Premier Financial (PFC) 10-Q 2009 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended June 30, 2009

OR

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

Commission file number 0-26850

First Defiance Financial Corp.

(Exact name of registrant as specified in its charter)

Ohio	34-1803915
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
601 Clinton Street, Defiance, Ohio	43512
(Address or principal executive office)	(Zip Code)

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

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

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date. Common Stock, $.01 Par Value – 8,117,520 shares outstanding at August 10, 2009.

FIRST DEFIANCE FINANCIAL CORP.

INDEX

		Page Number
PART I.-FINANCIAL INFORMATION
Item 1.	Consolidated Condensed Financial Statements (Unaudited):
	Consolidated Condensed Statements of Financial Condition – June 30, 2009 and December 31, 2008	2
	Consolidated Condensed Statements of Income – Three and six months ended June 30, 2009 and 2008	4
	Consolidated Condensed Statement of Changes in Stockholders’ Equity – Three and six months ended June 30, 2009 and 2008	5
	Consolidated Condensed Statements of Cash Flows - Six months ended June 30, 2009 and 2008	6
	Notes to Consolidated Condensed Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	50
Item 4.	Controls and Procedures	50
PART II-OTHER INFORMATION:
Item 1.	Legal Proceedings	51
Item 1A.	Risk Factors	51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3.	Defaults upon Senior Securities	51
Item 4.	Submission of Matters to a Vote of Security Holders	52
Item 5.	Other Information	52
Item 6.	Exhibits	52
	Signatures	53

1

PART 1-FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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

	June 30, 2009		December 31, 2008
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions	$	31,606	$	40,980
Interest-bearing deposits		57,178		5,172
		88,784		46,152
Securities:
Available-for-sale, carried at fair value		133,009		117,575
Held-to-maturity, carried at amortized cost (fair value $864 and $917 at June 30, 2009 and December 31, 2008, respectively)		831		886
		133,840		118,461
Loans held for sale		23,835		10,960
Loans receivable, net of allowance of $25,840 at June 30, 2009 and $24,592 at December 31, 2008, respectively		1,584,620		1,592,643
Accrued interest receivable		7,023		7,293
Federal Home Loan Bank stock		21,376		21,376
Bank owned life insurance		28,884		28,747
Premises and equipment		46,835		47,756
Real estate and other assets held for sale		8,567		7,000
Goodwill		56,585		56,585
Core deposit and other intangibles		7,598		8,344
Mortgage servicing rights		8,919		6,611
Deferred taxes		52		336
Other assets		6,645		5,136
Total assets	$	2,023,563	$	1,957,400

(continued)

2

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Financial Condition

(UNAUDITED)

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

	June 30, 2009			December 31, 2008
Liabilities and stockholders’ equity
Liabilities:
Deposits	$	1,553,144		$	1,469,912
Advances from the Federal Home Loan Bank		146,947			156,067
Securities sold under repurchase agreements		40,284			49,454
Subordinated debentures		36,083			36,083
Advance payments by borrowers		389			652
Other liabilities		14,033			16,073
Total liabilities		1,790,880			1,728,241
Stockholders’ equity:
Preferred stock, $.01 par value per share: 37,000 shares authorized and issued with a liquidation preference of $37,000,000, net of discount		36,211			36,133
Preferred stock, no par value per share:
5,000,000 shares authorized; no shares issued		—			—
Common stock, $.01 par value per share:
20,000,000 shares authorized; 12,739,496 and 12,739,496 shares issued and 8,117,520 and 8,117,120 shares outstanding, respectively		127			127
Common stock warrant		878			878
Additional paid-in capital		140,567			140,449
Accumulated other comprehensive income (loss), net of tax of ($974) and ($1,025), respectively		(1,813	)		(1,904	)
Retained earnings		129,344			126,114
Treasury stock, at cost, 4,621,976 and 4,622,376 shares respectively		(72,631	)		(72,638	)
Total stockholders’ equity		232,683			229,159
Total liabilities and stockholders’ equity	$	2,023,563		$	1,957,400

See accompanying notes

3

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Income

(UNAUDITED)

(Amounts in Thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
Interest Income
Loans	$	23,086		$	24,506		$	46,463		$	47,319
Investment securities:
Taxable		996			1,139			2,079			2,287
Non-taxable		478			323			887			660
Interest-bearing deposits		33			15			47			113
FHLB stock dividends		229			254			468			497
Total interest income		24,822			26,237			49,944			50,876
Interest Expense
Deposits		6,859			7,522			14,042			16,193
FHLB advances and other		1,279			1,545			2,598			3,200
Subordinated debentures		369			456			795			984
Notes payable		136			468			293			662
Total interest expense		8,643			9,991			17,728			21,039
Net interest income		16,179			16,246			32,216			29,837
Provision for loan losses		3,965			2,797			6,711			3,855
Net interest income after provision for loan losses		12,214			13,449			25,505			25,982
Non-interest Income
Service fees and other charges		3,326			3,417			6,412			6,039
Insurance commission income		1,293			1,267			2,816			3,202
Mortgage banking income		3,983			1,501			6,697			2,616
Gain on sale of non-mortgage loans		45			8			100			43
Gain on sale or call of securities		125			—			125			19
Impairment on available-for-sale securities (includes total losses of $373 and $1.4 million for the three and six months ended June 30, 2009, plus $502 and $169 of losses recognized from other comprehensive income, respectively, pre-tax)		(875	)		(432	)		(1,547	)		(532	)
Trust income		103			118			205			229
Income from Bank Owned Life Insurance		78			254			137			527
Other non-interest income		281			17			218			22
Total non-interest income		8,359			6,150			15,163			12,165
Non-interest Expense
Compensation and benefits		7,585			7,318			14,950			14,441
Occupancy		1,924			1,944			4,041			3,613
FDIC insurance premium		1,497			431			2,064			465
State franchise tax		596			513			1,097			1,007
Data processing		1,176			1,134			2,230			2,163
Acquisition related charges		—			262			—			1,012
Amortization of intangibles		355			420			746			611
Other non-interest expense		3,000			3,493			6,001			5,679
Total non-interest expense		16,133			15,515			31,129			28,991
Income before income taxes		4,440			4,084			9,539			9,156
Federal income taxes		1,539			1,349			3,230			3,002
Net Income	$	2,901		$	2,735		$	6,309		$	6,154
Dividends accrued on preferred shares	$	(468	)	$	—		$	(930	)	$	—
Accretion on preferred shares	$	(40	)	$	—		$	(78	)	$	—
Net income applicable to common shares	$	2,393		$	2,735		$	5,301		$	6,154
Earnings per common share (Note 8)
Basic	$	0.29		$	0.34		$	0.65		$	0.80
Diluted	$	0.29		$	0.34		$	0.65		$	0.80
Dividends declared per share (Note 7)	$	0.085		$	0.26		$	0.255		$	0.52
Average shares outstanding (Note 8)
Basic		8,117			8,094			8,117			7,662
Diluted		8,182			8,126			8,117			7,701

See accompanying notes

4

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Changes in Stockholders’ Equity

(UNAUDITED)

(Amounts in Thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
Balance at beginning of period	$	230,608		$	194,835		$	229,159		$	165,954
Comprehensive income:
Net income		2,901			2,735			6,309			6,154
Other comprehensive income (loss) (Note 3)		271			(1,787	)		91			(2,117	)
Total comprehensive income		3,172			948			6,400			4,037
ESOP shares released		—			—			—			552
Stock option expense		56			60			120			114
Tax benefit of employee plans		—			17			—			72
Shares issued under stock option plans		5			213			5			768
Treasury shares repurchased		—			(163	)		—			(625	)
Acquisition of Pavilion Bancorp		—			(11	)		—			27,128
Preferred stock dividends accrued		(468	)		—			(930	)		—
Common cash dividends declared (Note 7)		(690	)		(2,099	)		(2,071	)		(4,200	)
Balance at end of period	$	232,683		$	193,800		$	232,683		$	193,800

See Accompanying Notes

5

FIRST DEFIANCE FINANCIAL CORP.

Consolidated Condensed Statements of Cash Flows

(UNAUDITED)

(Amounts in Thousands)

	Six Months Ended June 30,
	2009			2008
Operating Activities
Net cash provided by operating activities	$	117		$	3,583
Investing Activities
Proceeds from maturities of held-to-maturity securities		55			81
Proceeds from maturities and pay-downs of available-for-sale securities		10,139			20,529
Proceeds from sale of real estate and other assets held for sale		1,329			2,141
Proceeds from the sale of available-for-sale securities		3,604			—
Net cash paid for acquisition of Pavilion Bancorp, Inc.		—			(23,587	)
Proceeds from sale of non-mortgage loans		2,867			3,505
Purchases of available-for-sale securities		(29,958	)		(21,884	)
Purchases of office properties and equipment		(1,002	)		(2,277	)
Net increase in loans receivable		(5,749	)		(62,621	)
Net cash used in investing activities		(18,715	)		(84,113	)
Financing Activities
Net increase in deposits and advance payments by borrowers		83,098			418
Repayment of Federal Home Loan Bank long-term advances		(20	)		(6,389	)
Net increase (decrease) in Federal Home Loan Bank short-term advances		(9,100	)		33,600
Proceeds from Federal Home Loan Bank long-term advances		—			19,000
Increase (decrease) in securities sold under repurchase agreements		(9,170	)		6,738
Net increase in short-term borrowings		—			10,000
Purchase of common stock for treasury		—			(625	)
Cash dividends paid on common stock		(2,761	)		(3,925	)
Cash dividends paid on preferred stock		(822	)		—
Proceeds from exercise of stock options		5			768
Excess tax benefits from exercise of stock options		—			72
Net cash provided by (used in) financing activities		61,230			59,657
Increase (decrease) in cash and cash equivalents		42,632			(20,873	)
Cash and cash equivalents at beginning of period		46,152			65,553
Cash and cash equivalents at end of period	$	88,784		$	44,680
Supplemental cash flow information:
Interest paid	$	17,585		$	21,759
Income taxes paid	$	6,000		$	4,055
Transfers from loans to other real estate owned and other assets held for sale	$	3,610		$	1,715

See accompanying notes.

6

FIRST DEFIANCE FINANCIAL CORP.

Notes to Consolidated Condensed Financial Statements

(Unaudited at June 30, 2009 and 2008)

1. Basis of Presentation

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

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

The consolidated condensed statement of financial condition at December 31, 2008 has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K.

The accompanying consolidated condensed financial statements as of June 30, 2009 and for the three and six month periods ended June 30, 2009 and 2008 have been prepared by First Defiance without audit and do not include information or footnotes necessary for the complete presentation of financial condition, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States. These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in First Defiance’s 2008 Annual Report on Form 10-K for the year ended December 31, 2008. However, in the opinion of management, all adjustments, consisting of only normal recurring items, necessary for the fair presentation of the financial statements have been made. The results for the three and six month periods ended June 30, 2009 are not necessarily indicative of the results that may be expected for the entire year.

2.Significant Accounting Policies

Use of Estimates

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

7

Earnings Per Common Share

Basic earnings per common share is net income applicable to common shares divided by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock options, warrants and stock grants. Unreleased shares held by the Company’s Employee Stock Ownership Plan are not included in average shares for purposes of calculating earnings per share. As shares are released for allocation, they are included in the average shares outstanding. All shares under the ESOP plan were allocated as of December 31, 2008.

Comprehensive Income

Comprehensive income (loss) consists of net income and other comprehensive income (loss). Other comprehensive income includes unrealized gains and losses on available for sale investment 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 (loss) are reported net of tax.

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. 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. Securities with unrealized losses are reviewed quarterly to determine if 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 the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. If the fair value of a security is less than amortized cost and the impairment is determined to be other-than-temporary, it is reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of impairment related to other factors is recognized in other comprehensive income (loss).

8

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.

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.

A loan is impaired when full payment under the loan terms is not expected. 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, at 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.

Goodwill and Other Intangibles

Goodwill results from business acquisitions and represents the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment is recognized in the period identified. Identified purchased intangibles, which consist of core deposit intangibles, customer relationship intangibles and non-compete agreements, are recorded at cost or estimated fair value and amortized 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.

Stock Compensation Plans

Compensation cost is recognized for stock options 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. 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.

9

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. 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.

Mortgage Banking Derivatives

Commitments to fund mortgage loans (interest rate locks) to be sold in the secondary market and forward commitments for the future delivery of these mortgage loans to the secondary market are accounted for as derivatives not qualifying for hedge accounting. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date of commitments. Changes in the 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 of SFAS 131,Disclosures about Segments of an Enterprise and Related Information are monitored. For the six months ended June 30, 2009, the reported revenue for First Insurance was 5.9% 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 six months ended June 30, 2009 was 7.3% of consolidated net income. Total assets of First Insurance at June 30, 2009 were 0.4% of total assets. First Insurance does not meet any of the quantitative thresholds of SFAS 131. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.

Income Taxes

The Company’s effective tax rate differs from the statutory 35% federal tax rate primarily because of the volatility of income tax expense attributable to the change in income before income taxes and the impact of the Company’s tax exempt income on obligations of state and political subdivisions. In accordance with Accounting Principles Board Opinion No. 28, income tax expense should be recorded using the Company’s best estimate of the effective tax rate for a full year. With the other-than-temporary impairment charge recorded for the Company’s trust preferred collateralized debt obligations and the higher than anticipated

10

provisions for loan losses being necessary, the Company’s pre-tax income is lower than expected. This has been mostly offset by the large increase in mortgage banking income. As a result, the Company’s tax exempt income had a larger impact than originally estimated and resulted in a than lower expected tax rate for the second quarter ended June 30, 2009.

Reclassifications

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

New Accounting Standards

Statements of Financial Accounting Standards

SFAS No. 165, “Subsequent Events.”SFAS 165 requires entities to disclose the date through which they have evaluated subsequent events and whether the date corresponds with the release date of their financial statements. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. SFAS 165 did not have an impact on the Company’s financial statements.

SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles.” SFAS 168 provides for the FASB Accounting Standards Codification to become the official source of authoritative, nongovernmental U.S. generally accepted accounting principles (GAPP). SFAS 168 is effective for the Company for interim and annual periods ending after September 15, 2009.

Financial Accounting Standards Board Staff Positions and Interpretations

FSP SFAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP SFAS 157-4 affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. FSP SFAS 157-4 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. FSP SFAS 157-4 also amended SFAS 157, “FairValue Measurements,” to expand certain disclosure requirements. FSP SFAS 157-4 is effective for the Company for interim and annual reporting periods ending after June 15, 2009, applied prospectively; early adoption is permitted for periods ending after March 15, 2009. The Company elected to early adopt FSP SFAS 157-4 for the period ending March 31, 2009 and it did not have a significant impact on the Company’s financial statements.

FSP SFAS 115-2 and SFAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP SFAS 115-2 and SFAS 124-2 (i) changes existing guidance for determining whether an impairment is other than temporary to debt securities and (ii) replaces the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell

11

the security before recovery of its cost basis. Under FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. FSP SFAS 115-2 and SFAS 124-2 is effective for the Company for interim and annual reporting periods ending after June 15, 2009; early adoption is permitted for periods ending after March 15, 2009. The Company adopted the FSP effective January 1, 2009. No amounts were reversed for non-credit portion of cumulative other-than-temporary impairment (“OTTI”) charges from previous periods. As a result of implementing the new standard, the amount of OTTI recognized in the first and second quarters of 2009 was $672,000 and $875,000, respectively. Had the standard not been issued, the amount of OTTI that would have been recognized for the first and second quarter if 2009 would have been $2,211,000 and $1,101,000, respectively.

FSP SFAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP SFAS 107-1 and APB 28-1 amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require an entity to provide disclosures about fair value of financial instruments in interim financial information and amends Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. Under FSP SFAS 107-1 and APB 28-1, a publicly traded company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim reporting periods. In addition, entities must disclose, in the body or in the accompanying notes of its summarized financial information for interim reporting periods and in its financial statements for annual reporting periods, the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the statement of financial position, as required by SFAS 107. FSP SFAS 107-1 and APB 28-1 is effective for the Company for interim and annual reporting periods ending after June 15, 2009; early adoption is permitted for periods ending after March 15, 2009. The Company elected to early adopt FSP SFAS 107-1 and APB 28-1 for the period ending March 31, 2009 and the new interim disclosures are included within Note 4.

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3. Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss) (“OCI”). Other comprehensive income (loss) includes unrealized gains and losses on securities available-for-sale and the net unrecognized actuarial losses and unrecognized prior services costs associated with the Company’s Defined Benefit Postretirement Medical Plan. All items reported in other comprehensive income (loss) are reported net of tax. Following is a summary of other comprehensive income (loss) for the three and six months ended June 30, 2009 and 2008:

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
	(In thousands)
Net income	$	2,901		$	2,735		$	6,309		$	6,154
Change in securities available-for-sale:
Other-than-temporary impairment on available-for-sale securities		(373	)		(432	)		(1,378	)		(532	)
Other-than-temporary impairment on available-for-sale securities associated with credit losses realized in income		875			432			1,547			532
Other-than-temporary impairment on available-for-sale securities recorded in OCI		502			—			169			—
Unrealized holding gains (losses) on available-for-sale securities arising during the period		43			(2,954	)		98			(3,481	)
Reclassification adjustment for (gains) losses realized in income		(125	)		—			(125	)		19
Net unrealized gains (losses)		(82	)		(2,954	)		(27	)		(3,462	)
Income tax effect		(149	)		1,167			(51	)		1,345
Total other comprehensive income (loss)		271			(1,787	)		91			(2,117	)
Comprehensive income	$	3,172		$	948		$	6,400		$	4,037

The following table summarizes the changes within each classification of accumulated comprehensive income for the six months ended June 30, 2009 and 2008:

	Unrealized gains (losses) on available for sale securities			Postretirement Benefit			Accumulated other comprehensive income (loss), net
	(In thousands)
Balance at December 31, 2008	$	(1,100	)	$	(804	)	$	(1,904	)
Other comprehensive income (loss), net		91			—			91
Balance at June 30, 2009	$	(1,009	)	$	(804	)	$	(1,813	)

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	Unrealized gains (losses) on available for sale securities			Postretirement Benefit			Accumulated other comprehensive income (loss), net
	(In thousands)
Balance at December 31, 2007	$	364		$	(779	)	$	(415	)
Other comprehensive income (loss), net		(2,118	)		—			(2,118	)
Balance at June 30, 2008	$	(1,754	)	$	(779	)	$	(2,533	)

4. Fair Value

SFAS 157 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.

SFAS 157 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, SFAS 157 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 that 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.

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

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

Available for sale securities. Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Company obtains fair value measurements from an independent pricing service which uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. Securities in Level 1 include other federal agency securities. Securities in Level 2 include U.S. Government agencies, mortgage-backed securities and municipal securities. The Company classifies its pooled trust preferred collateralized debt obligations as Level 3. The portfolio consists of collateralized debt obligations backed by pools of trust preferred securities issued by financial institutions and insurance companies. Based on the lack of observable market data, the Company estimated fair values based on the observable data available and reasonable unobservable market data. The Company estimated fair value based on a discounted cash flow model which used appropriately adjusted discount rates reflecting credit and liquidity risks. The Company used an independent third party which is described further in Note 9.

Impaired loans. Impaired loans are reported at the fair value of the underlying collateral, if repayment is expected solely from collateral. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in impaired loans being valued using Level 3 inputs.

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

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

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

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

Assets and Liabilities Measured on a Recurring Basis

June 30, 2009	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Available for sale securities:
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	—	$	17,533	$	—	$	17,533
Mortgage-backed securities		—		34,074		—		34,074
REMICs		—		3,985		—		3,985
Collateralized mortgage obligations		—		31,477		—		31,477
Trust preferred stock		—		—		2,161		2,161
Preferred stock		103		—		—		103
Obligations of state and political subdivisions		—		43,676		—		43,676
Mortgage banking derivative – asset		—		539		—		539
Mortgage banking derivative – liability		—		—		—		—
December 31, 2008	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Available for sale securities:
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	—	$	14,685	$	—	$	14,685
Mortgage-backed securities		—		35,366		—		35,366
REMICs		—		4,159		—		4,159
Collateralized mortgage obligations		—		22,430		—		22,430
Trust preferred stock		—		—		3,873		3,873
Preferred stock		49		—		—		49
Obligations of state and political subdivisions		—		37,013		—		37,013
Mortgage banking derivative – asset		—		1,264		—		1,264
Mortgage banking derivative – liability		—		166		—		166

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The table below presents a reconciliation and income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2009:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands)
Beginning balance, April 1, 2009	$	2,371
Total gains or losses (realized/unrealized)
Included in earnings		(875	)
Included in other comprehensive income (presented gross of taxes)		663
Purchases, issuances, and settlements		2
Transfers in and/or out of Level 3		—
Ending balance, June 30, 2009	$	2,161
	Fair Value Measurements Using Significant Unobservable Inputs (Level 3) (In Thousands)
Beginning balance, January 1, 2009	$	3,873
Total gains or losses (realized/unrealized)
Included in earnings		(1,547	)
Included in other comprehensive income (presented gross of taxes)		(161	)
Purchases, issuances, and settlements		(4	)
Transfers in and/or out of Level 3		—
Ending balance, June 30, 2009	$	2,161

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

Assets and Liabilities Measured on a Non-Recurring Basis

June 30, 2009	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Impaired loans	$	—	$	—	$	15,354	$	15,354
Mortgage servicing rights		—		8,919		—		8,919
Real estate held for sale		—		—		1,774		1,774
December 31, 2008	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total Fair Value
	(In Thousands)
Impaired loans	$	—	$	—	$	14,782	$	14,782
Mortgage servicing rights		—		6,611		—		6,611
Real estate held for sale		—		—		90		90

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a fair value of $15,354,000, with a valuation allowance of $5,819,000 at June 30, 2009. A provision expense of $1,857,000 and $2,624,000 for the three and six months ended June 30, 2009 was included in earnings.

Mortgage servicing rights which are carried at lower of cost or fair value had a fair value of $8,919,000 at June 30, 2009, resulting in a valuation allowance of $1,103,000. A recovery of $1,520,000 and $1,689,000 for the three and six months ended June 30, 2009 was included in earnings.

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Real estate held for sale is determined using Level 3 inputs which include current and prior appraisals and estimated costs to sell. The change in fair value of real estate held for sale was $374,000 and $663,000 for the three and six months ended June 30, 2009 which was recorded directly as an adjustment to current earnings through non-interest expense.

In accordance with FSP FAS 107-1, the following table is a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of June 30, 2009 and December 31, 2008. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance Financial Corp.

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, warehouse and 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.

For investment securities, fair value has been based on current market quotations. If market prices are not available, fair value has been estimated based upon the quoted price of similar instruments.

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

SFAS No. 107 requires that the fair value of demand, savings, NOW and certain money market accounts be equal to their carrying amount. The Company believes that the fair value of these deposits may be greater or less than that prescribed by SFAS No. 107.

The carrying value of Subordinated Debentures and deposits with fixed maturities is estimated based on interest rates currently being offered on instruments with similar characteristics and maturities. FHLB advances with maturities greater than 90 days are valued based on discounted cash flow analysis, using interest rates currently being quoted for similar characteristics and maturities. The cost or value of any call or put options is based on the estimated cost to settle the option at June 30, 2009.

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	June 30, 2009				December 31, 2008
	Carrying Value		Estimated Fair Values		Carrying Value		Estimated Fair Values
	(In Thousands)
Assets:
Cash and cash equivalents	$	88,784	$	88,784	$	46,152	$	46,152
Investment securities		133,840		133,873		118,461		118,492
Loans, net, including loans held for sale		1,608,455		1,611,932		1,603,603		1,619,409
		1,831,079	$	1,834,589		1,768,216	$	1,784,053
Other assets		192,484				189,184
Total assets	$	2,023,563			$	1,957,400
Liabilities and stockholders’ equity:
Deposits	$	1,553,144	$	1,559,707	$	1,469,912	$	1,476,135
Advances from Federal Home Loan Bank		146,947		152,187		156,067		162,776
Subordinated debentures		36,083		36,442		36,083		40,282
Securities sold under repurchase agreements		40,284		40,284		49,454		49,454
Advance payments by borrowers for taxes and insurance		389		389		652		652
		1,776,847	$	1,789,009		1,712,168	$	1,729,299
Other liabilities		14,033				16,073
Total liabilities		1,790,880				1,728,241
Stockholders’ equity		232,683				229,159
Total liabilities and stockholders’ equity	$	2,023,563			$	1,957,400

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5. Stock Compensation Plans

First Defiance has established incentive stock option plans for its directors and employees and has reserved 1,727,485 shares of common stock for issuance under the plans. As of June 30, 2009, 500,750 options (478,750 for employees and 22,000 for directors) have been granted and remain outstanding at option prices based on the market value of the underlying shares on the date the options were granted.

The Company can issue incentive stock options and nonqualified stock options under their incentive stock plans. Generally, one-fifth of the options awarded become exercisable on each of the first five anniversaries of the date of grant. The option period expires ten years from the date of grant and the exercise price is the market price at the date of grant.

Following is activity under the plans:

	Six Months Ended June 30, 2009
	Options Outstanding		Weighted Average Exercise Price		Aggregate Intrinsic Value
Options outstanding, beginning of period	439,800		$	20.58
Forfeited or cancelled	(3,000	)		22.25
Exercised	(400	)		11.75
Granted	64,350			9.43
Options outstanding, end of period	500,750		$	19.14	$	257,000
Vested or expected to vest at period end	473,333		$	19.22
Exercisable at period end	299,100		$	20.30	$	29,000

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

	Six Months Ended June 30,
	2009		2008
Cash received from option exercises	$	5,000	$	768,000
Tax benefit realized from option exercises		—		72,000
Intrinsic value of options exercised		1,000		290,000

As of June 30, 2009, there was $544,000 of total unrecognized compensation costs related to unvested stock options granted under the Company Stock Option Plans. The cost is expected to be recognized over a weighted-average period of 3.1 years.

As of June 30, 2009 there were 85,500 shares available for grant under the Company’s stock option plans.

The fair value of stock options granted during the six months ended June 30, 2009 and 2008 was determined at the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:

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	Six Months Ended June 30
	2009		2008
Expected average risk-free rate	3.38	%	4.20	%
Expected average life	6.41	years	6.46	years
Expected volatility	26.10	%	22.30	%
Expected dividend yield	3.62	%	5.98	%

The weighted-average fair value of options granted for the six months ended June 30, 2009 and 2008 were $1.87 and $2.07, respectively.

6. Acquisitions

On March 14, 2008, First Defiance completed the acquisition of Pavilion, which is headquartered in Adrian, Michigan. Each Pavilion shareholder received 1.4209 shares of First Defiance common stock and $37.50 in cash for each share of Pavilion stock. In connection with this transaction, 1,036,861 shares of First Defiance common stock were issued at a value of $27.1 million. The common shares issued were valued at $26.117 per share representing the average of the closing bid and ask price as of the date of announcement plus two days prior and two days subsequent to the announcement. The total cost of the transaction, including legal and investment banking fees, was $55.5 million. The assets and liabilities of Pavilion were recorded on the balance sheet at their fair value as of the acquisition date. The results of Pavilion’s operations have been included in the First Defiance’s consolidated statement of income from the date of acquisition.

The following tables summarize the estimated fair values of the net assets acquired and the computation of the purchase price and goodwill related to the Pavilion acquisition.

	Acquisition Date March 14, 2008
	(In Thousands)
Assets
Cash and cash equivalents	$	4,514
Investment securities		9,136
Loans, net of allowance for loan losses		232,499
Premises and equipment		6,992
Federal Home Loan Bank stock		2,036
Goodwill and other intangibles		26,016
Other assets		6,801
Total Assets		287,994
Liabilities
Deposits		209,385
Borrowings		18,403
Other liabilities		4,658
Total Liabilities		232,446
Net assets acquired	$	55,548

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6.Acquisitions (continued)

	Acquisition Date March 14, 2008
	(In Thousands)
Purchase price	$	55,548
Pavilion’s carrying value of net assets acquired		(28,228	)
Excess purchase price over Pavilion’s carrying Value of net assets acquired		27,320
Purchase accounting adjustments
Portfolio loans		(6,632	)
Premises and equipment		2,579
Mortgage servicing rights		(1,010	)
Deposits		1,021
Deferred tax liabilities		2,648
Total net tangible assets		(1,394	)
Core deposit and other intangibles		(6,251	)
Goodwill	$	19,765

During the six months ended June 30, 2008, First Defiance recognized $1,012,000 of acquisition related charges, of which, $198,000 related to retention bonuses and $173,000 related to termination of certain contracts. The remaining $641,000 includes items related to professional services, start-up costs of system conversions, supplies and other non-recurring costs associated with the completion of the acquisition and the transition of operations.

7. Dividends on Common Stock

As of June 30, 2009, First Defiance had declared a quarterly cash dividend of $.085 per common share for the second quarter of 2009, payable on July 24, 2009. As a result of the Company’s participation in the Capital Purchase Program, First Defiance is prohibited, without prior approval from the U.S. Treasury, from paying a quarterly dividend of more than $0.26 per share until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party.

8. Earnings Per Share

Basic earnings per share as disclosed under SFAS No. 128 has been calculated by dividing net income applicable to common shares by the weighted average number of shares of common stock outstanding for the three and six-month periods ended June 30, 2009 and 2008. First Defiance accounts for the shares issued to its Employee Stock Ownership Plan (“ESOP”) in accordance with Statement of Position 93-6 of the American Institute of Certified Public Accountants (“AICPA”). As a result, shares controlled by the ESOP are not considered in the weighted average number of shares of common stock outstanding until the shares are committed for allocation to an employee’s individual account. In the calculation of diluted earnings per share for the three and six-month periods ended June 30, 2009 and 2008, the effect of shares issuable under stock option plans and unvested shares under the Management Recognition Plan have been accounted for using the Treasury Stock method.

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

	Three months ended June 30,				Six months ended June 30,
	2009		2008		2009		2008
Numerator for basic and diluted earnings per common share – Net income applicable to common shares	$	2,393	$	2,735	$	5,301	$	6,154
Denominator:
Denominator for basic earnings per common share – weighted average shares		8,117		8,094		8,117		7,662
Effect of warrants		65		—		—		—
Effect of employee stock options		—		32		—		39
Denominator for diluted earnings per common share		8,182		8,126		8,117		7,701
Basic earnings per common share	$	0.29	$	0.34	$	0.65	$	0.80
Diluted earnings per common share	$	0.29	$	0.34	$	0.65	$	0.80

There were 490,750 shares under option related to employees excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and six months ended June 30, 2009. Shares under option of 307,638 were excluded from the diluted earnings per common share calculation as they were anti-dilutive for the three and six months ended June 30, 2008. Additionally, the 550,595 shares issuable related to warrants were anti-dilutive and excluded from the diluted earnings per share calculation for the six months ended June 30, 2009.

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9. Investment Securities

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
At June 30, 2009
Available-for-Sale Securities:
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	17,134	$	406	$	(7	)	$	17,533
Mortgage-backed securities		33,010		1,090		(26	)		34,074
REMICs		3,852		133		—			3,985
Collateralized mortgage obligations		30,895		758		(176	)		31,477
Trust preferred stock and preferred stock		6,488		—		(4,224	)		2,264
Obligations of state and political subdivisions		43,179		817		(320	)		43,676
Totals	$	134,558	$	3,204	$	(4,753	)	$	133,009
Held-to-Maturity Securities:
FHLMC certificates	$	134	$	6	$	—		$	140
FNMA certificates		342		2		(2	)		342
GNMA certificates		115		4		—			119
Obligations of state and political subdivisions		240		23		—			263
Totals	$	831	$	35	$	(2	)	$	864
At December 31, 2008
Available-for-Sale Securities:
U.S. Treasury securities and obligations of U.S. Government corporations and agencies	$	14,180	$	505	$	—		$	14,685
Mortgage-backed securities		34,232		1,137		(3	)		35,366
REMICs		4,041		118		—			4,159
Collateralized mortgage obligations		22,196		486		(252	)		22,430
Trust preferred stock and preferred stock		8,038		—		(4,116	)		3,922
Obligations of state and political subdivisions		36,581		754		(322	)		37,013
Totals	$	119,268	$	3,000	$	(4,693	)	$	117,575
Held-to-Maturity Securities:
FHLMC certificates	$	141	$	5	$	—		$	146
FNMA certificates		378		1		(2	)		377
GNMA certificates		127		1		—			128
Obligations of state and political subdivisions		240		26		—			266
Totals	$	886	$	33	$	(2	)	$	917

The amortized cost and fair value of securities at June 30, 2009 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities (“MBS”), collateralized mortgage obligations (“CMO”) and REMICs, which are not due at a single maturity date, have not been allocated over the maturity groupings. The MBS, CMO and REMIC securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

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	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(In Thousands)
Due in one year or less	$	2,678	$	2,700	$	60	$	61
Due after one year through five years		15,693		16,189		180		202
Due after five years through ten years		10,307		10,499		—		—
Due after ten years		38,123		34,085		—		—
MBS/CMO/REMIC		67,757		69,536		591		601
	$	134,558	$	133,009	$	831	$	864

Investment securities with a carrying amount of $100.4 million at June 30, 2009 were pledged as collateral on public deposits, securities sold under repurchase agreements and FHLB advances and for other purposes required or permitted by law.

As of June 30, 2009, the Company’s investment portfolio consisted of 294 securities, 65 of which were in an unrealized loss position.

The following table summarizes First Defiance’s securities that were in an unrealized loss position at June 30, 2009:

	Duration of Unrealized Loss Position
	Less than 12 Months					12 Month or Longer					Total
	Fair Value		Gross Unrealized Loss			Fair Value		Gross Unrealized Loss			Fair Value		Unrealized Losses
	(In Thousands)
At June 30, 2009
Available-for-sale securities:
U.S. treasury securities and obligations of U.S. government corporations and agencies	$	2,015	$	(7	)	$	—	$	—		$	2,015	$	(7	)
Mortgage-backed securities		4,973		(26	)		—		—			4,973		(26	)
Collateralized mortgage obligations and REMICs		3,677		(33	)		636		(143	)		4,313		(176	)
Trust preferred stock and preferred stock		103		(49	)		2,161		(4,175	)		2,264		(4,224	)
Obligations of state and political subdivisions		5,896		(90	)		4,612		(230	)		10,508		(320	)
Held to maturity securities:
Mortgage-backed securities		38		—			147		(2	)		185		(2	)
Total temporarily impaired securities	$	16,702	$	(205	)	$	7,556	$	(4,550	)	$	24,258	$	(4,755	)

With the exception of Trust Preferred Stock, the above securities all have fixed interest rates, and all securities have defined maturities. Their fair value is sensitive to movements in the market interest rates. First Defiance does not intend to sell and does not believe it is more likely than not that it will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis.

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Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequent 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 SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities,and the newly adopted FSP SFAS 115-2 and SFAS 124-2. Certain collateralized debt obligations are evaluated for OTTI under EITF 99-20,Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests that Continue to be Held by a Transfer in Securitized Financial Assetsand EITF 99-20-1,Amendments to the Impairment Guidance of EITF Issue No. 99-20.

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.

The Company holds twelve trust preferred collateralized debt obligations (“CDOs”) at June 30, 2009. Management’s analysis in the first quarter of 2009 deemed that the value of seven CDOs were other-than-temporarily impaired. Three of these CDOs were written off in full at March 31, 2009. Of the other four impaired investments at March 31, 2009, management determined that additional other than-temporary impairment had arose on three during second quarter 2009 along with identifying new other than-temporary impairment on an additional CDO during second quarter 2009. Thus a total of eight CDOs were classified as other-than-temporarily impaired at June 30, 2009. During second quarter 2009 total other-than-temporary impairment losses of $(373,000) were identified of which $(875,000) was recorded as an expense and $502,000 was recorded as an adjustment to other comprehensive income. For the six months ended June 30, 2009 other-than-temporary impairment losses of $(1,378,000) were identified, of which $(1,547,000) was recorded as an expense and $169,000 was recorded as an adjustment to other comprehensive income. As required under FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses.

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Management’s analysis in the second quarter of 2009 deemed that the value of four trust preferred collateralized debt obligations (“CDOs”) were other-than-temporarily impaired. These securities had other-than-temporary impairment losses of $(373,000), of which $(875,000) was recorded as an expense and $502,000 was recorded as an adjustment to other comprehensive income for the three months ended June 30, 2009. For the six months ended June 30, 2009, five CDOs were other-than-temporarily impaired. These securities had other-than-temporary impairment losses of $(1,378,000), of which $(1,547,000) was recorded as an expense and $169,000 was recorded as an adjustment to other comprehensive income. As required under FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. Life-to date, the Company has a total of eight securities that are other-than-temporarily impaired at June 30, 2009 and remain classified as available for sale. Three of these securities were written down to zero at March 31, 2009.

Given the conditions in the debt markets today and the absence of observable transactions in the secondary and new issue markets, the Company’s CDOs will be classified within Level 3 of the fair value hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

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

The following table details the eight securities with other-than-temporary impairment, their Moody’s credit rating at June 30, 2009 and the related credit losses recognized in earnings for the periods ended March 31, 2009 and June 30, 2009 (In Thousands):

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	Preferred Term VI		TPREF Funding II		Alesco Preferred Funding		Alesco Preferred Funding XVIA C		Alesco Preferred Term Sec XVII A		Trapeza CDO I		Alesco Preferred Funding VIII		Alesco Preferred Funding IX
	Rated Caa1		Rated Caa3		Rated Ca		Rated Ca		Rated Ca		Rated Ca		Not Rated		Not Rated		Total
Amount of OTTI related to credit loss at January 1, 2009	$	—	$	—	$	—	$	—	$	—	$	488	$	428	$	440	$	1,356
Addition – Qtr 1		15		1		212		25		—		369		25		25		672
Amount of OTTI related to credit loss at March 31, 2009	$	15	$	1	$	212	$	25	$	—	$	857	$	453	$	465	$	2,028
Addition – Qtr 2		—		123		625		84		43		—		—		—		875
Amount of OTTI related to credit loss at June 30, 2009	$	15	$	124	$	837	$	109	$	43	$	857	$	453	$	465	$	2,903

Sales and write-downs of available for sale securities were as follows:

	Three Months Ended June 30,								Six Months Ended June 30,
	2009			2008				2009			2008
	(In thousands)						(In thousands)
Proceeds	$	3,604		$	—		$3,604			$—
Gross realized gains		125			—		125			—
Gross realized losses		—			—		—			—
Other-than-temporary impairment charges		(875	)		(432	)	(1,547)			(532)

Gross gains from calls of securities available for sale during the first six months of 2008 were $19,000.

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10. Loans

Loans receivable consist of the following (in $000s):

	June 30, 2009		December 31, 2008
Real Estate:
One-to-four family residential	$	238,000	$	251,807
Construction		44,670		72,938
Non-residential and multi-family		768,636		755,740
		1,051,306		1,080,485
Other Loans:
Commercial		382,434		356,574
Consumer finance		38,074		41,012
Home equity and improvement		151,213		161,106
		571,721		558,692
Total real estate and other loans		1,623,027		1,639,177
Deduct:
Loans in process		11,602		20,892
Net deferred loan origination fees and costs		965		1,050
Allowance for loan loss		25,840		24,592
Totals	$	1,584,620	$	1,592,643

Changes in the allowance for loan losses were as follows (in $000s):

	Three Months ended June 30,				Six Months ended June 30,
	2009		2008		2009		2008
Balance at beginning of period	$	25,694	$	18,556	$	24,592	$	13,890
Provision for loan losses		3,965		2,797		6,711		3,855
Reserve acquired from Pavilion		—		38		—		4,137
Charge-offs:
One-to-four family residential real estate		505		281		653		338
Non-residential and multi-family real estate		2,066		319		2,735		783
Commercial		950		220		1,652		220
Home equity and improvement		301		18		431		90
Consumer finance		83		56		206		83
Total charge-offs		3,905		894		5,677		1,514
Recoveries		86		81		214		210
Net charge-offs		3,819		813		5,463		1,304
Ending allowance	$	25,840	$	20,578	$	25,840	$	20,578

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

	June 30, 2009		December 31, 2008
	(in thousands)
Non-accrual loans	$	35,528	$	28,017
Loans over 90 days past due and still accruing		—		—
Troubled debt restructuring, still accruing		4,845		6,250
Total non-performing loans		40,373	$	34,267
Real estate owned (REO)		8,567		7,000
Total non-performing assets	$	48,940	$	41,267

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11. Mortgage Banking

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
	(in thousands)
Gain from sale of mortgage loans	$	2,922		$	1,041		$	5,735		$	2,184
Mortgage loans servicing revenue (expense):
Mortgage loans servicing revenue		695			682			1,384			1,148
Amortization of mortgage servicing rights		(1,154	)		(389	)		(2,111	)		(740	)
Mortgage servicing rights valuation adjustments		1,520			167			1,689			24
		1,061			460			962			432
Net revenue from sale and servicing of mortgage loans	$	3,983		$	1,501		$	6,697		$	2,616

The unpaid principal balance of residential mortgage loans serviced for third parties was $1.2 billion for June 30, 2009 and $1.1 billion for June 30, 2008.

Activity for capitalized mortgage servicing rights and the related valuation allowance follows for the six months ended June 30, 2009 and for the year ended December 31, 2008:

	June 30, 2009			December 31, 2008
	(in thousands)
Mortgage servicing assets:
Balance at beginning of period	$	9,403		$	6,089
Loans sold, servicing retained		2,730			1,450
Fair value of servicing assets acquired from Pavilion		—			3,130
Amortization		(2,111	)		(1,266	)
Carrying value before valuation allowance at end of period		10,022			9,403
Valuation allowance:
Balance at beginning of period		(2,792	)		(116	)
Impairment recovery (charges)		1,689			(2,676	)
Balance at end of period		(1,103	)		(2,792	)
Net carrying value of MSRs at end of period	$	8,919		$	6,611
Fair value of MSRs at end of period	$	8,919		$	6,611

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

12. Deposits

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

	June 30, 2009		December 31, 2008
Non-interest-bearing checking accounts	$	180,035	$	176,063
Interest-bearing checking and money market accounts		456,177		374,488
Savings accounts		135,821		132,146
Retail certificates of deposit less than $100,000		568,595		578,244
Retail certificates of deposit greater than $100,000		165,401		170,485
Brokered or national certificates of deposit		47,115		38,486
	$	1,553,144	$	1,469,912

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13. Borrowings

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

	June 30, 2009		December 31, 2008
	(in thousands)
FHLB Advances:
Overnight borrowings	$	—	$	9,100
Single maturity fixed rate advances		35,000		10,000
Single maturity LIBOR based advances		20,000		45,000
Putable advances		64,000		64,000
Strike-rate advances		27,000		27,000
Amortizable mortgage advances		947		967
Total	$	146,947	$	156,067
Junior subordinated debentures owed to unconsolidated subsidiary trusts	$	36,083	$	36,083

The putable advances can be put back to the Company at the option of the FHLB on a quarterly basis. $14.0 million of the putable advances with a weighted average rate of 2.69% are not yet callable by the FHLB. The call dates for these advances range from January 14, 2010 to February 11, 2011 and the maturity dates range from February 11, 2013 to March 12, 2018. The FHLB has the option to call the remaining $50.0 million of putable advances with a weighted average rate of 5.01%. The maturity dates of these advances range from September 1, 2010 to January 14, 2015. The strike-rate advances are putable at the option of the FHLB only when the three month LIBOR rates exceed the agreed upon strike-rate in the advance contract which ranges from 7.5% to 8.0%. The three month LIBOR rate at June 30, 2009 was 0.60%. The weighted average rate of the strike-rate advances is 4.18% and the maturity dates range from March 8, 2011 to February 25, 2013.

In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (Trust Affiliate II) that issued $15 million of Guaranteed Capital Trust Securities (Trust Preferred Securities). In connection with this transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) to Trust Affiliate II. The Company formed Trust Affiliate II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. Distributions on the Trust Preferred Securities issued by Trust

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Affiliate II are payable quarterly at a fixed rate equal to 6.441% for the first five years and a floating interest rate based on three-month LIBOR plus 1.50% points, repricing quarterly, thereafter.

The Company also sponsored an affiliated trust, First Defiance Statutory Trust I (Trust Affiliate I), that issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Junior Debentures held by Trust Affiliate I are the sole assets of the trust. 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 2.01% and 3.38% on June 30, 2009 and December 31, 2008 respectively.

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

A summary of all junior 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 (in thousands):

	June 30, 2009		December 31, 2008
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. Commitments, Guarantees and Contingent Liabilities

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

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

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

	June 30, 2009				December 31, 2008
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
Commitments to make loans	$	51,259	$	78,492	$	22,710	$	70,114
Unused lines of credit		37,106		209,899		44,535		211,291
Standby letters of credit		13		19,427		67		18,860
Total	$	88,378	$	307,818	$	67,312	$	300,265

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

In addition to the above commitments, First Defiance had commitments to sell $40.8 million and $72.9 million of loans to Freddie Mac, Fannie Mae, Federal Home Loan Bank of Cincinnati or BB&T Mortgage at June 30, 2009 and December 31, 2008, respectively.

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15. 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. A description of employees or former employees eligible for coverage is included in Footnote 16 in the financial statements included in First Defiance’s 2008 Annual Report on Form 10-K.

Net periodic postretirement benefit costs include the following components for the three and six-month periods ended June 30, 2009 and 2008:

	Three Months Ended June 30,				Six Months Ended June 30,
	2008		2007		2008		2007
	(In Thousands)
Service cost-benefits attributable to service during the period	$	15	$	15	$	30	$	28
Interest cost on accumulated post- retirement benefit obligation		43		39		83		76
Net amortization and deferral		14		16		28		31
Net periodic postretirement benefit cost	$	72	$	70	$	141	$	135

16. Income Taxes

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for the years before 2005.

17. Derivative Financial Instruments

The Company adopted SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133,” at the beginning of the first quarter of 2009, and has included here the expanded disclosures required by that statement.

Mortgage Banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts (“forward contracts”) and rate lock loan commitments. The fair value of the Company’s derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.

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The table below provides data about the carrying values of derivative instruments:

	June 30, 2009						December 31, 2008
	Assets		(Liabilities)				Assets		(Liabilities)
	Carrying Value		Carrying Value		Derivative Net Carrying Value		Carrying Value		Carrying Value			Derivative Net Carrying Value
	(In Thousands)
Derivatives not designated as hedging instruments
Mortgage Banking Derivatives	$	539	$	—	$	539	$	1,264	$	(166	)	$	1,098

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

	Three Months Ended June 30,					Six Months Ended June 30,
	2009			2008		2009			2008
	(in thousands)
Derivatives designated as hedging instruments
Mortgage Banking Derivatives – Gain (Loss)	$	(847	)	$	—	$	(559	)	$	—

18. Subsequent Events

The Company evaluated subsequent events up to and through August 10, 2009. As a result of that evaluation, no subsequent events were identified that required recognition or disclosure in the financial statements.

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

General

First Defiance Financial Corp. (“First Defiance” or “the Company”) is a unitary thrift holding company which conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal”) and First Insurance and Investments, Inc. (“First Insurance”). First Federal is a federally chartered savings bank that provides financial services through 35 full-service branches in communities based in northwest Ohio, northeast Indiana, and southeastern Michigan. On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc. (“Pavilion”), which added eight banking centers in southeast Michigan, expanding the Company’s reach to markets adjacent to its existing branch network. First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust services. First Insurance sells a variety of property and casualty, group health and life, and individual health and life insurance products and investment and annuity products. Insurance products are sold through First Insurance’s offices in Defiance and Bowling Green, Ohio while investment and annuity products are sold through registered investment representatives located at certain First Federal banking center locations.

First Defiance invests in U.S. Treasury and federal government agency obligations, obligations of municipal and other political subdivisions, mortgage-backed securities which are issued by federal agencies, corporate bonds, and collateralized mortgage obligations (“CMOs”) and real estate mortgage investment conduits (“REMICs”). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB Statement No. 115,Accounting for Certain Investments in Debt and Equity Securities.

Securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the security to maturity. Held-to-maturity securities are stated at amortized cost and had a recorded value of $831,000 at June 30, 2009. Securities not classified as held-to-maturity are classified as available-for-sale, which are stated at fair value and had a recorded value of $133.0 million at June 30, 2009. The available-for-sale portfolio consists of obligations of U.S. Government corporations and agencies ($17.5 million), certain municipal obligations ($43.7 million), CMOs and REMICs ($35.4 million), mortgage backed securities ($34.1 million) and trust preferred stock ($2.3 million).

In accordance with FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income.

The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, Federal Home Loan Bank advances, and other borrowings. The Company’s non-interest income is mainly derived from service fees and other charges, mortgage banking income, and insurance commissions. First Defiance’s earnings also depend on the provision

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for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense.

Participation in the U.S. Treasury Capital Purchase Program

On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (“EESA”), which creates the Troubled Asset Relief Program (“TARP”) and provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. The Capital Purchase Program (“CPP”) was announced by the U.S. Treasury on October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will purchase up to $250 billion of senior preferred shares on standardized terms from qualifying financial institutions. The purpose of the CPP is to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy.

The CPP is voluntary and requires a participating institution to comply with a number of restrictions and provisions, including standards for executive compensation and corporate governance and limitations on share repurchases and the declaration and payment of dividends on common shares. The standard terms of the CPP require that a participating financial institution limit the payment of dividends to the most recent quarterly amount prior to October 14, 2008, which is $0.26 per share in the case of First Defiance. This dividend limitation will remain in effect until such time that the preferred shares are no longer outstanding.

Eligible financial institutions could generally apply to issue senior preferred shares to the U.S. Treasury in aggregate amounts between 1% to 3% of the institution’s risk-weighted assets. In the case of First Defiance, an application was approved by the U.S. Treasury and on December 5, 2008, First Defiance issued $37.0 million of cumulative perpetual preferred shares, with a liquidation preference of $1,000 per share (“Senior Preferred Shares”). The Senior Preferred Shares constitute Tier 1 capital and rank senior to First Defiance’s common shares. The Senior Preferred Shares pay cumulative dividends at a rate of 5% per annum for the first five years and will reset to a rate of 9% per annum after five years.

As part of its participation in the CPP, First Defiance also issued a warrant to the U.S. Treasury to purchase 550,595 common shares having an exercise price of $10.08 per share. The initial exercise price for the warrant and the market price for determining the number of common shares subject to the warrant was determined by reference to the market price of the common shares on the date of the investment by the U.S. treasury in the Senior Preferred Shares (calculated on a 20-day trailing average). The warrant has a term of 10 years.

Forward-Looking Information

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

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Changes in Financial Condition

At June 30, 2009, First Defiance’s total assets, deposits and stockholders’ equity amounted to $2.02 billion, $1.55 billion and $232.7 million, respectively, compared to $1.96 billion, $1.47 billion and $229.2 million, respectively, at December 31, 2008.

Net loans receivable (excluding loans held for sale) decreased $8.0 million to $1.58 billion at June 30, 2009 compared to $1.59 billion at December 31, 2008. The decrease in loans receivable between December 31, 2008 and June 30, 2009 included decreases in one-to-four family residential real estate loans (down $13.8 million), home equity and improvement loans (down $10.0 million), construction loans (down $28.3 million), and consumer loans (down $2.9 million) while commercial loans increased $25.9 million and non-residential and multi-family loans increased $13.0 million.

The investment securities portfolio increased $15.4 million to $133.8 million at June 30, 2009 from $118.5 million at December 31, 2008. The increase is the result of $30.0 million of securities being purchased during the first six months of 2009 partially offset by $1.8 million of securities being matured or called in the period, principal pay downs of $8.4 million in CMOs and mortgage-backed securities, and $3.5 million of securities being sold. The unrealized loss in the investment portfolio decreased $143,000 to $1.5 million at June 30, 2009 from $1.7 million at December 31, 2008.

Deposits increased from $1.47 billion at December 31, 2008 to $1.55 billion as of June 30, 2009. Of the $83.2 million increase, interest-bearing demand deposits and money market accounts increased $81.7 million to $456.2 million, savings accounts increased $3.7 million to $135.8 million, non-interest bearing checking accounts increased $4.0 million to $180.0 million and broker/national certificates of deposit increased $8.6 million to $47.1 million. These increases were slightly offset by a decline in retail time deposits of $14.8 million to $734.0 million.

The FHLB advances decreased $9.1 million to $147.0 million at June 30, 2009 from $156.1 million at December 31, 2008. The decrease is attributable to a $9.1 million decrease in overnight advances due in large part from the growth in deposits.

Stockholders’ equity increased from $229.2 million at December 31, 2008 to $232.7 million at June 30, 2009. The increase is primarily the result of recording net income of $6.3 million partially offset by $2.1 million of cash dividends declared on common stock and $930,000 of accrued dividends on preferred stock.

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

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

	Three Months Ended June 30,
	2009						2008
	Average Balance		Interest(1)		Yield/ Rate(2)		Average Balance		Interest(1)		Yield/ Rate(2)
Interest-earning assets:
Loans receivable	$	1,592,513	$	23,116	5.82	%	$	1,544,409	$	24,536	6.39	%
Securities		130,663		1,739	5.26			121,506		1,648	5.42
Interest-earning deposits		83,720		33	0.16			2,616		15	2.31
FHLB stock and other		21,376		229	4.30			20,867		254	4.90
Total interest-earning assets		1,828,272		25,117	5.50			1,689,398		26,453	6.29
Non-interest-earning assets		199,488						208,767
Total assets	$	2,027,760					$	1,898,165
Interest-bearing liabilities:
Deposits	$	1,377,317	$	6,859	2.00	%	$	1,252,165	$	7,522	2.42	%
FHLB advances and other		146,951		1,279	3.49			164,811		1,545	3.77
Notes payable		43,122		136	1.27			53,724		468	3.50
Subordinated debentures		36,242		369	4.08			36,225		456	5.06
Total interest-bearing liabilities		1,603,632		8,643	2.16			1,506,925		9,991	2.67
Non-interest bearing deposits		175,216		—				171,101		—
Total including non-interest bearing demand deposits		1,778,848		8,643	1.95			1,678,026		9,991	2.39
Other non-interest-bearing liabilities		17,515						24,294
Total liabilities		1,796,363						1,702,320
Stockholders’ equity		231,397						195,845
Total liabilities and stock- holders’ equity	$	2,027,760					$	1,898,165
Net interest income; interest rate spread			$	16,474	3.34	%			$	16,462	3.62	%
Net interest margin (3)					3.61	%					3.91	%
Average interest-earning assets to average interest-bearing liabilities					114	%					112	%

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

(2) Annualized

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

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	Six Months Ended June 30,
	2009						2008
	Average Balance		Interest(1)		Yield/ Rate(2)		Average Balance		Interest(1)		Yield/ Rate(2)
Interest-earning assets:
Loans receivable	$	1,594,553	$	46,521	5.88	%	$	1,435,438	$	47,363	6.64	%
Securities		124,988		3,460	5.51			119,112		3,323	5.60
Interest-earning deposits		64,227		47	0.15			8,352		113	2.72
FHLB stock and other		21,376		468	4.42			19,738		497	5.06
Total interest-earning assets		1,805,144		50,496	5.61			1,582,640		51,296	6.52
Non-interest-earning assets		201,229						189,161
Total assets	$	2,006,373					$	1,771,801
Interest-bearing liabilities:
Deposits	$	1,362,747	$	14,042	2.08	%	$	1,181,938	$	16,193	2.76	%
FHLB advances and other		147,021		2,598	3.56			155,666		3,200	4.13
Notes payable		41,327		293	1.43			39,841		662	3.34
Subordinated debentures		36,247		795	4.41			36,253		984	5.46
Total interest-bearing liabilities		1,587,342		17,728	2.25			1,413,698		21,039	2.99
Non-interest bearing deposits		170,548		—				147,872		—
Total including non-interest bearing demand deposits		1,757,890		17,728	2.03			1,561,570		21,039	2.71
Other non-interest-bearing liabilities		17,735						26,462
Total liabilities		1,775,625						1,588,032
Stockholders’ equity		230,748						183,769
Total liabilities and stock- holders’ equity	$	2,006,373					$	1,771,801
Net interest income; interest rate spread			$	32,768	3.36	%			$	30,257	3.53	%
Net interest margin (3)					3.66	%					3.84	%
Average interest-earning assets to average interest-bearing liabilities					114	%					112	%

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

(2) Annualized

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

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Results of Operations

Three Months Ended June 30, 2009 and 2008

On a consolidated basis, First Defiance’s net income for the quarter ended June 30, 2009 was $2.90 million compared to income of $2.74 million for the comparable period in 2008. Net income applicable to common shares was $2.39 million for the second quarter of 2009. On a per share basis, basic and diluted earnings per common share for the three months ended June 30, 2009 were both $0.29, compared to basic and diluted earnings per common share of $0.34 for the quarter ended June 30, 2008.

Net Interest Income.

The Company’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 is the Company’s largest source of revenue, representing 65.9% of total revenue during the second quarter of 2009. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The federal funds rate, which is the cost of immediately overnight funds and established by the Federal Reserve Board’s Open Market Committee, began 2008 at 4.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 0.25%. During the second quarter of 2009, the federal funds rate did not change ending the quarter at 0.25%. The federal funds rate drives the Company’s prime rate, which is used to price a substantial balance of loans in the commercial and home equity portfolios. The prime interest rate began 2008 at 7.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 3.25%. During the second quarter of 2009, the prime interest rate did not change ending the quarter at 3.25%. First Defiance effectively managed the impact of the change in the prime rate by reducing its deposit rates and by changing the mix of its interest-bearing liabilities.

Net interest income was $16.2 million for the second quarter of 2009 compared to $16.2 million in the second quarter of 2008. For the second quarter of 2009, total interest income was $24.8 million, a $1.4 million decrease from the second quarter of 2008. The decline in total interest income is the result of the decline in loan yields from period to period.

Interest expense was $8.6 million for the second quarter of 2009 compared to $10.0 million in the second quarter of 2008. The majority of the decrease in interest expense occurred in interest-bearing deposits, where despite average balances increasing $125.2 million to $1.38 billion for the second quarter of 2009, the cost of that funding decreased 0.42% between the 2008 and 2009 second quarters, to 2.00% from 2.42%.

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Net interest margin for the quarter ended June 30, 2009 was 3.61%, a 0.30% decline from the 2008 second quarter margin of 3.91%. The Company’s interest rate spread declined as well to 3.34% in the 2009 second quarter compared to 3.62% in the same 2008 quarterly period. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. In this low rate environment, management’s attention will be to focus on a disciplined pricing strategy to strengthen the net interest margin for the remainder of 2009.

Provision for Loan Losses.

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable credit losses within the existing loan portfolio. The provision for loan losses was $4.0 million in the second quarter of 2009 compared to $2.8 million for the second quarter of 2008. The period over period increase was primarily due to the deterioration of a number of large credits in the commercial portfolio as well as increases in reserves on loans with existing reserves based on declining collateral values. Charge-offs for the second quarter of 2009 were $3.9 million and recoveries of previously charged off loans totaled $86,000 for net charge-offs of $3.8 million. By comparison, $894,000 of charge-offs were recorded in the 2008 second quarter and $81,000 of recoveries were realized for net charge-offs of $813,000. As a percentage of average loans, annualized net charge-offs were 0.96% for the second quarter of 2009 compared to 0.21% in the same period in 2008.

Non-performing assets, which include non-accrual loans, accruing restructured loans and real estate owned, increased to $48.9 million at June 30, 2009 from $20.9 million at June 30, 2008 and from $41.3 million at December 31, 2008. Non-performing assets and asset quality ratios for First Defiance were as follows at June 30, 2009 and December 31, 2008:

	June 30, 2009			December 31, 2008
	(in thousands)
Non-accrual loans	$	35,528		$	28,017
Restructured loans, accruing		4,845			6,250
Total non-performing loans	$	40,373		$	34,267
Real estate owned (REO)		8,567			7,000
Total non-performing assets	$	48,940		$	41,267
Allowance for loans losses as a percentage of total loans		1.60	%		1.52	%
Allowance for loan losses as a percentage of non-performing assets		52.80	%		59.59	%
Allowance for loan losses as a percentage of non-performing loans		64.00	%		71.77	%
Total non-performing assets as a percentage of total assets		2.42	%		2.11	%
Total non-performing loans as a percentage of total loans		2.47	%		2.10	%

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Of the $35.5 million in non-accrual loans, $5.5 million were 1-4 family residential loans, $29.3 million were commercial or commercial real estate loans and $0.7 million were home equity or consumer loans.

First Federal Bank’s Asset Review Committee meets monthly to review the status of work-out strategies for all criticized relationships, which include all non-accrual loans. Based on such factors as anticipated collateral values in liquidation scenarios, cash flow projections, assessment of net worth of guarantors and all other factors which may mitigate risk of loss, the Asset Review Committee makes recommendations regarding required allowances and proposed charge-offs which are approved by the Senior Loan Committee (in the case of charge-offs) or the Loan Loss Reserve Committee (in the case of specific allowances). At June 30, 2009 the specific allowance for loan losses recorded against the $29.3 million of non-accrual commercial and commercial real estate loans totaled $6.1 million. In management’s opinion, the allowance for loan losses is appropriate. The allowance for loan losses at June 30, 2009 was $25.8 million compared to $24.6 million at December 31, 2008.

Non-Interest Income.

Total non-interest income increased to $8.4 million in the second quarter of 2009, compared with $6.2 million in the same period in 2008.

Service Fees.Service fees and other charges decreased by $91,000 or 2.7% in the 2009 second quarter compared to the same period in 2008. The decrease can be attributed to customers retaining more cash reserves in their checking and saving accounts resulting in less NSF fees transactions.

First Defiance’s overdraft privilege program generally provides for the automatic payment of modest overdraft limits on all accounts deemed to be in good standing when the account is accessed using paper-based check processing, a teller withdrawal, a point-of-sale terminal, an ACH transaction, or an ATM. To be in good standing, an account must be brought to a positive balance within a 30-day period. Overdraft limits are established for all customers without discrimination using a risk assessment approach for each account classification. The approach includes a systematic review and evaluation of the normal deposit flows made to each account classification to establish reasonable and prudent negative balance limits that would be routinely repaid by normal, expected and reoccurring deposits. The risk assessment by portfolio approach assumes a minimal degree of undetermined credit risk associated with unidentified individual accounts that are overdrawn for 30 or more days. Accounts overdrawn for more than 60 days are automatically charged off. Fees are charged as a one-time fee per occurrence and the fee charged for an item that is paid is equal to the fee charged for a non-sufficient fund item that is returned.

Overdrawn balances, net of allowance for losses, are reflected as loans on First Defiance’s balance sheet. The fees charged for this service are established based both on the return of processing costs plus a profit, and on the level of fees charged by competitors in the Company’s market area for similar services. These fees are considered to be compensation for providing a service to the customer and therefore are deemed to be non-interest income rather than interest income. Fee income related to the overdraft privilege product, net of adjustments to the allowance for uncollectible overdrafts, was $2.1 million for the quarter ended June 30, 2009 compared to $2.2 million for the same period of 2008.

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Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans increased $2.5 million to $4.0 million for the second quarter of 2009 compared to $1.5 million for the same period of 2008. Gains realized from the sale of mortgage loans nearly tripled in the second quarter of 2009 to $2.9 million from $1.0 million in the second quarter of 2008. Mortgage loan servicing revenue remained relatively flat in the second quarter of 2009 compared to the second quarter of 2008. The increases in gains and servicing revenue were somewhat offset by expense increases of $765,000 for the amortization of mortgage servicing rights due to the higher refinance activity during the second quarter of 2009. The Company had a positive valuation adjustment of $1.5 million in the second quarter of 2009 compared to $167,000 in the second quarter of 2008. The mortgage servicing rights valuation is a reflection of the increase in the fair value of certain sectors of the Company’s portfolio of mortgage servicing rights.

Loss on Sale or Write-Down of Securities. Non-interest income also includes investment securities gains or losses. In the second quarter of 2009, First Defiance recognized other-than-temporary impairment (“OTTI”) charges of $875,000 for certain impaired investment securities, where in management’s opinion, the value of the investment will not be recovered. The OTTI charge related to four Trust Preferred Collateralized Debt Obligation (“CDOs”) investments with a remaining book value of $2.3 million. In the second quarter of 2008, management recorded a $432,000 OTTI charge on its investment in the equity notes of two CDOs that have since been fully written off. OTTI was determined as a result of additional defaults and deferrals during the period from credit deterioration of the underlying collateral. In the second quarter of 2009, four available for sale securities were sold for a gain of $125,000 compared to no security sales in the same period of 2008.

Non-Interest Expense.

Non-interest expense increased to $16.1 million for the second quarter of 2009 compared to $15.5 million for the same period in 2008. The 2008 second quarter amount includes $262,000 of non-recurring acquisition related charges associated with the March 14, 2008 acquisition of Pavilion Bancorp.

Compensation and Benefits. Compensation and benefits increased to $7.6 million for the quarter ended June 30, 2009 from $7.3 million for the same period in 2008. The increase is mainly attributable to an increase in medical costs.

FDIC insurance premium. FDIC insurance expense increased to $1.5 million in the second quarter of 2009 from $431,000 in the same period of 2008. This was the result of the FDIC rate increase in 2009, higher insured deposits, and a special FDIC assessment of $904,000.

Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles and other) decreased by $433,000 to $5.1 million for the quarter ended June 30, 2009 from $5.6 million for the same period in 2008. The second quarter of 2008 includes $752,000 of expense associated with losses related to a former investment advisor. Increases between the 2009 and 2008 second quarters include an increase in credit, collection and OREO expenses of $574,000 for other real estate owned and repossessed assets. These costs were partially offset by a decrease in office supply expense (down $16,000) and postage (down $98,000) as a direct result of management’s cost control initiative.

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The efficiency ratio for the second quarter of 2009 was 63.06% compared to 67.33% for the second quarter of 2008. Excluding the impact of the acquisition related costs, the efficiency ratio for the 2008 second quarter was 66.19%.

Income Taxes.

First Defiance computes federal income tax expense in accordance with FASB Statement No. 109, which resulted in an effective tax rate of 34.66% for the quarter ended June 30, 2009 compared to 33.03% for the same period in 2008.

Six Months Ended June 30, 2009 and 2008

On a consolidated basis, First Defiance recognized net income for the six months ended June 30, 2009 of $6.3 million compared to income of $6.2 million for the comparable period in 2008. Net income applicable to common shares was $5.3 million for the six months ended June 30, 2009. On a per share basis, basic and diluted earnings per common share for the six months ended June 30, 2009 were both $0.65, compared to basic and diluted earnings per common share of $0.80 for the six months ended June 30, 2008.

Net Interest Income.

Net interest income was $32.2 million for the six months ended June 30, 2009 compared to $29.8 million for the same period in 2008. For the six month period ended June 30, 2009, total interest income was $49.9 million, a $932,000 decrease from the same period in 2008. Despite average earning assets increasing $222.5 million in the first six months of 2009, the average yield declined 91 basis points as a result of a lower rate environment. The amount of interest income recognized was also affected in the first six months of 2009 by an increase in the balance of loans that were delinquent by more than 90 days. It is the Company’s policy to reverse interest accrued on loans when they become 90 days past due. As a result of the increase in these non-performing loans, interest income was reduced by $1.2 million in the first six months of 2009 compared to $732,000 for the same period in 2008.

Interest expense decreased by $3.3 million to $17.7 million for the six months ended June 30, 2009 compared to $21.0 million in the first half of 2008. While the average balance of interest-bearing liabilities increased by $173.6 million between the first halves of 2008 and 2009, the expense associated with the higher balance was more than offset by a decline in the average cost of interest-bearing deposits for the six months ending June 30, 2009, to 2.08%, a 68 basis point decrease from the 2.76% average cost in the first half of 2008.

Provision for Loan Losses.

The provision for loan losses was $6.7 million for the six months ended June 30, 2009, compared to $3.9 million during the six months ended June 30, 2008. The year over year increase was primarily the result of the deterioration of a number of large credits in the commercial loan portfolio along with a decline in the overall economy in the Company’s primary

45

market area, and the resulting increase in loan delinquencies. Charge-offs for the first half of 2009 were $5.7 million and recoveries of previously charged off loans totaled $214,000 for net charge-offs of $5.5 million. By comparison, $1.5 million of charge-offs were recorded in the same period of 2008 and $210,000 of recoveries were realized for net charge-offs of $1.3 million.

Non-Interest Income.

Total non-interest income increased to $15.2 million for the six months ended June 30, 2009 from $12.2 million recognized in the same period of 2008.

Service Fees.Service fees and other charges increased by $373,000 or 6.2% in the six months ended June 30, 2009 compared to the same period in 2008. The increase was primarily related to an overall increase in the number of accounts serviced following the Pavilion acquisition in the first quarter of 2008.

Mortgage Banking Activity. Total revenue from the sale and servicing of mortgage loans increased 156.0% to $6.7 million for the six months ended June 30, 2009 from $2.6 million for the same period of 2008. Gains realized from the sale of mortgage loans increased $3.5 million to $5.7 million for the first half of 2009 from $2.2 million during the same period of 2008. Mortgage loan servicing revenue increased $236,000 in the first half of 2009 compared to the same period of 2008. These increases were offset by a $1.4 million increase in the amortization of mortgage servicing rights in the first half of 2009 when compared to 2008. The Company had a positive valuation adjustment of $1.7 million in the first half of 2009 compared to $24,000 in the first half of 2008. The mortgage servicing rights valuation is a reflection of the increase in the fair value of certain sectors of the Company’s portfolio of mortgage servicing rights.

Insurance and Investment Sales Commission.Insurance and investment sales commission income decreased $386,000, to $2.8 million for the six months ended June 30, 2009, from $3.2 million during the same period of 2008. This is the result of receiving less contingent commission income in the first half of 2009 compared to the first half of 2008. In 2009, $432,000 was received compared to $784,000 in 2008.

Loss on Securities.Non-interest income was reduced in the first half of 2009 by $1.4 million as First Defiance recognized $1.5 million of other-than-temporary impairment charges for certain impaired investment securities partially offset by the gain on sale of $125,000 from available for sale securities. In the first half of 2008, $532,000 of other-than-temporary impairment charges were recorded on impaired investments partially offset by the $19,000 gain recorded from the call or maturity of securities.

Other Non-Interest Income. Other sources of non-interest income include gains from the sale of non-mortgage loans, trust income, earnings from bank-owned life insurance (“BOLI”) and other. In total, these categories declined by $161,000 in the first half of 2009 compared to 2008. The value of the life insurance assets used to fund the plan increased by $65,000 in the first half of 2009 and declined by $163,000 in the first half of 2008 resulting in a net increase in non-interest income related to this item of $228,000. This was offset by a related change in the deferred compensation liability, which is included in other non-interest expense. Also, earnings from the Company’s BOLI declined in the first half of 2009 due to a lower crediting rate on the Company’s investment.

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Non-Interest Expense.

Non-interest expense increased to $31.1 million for the first six months of 2009 compared to $29.0 million for the same period in 2008. The year-to-date 2008 amount includes $1.0 million of non-recurring costs associated with the Pavilion acquisition. These costs included termination fees of certain contracts, costs to grant prior service credit to former Pavilion employees in the Company’s retiree medical plan and other non-recurring costs associated with the completion of the acquisition and the transition of operations. Also in the first six months of 2008, $752,000 of loss was recognized related to a former investment advisor.

Compensation and Benefits. Compensation and benefits increased to $15.0 million for the first six months ended June 30, 2009 from $14.4 million for the same period in 2008. A significant part of this increase relates to the ongoing costs of operating the eight branches acquired in the Pavilion acquisition for a full period in 2009. Compensation also increased because of year-over-year annual pay increases.

Occupancy. Occupancy costs increased $428,000 in the first six months of 2009. The Pavilion acquisition increased expense by $337,000. This increase can be attributable to operating costs of a full period of the Pavilion branches.

FDIC insurance premium. FDIC insurance expense increased to $2.1 million in the first half of 2009 from $465,000 in the same period of 2008. This was the result of the FDIC rate increase in 2009, higher insured deposits, a special FDIC assessment of $904,000, and full utilization early in 2008 first quarter of credits issued by the FDIC.

Other Non-Interest Expenses. Other non-interest expenses (including state franchise tax, data processing, amortization of intangibles and other) increased by $614,000 to $10.1 million for the first six months of 2009 from $9.5 million for the same period in 2008. Significant increases between the first six months of 2009 and 2008 include an increase in the amortization of intangibles of $135,000 due to recording the core deposit and customer relationship intangible in conjunction with the Pavilion acquisition and an increase in credit, collection and OREO expenses of $1.1 million for other real estate owned and repossessed assets. These costs were partially offset by a decrease in office supply expense (down $40,000) and postage (down $153,000) as a direct result of management’s cost control initiative. Included in the 2008 results was $752,000 related to losses associated with the former investment advisor which were not covered by First Defiance’s fidelity bond.

The efficiency ratio for the first half of 2009 was 63.07% compared to 67.52% for the same period of 2008. Excluding the impact of the acquisition related costs, the efficiency ratio for the first six months of 2008 was 65.17%.

Liquidity

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

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First Defiance had $117 of cash provided by operating activities during the first six months of 2009. The Company’s cash used in operating activities resulted from the origination of loans held for sale mostly offset by the proceeds on the sale of loans.

At June 30, 2009, First Defiance had $129.8 million in outstanding loan commitments and loans in process to be funded generally within the next six months and an additional $266.4 million committed under existing consumer and commercial lines of credit and standby letters of credit. Also at that date, First Defiance had commitments to sell $40.8 million of loans held-for-sale. Also, the total amount of certificates of deposit that are scheduled to mature by June 30, 2010 is $400.2 million. First Defiance believes that it has adequate resources to fund commitments as they arise and that it can adjust the rate on savings certificates to retain deposits in changing interest rate environments. If First Defiance requires funds beyond its internal funding capabilities, advances from the FHLB of Cincinnati and other financial institutions are available.

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

ALCO uses an economic value of equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of First Federal’s assets and liabilities in rate shock environments that range from -300 basis points to +300 basis points. The likelihood of a decrease in rates as of June 30, 2009 was considered to be remote given the current interest rate environment and therefore, was not included in this analysis. The results of this analysis are reflected in the following tables for the six months ended June 30, 2009 and the year-ended December 31, 2008.

June 30, 2009 Economic Value of Equity
Change in Rates	$ Amount	$ Change		% Change
	(Dollars in Thousands)
+ 300 bp	246,825	(19,032	)	(7.16	)%
+ 200 bp	254,825	(11,032	)	(4.15	)%
+ 100 bp	262,195	(3,662	)	(1.38	)%
0 bp	265,857	—		—
December 31, 2008 Economic Value of Equity
Change in Rates	$ Amount	$ Change		% Change
	(Dollars in Thousands)
+ 300 bp	250,485	(29,300	)	(10.47	)%
+ 200 bp	261,652	(18,133	)	(6.48	)%
+ 100 bp	271,860	(7,925	)	(2.83	)%
0 bp	279,785	—		—

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Capital Resources

First Federal is required to maintain specified amounts of capital pursuant to regulations promulgated by the OTS. The capital standards generally require the maintenance of regulatory capital sufficient to meet a tangible capital requirement, a core capital requirement, and a risk-based capital requirement. The following table sets forth First Federal’s compliance with each of the capital requirements at June 30, 2009.

	Core Capital						Risk-Based Capital
	Adequately Capitalized			Well Capitalized			Adequately Capitalized			Well Capitalized
Regulatory capital	$	206,058		$	206,058		$	226,835		$	226,835
Minimum required regulatory capital		78,543			98,179			143,235			179,044
Excess regulatory capital	$	127,515		$	107,879		$	83,600		$	47,791
Regulatory capital as a percentage of assets (1)		10.49	%		10.49	%		12.67	%		12.67	%
Minimum capital required as a percentage of assets		4.00	%		5.00	%		8.00	%		10.00	%
Excess regulatory capital as a percentage of assets		6.49	%		5.49	%		4.67	%		2.67	%

(1) Core capital is computed as a percentage of adjusted total assets of $1.96 billion. Risk-based capital is computed as a percentage of total risk-weighted assets of $1.79 billion.

Critical Accounting Policies

First Defiance has established various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of its financial statements. The significant accounting policies of First Defiance are described in the footnotes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. Those policies which are identified and discussed in detail in the Company’s Annual Report on Form 10-K include the Allowance for Loan Losses, Valuation of Securities, and the Valuation of Mortgage Servicing Rights. There have been no material changes in assumptions or judgments relative to those critical policies during the first six months of 2009.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

As discussed in detail in the 2008 Annual Report on Form 10-K, First Defiance’s ability to maximize net income is dependent on management’s ability to plan and control net interest income through management of the pricing and mix of assets and liabilities. Because a large portion of assets and liabilities of First Defiance are monetary in nature, changes in interest rates and monetary or fiscal policy affect its financial condition and can have significant impact on the net income of the Company. First Defiance does not use off-balance sheet derivatives to enhance its risk management, nor does it engage in trading activities beyond the sale of mortgage loans.

First Defiance monitors its exposure to interest rate risk on a monthly basis through simulation analysis which measures the impact changes in interest rates can have on net income. The simulation technique analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with management’s estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity deposit assumptions and capital requirements. The results of the simulation indicate that in an environment where interest rates rise or fall 100 basis points over a 12 month period, using June 30, 2009 amounts as a base case, First Defiance’s net interest income would be impacted by less than the board mandated guidelines of 10%.

Item 4. Controls and Procedures

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

An evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of June 30, 2009. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective. No changes occurred in the Company’s internal controls over financial reporting during the quarter ended June 30, 2009 that materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting.

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FIRST DEFIANCE FINANCIAL CORP.

PART II-OTHER INFORMATION

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

There were no material changes to the risk factors as presented in First Defiance Financial Corp.’s annual report on Form 10-K for the year ended December 31, 2008.

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

First Defiance did not have any common stock repurchases during the second quarter of 2009, but has 93,124 shares that may be purchased under a plan announced by the Board of Directors on July 18, 2003. Participation in the Capital Purchase Program prohibits the Company from repurchasing any of its common shares without the prior approval of the U.S. Treasury until the earlier of December 5, 2011 or the date the U.S. Treasury’s preferred stock is redeemed or transferred to an unaffiliated third party.

Item 3. Defaults upon Senior Securities

Not applicable.

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Item 4. Submission of Matters to a Vote of Security Holders

At the annual meeting of shareholders held on April 21, 2009, in Defiance, Ohio the shareholders elected three directors to three-year terms. The following are tabulations of all votes timely cast in person or by proxy by shareholders of First Defiance for the annual meeting:

I. Nominees for Director with Three-year Terms Expiring in 2012:

NOMINEE	FOR	WITHHELD
Douglas A. Burgei	5,643,099	285,972
Dwain I. Metzger	5,291,116	637,955
Samuel S. Strausbaugh	5,381,633	547,438

Item 5. Other Information

Not applicable.

Item 6. Exhibits

Exhibit 31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
Exhibit 31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
Exhibit 32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
Exhibit 32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act

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FIRST DEFIANCE FINANCIAL CORP.

SIGNATURES

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

	First Defiance Financial Corp. (Registrant)
Date: August 10, 2009	By:	/s/ William J. Small
		William J. Small
		Chairman, President and Chief Executive Officer
Date: August 10, 2009	By:	/s/ Donald P. Hileman
		Donald P. Hileman
		Executive Vice President and Chief Financial Officer

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