General
First Defiance Financial Corp. ("First Defiance" or "the Company") is a holding company which conducts business through its two wholly owned subsidiaries, First Federal Bank of the Midwest ("First Federal") and First Insurance and Investments, Inc. ("First Insurance"). First Federal is a federally chartered savings bank that provides financial services through 36 full-service branches in communities based in northwest Ohio, northeast Indiana, and southeastern Michigan. On March 14, 2008, First Defiance completed the acquisition of Pavilion Bancorp, Inc. ("Pavilion"), which added eight banking centers in southeast Michigan, expanding the Company's reach to markets adjacent to its existing branch network. First Federal provides a broad range of financial services including checking accounts, savings accounts, certificates of deposit, real estate mortgage loans, commercial loans, consumer loans, home equity loans and trust services. First Insurance sells a variety of property and casualty, group health and life, and individual health and life insurance products and investment and annuity products. Insurance products are sold through First Insurance's offices in Defiance and Bowling Green, Ohio while investment and annuity products are sold through registered investment representatives located at certain First Federal banking center locations.

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

Securities are classified as held-to-maturity when First Defiance has the positive intent and ability to hold the security to maturity. Held-to-maturity securities are stated at amortized cost and had a recorded value of $978,000 at September 30, 2008. Securities not classified as held-to-maturity are classified as available-for-sale, which are stated at fair value and had a recorded value of $113.0 million at September 30, 2008. The available-for-sale portfolio consists of U.S. Treasury securities and obligations of U.S. Government corporations and agencies ($15.8 million), certain municipal obligations ($34.0 million), CMOs and REMICs ($24.9 million), mortgage backed securities ($35.5 million) and preferred stock ($2.8 million).

In accordance with SFAS No. 115, unrealized holding gains and losses deemed temporary on available-for-sale securities are reported in a separate component of stockholders' equity, net of tax, and are not reported in earnings until realized. Net unrealized holding losses on available-for-sale securities were $6.4 million at September 30, 2008. The impact to stockholders' equity of unrealized losses on available-for-sale securities was $4.2 million after considering the related deferred tax liability.

The profitability of First Defiance is primarily dependent on its net interest income and non-interest income. Net interest income is the difference between interest income on interest-earning assets, principally loans and securities, and interest expense on interest-bearing deposits, Federal Home Loan Bank advances, and other borrowings. The Company's non-interest income includes

deposit and loan servicing fees, mortgage banking income, and insurance commissions. First Defiance's earnings also depend on the provision for loan losses and non-interest expenses, such as employee compensation and benefits, occupancy and equipment expense, deposit insurance premiums, and miscellaneous other expenses, as well as federal income tax expense.

Participation in the Treasury Capital Purchase Plan

On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 ("EESA"), which provides the U.S. Secretary of the Treasury with broad authority to deploy up to $750 billion into the financial system to help restore stability and liquidity to U.S. capital and credit markets. On October 24, 2008, Treasury announced plans to direct up to $250 billion of the EESA funding to the Treasury Capital Purchase Program ("CPP"), which provides for a direct equity investment through the purchase by the Treasury of perpetual preferred stock in participating financial institutions. Companies participating in the CPP must comply with a number of operating restrictions, including limits on executive compensation, stock redemptions and increases in cash dividends.

The CPP provides for a minimum investment of 1% of risk-weighted assets, with a maximum investment equal to the lesser of 3% of total risk-weighted assets or $25 billion. The perpetual preferred stock investment will have a dividend rate of 5% per year, until the fifth anniversary of the Treasury investment, and a dividend of 9%, thereafter. The preferred stock cannot be redeemed for three years unless the issuer raises a specified amount of private capital, The CPP also requires participating institutions to issue to the Treasury warrants for common stock equal to 15% of the capital invested by the Treasury.

Participation in the program is voluntary and subject to approval by the Treasury. Applications must be submitted by November 14, 2008 and are subject to approval by the Treasury. The Company has filed an application to participate in this program, but no assurance can be given that the Company will receive approval.

Forward-Looking Information

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

Changes in Financial Condition

At September 30, 2008, First Defiance's total assets, deposits and stockholders' equity amounted to $1.92 billion, $1.44 billion and $189.7 million, respectively, compared to $1.61 billion, $1.22 billion and $166.0 million, respectively, at December 31, 2007.

Net loans receivable (excluding loans held for sale) increased $297.1 million to $1.57 billion at September 30, 2008 compared to $1.28 billion at December 31, 2007. The increase included increases in commercial real estate loans (up $166.1 million), commercial loans (up $70.4 million), one-to-four family residential real estate loans (up $20.7 million), home equity and improvement loans (up $30.9 million), construction loans (up $19.1 million), and consumer loans (up $4.2 million). Of the $297.1 million increase in loans receivable, $232.6 million was the result of the Pavilion acquisition. The remaining growth is primarily in the commercial and non-residential real estate loan categories and is the result of strong loan demand in the Company's market area.

The investment securities portfolio increased $527,000 to $114.0 million at September 30, 2008 from $113.5 million at December 31, 2007. The increase is the result of $26.0 million of securities being purchased during the first nine months of 2008 mostly offset by $18.0 million of securities being matured or called in the period and principal pay downs of $6.8 million in CMO's and mortgage-backed securities. First Defiance also acquired $9.1 million of investment securities through the Pavilion acquisition. The unrealized loss in the investment portfolio was $6.4 million at September 30, 2008 compared to an unrealized gain of $560,000 at December 31, 2007.

Deposits increased from $1.22 billion at December 31, 2007 to $1.44 billion as of September 30, 2008. Of the $217.9 million increase, non-interest bearing demand deposits increased $36.6 million to $158.1 million, savings deposits increased $39.1 million to $145.0 million, interest-bearing demand deposits and money market accounts increased $22.9 million to $365.3 million, and retail time deposits increased $119.3 million to $767.4 million. The Pavilion acquisition added $209.0 million in deposits as of March 14, 2008 which consisted of $45.6 million in non-interest-bearing demand deposits, $39.7 million in interest-bearing demand deposits, $26.2 million in savings, and $97.9 million in retail time deposits.

The FHLB advances increased $34.1 million to $173.6 million at September 30, 2008 from $139.5 million at December 31, 2007. First Defiance added $19.0 million in putable advances during the first quarter of 2008 which have attractive rates with one to two year lock-out periods before they can be called by the FHLB. First Defiance also acquired $6.2 million of advances in the Pavilion acquisition, all of which matured during the 2008 second quarter. The balance of the increase in outstanding FHLB advances is in overnight advances. The higher level of advances has funded loan growth during the first nine months of 2008.

Stockholders' equity increased from $166.0 million at December 31, 2007 to $189.7 million at September 30, 2008. The increase is primarily the result of issuing 1,036,861 shares of common stock valued at $26.117 per common share to Pavilion shareholders. The Company also recorded net income of $6.5 million, realized $768,000 of proceeds from stock option exercises, declared $6.3 million of cash dividends, and repurchased $635,000 of treasury shares.

High Loan-to-Value Mortgage Loans

The majority of First Defiance's mortgage loans are collateralized by one-to-four family residential real estate and have loan-to-value ratios of 80% or less. First Federal usually requires residential mortgage loan borrowers whose loan-to-value is greater than 80% to purchase private mortgage insurance (PMI). First Federal does originate and retain a limited number of residential mortgage loans with loan-to-value ratios that exceed 80% where PMI is not required if the

borrower possesses other demonstrable strengths. The loan-to-value ratios on these loans are generally limited to 85% and exceptions must be approved by First Federal's senior loan committee. Management monitors the balance of one-to-four family residential loans, including home equity loans and committed lines of credit that exceed certain loan-to-value standards (90% for owner occupied residences, 85% for non-owner occupied residences and one-to-four family construction loans, 75% for developed land and 65% for raw land). Total loans that exceed those standards at September 30, 2008 totaled $35.2 million. These loans are generally paying as agreed. First Defiance does not make interest-only first mortgage residential loans, nor does it have residential mortgage loan products, or other consumer products, that allow negative amortization.

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

                                                              Three Months Ended September 30,
                                                  2008                                                2007
                               Average                             Yield/          Average                             Yield/
                               Balance         Interest(1)        Rate(2)          Balance         Interest(1)        Rate(2)
Interest-earning assets:
Loans receivable             $ 1,585,489      $      24,934            6.26 %    $ 1,244,531      $      22,995            7.33 %
Securities                       118,502              1,636            5.31          112,645              1,615            5.66
Interest-earning deposits          2,231                  5            0.89           21,760                262            4.78
FHLB stock and other              21,121                301            5.67           18,585                305            6.51
Total interest-earning
assets                         1,727,343             26,876            6.18        1,397,521             25,177            7.14
Non-interest-earning
assets                           201,644                                             152,653
Total assets                 $ 1,928,987                                         $ 1,550,174

Interest-bearing
liabilities:
Deposits                     $ 1,268,016      $       7,658            2.40 %    $ 1,074,413      $      10,536            3.89 %
FHLB advances and other          174,343              1,603            3.66          128,597              1,636            5.05
Notes payable                     64,368                555            3.43           24,935                193            3.07
Subordinated debentures           36,228                461            5.06           36,295                597            6.53
Total interest-bearing
liabilities                    1,542,955             10,277            2.65        1,264,240             12,962            4.07
Non-interest bearing
deposits                         169,257                  -                          103,181                  -
Total including
non-interest bearing
demand deposits                1,712,212             10,277            2.39        1,367,421             12,962            3.76
Other
non-interest-bearing
liabilities                       22,323                                              18,002
Total liabilities              1,734,535                                           1,385,423
Stockholders' equity             194,452                                             164,751
Total liabilities and
stock-
holders' equity              $ 1,928,987                                         $ 1,550,174
Net interest income;
interest
rate spread                                   $      16,599            3.53 %                     $      12,215            3.07 %
Net interest margin (3)                                                3.81 %                                              3.47 %
Average interest-earning
assets
to average
interest-bearing
liabilities                                                             112 %                                               111 %


________________________

(2) Annualized

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

                                                              Nine Months Ended September 30,
                                                  2008                                                2007
                               Average                             Yield/          Average                             Yield/
                               Balance         Interest(1)        Rate(2)          Balance         Interest(1)        Rate(2)
Interest-earning assets:
  Loans receivable           $ 1,485,455      $      72,297            6.50 %    $ 1,233,987      $      67,916            7.36 %
  Securities                     118,908              4,959            5.50          112,466              4,795            5.68
  Interest-earning
deposits                           6,311                119            2.52           12,461                483            5.18
  FHLB stock and other            20,199                797            5.27           18,585                898            6.46
  Total interest-earning
assets                         1,630,873             78,172            6.40        1,377,499             74,092            7.19
Non-interest-earning
assets                           193,324                                             151,905
  Total assets               $ 1,824,197                                         $ 1,529,404

Interest-bearing
liabilities:
  Deposits                   $ 1,210,631      $      23,851            2.63 %    $ 1,053,810      $      30,130            3.82 %
  FHLB advances and other        161,891              4,803            3.96          139,087              5,253            5.05
  Notes payable                   48,018              1,217            3.39           22,920                519            3.03
  Subordinated debentures         36,245              1,445            5.33           31,147              1,518            6.52
  Total interest-bearing
liabilities                    1,456,785             31,316            2.87        1,246,964             37,420            4.01
Non-interest bearing
deposits                         155,000                  -                          100,908                  -
Total including
non-interest bearing
  demand deposits              1,611,785             31,316            2.60        1,347,872             37,420            3.71
Other
non-interest-bearing
liabilities                       25,082                                              18,042
  Total liabilities            1,636,867                                           1,365,914
Stockholders' equity             187,330                                             163,490
  Total liabilities and
stock-
    holders' equity          $ 1,824,197                                         $ 1,529,404
Net interest income;
interest
  rate spread                                 $      46,856            3.53 %                     $      36,672            3.18 %
Net interest margin (3)                                                3.83 %                                              3.56 %
Average interest-earning
assets
  to average
interest-bearing
  liabilities                                                           112 %                                               110 %


________________________________

(2) Annualized

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

Results of Operations

Three Months Ended September 30, 2008 and 2007

First Defiance's net income for the quarter ended September 30, 2008 was $322,000 compared to income of $3.1 million for the comparable period in 2007. Basic and diluted earnings per share for the three months ended September 30, 2008 were both $0.04 compared to basic and diluted earnings per share of $0.44 for the quarter ended September 30, 2007.

Net Interest Income.

The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by First Federal and many other financial institutions. The targeted federal funds rate, which is established by the Federal Reserve Board's Open Market Committee, lowered the target rate by 1.0% in 2007 and by an additional 2.25% during the first nine months of 2008, to 2.00%. The targeted federal funds rate drives the Company's pricing of a substantial balance of loans in the commercial and home equity portfolios. First Defiance managed the impact of the change in the prime rate by effectively managing its deposit rates and by changing the mix of its interest-bearing liabilities.

Net interest income was $16.4 million for the third quarter of 2008 compared to $12.0 million in the third quarter of 2007. Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, is the most significant component of First Defiance's earnings and is affected by changes in the volumes, rates and composition of interest-earning assets and interest-bearing liabilities. For the third quarter of 2008, total interest income was $26.6 million, a $1.7 million increase over the third quarter of 2007. The increase in interest income was due to a $329.8 million increase in average earning assets, offset by a decline of 96 basis points in the yield of those assets. The amount of interest income recognized was also impacted in the third quarter of 2008 by an increase in the balance of loans that were delinquent by more than 90 days. It is the Company's policy to reverse interest accrued on loans when they become 90 days past due. As a result of the increase in these non-performing loans, interest income was reduced by $550,000 in the third quarter of 2008 compared to $325,000 for the same period in 2007.

Interest expense was $10.3 million for the third quarter of 2008 compared to $13.0 million in the third quarter of 2007. The majority of the decrease in interest expense occurred in interest-bearing deposits, where despite average balances increasing $193.6 million to $1.268 billion for the third quarter of 2008, the cost of that funding decreased 149 basis points between the 2007 and 2008 third quarters, to 2.40% from 3.89%.

Net interest margin for the quarter ended September 30, 2008 was 3.81%, a 34 basis point improvement from the 2007 third quarter margin of 3.47%. The Company's interest rate spread improved to 3.53% in the 2008 third quarter compared to 3.07% in the same 2007 quarterly period. The margin was favorably impacted by an increase in the average balance of non-interest bearing deposits, which were $169.3 million in the third quarter of 2008 compared to $103.2 million in the same period in 2007. The Pavilion acquisition had a favorable impact on the margin as Pavilion had historically operated at a higher margin than First Defiance.

Provision for Loan Losses.

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management's estimation, is necessary to absorb probable credit losses within the existing loan portfolio. The provision for loan losses was $4.9 million in the third quarter of 2008 compared to $671,000 for the third quarter of 2007. The period over period increase was primarily as attributable to thirty credits which accounted for $3.1 million of provision expense in the 2008 third quarter. Charge-offs for the third quarter of 2008 were $2.3 million and recoveries of previously charged off loans totaled $101,000 for net charge-offs of $2.2 million. By comparison, $749,000 of charge-offs were recorded in the 2007 third quarter and $88,000 of recoveries were realized for net charge-offs of $661,000. As a percentage of average loans, annualized net charge-offs were 0.55% for the third quarter of 2008 compared to 0.21% in the same period in 2007.

Non-performing assets, which include non-accrual loans, restructured loans, and real estate owned, increased to $30.3 million at September 30, 2008 from $11.9 million at September 30, 2007 and from $11.7 million at December 31, 2007. Non-performing assets and asset quality ratios for First Defiance were as follows at September 30, 2008 and December 31, 2007:

                                                September 30,        December 31,
                                                    2008                 2007
                                                         (in thousands)
   Non-accrual loans                           $        24,630      $        9,217
   Restructured loans, accruing                            905                   -
   Total non-performing loans                  $        25,535      $        9,217
   Real estate and other assets held for
   sale                                                  4,776               2,460
   Total non-performing assets                 $        30,311      $       11,677

   Allowance for loans losses as a
   percentage of total loans                              1.47 %              1.08 %
   Allowance for loan losses as a
   percentage of non-
   performing assets                                     77.35 %            118.95 %
   Allowance for loan losses as a
   percentage of non-
   performing loans                                      91.82 %            150.70 %
   Total non-performing assets as a
   percentage of total assets                             1.58 %              0.73 %
   Total non-performing loans as a
   percentage of total loans                              1.60 %              0.71 %

Of the $24.6 million in non-accrual loans, $5.4 million were 1-4 family residential loans, $18.8 million were commercial or commercial real estate loans and $400,000 were home equity or consumer loans.

Included in the non-performing assets at September 30, 2008 are $8.8 million in non-accrual loans and $3.0 million in REO related to the former Pavilion operation. Excluding the acquired assets, the Company's overall non-performing assets have increased by $6.8 million since the beginning of 2008.

Certain impaired loans acquired in an acquisition are recorded at fair value in accordance with AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a

Transfer ("SOP 03-3"), net of any expected credit losses. As such, these loans are included in the non-performing loan balances without any offsetting allowance for loan losses. Such impairment discounts totaled $4.1 million at September 30, 2008 and are reflected in the net loan receivable for the period ended September 30, 2008.

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