fdef-10q_20200331.htm

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐

As of June 5, 2020, the registrant had 37,285,731 shares of common stock, $.01 par value per share, outstanding.

In accordance with the Securities and Exchange Commission Order Under Section 36 of the Securities Exchange Act of 1934 Modifying Exemptions from the Reporting and Proxy Delivery Requirements for Public Companies, SEC Release No. 34-88465, dated March 25, 2020 (the “Order”), First Defiance relied on the relief provided by the Order to delay the filing of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 (the “First Quarter Form 10-Q”) by up to 45 days. We experienced significant disruptions to our business and operations as a result of the COVID-19 pandemic. In particular, we have a majority of our employees working remotely, including most of our finance staff. In addition, we rely on several third parties to perform analyses related to the preparation of our financial statements, and those third parties have also experienced disruptions to their operations due to COVID-19. Accordingly, we relied on the Order to postpone the filing of our First Quarter Form 10-Q to provide us with additional time to develop and process our financial information as well as prepare additional required disclosures related to COVID -19.

Pursuant to the requirements of the Order, we filed a Form 8-K with the Commission on April 29, 2020, indicating our intention to rely upon the Order with respect to the filing of this Form 10-Q. This Form 10-Q is being filed within the 45-day extension period provided by the Order.

	Three Months Ended March 31,
	2020			2019
Interest Income
Loans	$	51,460		$	31,214
Investment securities:
Taxable		1,834			1,365
Non-taxable		883			840
Interest-bearing deposits		230			285
FHLB stock dividends		115			215
Total interest income		54,522			33,919
Interest Expense
Deposits		7,771			5,005
FHLB advances and other		1,006			276
Subordinated debentures		273			364
Notes payable		9			4
Total interest expense		9,059			5,649
Net interest income		45,463			28,270
Credit loss expense		43,786			212
Net interest income after credit loss expense		1,677			28,058
Non-interest Income
Service fees and other charges		5,183			3,007
Insurance commissions		5,155			4,115
Mortgage banking income		848			1,841
Gain on sale of non-mortgage loans		234			89
Trust income		838			523
Income from Bank Owned Life Insurance		781			392
Other non-interest income		960			846
Total non-interest income		13,999			10,813
Non-interest Expense
Compensation and benefits		17,585			14,085
Occupancy		3,731			2,241
FDIC insurance premium		492			273
Financial institutions tax		834			556
Data processing		3,040			2,297
Acquisition related charges		11,486			—
Amortization of intangibles		1,245			299
Other non-interest expense		5,355			5,115
Total non-interest expense		43,768			24,866
Income before income taxes		(28,092	)		14,005
Federal income taxes		(5,610	)		2,523
Net (loss) income	$	(22,482	)	$	11,482
(Loss) earnings per common share
Basic	$	(0.71	)	$	0.57
Diluted	$	(0.71	)	$	0.57

	Preferred Stock		Common Stock Shares			Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Income		Retained Earnings			Treasury Stock			Total Stockholders Equity
Balance at January 1, 2020	$	—		19,729,886		$	127	$	161,955		$	4,595	$	329,175		$	(69,685	)	$	426,167
Net (loss)														(22,482	)					(22,482	)
Other comprehensive income												7,473								7,473
Adoption of ASC 326														(2,566	)					(2,566	)
Deferred compensation plan				7,524					(94	)							94			—
Stock based compensation expenses									1,230								6			1,236
Capital stock issuance				17,927,017			179		526,696											526,875
Vesting of incentive plans				39,548					(1,989	)							493			(1,496	)
Restricted share issuance				13,349					198					(374	)		176			—
Restricted share forfeitures				(750	)															—
Shares issued from direct stock sales																				—
Shares repurchased				(430,000	)												(10,078	)		(10,078	)
Common stock dividends declared ($0.22 per share)														(8,286	)					(8,286	)
Balance at March 31, 2020	$	—		37,286,574		$	306	$	687,996		$	12,068	$	295,467		$	(78,994	)	$	916,843

	Preferred Stock		Common Stock Shares			Common Stock		Additional Paid-In Capital			Accumulated Other Comprehensive Income			Retained Earnings			Treasury Stock			Total Stockholders Equity
Balance at January 1, 2019	$	—		20,171,392		$	127	$	161,593		$	(2,148	)	$	295,588		$	(55,571	)	$	399,589
Net income															11,482						11,482
Other comprehensive income												3,717									3,717
Deferred compensation plan									(22	)								42			20
Stock based compensation expenses									11												11
Shares issued under stock option plan, net of 178 repurchased and retired				17,822					(22	)					(5	)		212			185
Restricted share activity under stock incentive plans net of 25,195 repurchased and retired				38,890					(751	)								440			(311	)
Shares issued from direct stock sales				1,065					19									12			31
Shares repurchased				(515,977	)													(15,147	)		(15,147	)
Common stock dividends declared ($0.19 per share)															(3,788	)					(3,788	)
Balance at March 31, 2019	$	—	$	19,713,192		$	127	$	160,828		$	1,569		$	303,277		$	(70,012	)	$	395,789

	Three Months Ended March 31,
	2020			2019
Operating Activities
Net (loss) income	$	(22,482	)	$	11,482
Items not requiring (providing) cash:
Provision for credit losses		43,786			212
Depreciation		1,631			1,031
Amortization of mortgage servicing rights, net of impairment charges/recoveries		5,648			399
Amortization of core deposit and other intangible assets		1,245			299
Net accretion of premiums and discounts on loans and deposits		(1,745	)		(155	)
Amortization of premiums and discounts on securities		633			285
Change in deferred taxes		77			155
Proceeds from the sale of loans held for sale		101,090			38,910
Originations of loans held for sale		(110,026	)		(37,513	)
Gain from sale of loans		(5,136	)		(1,390	)
Loss on sale or write down of property plant and equipment		0			10
Gain/loss on sale / write-down of real estate and other assets held for sale		10			249
Stock option expense		1,236			11
Restricted stock vesting		(1,496	)		(311	)
Income from bank owned life insurance		(781	)		(392	)
Excess tax benefit on stock compensation plans		—			(105	)
Changes in:
Accrued interest receivable		(438	)		(1,539	)
Other assets		(2,416	)		(3,609	)
Other liabilities		2,525			1,662
Net cash provided by operating activities		13,361			9,691

Investing Activities
Proceeds from maturities, calls and pay-downs of available-for-sale securities		19,389			6,673
Proceeds from sale of premises and equipment, real estate and other assets held for sale		481			161
Proceeds from sale of non-mortgage loans		3,241			1,749
Purchases of available-for-sale securities		—			(8,172	)
Purchases of Federal Home Loan stock		(64,584	)		—
Proceeds from Federal Home Loan stock redemption		—			1,982
Net cash from acquisition (Reference Footnote 18 Business Combinations)		52,448			—
Purchases of premises and equipment, net		(722	)		(793	)
Net increase in loans receivable		(44,623	)		(10,959	)
Net cash used by investing activities		(34,370	)		(9,359	)
Financing Activities
Net increase in deposits and advance payments by borrowers		34,437			64,201
Net Proceeds from (repayment of) Federal Home Loan Bank advances		19,937			(30,031	)
Decrease in securities sold under repurchase agreements		(1,038	)		(2,228	)
Net cash paid for repurchase of common stock		(10,078	)		(15,147	)
Proceeds from exercise of stock options		—			185
Proceeds from direct stock sales		—			31
Cash dividends paid on common stock		(8,286	)		(3,788	)
Net cash provided by financing activities		34,972			13,223
Increase in cash and cash equivalents		13,963			13,555
Cash and cash equivalents at beginning of period		131,254			98,962
Cash and cash equivalents at end of period	$	145,217		$	112,517
Supplemental cash flow information:
Interest paid	$	9,028		$	5,593
Income taxes paid	$	—		$	—
Initial recognition of right-of-use asset	$	8,994		$	8,808
Initial recognition of lease liability	$	9,143		$	9,339
Initial recognition of ASC 326	$	2,566		$	—
Transfers from loans to real estate and other assets held for sale	$	37		$	146

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

On January 31, 2020, First Defiance completed its previously announced acquisition of United Community Financial Corp., an Ohio corporation (“UCFC”), pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), dated as of September 9, 2019, by and between First Defiance and UCFC. At the effective time of the merger (the “Merger”), UCFC merged with and into First Defiance, with First Defiance surviving the Merger. Simultaneously with the completion of the Merger, First Defiance converted from a unitary thrift holding company to a bank holding company, making an election to be a financial holding company.

Immediately following the Merger, First Federal, acquired UCFC’s wholly owned bank subsidiary, Home Savings Bank (“Home Savings”). Immediately prior to the merger of the banks, First Federal converted from a federal thrift into an Ohio state-chartered bank. In addition, immediately following the merger of the banks, UCFC’s wholly-owned insurance subsidiaries, HSB Insurance, LLC and United American Financial Services, Inc., each merged into First Insurance, with First Insurance surviving the mergers. First Defiance acquired two additional subsidiaries in the Merger, HSB Capital, LLC and HSB Insurance, Inc.

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

HSB Capital was formed as an Ohio limited liability company by UCFC during 2016 for the purpose of providing mezzanine funding for customers of Home Savings. Mezzanine loans are offered by HSB Capital to customers in the Company’s market area and are expected to be repaid from the cash flow from operations of the business.

First Insurance is an insurance agency that conducts business throughout First Federal’s markets. The Maumee and Oregon, Ohio, offices were consolidated into a new office in Sylvania, Ohio, in January 2018. First Insurance offers property and casualty insurance, life insurance and group health insurance.

First Defiance Risk Management is a wholly-owned insurance company subsidiary of the Company that insures the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace.

First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to help minimize the risk allocable to each participating insurer.

HSB Insurance, Inc. was formed on June 1, 2017 as a Delaware-based captive insurance company that insures against certain risks that are unique to the operations of the Company and its subsidiaries and for which insurance may not be currently available or economically feasible; by pooling resources with several other insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. HSB Insurance, Inc. is subject to regulations of the State of Delaware and undergoes periodic examinations by the Delaware Division of Insurance.

The consolidated condensed statement of financial condition at December 31, 2019, has been derived from the audited financial statements at that date, which were included in First Defiance’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”).

The accompanying consolidated condensed financial statements as of March 31, 2020, and for the three month periods ended March 31, 2020 and 2019 have been prepared by the Company 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 (“GAAP”). These consolidated condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the 2019 Form 10-K. 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 month period ended March 31, 2020, are not necessarily indicative of the results that may be expected for the entire year.

ASU 2018-13 - Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement: In August 2018, the FASB issued ASU 2018-13 - Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements in Topic 820, Fair Value Measurement by removing, modifying and adding certain requirements. The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of this ASU. An entity is permitted to early adopt and remove or modify disclosures upon issuance of the ASU and delay adoption of the additional disclosures until their effective date. The adoption of this guidance on January 1, 2020 did not have a material impact on the Company’s consolidated financial statements.

ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment: Issued in January 2017, ASU 2017-04 simplifies the manner in which an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill. In computing the implied fair value of goodwill under Step 2, an entity, prior to the amendments in ASU 2017-04, had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities, including unrecognized assets and liabilities, in accordance with the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. However, under the amendments in ASU 2017-04, an entity should (1) perform its annual or interim goodwill

impairment test by comparing the fair value of a reporting unit with its carrying amount, and (2) recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value, with the understanding that the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, ASU 2017-04 removes the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails such qualitative test, to perform Step 2 of the goodwill impairment test. ASU 2017-04 became effective for the Company on January 1, 2020, and the amendments of this ASU will be applicable to the goodwill impairment testing for 2020.

ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments: Issued in June 2016, ASU 2016-13 will add FASB ASC Topic 326, “Financial Instruments-Credit Losses” and finalizes amendments to FASB ASC Subtopic 825-15, “Financial Instruments-Credit Losses.” The amendments of ASU 2016-13 are intended to provide financial statement users with more decision-useful information related to expected credit losses on financial instruments and other commitments to extend credit by replacing the current incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to determine credit loss estimates. The amendments of ASU 2016-13 eliminate the probable initial recognition threshold and, in turn, reflect an entity’s current estimate of all expected credit losses. ASU 2016-13 does not specify the method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. The amendments of ASU 2016-13, and all subsequent ASUs issued by FASB to provide additional guidance and clarification related to this Topic, became effective for the Company on January 1, 2020.

As a result of adopting the amendments of ASU 2016-13, the Company recorded an increase to its allowance for credit losses of $2.4 million and an increase to its allowance for credit losses on off-balance sheet credit exposures of $0.9 million resulting in a one-time cumulative effect adjustment through retained earnings of $2.6 million net of $.7 million tax at the date of adoption. Future changes in the allowance for credit losses on off-balance sheet credit exposures will be recorded in other liabilities. This adjustment included a qualitative adjustment to the allowance for credit losses related to loans and an allowance on off-balance sheet credit exposures. The Company estimates losses over an approximate one-year forecast period using Moody’s baseline economic forecasts, and then reverts to longer term historical loss experience over a three-year period.

ASU No. 2020-04: Reference Rate Reform – Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Topic 848): This guidance provides temporary options to ease the potential burden in accounting for reference rate reform. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective as of March 12, 2020 through December 31, 2022. The Company anticipates being fully prepared to implement a replacement for the reference rate and has determined that any change will not have a material impact to the consolidated financial statements.

FASB ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value

of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

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

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

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

Loans held for sale, carried at fair value – The Company elected the fair value option for all conventional residential one-to four-family loans held for sale and all permanent construction loans held for sale that were acquired from UCFC in the merger. In addition, the Company has elected the fair value option for all loans held for sale originated after January 31, 2020.

The fair value of conventional loans held for sale is determined using the current 15 day forward contract price for either 15 or year conventional mortgages and the 60 day forward contract price for either 15

or 30 year Federal Housing Authority mortgages (Level 2). The fair value of permanent construction loans held for sale is determined using the current 60 day forward contract price for 15 or 30 years conventional mortgages which is then adjusted for unobservable market data such as estimated fall out rates and estimated time from origination to completion of construction (Level 3).

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

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

Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, a member of the Company’s asset quality or collections department reviews the assumptions and approaches utilized in the appraisal. Appraisal values are discounted from 0% to 30% to account for other factors that may impact the value of collateral. In determining the value of impaired collateral dependent loans and other real estate owned, significant unobservable inputs may be used, which include but are not limited to: physical condition of comparable properties sold, net operating income generated by the property and investor rates of return.

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

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

Purchased and written certificate of deposit option – The Company acquired purchased and written certificate of deposit options in its merger with UCFC. These written and purchased options are mirror

derivative instruments which are carried at fair value on the statement of financial condition. The Company uses an independent third party that performs a market valuation analysis for purchased and written certificate of deposit options. (Level 2)

Interest rate swaps – The Company periodically enters into interest rate swap agreements with its commercial customers who desire a fixed rate loan term that is longer than the Company is willing to extend. The Company then enters into a reciprocal swap agreement with a third party that offsets the interest rate risk from the interest rate swap extended to the customer. The interest rate swaps are derivative instruments which are carried at fair value on the statement of financial condition. The Company uses an independent third party that performs a market valuation analysis for both swap positions. (Level 2)

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

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:

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of March 31, 2020, the significant unobservable inputs used in the fair value measurements were as follows:

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows:

The Company has elected the fair value option for new applications taken post January 31, 2020, and subsequently originated for residential mortgage and permanent construction loans held for sale. These loans are intended for sale and the Company believes that fair value is the best indicator of the resolution of these loans. Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policies. None of these loans are 90 or more days past due nor on nonaccrual status as of March 31, 2020. There were no loans at December 31, 2019, where the fair value option had been elected.

The aggregate fair value of these loans at March 31, 2020 was $58.2 million and they had a contractual balance of $52.6 million for this same period. The $5.6 million difference between these two figures was recorded in gains and losses on the sale of loans held for sale during the quarter ended March 31, 2020.

In accordance with FASB ASC Topic 825, the Fair Value Measurements tables are a comparative condensed consolidated statement of financial condition based on carrying amount and estimated fair values of financial instruments as of March 31, 2020, and December 31, 2019. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of First Defiance.

Much of the information used to arrive at “fair value” is highly subjective and judgmental in nature and therefore the results may not be precise. Subjective factors include, among other things, estimated cash flows, risk characteristics and interest rates, all of which are subject to change. With the exception of investment securities, the Company’s financial instruments are not readily marketable and market prices do not exist. Since negotiated prices for the instruments, 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 and notes payable, as a result of their short-term nature, is considered to be equal to fair value and are classified as Level 1.

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

The Company’s loans were valued on an individual basis, with consideration given to the loans underlying characteristics, including account types, remaining terms (in months), annual interest rates or coupons, interest types, past delinquencies, timing of principal and interest payments, current market rates, loss exposures, and remaining balances. The model utilizes a discounted cash flow approach to estimate the fair value of the loans using assumptions for the coupon rates, remaining maturities, prepayment speeds, projected default probabilities, losses given defaults, and estimates of prevailing discount rates. The discounted cash flow approach models the credit losses directly in the projected cash flows. The model applies various assumptions regarding credit, interest, and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications. The estimated fair value of impaired loans is based on the fair value of the collateral, less estimated cost to sell, or the present value of the loan’s expected future cash flows (discounted at the loan’s effective interest rate). All impaired loans are classified as Level 3 within the valuation hierarchy.

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

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

The fair values of securities sold under repurchase agreements are equal to their carrying amounts resulting in a Level 1 classification. The carrying value of subordinated debentures was considered to be the carrying value as the debt is floating rate and can be prepaid at any time without penalty.

FHLB advances with maturities greater than 90 days are valued based on a discounted cash flow analysis, using interest rates currently being quoted for similar characteristics and maturities resulting in a Level 2 classification. The cost or value of any call or put options is based on the estimated cost to settle the option at March 31, 2020.

First Defiance has established equity based compensation plans for its directors and employees. On February 27, 2018, the Board adopted, and the shareholders approved at the 2018 Annual Shareholders Meeting, the First Defiance Financial Corp. 2018 Equity Incentive Plan (the “2018 Equity Plan”). The 2018 Equity Plan replaced all existing plans, although the Company’s former equity plans remain in existence to the extent there were outstanding grants thereunder at the time the 2018 Equity Plan was approved. In addition, as a result of the Merger, First Defiance assumed certain outstanding stock options granted under UCFC’s Amended and Restated 2007 Long-Term Incentive Plan and UCFC’s 2015 Long Term Incentive Plan (the “UCFC 2015 Plan”). First Defiance also assumed the UCFC 2015 Plan with respect to the available shares under the UCFC 2015 Plan as of the effective date of the Merger, with appropriate adjustments to the number of shares available to reflect the Merger. The stock options assumed from UCFC in the Merger will become exercisable solely to purchase shares of First Defiance, with appropriate adjustments to the number of shares subject to the assumed stock options and the exercise price of such stock options. All awards currently outstanding under prior plans will remain in effect in accordance with their respective terms. Any new awards will be made under the 2018 Equity Plan. The 2018 Equity Plan allows for issuance of up to 900,000 common shares through the award of options, stock grants, restricted stock units (“RSU”), stock appreciation rights or other stock-based awards.

As of March 31, 2020, 57,683 options to acquire First Defiance shares were outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Of this figure, 39,983 are associated with the conversion of all of the outstanding stock options on the books of UCFC into stock options of First Defiance at the same conversion price and ratio applied to UCFC common shares at January 31, 2020. Options granted in prior years vest 20% per year. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

The Company approved a Short-Term Incentive Plan (“STIP”) and a Long-Term Equity Incentive Plan (“LTIP”) for selected members of management.

Under the 2019 and 2020 STIPs, the participants could earn between 10% to 45% of their salary for potential payout based on the achievement of certain corporate performance targets during the calendar year. The final amount of benefits under the STIPs is determined as of December 31 of the same year and paid out in cash in the first quarter of the following year. The participants are required to be employed on the day of payout in order to receive the payment.

Under each LTIP, the participants could earn between 20% to 45% of their salary for potential payout in the form of equity awards based on the achievement of certain corporate performance targets over a three-year period. The Company plans to grant these RSU’s to participants in the second quarter of 2020. The amount of benefit under each LTIP will be determined individually at the end of the 36 month performance period ending December 31. The benefits earned under each LTIP will be paid out in equity in the first quarter following the end of the performance period. The participants are required to be employed on the day of payout in order to receive the payment.

In the three months ended March 31, 2020, the Company also granted 13,349 shares of restricted stock to directors. These shares have a one-year vesting period.

Following is stock option activity under the plans during the three months ended March 31, 2020:

All of the 39,983 options exchanged are associated with the conversion of all of the outstanding stock options on the books of UCFC into stock options of First Defiance.

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

As of March 31, 2020, there was $10,000 of total unrecognized compensation cost related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 0.76 years.

At March 31, 2020, 46,129 RSUs and 60,650 restricted stock grants were unvested. Compensation expense related to RSUs and STIP is recognized over the performance period based on the achievements of targets as established under the plan documents. Total expense of $1.0 million was recorded during the three months ended March 31, 2020, compared to expense of $523,000 for the three months ended March 31, 2019. There was approximately $858,000 and $1.2 million included within other liabilities at March 31, 2020 and December 31, 2019, respectively, related to the STIP.

The maximum amount of compensation expense that may be recorded for the active LTIPs at March 31, 2020, is approximately $2.7 million. However, the estimated expense expected to be recorded as of March 31, 2020, based on the performance measures in the plans, is $2.7 million, of which $2.5 million is unrecognized at March 31, 2020, and will be recognized over the remaining performance periods.

First Defiance declared and paid a $0.22 per common stock dividend in the first quarter of 2020 and declared and paid a $0.19 per common stock dividend in the first quarter of 2019.

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

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

Since net income allocated to common shareholders was negative for the quarter ended March 31, 2020, there is no dilutive effect of stock options included in the diluted (loss) earnings per common share calculation. 3,376 shares subject to issue upon exercise of options of in 2019 were excluded from the diluted earnings per common share calculation as they were anti-dilutive.

As a result of the merger, securities with a fair value of $262.8 million were acquired on January 31, 2020.

The amortized cost and fair value of the investment securities portfolio at March 31, 2020, are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMO”) which are not due at a single maturity date, have not been allocated over the maturity groupings. These securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

Investment securities with a carrying amount of $321.3 million at March 31, 2020, were pledged as collateral on public deposits, securities sold under repurchase agreements and the Federal Reserve discount window.

The following tables summarize First Defiance’s securities that were in an unrealized loss position at March 31, 2020, and December 31, 2019:

There were no sales of securities during the three months ended March 31, 2020 or 2019.

ASU 2016-13 makes targeted improvements to the accounting for credit losses on securities available for sale. The concept of other than-temporarily impaired has been replaced with the allowance for credit losses. Unlike securities held to maturity, securities available for sale are evaluated on an individual level and pooling of securities is not allowed.

Quarterly, the Company evaluates if any security has a fair value less than its amortized cost. Once these securities are identified, in order to determine whether a decline in fair value resulted from a credit loss or other factors, the Company performs further analysis as outlined below:

Loan segments have been identified by evaluating the portfolio based on collateral and credit risk characteristics. Loans receivable consist of the following:

The following table discloses allowance for credit loss activity for the quarters ended March 31, 2020 and 2019 by portfolio segment (In Thousands):

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2019 (in thousands):

As of December 31, 2019	Residential Real Estate		Commercial Real Estate		Construction		Commercial		Home Equity and Improvement		Consumer Finance		Total
Allowance for credit loss attributable to:
Individually evaluated for impairment	$	115	$	85	$	—	$	174	$	48	$	—	$	422
Collectively evaluated for impairment		2,752		16,217		996		8,829		1,652		375		30,821
Acquired with deteriorated credit quality		—		—		—		—		—		—		—
Total Allowance	$	2,867	$	16,302	$	996	$	9,003	$	1,700	$	375	$	31,243


Loans:
Individually evaluated for impairment	$	7,049	$	21,132	$	—	$	6,655	$	759	$	28	$	35,623
Collectively evaluated for impairment		318,106		1,490,306		206,721		573,244		122,963		37,808		2,749,148
Acquired with deteriorated credit quality		989		921		—		12		—		—		1,922
Total loans	$	326,144	$	1,512,359	$	206,721	$	579,911	$	123,722	$	37,836	$	2,786,693

The following table presents the average balance, interest income recognized and cash basis income recognized on impaired loans by class of loans for the three months ended March 31, 2019 (in thousands):

The following table presents the amortized cost basis of collateral-dependent loans by class of loans and collateral type as of March 31, 2020 (in thousands):

The following table presents loans individually evaluated for impairment by class of loans (in thousands):

	December 31, 2019
	Unpaid Principal Balance*		Recorded Investment		Allowance for Credit Loss Allocated
With no allowance recorded:
Residential Owner Occupied	$	86	$	86	$	—
Residential Non Owner Occupied		962		967		—
Total Residential Real Estate		1,048		1,053		—
CRE Owner Occupied		5,098		4,814		—
CRE Non Owner Occupied		1,815		1,006		—
Multi-Family Real Estate		128		130		—
Agriculture Land		12,734		12,792		—
Other CRE		—		—		—
Total Commercial Real Estate		19,775		18,742		—
Construction		—		—		—
Commercial Working Capital		5,417		5,435		—
Agriculture Production		—		—		—
Commercial Other		469		471		—
Total Commercial		5,886		5,906		—
Home Equity and Improvement		151		151		—
Consumer Finance		—		—		—
Total loans with no allowance recorded	$	26,860	$	25,852	$	—

With an allowance recorded:
Residential Owner Occupied	$	5,137	$	4,977	$	104
Residential Non Owner Occupied		1,014		1,019		11
Total Residential Real Estate		6,151		5,996		115
CRE Owner Occupied		2,085		1,623		60
CRE Non Owner Occupied		317		319		13
Multi-Family Real Estate		—		—		—
Agriculture Land		262		268		3
Other CRE		401		180		9
Total Commercial Real Estate		3,065		2,390		85
Construction		—		—		—
Commercial Working Capital		682		450		150
Agriculture Production		—		—		—
Commercial Other		318		299		24
Total Commercial		1,000		749		174
Home Equity and Improvement		654		608		48
Consumer Finance		28		28		—
Total loans with an allowance recorded	$	10,898	$	9,771	$	422

Non-performing loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. All loans greater than 90 days past due are placed on non-accrual status. Effective January 1, 2020 with the adoption of ASC Topic 326, the Company began including non-accrual purchase credit deteriorated (PCD) loans in its non-performing loans. As such, the non-performing loans as of March 31, 2020 include PCD loans accounted for pursuant to ASC Topic 326 as these loans are individually evaluated. The non-performing loans do not include PCD (formerly purchase credit impaired (PCI)) loans as of December 31, 2019, as the PCD loans prior to adopting ASC Topic 326 were evaluated on a pool basis. The following table presents the current balance of the aggregate amounts of non-performing assets, comprised of non-performing loans and real estate owned as of the dates indicated:

The following table presents the aging of the amortized cost in past due and non- accrual loans as of March 31, 2020, by class of loans (In Thousands):

The following table presents the aging of the recorded investment in past due and non-accrual loans as of December 31, 2019, by class of loans (In Thousands):

As of March 31, 2020, and December 31, 2019, the Company had a recorded investment in troubled debt restructurings (“TDRs”) of $13.8 million and $15.1 million, respectively. The Company allocated $301,000 and $388,000 of specific reserves to those loans at March 31, 2020, and December 31, 2019, respectively, and had committed to lend additional amounts totaling up to $250,000 and $226,000 at March 31, 2020, and December 31, 2019, respectively.

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

Of the loans modified in a TDR as of March 31, 2020, $6.3 million were on non-accrual status and partial charge-offs have in some cases been taken against the outstanding balance. Loans modified as a TDR may have the financial effect of increasing the allowance associated with the loan. If the loan is determined to be collateral dependent, the estimated fair value of the collateral, less any selling costs is used to determine if there is a need for a specific allowance or charge-off. If the loan is determined to be cash flow dependent, the allowance is measured based on the present value of expected future cash flows discounted at the loan’s pre-modification effective interest rate.

The following tables present loans by class modified as TDRs that occurred during the three month periods ending March 31, 2020, and March 31, 2019:

The loans described above increased the allowance for credit losses (“ACL”) by $29,000 in the three month period ending March 31, 2020.

The loans described above decreased the ALLL by $6,000 in the three month period ending March 31, 2019.

The following tables present loans by class modified as TDRs for which there was a payment default within twelve months following the modification during the three month periods ended March 31, 2020, and March 31, 2019:

The TDRs that subsequently defaulted described above had no effect on the ACL for the three month period ended March 31, 2020 and increased the ACL by $15,000 for the three month period ended March 31, 2020.

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

The TDRs that subsequently defaulted described above decreased the ALLL by $1,000 for the three month period ended March 31, 2019.

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

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

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

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

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

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2020, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

As of December 31, 2019, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (In Thousands):

The table below presents the amortized cost basis of loans by credit quality indicator and class of loans based on the most recent analysis performed ($ in thousands):

	Term of loans by origination
	2020		2019		2018		2017		2016		Prior		Revolving Loans		Total
As of March 31, 2020

Real Estate
Residential:
Risk Rating
Pass	$	58,175	$	162,634	$	206,799	$	190,256	$	186,702	$	437,887	$	2,691	$	1,245,144
Special Mention		—		97		58		—		123		98		14		390
Substandard		—		—		236		63		219		3,167		—		3,685
Doubtful		—		—		—		—		—		—		—		—
Total	$	58,175	$	162,731	$	207,093	$	190,319	$	187,044	$	441,152	$	2,705	$	1,249,219

Commercial:
Risk Rating
Pass	$	105,546	$	450,533	$	370,078	$	391,162	$	243,768	$	530,218	$	18,654	$	2,109,959
Special Mention		—		1,664		999		3,096		2,628		18,935		723		28,045
Substandard		—		291		1,607		2,497		1,340		18,839		2,698		27,272
Doubtful		—		—		—		—		—		—		—		—
Total	$	105,546	$	452,488	$	372,684	$	396,755	$	247,736	$	567,992	$	22,075	$	2,165,276

Construction:
Risk Rating
Pass	$	4,502	$	148,694	$	94,356	$	49,665	$	13,137	$	437	$	-	$	310,791
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—		—
Doubtful		—		—		—		—		—		—		—		—
Total	$	4,502	$	148,694	$	94,356	$	49,665	$	13,137	$	437	$	-	$	310,791

Other Loans
Commercial:
Risk Rating
Pass	$	55,857	$	191,337	$	108,146	$	61,628	$	34,192	$	43,359	$	345,398	$	839,917
Special Mention		25		881		129		2,970		60		592		15,820		20,477
Substandard		22		136		228		231		340		273		10,344		11,574
Doubtful		—		—		—		—		—		—		—		—
Total	$	55,904	$	192,354	$	108,503	$	64,829	$	34,592	$	44,224	$	371,562	$	871,968

Home equity and Improvement:
Risk Rating
Pass	$	2,741	$	10,976	$	5,857	$	9,960	$	9,489	$	36,520	$	219,285	$	294,828
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		80		242		322
Doubtful		—		—		—		—		—		—		—		—
Total	$	2,741	$	10,976	$	5,857	$	9,960	$	9,489	$	36,600	$	219,527	$	295,150

Consumer Finance:
Risk Rating
Pass	$	11,543	$	52,569	$	30,898	$	17,149	$	8,692	$	4,922	$	6,499	$	132,272
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		31		—		—		—		31
Doubtful		—		—		6		—		7		—		—		13

The Company has adopted ASU 2016-13 (Topic 326 – Credit Losses) to calculate the ACL which requires a projection of credit loss over the contract lifetime of the credit adjusted for prepayment tendencies. This valuation account is deducted from the loans amortized cost basis to present the net amount expected to be collected on the loan. The ACL is adjusted through the provision for credit losses and reduced by net charge offs of loans.

The credit loss estimation process involves procedures that consider the unique characteristics of the Company’s portfolio segments. These segments are further disaggregated into the loan pools for monitoring. When computing allowance levels, a model of risk characteristics, such as loss history and delinquency status, along with current conditions and a supportable forecast is used to determine credit loss assumptions.

The Company is generally utilizing two methodologies to analyze loan pools, discounted cash flows (“DCF”) and probability of default/loss given default (“PD/LGD”).

A default can be trigger by one of several different asset quality factors including past due status, non-accrual status or if the loan has had a charge-off. The PD/LGD utilizes charge off data from the Federal Financial Institutions Examination Council to construct a default rate. The Company estimates losses over an approximate one-year forecast period using Moody’s baseline economic forecasts, and then reverts to longer term historical loss experience over a three-year period. This default rate is further segmented based on the risk of the credit assigning a higher default rate to riskier credits.

The DCF methodology was selected as the most appropriate for loan segments with longer average lives and regular payment structures. The DCF model has two key components, the loss driver analysis combined with a cash flow analysis. The contractual cash flow is adjusted for PD/LGD and prepayment speed to establish a reserve level. The prepayment studies are updated quarterly by a third-party for each applicable pool.

The remaining life method was selected for the consumer loan segment since the pool contains loans with many different structures and payment streams and collateral. The weighted average remaining life uses an average annual charge-off rate applied to the contractual term, further adjusted for estimated prepayments to determine the unadjusted historical charge-off rate for the remaining balance of assets.

According to the accounting standard an entity may make an accounting policy election not to measure an allowance for credit losses for accrued interest receivable if the entity writes off the applicable accrued interest receivable balance in a timely manner. The Company has made the accounting policy election not to measure an allowance for credit losses for accrued interest receivables for all loan segments. Current policy dictates that a loan will be placed on nonaccrual status, with the current accrued interest receivable balance being written off, upon the loan being 90 days delinquent or when the loan is deemed to be collateral dependent and the collateral analysis shows less than 1.2 times discounted collateral coverage based on a current assessment of the value of the collateral.

In addition to the ASC Topic 326 requires the Company to establish a liability for anticipated credit losses for unfunded commitments. To accomplish this, the company must first establishes a loss expectation for extended (funded) commitments. This loss expectation, expressed as a ratio to the amortized cost basis, is then applied to the portion of unfunded commitments not considered unilaterally cancelable, and considered by the company’s management as likely to fund over the life of the instrument. At March 31, 2020, the Company had $1.3 billion in unfunded commitments and set aside $5.7 million in anticipated credit losses. This reserve is recorded in other liabilities as opposed to the ACL.

The determination of ACL is complex and the Company makes decisions on the effects of matters that are inherently uncertain. Evaluations of the loan portfolio and individual credits require certain estimates, assumptions and judgements as to the facts and circumstances related to particular situations or credits. There may be significant changes in the ACL in future periods determined by prevailing factors at that point in time along with future forecasts.

As a result of the Merger, the Company acquired $2.3 billion in loans. Par value of purchased loans follows (in thousands):

Under ASU Topic 326, when loans are purchased with evidence of more than insignificant deterioration of credit they are accounted for as purchase credit deteriorated (“PCD”). PCD loans acquired in a transaction are marked to fair value and a mark on yield is recorded. In addition, an adjustment is made to the ACL for the expected loss on the acquisition date. These loans are assessed on a regular basis and subsequent adjustments to the ACL are recorded on the income statement. On January 31, 2020, the Company acquired PCD loans with a fair value of $79.1 million, credit discount $7.7 million and a noncredit discount of $4.1 million. The outstanding balance at March 31, 2020 and related allowance on these loans is as follows (in thousands):

At March 30, 2020 the Company had $2.0 million in loans that had previously been accounted for as purchase credit impaired.

Consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure totaled $6.3 million as of March 31, 2020, and $981,000 as of December 31, 2019. The increase is a result of the merger with UCFC.

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

The unpaid principal balance of residential mortgage loans serviced for third parties was $3.0 billion at March 31, 2020, and $1.46 billion at December 31, 2019.

Activity for capitalized mortgage servicing rights and the related valuation allowance follows for the three months ended March 31, 2020 and 2019:

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.

The Company has established an accrual for secondary market buy-back activity. A liability of $43,000 was accrued at both March 31, 2020, and December 31, 2019, respectively. There was no expense or credit recognized related to the accrual in the three months ended March 31, 2020 or 2019.

Due to the merger with UCFC, on January 31, 2020, the Company performed a valuation on UCFC’s leases to determine an initial right of use asset (ROU asset) and lease liability. The Company recorded an initial ROU asset of $5.0 million and a lease liability of $5.1 million for these leases.

The Company’s lease agreements have maturity dates ranging from December 2020 to September 2044, some of which include options for multiple five and ten year extensions. The weighted average remaining life of the lease term for these leases was 17.58 years as of March 31, 2020 and 17.07 years as of December 31, 2019. The weighted average discount rate for leases was 2.55% as of March 3, 2020 and 3.17% as of December 31, 2019.

The total operating lease costs were $517,000 for the three months ended March 31, 2020, and $243,000 for the three months ended March 31, 2019, respectively. The right-of-use asset, included in other assets, was $17.7 million and $8.9 million at March 31, 2020 and December 31, 2019, respectively. The lease liabilities, included in other liabilities, were $18.2 million and $9.5 million as of March 31, 2020 and December 31, 2019, respectively.

Undiscounted cash flows included in lease liabilities have expected contractual payments as follows:

First Defiance’s debt, FHLB advances and junior subordinated debentures owed to unconsolidated subsidiary trusts are comprised of the following:

The FHLB advances outstanding at March 31, 2020, have maturities of $451.0 million in 2020, $5.0 million in 2021 and $10.0 maturing in each of 2022, 2023 and 2024.

In March 2007, the Company sponsored an affiliated trust, First Defiance Statutory Trust II (“Trust Affiliate II”) that issued $15 million of Guaranteed Capital Trust Securities (“Trust Preferred Securities”). In connection with this transaction, the Company issued $15.5 million of Junior Subordinated Deferrable Interest Debentures (Subordinated Debentures) to Trust Affiliate II. The Company formed Trust Affiliate II for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Subordinated Debentures held by Trust Affiliate II are the sole assets of that trust. The Company is not considered the primary beneficiary of Trust Affiliate II (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate II are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.5%. The coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate II was 2.24% as of March 31, 2020, and 4.29% as of December 31, 2019.

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

The Company also sponsored an affiliated trust, First Defiance Statutory Trust I (“Trust Affiliate I”), that issued $20 million of Trust Preferred Securities in 2005. In connection with this transaction, the Company issued $20.6 million of Subordinated Debentures to Trust Affiliate I. Trust Affiliate I was formed for the purpose of issuing Trust Preferred Securities to third-party investors and investing the proceeds from the sale of these capital securities solely in Subordinated Debentures of the Company. The Junior Debentures held by Trust Affiliate I are the sole assets of the trust. The Company is not considered the primary beneficiary of Trust Affiliate I (variable interest entity), therefore the trust is not consolidated in the Company’s financial statements, but rather the subordinated debentures are shown as a liability. Distributions on the Trust Preferred Securities issued by Trust Affiliate I are payable quarterly at a variable rate equal to the three-month LIBOR rate plus 1.38%. The coupon rate payable on the Trust Preferred Securities issued by Trust Affiliate I was 2.12% and 4.17% on March 31, 2020 and December 31, 2019, respectively.

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

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

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.

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

The balance of repurchase agreements was $2.0 million and $3.0 million at March 31, 2020 and December 31, 2019, respectively. All of the repurchase agreements were overnight and continuous as of March 31, 2020 and December 31, 2019. The repurchase agreements were collateralized by investment securities having a market value of $5.6 million and $5.8 at March 31, 2020 and December 31, 2019, respectively.

Loan commitments are made to accommodate the financial needs of First Federal’s customers 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):

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Indiana. The Company is no longer subject to examination by taxing authorities for years before 2015. The Company currently operates primarily in the states of Ohio, Michigan, Pennsylvania and West Virginia which tax financial institutions based on their equity rather than their income.

For further information on taxes refer to the discussion on CECL in Note 8. Loans and the Merger information in Note 18. Business Combinations.

At March 31, 2020, the Company had approximately $262.9 million of interest rate lock commitments and $318.1 million of forward commitments for the future delivery of residential mortgage loans and forward sales of mortgage backed securities. These commitments are considered derivatives. The Company had $17.0 million of interest rate lock commitments and $34.4 million of forward commitments at December 31, 2019.

The fair value of these mortgage banking derivatives are reflected by a derivative asset recorded in other assets and a derivative liability recorded in other liabilities in the Consolidated Statements of Financial Condition. The table below provides data about the carrying values of these derivative instruments:

The Company maintains an interest rate protection program for commercial loan customers that was acquired in the merger with UCFC. Under this program, the Company provides a customer with a fixed rate loan while creating a variable rate asset for the Company by the customer entering into an interest rate swap

with terms that match the loan. The Company offsets its risk exposure by entering into an offsetting interest rate swap with an unaffiliated institution. The Company had interest rate swaps associated with commercial loans with a notional value of $50.1 million and fair value of $1.9 million in other assets and $2.1 million in other liabilities at March 31, 2020. The difference in fair value of $194,000 between the asset and liability represents a credit valuation adjustment that flows through noninterest income. Since January 31, 2020, $108,000 of the $194,000 has flowed through noninterest income. The remainder was part of the Merger consideration. The Company had no interest rate swaps outstanding at December 31, 2019.

The Company also acquired time deposits in its acquisition of UCFC that have written and purchased option derivatives to facilitate an equity linked time deposit product. The time deposit provides the purchaser a guaranteed return of principal at maturity plus a potential equity return (a written option), while the Bank receives a known stream of funds based on the equity return (a purchase option). The written and purchased options are mirror derivative instruments which are carried at fair value on the consolidated statement of financial condition. At March 31, 2020, the balance of the equity linked time deposits was $9.6 million and the written and purchased options each had a fair value of $86,000.

The before and after tax amounts allocated to each component of other comprehensive income (loss) are presented in the table below. Reclassification adjustments related to securities available for sale are included in gains on sale or call of securities in the accompanying consolidated condensed statements of income.

Activity in accumulated other comprehensive income (loss), net of tax, was as follows:

The COVID-19 pandemic is creating extensive disruptions to the global economy and to the lives of individuals throughout the world. Business and consumer customers of the Bank are experiencing varying degrees of financial distress, which is expected to increase over the coming months and will likely adversely affect their ability to pay interest and principal on their loans and the value of the collateral securing their obligations may decline. These uncertainties may negatively impact the Statement of Financial Condition, the Statement of Income and the Statement of Cash Flows of the Company.

The Company responded to the pandemic in numerous ways, including by actively participating in the Paycheck Protection Program (“PPP”) and distributing nearly $450 million to small businesses in our markets. In addition, the Company continues to receive requests for payment deferrals on loans. Through May, the Company approved approximately 600 deferrals totaling $611.3 million in net balances. Almost half of the deferrals were for the full six month period with the next largest category being a three month deferral. These actions may impact the Company’s performance during the remainder of 2020 although the specific details cannot be determined at this time.

Effective January 31, 2020, the Company merged with UCFC and its subsidiaries, pursuant to the Merger Agreement. Pursuant to the Merger Agreement, UCFC was merged with and into First Defiance. Immediately following the Merger, Home Savings was merged with and into First Federal Bank of the Midwest, with First Federal surviving the Merger. In addition, UCFC’s wholly-owned insurance subsidiaries, HSB Insurance, LLC and United American Financial Services, Inc., each merged with the Company’s wholly-owned insurance subsidiary, First Insurance Group of the Midwest, Inc., with First Insurance Group of the Midwest, Inc. surviving the Merger. UCFC’s consolidated assets and equity (unaudited) as of January 31, 2020 totaled $2.8 billion and $324.5 million, respectively. The Company accounted for the transaction under the acquisition method of

accounting, which means that the acquired assets and liabilities were recorded at fair value at the date of acquisition. The fair value estimates included in these financial statements are based on preliminary valuations.

In accordance with ASC 805, the Company expensed approximately $11.5 million of direct acquisition costs during the three months ended March 31, 2020, of which $4.7 million was to settle employment and benefit agreements and for personnel expenses related to operating the new UCFC locations. The Company recorded $217.5 million of goodwill and $33.0 million of intangible assets in the first quarter of 2020. Goodwill represents the future economic benefits arising from net assets acquired that are not individually identified and separately recognized and is attributable to synergies expected to be derived from the combination of the two entities. The Merger was consistent with the Company’s strategy to enhance and expand its presence in northern Ohio. The Merger offers the Company the opportunity to increase profitability by introducing existing products and services to the acquired customer base as well as add new customers in the expanded market area. The intangible assets are related to core deposits, which are being amortized over 10 years on an accelerated basis, and customer relationships, which are being amortized over 10 years on a straight-line basis. For tax purposes, goodwill is non-deductible but will be evaluated annually for impairment. The following table summarizes the fair value of the total consideration transferred as part of the Merger as well as the fair value of identifiable assets and liabilities assumed as of the effective date of the transaction.

As a result of the Merger and in accordance with the Merger Agreement, each share of UCFC common stock issued and outstanding immediately prior to the effective time was converted into 0.3715 share of First Defiance common stock. No fractional shares of First Defiance common stock were issued in the Merger, and UCFC’s shareholders became entitled to receive cash in lieu of fractional shares. The Company issued 17,927,017 First Defiance common shares and paid approximately $0.1 million to UCFC shareholders as a result of the Merger. The fair value of First Defiance common shares issued as part of the consideration paid for the UCFC

common shares was determined based on the closing price of the Company’s common shares on the effective date of the Merger.

The following table presents unaudited pro forma information as if the acquisition had occurred on January 1, 2019, after giving effect to certain adjustments. The unaudited pro forma information for the three months ended March 31, 2020 and March 31, 2019 includes adjustments for interest income on loans and securities acquired, amortization of intangibles arising from the transaction, interest expense on deposits and borrowings acquired, and the related income tax effects. The unaudited pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transaction been effected on the assumed date.

The above pro forma financial information related to 2020 excludes non-recurring merger costs that totaled $11.5 million on a pre-tax basis. The above pro forma financial information excludes the $25.9 million pre-tax provision expense recognized for the three months ended March 31, 2020 under CECL for acquired non-PCD loans as CECL was not effective as of the assumed transaction date of January 1, 2019.

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

This quarterly report may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21 B of the Securities Exchange Act of 1934, as amended. Those statements may include, but are not limited to, all statements regarding intent, beliefs, expectations, projections, forecasts and plans of First Defiance Financial Corp. (“First Defiance” or the “Company”) and its management, and specifically include statements regarding: changes in economic conditions; the nature, extent and timing of governmental actions and reforms; future movements of interest rates; the ability to benefit from a changing interest rate environment; the production levels of mortgage loan generation; the ability to continue to grow loans and deposits; the ability to sustain credit quality ratios at current or improved levels; continued strength in the market area for First Federal; the ability to sell real estate owned properties; and the ability to grow in existing and adjacent markets. These forward-looking statements involve numerous risks and uncertainties, including: impacts from the novel coronavirus (COVID-19) pandemic on our business, operations, customers and capital position; higher default rates on loans made to our customers related to COVID-19 and its impact on our customers’ operations and financial condition; the impact of COVID-19 on local, national and global economic conditions; unexpected changes in interest rates or disruptions in the mortgage market related to COVID-19 or responses to the health crisis; the effects of various governmental responses to the COVID-19 pandemic; those inherent in general and local banking, insurance and mortgage conditions; competitive factors specific to markets in which First Defiance and its subsidiaries operate; future interest rate levels; legislative and regulatory decisions or capital market conditions; and other risks and uncertainties detailed from time to time in our Securities and Exchange Commission (SEC) filings, including our Annual Report on Form 10-K for the year ended December 31, 2019. One or more of these factors have affected or could in the future affect First Defiance’s business and financial results in future periods and could cause actual results to differ materially from plans and projections. Therefore, there can be no assurances that the forward-looking statements included in this quarterly report will prove to be accurate. In light of the significant uncertainties in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by First Defiance or any other persons, that our objectives and plans will be achieved. All forward-looking statements made in this quarterly report are based on information presently available to the management of First Defiance and speak only as of the date on which they are made. We assume no obligation to update any forward-looking statements, whether as a result of new information, future developments or otherwise, except as may be required by law.

In addition to results presented in accordance with GAAP, this report includes non-GAAP financial measures. The Company believes these non-GAAP financial measures provide additional information that is useful to investors in helping to understand the underlying performance and trends of the Company. The Company monitors the non-GAAP financial measures and the Company’s management believes they are helpful to investors because they provide an additional tool to use in evaluating the Company’s financial and business trends and operating results. In addition, the Company’s management uses these non-GAAP measures to compare the Company’s performance to that of prior periods for trend analysis and for budgeting and planning purposes. Fully taxable-equivalent (“FTE”) is an adjustment to net interest income to reflect tax-exempt income on an equivalent before-tax basis.

Non-GAAP financial measures have inherent limitations, which are not required to be uniformly applied and are not audited. Readers should be aware of these limitations and should be cautious with respect to the use of such measures. To mitigate these limitations, the Company has practices in place to ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and to ensure

that our performance is properly reflected to facilitate consistent period-to-period comparisons. The Company’s method of calculating these non-GAAP measures may differ from methods used by other companies. Although the Company believes the non-GAAP financial measures disclosed in this report enhance investors' understanding of our business and performance, these non-GAAP measures should not be considered in isolation, or as a substitute for those financial measures prepared in accordance with GAAP.

The following tables present a reconciliation of non-GAAP measures to their respective GAAP measures for the three month periods ended March 31, 2020 and 2019.

Non-GAAP Financial Measures – Net Interest Income on an FTE basis, Net Interest Margin and Efficiency Ratio

The Company has established various accounting policies which govern the application of GAAP in the preparation of its financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the 2019 Form 10-K and in Footnote 2 of this document. 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 2019 Form 10-K and in Footnote 2 of this document include the Allowance for Credit Losses, Goodwill, and the Valuation of Mortgage Servicing Rights.

First Defiance Financial Corp. is a financial holding company that conducts business through its wholly owned subsidiaries, First Federal Bank of the Midwest (“First Federal” or the “Bank”), First Insurance Group of the Midwest, Inc. (“First Insurance”), First Defiance Risk Management Inc. (“First Defiance Risk Management”), HSB Capital, LLC (HSB Capital”), and HSB Insurance, Inc. (“HSB Insurance”).

Immediately following the Merger, First Federal, acquired UCFC’s wholly owned bank subsidiary, Home Savings Bank. Immediately prior to the merger of the banks, First Federal converted from a federal thrift into an Ohio state-chartered bank. In addition, immediately following the merger of the banks, UCFC’s wholly-owned insurance subsidiaries, HSB Insurance, LLC and United American Financial Services, Inc., each merged into First Insurance, with First Insurance surviving the mergers. The Company acquired two additional subsidiaries in the Merger, HSB Capital and HSB Insurance.

The Bank is an Ohio state chartered bank headquartered in Youngstown, Ohio. It conducts operations through 77 banking center offices, 12 loan offices and 3 wealth offices in Ohio, Michigan, Indiana, Pennsylvania and West Virginia.

The Bank provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust and wealth management services through its extensive branch network.

HSB Capital was formed as an Ohio limited-liability company by UCFC during 2016 for the purpose of providing mezzanine funding for customers of Home Savings. Mezzanine loans are offered by HSB Capital to customers in the Company’s market area and are expected to be repaid from the cash flow from operations of the business.

First Insurance is a wholly owned subsidiary of the Company. First Insurance is an insurance agency that conducts business throughout the Company’s markets. First Insurance offers property and casualty insurance, life insurance and group health insurance.

First Defiance Risk Management is a wholly owned insurance company subsidiary of the Company to insure the Company and its subsidiaries against certain risks unique to the operations of the Company and for which insurance may not be currently available or economically feasible in today’s insurance marketplace. First Defiance Risk Management pools resources with several other similar insurance company subsidiaries of financial institutions to help minimize the risk allocable to each participating insurer.

Regulation – The Company is subject to regulation, examination and oversight by the Federal Reserve Board (“Federal Reserve”) and the SEC. The Bank is subject to regulation, examination and oversight by the Federal Deposit Insurance Corporation (FDIC) and the Division of Financial Institutions of the Ohio Department of Commerce (ODFI). In addition, the Bank is subject to regulations of the Consumer Financial Protection Bureau (the “CFPB”) which was established by the 2010 Dodd-Frank Wall Street Reform and

Consumer Protection Act (“Dodd-Frank Act”) and has broad powers to adopt and enforce consumer protection regulations. The Company and the Bank must file periodic reports with the Federal Reserve, and examinations are conducted periodically by the Federal Reserve, the FDIC and the ODFI to determine whether the Company and the Bank are in compliance with various regulatory requirements and are operating in a safe and sound manner.

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

On May 25, 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Regulatory Relief Act”) was signed into law. The Regulatory Relief Act was designed to provide regulatory relief for banking organizations, particularly for all but the very largest, those with assets in excess of $250 billion. Bank holding companies with assets of less than $100 billion are no longer subject to enhanced prudential standards, and those with assets between $100 billion and $250 billion will be relieved of those requirements in 18 months, unless the Federal Reserve Board takes action to maintain those standards. Certain regulatory requirements applied only to banks with assets in excess of $50 billion and so did not apply to the Bank even before the enactment of the Regulatory Relief Act.

The Regulatory Relief Act also provides that the banking regulators must adopt regulations implementing the provision that banking organizations with assets of less than $10 billion are permitted to satisfy capital standards and be considered “well capitalized” under the prompt corrective action framework if their leverage ratios of tangible assets to average consolidated assets is between 8% and 10%, unless the bank’s federal banking agency determines that the organization’s risk profile warrants a more stringent leverage ratio. The Federal Reserve Board and the FDIC have proposed for comment the leverage ratio framework for any banking organization with total consolidated assets of less than $10 billion, limited amounts of certain types of assets and off-balance sheet exposures, and a community bank leverage ratio greater than 9%. The community bank leverage ratio would be calculated as the ratio of tangible equity capital divided by average total consolidated assets. Tangible equity capital would be defined as total bank equity capital or total holding company equity capital, as applicable, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net operating loss and tax credit carry forwards, goodwill and other intangible assets (other than mortgage servicing assets). Average total assets would be calculated in a manner similar to the current tier 1 leverage ratio denominator in that amounts deducted from the community bank leverage ratio numerator would also be excluded from the community bank leverage ratio denominator.

The Federal Reserve Board and the FDIC also adopted a rule providing banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from the adoption of new current expected credit loss methodology accounting under GAAP.

The Regulatory Relief Act also relieves bank holding companies and banks with assets of less than $100 billion in assets from certain record-keeping, reporting and disclosure requirements.

Holding Company Regulation – The Company is a financial holding company and is subject to the Federal Reserve regulations, examination, supervision and reporting requirements. Federal law generally prohibits a bank holding company from controlling any other institution without prior approval of the Federal Reserve, or from acquiring or retaining more than 5% of the voting shares of a bank or holding company thereof, which is not a subsidiary.

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

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

The rules include (a) a minimum common equity Tier 1 (“CET1”) capital ratio of 4.5%, (b) a minimum Tier 1 capital ratio of 6.0%, (c) a minimum total capital ratio of 8.0%, and (d) a minimum leverage ratio of 4%.

Common equity for the CET1 capital ratio includes common stock (plus related surplus) and retained earnings, plus limited amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.

Tier 1 capital includes common equity as defined for the CET1 capital ratio, plus certain non-cumulative preferred stock and related surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered (but which are not permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital instruments, less certain deductions.

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

The deductions from CET1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-servicing assets above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own capital instruments and investments in the capital of unconsolidated financial institutions (above certain levels).

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

The rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus payments to executive officers if the company does not hold a capital conservation buffer of greater than 2.5% composed of CET1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. The capital conservation buffer was fully phased in effective January 1, 2019 at 2.5%.

The federal banking agencies have established a system of “prompt corrective action” to resolve certain problems of undercapitalized banks. This system is based on five capital level categories for insured depository institutions: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized”

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

In order to be “well-capitalized,” a financial institution must have a CET1 capital ratio of 6.5%, a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital of at least 8% and a leverage ratio of at least 5%, and the institution must not be subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. As of March 31, 2020, the Bank met the ratio requirements in effect to be deemed "well-capitalized."

Deposit Insurance - The FDIC maintains the Deposit Insurance Fund (“DIF’), which insures the deposit accounts of the Bank to the maximum amount provided by law. The general insurance limit is $250,000 per separately insured depositor. This insurance is backed by the full faith and credit of the United States government.

The FDIC assesses deposit insurance premiums on each insured institution quarterly based on risk characteristics of the institution. The FDIC may also impose a special assessment in an emergency situation.

Pursuant to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio (“DRR”), which is the ratio of the DIF to insured deposits of the total industry. In March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of 1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the effect on institutions with assets of less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former statutory minimum of 1.15%. The FDIC’s rules reduced assessment rates on all banks but imposed a surcharge on banks with assets of $10 billion or more until the DRR reaches 1.35% and provide assessment credits to banks with assets of less than $10 billion for the portion of their assessments that contribute to the increase of the DRR to 1.35%. The DRR reached 1.36% at March 31, 2019. The credits will be applied when the reserve ratio is at least 1.38%. The rules also changed the method to determine risk-based assessment rates for established banks with less than $10 billion in assets to better ensure that banks taking on greater risks pay more for deposit insurance than less risky banks.

As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, federally-insured institutions. It also may prohibit any federally-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the DIF. The FDIC also has the authority to take enforcement actions against insured institutions. Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged or is engaging in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or written agreement entered into with the FDIC.

Business Strategy – The Company’s primary objective is to be a high-performing community-focused financial institution, well regarded in its market areas. The Company accomplishes this through emphasis on local decision making and empowering its employees with tools and knowledge to serve its customers’ needs. The Company believes this strategy results in greater customer loyalty and profitability through core relationships. The Company is focused on diversification of revenue sources and increased market penetration in areas where the growth potential exists for a balance between acquisition and organic growth. The primary elements of the Company’s business strategy are commercial banking, consumer banking, including the

origination and sale of single-family residential loans, enhancement of fee income, wealth management and insurance sales, each united by a strong customer service culture throughout the organization.

Commercial and Commercial Real Estate Lending - Commercial and commercial real estate lending have been an ongoing focus and a major component of the Company’s success. The Company provides primarily commercial real estate and commercial business loans with an emphasis on owner-occupied commercial real estate and commercial business lending, including a focus on the deposit balances that accompany these relationships. The Company’s client base tends to be small to middle market customers with annual gross revenues generally between $1 million and $50 million. The Company’s focus is also on securing multiple guarantors in addition to collateral where possible. These customers require the Company to have a high degree of knowledge and understanding of their business in order to provide them with solutions to meet their financial needs. The Company believes this personal service model differentiates it from its competitors, particularly the larger regional institutions. The Company offers a wide variety of products to support commercial clients including remote deposit capture and other cash management services. The Company also believes that the small business customer is a strong market for it. The Company participates in many of the Small Business Administration (“SBA”) lending programs and implemented a program targeting the small business customer. Maintaining a diversified portfolio with an emphasis on monitoring industry concentrations and reacting to changes in the credit characteristics of industries is an ongoing focus.

Consumer Banking – The Company offers customers a full range of deposit and investment products including demand, checking, money market, certificates of deposits, Certificate of Deposit Account Registry Service and savings accounts. The Company offers a full range of investment products through the wealth management department and a wide variety of consumer loan products, including residential mortgage loans, home equity loans, and installment loans. The Company also offers online banking services, which include mobile banking, People Pay, online bill pay, and online account opening as well as the MoneyPass ATM Network offering access to our customers to over 32,000 ATMs nationwide without a surcharge fee.

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

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

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

Expansion Opportunities – The Company believes it is well positioned to take advantage of acquisitions or other business expansion opportunities in its market areas. The Company believes it has a track record of successfully accomplishing both acquisitions and de novo branching in its market area. This track record puts the Company in a solid position to enter or expand its business. The Company will continue to be disciplined as well as opportunistic in its approach to future acquisitions and de novo branching with a focus on its primary geographic market area, which it knows well, and has been competing in for a long period of time, as well as surrounding market areas.

Investments – The Company 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”). Management determines the appropriate classification of all such securities at the time of purchase in accordance with FASB ASC Topic 320, Investments –Debt and Equity Securities.

The Company’s securities portfolio is classified as either “available-for-sale” or “held-to-maturity.” Securities classified as available-for-sale may be sold prior to maturity due to changes in interest rates, prepayment risks, and availability of alternative investments, or to meet the Company’s liquidity needs. Securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the security to maturity.

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

The Company generally does not require updated appraisals for performing loans unless significant new money is requested by the borrower.

When a collateral dependent loan is downgraded to classified status, the Company reviews the most current appraisal on file and, if necessary, based on its assessment of the appraisal, such as age, market, etc., the Company will discount this amount to a more appropriate current value based on inputs from lenders and realtors. This amount may then be discounted further by estimation of the carrying and selling costs. In most instances, if the appraisal is more than twelve to fifteen months old, a new appraisal may be required. Finally, the Company assesses whether there is any collateral short fall, taking into consideration guarantor support and liquidity, and determines if a charge off is necessary.

When a collateral dependent loan moves to non-performing status, the Company generally gets a new third party appraisal and charges the loan down appropriately based upon the new appraisal and an estimate of costs to liquidate the collateral. All properties that are moved into the Other Real Estate Owned (“OREO”) category are supported by current appraisals, and the OREO is carried at the lower of cost or fair value, which is determined based on appraised value less an estimate of the liquidation costs.

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

All loans over 90 days past due and/or on non-accrual are classified as non-performing loans. Non-performing status automatically occurs in the month in which the 90 day delinquency occurs.

Any partially charged-off collateral dependent loans are considered non-performing, and as such, would need to show an extended period of time with satisfactory payment performance as well as cash flow coverage capability supported by current financial statements before the Company will consider an upgrade to performing status. The Company may consider moving the loan to accruing status after approximately six months of satisfactory payment performance.

For loans where the Company determines that an updated appraisal is not necessary, other means are used to verify the value of the real estate, such as recent sales of similar properties on which the Company had loans as well as calls to appraisers, brokers, realtors and investors. The Company monitors and tracks its loan to value quarterly to determine accuracy and any necessary charge-offs. Based on these results, changes may occur in the processes used.

Loan modifications constitute a troubled debt restructuring (“TDR”) if the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. For loans that are considered TDRs, the Company either computes the present value of expected future cash flows discounted at the original loan’s effective interest rate or it may measure impairment based on the fair value of the collateral. For those loans measured for impairment utilizing the present value of future cash flows method, any discount is carried as a reserve in the ACL. For those loans measured for impairment utilizing the fair value of the collateral, any shortfall is charged off.

Earnings - The profitability of the Company 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 of Cincinnati (“FHLB”) advances, and other borrowings. The Company’s non-interest income is mainly derived from service fees and other charges, mortgage banking income, and insurance commissions. The Company’s earnings also depend on the provision for credit losses, non-interest expenses (such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses) and federal income tax expense.

At March 31, 2020, the Company's total assets amounted to $6.5 billion compared to $3.5 billion at December 31, 2019. The increase is primarily attributable to the Merger which added $2.8 billion in identified assets as of January 31, 2020.

Gross loans receivable, excluding loans held for sale, were $5.1 billion at March 31, 2020, compared to $2.8 billion at December 31, 2019. For the quarter, gross loans receivable grew $2.3 billion, including $2.2 billion from the Merger.

The investment securities portfolio increased $250.8 million to $534.2 million at March 31, 2020 from $283.4 million at December 31, 2019. The increase is a result of $262.8 million of available for sale securities acquired in the Merger and a $9.5 million increase in the market value of available-for-sale securities offset by runoff and amortization of $21.5 million during the quarter.

Deposits increased $2.1 billion from $2.9 billion at December 31, 2019, to $5.0 billion as of March 31, 2020. The increase was due to the deposits acquired in the Merger which added $430.9 million of non-interest deposits and $1.7 billion of interest-bearing deposits.

Stockholders’ equity increased $490.2 million from $426.2 million at December 31, 2019, to $916.4 million at March 31, 2020. The increase in stockholders’ equity was primarily the result of the Merger and $7.5 million in other comprehensive gain. The increase was partially offset by the repurchase of 430,000 shares of common stock totaling $10.1 million, the net operating loss of $22.5 million and $8.3 million of common stock dividends 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 fully tax-equivalent basis. All average balances are based upon daily balances (dollars in thousands).

	Three Months Ended March 31,
	2020							2019
	Average				Yield/			Average				Yield/
	Balance		Interest(1)		Rate(2)			Balance		Interest(1)		Rate(2)
Interest-earning assets:
Loans receivable	$	4,317,857	$	51,485		4.80	%	$	2,517,283	$	31,238		5.03	%
Securities (3)		449,744		2,943		2.69			295,824		2,428		3.31
Interest bearing deposits		68,980		230		1.34			44,752		285		2.58
FHLB stock		25,951		115		1.78			13,481		215		6.47
Total interest-earning assets		4,862,532		54,773		4.54			2,871,340		34,166		4.82
Non-interest-earning assets		495,066							311,672
Total assets	$	5,357,598						$	3,183,012

Interest-bearing liabilities:
Deposits	$	3,343,833	$	7,771		0.93	%	$	2,061,023	$	5,005		0.98	%
FHLB advances and other		209,508		1,006		1.93			58,954		276		1.90
Subordinated debentures		36,083		273		3.04			36,083		364		4.09
Securities sold under repurchase agreements		2,359		9		1.53			5,431		4		0.30
Total interest-bearing liabilities		3,591,783		9,059		1.01			2,161,491		5,649		1.06
Non-interest bearing deposits		896,220		—		—			581,135		—
Total including non-interest bearing demand deposits		4,488,003		9,059		0.81			2,742,626		5,649		0.84
Other non-interest-bearing liabilities		82,758							45,248
Total liabilities		4,570,761							2,787,874
Stockholders’ equity		786,837							395,138
Total liabilities and stock-Holders’ equity	$	5,357,598						$	3,183,012
Net interest income; interest rate spread			$	45,714		3.53	%			$	28,517		3.76	%
Net interest margin (4)						3.78	%						4.03	%
Average interest-earning assets to average interest-bearing liabilities						135	%						133	%

On a consolidated basis, the Company reported a net loss for the quarter ended March 31, 2020 of $22.5 million compared to net income of $11.5 million for the comparable period in 2019. On a per share basis, the basic and diluted loss per share was $0.71 for the three months ended March 31, 2020 and basic and diluted earnings per common share were $0.57 for the three months ended March 31, 2019. The year-to-year results are impacted by the Merger and include $43.8 million in credit loss expense, $25.9 million related to acquisition accounting, for an after-tax cost of $20.5 million. The results for the first quarter of 2020 also included $11.5 million of acquisition-related charges, which had an after-tax cost of $9.5 million. The results for the first quarter of 2020 include two months of activity for UCFC compared to none in 2019

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 was $45.5 million for the quarter ended March 31, 2020, up from $28.3 million for the same period in 2019. The tax-equivalent net interest margin was 3.78% for the quarter ended March 31, 2020, a decrease from 4.03% for the same period in 2019. The decrease in margin between the 2020 and 2019 first quarters was primarily due to a decrease in the yield on earning assets. The decline in interest rates in the in 2019 and through the first quarter of 2020 was the primary reason for this decrease along with the Merger. The yield on interest-earning assets was 4.54% for the quarter ended March 31, 2020, down 28 basis points from 4.82% for the same period in 2019. The cost of interest-bearing liabilities between the two periods declined 5 basis points to 1.01% in the first quarter of 2020 from 1.06% in the first quarter of 2019.

Total interest income increased $20.6 million to $54.5 million for the quarter ended March 31, 2020, from $33.9 million for the quarter ended March 31, 2019. This increase is due to continued solid loan growth and the Merger which resulted in average earning asset growth of $2.0 billion year-over-year. Income from loans increased to $51.5 million for the quarter ended March 31, 2020, compared to $31.2 million for the same period in 2019 due to average loan growth of $1.8 billion. The decrease in the loan portfolio yield to 4.80% for the three months ended March 31, 2020 from 5.03% for the same period in 2019, was due mainly to declining rates. Interest income from investments increased $512,000 in the first quarter of 2020 to $2.7 million compared to the same period in 2019. The yield decreased 62 basis points to 2.69% for the three months ended March 31, 2020, compared to 3.31% for the same period in 2019. Income from interest bearing deposits decreased to $230,000 in the first quarter of 2020 compared to $285,000 for the same period in 2019 while income from FHLB stock decreased to $115,000 in the first quarter of 2020 compared to $215,000 for the same period in 2019.

Interest expense increased by $3.4 million in the first quarter of 2020 compared to the same period in 2019, to $9.1 million from $5.6 million. This increase was due to growth in deposits along with the Merger. Interest expense related to interest-bearing deposits was $7.8 million in the first quarter of 2020 compared to $5.0 million for the same period in 2019. Interest expense recognized by the Company related to FHLB advances was $1.0 million in the first quarter of 2020 compared to $276,000 for the same period in 2019 as a result of increased volume from the merger. Expenses on subordinated debentures and notes payable were $273,000 and $9,000 respectively in the first quarter of 2020 compared to $364,000 and $4,000 respectively for the same period in 2019.

The Company adopted ASU 2016-13, the Current Expected Credit Loss (“CECL”) model on January 1, 2020. Under CECL, a valuation reserve will be established in the ACL and maintained through expense in the provision for credit losses. Upon adoption of CECL, the Company made a one-time adjustment, net of taxes, to retained earnings for $1.9 million. The ACL represents management’s assessment of the estimated credit losses the Company will receive over the life of the loan. ACL requires a projection of credit losses over the contract lifetime of the credit adjusted for prepayment tendencies. Management analyzes the adequacy of the ACL regularly through reviews of the loan portfolio. Consideration is given to economic conditions, changes in interest rates and the effect of such changes on collateral values and borrower’s ability to pay, changes in the composition of the loan portfolio and trends in past due and non-performing loan balances. The ACL is a material estimate that is susceptible to significant fluctuation and is established through a provision for credit losses based on management’s evaluation of the inherent risk in the loan portfolio. In addition to extensive in-house loan monitoring procedures, the Company utilizes an outside party to conduct an independent loan review of commercial loan and commercial real estate loan relationships. The Company’s goal is to have 50% or greater of the portfolio reviewed annually. Management utilizes the results of this outside loan review to assess the effectiveness of its internal loan grading system as well as to assist in the assessment of the overall adequacy of the ACL associated with these types of loans.

The ACL is made up of two basic components. The first component of the allowance for credit loss is the specific reserve in which the Company sets aside reserves based on the analysis of individual impaired credits. In establishing specific reserves, the Company analyzes all substandard, doubtful and loss graded loans quarterly and makes judgments about the risk of loss based on the cash flow of the borrower, the value of any collateral and the financial strength of any guarantors. If the loan is impaired and cash flow dependent, then a specific reserve is established for the discount on the net present value of expected future cash flows. If the loan is impaired and collateral dependent, then any shortfall is usually charged off. The Company also considers the impacts of any SBA or Farm Service Agency guarantees. The specific reserve portion of the ACL was $683,000 at March 31, 2020, and $422,000 at December 31, 2019.

The second component is a general reserve, which is used to record loan loss reserves for groups of homogenous loans in which the Company estimates the potential losses over the contractual lifetime of the loan adjusted for prepayment tendencies. In addition the future economic environment is incorporated in projection with loss expectations to revert to the long-run historical mean after such time as management can no longer make or obtain a reasonable and supportable forecast. For purposes of the general reserve analysis, the six loan portfolio segments are further segregated into thirteen different loan pools to allocate the ACL. Residential real estate is further segregated into owner occupied and nonowner occupied for ACL. Commercial real estate is split into owner occupied, nonowner occupied, multifamily, agriculture land and other commercial real estate. And commercial credits are comprised of commercial working capital, agriculture production and other commercial credits. The Company utilizes three different methodologies to analyze loan pools.

Discounted cash flows (DCF) was selected as the appropriate method for loan segments with longer average lives and regular payment structures. This method is applied to a majority of the Company’s real estate loans. DCF generates cash flow projections at the instrument level where payment expectations are adjusted for prepayment and curtailment to produce an expected cashflow stream. This expected cashflow stream is compared to the net present value of expected cash flows to establish a valuation account for these loans.

The probability of default/loss given default methodology was selected as most appropriate for loan segments with average lives of three years or less and/or irregular payment structures. This methodology was used for home equity and commercial portfolios. A loan is considered to default if one of the following is detected:

The default rate is measured on the current life of the loan segment using s weighted average of the four most recent quarters. PD/LGD is determined on a dollar-ratio basis, measuring the ratio of net charged off principal to defaulted principal.

The consumer portfolio contains loans with many different payment structures, payment streams and collateral. The remaining life method was deemed most appropriate for these loans. The weighted average remaining life uses an annual charge-off rate over several vintages to estimate credit losses. The average annual charge-off rate is applied to the contractual term adjusted for prepayments.

Additionally, CECL requires a reasonable and supportable forecast when establishing the ACL. The Company estimates losses over an approximate one-year forecast period using Moody’s baseline economic forecasts, and then reverts to longer term historical loss experience over a three-year period.

The quantitative general allowance increased to $41.6 million at March 31, 2020, from $6.6 million at December 31, 2019.

In addition to the quantitative analysis, a qualitative analysis is performed each quarter to provide additional general reserves on the non-impaired loan portfolio for various factors. The overall qualitative factors are based on nine sub-factors. The nine sub-factors have been aggregated into three qualitative factors: economic, environment and risk.

The qualitative analysis indicated a general reserve of $35.8 million at March 31, 2020 compared to $24.2 million at December 31, 2019. The increase was mainly due to the Merger, which increased the pool of loans to which the qualitative reserves are applied, and changes in the economy. Management reviewed the overall economic, environmental and risk factors and determined that it was appropriate to make adjustments to these sub-factors based on that review.

The economic factors for all loan segments increased in the first three months of 2020, due to a slight increase in local unemployment levels and uncertainty in global economic conditions.

The environmental factors for the commercial real estate, commercial loan and construction loan segments decreased in the first three months of 2020, mainly due to decreases in credit concentrations and strengthened credit function. The environmental factors for the home equity and improvement, consumer and residential loan segments remained flat in the first three months of 2020.

The risk factors for commercial real estate, construction, and consumer loans increased in the first three months of 2020 primarily due to unfavorable trends in external factors. The risk factors for commercial, home equity and improvement, and residential loans decreased in the first three months of 2020 primarily due to favorable trends in non-performing assets.

The Company’s general reserve percentages for main loan segments not otherwise classified ranged from 0.45% for construction loans to 2.46% for consumer loans at March 31, 2020.

Under CECL, when loans are purchased with evidence of more than insignificant deterioration of credit they are accounted for as purchase credit deteriorated (“PCD”). PCD loans acquired in a transaction are marked to fair value and a mark on yield is recorded. In addition, an adjustment is made to the ACL for the expected loss through retained earnings on the acquisition date. These loans are assessed on a regular basis and subsequent adjustments to the ACL are recorded on the income statement. On January 31, 2020, the Company acquired PCD loans with a fair value of $79.1 million, a recorded adjustment on yield of $4.1 million and an increase to the ACL of $7.7million.

As a result of the quantitative and qualitative analyses, along with the change in specific reserves and the decrease in net charge-offs in the quarter, the Company’s provision for credit losses for the first quarter of 2020 was $43.8 million, including $25.9 million attributable to the acquisition, compared to $0.2 million for the same period in 2019. The ACL was $85.9 million at March 31, 2020 and $31.2 million at December 31, 2019. The ACL represented 1.68% of loans, net of undisbursed loan funds and deferred fees and costs, at March 31, 2020 and 1.12% at December 31, 2019. In management’s opinion, the overall ACL of $85.9 million as of March 31, 2020, is adequate to cover current estimated credit losses.

Management also assesses the value of OREO as of the end of each accounting period and recognizes write-downs to the value of that real estate in the income statement if conditions dictate. In the three month period ended March 31, 2020, there were no write-downs of real estate held for sale. Management believes that the values recorded at March 31, 2020, for OREO and repossessed assets represent the realizable value of such assets.

Total classified loans increased to $70.5 million at March 31, 2020, compared to $34.2 million at December 31, 2019, an increase of $36.3 million primarily due to the acquisition of HSB.

The Company’s ratio of ALLL to non-performing loans was 263.4% at March 31, 2020, compared with 232.5% at December 31, 2019. Management monitors collateral values of all loans included on the watch list that are collateral dependent and believes that allowances for those loans at March 31, 2020, are appropriate. Of the $32.6 million in non-accrual loans at March 31, 2020, $16.9 million or 51.8% are less than 90 days past due.

At March 31, 2020, the Company had total non-performing assets of $33.1 million, compared to $13.6 million at December 31, 2019. Non-performing assets include loans that are on non-accrual, OREO and other assets held for sale. Non-performing assets at March 31, 2020, and December 31, 2019, by category were as follows:

Non-performing loans in the commercial loan category represented 0.44% of the total loans in that category at March 31, 2020, compared to 0.51% for the same category at December 31, 2019. Non-performing loans in the non-residential and multi-family residential real estate loan category were 0.88% of the total loans in this category at March 31, 2020, compared to 0.51% at December 31, 2019. Non-performing loans in the residential loan category represented 0.53% of the total loans in that category at March 31, 2020, compared to 0.74% for the same category at December 31, 2019.

The Bank’s Special Assets 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 Special Asset Committee makes recommendations regarding proposed charge-offs which are approved by the Loan Loss Reserve Committee.

The following table sets forth information concerning the allocation of the Company’s ACL by loan categories at the dates indicated.

	March 31, 2020					December 31, 2019					September 30, 2019					June 30, 2019					March 31, 2019
	Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category			Amount		Percent of total loans by category
	(Dollars In Thousands)
Residential	$	23,324		23.78	%	$	2,867		11.30	%	$	2,938		11.94	%	$	2,793		11.67	%	$	2,811		11.96	%
Construction		884		9.79	%		996		10.60	%		1,103		11.13	%		887		12.16	%		731		11.32	%
Multi-Family residential and Commercial real estate		42,515		41.32	%		16,302		52.40	%		16,195		51.70	%		15,251		51.12	%		15,069		51.87	%
Commercial		11,901		16.86	%		9,003		20.10	%		7,888		19.43	%		7,888		19.21	%		7,276		18.95	%
Consumer		3,281		2.59	%		375		1.30	%		374		1.32	%		352		1.28	%		349		1.27	%
Home equity and improvement		3,954		5.66	%		1,700		4.30	%		1,752		4.48	%		1,763		4.56	%		1,928		4.63	%
	$	85,859		100.00	%	$	31,243		100.00	%	$	30,250		100.00	%	$	28,934		100.00	%	$	28,164		100.00	%

Total non-interest income increased $3.2 million in the first quarter of 2020 to $14.0 million from $10.8 million for the same period in 2019.

Service Fees. Service fees and other charges increased by $2.2 million in the first quarter of 2020 compared to the same period in 2019. The increase is due primarily to the Merger.

Mortgage Banking Activity. Mortgage banking income decreased to $0.8 million in the first quarter of 2020 from $1.8 million in the first quarter of 2019. Gains from the sale of mortgage loans increased to $4.9 million in the first quarter of 2020 from $1.3 million in the first quarter of 2019. Mortgage loan servicing revenue increased to $1.6 million in the first quarter of 2020 from $0.9 million in the first quarter of 2019. Amortization of mortgage servicing rights increased to $1.2 million in the first quarter of 2020 from $286,000 in the first quarter of 2019. The Company had a negative change in the valuation adjustment in mortgage servicing assets of $4.5 million in the first quarter of 2020 compared with a negative adjustment of $113,000 in the first quarter of 2019. The year-over-year change is primarily due to the significant decline in rates with the 10-year treasury declining 122 basis points during the first quarter of 2020 compared to a 28 basis point decline in the first quarter of 2019.

Bank-Owned Life Insurance. Income from bank-owned life insurance was $781,000 for the first quarter of 2020 compared to $392,000 in the first quarter of 2019. This increase was primarily a result of the Merger.

Other Non-Interest Income. Other non-interest income increased to $960,000 in the first quarter of 2020 from the same period in 2019 due mainly to the Merger.

Non-interest expense increased $18.9 million to $43.8 million for the first quarter of 2020 compared to $24.9 million for the same period in 2019. The increase is mainly attributable to the Merger. Acquisition related charges associated with the merger totaled $11.5 million in the first quarter of 2020.

Compensation and Benefits. Compensation and benefits increased to $17.6 million in the first quarter of 2020, compared to $14.1 million in the first quarter of 2019. The increase in compensation and benefits from a year ago is mainly due to the Merger offset by increased contra salary expense from greater loan origination volume.

Occupancy. Occupancy expense increased to $3.7 million in the first quarter of 2020 compared to $2.2 million in the first quarter of 2019. The increase was due to the Merger with UCFC.

Data Processing. Data processing cost was $3.0 million in the first quarter of 2020, an increase of $0.7 million from $2.3 million in the first quarter of 2019. This is due to the Merger with UCFC.

Amortization of Intangibles. Expense from the amortization of intangibles increased to $1.2 million in the first quarter of 2020 from $0.3 million in the first quarter of 2019 due to the Merger with UCFC.

As a regulated financial institution, the Company is required to maintain appropriate levels of “liquid” assets to meet short-term funding requirements. The Company’s liquidity, primarily represented by cash and cash equivalents, is a result of its operating, investing and financing activities.

The principal source of funds for the Company are deposits, loan repayments, maturities of securities, borrowings from financial institutions and other funds provided by operations. The Bank also has the ability to borrow from the FHLB. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan repayments are more influenced by interest rates, general economic conditions and competition. Investments in liquid assets maintained by the Company and the Bank are based upon management’s assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset and liability management program.

The Bank’s Asset/Liability Committee (ALCO) is responsible for establishing and monitoring liquidity guidelines, policies and procedures. ALCO uses a variety of methods to monitor the liquidity position of the Bank including liquidity analyses that measure potential sources and uses of funds over future periods out to one year. ALCO also performs contingency funding analyses to determine the Bank’s ability to meet potential liquidity needs under stress scenarios that cover varying time horizons ranging from immediate to longer term.

At March 31, 2020, the Bank had on-hand liquidity, defined as cash and cash equivalents, unencumbered securities and additional FHLB borrowing capacity, of $1.3 billion.

Liquidity risk arises from the possibility that the Company may not be able to meet its financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, the Company’s Board of Directors has established a Liquidity Policy that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements. This policy designates the Bank’s Asset/Liability Committee (“ALCO”) as the body

responsible for meeting these objectives. The ALCO reviews liquidity on a monthly basis and approves significant changes in strategies that affect balance sheet or cash flow positions.

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

In July 2013, the federal banking agencies approved the final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Company and the Bank on January 1, 2016, and were subject to a phase-in period through January 1, 2019, minimum requirements increased for both quantity and quality of capital held by the Company and the Bank. The rules include a new minimum CET1 capital to risk-weighted assets ratio of 4.5% and a capital conservation buffer of 0.625% of risk-weighted assets during 2016, 1.25% during the year 2017, 1.875% during the year 2019, and increasing each year until fully phased-in during 2019 at 2.50%, effectively resulting in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), which effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance sheet exposures.

In the first quarter of 2020, the federal banking agencies approved the final rules implementing the Current Expected Credit Loss model known as CECL. Under the final rules the Company had the ability to phase in the effects of the adoption of CECL which it chose not to elect. The full effect of the adoption of CECL was absorbed in the Company’s March 31, 2020 capital calculations.

The Company met each of the well-capitalized ratio guidelines at March 31, 2020. The following table indicates the capital ratios for the Company (consolidated) and the Bank at March 31, 2020, and December 31, 2019. (In Thousands):

	March 31, 2020
	Actual					Minimum Required for Adequately Capitalized					Minimum Required for Well Capitalized
	Amount		Ratio			Amount		Ratio(1)			Amount		Ratio
CET1 Capital (to Risk-Weighted Assets)
Consolidated	$	556,796		10.48	%	$	238,991		4.5	%	N/A		N/A
First Federal	$	563,438		10.65	%	$	238,090		4.5	%	$	343,907		6.5	%

Tier 1 Capital (1)
Consolidated	$	591,796		11.85	%	$	199,761		4.0	%	N/A		N/A
First Federal	$	563,438		11.29	%	$	199,599		4.0	%	$	199,599		5.0	%

Tier 1 Capital (to Risk Weighted Assets) (1)
Consolidated	$	591,796		11.14	%	$	318,655		6.0	%	N/A		N/A
First Federal	$	563,438		10.65	%	$	317,453		6.0	%	$	423,271		8.0	%

Total Capital (to Risk Weighted Assets) (1)
Consolidated	$	658,423		12.40	%	$	424,874		8.0	%	N/A		N/A
First Federal	$	629,817		11.90	%	$	423,271		8.0	%	$	529,088		10.0	%

	December 31, 2019
	Actual					Minimum Required for Adequately Capitalized					Minimum Required to be Well Capitalized for Prompt Corrective Action
	Amount		Ratio			Amount		Ratio(1)			Amount		Ratio
CET1 Capital (to Risk-Weighted Assets) (2)
Consolidated	$	322,813		10.60	%	$	137,001		4.5	%	N/A		N/A
First Federal	$	335,251		11.03	%	$	136,752		4.5	%	$	197,531		6.5	%

Tier 1 Capital (2)
Consolidated	$	357,813		10.78	%	$	132,805		4.0	%	N/A		N/A
First Federal	$	335,251		10.13	%	$	132,435		4.0	%	$	165,544		5.0	%


Tier 1 Capital (to Risk Weighted Assets) (2)
Consolidated	$	357,813		11.75	%	$	182,667		6.0	%	N/A		N/A
First Federal	$	335,251		11.03	%	$	182,336		6.0	%	$	243,114		8.0	%

Total Capital (to Risk Weighted Assets) (2)
Consolidated	$	389,056		12.78	%	$	243,556		8.0	%	N/A		N/A
First Federal	$	366,494		12.06	%	$	243,114		8.0	%	$	303,893		10.0	%

As discussed in detail in the 2019 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 that measures the impact changes in interest rates can have on net interest income. The simulation technique analyzes the effect of a presumed 100 basis point shift in interest rates (which is consistent with management’s estimate of the range of potential interest rate fluctuations) and takes into account prepayment speeds on amortizing financial instruments, loan and deposit volumes and rates, non-maturity deposit assumptions and capital requirements.

The table below presents, for the twelve months subsequent to March 31, 2020 and December 31, 2019, an estimate of the change in net interest income that would result from an immediate (shock) change in interest rates, moving in a parallel fashion over the entire yield curve, relative to the measured base case scenario. Based on our net interest income simulation as of March 31, 2020, net interest income sensitivity to changes in

interest rates for the twelve months subsequent to March 31, 2020, remained relatively stable for the shock compared to the sensitivity profile for the twelve months subsequent to December 31, 2019.

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

The results of all the simulation scenarios are within the Company’s Board mandated guidelines as of March 31, 2020.

In addition to the simulation analysis, First Defiance also 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 generally calculates the net present value of First Federal’s assets and liabilities in rate shock environments that range from -400 basis points to +400 basis points. The results of this analysis are reflected in the following tables for the quarter ended March 31, 2020, and the year ended December 31, 2019.

Disclosure controls and procedures are controls and other 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 rules and forms of the Securities and Exchange Commission, including those disclosure controls and procedures 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 amended) as of March 31, 2020. 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 March 31, 2020, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Neither First Defiance nor any of its subsidiaries is engaged in any legal proceedings of a material nature.

We are supplementing the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the Securities and Exchange Commission, with the following additional risk factor:

The outbreak of the novel coronavirus (“COVID-19”) has adversely impacted our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

We have identified specific areas, such as MSR’s and Goodwill, which could be impacted by COVID-19. We have assessed these specific items and determined they have not been significantly impacted as of the date of this report, but have the potential for future risk.

The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, increased unemployment levels and decreased consumer confidence generally. In addition, the pandemic has resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities. The COVID-19 pandemic could influence the recognition of credit losses in our loan portfolios and will increase our allowance for credit losses, particularly as businesses remain closed and as more customers are expected to draw on their lines of credit or seek additional loans to help finance their businesses. Furthermore, the pandemic could affect the stability of our deposit base as well as our capital and liquidity position, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, result in lost revenue and cause us to incur additional expenses. Similarly, because of changing economic and market conditions affecting issuers, we may be required to recognize other-than-temporary impairments in future periods on goodwill or the securities we hold as well as reductions in other comprehensive income.

The extent of the impact of the COVID-19 pandemic on our capital, liquidity, and other financial positions and on our business, results of operations, and prospects will depend on a number of evolving factors, including:

•The duration, extent, and severity of the pandemic. COVID-19 has not been contained and could affect significantly more households and businesses. The duration and severity of the pandemic continue to be impossible to predict.

•The response of governmental and nongovernmental authorities. Many of the actions taken by authorities have been directed at curtailing personal and business activity to contain COVID-19 while

simultaneously deploying fiscal-and monetary-policy measures to assist in mitigating the adverse effects on individuals and businesses.

•The effect on our customers, counterparties, employees, and third-party service providers. COVID-19 and its associated consequences and uncertainties may affect individuals, households, and businesses differently and unevenly. In the near-term if not longer, however, our credit, operational, and other risks are generally expected to increase.

•The effect on economies and markets. Whether the actions of governmental and nongovernmental authorities will be successful in mitigating the adverse effects of COVID-19 is unclear. National, regional, and local economies and markets could suffer disruptions that are lasting.

•The success of hardship relief efforts to bridge the gap to reopening the economy. The U.S. government has implemented programs to directly compensate individuals and grant or loan money to businesses in an effort to provide funding while the economy is shut down. Many banks, including First Federal Bank of the Midwest, have implemented hardship relief programs that include payment deferral and short-term funding options. The success of these programs could mute the effect on the Company’s credit losses, which may be difficult to determine.

In an effort to help our customers during this time, First Defiance has maintained full staffing of all branch drive-thru lanes, provided for branch lobby appointments, communicated with and encouraged our customers to use our free self-service tools such as ATMs and mobile/online technology, reduced or waived various customer fees, implemented loan payment deferral programs and participated in governmental stimulus programs such as the Small Business Administration Payment Protection Program (“PPP”). A significant number of our borrowers have enrolled in one of our programs to defer some or all loan payments for up to six months. These programs may negatively impact our revenue and other results of operations in the near term and, if not effective in mitigating the effect of COVID-19 on our customers, may adversely affect our business and results of operations more substantially over a longer period of time.

The sharp deterioration in the United States economy that has resulted from the COVID-19 pandemic and the actions taken by the federal and state governments to slow the spread of that virus have resulted in a significant increase in the unemployment rate throughout the United States, including in the local economies in which we conduct business. We anticipate that this increase in unemployment will affect the ability of some of our clients to repay their loans on a timely basis and will adversely affect the financial results of our commercial clients in localities with high unemployment, resulting in loan defaults and the possible impairments in the value of our collateral. These developments could adversely impact our results of operations and financial condition, although the extent of such impact cannot be determined at this time.

There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. We do not yet know the full extent of the impacts on our business, our operations or the global economy as a whole. Even after COVID-19 has subsided, we may continue to experience materially adverse impacts to our business. However, the effects could have a material impact on our results of operations and heighten many of our known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Our participation in the PPP may expose us to reputational harm, increased litigation risk, as well as the risk that the SBA may not fund some or all of the guarantees associated with PPP loans.

Lenders participating in the PPP have faced increased public scrutiny about their loan application process and procedures, and the nature and type of the borrowers receiving PPP loans. We depend on our reputation as a trusted and responsible financial services company to compete effectively in the communities that we serve, and any negative public or customer response to, or any litigation or claims that might arise out

of, our participation in the PPP and any other legislative or regulatory initiatives and programs that may be enacted in response to the COVID-19 pandemic, could adversely impact our business. Other banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP, and we may be subject to the same or similar litigation. In addition, if the SBA determines that there is a deficiency in the manner in which a PPP loan was originated, funded, or serviced by us, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from us.

The Company had no unregistered sales of equity securities during the quarter ended March 31, 2020.

The following table provides information regarding First Defiance’s purchases of its common stock during the three-month period ended March 31, 2020:

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

Ohio	34-1803915
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
601 Clinton Street Defiance, OH	43512
(Address of principal executive offices)	(Zip Code)


		Page Number

PART I - FINANCIAL INFORMATION

Item 1.	Consolidated Condensed Financial Statements (Unaudited):	2

	Consolidated Condensed Statements of Financial Condition – March 31, 2020 and December 31, 2019	2

	Consolidated Condensed Statements of Income Three months ended March 31, 2020 and 2019	4

	Consolidated Condensed Statements of Comprehensive Income – Three months ended March 31, 2020 and 2019	5

	Consolidated Condensed Statements of Changes in Stockholders’ Equity – Three months ended March 31, 2020 and 2019	6

	Consolidated Condensed Statements of Cash Flows - Three months ended March 31, 2020 and 2019	7

	Notes to Consolidated Condensed Financial Statements	8

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	45

Item 3	Quantitative and Qualitative Disclosures about Market Risk	65

Item 4	Controls and Procedures	67

PART II - OTHER INFORMATION:

Item 1	Legal Proceedings	71

Item 1A.	Risk Factors	71

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	72

Item 3	Defaults upon Senior Securities	73

Item 4	Mine Safety Disclosures	73

Item 5	Other Information	73

Item 6	Exhibits	73

	Signatures	75

	March 31, 2020		December 31, 2019
Assets
Cash and cash equivalents:
Cash and amounts due from depository institutions	$	79,000	$	46,254
Interest-bearing deposits		66,217		85,000
		145,217		131,254
Securities available-for-sale, carried at fair value		534,206		283,448
Loans held for sale, carried at fair value		58,222		—
Loans held for sale, at lower of cost or market		27,372		18,008
Loans receivable, net of allowance for credit losses of $85,859 at March 31, 2020 and $31,243 at December 31, 2019, respectively		5,028,058		2,746,321
Mortgage servicing rights		15,742		10,267
Accrued interest receivable		19,048		10,244
Federal Home Loan Bank stock		89,252		11,915
Bank owned life insurance		142,259		75,544
Premises and equipment		59,870		39,563
Real estate and other assets held for sale		548		100
Goodwill		317,520		100,069
Core deposit and other intangibles		35,540		3,772
Other assets		66,088		38,487
Total assets	$	6,538,942	$	3,468,992

	March 31, 2020			December 31, 2019
Liabilities and stockholders’ equity
Liabilities:
Deposits	$	4,994,148		$	2,870,325
Advances from the Federal Home Loan Bank		486,000			85,063
Subordinated debentures		36,083			36,083
Securities sold under repurchase agreements		1,961			2,999
Advance payments by borrowers		23,962			5,491
Deferred taxes		3,642			905
Other liabilities		76,303			41,959
Total liabilities		5,622,099			3,042,825

Stockholders’ equity:
Preferred stock, $.01 par value per share: 37,000 shares authorized; no shares issued	—			—
Preferred stock, $.01 par value per share: 4,963,000 shares authorized; no shares issued	—			—
Common stock, $.01 par value per share: 50,000,000 shares authorized; 43,297,259 and 25,371,086 shares issued and 37,286,574 and 19,729,886 shares outstanding at March 31, 2020 and December 31, 2019, respectively		306			127
Additional paid-in capital		687,996			161,955
Accumulated other comprehensive income (loss), net of tax of $3,208 and $1,221, respectively		12,068			4,595
Retained earnings		295,467			329,175
Treasury stock, at cost, 6,011,529 shares at March 31, 2020 and 5,641,200 shares at December 31, 2019		(78,994	)		(69,685	)
Total stockholders’ equity		916,843			426,167
Total liabilities and stockholders’ equity	$	6,538,942		$	3,468,992

	Three Months Ended March 31,
	2020			2019
Net (loss) income	$	(22,482	)	$	11,482

Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale		9,458			4,603
Reclassification adjustment for securities gains included in net income		—			—
Income tax expense (benefit)		(1,985	)		(968	)
Net of tax amount		7,473			3,635

Change in unrealized gain/(loss) on postretirement benefit:
Reclassification adjustment for deferred tax on defined benefit postretirement medical plan		—			82
Net of tax amount		—			82

Total other comprehensive income (loss)		7,473			3,717

Comprehensive (loss) income	$	(15,009	)	$	15,199

March 31, 2020	Level 1 Inputs		Level 2 Inputs		Level 3 Inputs		Total FairValue
	(In Thousands)
Assets:
Available for sale securities:
Obligations of U.S. federal government corporations and agencies	$	—	$	30,282	$	—	$	30,282
Mortgage-backed securities		—		201,026		—		201,026
Collateralized mortgage obligations		—		137,608		—		137,608
Corporate bonds		—		22,067		—		22,067
Obligations of state and political subdivisions		—		137,393		5,830		143,223
Loans held for sale, at fair value		—		13,802		44,420		58,222
Purchased certificate of deposit option		—		86		—		86
Interest rate swaps		—		1,868		—		1,868
Mortgage banking derivative		—		4,073		—		4,073
Liabilities:		—						—
Written certificate of deposit option		—		86		—		86
Interest rate swaps		—		2,119		—		2,119
Mortgage banking derivative		—		586		—		586

			Fair Value Measurements at March 31, 2020
			(In Thousands)
	Carrying Value		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	145,217	$	145,217	$	145,217	$	—	$	—
Investment securities		534,206		534,206		—		528,376		5,830
Federal Home Loan Bank Stock		89,252	N/A		N/A		N/A		N/A
Loans receivable, net		5,028,058		5,141,454		—		—		5,141,454
Loans held for sale, carried at fair value		58,222		58,222		—		13,802		44,420
Loans held for sale, carried at lower of cost or market		27,372		28,383		—		28,383		—

Financial Liabilities:
Deposits	$	4,994,148	$	5,003,154	$	3,717,546	$	1,285,608	$	—
Advances from Federal Home Loan Bank		486,000		487,027		—		487,027		—
Securities sold under repurchase agreements		1,961		1,961		—		1,961		—
Subordinated debentures		36,083		36,083		—		36,083		—

			Fair Value Measurements at December 31, 2019
			(In Thousands)
	Carrying Value		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and cash equivalents	$	131,254	$	131,254	$	131,254	$	—	$	—
Investment securities		283,448		283,448		—		280,037		3,411
FHLB Stock		11,915	N/A		N/A		N/A		N/A
Loans, net, including loans held for sale		2,764,329		2,756,092		—		18,456		2,737,636

Financial Liabilities:
Deposits	$	2,870,325	$	2,871,166	$	2,131,537	$	739,629	$	—
Advances from FHLB		85,063		85,003		—		85,003		—
Securities sold under repurchase agreements		2,999		2,999		2,999		—		—
Subordinated debentures		36,083		36,083		—		36,083		—

	Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in 000’s)
Options outstanding, January 1, 2020		17,700	$	17.60
Forfeited or cancelled		—		—
Exercised		—		—
Exchanged		39,983		16.00
Granted		—		—
Options outstanding, March 31, 2020		57,683	$	16.49		5.06	$	152
Vested or expected to vest at March 31, 2020		57,683	$	16.49		5.06	$	152
Exercisable at March 31, 2020		55,783	$	16.41		5.04	$	152

	Restricted Stock Units					Stock Grants
Unvested Shares	Shares			Weighted- Average Grant Date Fair Value		Shares			Weighted- Average Grant Date Fair Value
Unvested at January 1, 2020		158,470		$	25.72		48,545		$	27.49
Granted		—			—		13,349			25.75
Vested		(86,050	)		25.48		(1,244	)		28.60
Forfeited		(26,291	)		25.58		—			—
Unvested at March 31, 2020		46,129		$	26.24		60,650		$	27.09

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In Thousands)
At March 31, 2020
Available-for-Sale Securities:
Obligations of U.S. government corporations and agencies	$	28,871	$	1,411	$	—		$	30,282
Mortgage-backed securities		193,575		7,455		(4	)		201,026
Collateralized mortgage obligations		134,144		3,476		(12	)		137,608
Corporate bonds		22,381		74		(388	)		22,067
Obligations of state and political subdivisions		139,652		4,252		(681	)		143,223
Total Available-for-Sale	$	518,623	$	16,668	$	(1,085	)	$	534,206

	Available-for-Sale
	Amortized Cost		Fair Value
	(In Thousands)
Due in one year or less	$	4,393	$	4,391
Due after one year through five years		20,876		20,747
Due after five years through ten years		65,575		67,675
Due after ten years		100,060		102,759
MBS/CMO		327,719		338,634
	$	518,623	$	534,206

	Duration of Unrealized Loss Position
	Less than 12 Months				12 Months or Longer					Total
	Fair Value		Gross Unrealized Loss		Fair Value		Gross Unrealized Loss			Fair Value		Unrealized Losses
	(In Thousands)
At March 31, 2020
Available-for-sale securities:
Mortgage-backed securities		—		—		199		(4	)		199		(4	)
Collateralized mortgage obligations						8,793		(12	)		8,793		(12	)
Corporate bonds						16,933		(388	)		16,933		(388	)
Obligations of state and political subdivisions						38,674		(681	)		38,674		(681	)
Total temporarily impaired securities	$	—	$	—	$	64,599	$	(1,085	)	$	64,599	$	(1,085	)

Quarter Ended March 31, 2020	Residential Real Estate			Commercial Real Estate			Construction			Commercial			Home Equity and Improvement			Consumer Finance			Total
Beginning Allowance	$	2,867		$	16,302		$	996		$	9,003		$	1,700		$	375		$	31,243
Impact of ASC 326 Adoption		1,765			3,682			(223	)		(2,263	)		(521	)		(86	)		2,354
Acquisition related allowance for credit loss (PCD)		1,077			4,053			—			2,272			248			48			7,698
Charge-Offs		(184	)		(16	)		—			(96	)		(30	)		(108	)		(434	)
Recoveries		101			340			—			669			42			60			1,212
Provisions(1)(2)		17,698			18,154			111			2,316			2,515			2,992			43,786
Ending Allowance	$	23,324		$	42,515		$	884		$	11,901		$	3,954		$	3,281		$	85,859

Quarter Ended March 31, 2019	Residential Real Estate			Commercial Real Estate			Construction		Commercial			Home Equity and Improvement			Consumer Finance			Total
Beginning Allowance	$	2,881		$	15,142		$	682	$	7,281		$	2,026		$	319		$	28,331
Charge-Offs		(172	)		—			—		(187	)		(33	)		(142	)		(534	)
Recoveries		13			96			—		12			24			10			155
Provisions		89			(169	)		49		170			(89	)		162			212
Ending Allowance	$	2,811		$	15,069		$	731	$	7,276		$	1,928		$	349		$	28,164

	Three Months Ended March 31, 2019
	Average Balance		Interest Income Recognized		Cash Basis Income Recognized
Residential Owner Occupied	$	4,552	$	64	$	60
Residential Non Owner Occupied		2,080		30		32
Total Residential Real Estate		6,632		94		92
CRE Owner Occupied		7,365		166		132
CRE Non Owner Occupied		1,989		33		26
Multi-Family Real Estate		1,332		20		20
Agriculture Land		12,903		206		197
Other CRE		1,154		34		33
Total Commercial Real Estate		24,743		459		408
Construction		—		—		—
Commercial Working Capital		8,089		143		91
Agriculture Production		—		—		—
Commercial Other		1,870		27		24
Total Commercial		9,959		170		115
Home Equity and Improvement		921		14		13
Consumer Finance		36		1		1
Total Impaired Loans	$	42,291	$	738	$	629

	March 31, 2020
	Real Estate		Equipment and Machinery		Inventory and Receivables		Vehicles		Total
Real Estate:
Residential	$	1,505	$	—	$	—	$	—	$	1,505
Commercial		18,688		—		—		—		18,688
Construction		—		—		—		—		—

Other Loans:
Commercial		440		4,010		1,285		332		6,067
Home equity and improvement		1		—		—		—		1
Consumer finance		—		—		—		72		72

Total	$	20,634	$	4,010	$	1,285	$	404	$	26,333

	Current		30 - 59 days		60 - 89 days		90 + days		Total Past Due		Total Non- Accrual
Real Estate:
Residential		1,242,282		2,649		1,303		—		3,952		2,985
Commercial		2,160,018		57		5		—		62		5,196
Construction		310,783		8		—		—		8		—

Other Loans:
Commercial		867,758		124		125		—		249		3,961
Home equity and improvement		292,442		2,490		218		—		2,708		—
Consumer finance		131,117		343		29		99		471		728
PCD		66,286		2,393		795		—		3,188		19,723

Total Loans	$	5,070,686	$	8,064	$	2,475	$	99	$	10,638	$	32,593

	Loans Modified as a TDR for the Three Months Ended March 31, 2020 ($ in thousands)
Troubled Debt Restructurings	Number of Loans		Recorded Investment (as of period end)
Real Estate:
Residential		2	$	378
Commercial		1		93
Construction		—		—

Other Loans:
Commercial		5		156
Home equity and improvement		1		26
Consumer finance		—		—

Total		9	$	653

	Three Months Ended March 31, 2020
	($ in thousands)
Troubled Debt Restructurings That Subsequently Defaulted	Number of Loans		Recorded Investment (as of period end)
Real Estate:
Residential		3	$	268
Commercial		1		172
Construction		—		—

Other Loans:
Commercial		1		132
Home equity and improvement		1		146
Consumer finance		—		—

Total		6	$	718

Class	Pass		Special Mention		Substandard		Doubtful		Not Graded		Total
Real Estate:
Residential		1,046,718		390		3,685		—		198,426		1,249,219
Commercial		2,108,684		28,045		27,272		—		1,275		2,165,276
Construction		290,253		—		—		—		20,538		310,791

Other Loans:
Commercial		839,917		20,477		11,574		—		—		871,968
Home equity and improvement		194,262		—		322		—		100,566		295,150
Consumer finance		100,059		—		31		13		32,213		132,316
PCD		27,851		21,151		40,195		—		—		89,197

Total Loans	$	4,607,744	$	70,063	$	83,079	$	13	$	353,018	$	5,113,917

Portfolio Segments	Loan Pool	Methodology	Loss Drivers
Residential real estate	1-4 Family nonowner occupied	DCF	National unemployment
	1-4 Family owner occupied	DCF	National unemployment
Commercial real estate	Commercial real estate nonowner occupied	DCF	National unemployment
	Commercial real estate owner occupied	DCF	National unemployment
	Multi Family	DCF	National unemployment
	Agriculture Land	DCF	National unemployment
	Other commercial real estate	DCF	National unemployment
Construction secured by real estate	Construction	PD/LGD	Call report loss history

Commercial	Commercial working capital	PD/LGD	Call report loss history
	Agriculture production	PD/LGD	Call report loss history
	Other commercial	PD/LGD	Call report loss history
Home equity and improvement	Home equity and improvement	PD/LGD	Call report loss history
Consumer finance	Consumer finance	Remaining life	Call report loss history

	2020
Par value of acquired loans at acquisition	$	2,314,588
Credit discount		34,610
Non-credit discount/(premium) at acquisition		(8,497	)
Purchase price of loans at acquisition	$	2,340,701

	Loan Balance		ACL Balance
	(In Thousands)
Real Estate:
Residential	$	17,651	$	1,345
Commercial		37,070		3,935
Construction		1,034		52
		55,755		5,332
Other Loans:
Commercial		25,921		2,255
Home equity and improvement		6,268		258
Consumer finance		1,253		64
		33,442		2,577
Total	$	89,197	$	7,909


	March 31, 2020		December 31, 2019
Commitments to make loans	$	361,397	$	178,811
Unused lines of credit		895,487		433,109
Standby letters of credit		12,745		14,215
Total	$	1,269,629	$	626,135

	Before Tax Amount		Tax (Expense) Benefit			Net of Tax Amount
	(In Thousands)
Three months ended March 31, 2020:
Securities available for sale and transferred securities:
Change in net unrealized gain/loss during the period	$	9,458	$	(1,985	)	$	7,473
Reclassification adjustment for net gains included in net income		—		—			—
Defined benefit postretirement medical plan:
Reclassification adjustment for deferred tax on defined benefit postretirement medical plan		—		—			—
Total other comprehensive loss	$	9,458	$	(1,985	)	$	7,473

	Before Tax Amount		Tax Expense (Benefit)			Net of Tax Amount
	(In Thousands)
Three months ended March 31, 2019:
Securities available for sale:
Change in net unrealized gain/loss during the period	$	4,603	$	(968	)	$	3,635
Reclassification adjustment for net gains included in net income		—		—			—
Defined benefit postretirement medical plan:
Reclassification adjustment for deferred tax on defined benefit
Postretirement medical plan		—		82			82
Total other comprehensive loss	$	4,603	$	(886	)	$	3,717

	Securities Available For Sale			Post- retirement Benefit			Accumulated Other Comprehensive Income (Loss)
	(In Thousands)
Balance January 1, 2020	$	4,839		$	(244	)	$	4,595
Other comprehensive income before reclassifications		7,473			—			7,473
Amounts reclassified from accumulated other comprehensive income		—			—			—

Net other comprehensive income during period		7,473			—			7,473

Balance March 31, 2020	$	12,312		$	(244	)	$	12,068

Balance January 1, 2019	$	(2,057	)	$	(91	)	$	(2,148	)
Other comprehensive income (loss) before reclassifications		3,635			—			3,635
Amounts reclassified from accumulated other comprehensive income		—			82			82

Net other comprehensive income during period		3,635			82			3,717

Balance March 31, 2019	$	1,578		$	(9	)	$	1,569

	January 31, 2020
	(In Thousands)

Cash Consideration	$	132
Equity - Dollar Value of Issued Shares		526,875
Fair Value of Total Consideration Transferred		527,007

Recognized Amounts of Identifiable Assets Acquired and Liabilities Assumed:
Cash and Cash Equivalents		52,580
Securities available for sale		262,753
Net loans, including loans held for sale and allowance		2,340,701
FHLB Stock		12,753
Office Properties and Equipment		21,216
Intangible Assets		33,014
Bank Owned Life Insurance		65,934
Mortgage Servicing Rights		9,747
Accrued Interest Receivable and Other Assets		34,452
Deposits - Non-Interest Bearing		(430,921	)
Deposits - Interest Bearing		(1,651,669	)
Advances from FHLB		(381,000	)
Deferred tax liability		(2,262	)
Accrued Interest Payable and Other Liabilities		(57,742	)
Total Identifiable Net Assets		309,556

Goodwill	$	217,451

	Pro Forma Three Months Ended March 31,
	2020			2019
	(In Thousands)
Net interest income	$	53,380		$	52,460
Provision for credit losses		(17,831	)		(273	)
Non-interest income		17,281			16,796
Non-interest expense		(41,141	)		(43,946	)
Income (loss) before income taxes		11,689			25,037
Income tax benefit (expense)		(2,734	)		(4,498	)
Net income (loss)	$	8,955		$	20,539
Diluted earnings per share	$	0.24		$	0.54

	March 31,			December 31,
	2020			2019
	(In Thousands)
Non-performing loans:
One to four family residential real estate	$	6,707		$	2,411
Non-residential and multi-family residential real estate		19,386			7,609
Commercial		3,961			2,961
Home equity and improvement		1,299			449
Consumer finance		1,240			7
Total non-performing loans		32,593			13,437

Real estate owned		548			100
Total repossessed assets		548			100

Total Nonperforming assets	$	33,141		$	13,537
TDR loans, accruing				$	8,486

Total nonperforming assets as a percentage of total assets		0.51	%		0.39	%
Total nonperforming loans as a percentage of total loans*					0.49	%
Total nonperforming assets as a percentage of total loans plus REO*		0.65	%		0.49	%
ACL as a percent of total nonperforming assets		259.07	%		230.80	%

	For the Three Months Ended March 31, 2020						As of March 31, 2020
	Net Charge-offs (Recovery)			% of Total Net Charge-offs			Nonaccrual Loans		% of Total Non- Accrual Loans
	(In Thousands)						(In Thousands)
Residential	$	83			(10.67	)%	$	6,707		20.58	%
Construction		—			—			—		—
Multi-Family residential and Commercial real estate		(324	)		41.65	%		19,386		59.48	%
Commercial		(573	)		73.65	%		3,961		12.15	%
Consumer Finance		48			(6.17	)%		1,240		3.80	%
Home equity and improvement		(12	)		1.54	%		1,299		3.99	%
Total	$	(778	)		100.00	%	$	32,593		100.00	%

	For the Three Months Ended March 31, 2019						As of March 31, 2019
	Net Charge-offs (Recovery)			% of Total Net Charge-offs			Nonaccrual Loans		% of Total Non-Accrual Loans
	(In Thousands)						(In Thousands)
Residential	$	159			41.70	%	$	3,184		18.04	%
Construction		—			0.00	%		—		0.00	%
Commercial real estate		(96	)		(25.33	)%		9,460		53.61	%
Commercial		175			46.17	%		4,358		24.70	%
Consumer		132			35.09	%		38		0.22	%
Home equity and improvement		9			2.37	%		605		3.43	%
Total	$	379			100.00	%	$	17,645		100.00	%

	For the Quarter Ended
	1st 2020			4th 2019		3rd 2019		2nd 2019			1st 2019
	(In Thousands)
Allowance at beginning of period	$	31,243		$	30,250	$	28,934	$	28,164		$	28,331
Impact of ASC 326 adoption		2,354			—		—		—			—
Acquisition related allowance for credit losses (PCD)		7,698			—		—		—			—
Provision for credit losses		43,786			1,084		1,327		282			212
Charge-offs:
Residential		184			258		74		11			172
Multi-Family residential and Commercial real estate		16			133		—		15			—
Commercial		96			303		25		13			187
Consumer finance		108			34		80		33			142
Home equity and improvement		30			136		12		64			33
Total charge-offs		434			864		191		136			534
Recoveries		1,212			773		180		624			155
Net charge-offs		(778	)		91		11		(488	)		379
Ending allowance	$	85,859		$	31,243	$	30,250	$	28,934		$	28,164