total deposits at December 31, 2016 were $1.98 billion compared to $1.84 billion at December 31, 2015, an increase of $145.5 million or 7.9%. Non-interest bearing checking accounts grew by $67.0 million, interest bearing checking accounts and money markets grew by $49.5 million, savings grew by $23.7 million and retail certificates of deposit grew by $5.3 million. Management can utilize the national market for certificates of deposit to supplement its funding needs if necessary. For more details on the deposit balances in general see Note 11 – Deposits in the Notes to the Consolidated Financial Statements.

Borrowings

FHLB advances totaled $103.9 million at December 31, 2016 compared to $59.9 million at December 31, 2015. The balance at the end of 2016 includes $5.0 million of convertible advances with a rate of 2.35%. This advance is callable by the FHLB, at which point it would convert to a three-month LIBOR advance if not paid off. This advance has a final maturity date in 2018. In addition, First Defiance has ten fixed-rate advances totaling $92.0 million with rates ranging from 0.99% to 2.16% and one amortizing advance totaling $6.9 million with a rate of 1.78%.

At December 31, 2016, First Defiance also had $31.8 million of securities that were sold with agreements to repurchase, compared to $57.2 million at December 31, 2015.

Equity

Total stockholders’ equity increased $12.8 million to $293.0 million at December 31, 2016. This increase is a result of net income of $28.8 million and capital of $714,000 from the exercise of 37,970 net shares under stock option plans, which was partially offset by repurchasing 167,868 shares of common stock totaling $6.3 million and $7.9 million of common stock dividends being paid in 2016. In 2015, 225,808 shares were repurchased, resulting in an $8.4 million decrease in stockholders’ equity, and 73,800 net shares were exercised under stock option plans resulting in a $1.5 million increase in stockholder’s equity.

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Results of Operations

Summary

First Defiance reported net income of $28.8 million for the year ended December 31, 2016 compared to $26.4 million and $24.3 million for the years ended December 31, 2015 and 2014, respectively. On a diluted per common share basis, First Defiance earned $3.19 in 2016, $2.82 in 2015 and $2.44 in 2014.

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.

Net interest income was $78.9 million for the year ended December 31, 2016 compared to $74.1 million and $69.7 million for the years ended December 31, 2015 and 2014, respectively. The tax-equivalent net interest margin was 3.74%, 3.81% and 3.68% for the years ended December 31, 2016, 2015 and 2014, respectively. The margin decreased 7 basis points between 2015 and 2016. Interest-earning asset yields decreased 2 basis points (to 4.13% in 2016 from 4.15% in 2015) and the cost of interest bearing liabilities between the two periods increased 8 basis points (to 0.52% in 2016 from 0.44% in 2015).

Total interest income increased by $6.6 million or 8.1% to $87.4 million for the year ended December 31, 2016 from $80.8 million for the year ended December 31, 2015. The increase in interest income was due to the significant increase in loan volume. The average balance of loans receivable increased $166.0 million to $1.85 billion at December 31, 2016 from $1.69 billion at December 31, 2015. Interest income from loans increased to $80.2 million for 2016 compared to $73.3 million in 2015, which represents an increase of 9.4%.

During the same period, the average balance of investment securities decreased to $233.4 million for 2016 from $239.9 million for the year ended December 31, 2015. Interest income from investment securities decreased to $6.2 million in 2016 compared to $6.8 million in 2015, which represents a decrease of 7.7%. The overall duration of investments decreased to 3.6 years at December 31, 2016 from 4.2 years at December 31, 2015.

Interest expense increased by $1.6 million in 2016 compared to 2015, to $8.4 million from $6.8 million. This increase was mainly due to an eight basis point increase in the average cost of interest-bearing liabilities in 2016 and a $110.2 million increase in the average balance of interest-bearing liabilities. The average balance of interest bearing deposits increased $64.3 million to $1.46 billion at December 31, 2016 from $1.40 billion at December 31, 2015. Interest expense related to interest-bearing deposits was $6.3 million in 2016 compared to $5.3 million in 2015. Interest expenses on FHLB advances and other interest-bearing funding sources were $1.3 million and $138,000 respectively, in 2016 and $675,000 and $152,000 respectively in 2015. The increase in FHLB advance expense was due to a $47.7 million increase in the average balance of FHLB advances to $85.9 million at December 31, 2016 compared to $38.1 million at December 31, 2015. Interest expense recognized by the Company related to subordinated debentures was $753,000 in 2016 and $613,000 in 2015 due to rising rates.

Total interest income increased by $4.6 million or 6.0% to $80.8 million for the year ended December 31, 2015 from $76.2 million for the year ended December 31, 2014. The increase in interest income was due to the significant increase in loan volume and deploying lower yielding interest bearing deposit balances into higher yielding loans. The average balance of interest bearing deposits decreased to $59.4 million from $134.1 million at December 31, 2014. Interest income from loans increased to $73.3 million for 2015 compared to $68.7 million in 2014, which represents an increase of 6.8%.

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During the same period, the average balance of investment securities increased to $239.9 million for 2015 from $223.5 million for the year ended December 31, 2014. Interest income from investment securities increased to $6.8 million in 2015 compared to $6.6 million in 2014, which represents an increase of 3.0%. The overall duration of investments decreased to 4.2 years at December 31, 2015 from 4.9 years at December 31, 2014.

Interest expense increased by $222,000 in 2015 compared to 2014, to $6.8 million from $6.6 million. This increase was mainly due to a one basis point increase in the average cost of interest-bearing liabilities in 2015. Interest expense related to interest-bearing deposits was $5.3 million in 2015 and 2014. Expenses on FHLB advances and other interest-bearing funding sources were $675,000 and $152,000 respectively in 2015 and $528,000 and $161,000 respectively in 2014. Interest expense recognized by the Company related to subordinated debentures was $613,000 in 2015 and $587,000 in 2014 due to rising rates.

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The following table shows an analysis of net interest margin on a tax equivalent basis for the years ended December 31, 2016, 2015 and 2014:

Table 3 – Net Interest Margin

	Year Ended December 31
	(In Thousands)
	2016							2015							2014
	Average Balance		Interest (1)		Yield/ Rate (2)			Average Balance		Interest (1)		Yield/ Rate			Average Balance		Interest (1)		Yield/ Rate

Interest-Earning Assets:
Loans receivable (5)	$	1,853,419	$	80,423		4.34	%	$	1,687,413	$	73,544		4.36	%	$	1,574,753	$	68,828		4.37	%
Securities (6)		233,407		7,871		3.48	%		239,852		8,476		3.64	%		223,534		8,227		3.79	%
Interest-earning deposits		67,420		367		0.54	%		59,410		169		0.27	%		134,114		349		0.26	%
FHLB stock		13,800		552		4.00	%		13,802		552		4.00	%		14,677		642		4.37	%
Total interest-earning assets		2,168,046		89,213		4.13	%		2,000,477		82,741		4.15	%		1,947,078		78,046		4.01	%
Non-interest-earning assets		229,393							222,389							215,390

Total Assets	$	2,397,439						$	2,222,866						$	2,162,468

Interest-Bearing Liabilities:
Interest-bearing deposits	$	1,463,890	$	6,261		0.43	%	$	1,399,619	$	5,341		0.38	%	$	1,399,507	$	5,283		0.38	%
FHLB advances		85,856		1,288		1.50	%		38,134		675		1.77	%		21,995		528		2.40	%
Subordinated debentures		36,141		753		2.09	%		36,129		613		1.70	%		36,131		587		1.62	%
Other borrowings		52,826		138		0.26	%		54,619		152		0.28	%		54,524		161		0.30	%
Total interest-bearing liabilities		1,638,713		8,440		0.52	%		1,528,501		6,781		0.44	%		1,512,157		6,559		0.43	%
Non-interest bearing demand deposits		441,731		–					388,257		–					350,677		–
Total including non-interest- bearing demand deposits		2,080,444		8,440		0.41	%		1,916,758		6,781		0.35	%		1,862,834		6,559		0.35	%
Other non-interest liabilities		31,361							28,463							23,097
Total Liabilities		2,111,805							1,945,221							1,885,931
Stockholders’ equity		285,634							277,645							276,537
Total liabilities and stockholders’ equity	$	2,397,439						$	2,222,866						$	2,162,468
Net interest income; interest rate spread (3)			$	80,773		3.61	%			$	75,960		3.71	%			$	71,487		3.57	%

Net interest margin (4)						3.74	%						3.81	%						3.68	%
Average interest-earning assets to average interest- bearing liabilities						132.3	%						130.9	%						128.8	%

(1)

Interest on certain tax exempt loans (amounting to $383,000, $368,000 and $271,000 in 2016, 2015 and 2014 respectively) and tax-exempt securities ($3.0 million, $3.2 million and $3.1 million in 2016, 2015, and 2014) is not taxable for Federal income tax purposes. The average balance of such loans was $11.8 million, $10.7 million and $7.8 million in 2016, 2015, and 2014 while the average balance of such securities was $83.4 million, $86.0 million and $82.2 million in 2016, 2015, and 2014, respectively. 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)

At December 31, 2016, the yields earned and rates paid were as follows: loans receivable, 4.20%; securities, 3.08%; FHLB stock,4.00%; total interest-earning assets, 4.07%; deposits, 0.26%; FHLB advances, 1.42%; other borrowings, 0.22%, subordinated debentures, 2.39%; total including non- interest-bearing liabilities, 0.35%; and interest rate spread, 3.72%.

(3)

Interest rate spread is the difference in the yield on interest-earning assets and the cost of interest-bearing liabilities.

(4)

Net interest margin is net interest income divided by average interest-earning assets excluding average unrealized gains/losses.

(5)

For the purpose of the computation for loans, nonaccrual loans are included in the average loans outstanding.

(6)

Securities yield = annualized interest income divided by the average balance of securities, excluding average unrealized gains/losses.

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The following table describes the extent to which changes in interest rates and changes in volume of interest-related assets and liabilities have affected First Defiance’s tax-equivalent interest income and interest expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) change in rate (change in rate multiplied by prior year volume), and (iii) total change in rate and volume. The combined effect of changes in both rate and volume has been allocated proportionately to the change due to rate and the change due to volume.

Table 4 – Changes in Interest Rates and Volumes

	Year Ended December 31
	(In Thousands)
	2016 vs. 2015									2015 vs. 2014
	Increase (decrease) due to rate			Increase (decrease) due to volume			Total increase (decrease)			Increase (decrease) due to rate			Increase (decrease) due to volume			Total increase (decrease)
Interest-Earning Assets
Loans	$	(326	)	$	7,205		$	6,879		$	(195	)	$	4,911		$	4,716
Securities		(381	)		(224	)		(605	)		(336	)		585			249
Interest-earning deposits		173			25			198			30			(210	)		(180	)
FHLB stock		-			-			-			(53	)		(37	)		(90	)
Total interest-earning assets	$	(534	)	$	7,006		$	6,472		$	(554	)	$	5,249		$	4,695

Interest-Bearing Liabilities
Deposits	$	667		$	253		$	920		$	58		$	-		$	58
FHLB advances		(117	)		730			613			(165	)		312			147
Subordinated Debentures		140			-			140			26			-			26
Notes Payable		(9	)		(5	)		(14	)		(9	)		-			(9	)
Total interest- bearing liabilities	$	681		$	978		$	1,659		$	(90	)	$	312		$	222

Increase (decrease) in net interest income							$	4,813								$	4,473

Provision for Loan Losses – First Defiance’s provision for loan losses was $283,000 for the year ended December 31, 2016 compared to $136,000 for December 31, 2015 and $1.1 million for December 31, 2014.

Provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management to absorb probable losses incurred in the loan portfolio. Factors considered by management include identifiable risk in the portfolios, historical experience, the volume and type of lending conducted by First Defiance, the amount of non-performing loans (including loans which meet the FASB ASC Topic 310 definition of impaired), the amount of loans graded by management as substandard, doubtful, or loss, general economic conditions (particularly as they relate to First Defiance’s market areas); and other factors related to the collectability of First Defiance’s loan portfolio. See also Allowance for Loan Losses in Management’s Discussion and Analysis and Note 7 to the Consolidated Financial Statements.

Noninterest Income – Noninterest income increased by $2.2 million or 7.0% in 2016 to $34.0 million from $31.8 million for the year ended December 31, 2015. That followed an increase of $162,000 or 0.5% in 2015 from $31.6 million in 2014.

Service fees and other charges increased to $10.9 million for the year ended December 31, 2016 from $10.8 million for 2015 and increased from $10.3 million for 2014. The increase in noninterest income in 2016 and 2015 from 2014 is due to new fee structures and product redesigns that were implemented in the third quarter of 2014.

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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, an online banking or voice-response transfer, or an ATM. To be in good standing, an account must be brought to a positive balance within a 30-day period and have not excessively used the overdraft privilege program. 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. Consumer accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence, up to five charges per day, 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 years ending December 31, 2016 and 2015 related to the overdraft privilege product, net of adjustments to the allowance for uncollectible overdrafts, were $2.4 million and $2.8 million, respectively. Accounts charged off are included in noninterest expense. The allowance for uncollectible overdrafts was $14,000 at December 31, 2016 and $18,000 at December 31, 2015.

Noninterest income also includes gains, losses and impairment on investment securities. In 2016, First Defiance realized a $509,000 gain on sale of securities. In 2015, a $22,000 gain was recognized compared to a $932,000 net gain in 2014.

Mortgage banking income includes gains from the sale of mortgage loans, fees for servicing mortgage loans for others, an offset for amortization of mortgage servicing rights, and adjustments for impairment in the value of mortgage servicing rights. Mortgage banking income totaled $7.3 million, $6.7 million and $5.6 million in 2016, 2015 and 2014, respectively. The $557,000 increase in 2016 from 2015 is attributable to a $747,000 increase in the gain on sale of loans, along with a $57,000 positive change in servicing revenue. These were partially offset by an increase of $104,000 in mortgage servicing rights amortization expense along with a $143,000 negative change in the valuation adjustments on mortgage servicing rights. First Defiance originated $263.7 million of residential mortgages for sale into the secondary market in 2016 compared with $213.4 million in 2015. The balance of the mortgage servicing right valuation allowance stands at $522,000 at the end of 2016. The $1.1 million increase in 2015 from 2014 is attributable to a $1.2 million increase in the gain on sale of loans, along with a $150,000 positive change in the valuation adjustments on mortgage servicing rights. These were partially offset by an increase of $219,000 in mortgage servicing rights amortization expense. The positive valuation adjustment is a reflection of the increase in the fair value of certain sectors of the Company’s portfolio of mortgage servicing rights. First Defiance originated $213.4 million of residential mortgages for sale into the secondary market in 2015 compared with $153.8 million in 2014. See Note 8 to the Consolidated Financial Statements.

Gains on the sale of non-mortgages, which include SBA and FSA loans, totaled $753,000 in 2016 compared to $824,000 in 2015 and $181,000 in 2014. The Company has built up its pipeline of eligible small business administration loans since 2014 and increased its selling efforts in 2015 and 2016.

Insurance commission income increased $365,000 or 3.6% to $10.4 million in 2016 from $10.1 million in 2015 mainly due to an increase in general production in the property and casualty and group employee benefits lines of business. Insurance commission income increased $217,000 or 2.2% to $10.1 million in 2015 from $9.9 million in 2014.

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Income from bank owned life insurance increased slightly to $909,000 in 2016 from $895,000 in 2015, but decreased from $1.8 million in 2014. The decrease in 2015 from 2014 is the result of a tax-free benefit from a bank-owned life insurance policy due to a death claim in 2014.

Other income increased $479,000 to $1.5 million in 2016 compared to $1.1 million in 2015 and $1.8 million in 2014. The $479,000 increase in 2016 from 2015 is due to a $231,000 increase in the value of the assets of the Company’s deferred compensation plan as well as a $139,000 increase in the gain on sale of other real estate owned. The $708,000 decrease in 2015 from 2014 is mainly the result of a $498,000 tax-free gain realized in 2014 through the Company’s deferred compensation plan trust attributable to the aforementioned death claim.

Noninterest Expense – Total noninterest expense for 2016 was $71.1 million compared to $67.9 million for the year ended December 31, 2015 and $66.8 million for the year ended December 31, 2014.

Compensation and benefits increased $2.4 million or 6.4% to $40.2 million from $37.8 million in 2015. The increase is mainly related to merit increases and new staff for growth strategies, higher incentive compensation accruals and higher medical insurance costs. Other non-interest expenses increased $436,000 or 2.8% to $16.0 million in 2016 from $15.5 million in 2015 mainly due to acquisition related costs for the pending acquisition of Commercial Bancshares, Inc. and $300,000 for a termination of a lease partially offset by a decrease in the amortization of intangibles of $164,000. Occupancy expense increased $221,000, to $7.4 million in 2016 compared to $7.2 million in 2015 and data processing expense increased $284,000 to $6.4 million in 2016 from $6.1 million in 2015. These increases were partially offset by decreases in FDIC insurance premiums of $155,000.

Compensation and benefits increased $2.2 million or 6.3% in 2015 to $37.8 million from $35.5 million in 2014. The increase in compensation and benefits is due to merit increases, staff additions for growth and an increase in incentive compensation as a direct reflection of the improved financial performance of the Company. Occupancy expense increased $514,000 or 7.7% to $7.2 million in 2015, from $6.7 million in 2014. The increase is attributable to projects relating to preventative maintenance and upkeep of the Company’s branch network. Other non-interest expenses decreased $1.7 million or 10.1% to $15.5 million in 2015 from $17.3 million in 2014. The decrease is due to $786,000 of costs in 2014 associated with the termination of First Federal’s merger agreement with First Community Bank.

Income Taxes – Income taxes totaled $12.8 million in 2016 compared to $11.4 million in 2015 and $9.2 million in 2014. The effective tax rates for those years were 30.7%, 30.2%, and 27.4%, respectively. 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. See Note 18 – Income Taxes in the Notes to the Consolidated Financial Statements for further details.

Concentrations of Credit Risk

Financial institutions such as First Defiance generate income primarily through lending and investing activities. The risk of loss from lending and investing activities includes the possibility that losses may occur from the failure of another party to perform according to the terms of the loan or investment agreement. This possibility is known as credit risk.

Lending or investing activities that concentrate assets in a way that exposes the Company to a material loss from any single occurrence or group of occurrences increases credit risk. Diversifying loans and investments to prevent concentrations of risks is one way a financial institution can reduce potential losses due to credit risk. Examples of asset concentrations would include multiple loans made to a single borrower and loans of inappropriate size relative to the total capitalization of the institution. Management believes adherence to its loan and investment policies allows it to control its exposure to concentrations of credit risk at acceptable levels. First Defiance’s loan portfolio is concentrated geographically in its northwest Ohio, northeast Indiana, central Ohio and southeast Michigan market areas. Management has also identified lending for income-generating rental properties as an industry concentration. Total loans for income- generating property totaled $687.5 million at December 31, 2016, which represents 33.8% of the Company’s loan portfolio. Management believes it has the skill and experience to manage any risks associated with this type of lending. Loans in this category are generally paying as agreed without any unusual or unexpected levels of delinquency. The delinquency rate in this category, which is any loan 30 days or more past due, was 0.04% at December 31, 2016. There are no other industry concentrations that exceed 10% of the Company’s loan portfolio.

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Liquidity and Capital Resources

The Company’s primary source of liquidity is its core deposit base, raised through First Federal’s branch network, along with wholesale sources of funding and its capital base. These funds, along with investment securities, provide the ability to meet the needs of depositors while funding new loan demand and existing commitments.

Cash generated from operating activities was $27.0 million, $30.7 million and $30.1 million in 2016, 2015 and 2014, respectively. The adjustments to reconcile net income to cash provided by or used in operations during the periods presented consist primarily of proceeds from the sale of loans (less the origination of loans held for sale), the provision for loan losses, depreciation expense, the origination, amortization and impairment of mortgage servicing rights and increases and decreases in other assets and liabilities.

The primary investing activity of First Defiance is lending, which is funded with cash provided from operating and financing activities, as well as proceeds from payment on existing loans and proceeds from maturities of investment securities. In 2016 and 2014, the Company purchased $822,000 and $16.6 million, respectively, in portfolio residential home loans. There were no purchases in 2015.

In considering the more typical investing activities, during 2016, $36.4 million and $14.9 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $163.0 million was used by an increase in loans while $71.3 million was used to purchase available-for-sale investment securities. During 2015, $31.2 million and $426,000 was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $177.0 million was used by an increase in loans while $30.5 million was used to purchase available-for-sale investment securities. During 2014, $20.4 million and $14.9 million was generated from the combination of maturity or pay-downs and the sale or call of available-for-sale investment securities, respectively, and $73.2 million was used by an increase in loans while $70.1 million was used to purchase available-for-sale investment securities.

Principal financing activities include the gathering of deposits, the utilization of FHLB advances, and the sale of securities under agreements to repurchase such securities and borrowings from other banks. In 2016, total deposits increased by $145.5 million. Securities sold under repurchase arrangements decreased by $25.4 million in 2016. Also in 2016, the Company paid $7.9 million in common stock dividends coupled with paying $6.3 million in common stock repurchases. In 2015, total deposits increased by $75.7 million. Securities sold under repurchase arrangements increased by $2.4 million in 2015. Also in 2015, the Company paid $7.2 million in common stock dividends coupled with paying $8.4 million in common stock repurchases. In 2014, total deposits increased by $25.8 million. Securities sold under repurchase arrangements increased by $2.8 million in 2014. Also in 2014, the Company paid $5.9 million in common stock dividends coupled with paying $15.5 million in common stock repurchases. For additional information about cash flows from First Defiance’s operating, investing and financing activities, see the Consolidated Statements of Cash Flows included in the Consolidated Financial Statements.

At December 31, 2016, First Defiance had the following commitments to fund deposit, advance, borrowing obligations and post-retirement benefits:

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Table 5 – Contractual Obligations

	Maturity Dates by Period at December 31, 2016
			Less than						After 5
Contractual Obligations	Total		1 year		1-3 years		4-5 years		years
	(In Thousands)
Certificates of deposit	$	433,931	$	156,767	$	196,377	$	80,787		-
FHLB fixed advances including interest (1)		107,384		32,306		40,490		31,426		3,162
Subordinated debentures		36,083		-		-		-		36,083
Securities sold under repurchase agreements		31,816		31,816		-		-		-
Lease obligations		4,462		584		737		487		2,654
Post-retirement benefits		1,927		160		355		377		1,035
Total contractual obligations	$	615,603	$	221,633	$	237,959	$	113,077	$	42,934

(1) Includes principal payments of $103,943 and interest payments of $3,441.

At December 31, 2016, First Defiance had the following commitments to fund loan or line of credit obligations:

Table 6 - Commitments

	Total		Amount of Commitment Expiration by Period
	Amounts		Less than 1						After 5
Commitments	Committed		year		1-3 years		4-5 years		years
	(In Thousands)
Fixed commitments to make loans	$	34,432	$	29,593	$	38	$	3,892	$	909
Variable commitments to make loans		106,356		91,788		1,331		277		12,960
Fixed unused lines of credit		14,384		8,638		1,265		82		4,399
Variable unused lines of credit		400,542		270,099		27,686		5,838		96,919
Total loan commitments		555,714		400,118		30,320		10,089		115,187

Standby letters of credit		9,668		5,636		4,017		15		-

Total Commitments	$	565,382	$	405,754	$	34,337	$	10,104	$	115,187

In addition to the above commitments, at December 31, 2016, First Defiance had commitments to sell $22.5 million of loans to Freddie Mac, Fannie Mae, FHLB of Cincinnati or BB&T Mortgage.

To meet its obligations management can adjust the rate of savings certificates to retain deposits in changing interest rate environments; it can sell or securitize mortgage and non-mortgage loans; and it can turn to other sources of financing including FHLB advances, the Federal Reserve, and brokered certificates of deposit. At December 31, 2016, First Defiance had $448.9 million in capacity under its agreements with the FHLB.

First Federal is subject to various capital requirements of the OCC. At December 31, 2016, First Federal had capital ratios that exceeded the standard to be considered “well capitalized.” For additional information about First Defiance and First Federal’s capital requirements, see Note 17 – Regulatory Matters to the Consolidated Financial Statements.

Critical Accounting Policies

First Defiance has established various accounting policies that govern the application of accounting principles generally accepted in the United States in the preparation of its Consolidated Financial Statements. The significant accounting policies of First Defiance are described in the footnotes to the consolidated financial statements. 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. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying value of assets and liabilities and the results of operations of First Defiance.

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Allowance for Loan Losses - First Defiance believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of its consolidated financial statements. In determining the appropriate estimate for the allowance for loan losses, management considers a number of factors relative to both specific credits in the loan portfolio and macro-economic factors relative to the economy of the United States as a whole and the economy of the northwest Ohio, northeast Indiana and southeast Michigan regions in which the Company does business.

Factors relative to specific credits that are considered include a customer’s payment history, a customer’s recent financial performance, an assessment of the value of collateral held, knowledge of the customer’s character, the financial strength and commitment of any guarantors, the existence of any customer or industry concentrations, changes in a customer’s competitive environment and any other issues that may impact a customer’s ability to meet his obligations.

Economic factors that are considered include levels of unemployment and inflation, specific plant or business closings in the Company’s market area, the impact of strikes or other work stoppages, the impact of weather or environmental conditions, especially relative to agricultural borrowers, and other matters that may have an impact on the economy as a whole.

In addition to the identification of specific customers who may be potential credit problems, management considers its historical losses, the results of independent loan reviews, an assessment of the adherence to underwriting standards, and other factors in providing for loan losses that have not been specifically classified. Management believes that the level of its allowance for loan loss is sufficient to cover the estimates loss incurred but not yet recognized on the loan portfolio. Refer to the section titled “Allowance for Loan Losses” and Note 2, Statement of Accounting Policies for a further description of the Company’s estimation process and methodology related to the allowance for loan losses.

Valuation of Mortgage Servicing Rights - First Defiance believes the valuation of mortgage servicing rights is a critical accounting policy that requires significant estimates in preparation of its consolidated financial statements. First Defiance recognizes as separate assets the value of mortgage servicing rights, which are acquired through loan origination activities. First Defiance does not purchase any mortgage servicing rights.

Key assumptions made by management relative to the valuation of mortgage servicing rights include the stratification policy used in valuing servicing, assumptions relative to future prepayments of mortgages, the potential value of any escrow deposits maintained or ancillary income received as a result of the servicing activity and discount rates used to value the present value of a future cash flow stream. In assessing the value of the mortgage servicing rights portfolio, management utilizes a third party that specializes in valuing servicing portfolios. That third party reviews key assumptions with management prior to completing the valuation. Prepayment speeds are determined based on projected median prepayment speeds for 15 and 30 year mortgage backed securities. Those speeds are then adjusted up or down based on the size of the loan. The discount rate used in this analysis is the pretax yield generally required by purchasers of bulk servicing rights as of the valuation date. The value of mortgage servicing rights is especially vulnerable in a falling interest rate environment. Refer also to the section entitled Mortgage Servicing Rights and Note 2 - Statement of Accounting Policies, and Note 8 - Mortgage Banking, for a further description of First Defiance’s valuation process, methodology and assumptions along with sensitivity analyses.

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Goodwill - First Defiance has two reporting units: First Federal and First Insurance. At December 31, 2016, First Defiance had goodwill of $61.8 million, including $51.0 million in First Federal, representing 83% of total goodwill and $10.8 million in First Insurance, representing 17% of total goodwill. The carrying value of goodwill is tested annually for impairment or more frequently if it is determined appropriate. The evaluation for impairment involves comparing the current estimated fair value of each reporting unit to its carrying value, including goodwill. If the current estimated fair value of a reporting unit exceeds its carrying value, no additional testing is required and impairment loss is not recorded. If the estimated fair value of a reporting unit is less than the carrying value, further valuation procedures are performed and could result in impairment of goodwill being recorded. Further valuation procedures would include allocating the estimated fair value to all assets and liabilities of the reporting unit to determine an implied goodwill value. If the implied value of goodwill of a reporting unit is less than the carrying amount of that goodwill, an impairment loss is recognized in an amount equal to that excess.

If, for any future period First Defiance determines that there has been impairment in the carrying value of goodwill balances, First Defiance will record a charge to earnings, which could have a material adverse effect on net income, but not risk-based capital ratios.

First Defiance has core deposit and other intangible assets resulting from acquisitions which are subject to amortization. First Defiance determines the amount of identifiable intangible assets based upon independent core deposit and customer relationship analyses at the time of the acquisition. Intangible assets with finite useful lives are evaluated for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. No events or changes in circumstances that would indicate that the carrying amount of any identifiable intangible assets may not be recoverable had occurred during the years ended December 31, 2016 and 2015.

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Asset/Liability Management

A significant portion of the Company’s revenues and net income is derived from net interest income and, accordingly, the Company strives to manage its interest-earning assets and interest-bearing liabilities to generate an appropriate contribution from net interest income. Asset and liability management seeks to control the volatility of the Company’s performance due to changes in interest rates. The Company attempts to achieve an appropriate relationship between rate sensitive assets and rate sensitive liabilities. First Defiance does not presently use off balance sheet derivatives to enhance its risk management.

First Defiance monitors interest rate risk on a monthly basis through simulation analysis that measures the impact changes in interest rates can have on net interest 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. At December 31, 2016, the results of the simulation indicate that in an environment where interest rates rise 100 basis points over a 24 month period, First Defiance’s net interest income would increase by 3.08% over the base case scenario. It should be noted that other areas of First Defiance’s income statement, such as gains from sales of mortgage loans and amortization of mortgage servicing rights are also impacted by fluctuations in interest rates, but are not considered in the simulation of net interest income.

The majority of First Federal’s lending activities are in commercial real estate and commercial loan areas. In addition to carrying higher credit risk than residential mortgage lending, such loans tend to be more rate sensitive than residential mortgage loans. The balance of First Federal’s commercial real estate and multi-family real estate loan portfolio was $1.04 billion, which was split between $142.5 million of fixed-rate loans and $898.1million of adjustable-rate loans, at December 31, 2016. The commercial loan portfolio increased to $469.1 million, which was split between $173.1 million of fixed-rate loans and $296.0 million of adjustable-rate loans, at December 31, 2016. Certain loans classified as adjustable have fixed rates for an initial term that may be as long as five years. The maturities on fixed-rate loans are generally less than seven years. First Federal also has significant balances of home equity and improvement loans ($118.4 million at December 31, 2016) of which $104.8 million fluctuate with changes in the prime lending rate and $13.7 million of home equity and improvement loans have fixed rates. First Federal also has consumer loans ($16.7 million at December 31, 2016) which tend to have a shorter duration than residential mortgage loans. Also, to limit its interest rate risk, as well as to provide liquidity, First Federal sells a majority of its fixed-rate mortgage originations into the secondary market.

The table below presents, for the twelve months subsequent to December 31, 2016 and December 31, 2015, an estimate of the change in net interest income that would result from a gradual (ramp) and immediate (shock) change in interest rates, moving in a parallel fashion over the entire yield curve, relative to the measured base case scenario. Based on our net interest income simulation as of December 31, 2016, net interest income sensitivity to changes in interest rates for the twelve months subsequent to December 31, 2016 was more asset sensitive for the ramp and shock compared to the sensitivity profile for the twelve months subsequent to December 31, 2015. This is due in part to our strategy to grow longer term loans and funding that growth out of existing liquidity.

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Table 7 – Net Interest Income Sensitivity Profile

	Impact on Future Annual Net Interest Income
(dollars in thousands)	December 31, 2016					December 31, 2015
Gradual Change in Interest Rates
+200	$	1,970		2.32	%	$	563		0.71	%
+100		972		1.14	%		215		0.27	%
-100		(2,201	)	-2.59	%		(1,332	)	-1.68	%

Immediate Change in Interest Rates
+200	$	4,236		4.99	%	$	1,660		2.09	%
+100		2,131		2.51	%		719		0.91	%
-100		(4,132	)	-4.87	%		(2,605	)	-3.28	%

To analyze the impact of changes in interest rates in a more realistic manner, non-parallel interest rate scenarios are also simulated. These non-parallel interest rate scenarios indicate that net interest income may decrease from the base case scenario should the yield curve flatten. Conversely, if the yield curve should steepen or become inverted, net interest income may increase.

The results of all the simulation scenarios are within the board mandated guidelines as of December 31, 2016.

In addition to the simulation analysis, First Federal also prepares an “economic value of equity” (“EVE”) analysis. This analysis generally 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. However, the likelihood of a decrease in interest rates beyond 100 basis points as of December 31, 2016 was considered to be unlikely given the current interest rate levels and therefore was not included in this analysis. The results of this analysis are reflected in the following table.

Table 8 – Economic Value of Equity Analysis

December 31, 2016
									Economic Value of Equity as % of
	Economic Value of Equity								Present Value of Assets
Change in Rates	$ Amount		$ Change			% Change			Ratio			Change
(Dollars in Thousands)
+ 400 bp		569,397		85,791			17.74	%		24.99	%		522 bp
+ 300 bp		553,285		69,679			14.41	%		23.86	%		408 bp
+ 200 bp		534,478		50,873			10.52	%		22.63	%		286 bp
+ 100 bp		512,132		28,526			5.90	%		21.30	%		153 bp
0 bp		483,606		-			-			19.77	%		–
- 100 bp		429,266		(34,339	)		(7.10	)%		17.29	%		(249) bp

December 31, 2015
									Economic Value of Equity as % of
	Economic Value of Equity								Present Value of Assets
Change in Rates	$ Amount		$ Change			% Change			Ratio			Change
(Dollars in Thousands)
+ 400 bp		509,640		56,545			12.48	%		24.08	%		422 bp
+ 300 bp		499,038		45,943			10.14	%		23.15	%		329 bp
+ 200 bp		486,652		33,558			7.41	%		22.15	%		229 bp
+ 100 bp		471,332		18,237			4.03	%		21.05	%		119 bp
0 bp		453,095		-			-			19.86	%		–
- 100 bp		426,010		(27,085	)		(5.98	)%		18.39	%		(147) bp

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Based on the above analysis, in the event of a 200 basis point increase in interest rates as of December 31, 2016, First Federal would experience a 10.52% increase in its economic value of equity. During periods of rising rates, the value of monetary assets declines. Conversely, during periods of falling rates, the value of monetary assets increases. It should be noted that the amount of change in value of specific assets and liabilities due to changes in rates is not the same in a rising rate environment as in a falling rate environment. Based on the EVE analysis, the change in the economic value of equity in both rising and falling rate environments is relatively low because both its assets and liabilities have relatively short durations. The average duration of its assets at December 31, 2016 was 1.70 years while the average duration of its liabilities was 3.63 years.

In evaluating First Federal’s exposure to interest rate risk, certain shortcomings inherent in each of the methods of analysis presented must be considered. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market rates while interest rates on other types of financial instruments may lag behind current changes in market rates. Furthermore, in the event of changes in rates, prepayments and early withdrawal levels could differ significantly from the assumptions in calculating the table and the results therefore may differ from those presented.

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Item 8. Financial Statements and Supplementary Data

Management’s Report on Internal Control Over Financial Reporting

The management of First Defiance Financial Corp. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(1) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of; our principal executive and principal financial officers and effected by the board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that:

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate.

Based on our evaluation under the framework in the 2013 Internal Control – Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2016.

Crowe Horwath LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued a report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. The report, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, is herein.



Donald P. Hileman		Kevin T. Thompson
President and		Executive Vice President and
Chief Executive Officer		Chief Financial Officer

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Report of Independent Registered Public Accounting Firm

Members of the Audit Committee

First Defiance Financial Corp.

Defiance, Ohio

We have audited the accompanying consolidated statements of financial condition of First Defiance Financial Corp. (the “Company”) as of December 31, 2016 and 2015 and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2016. We also have audited First Defiance Financial Corp.’s internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO”). The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company's internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

- 58 -

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Defiance Financial Corp. as of December 31, 2016 and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, First Defiance Financial Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in the 2013 Internal Control – Integrated Framework issued by the COSO.

/s/ Crowe Horwath LLP
Crowe Horwath LLP
South Bend, Indiana
February 28, 2017

- 59 -

First Defiance Financial Corp.

Consolidated Statements of Financial Condition

Dollars in Thousands, except per share data

	December 31
	2016		2015
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions	$	53,003	$	38,769
Federal funds sold		46,000		41,000
		99,003		79,769

Securities available-for-sale, carried at fair value		250,992		236,435
Securities held-to-maturity, carried at amortized cost (fair value $187 and $245 at December 31, 2016 and 2015 respectively)		184		243
		251,176		236,678
Loans held for sale		9,607		5,523
Loans receivable, net of allowance of $25,884 and $25,382 at December 31, 2016 and 2015, respectively		1,914,603		1,776,835
Mortgage servicing rights		9,595		9,248
Accrued interest receivable		6,760		6,171
Federal Home Loan Bank (FHLB) stock		13,798		13,801
Bank owned life insurance		52,817		51,908
Premises and equipment		36,958		38,166
Real estate and other assets held for sale (REO)		455		1,321
Goodwill		61,798		61,798
Core deposit and other intangibles		1,336		1,871
Deferred taxes		2,212		-
Other assets		17,479		14,587
Total assets	$	2,477,597	$	2,297,676

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First Defiance Financial Corp

Consolidated Statements of Financial Condition (continued)

Dollars in Thousands, except per share data

	December 31
	2016			2015
Liabilities and stockholders’ equity
Liabilities:
Deposits:
Noninterest-bearing	$	487,663		$	420,691
Interest-bearing		1,493,965			1,415,446
Total		1,981,628			1,836,137
Advances from the Federal Home Loan Bank		103,943			59,902
Securities sold under agreements to repurchase		31,816			57,188
Subordinated debentures		36,083			36,083
Advance payments by borrowers		2,650			2,674
Deferred taxes		-			877
Other liabilities		28,459			24,618
Total liabilities		2,184,579			2,017,479

Commitments and Contingent Liabilities (Note 6)

Stockholders’ equity:
Preferred stock, $.01 par value per share: 37,000 shares authorized; no shares issued		–			–
Preferred stock, $.01 par value per share: 4,963,000 shares authorized; no shares issued		–			–
Common stock, $.01 par value per share: 25,000,000 shares authorized; 12,720,347 and 12,721,959 shares issued and 8,983,206 and 9,102,831 shares outstanding, respectively		127			127
Additional paid-in capital		126,390			125,734
Accumulated other comprehensive income, net of tax of $117 and $1,950, respectively		215			3,622
Retained earnings		240,592			219,737
Treasury stock, at cost, 3,737,141 and 3,619,128 shares respectively		(74,306	)		(69,023	)
Total stockholders’ equity		293,018			280,197

Total liabilities and stockholders’ equity	$	2,477,597		$	2,297,676

See accompanying notes.

- 61 -

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Income

(Dollar Amounts in Thousands, except per share data)

	Years Ended December 31
	2016		2015		2014
Interest Income
Loans	$	80,217	$	73,346	$	68,682
Investment securities:
Taxable		3,231		3,598		3,507
Tax-exempt		3,016		3,171		3,068
Interest-bearing deposits		367		169		349
FHLB stock dividends		552		552		642
Total interest income		87,383		80,836		76,248

Interest Expense
Deposits		6,261		5,341		5,283
Federal Home Loan Bank advances and other		1,288		675		528
Subordinated debentures		753		613		587
Securities sold under agreement to repurchase		138		152		161
Total interest expense		8,440		6,781		6,559
Net interest income		78,943		74,055		69,689

Provision for loan losses		283		136		1,117
Net interest income after provision for loan losses		78,660		73,919		68,572

Noninterest Income
Service fees and other charges		10,909		10,752		10,258
Mortgage banking income		7,270		6,713		5,602
Insurance commissions		10,441		10,076		9,859
Gain on sale of non-mortgage loans		753		824		181
Gain (loss) on sale or call of securities		509		22		932
Trust income		1,701		1,462		1,240
Income from bank owned life insurance		909		895		1,802
Other noninterest income (Note 15)		1,538		1,059		1,767
Total noninterest income		34,030		31,803		31,641

Noninterest Expense
Compensation and benefits		40,187		37,769		35,543
Occupancy		7,418		7,197		6,683
FDIC insurance		1,169		1,324		1,419
Data processing		6,367		6,083		5,856
Other noninterest expense		15,952		15,516		17,257
Total noninterest expense		71,093		67,889		66,758

Income before income taxes		41,597		37,833		33,455
Federal income taxes		12,754		11,410		9,163
Net Income	$	28,843	$	26,423	$	24,292

Earnings per common share (Note 4)
Basic	$	3.21	$	2.87	$	2.55
Diluted	$	3.19	$	2.82	$	2.44
Dividends declared per common share	$	0.880	$	0.775	$	0.625

See accompanying notes

- 62 -

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Comprehensive Income

(Dollar Amounts in Thousands)

	For the Years Ended December 31
	2016			2015			2014

Net income	$	28,843		$	26,423		$	24,292
Change in securities available-for-sale (AFS):
Unrealized holding gains (losses) on available-for-sale securities arising during the period		(4,933	)		(985	)		6,763
Reclassification adjustment for (gains) losses realized in income		(509	)		(22	)		(932	)
Net unrealized gains (losses)		(5,442	)		(1,007	)		5,831

Income tax effect		1,904			352			(2,040	)
Net of tax amount		(3,538	)		(655	)		3,791

Change in unrealized gain/(loss) on postretirement benefit:
Net gain (loss) on defined benefit postretirement medical plan realized during the period		172			204			(377	)
Net amortization and deferral		30			47			35
Net gain (loss) activity during the period		202			251			(342	)
Income tax effect		(71	)		(88	)		120
Net of tax amount		131			163			(222	)

Total other comprehensive income (loss)		(3,407	)		(492	)		3,569
Comprehensive income	$	25,436		$	25,931		$	27,861

See accompanying notes

- 63 -

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Changes in Stockholders’ Equity

(Dollar Amounts In Thousands, except number of shares)

														Accumulated
			Common					Common			Additional			Other									Total
	Preferred		Stock			Common		Stock			Paid-In			Comprehensive			Retained			Treasury			Stockholder’s
	Stock		Shares			Stock		Warrant			Capital			Income			Earnings			Stock			Equity
Balance at January 1, 2014	$	-		9,719,521		$	127	$	878		$	136,403		$	545		$	182,290		$	(48,096	)	$	272,147
Net income																		24,292						24,292
Other comprehensive income															3,569									3,569
Stock based compensation expenses												78												78
Shares issued under stock option plan				52,258								88						(45	)		878			921
Restricted share activity under stock incentive plans				13,087								(334	)								212			(122	)
Shares issued from direct stock sales				2,804								31									45			76
Shares repurchased				(553,136	)																(15,519	)		(15,519	)
Common stock dividends declared																		(5,937	)					(5,937	)
Balance at December 31, 2014	$	-		9,234,534		$	127	$	878		$	136,266		$	4,114		$	200,600		$	(62,480	)	$	279,505
Net income																		26,423						26,423
Other comprehensive loss															(492	)								(492	)
Stock based compensation expenses												150												150
Warrant repurchase									(878	)		(11,101	)											(11,979	)
Shares issued under stock option plan,				74,300
net of 14,350 repurchased and retired												230						(313	)		1,552			1,469
Restricted share activity under stock incentive plans				18,006								(58	)					186			308			436
Excess tax benefit on stock compensation plans												216												216
Shares issued from direct stock sales				1,799								31									33			64
Shares repurchased				(225,808	)																(8,436	)		(8,436	)
Common stock dividends declared																		(7,159	)					(7,159	)
Balance at December 31, 2015	$	-		9,102,831		$	127	$	-		$	125,734		$	3,622		$	219,737		$	(69,023	)	$	280,197
Net income																		28,843						28,843
Other comprehensive loss															(3,407	)								(3,407	)
Stock based compensation expenses												274												274
Shares issued under stock option plan,
net of 1,612 repurchased and retired				36,358								(21	)					(26	)		761			714
Restricted share activity under stock incentive plans				10,405								370						(72	)		219			517
Shares issued from direct stock sales				1,480								33									30			63
Shares repurchased				(167,868	)																(6,293	)		(6,293	)
Common stock dividends declared																		(7,890	)					(7,890	)
Balance at December 31, 2016	$	-		8,983,206		$	127	$	-		$	126,390		$	215		$	240,592		$	(74,306	)	$	293,018

See accompanying notes

- 64 -

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Cash Flows

(Dollar Amounts in Thousands)

	Years Ended December 31
	2016			2015			2014
Operating Activities
Net income	$	28,843		$	26,423		$	24,292
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		283			136			1,117
Provision for depreciation		3,356			3,267			2,952
Net amortization of premium and discounts on loans, securities, deposits and debt obligations		1,128			1,148			1,020
Amortization of mortgage servicing rights		1,724			1,620			1,401
Net impairment (recovery) of mortgage servicing rights		(123	)		(266	)		(116	)
Amortization of intangibles		535			699			1,102
Gain on sale of loans		(6,064	)		(5,388	)		(3,517	)
Loss on sale or disposals or write-downs of property, plant and equipment		-			428			-
(Gain) loss on sale or write-down of REO		(300	)		150			(73	)
(Gain) loss on sale or call of securities		(509	)		(22	)		(932	)
Change in deferred taxes		(615	)		(35	)		(179	)
Proceeds from sale of loans held for sale		262,958			215,402			159,305
Origination of loans held for sale		(263,679	)		(213,416	)		(153,753	)
Stock based compensation expenses		274			150			78
Restricted stock unit expense (credit)		517			436			(122	)
Excess tax benefit (expense)on stock compensation plans		(192	)		216			-
Income from bank owned life insurance		(909	)		(895	)		(1,802	)
Change in interest receivable and other assets		(4,121	)		(1,356	)		(5,962	)
Change in accrued interest and other liabilities		3,878			1,955			5,254
Net cash provided by operating activities		26,984			30,652			30,065

Investing Activities
Proceeds from maturities, calls and paydowns of held-to-maturity securities		59			69			73
Proceeds from maturities, calls and paydowns of available-for-sale securities		36,390			31,240			20,400
Proceeds from sale of available-for-sale securities		14,871			426			14,913
Proceeds from sale of REO		1,705			3,407			2,108
Proceeds from sale of office properties and equipment		1			212			84
Purchases of available-for-sale securities		(71,276	)		(30,483	)		(70,149	)
Purchases of office properties and equipment		(2,106	)		(1,843	)		(4,935	)
Investment in bank owned life insurance		-			(4,000	)		(3,406	)
Proceeds from FHLB stock redemption		3			1			5,548
Proceeds from bank owned life insurance death benefit		-			-			910
Net cash paid in Buckeye Insurance acquisition		-			(297	)		-
Purchase of portfolio mortgage loans		(822	)		-			(16,594	)
Proceeds from sale of non-mortgage loans		20,816			24,027			20,592
Net increase in loans receivable		(158,121	)		(177,013	)		(73,206	)
Net cash used in investing activities		(158,480	)		(154,254	)		(103,662	)

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FIRST DEFIANCE FINANCIAL CORP.

Consolidated Statements of Cash Flows (continued)

(Dollar Amounts in Thousands)

	Years Ended December 31
	2016			2015			2014
Financing Activities
Net increase in deposits and advance payments by borrowers		145,467			75,689			25,810
Repayment of Federal Home Loan Bank long-term advances		(959	)		(8,642	)		(976	)
Proceeds from Federal Home Loan Bank long-term advances		45,000			47,000			-
Increase (decrease) in securities sold under repurchase agreements		(25,372	)		2,429			2,840
Cash dividends paid on common stock		(7,890	)		(7,159	)		(5,937	)
Net cash paid for repurchase of common stock		(6,293	)		(8,436	)		(15,519	)
Repayment of warrants		-			(11,979	)		-
Proceeds from exercise of stock options		714			1,469			921
Proceeds from direct treasury stock sales		63			64			76
Net cash provided by financing activities		150,730			90,435			7,215

Increase (decrease) in cash and cash equivalents		19,234			(33,167	)		(66,382	)
Cash and cash equivalents at beginning of period		79,769			112,936			179,318
Cash and cash equivalents at end of period	$	99,003		$	79,769		$	112,936

Supplemental cash flow information:
Interest paid	$	8,370		$	6,764		$	6,557
Income taxes paid		12,700			10,000			8,950
Transfers from loans to other real estate owned and other assets held for sale		583			974			2,357
Transfer from real estate owned and other assets held for sale to loans		-			2,544			-
Transfer from (to) property and equipment to real estate and other assets held for sale		(44	)		267			-
Transfer from loans held for sale to loans		-			-			1,178
Securities traded but not yet settled		357			-			-

See accompanying notes.

- 66 -

Notes to the Consolidated Financial Statements

1. Basis of Presentation

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

First Federal is primarily engaged in 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, Bryan, Bowling Green, Lima, Maumee and Oregon, Ohio areas, offering property and casualty, and group health and life insurance products. First Defiance Risk Management was incorporated on December 20, 2012, as a wholly owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace.

2. Statement of 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. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

Earnings Per Common Share

Basic earnings per common share is computed by dividing net income applicable to common shares (net income less dividend requirements for preferred stock, accretion of preferred stock discount and redemption of preferred stock) 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 includes the dilutive effect of additional potential common shares issuable under stock options, warrants, restricted stock awards and stock grants. See also Note 4.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on available-for-sale securities and the net unrecognized actuarial losses and unrecognized prior service costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items included in other comprehensive income are reported net of tax. See also Notes 5, 16 and 25 and the Consolidated Statements of Comprehensive Income.

- 67 -

Cash Flows

Cash and cash equivalents include amounts due from banks and overnight investments with the Federal Home Loan Bank (“FHLB”) and the Federal Reserve. Cash and amounts due from depository institutions include required balances on hand or on deposit at the FHLB and Federal Reserve of approximately $1,809,000 and $1,896,000, respectively, at December 31, 2016 to meet regulatory reserve and clearing requirements. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions and repurchase agreements.

Investment Securities

Management determines the appropriate classification of debt securities at the time of purchase and evaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the securities to maturity and are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.

Debt securities not classified as held-to-maturity and equity securities are classified as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of tax, reported in other comprehensive income (loss) until realized. Realized gains and losses are included in gains (losses) on securities or other-than-temporary impairment losses on securities. Realized gains and losses on securities sold are recognized on the trade date based on the specific identification method.

Interest income includes amortization of purchase premiums and discounts. Premiums and discounts are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are expected. Securities with unrealized losses are reviewed quarterly to determine if value impairment is other–than-temporary. In performing this review management considers the length of time and extent that fair value has been less than cost, the financial condition of the issuer, the impact of changes in market interest rates on market value and whether the Company intends to sell or it would be more than likely required to sell the securities prior to their anticipated recovery. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) other-than-temporary impairment (“OTTI”) related to credit loss, which must be recognized in the income statement and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

FHLB Stock

First Federal is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. At December 31, 2016, the Company held $13.8 million at the FHLB of Cincinnati and $5,000 at the FHLB of Indianapolis.

Loans Receivable

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal amount outstanding, net of deferred loan fees and costs, purchase premiums and discounts and the allowance for loan losses. Deferred fees net of deferred incremental loan origination costs, are amortized to interest income generally over the contractual life of the loan using the interest method without anticipating prepayments. The recorded investment in loans includes accrued interest receivable and net deferred fees and costs and undisbursed loan amounts.

- 68 -

Mortgage loans originated and intended for sale in the secondary market are classified as loans held for sale and are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains or losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

The Company may incur losses pertaining to loans sold to Fannie Mae and Freddie Mac but repurchased due to underwriting issues. Repurchase losses are recognized when the Company determines they are probable and estimable.

Interest receivable is accrued on loans and credited to income as earned. The accrual of interest on loans 90 days delinquent or impaired is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. For these loans, interest accrual is only to the extent cash payments are received. The accrual of interest on these loans is generally resumed after a pattern of repayment has been established and the collection of principal and interest is reasonably assured.

Acquired Loans

The Company acquires loans individually and in groups or portfolios. At acquisition, the Company reviews each loan to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that it will be unable to collect all amounts due according to the loan’s contractual terms. If both conditions exist, the Company determines whether each such loan is to be accounted for individually or whether such loans will be assembled into pools of loans based on common risk characteristics (credit score, loan type and date of origination). The Company considers expected prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other cash flows (expected at acquisition) for each loan and subsequently aggregated pool of loans.

The Company determines the excess of the loan’s or pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference). The remaining amount—representing the excess of the loan’s cash flows expected to be collected over the amount paid—is accreted into interest income over the remaining life of the loan or pool (accretable yield).

Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected, and evaluates whether the present value of its loans determined using the effective interest rates has decreased and, if so, recognizes a loss. Valuation allowances for all acquired loans subject to FASB ASC Topic 310 reflect only those losses incurred after acquisition—that is, the present value of cash flows expected at acquisition that are not expected to be collected. The present value of any subsequent increase in the loan’s or pool’s actual cash flows or cash flows expected to be collected is used first to reverse any existing valuation allowance for that loan or pool. For any remaining increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life.

- 69 -

Allowance for Loan Losses

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses in the loan portfolio and is based on the size and current risk characteristics of the loan portfolio, an assessment of individual problem loans, actual loss experience, current economic events in specific industries and geographical areas and other pertinent factors, including general economic conditions. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience and consideration of economic trends, all of which may be susceptible to significant change. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.

Beginning June 30, 2015, the Company refined the methodology to its allowance for loan loss calculation pertaining to the general reserve component for non-impaired loans. There was no change to the calculation of the component for reserves on impaired loans. Within the general reserve, the determination of the historical loss component was modified from using a three-year average annual loss rate to a loss migration measurement. The loss migration measurement implemented June 30, 2015, utilized an average of four (4) four-year loss migration periods for each loan portfolio segment with differentiation between loan risk grades. Prior to June 30, 2015, the approach to this component quantified the historical loss by calculating a rolling twelve quarter average annual loss rate for each portfolio segment, without differentiation between loan risk grades. Beginning December 31, 2016 the historical loss calculation was changed from using an average of four (4) four-year loss migration periods to using an average of all four-year loss migration periods to the present beginning with data from the second quarter 2011. Management believes this enhancement is consistent with the rationale of the previous measurement but provides a more precise calculation of historical losses by incorporating more data points for the average loss ratio and including periods that provide a more complete coverage of the full business cycle. Management believes that capturing the risk grade changes and cumulative losses over the life cycle of a loan more accurately depicts management’s estimate of historical losses as well as being more reflective of the ongoing risks in the loan portfolio. These modifications resulted in a change in the general reserves between the loan portfolio segments but did not have a material impact on the overall allowance for loan losses.

Loan losses are charged off against the allowance when in management’s estimation it is unlikely that the loan will be collected, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan loss is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors in order to maintain the allowance for loan losses at the level deemed adequate by management. The determination of whether a loan is considered past due or delinquent is based on the contractual payment terms. Loans are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date. All loans are placed on nonaccrual status at 90 days past due unless the loan is adequately secured and is in process of collection. Any loan in the portfolio may be placed on nonaccrual status prior to becoming 90 days past due when collection of principal or interest is in doubt.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. Impaired loans have been recognized in conformity with FASB ASC Topic 310.

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loans agreement. Loans, for which terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. An analysis of the net present value of estimated cash flows is performed and an allowance may be established based on the outcome of that analysis, or if the loan is deemed to be collateral dependent an allowance is established based on the fair value of collateral. All modifications are reviewed by the First Federal’s Chief Credit Officer to determine whether or not the modification constitutes a troubled debt restructure. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net of the allowance allocation which is determined based on the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.

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The following portfolio segments have been identified:

Commercial Real Estate Loans (consisting of multi-family residential and non-residential): Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans. These loans are viewed primarily as cash flow loans and the repayment of these loans is largely dependent on the successful operation of the property. Loan performance may be adversely affected by factors impacting the general economy or conditions specific to the real estate market such as geographic location and/or property type.

Commercial Loans: Commercial credit is extended primarily to middle market customers. Such credits are typically comprised of working capital loans, loans for physical asset expansion, asset acquisition loans and other business loans. Loans to closely held businesses will generally be guaranteed in full or for a meaningful amount by the businesses' principal owners. Commercial loans are made based primarily on the historical and projected cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not behave as forecasted and collateral securing loans may fluctuate in value due to economic or individual performance factors. Minimum standards and underwriting guidelines have been established for all commercial loan types.

Consumer Finance Loans: Consumer finance loans are generally made to borrowers for a specific consumer purchase and are made based on their ability to repay with their current debt to income as well as the underlying collateral value of the item being purchased. Credit scores are part of the decision process of whether or not credit is extended. Minimum standards and underwriting guidelines have been established for all consumer loan types.

1-4 Family Residential Real Estate Loans: 1-4 family residential real estate loans can be categorized two different ways. One part of this portfolio is owner occupied and are made based primarily on the ability of the individual borrower to support the payments as well as the payments of any other debt the borrower may have outstanding at the time the loan is made. The other part of this portfolio is non-owner occupied income producing property and is made primarily based on the cash flow stream from rental income as well as the cash flow support from the borrower’s unrelated cash flow. Both types of loans have a secondary repayment source of the underlying collateral and generally the loans are not extended at higher than an 80% LTV. Minimum standards and underwriting guidelines have been established for all 1-4 family residential real estate loan types.

Construction Loans: The Company defines construction loans as loans where the loan proceeds are controlled by the Company and used exclusively for the improvement of real estate in which the Company holds a mortgage.

Home Equity and Improvement Loans: Home Equity and Improvement loans are made to borrowers based on their ability to repay with their current debt to income as well as the underlying collateral value of the real estate taken as security. Minimum standards and underwriting guidelines have been established for all 1-4 family residential real estate loan types.

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Consumer finance, 1-4 family residential real estate (including construction) and home equity and improvement loans are subject to adverse employment conditions in the local economy which could increase default rate on loans.

Servicing Rights

Servicing rights are recognized separately when they are acquired through sales of loans. Servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The Company compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans, driven, generally, by changes in market interest rates.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. Changes in valuation allowances are reported with mortgage banking income on the income statement. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Servicing fee income, which is reported on the income statement with mortgage banking income, is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan, and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Servicing fees totaled $3.6 million, $3.5 million and $3.6 million for the years ended December 31, 2016, 2015 and 2014. Late fees and ancillary fees related to loan servicing are not material. See Note 8.

Bank Owned Life Insurance

The Company has purchased life insurance policies for certain key employees. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Premises and Equipment and Long Lived Assets

Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:

Buildings and improvements			20 to 50 years
Furniture, fixtures and equipment			3 to 15 years

Long-lived assets to be held and those to be disposed of and certain intangibles are periodically evaluated for impairment. See Note 9.

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Goodwill and Other Intangibles

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

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

Real Estate and Other Assets Held for Sale

Real estate and other assets held for sale are comprised of properties or other assets acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. These assets are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Losses arising from the acquisition of such property are charged against the allowance for loan losses at the time of acquisition. These properties are carried at the lower of cost or fair value, less estimated costs to dispose. If fair value declines subsequent to foreclosure, the property is written down against expense. Costs after acquisition are expensed.

Stock Compensation Plans

Compensation cost is recognized for stock options and restricted share awards issued to employees and directors, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options. Restricted shares awards are valued at the market value of Company stock at the date of the grant. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. See Note 20.

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 22. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

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Mortgage Banking Derivatives

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked. The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans. Changes in fair values of these derivatives are included in mortgage banking income.

Operating Segments

Management considers the following factors in determining the need to disclose separate operating segments: (1) The nature of products and services, which are all financial in nature. (2) The type and class of customer for the products and services; in First Defiance’s case retail customers for retail bank and insurance products and commercial customers for commercial loan, deposit, life, health and property and casualty insurance needs. (3) The methods used to distribute products or provide services; such services are delivered through banking and insurance offices and through bank and insurance customer contact representatives. Retail and commercial customers are frequently targets for both banking and insurance products. (4) The nature of the regulatory environment; both banking and insurance entities are subject to various regulatory bodies and a number of specific regulations.

Quantitative thresholds as stated in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280, Segment Reporting are monitored. For the year ended December 31, 2016, the reported revenue for First Insurance was 9.2% of total revenue for First Defiance. Total revenue includes net interest income (before provision for loan losses) plus non-interest income. Net income for First Insurance for the year ended December 31, 2016 was 4.9% of consolidated net income. Total assets of First Insurance at December 31, 2016 were 0.6% of total assets. First Insurance does not meet any of the quantitative thresholds of FASB ASC Topic 280. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.

Dividend Restriction

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the savings bank to the holding company. See Note 17 for further details on restrictions.

Loan Commitments and Related Financial Instruments

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Loss Contingencies

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the financial statements.

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Income Taxes

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.

An effective tax rate of 35% is used to determine after-tax components of other comprehensive income (loss) included in the statements of stockholders’ equity. See Note 18.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

Retirement Plans

Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Employee 401(k) plan expense is the amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service. See Note 16 and 19.

Reclassifications

Some items in the prior year financial statements were reclassified to conform to the current presentation.

Accounting Standards Updates

In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2016-05 — Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force). The amendments in this update provide guidance on eight specific cash flow issues. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The amendments in this update are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted. The Company does not believe this standard will have a material impact on its consolidated statements of cash flows.

In June 2016, the FASB issued new accounting guidance in ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments (Topic 326). The main objective of the update is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this update replace the incurred loss impairment methodology in current Generally Accepted Accounting Principles with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to form credit loss estimates. The amendments in this update become effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2019. The Company is currently evaluating the impact of this new accounting standard on the Company's consolidated financial statements. Management’s initial review indicates it has maintained sufficient historical loan data to support the requirement of this pronouncement and is currently evaluating the various loss methodologies to determine their correlations to the Company’s loan segments historical performance.

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In February 2016, the FASB issued ASU No. 2016-02 — Leases (Topic 842). The objective of the update is to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact this standard will have on its financial position and results of operations, though the Company expects that its real estate leases will be recognized on the consolidated balance sheet.

In January 2016, the FASB issued ASU No. 2016-01 — Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2017, and requires a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Early adoption is not permitted. The Company is currently evaluating the impact of adopting the new guidance on the consolidated financial statements. Management’s preliminary finding is that the new pronouncement will not have a significant impact on its results of operations. The pronouncement will require some revision to the Company’s disclosures within the consolidated financial statements and is currently evaluating the impact.

In May 2014, the FASB issued ASU No. 2014-09 — Revenue from Contracts with Customers, and subsequently has issued five related accounting standard updates clarifying several aspects of ASU 2014-09, including technical corrections and improvements. The overall objective of the new standards updates is to provide a single, comprehensive revenue recognition model for all contracts with customers to improve comparability within industries, across industries, and across capital markets. The revenue standard contains principles that will be applied to determine the measurement of revenue and timing of when it is recognized. The Company anticipates adopting the new standard on its effective date, January 1, 2018, though the Company has not yet selected whether it would adopt using the retrospective approach with adjustments to each prior period or the retrospective method with the cumulative effect of initial application recognized at the date of initial application. While the Company is continuing to assess all potential impacts this standard will have on its financial position and results of operations, early conclusions indicate that these standards will not have a material impact. The implementation efforts include the identification of revenue within the scope of the guidance, as well as the evaluation of revenue contracts.

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3. Acquisitions/Subsequent Event

On August 23, 2016, First Defiance announced the execution of a definitive agreement (the “Agreement”) to acquire Commercial Bancshares, Inc. (“Commercial Bancshares”) and its wholly-owned subsidiary, the Commercial Savings Bank (“CSB”). The transaction closed on February 24, 2017. The total purchase price for Commercial Bancshares was $70.3 million, consisting of $13.8 million of cash and cash payment to cancel outstanding options and the issuance of 1.1 million shares of First Defiance Common Stock valued at $56.5 million. The Company expects to record goodwill arising from the acquisition consisting largely of synergies and cost savings resulting from combining the operations of the companies. The amount of goodwill is not expected to be deductible for tax purposes. The fair value of intangible assets and acquired assets and liabilities will be determined as of the acquisition date but are still being evaluated as of the date of these financial statements. The purpose of the acquisition is to extend the Company’s growing market area into central Ohio supporting the Company’s overall strategic plan.

4. Earnings Per Common Share

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

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

	2016		2015		2014
	(In Thousands, Except Per Share Amounts)
Basic Earnings Per Share:
Net income available to common shareholders	$	28,843	$	26,423	$	24,292
Less: Income allocated to participating securities		39		8		4
Net income allocated to common shareholders		28,804		26,415		24,288

Weighted average common shares outstanding Including participating securities		8,980		9,221		9,511
Less: Participating securities		11		11		6
Average common shares		8,969		9,210		9,505

Basic earnings per common share	$	3.21	$	2.87	$	2.55

Diluted Earnings Per Share:
Net income allocated to common shareholders	$	28,804	$	26,415	$	24,288
Weighted average common shares outstanding for basic earnings per common share		8,969		9,210		9,505
Add: Dilutive effects of stock options		66		87		111
Add: Dilutive effects of warrants		-		75		353
Average shares and dilutive potential common shares		9,035		9,371		9,969

Diluted earnings per common share	$	3.19	$	2.82	$	2.44

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Shares subject to issue upon exercise of options of 12,550 in 2016, 8,750 in 2015 and 10,500 in 2014 were excluded from the diluted earnings per common share calculation as they were anti-dilutive.

5. Investment Securities

The following tables summarize the amortized cost and fair value of available-for-sale securities and held-to-maturity investment securities at December 31, 2016 and 2015 and the corresponding amounts of gross unrealized and unrecognized gains and losses:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
2016
Available-for-sale
Obligations of U.S. government corporations and agencies	$	4,000	$	-	$	(85	)	$	3,915
Mortgage-backed securities - residential		82,619		390		(1,302	)		81,707
REMICs		1,309		-		(2	)		1,307
Collateralized mortgage obligations		63,204		422		(621	)		63,005
Preferred stock		-		2		-			2
Corporate bonds		12,919		97		(3	)		13,013
Obligations of state and political subdivisions		86,165		2,491		(613	)		88,043
Total Available-for-Sale	$	250,216	$	3,402	$	(2,626	)	$	250,992

			Gross		Gross
	Amortized		Unrecognized		Unrecognized		Fair
	Cost		Gains		Losses		Value
	(In Thousands)
Held-to-Maturity
FHLMC certificates	$	12	$	-	$	-	$	12
FNMA certificates		56		2		-		58
GNMA certificates		23		1		-		24
Obligations of states and political subdivisions		93		-		-		93
Total Held-to-Maturity	$	184	$	3	$	-	$	187

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			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
2015
Available-for-sale
Obligations of U.S. government corporations and agencies	$	3,000	$	1	$	(7	)	$	2,994
Mortgage-backed securities - residential		63,815		898		(59	)		64,654
REMICs		1,592		28		-			1,620
Collateralized mortgage obligations		71,176		976		(353	)		71,799
Preferred stock		-		1		-			1
Corporate bonds		4,955		39		(17	)		4,977
Obligations of state and political subdivisions		85,680		4,712		(2	)		90,390
Total Available-for-Sale	$	230,218	$	6,655	$	(438	)	$	236,435

			Gross		Gross
	Amortized		Unrecognized		Unrecognized			Fair
	Cost		Gains		Losses			Value
	(In Thousands)
Held-to-Maturity
FHLMC certificates	$	14	$	-	$	-		$	14
FNMA certificates		74		2		(1	)		75
GNMA certificates		31		1		-			32
Obligations of states and political subdivisions		124		-		-			124
Total Held-to-Maturity	$	243	$	3	$	(1	)	$	245

The amortized cost and fair value of the investment securities portfolio at December 31, 2016 is shown below by contractual maturity. Expected maturities will differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity tables below, mortgage-backed securities and collateralized mortgage obligations, which are not due at a single maturity date, have not been allocated over maturity groupings.

	Available-for-Sale
	Amortized		Fair
	Cost		Value
	(In Thousands)
2016
Available-for-sale
Due in one year or less	$	577	$	586
Due after one year through five years		21,850		22,136
Due after five years through ten years		41,311		42,784
Due after ten years		39,346		39,467
MBS/CMO/REMIC		147,132		146,019
Total	$	250,216	$	250,992
Held-to-maturity
Due after one year through five years	$	93	$	93
MBS		91		94
Total	$	184	$	187

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Securities pledged at year-end 2016 and 2015 had a carrying amount of $142.6 million and $134.8 million and were pledged to secure public deposits, securities sold under repurchase agreements and FHLB advances.

As of December 31, 2016, the Company’s investment portfolio consisted of 383 securities, 117 of which were in an unrealized loss position. The Company did not hold any single security that was greater than 10% of the Company’s equity at December 31, 2016.

The following table summarizes First Defiance’s securities that were in an unrealized loss position at December 31, 2016 and December 31, 2015:

	Duration of Unrealized Loss Position
	Less than 12 Months					12 Months or Longer					Total
			Gross					Gross
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Loss			Value		Loss			Value		Loses
	(In Thousands)
At December 31, 2016
Available-for-sale securities:
Obligations of U.S. government corporations and agencies	$	3,915	$	(85	)	$	-	$	-		$	3,915	$	(85	)
Mortgage-backed securities-residential		63,736		(1,302	)		-		-			63,736		(1,302	)
REMICs		1,308		(2	)		-		-			1,308		(2	)
Collateralized mortgage obligations		28,882		(566	)		1,227		(55	)		30,110		(621	)
Corporate bonds		-		-			997		(3	)		997		(3	)
Obligations of state and political subdivisions		19,172		(613	)		-		-			19,172		(613	)
Total temporarily impaired securities	$	117,013	$	(2,568	)	$	2,224	$	(58	)	$	119,238	$	(2,626	)

At December 31, 2015
Available-for-sale securities:
Obligations of U.S. government corporations and agencies	$	993	$	(7	)	$	-	$	-		$	993	$	(7	)
Mortgage-backed securities-residential		12,525		(59	)		-		-			12,525		(59	)
Collateralized mortgage obligations		12,374		(150	)		8,158		(203	)		20,532		(353	)
Corporate bonds		983		(17	)		-		-			983		(17	)
Obligations of state and political subdivisions		-		-			433		(2	)		433		(2	)
Held to maturity securities:
FNMA certificates		13		(1	)		-		-			13		(1	)
Total temporarily impaired securities	$	26,888	$	(234	)	$	8,591	$	(205	)	$	35,479	$	(439	)

Management evaluates securities for OTTI on at least 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 (“CDOs”) are evaluated for OTTI under FASB ASC Topic 325, Investment – Other.

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

With the exception of corporate bonds, the 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.

In 2016, 2015 and 2014, management determined there was no OTTI. In 2013, management determined that two CDOs had OTTI because they were disallowed under the Final Interim Volcker Rule of the Dodd-Frank Act released on January 14, 2014. The Company sold these two securities on January 15, 2014.

There was no OTTI recognized in accumulated other comprehensive income (“AOCI”) relating to the CDOs at December 31, 2016 and 2015.

The table below presents a roll-forward of the credit losses relating to debt securities recognized in earnings for the years ended December 31, 2016, 2015 and 2014 (In Thousands):

	2016		2015		2014
Beginning balance, January 1	$	-	$	-	$	3,513
Additions for amounts related to credit loss for which an OTTI was not previously recognized		-		-		-

Reductions for amounts realized for securities sold/redeemed during the period		-		-		(3,513	)

Ending balance, December 31	$	-	$	-	$	-

Realized gains from the sales and calls of investment securities totaled $509,000 ($331,000 after tax) in 2016 while there were realized gains of $22,000 ($15,000 after tax) and $932,000 ($652,000 after tax) in 2015 and 2014, respectively.

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

	2016		2015		2014
	(In Thousands)
Proceeds	$	14,871	$	426	$	14,913
Gross realized gains		509		22		1,574
Gross realized losses		-		-		(642	)

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6. Commitments and Contingent Liabilities

Loan Commitments

Loan commitments are made to accommodate the financial needs of First Federal’s customers. 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 on December 31 was as follows (In Thousands):

	2016				2015
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
Commitments to make loans	$	34,432	$	106,356	$	80,862	$	76,253
Unused lines of credit		14,384		400,542		31,991		323,171
Standby letters of credit		-		9,668		-		19,632
Total	$	48,816	$	516,566	$	112,853	$	419,056

Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments at December 31, 2016 had interest rates ranging from 2.63% to 18.00% and maturities ranging from less than 1 year to 30 years.

In addition to the above commitments, at December 31, 2016, First Defiance had commitments to sell $22.5 million of loans to Freddie Mac, Fannie Mae, FHLB of Cincinnati or BB&T Mortgage.

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7. Loans

Loans receivable consist of the following:

	December 31, 2016			December 31, 2015
	(In Thousands)
Real Estate:
Secured by 1-4 family residential	$	207,550		$	205,330
Secured by multi-family residential		196,983			167,558
Secured by commercial real estate		843,579			780,870
Construction		182,886			163,877
		1,430,998			1,317,635
Other Loans:
Commercial		469,055			419,349
Home equity and improvement		118,429			116,962
Consumer Finance		16,680			16,281
		604,164			552,592
Total loans		2,035,162			1,870,227
Deduct:
Undisbursed loan funds		(93,355	)		(66,902	)
Net deferred loan origination fees and costs		(1,320	)		(1,108	)
Allowance for loan loss		(25,884	)		(25,382	)
Totals	$	1,914,603		$	1,776,835

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

The following table discloses the year-to-date activity in the allowance for loan loss for the dates indicated by portfolio segment (In Thousands):

Year to Date December 31, 2016	1-4 Family Residential Real Estate			Multi- Family Residential Real Estate		Commercial Real Estate			Construction			Commercial			Home Equity and Improvement			Consumer Finance			Total
Beginning Allowance	$	3,212		$	2,151	$	11,772		$	517		$	5,255		$	2,304		$	171		$	25,382
Charge-Offs		(350	)		-		(92	)		-			(615	)		(268	)		(94	)		(1,419	)
Recoveries		166			-		923			-			335			150			64			1,638
Provisions		(401	)		77		(1,978	)		(67	)		2,386			200			66			283
Ending Allowance	$	2,627		$	2,228	$	10,625		$	450		$	7,361		$	2,386		$	207		$	25,884

Year to Date December 31, 2015	1-4 Family Residential Real Estate			Multi- Family Residential Real Estate			Commercial Real Estate			Construction		Commercial			Home Equity and Improvement			Consumer Finance			Total
Beginning Allowance	$	2,494		$	2,453		$	11,268		$	221	$	6,509		$	1,704		$	117		$	24,766
Charge-Offs		(283	)		(114	)		(353	)		-		(68	)		(350	)		(53	)		(1,221	)
Recoveries		214			-			915			-		331			188			53			1,701
Provisions		787			(188	)		(58	)		296		(1,517	)		762			54			136
Ending Allowance	$	3,212		$	2,151		$	11,772		$	517	$	5,255		$	2,304		$	171		$	25,382

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Year to Date December 31, 2014	1-4 Family Residential Real Estate			Multi- Family Residential Real Estate			Commercial Real Estate			Construction		Commercial			Home Equity and Improvement			Consumer Finance			Total
Beginning Allowance	$	2,847		$	2,508		$	12,000		$	134	$	5,678		$	1,635		$	148		$	24,950
Charge-Offs		(426	)		-			(1,018	)		-		(2,982	)		(392	)		(41	)		(4,859	)
Recoveries		188			7			2,670			-		435			193			65			3,558
Provisions		(115	)		(62	)		(2,384	)		87		3,378			268			(55	)		1,117
Ending Allowance	$	2,494		$	2,453		$	11,268		$	221	$	6,509		$	1,704		$	117		$	24,766

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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, 2016: (In Thousands)

	1-4 Family		Multi Family
	Residential		Residential		Commercial						Home Equity		Consumer
	Real Estate		Real Estate		Real Estate		Construction		Commercial		& Improvement		Finance		Total

Allowance for loan losses:

Ending allowance balance attributable to loans:

Individually evaluated for impairment	$	202	$	4	$	255	$	-	$	35	$	313	$	-	$	809

Collectively evaluated for impairment		2,425		2,224		10,370		450		7,326		2,073		207		25,075

Acquired with deteriorated credit quality		-		-		-		-		-		-		-		-

Total ending allowance balance	$	2,627	$	2,228	$	10,625	$	450	$	7,361	$	2,386	$	207	$	25,884

Loans:

Loans individually evaluated for impairment	$	6,898	$	3,483	$	13,570	$	-	$	2,154	$	1,269	$	59	$	27,433

Loans collectively evaluated for impairment		200,907		193,714		832,446		89,244		468,246		117,744		16,625		1,918,926

Loans acquired with deteriorated credit quality		-		-		-		-		11		-		-		11

Total ending loans balance	$	207,805	$	197,197	$	846,016	$	89,244	$	470,411	$	119,013	$	16,684	$	1,946,370

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	1-4 Family		Multi Family
	Residential		Residential		Commercial						Home Equity		Consumer
	Real Estate		Real Estate		Real Estate		Construction		Commercial		& Improvement		Finance		Total

Allowance for loan losses:

Ending allowance balance attributable to loans:

Individually evaluated for impairment	$	201	$	-	$	139	$	-	$	63	$	34	$	-	$	437

Collectively evaluated for impairment		3,011		2,151		11,633		517		5,192		2,270		171		24,945

Acquired with deteriorated credit quality		-		-		-		-		-		-		-		-

Total ending allowance balance	$	3,212	$	2,151	$	11,772	$	517	$	5,255	$	2,304	$	171	$	25,382

Loans:

Loans individually evaluated for impairment	$	7,574	$	3,313	$	23,493	$	-	$	6,107	$	1,491	$	71	$	42,049

Loans collectively evaluated for impairment		198,106		164,382		759,281		96,845		414,527		115,977		16,199		1,765,317

Loans acquired with deteriorated credit quality		-		-		153		-		16		-		-		169

Total ending loans balance	$	205,680	$	167,695	$	782,927	$	96,845	$	420,650	$	117,468	$	16,270	$	1,807,535

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The following tables presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans for the years ended December 31, 2016, 2015 and 2014 (In Thousands):

	Twelve Months Ended December 31, 2016
	Average Balance		Interest Income Recognized		Cash Basis Income Recognized
Residential Owner Occupied	$	3,954	$	244	$	237
Residential Non Owner Occupied		3,133		211		210
Total 1-4 Family Residential Real Estate		7,087		455		447
Multi-Family Residential Real Estate		3,946		124		123
CRE Owner Occupied		6,925		203		183
CRE Non Owner Occupied		5,351		411		407
Agriculture Land		2,283		128		68
Other CRE		1,632		71		70
Total Commercial Real Estate		16,191		813		728
Construction		-		-		-
Commercial Working Capital		1,606		109		90
Commercial Other		2,393		81		79
Total Commercial		3,999		190		169
Home Equity and Home Improvement		1,543		85		83
Consumer Finance		67		8		8
Total Impaired Loans	$	32,833	$	1,675	$	1,558

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	Twelve Months Ended December 31, 2015
	Average Balance		Interest Income Recognized		Cash Basis Income Recognized
Residential Owner Occupied	$	6,985	$	246	$	244
Residential Non Owner Occupied		5,444		152		152
Total 1-4 Family Residential Real Estate		12,429		398		396
Multi-Family Residential Real Estate		3,799		40		40
CRE Owner Occupied		9,019		168		167
CRE Non Owner Occupied		10,125		349		348
Agriculture Land		2,980		88		56
Other CRE		3,554		81		80
Total Commercial Real Estate		25,678		686		651
Construction		50		2		2
Commercial Working Capital		2,217		58		56
Commercial Other		4,773		49		49
Total Commercial		6,990		107		115
Home Equity and Home Improvement		2,757		62		62
Consumer Finance		80		14		14
Total Impaired Loans	$	51,783	$	1,309	$	1,270

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	Twelve Months Ended December 31, 2014
	Average Balance		Interest Income Recognized		Cash Basis Income Recognized
Residential Owner Occupied	$	6,177	$	317	$	313
Residential Non Owner Occupied		3,920		143		143
Total 1-4 Family Residential Real Estate		10,097		460		456
Multi-Family Residential Real Estate		903		4		4
CRE Owner Occupied		8,906		145		142
CRE Non Owner Occupied		18,164		807		809
Agriculture Land		611		14		14
Other CRE		1,694		20		22
Total Commercial Real Estate		29,375		986		987
Construction		233		12		15
Commercial Working Capital		2,790		29		29
Commercial Other		4,576		14		12
Total Commercial		7,366		43		41
Home Equity and Home Improvement		2,233		95		94
Consumer Finance		47		3		3
Total Impaired Loans	$	50,254	$	1,603	$	1,600

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The following table presents loans individually evaluated for impairment by class of loans (In Thousands):

	December 31, 2016						December 31, 2015
	Unpaid Principal Balance*		Recorded Investment		Allowance for Loan Losses Allocated		Unpaid Principal Balance*		Recorded Investment		Allowance for Loan Losses Allocated
With no allowance recorded:
Residential Owner Occupied	$	1,912	$	1,765	$	-	$	1,383	$	1,360	$	-
Residential Non Owner Occupied		1,691		1,683		-		2,147		2,141		-
Total 1-4 Family Residential Real Estate		3,603		3,448		-		3,530		3,501		-
Multi-Family Residential Real Estate		3,578		3,430		-		3,463		3,313		-
CRE Owner Occupied		2,652		2,353		-		4,869		4,520		-
CRE Non Owner Occupied		4,372		4,240		-		7,932		7,685		-
Agriculture Land		1,695		1,722		-		3,546		3,596		-
Other CRE		1,225		1,115		-		4,076		4,046		-
Total Commercial Real Estate		9,944		9,430		-		20,423		19,847		-
Construction		-		-		-		-		-		-
Commercial Working Capital		838		786		-		1,644		1,648		-
Commercial Other		1,179		967		-		3,573		3,607		-
Total Commercial		2,017		1,753		-		5,217		5,255		-
Home Equity and Home Improvement		631		585		-		817		772		-
Consumer Finance		55		55		-		60		59		-
Total loans with no allowance recorded	$	19,828	$	18,701	$	-	$	33,510	$	32,747	$	-

With an allowance recorded:
Residential Owner Occupied	$	2,348	$	2,319	$	157	$	2,918	$	2,837	$	188
Residential Non Owner Occupied		1,137		1,131		45		1,231		1,236		13
Total 1-4 Family Residential Real Estate		3,485		3,450		202		4,149		4,073		201
Multi-Family Residential Real Estate		53		53		4		-		-		-
CRE Owner Occupied		2,362		1,894		102		3,250		2,767		132
CRE Non Owner Occupied		1,618		1,479		108		385		308		2
Agriculture Land		45		45		3		68		69		2
Other CRE		1,144		722		42		926		502		3
Total Commercial Real Estate		5,169		4,140		255		4,629		3,646		139
Construction		-		-		-		-		-		-
Commercial Working Capital		230		231		24		594		596		62
Commercial Other		167		170		11		252		256		1
Total Commercial		397		401		35		846		852		63
Home Equity and Home Improvement		688		684		313		724		719		34
Consumer Finance		4		4		-		12		12		-
Total loans with an allowance recorded	$	9,796	$	8,732	$	809	$	10,360	$	9,302	$	437

* Presented gross of charge offs

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

	December 31, 2016		December 31, 2015
	(In Thousands)
Non-accrual loans	$	14,348	$	16,261
Loans over 90 days past due and still accruing		-		-
Total non-performing loans		14,348		16,261
Real estate and other assets held for sale		455		1,321
Total non-performing assets	$	14,803	$	17,582

Troubled debt restructuring, still accruing	$	10,544	$	11,178

The following table presents the aging of the recorded investment in past due and non-accrual loans as of December 31, 2016 by class of loans (In Thousands):

	Current		30-59 days		60-89 days		90+ days		Total Past Due		Total Non Accrual

Residential Owner Occupied	$	139,015	$	56	$	842	$	544	$	1,442	$	1,931
Residential Non Owner Occupied		66,811		166		308		63		537		992

Total 1-4 Family Residential Real Estate		205,826		222		1,150		607		1,979		2,923

Multi-Family Residential Real Estate		197,197		-		-		-		-		2,637

CRE Owner Occupied		340,233		79		-		1,396		1,475		3,098
CRE Non Owner Occupied		338,724		81		16		426		523		1,808
Agriculture Land		102,397		-		-		-		-		755
Other Commercial Real Estate		62,415		-		-		249		249		1,292

Total Commercial Real Estate		843,769		160		16		2,071		2,247		6,953

Construction		89,244		-		-		-		-		-

Commercial Working Capital		202,786		-		10		38		48		435
Commercial Other		267,189		23		-		365		388		577

Total Commercial		469,975		23		10		403		436		1,012

Home Equity and Home Improvement		117,458		1,125		176		254		1,555		730
Consumer Finance		16,452		85		69		78		232		91

Total Loans	$	1,939,921	$	1,615	$	1,421	$	3,413	$	6,449	$	14,346

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The following table presents the aging of the recorded investment in past due and non-accrual loans as of December 31, 2015 by class of loans: (In Thousands)

	Current		30-59 days		60-89 days		90+ days		Total Past Due		Total Non Accrual

Residential Owner Occupied	$	138,974	$	159	$	673	$	391	$	1,223	$	1,428
Residential Non Owner Occupied		64,577		324		356		226		906		1,179

Total 1-4 Family Residential Real Estate		203,551		483		1,029		617		2,129		2,607

Multi-Family Residential Real Estate		165,671		-		-		2,024		2,024		2,417

CRE Owner Occupied		322,940		772		1,218		1,266		3,256		4,141
CRE Non Owner Occupied		304,166		-		106		538		644		1,229
Agriculture Land		98,055		57		-		-		57		695
Other Commercial Real Estate		53,494		-		-		315		315		1,364

Total Commercial Real Estate		778,655		829		1,324		2,119		4,272		7,429

Construction		96,845		-		-		-		-		-

Commercial Working Capital		168,938		16		-		154		170		251
Commercial Other		249,070		203		46		2,223		2,472		2,833

Total Commercial		418,008		219		46		2,377		2,642		3,084

Home Equity and Home Improvement		116,599		733		92		44		869		689
Consumer Finance		16,216		27		3		24		54		36

Total Loans	$	1,795,545	$	2,291	$	2,494	$	7,205	$	11,990	$	16,262

Troubled Debt Restructurings

As of December 31, 2016 and 2015, the Company had a recorded investment in troubled debt restructurings (“TDRs”) of $16.8 million and $17.6 million, respectively. The Company allocated $809,000 and $335,000, of specific reserves to those loans at December 31, 2016 and 2015, and committed to lend additional amounts totaling up to $20,000 and $48,000 at December 31, 2016 and 2015.

The Company offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Each TDR is uniquely designed to meet the specific needs of the borrower. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral or an additional guarantor is often requested when granting a concession. Commercial mortgage loans modified in a TDR often involve temporary interest-only payments, re-amortization of remaining debt in order to lower payments, and sometimes reducing the interest rate lower than the current market rate. Residential mortgage loans modified in a TDR are comprised of loans where monthly payments are lowered, either through interest rate reductions or principal only payments for a period of time, to accommodate the borrowers’ financial needs, interest is capitalized into principal, or the term and amortization are extended. Home equity modifications are made infrequently and usually involve providing an interest rate that is lower than the borrower would be able to obtain due to credit issues. All retail loans where the borrower is in bankruptcy are classified as TDRs regardless of whether or not a concession is made.

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Of the loans modified in a TDR, $6.2 million are on non-accrual status and partial charge-offs have in some cases been taken against the outstanding balance. Loans modified as a TDR may have the financial effect of increasing the allowance associated with the loan. If the loan is determined to be collateral dependent, the estimated fair value of the collateral, less any selling costs is used to determine if there is a need for a specific allowance or charge-off. If the loan is determined to be cash flow dependent, the allowance is measured based on the present value of expected future cash flows discounted at the loan’s pre-modification effective interest rate.

The following table presents loans by class modified as TDRs that occurred during the years indicated (Dollars in Thousands):

	Loans Modified as a TDR for the Twelve Months Ended December 31, 2016				Loans Modified as a TDR for the Twelve Months Ended December 31, 2015				Loans Modified as a TDR for the Twelve Months Ended December 31, 2014
TDRs	Number of Loans		Recorded Investment (as of period end)		Number of Loans		Recorded Investment (as of period end)		Number of Loans		Recorded Investment (as of period end)

Residential Owner Occupied		17	$	778		6	$	454		18	$	1,726
Residential Non Owner Occupied		5		494		4		59		3		517
Multi Family		2		1,885		-		-		-		-
CRE Owner Occupied		-		-		2		645		2		27
CRE Non Owner Occupied		5		974		2		244		3		403
Agriculture Land		1		45		3		1,443		-		-
Other CRE		1		348		-		-		-		-
Commercial Working Capital		1		226		2		62		4		1,353
Commercial Other		1		587		2		70		16		2,020
Home Equity and Home Improvement		9		281		13		324		17		471
Consumer Finance		2		14		9		62		4		15

Total		44	$	5,632		43	$	3,363		67	$	6,532

The loans described above increased the allowance for loan losses (“ALLL”) by $413,000 for the year ended December 31, 2016, decreased the ALLL by $13,000 for the year ended December 31, 2015, and increased the ALLL by $234,000 for the year ended December 31, 2014.

Of the 2016 modifications, fifteen were made TDRs due to the fact that the borrower filed bankruptcy, one was made a TDR due to an interest only period, six were made a TDR due to extending the maturity, five were made TDRs due to advancing or renewing funds to a watchlist credit, two were made TDRs to term out lines of credit, and fifteen were made TDRs to refinance current debt for payment relief.

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The following table presents loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the indicated:

	Twelve Months Ended December 31, 2016 ($ in thousands)				Twelve Months Ended December 31, 2015 ($ in thousands)				Twelve Months Ended December 31, 2014 ($ in thousands)
TDRs That Subsequently Defaulted:	Number of Loans		Recorded Investment (as of Period End)		Number of Loans		Recorded Investment (as of Period End)		Number of Loans		Recorded Investment (as of Period End)

Residential Owner Occupied		-	$	-		-	$	-		1	$	80
Residential Non Owner Occupied		-		-		-		-		1		178
CRE Owner Occupied		-		-		-		-		-		-
CRE Non Owner Occupied		1		205		-		-		-		-
Agriculture Land		-		-		-		-		-		-
Other CRE		-		-		-		-		-		-
Commercial Working Capital		-		-		1		120		2		868
Commercial Other		-		-		5		1,791		5		865
Home Equity and Home Improvement		-		-		1		22		-		-
Consumer		-		-		-		-		-		-

Total		1	$	205		7	$	1,933		9	$	1,991

The TDRs that subsequently defaulted described above had no effect on the ALLL for the year ended December 31, 2016 and 2015. They decreased the ALLL by $14,000 after $176,000 in charge-offs for the year ended December 31, 2014.

A default for purposes of this disclosure is a TDR loan in which the borrower is 90 days contractually past due under the modified terms.

The terms of certain other loans were modified during the periods ending December 31, 2016 and 2015 that did not meet the definition of a TDR. The modification of these loans involved a modification of the terms of a loan to borrowers who were not experiencing financial difficulties. A total of 373 loans were modified under this definition during the twelve month period ended December 31, 2016 and a total of 187 loans were modified under this definition during the twelve month period ended December 31, 2015.

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

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.

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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 December 31, 2016, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

Class	Pass		Special Mention		Substandard		Doubtful		Not Graded		Total

Residential Owner Occupied	$	5,980	$	402	$	1,824	$	-	$	132,250	$	140,456
Residential Non Owner Occupied		58,041		1,394		3,480		-		4,434		67,349

Total 1-4 Family Real Estate		64,021		1,796		5,304		-		136,684		207,805

Multi-Family Residential Real Estate		192,369		862		3,852		-		114		197,197

CRE Owner Occupied		316,335		20,559		4,430		-		384		341,708
CRE Non Owner Occupied		332,196		1,617		5,435		-		-		339,248
Agriculture Land		98,039		2,355		2,002		-		-		102,396
Other CRE		59,561		60		2,297		-		746		62,664

Total Commercial Real Estate		806,131		24,591		14,164		-		1,130		846,016

Construction		67,751		706		-		-		20,787		89,244

Commercial Working Capital		193,043		8,301		1,490		-		-		202,834
Commercial Other		262,076		3,749		1,752		-		-		267,577

Total Commercial		455,119		12,050		3,242		-		-		470,411

Home Equity and Home Improvement		-		-		696		-		118,317		119,013
Consumer Finance		-		-		90		-		16,594		16,684

Total Loans	$	1,585,391	$	40,005	$	27,348	$	-	$	293,626	$	1,946,370

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As of December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

Class	Pass		Special Mention		Substandard		Doubtful		Not Graded		Total

Residential Owner Occupied	$	5,828	$	123	$	2,427	$	-	$	131,820	$	140,198
Residential Non Owner Occupied		55,169		1,420		4,439		-		4,454		65,482

Total 1-4 Family Real Estate		60,997		1,543		6,866		-		136,274		205,680

Multi-Family Residential Real Estate		163,405		498		3,675		-		117		167,695

CRE Owner Occupied		297,856		17,896		9,730		-		714		326,196
CRE Non Owner Occupied		293,057		2,143		9,595		-		15		304,810
Agriculture Land		92,262		1,947		3,903		-		-		98,112
Other CRE		47,109		469		5,739		-		492		53,809

Total Commercial Real Estate		730,284		22,455		28,967		-		1,221		782,927

Construction		76,152		2,159		-		-		18,534		96,845

Commercial Working Capital		163,071		2,497		3,540		-		-		169,108
Commercial Other		243,308		2,706		5,528		-		-		251,542

Total Commercial		406,379		5,203		9,068		-		-		420,650

Home Equity and Home Improvement		-		-		689		-		116,779		117,468
Consumer Finance		-		-		15		-		16,255		16,270

Total Loans	$	1,437,217	$	31,858	$	49,280	$	-	$	289,180	$	1,807,535

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Certain loans acquired had evidence that the credit quality of the loan had deteriorated since its origination and in management’s assessment at the acquisition date it was probable that First Defiance would be unable to collect all contractually required payments due. In accordance with FASB ASC Topic 310 Subtopic 30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, these loans have been recorded based on management’s estimate of the fair value of the loans. Details of these loans are as follows:

	Contractual Amount Receivable			Impairment Discount			Recorded Loan Receivable
	(In Thousands)
Balance at January 1, 2014	$	503		$	273		$	230
Principal payments received		(90	)		-			(90	)
Loans charged off		-			-			-
Additional provision for loan loss		-			-			-
Loan accretion recorded		-			(46	)		46
Balance at December 31, 2014		413			227			186
Principal payments received		(51	)		-			(51	)
Loans charged off		-			-			-
Additional provision for loan loss		-			-			-
Loan accretion recorded		-			(34	)		34
Balance at December 31, 2015		362			193			169
Principal payments received		(261	)		-			(261	)
Loans charged off		(35	)		(35	)		-
Additional provision for loan loss		-			-			-
Loan accretion recorded		-			(103	)		103
Balance at December 31, 2016	$	66		$	55		$	11

Loans to executive officers, directors, and their affiliates are as follows:

	Years Ended December 31
	2016			2015
	(In Thousands)
Beginning balance	$	7,349		$	5,888
New loans		4,783			5,822
Effect of changes in composition of related parties		12,320			(54	)
Repayments		(8,253	)		(4,307	)
Ending Balance	$	16,199		$	7,349

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8. Mortgage Banking

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

	Years Ended December 31
	2016			2015			2014
	(In Thousands)
Gain from sale of mortgage loans	$	5,311		$	4,564		$	3,335
Mortgage loan servicing revenue (expense):
Mortgage loan servicing revenue		3,560			3,503			3,552
Amortization of mortgage servicing rights		(1,724	)		(1,620	)		(1,401	)
Mortgage servicing rights valuation adjustments		123			266			116
		1,959			2,149			2,267

Net mortgage banking income	$	7,270		$	6,713		$	5,602

The unpaid principal balance of residential mortgage loans serviced for third parties was $1.37 billion at December 31, 2016 and $1.34 billion at December 31, 2015.

Activity for capitalized mortgage servicing rights and the related valuation allowance follows:

	Years Ended December 31
	2016			2015			2014
	(In Thousands)
Mortgage servicing assets:
Balance at beginning of period	$	9,893		$	9,923		$	10,133
Loans sold, servicing retained		1,948			1,590			1,191
Amortization		(1,724	)		(1,620	)		(1,401	)
Carrying value before valuation allowance at end of period		10,117			9,893			9,923

Valuation allowance:
Balance at beginning of period		(645	)		(911	)		(1,027	)
Impairment recovery (charges)		123			266			116
Balance at end of period		(522	)		(645	)		(911	)
Net carrying value of MSRs at end of period	$	9,595		$	9,248		$	9,012
Fair value of MSRs at end of period	$	9,770		$	9,802		$	9,304

Amortization of mortgage servicing rights is computed based on payments and payoffs of the related mortgage loans serviced.

The Company had no actual losses from secondary market buy-backs in 2016. Based on management’s estimate of potential losses from secondary market buyback activity, a liability of $79,000 and $214,000 was accrued at December 31, 2016 and 2015, respectively, and is reflected in other liabilities in the Consolidated Statements of Financial Condition. Expense (credit) recognized related to the accrual was $(135,000), $(95,000) and $298,000 for the years ended December 31, 2016, 2015 and 2014, respectively.

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The Company’s servicing portfolio is comprised of the following:

	December 31
	2016				2015
	Number of		Principal		Number of		Principal
Investor	Loans		Outstanding		Loans		Outstanding
	(In Thousands)
Fannie Mae		5,004	$	470,692		5,104	$	484,155
Freddie Mac		9,229		889,280		9,015		845,564
Federal Home Loan Bank		101		11,081		118		12,605
Other		16		965		21		1,398
Totals		14,350	$	1,372,018		14,258	$	1,343,722

Custodial escrow balances maintained in connection with serviced loans were $12.6 million and $11.6 million at December 31, 2016 and 2015, respectively.

Significant assumptions at December 31, 2016 used in determining the value of MSRs include a weighted average prepayment speed assumption (“PSA”) of 152 and a weighted average discount rate of 12.01%. Significant assumptions at December 31, 2015 used in determining the value of MSRs include a weighted average prepayment rate of 181 PSA and a weighted average discount rate of 10.02%.

A sensitivity analysis of the current fair value to immediate 10% and 20% adverse changes in those assumptions as of December 31, 2016 is presented below. These sensitivities are hypothetical. Changes in fair value based on 10% and 20% variation in assumptions generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSR is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the discount rates), which might magnify or counteract the sensitivities.

	10% Adverse		20% Adverse
	Change		Change
	(In Thousands)
Assumption:
Decline in fair value from increase in prepayment rate	$	243	$	475
Decline in fair value from increase in discount rate		311		612

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9. Premises and Equipment

Premises and equipment are summarized as follows:

	December 31
	2016			2015
	(In Thousands)
Cost:
Land	$	7,534		$	7,494
Land improvements		1,310			1,310
Buildings		41,895			41,556
Leasehold improvements		971			971
Furniture, fixtures and equipment		31,253			29,622
Construction in process		787			656
		83,750			81,609
Less allowances for depreciation and amortization		(46,792	)		(43,443	)
	$	36,958		$	38,166

Depreciation expense was $3.4 million, $3.3 million and $3.0 million for the years ended December 31, 2016, 2015 and 2014, respectively.

Lease Agreements

The Company has entered into lease agreements covering six First Insurance Group offices, two banking center locations, two land leases for which the Company owns the banking centers, one land lease which is primarily used for parking, one land lease that is to be terminated in the first quarter of 2017 and numerous stand-alone Automated Teller Machine sites with varying terms and options to renew.

Future minimum commitments under non-cancelable operating leases are as follows (In Thousands):

2017	$	584
2018		400
2019		337
2020		265
2021		222
Thereafter		2,654
Total	$	4,462

Rental expenses under operating leases amounted to $571,000, $601,000 and $653,000 in 2016, 2015, and 2014, respectively.

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10. Goodwill and Intangible Assets

Goodwill

The change in the carrying amount of goodwill for the year is as follows:

	December 31
	2016		2015
	(In Thousands)
Beginning balance	$	61,798	$	61,525
Goodwill acquired or adjusted during the year		-		273
Ending balance	$	61,798	$	61,798

Acquired Intangible Assets

Activity in intangible assets for the years ended December 31, 2016, 2015 and 2014 was as follows:

	Gross
	Carrying		Accumulated			Net
	Amount		Amortization			Value
	(In Thousands)
Balance as of January 1, 2014	$	14,302	$	(10,805	)	$	3,497
Amortization of intangible assets		-		(1,102	)		(1,102	)
Balance as of December 31, 2014		14,302		(11,907	)		2,395
Intangible assets acquired		175		-			175
Amortization of intangible assets		-		(699	)		(699	)
Balance as of December 31, 2015		14,477		(12,606	)		1,871
Amortization of intangible assets		-		(535	)		(535	)
Balance as of December 31, 2016	$	14,477	$	(13,141	)	$	1,336

Estimated amortization expense for each of the next five years and thereafter is as follows (In Thousands):

2017	$	404
2018		332
2019		225
2020		149
2021		87
Thereafter		139
Total	$	1,336

11. Deposits

The following schedule sets forth interest expense by type of deposit:

	Years Ended December 31
	2016		2015		2014
	(In Thousands)
Checking and money market accounts	$	1,463	$	1,186	$	1,236
Savings accounts		88		89		90
Certificates of deposit		4,710		4,066		3,957
Totals	$	6,261	$	5,341	$	5,283

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Accrued interest payable on deposit accounts amounted to $42,000 and $43,000 at December 31, 2016 and 2015, respectively, which was comprised of $19,000 and $23,000 for certificates of deposit and checking and money market accounts, respectively, at December 31, 2016 and $25,000 and $18,000 for certificates of deposit and checking and money market accounts, respectively, at December 31, 2015.

A summary of deposit balances is as follows:

	December 31
	2016		2015
	(In Thousands)
Non-interest bearing checking accounts	$	487,663	$	420,691
Interest bearing checking and money market accounts		816,665		767,201
Savings deposits		243,369		219,655
Retail certificates of deposit less than $250,000		400,080		403,902
Retail certificates of deposit greater than $250,000		33,851		24,688
	$	1,981,628	$	1,836,137

Scheduled maturities of certificates of deposit at December 31, 2016 are as follows (In Thousands):

2017	$	156,767
2018		117,627
2019		78,750
2020		35,298
2021		45,489
Thereafter		-
Total	$	433,931

12. Advances from Federal Home Loan Bank

First Federal has the ability to borrow funds from the FHLB. First Federal pledges its single-family residential mortgage loan portfolio, certain investment securities; certain first mortgage home equity loans, certain commercial real estate loans, and certain agriculture real estate loans as security for these advances. Advances secured by investment securities must have collateral of at least 105% of the borrowing. Advances secured by residential mortgages must have collateral of at least 125% of the borrowings. Advances secured by commercial real estate loans, and agriculture real estate loans must have collateral of at least 300% of the borrowings. The total level of borrowing is also limited to 50% of total assets and at least 50% of the borrowings must be secured by either one-to-four family residential mortgages or investment securities. Total loans pledged to the FHLB at December 31, 2016 and December 31, 2015 were $843.8 million and $692.2 million, respectively. First Federal could obtain advances of up to approximately $448.9 million from the FHLB at December 31, 2016.

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At year-end, advances from the FHLB were as follows:

Principal Terms	Advance Amount		Range of Maturities		Weighted Average Interest Rate
(In Thousands)
December 31, 2016
Putable advances	$	5,000		March 2018		2.35	%
Single maturity fixed rate advances		92,000		November 2017 to March 2022		1.34	%
Amortizable mortgage advances		6,943		September 2018		1.78	%
	$	103,943

December 31, 2015
Putable advances	$	5,000		March 2018		2.35	%
Single maturity fixed rate advances		47,000		December 2017 to March 2022		1.51	%
Amortizable mortgage advances		7,902		December 2017 to October 2021		1.78	%
	$	59,902

Putable advances are callable at the option of the FHLB on a quarterly basis.

Estimated future minimum payments by fiscal year based on maturity date and current interest rates are as follows (In Thousands):

2017	$	32,306
2018		24,853
2019		15,637
2020		21,283
2021		10,143
Thereafter		3,162
Total minimum payments		107,384
Less amounts representing interest		(3,441	)
Totals	$	103,943

First Defiance also utilizes short-term advances from the FHLB to meet cash flow needs and for short-term investment purposes. First Defiance borrows short-term advances under a variety of programs at FHLB. At December 31, 2016 and 2015, there were no amounts outstanding under First Defiance’s Cash Management Advance line of credit. The total available under this line is $15.0 million. In addition, First Defiance has a $100.0 million REPO Advance line of credit available. There were no borrowings against this line at December 31, 2016 and 2015. Amounts are generally borrowed under the Cash Management and REPO lines on an overnight basis.

13. Junior Subordinated Debentures Owed to Unconsolidated Subsidiary Trust

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 the 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 variable rate equal to the three-month LIBOR rate plus 1.5%. The Coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate II was 2.46% and 2.01% as of December 31, 2016 and 2015 respectively.

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The Trust Preferred Securities issued by Trust Affiliate II are subject to mandatory redemption, in whole or part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on June 15, 2037, but can be redeemed at the Company’s option at any time now.

The Company also sponsors 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 2.34% and 1.89% as of December 31, 2016 and 2015 respectively.

The Trust Preferred Securities issued by Trust Affiliate I are subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures. The Company has entered into an agreement that fully and unconditionally guarantees the Trust Preferred Securities subject to the terms of the guarantee. The Trust Preferred Securities and Subordinated Debentures mature on December 15, 2035, but can be redeemed at the Company’s option at any time now.

The subordinated debentures may be included in Tier 1 capital (with certain limitations applicable) under current regulatory guidelines and interpretations.

A summary of all junior subordinated debentures issued by the Company to affiliates follows. These amounts represent the par value of the obligations owed to these affiliates, including the Company’s equity interest in the trusts. Junior subordinated debentures owed to the following affiliates were as follows:

	December 31
	2016		2015
	(In Thousands)
First Defiance Statutory Trust I due December 2035	$	20,619	$	20,619
First Defiance Statutory Trust II due June 2037		15,464		15,464
Total junior subordinated debentures owed to unconsolidated subsidiary Trusts	$	36,083	$	36,083

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.

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14. Securities Sold Under Agreements to Repurchase and Other Short Term Borrowings

Total securities sold under agreement to repurchase are summarized as follows:

	Years Ended December 31
	2016			2015
	(In Thousands, Except Percentages)
Securities sold under agreement to repurchase
Amounts outstanding at year-end	$	31,816		$	57,188
Year-end interest rate		0.22	%		0.27	%
Average daily balance during year		52,821			54,632
Maximum month-end balance during the year		57,984			60,272
Average interest rate during the year		0.26	%		0.28	%

We utilize securities sold under agreements to repurchase to facilitate the needs of our customers and to facilitate secured short-term funding needs. Securities sold under agreements to repurchase are stated at the amount of cash received in connection with the transaction. We monitor levels on a continuous basis. We may be required to provide additional collateral based on the fair value of the underlying securities. Securities pledged as collateral under repurchase agreements are maintained with our safekeeping agent.

The remaining contractual maturity of the securities sold under agreements to repurchase in the consolidated balance sheets as of December 31, 2016 and 2015 is presented in the following tables.

	Overnight and Continuous		Up to 30 Days		30-90 Days		Greater than 90 Days		Total
			(In Thousands)
At December 31, 2016
Repurchase agreements:
Mortgage-backed securities – residential	$	21,222	$	-	$	-	$	-	$	21,222
Collateralized mortgage obligations		10,594		-		-		-		10,594
Total borrowings	$	31,816	$	-	$	-	$	-	$	31,816
Gross amount of recognized liabilities for repurchase agreements									$	31,816

	Overnight and Continuous		Up to 30 Days		30-90 Days		Greater than 90 Days		Total
			(In Thousands)
At December 31, 2015
Repurchase agreements:
Mortgage-backed securities – residential	$	23,998	$	-	$	-	$	-	$	23,998
Collateralized mortgage obligations		33,190		-		-		-		33,190
Total borrowings	$	57,188	$	-	$	-	$	-	$	57,188
Gross amount of recognized liabilities for repurchase agreements									$	57,188

On December 29, 2016, First Defiance entered into a loan agreement with First Tennessee Bank for a $20 million line of credit. The rate on the line of credit is at three- month LIBOR and was undrawn on as of December 31, 2016.

As of December 31, 2016 and 2015, First Federal had the following undrawn lines of credit facilities available for short-term borrowing purposes:

A $11.2 million line of credit with the Federal Reserve Bank Discount Window, at an interest rate of 50 basis points over the fed funds rate. The fed funds rate as of December, 31, 2016 was 0.75%. This line was undrawn upon as of December 31, 2016 and 2015.

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A $20.0 million line of credit with MUFG Union Bank, N.A. The rate on this line of credit is Union Bank’s fed funds rate, which floats daily. This line was undrawn upon as of December 31, 2016 and 2015.

15. Other Noninterest Expense

The following is a summary of other noninterest expense:

	Years Ended December 31
	2016			2015		2014
	(In Thousands)
Legal and other professional fees	$	2,902		$	3,359	$	3,622
Marketing		1,835			1,752		1,820
State financial institutions tax		1,781			1,783		1,762
REO expenses and write-downs		244			1,064		743
Printing and office supplies		512			457		466
Amortization of intangibles		535			699		1,102
Postage		456			459		594
Check charge-offs and fraud losses		266			207		142
Credit and collection expense		303			334		395
Other		7,118	(1)		5,402		6,611	(2)
Total other noninterest expense	$	15,952		$	15,516	$	17,257

Includes $443,000 of acquisition related expenses and $300,000 of costs associated with termination of a lease agreement.

Includes $786,000 of costs associated with the termination of First Federal’s merger agreement with FCB.

16. Postretirement Benefits

First Defiance sponsors a defined benefit postretirement plan that is intended to supplement Medicare coverage for certain retirees who meet minimum age requirements. First Federal employees who retired prior to April 1, 1997 and who completed 20 years of service after age 40 receive full medical coverage at no cost. First Federal employees retiring after April 1, 1997 are provided medical benefits at a cost based on their combined age and years of service at retirement. Surviving spouses are also eligible for continued coverage after the retiree is deceased at a subsidy level that is 10% less than what the retiree is eligible for. First Federal employees retiring before July 1, 1997 receive dental and vision care in addition to medical coverage. First Federal employees who retire after July 1, 1997 are not eligible for dental or vision care.

First Federal employees who were born after December 31, 1950 are not eligible for the medical coverage described above at retirement. Rather, a one-time medical spending account of up to $10,000 (based on the participant’s age and years of service) will be established to reimburse medical expenses for those individuals. First Insurance employees who were born before December 31, 1950 can continue coverage until they reach age 65, or in lieu of continuing coverage, can elect the medical spending account option, subject to eligibility requirements. Employees hired or acquired after January 1, 2003 are eligible only for the medical spending account option.

Included in accumulated other comprehensive income at December 31, 2016, 2015 and 2014 are the following amounts that have not yet been recognized in net periodic benefit cost:

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	December 31
	2016			2015			2014
	(In Thousands)
Unrecognized prior service cost	$	52		$	53		$	65
Unrecognized actuarial losses		392			593			832
Total recognized in Accumulated Other Comprehensive Income		444			646			897
Income tax effect		(155	)		(226	)		(314	)
Net amount recognized in Accumulated Other Comprehensive Income	$	289		$	420		$	583

The prior service cost and actuarial loss included in other comprehensive income and expected to be recognized in net postretirement benefit cost during the fiscal year-ended December 31, 2017 is $12,000 ($8,000 net of tax) and $10,000 ($7,000 net of tax), respectively.

Reconciliation of Funded Status and Accumulated Benefit Obligation

The plan is not currently funded. The following table summarizes benefit obligation and plan asset activity for the plan measured as of December 31 each year:

	December 31
	2016			2015
	(In Thousands)
Change in benefit obligation:
Benefit obligation at beginning of year	$	3,115		$	3,263
Service cost		53			65
Interest cost		128			130
Participant contribution		29			27
Plan amendments for acquisitions		12			-
Actuarial (gains) / losses		(184	)		(204	)
Benefits paid		(168	)		(166	)
Benefit obligation at end of year		2,985			3,115
Change in fair value of plan assets:
Balance at beginning of year		-			-
Employer contribution		139			139
Participant contribution		29			27
Benefits paid		(168	)		(166	)
Balance at end of year		-			-
Funded status at end of year	$	(2,985	)	$	(3,115	)

Net periodic postretirement benefit cost includes the following components:

	Years Ended December 31
	2016			2015			2014
	(In Thousands)
Service cost-benefits attributable to service during the period	$	53		$	65		$	63
Interest cost on accumulated postretirement benefit obligation		128			130			136
Net amortization and deferral		30			47			35
Net periodic postretirement benefit cost		211			242			234
Net (gain) / loss during the year		(184	)		(204	)		377
Plan amendment for acquisition		12			-			-
Amortization of prior service cost and actuarial losses		(30	)		(47	)		(35	)
Total recognized in comprehensive income		(202	)		(251	)		342
Total recognized in net periodic postretirement benefit cost and other comprehensive income	$	9		$	(9	)	$	576

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The following assumptions were used in determining the components of the postretirement benefit obligation:

	2016			2015			2014
Weighted average discount rates:
Used to determine benefit obligations at December 31		4.00	%		4.25	%		4.25	%
Used to determine net periodic postretirement benefit cost for years ended December 31		4.25	%		4.25	%		4.75	%

Assumed health care cost trend rates at December 31:
Health care cost trend rate assumed for next year		7.50	%		6.50	%		7.00	%
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)		5.00	%		5.00	%		5.00	%
Year that rate reaches ultimate trend rate		2022			2019			2019

The following benefits are expected to be paid over the next five years and in aggregate for the next five years thereafter. Because the plan is unfunded, the expected net benefits to be paid and the estimated Company contributions are the same amount.

	Expected to be Paid
	(In Thousands)

2017	$	160
2018		173
2019		182
2020		197
2021		180
2022 through 2026		1,035

Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effect:

	One-Percentage-Point Increase				One-Percentage-Point Decrease
	Year Ended December 31				Year Ended December 31
	2016		2015		2016			2015
	(In Thousands)
Effect on total of service and interest cost	$	27	$	27	$	(22	)	$	(22	)
Effect on postretirement benefit obligation		369		376		(314	)		(320	)

The Company expects to contribute $160,000 before reflecting expected Medicare retiree drug subsidy payments in 2017.

17. Regulatory Matters

First Federal is subject to minimum capital adequacy guidelines. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators, which could have a material impact on First Federal’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Federal must maintain capital amounts in excess of specified minimum ratios based on quantitative measures of First Federal’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

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In July 2013, Federal Reserve and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Company and the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements will increase for both quantity and quality of capital held by the Company and the Bank. The rules include a new minimum common equity Tier 1 capital to risk-weighted assets ratio (“CET1”) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), which effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance sheet exposures.

The following schedule presents First Defiance consolidated and First Federal’s regulatory capital ratios as of December 31, 2016 and 2015 (Dollars in Thousands):

December 31, 2016
	Actual					Minimum Required for Adequately Capitalized					Minimum Required for Well Capitalized
	Amount		Ratio			Amount		Ratio(1)			Amount		Ratio

CET1 Capital (to Risk-Weighted Assets) (2)
Consolidated	$	234,809		10.45	%	$	101,108		4.5	%		N/A		N/A
First Federal	$	242,928		10.81	%	$	101,116		4.5	%	$	146,057		6.5	%

Tier 1 Capital (1)
Consolidated	$	269,809		11.24	%	$	95,975		4.0	%		N/A		N/A
First Federal	$	242,928		10.14	%	$	95,791		4.0	%	$	119,739		5.0	%

Tier 1 Capital (to Risk Weighted Assets) (1)
Consolidated	$	269,809		12.01	%	$	134,811		6.0	%		N/A		N/A
First Federal	$	242,928		10.81	%	$	134,822		6.0	%	$	179,763		8.0	%

Total Capital (to Risk Weighted Assets) (1)
Consolidated	$	295,693		13.16	%	$	179,748		8.0	%		N/A		N/A
First Federal	$	268,812		11.96	%	$	179,763		8.0	%	$	224,703		10.0	%

(1)

Excludes capital conservation buffer of 0.625% as of December 31, 2016.

(2)

December 31, 2015
	Actual					Minimum Required for Adequately Capitalized					Minimum Required for Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio

CET1 Capital (to Risk-Weighted Assets) (1)
Consolidated	$	218,297		10.71	%	$	91,710		4.5	%		N/A		N/A
First Federal	$	236,625		11.61	%	$	91,678		4.5	%	$	132,424		6.5	%

Tier 1 Capital (1)
Consolidated	$	253,297		11.46	%	$	88,424		4.0	%		N/A		N/A
First Federal	$	236,625		10.72	%	$	88,267		4.0	%	$	110,334		5.0	%

Tier 1 Capital (to Risk Weighted Assets) (1)
Consolidated	$	253,297		12.43	%	$	122,280		6.0	%		N/A		N/A
First Federal	$	236,625		11.61	%	$	122,237		6.0	%	$	162,983		8.0	%

Total Capital (to Risk Weighted Assets) (1)
Consolidated	$	278,679		13.67	%	$	163,040		8.0	%		N/A		N/A
First Federal	$	262,007		12.86	%	$	162,983		8.0	%	$	203,729		10.0	%

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(1)

Core capital is computed as a percentage of adjusted total assets of $2.21 billion for consolidated and the Bank. Risk-based capital is computed as a percentage of total risk-weighted assets of $2.04 billion for consolidated and the Bank.

Management believes that, as of December, 31, 2016, First Federal was “well capitalized” based on the ratios presented above. There are no conditions or events since the most recent notification from any of the regulatory agencies regarding those capital standards that management believes have changed any of the well capitalized categorizations of First Federal.

First Federal is subject to the regulatory capital requirements administered by the OCC and FDIC. Regulatory authorities can initiate certain mandatory actions if First Federal fails to meet the minimum capital requirements, which could have a direct material effect on the Corporation’s financial statements. Management believes, as of December 31, 2016, that First Federal meets all capital adequacy requirements to which they are subject.

First Defiance is a unitary thrift holding company and is regulated by the Federal Reserve. First Defiance did not have prompt corrective action capital requirements as of December 31, 2016.

Dividend Restrictions - Dividends paid by First Federal to First Defiance are subject to various regulatory restrictions. First Federal paid $22.0 million in dividends to First Defiance in 2016 and $29.0 million in 2015. First Federal can initiate dividend payments equal to its net profits (as defined by statute) for the last two fiscal years, plus any year to date net profits. First Insurance paid $1.2 million in dividends to First Defiance in 2016 and $900,000 in dividends in 2015. First Defiance Risk Management paid $1.0 million in dividends to First Defiance in 2016 and 2015.

18. Income Taxes

The components of income tax expense are as follows:

	Years Ended December 31
	2016			2015			2014
	(In Thousands)
Current:
Federal	$	13,125		$	11,299		$	9,198
State and local		244			146			144
Deferred		(615	)		(35	)		(179	)
	$	12,754		$	11,410		$	9,163

The effective tax rates differ from federal statutory rate applied to income before income taxes due to the following:

	Years Ended December 31
	2016			2015			2014
	(In Thousands)
Tax expense at statutory rate (35%)	$	14,559		$	13,240		$	11,709
Increases (decreases) in taxes from:
State income tax – net of federal tax benefit		159			95			94
Tax exempt interest income, net of TEFRA		(1,168	)		(1,219	)		(1,152	)
Bank owned life insurance		(341	)		(255	)		(816	)
Captive insurance		(414	)		(415	)		(390	)
Other		(41	)		(36	)		(282	)
Totals	$	12,754		$	11,410		$	9,163

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Deferred federal income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.

Significant components of First Defiance’s deferred federal income tax assets and liabilities are as follows:

	December 31
	2016		2015
	(In Thousands)
Deferred federal income tax assets:
Allowance for loan losses	$	9,059	$	8,884
Postretirement benefit costs		1,044		1,316
Deferred compensation		1,847		1,621
Impaired loans		1,087		261
Accrued vacation		454		644
Allowance for real estate held for sale losses		226		269
Deferred loan origination fees and costs		462		388
Accrued bonus		626		675
Other		1,554		794
Total deferred federal income tax assets		16,359		14,852

Deferred federal income tax liabilities:
FHLB stock dividends		2,279		2,279
Goodwill		5,967		5,527
Mortgage servicing rights		3,358		3,237
Fixed assets		1,217		1,268
Other intangible assets		301		422
Loan mark to market		59		165
Net unrealized gains on available-for-sale securities		272		2,176
Prepaid expenses		694		655
Total deferred federal income tax liabilities		14,147		15,729
Net deferred federal income tax asset/ (liability)	$	2,212	$	(877	)

The realization of the Company’s deferred tax assets is dependent upon the Company’s ability to generate taxable income in future periods and the reversal of deferred tax liabilities during the same period and the ability to carryback any losses. The Company has evaluated the available evidence supporting the realization of its deferred tax assets and determined it is more likely than not that the assets will be realized and thus no valuation allowance was required at December 31, 2016.

Retained earnings at December 31, 2016 include approximately $11.0 million for which no tax provision for federal income taxes has been made. This amount represents the tax bad debt reserve at December 31, 1987, which is the end of the Company’s base year for purposes of calculating the bad debt deduction for tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 2016 was approximately $3.85 million.

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A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (In Thousands):

Balance at January 1, 2014	$	-
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		-
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		-
Settlements		-
Balance at December 31, 2014	$	-

Balance at January 1, 2015	$	-
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		-
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		-
Settlements		-
Balance at December 31, 2015	$	-

Balance at January 1, 2016	$	-
Additions based on tax positions related to the current year		-
Additions for tax positions of prior years		398
Reductions for tax positions of prior years		-
Reductions due to the statute of limitations		-
Settlements		-
Balance at December 31, 2016	$	398

The Company does not expect the unrecognized tax benefits, to have an effect on its effective tax rate. The Company expects the entire amount of unrecognized tax benefits to settle within the next twelve months. The Company does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

The total amount of interest and penalties recorded in the income statement was $40,000 for the year ended December 31, 2016, and zero for 2015 and 2014, and the amount accrued for interest and penalties was $40,000 at December 31, 2016, and zero for 2015 and 2014.

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 2012. The Company currently operates primarily in the states of Ohio and Michigan, which tax financial institutions based on their equity rather than their income.

19. Employee Benefit Plans

401(k) Plan

Employees of First Defiance are eligible to participate in the First Defiance Financial Corp. 401(k) Employee Savings Plan (the “First Defiance 401(k)”) if they meet certain age and service requirements. Under the First Defiance 401(k), First Defiance matches 100% of the participants’ contributions up to 3% of compensation and then 50% of the participants’ contributions for the next 2% of compensation. The First Defiance 401(k) also provides for a discretionary First Defiance contribution in addition to the First Defiance matching contribution. First Defiance matching contributions totaled $979,000, $892,000 and $919,000 for the years ended December 31, 2016, 2015 and 2014, respectively. There were no discretionary contributions in any of those years.

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Group Life Plan

On June 30, 2010, First Federal adopted the First Federal Bank of the Midwest Executive Group Life Plan – Post Separation (the “Group Life Plan”) in which various employees, including the Company’s named executive officers, may participate. Under the terms of the Group Life Plan, First Federal will purchase and own life insurance policies covering the lives of employees selected by the board of directors of First Federal as participants. There was $71,000, $78,000 and $167,000 of expense recorded for the years ended December 31, 2016, 2015 and 2014, respectively, with a liability of $1.04 million, $970,000 and $892,000 for future benefits recorded at December 31, 2016, 2015 and 2014, respectively. The discount rate was reduced to 4.00% as of December 31, 2016, resulting in an increase to the Company’s liability.

20. Stock Compensation Plans

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

As of December 31, 2016, 54,750 options had been granted pursuant to the 2010 Equity Plan and previous plans, and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year except for the 2009 grant to the Company’s executive officers, which vested 40% in 2011 and then 20% annually. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

In each of the years 2014-2016, the Company approved a Short-Term (“STIP”) Equity Incentive Plan and a Long-Term (“LTIP”) Equity Incentive Plan for selected members of management.

Under the 2014 and 2015 STIPs, the participants could earn up to 30% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The 2016 STIP allows participants to earn up to 10% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The final amount of benefits under the STIPs is determined as of December 31 of the same year and paid out in cash in the first quarter of the following year. The participants are required to be employed on the day of payout in order to receive such payment.

Under each LTIP, the participants may earn up to 20% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three-year period. The Company granted 30,538; 24,757; and 24,526 RSU’s to the participants in the 2014, 2015 and 2016 LTIPs, respectively, effective January 1 in the year the award was made, which represents the maximum target award. The amount of benefit under each LTIP will be determined individually at the end of the 36 month performance period ending December 31. The benefits earned under each LTIP will be paid out in equity in the first quarter following the end of the performance period. The participants are required to be employed on the day of payout in order to receive such payment.

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In 2016, the Company also granted 3,894 restricted shares to directors and employees. 1,872 shares were issued to directors, 1,000 shares were issued to employees that have a one-year vesting period and 1,022 shares were issued to an employee with a four year vesting period.

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 shares. 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.

The fair value of stock options granted was determined at the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:

	Twelve Months Ended
	December 31, 2016	December 31, 2015
Expected average risk-free rate	2.05%	2.04%
Expected average life	8.96 years	10.00 years
Expected volatility	41.00%	42.00%
Expected dividend yield	2.33%	2.10%

Following is activity under the plans during 2016:

Stock options:	Options Outstanding			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in 000’s)
Options outstanding, January 1, 2016		86,220		$	20.27
Forfeited or cancelled		-			-
Exercised		(37,970	)		20.47
Granted		6,500			37.78
Options outstanding, December 31, 2016		54,750		$	22.21		3.51	$	1,562
Vested or expected to vest at December 31, 2016		54,750		$	22.21		3.51	$	1,562
Exercisable at December 31, 2016		38,300		$	17.86		1.57	$	1,259

Information related to the stock option plans follows:

	Year Ended December 31
	2016		2015		2014
	(In Thousands, except per share amounts)
Intrinsic value of options exercised	$	752	$	1,069	$	542
Cash received from option exercises		714		1,469		963
Tax benefit realized from option exercises		165		160		103
Weighted average fair value of options granted	$	13.95	$	13.13	$	10.79

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As of December 31, 2016, there was $156,000 of total unrecognized compensation costs related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 3.2 years.

At December 31, 2016, 75,468 RSU’s were outstanding. Compensation expense is recognized over the performance period based on the achievement of established targets. Total expense of $1.3 million, $1.1 million and $541,000 was recorded during the years ended December 31, 2016, 2015 and 2014, respectively, and approximately $773,000 and $556,000 is included within other liabilities at December 31, 2016 and 2015, respectively, related to the STIPs and LTIPs.

	Restricted Stock Units					Stock Grants
				Weighted-Average					Weighted-Average
				Grant Date					Grant Date
Unvested Shares	Shares			Fair Value		Shares			Fair Value

Unvested at January 1, 2016		74,545		$	25.86		10,927		$	30.98
Granted		24,526			39.30		10,905			23.39
Vested		(7,011	)		19.19		(10,171	)		24.02
Forfeited		(16,592	)		19.19		(500	)		32.00
Unvested at December 31, 2016		75,468		$	32.31		11,161		$	32.30

The maximum amount of compensation expense that may be earned for the 2016 STIP and the 2014, 2015 and 2016 LTIPs at December 31, 2016 is approximately $3.6 million in the aggregate. However, the estimated expense expected to be earned as of December 31, 2016 based on the performance measures in the plans, is $2.4 million of which $584,000 was unrecognized at December 31, 2016 and will be recognized over the remaining performance period.

As of December 31, 2016 and 2015, 168,251 and 186,079 shares, respectively, were available for grant under the 2010 Equity Plan. Options forfeited or cancelled under all plans except the 2010 Equity Plan are no longer available for grant to other participants.

21. Parent Company Statements

Condensed parent company financial statements, which include transactions with subsidiaries, follow:

	December 31
Statements of Financial Condition	2016		2015
	(In Thousands)
Assets
Cash and cash equivalents	$	23,017	$	12,919
Investment in banking subsidiary		290,053		287,436
Investment in non-bank subsidiaries		15,456		15,109
Other assets		1,155		1,191
Total assets	$	329,681	$	316,655

Liabilities and stockholders’ equity:
Subordinated debentures	$	36,083	$	36,083
Accrued liabilities		580		375
Stockholders’ equity		293,018		280,197
Total liabilities and stockholders’ equity	$	329,681	$	316,655

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	Years Ended December 31
Statements of Income	2016			2015			2014
	(In Thousands)

Dividends from subsidiaries	$	24,200		$	30,900		$	22,200
Interest on investments		-			1			-
Interest expense		(753	)		(613	)		(587	)
Other income		-			1			2
Noninterest expense		(644	)		(588	)		(861	)
Income before income taxes and equity in earnings of subsidiaries		22,803			29,701			20,754
Income tax credit		(466	)		(397	)		(485	)
Income before equity in earnings of subsidiaries		23,269			30,098			21,239
(Distributions in excess of) undistributed equity in earnings of subsidiaries		5,574			(3,675	)		3,053
Net income	$	28,843		$	26,423		$	24,292
Comprehensive income	$	25,436		$	25,931		$	27,861

	Years Ended December 31
Statements of Cash Flows	2016			2015			2014
	(In Thousands)
Operating activities:
Net income	$	28,843		$	26,423		$	24,292
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Distribution in excess of (undistributed equity in) earnings of subsidiaries		(5,574	)		3,675			(3,053	)
Change in other assets and liabilities		235			(205	)		59
Net cash provided by (used in) operating activities		23,504			29,893			21,298

Financing activities:
Repurchase of common stock		(6,293	)		(8,436	)		(15,519	)
Cash dividends paid		(7,890	)		(7,159	)		(5,937	)
Stock Options Exercised		714			1,469			921
Direct stock sales		63			64			76
Repayment of stock warrants		-			(11,979	)		-
Net cash used in financing activities		(13,406	)		(26,041	)		(20,459	)
Net increase (decrease) in cash and cash equivalents		10,098			3,852			839
Cash and cash equivalents at beginning of year		12,919			9,067			8,228
Cash and cash equivalents at end of year	$	23,017		$	12,919		$	9,067

22. 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.

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

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

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

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

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

Available for sale securities - Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service that uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include federal agency preferred stock securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities, corporate bonds and municipal securities.

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

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

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Company’s asset quality or collections department reviews the assumptions and approaches utilized in the appraisal. Appraisal values are discounted from 0% to 20% to account for other factors that may impact the value of collateral. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used, which include: physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

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

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

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:

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Assets and Liabilities Measured on a Recurring Basis

December 31, 2016	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	$	-	$	3,915	$	-	$	3,915
Mortgage-backed - residential		-		81,707		-		81,707
REMICs		-		1,307		-		1,307
Collateralized mortgage obligations		-		63,005		-		63,005
Preferred stock		2		-		-		2
Corporate bonds		-		13,013		-		13,013
Obligations of state and political subdivisions		-		88,043				88,043
Mortgage banking derivative - asset		-		491		-		491

December 31, 2015	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	$	-	$	2,994	$	-	$	2,994
Mortgage-backed - residential		-		64,654		-		64,654
REMICs		-		1,620		-		1,620
Collateralized mortgage obligations		-		71,799		-		71,799
Preferred stock		1		-		-		1
Corporate bonds		-		4,977		-		4,977
Obligations of state and political subdivisions		-		90,390				90,390
Mortgage banking derivative - asset		-		558		-		558

There were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2016 and 2015.

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:

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Assets and Liabilities Measured on a Non-Recurring Basis

December 31, 2016	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Impaired loans
1-4 Family Residential Real Estate	$	-	$	-	$	316	$	316
Multi Family Residential		-		-		-		-
Commercial Real Estate		-		-		848		848
Commercial						332		332
Home Equity and Improvement		-		-		-		-
Total impaired loans		-		-		1,496		1,496

Mortgage servicing rights		-		657		-		657
Real estate held for sale
Residential		-		-		-		-
CRE		-		-		377		377
Total Real Estate held for sale		-		-		377		377

December 31, 2015	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Impaired loans
1-4 Family Residential Real Estate	$	-	$	-	$	398	$	398
Multi Family Residential		-		-		91		91
Commercial Real Estate		-		-		4,575		4,575
Commercial						-		-
Home Equity and Improvement		-		-		82		82
Total impaired loans		-		-		5,146		5,146

Mortgage servicing rights		-		872		-		872
Real estate held for sale
Residential		-		-		-		-
CRE		-		-		280		280
Total Real Estate held for sale		-		-		280		280

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

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	Fair Value		Valuation Technique	Unobservable Inputs	Range of Inputs			Weighted Average
			(Dollars in Thousands)

Impaired Loans- Applies to all loan classes	$	1,496	Appraisals which utilize sales comparison, net income and cost approach	Discounts for collection issues and changes in market conditions		10-30	%		11	%

Real estate held for sale – Applies to all classes	$	377	Appraisals which utilize sales comparison, net income and cost approach	Discounts for changes in market conditions		0-20	%		7	%

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2015, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value		Valuation Technique	Unobservable Inputs	Range of Inputs			Weighted Average
			(Dollars in Thousands)

Impaired Loans- Applies to all loan classes	$	5,146	Appraisals which utilize sales comparison, net income and cost approach	Discounts for collection issues and changes in market conditions		10-30	%		11	%

Real estate held for sale – CRE	$	280	Appraisals which utilize sales comparison, net income and cost approach	Discounts for changes in market conditions		30	%		30	%

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $1.5 million, with a $1,000 valuation allowance and a fair value of $5.1 million with a valuation allowance of $8,000 at December 31, 2016 and 2015, respectively. A provision expense of $1.0 million, a provision recovery of $580,000 and a provision expense of $3.0 million for the years ended December 31, 2016, 2015 and 2014, respectively, related to these impaired loans was included in earnings.

Mortgage servicing rights, which are carried at the lower of cost or fair value, had a fair value of $657,000 with a valuation allowance of $522,000 and a fair value of $872,000 with a valuation allowance of $645,000 at December 31, 2016 and 2015, respectively. A recovery of $123,000, $266,000 and $116,000 for the years ended December 31, 2016, 2015 and 2014, respectively, was included in earnings.

Real estate held for sale is determined using Level 3 inputs which include appraisals and are adjusted for changes in market conditions. The change in fair value of real estate held for sale was $74,000, $297,000 and $251,000 for the years ended December 31, 2016, 2015 and 2014, respectively, which was recorded directly as an adjustment to current earnings through non-interest expense.

In accordance with FASB ASC Topic 825, the Fair Value Measurements tables are a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of December 31, 2016 and December 31, 2015. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

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

The carrying amount of cash and cash equivalents, term notes payable and advance payments by borrowers for taxes and insurance, as a result of their short-term nature, is considered to be equal to fair value and are classified as Level 1.

It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.

The fair value of loans that reprice within 90 days is equal to their carrying amount. For other loans, the estimated fair value is calculated based on discounted cash flow analysis, using interest rates currently being offered for loans with similar terms, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as previously described. The allowance for loan losses is considered to be a reasonable adjustment for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans held for sale is estimated based on binding contracts and quotes from third party investors resulting in a Level 2 classification.

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

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

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

FHLB advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using interest rates currently being quoted for similar characteristics and maturities resulting in a Level 2 classification. The cost or value of any call or put options is based on the estimated cost to settle the option at December 31, 2016.

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			Fair Value Measurements at December 31, 2016 (In Thousands)
	Carrying Value		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	99,003	$	99,003	$	99,003	$	-	$	-
Investment securities		251,176		251,179		2		251,177		-
Federal Home Loan Bank Stock		13,798		N/A		N/A		N/A		N/A
Loans, net, including loans held for sale		1,924,210		1,911,280		-		9,917		1,901,363
Accrued interest receivable		6,760		6,760		9		867		5,884

Financial Liabilities:
Deposits	$	1,981,628	$	1,987,723	$	487,663	$	1,500,060	$	-
Advances from Federal Home Loan Bank		103,943		103,019		-		103,019		-
Securities sold under repurchase agreements		31,816		31,816		-		31,816		-
Subordinated debentures		36,083		34,718		-		-		34,718

			Fair Value Measurements at December 31, 2015 (In Thousands)
	Carrying Value		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	79,769	$	79,769	$	79,769	$	-	$	-
Investment securities		236,678		236,680		1		236,679		-
Federal Home Loan Bank Stock		13,801		N/A		N/A		N/A		N/A
Loans, net, including loans held for sale		1,782,358		1,784,998		-		5,899		1,779,099
Accrued interest receivable		6,171		6,171		7		846		5,318

Financial Liabilities:
Deposits	$	1,836,137	$	1,840,464	$	420,691	$	1,419,773	$	-
Advances from Federal Home Loan Bank		59,902		59,653		-		59,653		-
Securities sold under repurchase agreements		57,188		57,188		-		57,188		-
Subordinated debentures		36,083		35,305		-		-		35,305

23. 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 $14.1 million and $14.9 million of interest rate lock commitments at December 31, 2016 and 2015, respectively. There were $22.5 million and $19.9 million of forward commitments for the future delivery of residential mortgage loans at December 31, 2016 and 2015, respectively.

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

December 31, 2016

December 31, 2015

Assets

(Liabilities)

Assets

(Liabilities)

Derivative

Carrying

Net Carrying

Carrying

Net Carrying

Value

(In Thousands)

Derivatives not designated as hedging instruments

Mortgage Banking Derivatives

491

558

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

	Twelve Months Ended December 31,
	2016			2015		2014
	(In Thousands)
Derivatives not designated as hedging instruments

Mortgage Banking Derivatives – Gain (Loss)	$	(67	)	$	231	$	27

The above amounts are included in mortgage banking income with gain on sale of mortgage loans. During 2014, 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 $5,000 loss related to a fair value adjustment on those loans was recorded in. No such adjustments were made in 2016 or 2015.

24. Quarterly Consolidated Results of Operations (Unaudited)

The following is a summary of the quarterly consolidated results of operations:

	Three Months Ended
	March 31		June 30		September 30		December 31
	(In Thousands, Except Per Share Amounts)
2016
Interest income	$	21,130	$	21,480	$	22,003	$	22,770
Interest expense		1,942		2,084		2,183		2,231
Net interest income		19,188		19,396		19,820		20,539
Provision for loan losses		364		53		15		(149	)
Net interest income after provision for loan losses		18,824		19,343		19,805		20,688
Gain on sale, call or write-down of securities		131		227		151		-
Noninterest income		8,505		8,348		8,375		8,293
Noninterest expense		17,274		17,347		18,292		18,180
Income before income taxes		10,186		10,571		10,039		10,801
Income taxes		3,017		3,307		2,994		3,436
Net income	$	7,169	$	7,264	$	7,045	$	7,365

Earnings per common share:
Basic	$	0.80	$	0.81	$	0.78	$	0.82
Diluted	$	0.80	$	0.80	$	0.78	$	0.81
Average shares outstanding:
Basic		8,994		8,968		8,976		8,969
Diluted		9,064		9,036		9,050		9,035

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	Three Months Ended
	March 31		June 30		September 30			December 31
	(In Thousands, Except Per Share Amounts)
2015
Interest income	$	19,757	$	20,037	$	20,266		$	20,776
Interest expense		1,567		1,672		1,733			1,809
Net interest income		18,190		18,365		18,533			18,967
Provision for loan losses		120		-		(27	)		43
Net interest income after provision for loan losses		18,070		18,365		18,560			18,924
Gain on sale, call or write-down of securities		-		-		-			22
Noninterest income		8,281		7,809		7,982			7,709
Noninterest expense		16,897		16,796		16,848			17,348
Income before income taxes		9,454		9,378		9,694			9,307
Income taxes		2,853		2,815		2,998			2,744
Net income	$	6,601	$	6,563	$	6,696		$	6,563

Earnings per common share:
Basic	$	0.71	$	0.71	$	0.72		$	0.72
Diluted	$	0.69	$	0.70	$	0.72		$	0.71
Average shares outstanding:
Basic		9,234		9,268		9,238			9,146
Diluted		9,611		9,349		9,322			9,235

25. Other Comprehensive Income (Loss)

The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the table below. Reclassification adjustments related to securities available for sale are included in gains on sale or call of securities in the accompanying consolidated condensed statements of income. Reclassification adjustments related to the defined benefit postretirement medical plan are included in compensation and benefits in the accompanying consolidated condensed statements of income.

	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
	(In Thousands)
Twelve months ended December 31, 2016:
Securities available for sale and transferred securities:
Change in net unrealized gain/(loss) during the period	$	(4,933	)	$	(1,726	)	$	(3,207	)
Reclassification adjustment for net gains included in net income		(509	)		(178	)		(331	)
Defined benefit postretirement medical plan:
Net gain on defined benefit postretirement medical plan realized during the period		172			60			112
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)		30			11			19
Total other comprehensive income	$	(5,240	)	$	(1,833	)	$	(3,407	)

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	Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
	(In Thousands)
Twelve months ended December 31, 2015:
Securities available for sale and transferred securities:
Change in net unrealized gain/(loss) during the period	$	(985	)	$	(345	)	$	(640	)
Reclassification adjustment for net gains included in net income		(22	)		(7	)		(15	)
Defined benefit postretirement medical plan:
Net gain on defined benefit postretirement medical plan realized during the period		204			72			132
Reclassification adjustment for net amortization and deferral on defined benefit postretirement medical plan (included in compensation and benefits)		47			16			31
Total other comprehensive income	$	(756	)	$	(264	)	$	(492	)

Activity in accumulated other comprehensive income (loss), net of tax, was as follows:

							Accumulated
	Securities			Post-			Other
	Available			retirement			Comprehensive
	For Sale			Benefit			Income
	(In Thousands)
Balance January 1, 2016	$	4,042		$	(420	)	$	3,622
Other comprehensive income before reclassifications		(3,207	)		112			(3,095	)
Amounts reclassified from accumulated other comprehensive loss		(331	)		19			(312	)

Net other comprehensive income during period		(3,538	)		131			(3,407	)

Balance December 31, 2016	$	504		$	(289	)	$	215

Balance January 1, 2015	$	4,697		$	(583	)	$	4,114
Other comprehensive income before reclassifications		(640	)		132			(508	)
Amounts reclassified from accumulated other comprehensive loss		(15	)		31			16

Net other comprehensive income during period		(655	)		163			(492	)

Balance December 31, 2015	$	4,042		$	(420	)	$	3,622

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Item 9.

Changes In and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A.

Controls and Procedures

First Defiance’s management carried out an evaluation, under the supervision and with the participation of the chief executive officer and the chief financial officer, of the effectiveness of First Defiance’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2016. Based upon that evaluation, the chief executive officer along with the chief financial officer concluded that First Defiance’s disclosure controls and procedures as of December 31, 2016, are effective.

The information set forth under “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” included in Item 8 above is incorporated herein by reference.

There were no changes in First Defiance’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the last fiscal quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect First Defiance’s internal control over financial reporting.

Item 9B.

Other Information

On February 23, 2017, the Compensation Committee of First Defiance approved a new form of restricted stock unit (“RSU”) award agreement that may be used to grant RSUs pursuant to First Defiance’s 2010 Equity Plan. The form agreement provides for a grant of RSUs that vest on the third anniversary of the grant date and are settled in common shares of First Defiance. Vesting is accelerated in the event of death, disability or retirement (as defined under the 2010 Equity Plan). Vesting also is accelerated in the event of termination of employment without cause after a change in control (as defined under the 2010 Equity Plan). The form of award agreement contains a non-solicitation covenant. The form of RSU award agreement is attached as Exhibit 10.24 and incorporated herein by reference.

PART III

Item 10.

Directors, Executive Officers and Corporate Governance

The information required by this item relating to our directors, nominees for directorship and executive officers is incorporated herein by reference from the section captioned “Composition of the Board” under the heading “PROPOSAL 1 – Election of Directors” and the section immediately following the heading “EXECUTIVE OFFICERS” in the definitive proxy statement to be filed on or about March 29, 2017 for the annual meeting of First Defiance shareholders to be held on May 9, 2017 (the “Proxy Statement”). Information regarding our Audit Committee and compliance with Section 16(a) of the Securities Act of 1943 required by this item is incorporated herein by reference from the sections respectively captioned, “Board Committees” under the “Proposal 1 – Election of Directors” and the section immediately following the heading “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” of the Proxy Statement. There have been no material changes to the procedures by which shareholders may recommend nominees to the board of directors.

First Defiance has adopted a code of ethics applicable to all officers, directors and employees that complies with SEC requirements, and is available on its Internet site at www.fdef.com under Governance Documents.

Item 11.

Executive Compensation

Information regarding director compensation is set forth under the section captioned “Director Compensation” under the heading “PROPOSAL 1 – Election of Directors” of the Proxy Statement, and is incorporated herein by reference. Executive compensation information has been provided under the headings “COMPENSATION DISCUSSION AND ANALYSIS” and “EXECUTIVE COMPENSATION” in the Proxy Statement, and is incorporated herein by reference.

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The Compensation Committee Report and information related to compensation committee interlocks and insider participation have been respectively set forth under the section immediately following the heading “COMPENSATION COMMITTEE REPORT” and under the section captioned “Compensation Committee Interlocks and Insider Participation” following the heading “PROPOSAL 1 – Election of Directors” in the Proxy Statement, and are incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information regarding security ownership of certain beneficial owners and management and information relating thereto is set forth in the section under the heading “BENEFICIAL OWNERSHIP” in the Proxy Statement, and is incorporated herein by reference.

Equity Compensation Plans

The following table provides information as of December 31, 2016 with respect to the shares of First Defiance common stock that are reserved for issuance under First Defiance’s existing equity compensation plans.

Plan Category

Number of securities to
be Issued Upon
Exercise of Outstanding
Options, Warrants and
Rights

Weighted Average
Exercise Price of
Outstanding Options,
Warrants and Rights

Number of Securities
Remaining Available
for Future Issuance
Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a)

(a)

(b)

(c)

Equity Compensation Plans Approved by Security Holders

54,750

22.21

168,251

Item 13.

Certain Relationships and Related Transactions, and Director Independence

The information required by this item, including related transactions and director independence, is set forth respectively in the section following the heading “RELATED PERSON TRANSACTIONS” and in the section captioned “Composition of the Board” following the heading “PROPOSAL 1 – Election of Directors” in the Proxy Statement, which are both incorporated by reference.

Item 14.

Principal Accountant Fees and Services

The information required by this item is set forth under the section captioned “Audit Fees” following the heading “INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” in the Proxy Statement, and is incorporated herein by reference.

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PART IV

Item 15. Exhibits, Financial Statement Schedules

(a)

Financial Statements

(1)

The following documents are filed as Item 8 of this Form 10-K.

	(A)	Report of Independent Registered Public Accounting Firm (Crowe Horwath LLP)
	(B)	Consolidated Statements of Financial Condition as of December 31, 2016 and 2015
	(C)	Consolidated Statements of Income for the years ended December 31, 2016, 2015 and 2014
	(D)	Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014
	(E)	Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2016, 2015 and 2014
	(F)	Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015 and 2014
	(G)	Notes to Consolidated Financial Statements

(2)

Separate financial statement schedules are not being filed because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or the related notes.

(3)

The exhibits required by this item are listed in the Exhibit Index of this Form 10-K. The management contracts and compensation plans or arrangements required to be filed with this Form 10-K are listed as Exhibits 10.1 through 10.24.

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SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

FIRST DEFIANCE FINANCIAL CORP.

February 28, 2017	By:	/s/ Kevin T. Thompson
	Kevin T. Thompson, Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on February 28, 2017.

Signature		Title

/s/ William J. Small		Chairman of the Board
William J. Small

/s/ Donald P. Hileman		President and Chief
Donald P. Hileman		Executive Officer

/s/ Kevin T. Thompson		Executive Vice President and Chief
Kevin T. Thompson		Financial Officer (principal accounting officer)

/s/ Stephen L. Boomer		Director, Vice Chairman
Stephen L. Boomer

/s/ John L. Bookmyer		Director
John L. Bookmyer

/s/ Dr. Douglas A. Burgei		Director
Dr. Douglas A. Burgei

/s/ Thomas A. Reineke		Director
Thomas A. Reineke

/s/ Barb A. Mitzel		Director
Barb A. Mitzel

/s/ Jean A. Hubbard		Director
Jean A. Hubbard

/s/ Samuel S. Strausbaugh		Director
Samuel S. Strausbaugh

/s/ Charles D. Niehaus		Director
Charles D. Niehaus

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Exhibit Index

This report incorporates by reference the documents listed below that we have previously filed with the SEC. The SEC allows us to incorporate by reference information in this document. The information incorporated by reference is considered to be part of this document.

This information may be read and copied at the Public Reference Room of the SEC at 100 F Street, N.E., Washington D.C. 20549. The SEC also maintains an internet web site that contains reports, proxy statements, and other information about issuers, like First Defiance, who file electronically with the SEC. The address of the site is http://www.sec.gov. The reports and other information filed by First Defiance with the SEC are also available at the First Defiance Financial Corp. web site. The address of the site is http://www.fdef.com. Except as specifically incorporated by reference into this Annual Report on Form 10-K, information on those web sites is not part of this report.

Exhibit
Number	Description
2.1	Amendment to Agreement and Plan of Merger, dated August 23, 2016 by and between First Defiance and Commercial Bancshares, Inc.	(29)
2.2	Amendment to Agreement and Plan of Merger, dated October 31, 2016 by and between First Defiance and Commercial Bancshares, Inc.	(12)
3.1	Articles of Incorporation	(1)
3.2	Code of Regulations	(1)
3.3	Amendment to Articles of Incorporation	(7)
4.1	Agreement to furnish instruments and agreements defining rights of holders of long-term debt	(27)
4.2	Form of Warrant for Purchase of Shares of Common Stock	(11)
10.1	Form of Stock Option Award Agreement under 2001 Stock Option and Incentive Plan	(2)
10.2	2001 Stock Option and Incentive Plan	(4)
10.3	Employment Agreement with Gregory R. Allen	(5)
10.4	2005 Stock Option and Incentive Plan	(6)
10.5	Letter Agreement, dated December 5, 2008, between First Defiance and the U.S. Treasury	(8)
10.6	2008 Long Term Incentive Compensation Plan (LTIP)	(9)
10.7	Form of Contingent Award Agreement under LTIP	(10)
10.8	Form of Stock Option Award Agreement under 2005 Stock Option and Incentive Plan	(3)
10.9	First Federal Amended and Restated Executive Group Life Plan – Post Separation	(13)
10.10	2010 Equity Incentive Plan	(14)
10.11	First Defiance Deferred Compensation Plan	(22)
10.12	Form of Restricted Stock Award Agreement (with TARP Limitations)	(15)
10.13	2010 Equity Plan Form of Long-Term Incentive Performance-Based Award Agreement	(16)
10.14	2010 Equity Plan Form of Short-Term Incentive Performance-Based Award Agreement	(17)
10.15	First Amendment to First Defiance Financial Corp. 2010 Equity Incentive Plan	(18)
10.16	First Defiance Financial Corp. and Affiliates Incentive Compensation Plan	(19)
10.17	First Defiance Financial Corp. Long-Term Restricted Stock Unit Award Agreement (2012 Long Term Incentive – TARP Applicable)	(20)
10.18	First Defiance Financial Corp. Long-Term Restricted Stock Unit Award Agreement (2012 Long Term Incentive)	(21)
10.19	Employment Agreement with Donald P. Hileman	(23)
10.20	Employment Agreement with Kevin T. Thompson	(24)
10.21	Form of Restricted Stock Award Agreement	(25)
10.22	Consulting Agreement with William J. Small	(26)
10.23	Change of Control and Non-Solicitation Agreement with John R. Reisner	(28)
10.24	Form of Restricted Stock Unit Award Agreement	(12)
21	List of Subsidiaries of the Company	(12)
23.1	Consent of Crowe Horwath LLP	(12)
31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	(12)
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	(12)
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	(12)
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	(12)
101	Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) the Notes to the Consolidated Financial Statements tagged as blocks of text and in detail.	(12)

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(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 10.2 in Registrant’s 2004 Form 10-K (Film No. 05685500)

(3)

Incorporated herein by reference to exhibit 10.16 in Registrant’s 2008 Form 10-K (Film No. 09683948)

(4)

Incorporated herein by reference to Appendix B to the 2001 Proxy Statement (Film No. 1577137)

(5)

Incorporated herein by reference to exhibit 10.4 in Form 8-K filed October 1, 2007 (Film No. 071144951)

(6)

Incorporated herein by reference to Appendix A to the 2005 Proxy Statement (Film No. 05692264)

(7)

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

(8)

Incorporated herein by reference to exhibit 10 in Form 8-K filed December 8, 2008 (Film No. 081236105)

(9)

Incorporated herein by reference to exhibit 10.1 in Form 8-K filed December 12, 2008 (Film No. 081245224)

(10)

Incorporated herein by reference to exhibit 10.2 in Form 8-K filed December 12, 2008 (Film No. 081245224)

(11)

Incorporated herein by reference to exhibit 4 in Form 8-K filed December 8, 2008 (Film No. 081236105)

(12)

Included herein

(13)

Incorporated herein by reference to exhibit 10.1 in Form 10-Q filed November 2, 2010 (Film No. 101158262)

(14)

Incorporated herein by reference to Annex A to 2010 Proxy Statement (Film No. 10693151)

(15)

Incorporated herein by reference to exhibit 10.1 in Form 8-K filed March 4, 2011 (Film No. 11664601)

(16)

Incorporated herein by reference to exhibit 10.1 in Form 10-Q filed November 8, 2011 (Film No. 111188059)

(17)

Incorporated herein by reference to exhibit 10.2 in Form 10-Q filed November 8, 2011 (Film No. 111188059)

(18)

Incorporated herein by reference to exhibit 10.1 in Form 8-K filed March 15, 2012 (Film No. 12694926)

(19)

Incorporated herein by reference to exhibit 10.2 in Form 8-K filed March 15, 2012 (Film No. 12694926)

(20)

Incorporated herein by reference to exhibit 10.3 in Form 8-K filed March 15, 2012 (Film No. 12694926)

(21)

Incorporated herein by reference to exhibit 10.4 in Form 8-K filed March 15, 2012 (Film No. 12694926)

(22)

Incorporated herein by reference to exhibit 10.1 in Form 8-K filed December 23, 2005 (Film No. 051284175)

(23)

Incorporated herein by reference to exhibit 10.1 in Form 8-K filed December 30, 2013 (Film No. 131303552)

(24)

Incorporated herein by reference to exhibit 10.2 in Form 8-K filed December 30, 2013 (Film No. 131303552)

(25)

Incorporated herein by reference to exhibit 10.3 in Form 8-K filed December 30, 2013 (Film No. 131303552)

(26)

Incorporated herein by reference to exhibit 10.4 in Form 8-K filed December 30, 2013 (Film No. 131303552

(27)

Incorporated herein by reference to like numbered exhibit in Registrant’s 2014 Form 10-K (Film No. 15655545)

(28)

Incorporated herein by reference to exhibit 10.23 in Registrant’s 2015 Form 10-K (Film No. 161468309)

(29)

Incorporated herein by reference to the like numbered exhibit in Form 8-K filed August 24, 2016 (Film No. 161848221)

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