Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


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

For the quarterly period ended: SEPTEMBER 30, 2011


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

Commission file number: 0-22387

DCB Financial Corp

(Exact name of registrant as specified in its charter)


Ohio		31-1469837
(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

110 Riverbend Avenue, Lewis Center, Ohio 43035
(Address of principal executive offices)

(740) 657-7000

(Registrant’s telephone number)

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 þ No o

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

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


Large accelerated filers o		Accelerated filer o		Non-accelerated filer o		Smaller reporting company þ

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

As of Nov 4, 2011, the latest practicable date, 3,717,385 shares of the registrant’s no par value common stock were issued and outstanding.

DCB FINANCIAL CORP

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)


Item 1.		Financial Statements


	September 30,			December 31,
	2011			2010
	(unaudited)
ASSETS
Cash and due from financial institutions	$	11,996		$	10,024
Interest-bearing deposits		30,294			23,497

Total cash and cash equivalents		42,290			33,521
Securities available-for-sale		84,701			69,597
Securities held-to-maturity		1,267			1,313

Total securities		85,968			70,910
Loans held for sale, at lower of cost or fair value		63			753
Loans		380,638			424,864
Less allowance for loan losses		(10,195	)		(12,247	)

Net loans		370,443			412,617
Real estate owned		5,024			5,284
Investment in FHLB stock		3,799			3,799
Premises and equipment, net		12,317			13,175
Bank-owned life insurance		17,658			17,073
Accrued interest receivable and other assets		6,100			7,973

Total assets	$	543,662		$	565,105


LIABILITIES
Deposits
Noninterest-bearing	$	69,535		$	63,695
Interest-bearing		382,450			401,381

Total deposits		451,985			465,076
Federal funds purchased and other short-term borrowings		1,296			1,265
Federal Home Loan Bank advances		50,816			58,502
Accrued interest payable and other liabilities		2,665			2,848

Total liabilities		506,762			527,691

SHAREHOLDERS’ EQUITY
Common stock, no par value, 7,500,000 shares authorized, 4,273,908 issued		3,785			3,785
Retained earnings		46,339			47,883
Treasury stock, at cost, 556,523 shares		(13,494	)		(13,494	)
Accumulated other comprehensive income (loss)		270			(760	)

Total shareholders’ equity		36,900			37,414

Total liabilities and shareholders’ equity	$	543,662		$	565,105

See Notes to condensed consolidated financial statements.

DCB FINANCIAL CORP

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share data)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010
Interest and dividend income
Loans	$	4,948		$	6,097		$	15,382		$	18,856
Taxable securities		550			621			1,600			2,026
Tax-exempt securities		72			145			252			526
Federal funds sold and other		27			33			84			79

Total interest income		5,597			6,896			17,318			21,487

Interest expense
Deposits		713			1,056			2,112			3,408
Borrowings		556			686			1,778			2,069

Total interest expense		1,269			1,742			3,890			5,477


Net interest income		4,328			5,154			13,428			16,010

Provision for loan losses		625			4,531			3,836			9,878


Net interest income after provision for loan losses		3,703			623			9,592			6,132

Noninterest income
Service charges on deposit accounts		697			652			2,076			1,915
Trust department income		223			225			688			718
Net gain on sales of securities		—			63			—			143
Net gain (loss) on sale of assets		(98	)		28			(2	)		114
Gains on sale of loans		23			144			61			251
Treasury management fees		69			117			263			361
Data processing servicing fees		79			163			506			463
Earnings on bank owned life insurance		169			167			585			577
Total other-than-temporary impairment losses		—			—			(75	)		(80	)
Portion of loss reclassified from other comprehensive loss (before taxes)		—			—			(17	)		(950	)

Net impairment losses recognized in income		—			—			(92	)		(1,030	)
Other		167			152			492			428

Total noninterest income		1,329			1,711			4,577			3,940

Noninterest expense
Salaries and other employee benefits		2,255			2,611			7,427			7,834
Occupancy and equipment		960			1,104			2,907			3,149
Professional services		371			475			1,132			1,178
Advertising		89			121			266			294
Postage, freight and courier		61			77			219			286
Supplies		43			43			130			102
State franchise taxes		98			152			348			456
Federal deposit insurance premiums		319			375			1,208			1,167
Other		799			1,284			2,610			3,001

Total noninterest expense		4,995			6,242			16,247			17,467


Net income (loss) before income tax expense (credits)		37			(3,908	)		(2,078	)		(7,395	)
Income tax expense (credits)		(239	)		5,151			(531	)		4,580

Net income (loss)	$	276		$	(9,059	)	$	(1,547	)	$	(11,975	)


Basic and diluted income (loss) per common share	$	0.07		$	(2.44	)	$	(0.42	)	$	(3.22	)

Dividends per share	$	—		$	—		$	—		$	—

See Notes to the condensed consolidated financial statements.

DCB FINANCIAL CORP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)


	Nine Months Ended
	September 30,
	2011			2010

Cash flows provided by operating activities	$	(2,789	)	$	1,474

Cash flows provided by investing activities
Securities
Purchases		(34,493	)		(19,734	)
Maturities, principal payments and calls		20,583			25,739
Sales		—			9,435
Net change in loans		44,228			32,895
Proceeds from sale of real estate owned		2,083			2,465
Investment in unconsolidated affiliate		—			(184	)
Premises and equipment expenditures		(97	)		(334	)

Net cash flows provided by investing activities		32,304			50,282


Cash flows used in financing activities
Net change in deposits		(13,091	)		(45,633	)
Net change in federal funds purchased and other short-term borrowings		31			(1,912	)
Repayment of Federal Home Loan Bank advances		(7,686	)		(3,761	)

Net cash used in financing activities		(20,746	)		(51,306	)


Net change in cash and cash equivalents		8,769			450

Cash and cash equivalents at beginning of period		33,521			41,453


Cash and cash equivalents at end of period	$	42,290		$	41,903


Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest on deposits and borrowings	$	3,878		$	4,885

Supplemental disclosure of non-cash investing and financing activities:
Transfers from loans to real estate owned	$	1,782		$	2,356

Cash dividends declared but unpaid	$	—		$	—

See Notes to the condensed consolidated financial statements.

DCB FINANCIAL CORP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Dollars in thousands, except per share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These consolidated interim financial statements are prepared without audit and reflect all adjustments which, in the opinion of management, are necessary to present fairly the financial position of DCB Financial Corp (the “Corporation”) at September 30, 2011, and its results of operations and cash flows for the nine month periods ended September 30, 2011 and 2010. All such adjustments are normal and recurring in nature. The accompanying consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not purport to contain all necessary financial disclosures required by accounting principles generally accepted in the United States of America that might otherwise be necessary in the circumstances, and should be read in conjunction with the consolidated financial statements, and notes thereto, included in its Annual Report as of December 31, 2010. Refer to the accounting policies of the Corporation described in the Notes to Consolidated Financial Statements contained in the Corporation’s Annual Report as of December 31, 2010. The Corporation has consistently followed these policies in preparing this Form 10-Q. The results of operations for the three and nine month periods ended September 30, 2011, are not necessarily indicative of the results that may be expected for the entire year.

The accompanying consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, The Delaware County Bank and Trust Company (the “Bank”), DCB Title Services LLC, Datatasx LLC, DCB Insurance Services, Inc. and ORECO (collectively referred to herein after as the “Corporation”). All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements. Management considers the Corporation to operate within one business segment, banking. In the second quarter of 2011, Management entered into an agreement to sell the outstanding contracts serviced through Datatasx LLC. Those contracts were converted to the new provider during the third quarter 2011. On a pre-tax net basis, Datatasx contributed approximately $298 in the first three quarters of 2011 to the consolidated companies. Management considers both the net contribution and Datatasx’s balance sheet to be immaterial to financial results on a consolidated basis.

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect amounts reported in the financial statements and disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments and status of contingencies are particularly subject to change. Income tax expense is based on the effective tax rate expected to be applicable for the entire year. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A full valuation allowance was recorded in 2010, reducing the carrying value of the deferred tax assets to $0. The full valuation allowance has remained throughout 2011.

Earnings per share

Earnings per common share is net income divided by the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed including the dilutive effect of additional potential common shares under stock options. Weighted-average shares for basic and diluted earnings per share are presented below.


	Three and Nine Months Ended
	September 30,
	2011		2010
Weighted-average common shares outstanding (basic)		3,717,385		3,717,385

Dilutive effect of assumed exercise of stock options		—		—


Weighted-average common shares outstanding (diluted)		3,717,385		3,717,385

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Options to purchase 233,433 shares of common stock with a weighted-average exercise price of $12.37, were outstanding at September 30, 2011, but were excluded from the computation of common share equivalents for the three and nine month periods then ended because the exercise price was greater than the average fair value of the shares.

Options to purchase 200,742 shares of common stock with a weighted-average exercise price of $19.59, were outstanding at September 30, 2010, but were excluded from the computation of common share equivalents for the three and nine month periods then ended because the exercise price was greater than the average fair value of the shares during the period.

Stock option plan

The Corporation’s shareholders approved an employee share option plan (the “Plan”) in May 2004. This plan grants certain employees the right to purchase shares at a predetermined price. The plan is limited to 300,000 shares. The shares granted to employees vest 20% per year over a five year period. The options expire after ten years. 500 shares were granted during the nine month period ending September 30, 2011, at a weighted average exercise price of $3.35. At September 30, 2011, 93,133 shares were exercisable and 66,567 shares were available for grant under this plan.

The Corporation recognizes compensation cost for unvested equity-based awards based on their grant-date fair value. The fair value of each option was estimated on the date of grant using the modified Black-Scholes options pricing model with the following weighted-average assumptions used for grants: dividend yield of 0.00% for 2010; expected volatility of 12.0% for 2010; risk-free interest rates of 1.00% for 2010; and contractual lives of 10 years for each grant. At September 30, 2011, outstanding options had no intrinsic value. The options that were issued in 2011 were subsequently forfeited so no fair valuation analysis was completed, nor was any expense recognized.

The expected term of the options is based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at the grant date. Volatility is based on historical volatility of the Corporation’s stock.

The Corporation recorded $30 and $26 in compensation cost for equity-based awards for the three month period ending September 30, 2011 and 2010, respectively. The Corporation recorded $90 and $74 in compensation cost for equity-based awards that vested during the nine month periods ended September 30, 2011 and 2010, respectively. The Corporation has $86 of total unrecognized compensation cost related to non-vested equity-based awards granted under its stock option plan as of September 30, 2011, which is expected to be recognized over a weighted-average period of 3.6 years.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

A summary of the status of the Corporation’s stock option plan as of September 30, 2011 and December 31, 2010, and changes during the periods then ended are presented below:


				Nine Months Ended
				September 30,
				2011
						Weighted
				Weighted		Average Remaining
				Average Exercise		Contractual
	Shares			Price		Life

Outstanding at beginning of period		285,806		$	11.87	8.6 years
Granted		500			3.35	9.7 years
Forfeited		(52,873	)		10.48


Outstanding at end of period		233,433		$	12.37	7.3 years


Options exercisable at period end		93,133		$	21.61


Weighted-average fair value of options granted during the year				$	0.01


				Year Ended
				December 31,
				2010
						Weighted
				Weighted		Average Remaining
				Average Exercise		Contractual
	Shares			Price		Life

Outstanding at beginning of year		204,883		$	24.77	8.6 years
Granted		131,816			3.50	9.9 years
Forfeited		(50,893	)		21.30


Outstanding at end of year		285,806		$	11.87	8.6 years


Options exercisable at year end		81,800		$	18.27


Weighted-average fair value of options granted during the year				$	0.76

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

The following information applies to options outstanding at September 30, 2011:


		Range of
Number Outstanding		Exercise Prices

63,738		$23.00 — $30.70
35,377		$14.15 — $16.90
134,318		$3.35 — $9.00

Application of Critical Accounting Policies

DCB’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. The application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; as this information changes, the financial statements could reflect different estimates, assumptions, and judgments.

The procedures for assessing the adequacy of the allowance for loan losses reflect our evaluation of credit risk after careful consideration of all information available to us. In developing this assessment, we must rely on estimates and exercise judgment regarding matters where the ultimate outcome is unknown, such as economic factors, developments affecting companies in specific industries and issues with respect to single borrowers. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or a decrease in the allowance for loan losses.

The allowance is regularly reviewed by management to determine whether the amount is considered adequate to absorb probable losses. This evaluation includes specific loss estimates on certain individually reviewed loans, statistical loss estimates for loan pools that are based on historical loss experience, and general loss estimates that are based upon the size, quality, and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower’s ability to repay, and current economic and industry conditions. Also considered as part of that judgment is a review of the Bank’s trends in delinquencies and loan losses, as well as trends in delinquencies and losses for the region and nationally, and economic factors.

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio. Management’s evaluation of the adequacy of the allowance is an estimate based on management’s current judgment about the credit quality of the loan portfolio. While the Corporation strives to reflect all known risk factors in its evaluations, judgment errors may occur.

The valuation of other assets requires that management utilize a variety of estimates and analysis to determine whether an asset is impaired or other-than-temporarily impaired (“OTTI”). After determining the appropriate methodology for fair value measurement, management then evaluates whether or not declines in fair value below book value are temporary or other-than-temporary impairments. When the Corporation does not intend to sell a debt security, and it is more likely than not, the Corporation will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, unamortized deferred loan fees and costs and the allowance for loan losses.

Interest income is accrued based on the unpaid principal balance and includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual status are reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable but unconfirmed credit losses, increased by the provision for loan losses and decreased by charge-offs net of recoveries. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the required allowance balance based on past loan loss experience, augmented by additional estimates related to the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors.

A loan is impaired when full payment of interest and principal under the original contractual loan terms is not expected. Commercial and industrial loans, commercial and multi-family real estate, and land development loans are individually evaluated for impairment. If a loan is impaired, the loan amount exceeding fair value, based on the most current information available, is reserved. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, such loans are not separately identified for impairment disclosures.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share data)

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)

New Accounting Pronouncements: FASB ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. In April 2011, the FASB issued ASU 2011-02, which provides additional guidance to help creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The amendments in this update are effective for the Corporation beginning in the quarter ended September 30, 2011 and are to be applied retrospectively to January 1, 2011. In addition, the modification disclosures described in ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, which were subsequently deferred by ASU 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings, are effective on a prospective basis beginning in the quarter ended September 30, 2011. The adoption of ASU 2011-02 did not have a material impact on the consolidated financial statements.

FASB ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the “Boards”) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value”. The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the Codification in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The impact of adoption of this ASU is not expected to be material.

FASB ASU 2011-05, Presentation of Comprehensive Income. In June 2011, the FASB issued ASU 2011-05, which provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income, along with a total for other comprehensive income, and a total amount for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. This update should be applied retrospectively effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. As the Corporation currently reports comprehensive income in two separate but consecutive statements with all of the components required by ASU 2011-05, the adoption of this guidance will not have an impact on the consolidated financial statements.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 2 — SECURITIES

The amortized cost and estimated fair values of securities available-for-sale were as follows:

September 30, 2011


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Costs		Gains		Losses			Value

U.S. Government and agency obligations	$	46,789	$	1,573	$	(3	)	$	48,359
State and municipal obligations		10,041		452		—			10,493
Mortgage-backed securities		24,712		1,137		—			25,849


Total	$	81,542	$	3,162	$	(3	)	$	84,701

December 31, 2010


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Costs		Gains		Losses			Value

U.S. Government and agency obligations	$	29,510	$	599	$	(123	)	$	29,986
State and municipal obligations		12,153		193		(84	)		12,262
Mortgage-backed securities		26,290		1,059		—			27,349


Total	$	67,953	$	1,851	$	(207	)	$	69,597

The amortized cost and estimated fair values of securities held-to-maturity were as follows:

September 30, 2011

Adjusted

Gross

Estimated

Amortized

Unrealized

Fair

Cost

Gains

Value

Collateralized Debt Obligations

1,267

1,270

December 31, 2010

Adjusted

Gross

Estimated

Amortized

Unrealized

Fair

Cost

Gains

Value

Collateralized Debt Obligations

1,313

367

1,680

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 2 — SECURITIES (continued)

The table below indicates the length of time individual securities have been in a continuous unrealized loss position at September 30, 2011 and December 31, 2010:

September 30, 2011


	(Less than 12 months)							(12 months or longer)										Total
Description of	Number of		Fair		Unrealized			Number of		Fair		Unrealized		Number of		Fair		Unrealized
Securities	investments		value		losses			investments		value		losses		investments		value		losses

U.S. Government and agency obligations		2	$	2,017	$	(3	)		—	$	—	$	—		2	$	2,017	$	(3	)
State and municipal obligations		—		—		—			—		—		—		—		—		—
Mortgage-backed securities and other		—		—		—			—		—		—		—		—		—


Total securities		2	$	2,017	$	(3	)		—	$	—	$	—		2	$	2,017	$	(3	)

December 31, 2010


	(Less than 12 months)							(12 months or longer)										Total
Description of	Number of		Fair		Unrealized			Number of		Fair		Unrealized		Number of		Fair		Unrealized
Securities	investments		value		losses			investments		value		losses		investments		value		losses

U.S. Government and agency obligations		10	$	9,904	$	(123	)		—	$	—	$	—		10	$	9,904	$	(123	)
State and municipal obligations		9		3,575		(84	)		—		—		—		9		3,575		(84	)
Mortgage-backed securities and other		—		—		—			—		—		—		—		—		—


Total securities		19	$	13,479	$	(207	)		—	$	—	$	—		19	$	13,479	$	(207	)

The unrealized losses on the Corporation’s investments in U.S. Government and agency obligations, state and political subdivision obligations and mortgage-backed securities were caused primarily by changes in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Corporation does not intend to sell the investments and it is not more likely than not the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Corporation does not consider those investments to be other-than-temporarily impaired at September 30, 2011 or December 31, 2010.

The Corporation’s unrealized loss on investments in collateralized debt obligations relates to an original investment of $8,000 in pooled trust securities. The company evaluates those investments on a quarterly basis for other-than-temporary impairment and other unrealized losses due to temporary market factors. The unrealized losses were primarily attributed to: declines in the performance of the underlying collateral due to weakness in the economy, and a lower than investment grade rating by industry analysts.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 2 — SECURITIES (continued)

Credit losses on these securities are calculated by comparing expected discounted cash flows based on performance indicators of the underlying assets in the security to the carrying value of the investment. Because the Corporation does not intend to sell the investment and it is not more likely than not the Corporation will be required to sell the investment before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investment in the securities to be other-than-temporarily impaired at September 30, 2011. Substantially all mortgage-backed securities are backed by pools of mortgages that are insured or guaranteed by the Federal National Mortgage Association (“FNMA”), the Government National Mortgage Association (“GNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”).

At September 30, 2011, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders’ equity other than the pooled trust securities as noted above.

The amortized cost and estimated fair value of all debt securities at September 30, 2011, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are shown separately since they are not due at a single maturity date.


	Available-for-sale				Held-to-maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Due in one year or less	$	—	$	—	$	—	$	—
Due from one to five years		23,185		23,570		—		—
Due from five to ten years		22,659		24,024		—		—
Due after ten years		10,986		11,258		1,267		1,270
Mortgage-backed and related securities		24,712		25,849		—		—

Total	$	81,542	$	84,701	$	1,267	$	1,270

Securities with a fair value of $78,584 at September 30, 2011 were pledged to secure public deposits and other obligations.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY

Allowance for Credit Losses

The allowance consists of both specific and general components. The specific component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the collateral value, or value of expected discounted cash flows of the impaired loan, is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Management utilizes historical loss rates in the calculation by applying weights, so that the most recent data bears a larger impact on future loss rate calculations. Management has the ability to adjust these loss rates by utilizing risk ratings based on current period trends. If current period trends differ either positively or negatively from the given weighted historical loss rates, adjustments can be made. The risk ratings either increase the expected loss rates, or decrease the expected loss rates, depending on the variance on actual versus historical trends. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risking rating data.

Management also utilizes its assessment of general economic conditions, and other localized economic data to more fully support its loan loss estimates. General economic data may include: inflation rates, savings rates and national unemployment rates. Local data may include: unemployment rates; housing starts; real estate valuations; and other economic data specific to the Corporation’s market area. Though not specific to individual loans, these economic trends can have an impact on portfolio performance as a whole.

A loan is impaired when full payment of interest and principal under the original contractual loan terms is not expected. Commercial and industrial loans, commercial real estate, including construction, land development and multi-family real estate loans are individually evaluated for impairment. If a loan is impaired, the loan amount exceeding fair value based on the most current information available is reserved. Management has developed a process by which commercial and commercial real estate loans receiving an internal grade of substandard or doubtful are individually evaluated for impairment through a loan quality review (“LQR”). The LQR details the various attributes of the relationship and collateral and determines based on the most recent available information if a specific reserve needs to be applied and at what level. The LQR process for all loans meeting the specific review criteria is completed on a quarterly basis.

Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, such loans are not separately identified for impairment disclosures. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Uncollectability is usually determined based on a pre-determined number of days in the case of consumer loans, or, in the case of commercial loans, is based on delinquency, collateral and other legal considerations. Consumer loans are charged-off prior to 120 days of delinquency, but could be charged off earlier, depending on the individual circumstances. Mortgage loans are charged down prior to 180 days of delinquency, but could be charged off sooner, again, depending upon individual circumstance. Typically, loans collateralized by consumer real estate are partially charged down to the estimated liquidation value, which is generally based on appraisal less costs to hold and liquidate. Commercial and commercial real estate loans are evaluated for impairment and typically reserved based on the results of the analysis, then subsequently charged down to a recoverable value when loan repayment is deemed to be collateral dependent. Both consumer and commercial loans can be partially charged down depending on a number of factors including: the remaining strength of the borrower and guarantor; the type and value of the collateral, and the ease of liquidating collateral; and whether or not collateral is brought onto the bank’s balance sheet via repossession.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

In the case of commercial and commercial real estate loans, charge-off, partial or whole, takes place when Management determines that full collectability of principal balance is unlikely to occur. Subsequent recoveries, if any, are credited to the allowance. Management’s policies for determining impairment, reserves and charge-offs are reviewed and approved by the Board of Directors on an annual basis, and were not materially changed in 2011. Management estimates the required allowance balance based on past loan loss experience, augmented by additional estimates related to the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors.

An individual loan is placed on a non-accruing status if, in the judgment of Management, it is unlikely that all principal and interest will be received according to the terms of the note. Loans on non-accrual may be eligible to be returned to an accruing status after six months of compliance. However, there are number of factors that could prevent a loan from returning to accruing status, even after remaining in compliance with loan terms for the aforementioned six month period. For example: deteriorating collateral, negative cash flow changes and inability to reduce debt to income ratios.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

The following table depicts the charge-offs, recoveries and provision for various categories of loans in the Corporation’s portfolios and indicates whether loans in those categories were individually or collectively evaluated for impairment. It also provides the dollar amount of reserves allocated to those portfolios based on Management’s analysis. Note that the reduced provision for commercial and industrial loans is the result of loans that were individually evaluated for impairment and assigned reserves in prior periods either improving their credit quality or paying off which subsequently reduced the need for carrying reserves.

Nine Months Ended September 30, 2011


										Residential
										Real Estate
	Consumer and			Commercial and			Commercial			and Home
	Credit Card			Industrial			Real Estate			Equity			Total

Beginning Balance	$	796		$	4,174		$	6,786		$	491		$	12,247

Charge Offs		(458	)		(1,861	)		(3,772	)		(78	)		(6,169	)
Recoveries		197			51			25			8			281
Provision		14			(482	)		4,416			(112	)		3,836


Ending Balance	$	549		$	1,882		$	7,455		$	309		$	10,195


Individually evaluated for impairment	$	—		$	288		$	6,377		$	—		$	6,665
Collectively evaluated for impairment		549			1,594			1,078			309			3,530


Ending Balance	$	549		$	1,882		$	7,455		$	309		$	10,195


Financing Receivables

Individually evaluated for impairment	$	—		$	14,054		$	39,745		$	—		$	53,799
Collectively evaluated for impairment		20,544			118,149			99,512			88,619			326,824


Total	$	20,544		$	132,203		$	139,257		$	88,619		$	380,623

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Impaired Loans

A loan is considered impaired when based on current information and events, it is probable the Bank will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. Generally, commercial and commercial real estate loans with risk grades Substandard, Vulnerable, Doubtful, or Loss, with aggregate relationships greater than $250 are evaluated for impairment. Interest income on impaired loans is recognized when accrued, for loans that remain in a performing status. Loans that are not performing and in a non-accrual status recognize interest only on cash basis if circumstances warrant.

The following tables indicate impaired loans with and without an allocated allowance:

At and for the nine months ended September 30, 2011


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded
Consumer and Credit Card	$	—	$	—	$	—	$	—	$	—
Commercial and Industrial		3,902		3,980		—		4,441		145
Commercial Real Estate		9,900		14,362		—		12,711		281
Residential RE and Home Equity		—		—		—		—		—
With Allowance Recorded
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		10,152		12,336		288		11,384		447
Commercial Real Estate		29,845		35,861		6,377		27,132		1,126
Residential RE and Home Equity		—		—		—		—		—
Total
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		14,054		16,316		288		15,825		592
Commercial Real Estate		39,745		50,223		6,377		39,843		1,407
Residential RE and Home Equity		—		—		—		—		—


Total	$	53,799	$	66,539	$	6,665	$	55,668	$	1,999

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

At and for the year ended December 31, 2010


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded
Consumer and Credit Card	$	—	$	—	$	—	$	—	$	—
Commercial and Industrial		5,615		5,757		—		4,196		295
Commercial Real Estate		17,529		20,855		—		14,597		993
Residential RE and Home Equity		—		—		—		—		—
With Allowance Recorded
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		13,352		15,238		2,812		13,651		741
Commercial Real Estate		24,575		28,823		5,158		25,209		821
Residential RE and Home Equity		—		—		—		—		—
Total
Consumer and Credit Card		—		—		—		—		—
Commercial and Industrial		18,967		20,995		2,812		17,847		1,036
Commercial Real Estate		42,104		49,678		5,158		39,806		1,814
Residential RE and Home Equity		—		—		—		—		—


Total	$	61,071	$	70,673	$	7,970	$	57,653	$	2,850

The allowance for impaired loans is included in the Corporation’s overall allowance for loan losses. The provision necessary to increase this allowance is included in the Corporation’s overall provision for losses on loans.

Financing receivables on nonaccrual status at September 30, 2011 and December 31, 2010 are as follows:


	September 30,		December 31,
	2011		2010

Consumer and credit card	$	46	$	33
Commercial and industrial		3,053		6,043
Commercial real estate		8,722		10,102
Residential real estate and home equity		685		389


Total	$	12,506	$	16,567

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Credit Quality Indicators

Corporate risk exposure by risk profile was as follows at September 30, 2011:


	Commercial and		Commercial Real
Category	Industrial		Estate

Prime-1	$	4,456	$	561
Good-2		17,450		17,918
Fair-3		39,554		30,423
Compromised-4		32,137		42,390
Vulnerable-5		18,794		4,673
Substandard-6		19,812		43,292
Doubtful-7		—		—
Loss-8		—		—


Total	$	132,203	$	139,257

Corporate risk exposure by risk profile was as follows at December 31, 2010:


	Commercial and		Commercial Real
Category	Industrial		Estate

Prime-1	$	8,459	$	561
Good-2		22,355		20,404
Fair-3		45,853		39,067
Compromised-4		31,628		27,692
Vulnerable-5		22,154		11,785
Substandard-6		24,959		52,865
Doubtful-7		2		—
Loss-8		—		—


Total	$	155,410	$	152,374

Risk Category Descriptions

Prime — 1

Prime loans based on liquid collateral, with adequate margin or supported by a strong financial statement audited with an unqualified opinion from a CPA firm. The character and repayment ability of the borrowers are excellent and without question. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans. This classification will also include all loans secured by CDs or cash equivalents.

Good — 2

Good loans of above average quality. Borrowers have a modest degree of risk. The margin of protection is good. Elements of strength are present in areas such as liquidity, stability of margins and cash flows, diversity of assets, and lack of dependence on one type of business or customer. Reasonable access to alternative bank financing is present and borrowers can obtain favorable rates and terms. These are well established regional firms and excellent local companies operating in a reasonably stable industry that may be moderately affected by the business cycle. Management and owners have unquestioned character, as demonstrated by repeated performance.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Fair — 3

Satisfactory loans of average or slightly above average risk — having some deficiency or vulnerability to changing economic conditions, but still fully collectible. Projects should clearly demonstrate at least break even debt service coverage. May be some weakness but with offsetting features of other support readily available. These loans are meeting the terms of repayment, but which may be susceptible to deterioration if adverse factors are encountered.

Compromised — 4

This risk grade may be established for a loan considered satisfactory but which is of below average credit risk due to financial weaknesses or uncertainty. The loans warrant a higher than average level of monitoring to ensure that weaknesses do not advance. The level of risk in Compromised classification is considered acceptable and within normal underwriting guidelines, so long as the loan is given the proper level of management supervision. Loans are considered Compromised when the following conditions apply:

•

At inception, the loan was properly underwritten and did not possess an unwarranted level of credit risk; also the loan met the above criteria for a risk grade of 1 (Prime), 2 (Good), 3 (Fair) or 4 (Compromised).

•

At inception, the loan was secured with collateral possessing a loan-to-value adequate to protect the Bank from loss.

•

The loan exhibited two or more years of satisfactory repayment with a reasonable reduction of the principal balance.

•

During the period that the loan has been outstanding, there has been no evidence of any credit weakness. Some examples of weakness include slow payment, lack of cooperation by the borrower, breach of loan covenants, or the business is in an industry which is known to be experiencing problems. If any of these credit weaknesses is observed, a lower risk grade may be warranted.

Vulnerable (Special Mention) — 5

Loans which possess some credit deficiency or potential weakness which deserves close attention, but which do not yet warrant substandard classification. Such loans pose unwarranted financial risk that, if not corrected, could weaken the loan and increase risk in the future. The key distinctions of a Vulnerable (Special Mention) classification are that (1) it is indicative of an unwarranted level of risk, and (2) weaknesses are considered “potential”, versus “well-defined”, impairments to the primary source of loan repayment.

Substandard — 6

Loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. One or more of the following characteristics may be exhibited in loans classified Substandard:

•

Loans, which possess a defined credit weakness and the likelihood that a loan will be paid from the primary source, is uncertain. Financial deterioration is underway and very close attention is warranted to ensure that the loan is collected without loss.

•

Loans are inadequately protected by the current net worth and paying capacity of the obligor.

•

The primary source of repayment is gone, and the Bank is forced to rely on a secondary source of repayment such as collateral liquidation or guarantees.

•

Loans are characterized by the distinct possibility that the Bank will sustain some loss if deficiencies are not corrected.

•

Unusual courses of action are needed to maintain a high probability of repayment.

•

The borrower is not generating enough cash flow to repay loan principal; however, continues to make interest payments.

•

The lender is forced into a subordinated or unsecured position due to flaws in documentation.

•

Loans have been restructured so that payment schedules, terms and collateral represent concessions to the borrower when compared to the normal loan terms.

•

The lender is seriously contemplating foreclosure or legal action due to the apparent deterioration in the loan.

•

There is a significant deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Doubtful — 7

One or more of the following characteristics may be exhibited in loans classified Doubtful:

•

Loans have all of the weaknesses of those classified as Substandard. Additionally, however, these weaknesses make collection or liquidation in full based on existing conditions improbable.

•

The primary source of repayment is gone, and there is considerable doubt as to the quality of the secondary source of repayment.

•

The possibility of loss is high, but, because of certain important pending factors, which may strengthen the loan, loss classification is deferred until its exact status is known. A Doubtful classification is established during this period of deferring the realization of the loss.

Loss — 8

Loans are considered uncollectible and of such little value that continuing to carry them as assets on the institution’s financial statements is not feasible. Loans will be classified Loss when it is neither practical nor desirable to defer writing off or reserving all or a portion of a basically worthless asset, even though partial recovery may be possible at some time in the future.

Consumer Risk

Consumer risk based on payment activity at September 30, 2011 is as follows.


			Residential Real
	Consumer and		Estate and Home
Payment Category	Credit Card		Equity

Performing	$	20,333	$	87,763
Non-Performing		211		856


Total	$	20,544	$	88,619

Consumer risk based on payment activity at December 31, 2010 is as follows.


			Residential Real
	Consumer and		Estate and Home
Payment Category	Credit Card		Equity

Performing	$	22,970	$	92,832
Non-Performing		441		814


Total	$	23,411	$	93,646

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Age Analysis of Past Due Loans

The following table presents past due loans aged as of September 30, 2011.


													Recorded
			60-89										Investment
			Days		90 Days						Total		> 90 days
	30-59 Days		Past		and Greater		Total				Financing		and
Category	Past Due		Due		Past Due		Past Due		Current		Receivables		Accruing

Consumer and Credit Card	$	142	$	52	$	211	$	405	$	20,139	$	20,544	$	165
Commercial and Industrial		205		16		819		1,040		131,163		132,203		819
Commercial Real Estate		82		—		7,996		8,078		131,179		139,257		—
Residential Real Estate and Home Equity		23		211		856		1,090		87,529		88,619		172


Total	$	452	$	279	$	9,882	$	10,613	$	370,010	$	380,623	$	1,156

The following table presents past due loans aged as of December 31, 2010.


													Recorded
			60-89										Investment
			Days		90 Days						Total		> 90 days
	30-59 Days		Past		and Greater		Total				Financing		and
Category	Past Due		Due		Past Due		Past Due		Current		Receivables		Accruing

Consumer and Credit Card	$	300	$	104	$	441	$	845	$	22,566	$	23,411	$	407
Commercial and Industrial		359		3		1,373		1,735		153,675		155,410		991
Commercial Real Estate		885		2,050		10,118		13,053		139,321		152,374		35
Residential Real Estate and Home Equity		472		123		814		1,409		92,237		93,646		425


Total	$	2,016	$	2,280	$	12,746	$	17,042	$	407,799	$	424,841	$	1,858

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Troubled Debt Restructurings

Information regarding Troubled Debt Restructuring (“TDR”) loans for the three and nine month periods ended September 30, 2011 is as follows:


	Three Months Ended				Nine Months Ended
	September 30, 2011				September 30, 2011
			Post-Modification				Post-Modification
	Number of		Outstanding		Number of		Outstanding
	Contracts		Recorded Investment		Contracts		Recorded Investment
Consumer and Credit Card		—	$	—		9	$	56
Commercial and Industrial		—		—		3		1,583
Commercial Real Estate		9		4,854		18		17,437
Residential Real Estate and Home Equity		—		—		2		14


Total		9	$	4,854		32	$	19,090

The following presents by class loans modified in a TDR from October 1, 2010 through September 30, 2011 that subsequently defaulted (i.e. 60 days or more past due following a modification) during the three and nine month periods ended September 30, 2011.


	Loans modified as a TDR within the previous				Loans modified as a TDR within the previous 12
	12 months that subsequently defaulted during				months that subsequently defaulted during
	the Three Months Ended				the Nine Months Ended
	September 30, 2011				September 30, 2011
	Number of		Recorded Investment		Number of		Recorded Investment
	Contracts		as of period end (1)		Contracts		as of period end (1)
Consumer and Credit Card		2	$	18		2	$	18
Commercial and Industrial		—		—		—		—
Commercial Real Estate		—		—		4		3,381
Residential Real Estate and Home Equity		—		—		—		—


Total		2	$	18		6	$	3,399


(1)		Period end balances are inclusive of all partial pay downs and charge-offs since the modification date. Loans modified in a TDR that were fully paid down, charged off, or foreclosed upon by period end are not reported.

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Depending on the financial condition of the borrower, the purpose of the loan and the type of collateral supporting the loan structure; modifications can be either short-term (12 months of less) or long term (greater than one year). Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 4 — CREDIT QUALITY (continued)

Land loans are also included in the class of commercial real estate loans. Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity. Land loans modified in a TDR typically involve extending the balloon payment by one to three years, changing the monthly payments from interest-only to principal and interest, while leaving the interest rate unchanged.

Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.

As mentioned above, an individual loan is placed on a non-accruing status if, in the judgment of Management, it is unlikely that all principal and interest will be received according to the terms of the note. Loans on non-accrual may be eligible to be returned to an accruing status after six months of compliance with the modified terms. However, there are number of factors that could prevent a loan from returning to accruing status, even after remaining in compliance with loan terms for the aforementioned six month period. For example: deteriorating collateral, negative cash flow changes and inability to reduce debt to income ratios.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 5 — FAIR VALUE MEASUREMENTS

The Corporation accounts for fair value measurements in accordance with FASB ASC 820, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.

FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The standard describes three levels of inputs that may be used to measure fair value:

	Level 1		Quoted prices in active markets for identical assets or liabilities.

	Level 2		Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

	Level 3		Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include certain equity securities and U.S. Government and agency obligations. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include U.S. Government and agency obligations, state and municipal obligations, corporate bonds and mortgage-backed securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 5 — FAIR VALUE MEASUREMENTS (continued)

The following table presents the fair value measurements of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2011 and December 31, 2010.

September 30, 2011


			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
U.S. Government and agency obligations	$	48,359	$	—	$	48,359	$	—
State and municipal obligations		10,493		—		10,493		—
Mortgage-backed securities and other		25,849		—		25,849		—


Total	$	84,701	$	—	$	84,701	$	—

December 31, 2010


			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
U.S. Government and agency obligations	$	29,986	$	—	$	29,986	$	—
State and municipal obligations		12,262		—		12,262		—
Mortgage-backed securities and other		27,349		—		27,349		—


Total	$	69,597	$	—	$	69,597	$	—

Following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Securities

Certain collateralized debt obligations are classified as held to maturity. The Corporation recognized other-than-temporary impairment on the securities as of September 30, 2011, based upon a Level 3 estimate of fair value, including a discounted cash flows calculation and a fair value estimate from an independent evaluation of the securities.

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 5 — FAIR VALUE MEASUREMENTS (continued)

The following table presents the fair value measurements of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2011 and December 31, 2010.

September 30, 2011


			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Collateralized debt obligations	$	1,270	$	—	$	—	$	1,270
Impaired loans		33,332		—		—		33,332
Real estate owned		2,907		—		—		2,907

December 31, 2010


			Fair Value Measurements Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)

Collateralized debt obligations	$	1,313	$	—	$	—	$	1,313
Impaired loans		24,187		—		—		24,187
Real estate owned		449		—		—		449

DCB FINANCIAL CORP
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands)

NOTE 5 — FAIR VALUE MEASUREMENTS (continued)

Carrying amount and estimated fair values of financial instruments were as follows:


	September 30,				December 31,
	2011				2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets
Cash and cash equivalents	$	42,290	$	42,290	$	33,521	$	33,521
Securities available-for-sale		84,701		84,701		69,597		69,597
Securities held-to-maturity		1,267		1,270		1,313		1,680
Loans held for sale		63		63		753		753
Loans		370,443		364,502		412,617		401,967
FHLB stock		3,799		3,799		3,799		3,799
Accrued interest receivable		1,514		1,514		1,673		1,673


	September 30,				December 31,
	2011				2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial liabilities
Noninterest-bearing deposits	$	69,535	$	69,535	$	63,695	$	63,695
Interest-bearing deposits		382,450		383,075		401,381		402,131
Federal funds purchased and other short-term borrowings		1,296		1,296		1,265		1,265
FHLB advances		50,816		51,467		58,502		60,581
Accrued interest payable		348		348		336		336

The estimated fair value of cash and cash equivalents, FHLB stock, accrued interest receivable, noninterest bearing deposits, federal funds purchased and other short-term borrowings and accrued interest payable approximates the related carrying amounts.

For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair value of loans held for sale is based on market quotes. Fair values of long-term FHLB advances are based on current rates for similar financing. Fair values of off-balance-sheet items are based on the current fee or cost that would be charged to enter into or terminate such agreements, which are not material.


Item 1A.		Risk Factors

There has been no material change in the nature of the risk factors set forth in the Corporation’s Form 10-K for the year ended December 31, 2010.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)


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

INTRODUCTION

In the following pages, management presents an analysis of the consolidated financial condition of DCB Financial Corp (the “Corporation”) at September 30, 2011, compared to December 31, 2010, and the consolidated results of operations for the three and nine months ended September 30, 2011, compared to the same periods in 2010. This discussion is designed to provide shareholders with a more comprehensive review of the operating results and financial position than could be obtained from reading the consolidated financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report.

FORWARD-LOOKING STATEMENTS

Certain statements in this report constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to the financial condition and prospects, lending risks, plans for future business development and marketing activities, capital spending and financing sources, capital structure, the effects of regulation and competition, and the prospective business of both the Corporation and its wholly-owned subsidiary The Delaware County Bank & Trust Company (the “Bank”). Where used in this report, the word “anticipate,” “believe,” “estimate,” “expect,” “intend,” and similar words and expressions, related to the Corporation or the Bank or their respective management, identify forward-looking statements. Such forward-looking statements reflect the current views of the Corporation and are based on information currently available to the management of the Corporation and the Bank and upon current expectations, estimates, and projections about the Corporation and its industry, management’s belief with respect thereto, and certain assumptions made by management. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements.

Potential risks and uncertainties include, but are not limited to: (i) significant increases in competitive pressure in the banking and financial services industries; (ii) changes in the interest rate environment which could reduce anticipated or actual margins; (iii) changes in political conditions or the legislative or regulatory environment; (iv) general economic conditions, either nationally or regionally (especially in central Ohio), becoming less favorable than expected resulting in, among other things, a deterioration in credit quality of assets; (v) changes occurring in business conditions and inflation; (vi) changes in technology; (vii) changes in monetary and tax policies; (viii) changes in the securities markets; and (ix) other risks and uncertainties detailed from time to time in the filings of the Corporation with the Securities and Exchange Commission.

The Corporation does not undertake, and specifically disclaims any obligation, to publicly revise any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Overview of the third quarter of 2011

The Corporation, through the Bank provides customary retail banking services to its customers, including checking and savings accounts, time deposits, IRAs, safe deposit facilities, personal loans, real estate mortgage loans and installment loans. The Bank also provides trust and wealth management products and services through its own trust department and its Raymond James affiliation. It also offers a variety of commercial and commercial real estate loans along with treasury management services to various commercial businesses.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

The Corporation, through the Bank, grants residential real estate, commercial real estate, consumer and commercial loans to customers located primarily in Delaware, Franklin, Licking, Morrow, Marion and Union Counties, Ohio. The economic conditions in the Corporation’s market are one of the strongest within the State of Ohio, however, these conditions continue to present challenges to the banking industry. There continues to be a slowdown in economic activity, increases in unemployment levels, increased loan foreclosure volume and a decline in real estate values. The Corporation’s business has been under pressure due primarily to decreased market activity, which has resulted in declining loan portfolios. Real estate values, especially in the Bank’s core geographic area, have declined during the past several years, and have not shown signs of increased prices or activity during 2011.

•

During the second quarter 2011 the Corporation developed a restructuring plan that included a reduction in force (RIF), branch closures and a restructure of the retail division in order to realign staff with the Corporation strategies to increase retail deposits and retail lending. The restructure will result in the elimination of approximately 32 full-time equivalent employees and the closure of five branch locations. For the second quarter, the Corporation recognized approximately $255 of restructure costs which mainly consists of severance payments for affected employees. The restructure is expected to save the Corporation approximately $1,000 per year on an annualized basis.

•

The Corporation and its wholly-owned subsidiary, The Delaware County Bank & Trust Co. currently operate under various written orders from regulatory bodies. Among other things, the Bank was required to reach a tier-1 capital ratio of 9% and a risk-based capital level of 13% by January 2011. The Bank has not yet achieved these numbers, but continues to explore various options and alternatives designed to address those requirements.

•

The Corporation is in ongoing communication with both the Federal Deposit Insurance Corp. (“FDIC”) and the Ohio Division of Financial Institutions (“ODFI”), and is subject to ongoing examination for compliance with the written agreements. The Corporation cannot predict when all terms of the written agreements will be satisfied, but will continue to work diligently with the agencies, and believes that it is making progress towards addressing all facets of the agreements.

•

The Corporation’s assets totaled $543,662 at September 30, 2011 compared to $565,105 at December 31, 2010, a decrease of $21,443, or 4.0%. The decrease in assets was mainly attributed to a decrease in cash and cash equivalents used to fund the reduction in CDARS deposits and FHLB borrowings.

•

Overall, loan balances continue to decline due to lower market activity. Loans, excluding loans held for sale, stood at $380,638 at September 30, 2011 compared to $424,864 at December 31, 2010, a decline of $44,226.

•

Net income (loss) for the three and nine months ended September 30, 2011 totaled $276 and ($1,547), respectively, compared to net losses in the same periods in 2010 of $9,059 and $11,975. The decline in losses is mainly attributed to the decline in the provision for loan losses period to period, offset by a decline in net interest income.

•

The provision for loan losses totaled $625 and $3,836 for the three and nine month periods ended September 30, 2011 compared to $4,531 and $9,878 for the three and nine month periods ended September 30, 2010. The Bank maintains an allowance for loan losses at a level to absorb management’s estimate of probable inherent credit losses in its portfolio. The decline in provision from the prior year is attributed to the stabilization of problem credits and the improvement in related credit metrics.

•

The Corporation did not write down its investment in preferred trust securities during the third quarter 2011. It did recognize a $92 other-than-temporary impairment charge on these investments in the first quarter 2011. The credit quality of these bonds has stabilized, but additional future losses for other-than-temporary impairment could occur if the credit quality of the collateral supporting these bonds declines.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

•

The Corporation’s net interest income declined from the same periods in 2010. Net interest income decreased to $4,328 for the third quarter and $13,428 for the nine months ended September 30, 2011 compared to $5,154 and $16,010 for the comparable periods in 2010. The lower net interest income is mainly attributed to the overall decline in interest earning assets within the loan and investment portfolios.

•

The ability to generate earnings is impacted in part by competitive pricing on loans and deposits, and by changes in the rates on various U.S. Treasury, U.S. Government agency obligations and State and political subdivision issues which comprise a significant portion of the Bank’s investment portfolio. The Bank is competitive with interest rates and loan fees that it charges, in pricing and variety of accounts it offers to the depositor. The Corporation confirms this by completing regular rate shops and comparisons versus competing financial services companies.

•

The dominant pricing mechanism on loans is the prime interest rate as published in the Wall Street Journal, on a fixed rate plus spread over the index. The interest spread depends on the overall account relationship and the creditworthiness of the borrower.

•

Deposit rates are reviewed weekly by management and are generally discussed by the Asset/Liability Committee on a monthly basis. The Bank’s primary objective in setting deposit rates is to remain competitive in the market area, and develop funding opportunities while earning an adequate interest rate margin.

•

FHLB advances decreased to $50,816 at September 30, 2011 from $58,502 at December 31, 2010. This is mainly due to a reduced reliance on borrowed funds because of the improved ability to raise the need deposits from its core customer base to support its current balance sheet structure. Additionally, Management has used excess cash to reduce the overall size of the balance sheet by paying down debt, in turn, supporting its capital ratios.

ANALYSIS OF FINANCIAL CONDITION

The Corporation’s assets totaled $543,662 at September 30, 2011, compared to $565,105 at December 31, 2010, a decrease of $21,443. Cash and cash equivalents were $42,290 at the end of the third quarter, an increase of $8,769 from December 31, 2010. The increase is mainly attributed to the reductions in the loan portfolio, offset by increases in total investments. Management has focused on re-directing this excess cash into investment securities and reducing FHLB advances in order to restructure balance sheet funding. The reduction of CDARS balances and FHLB advances will likely continue through the remainder of the year.

Total securities increased from $70,910 at December 31, 2010 to $85,968 at September 30, 2011. Management is targeting certain levels of limited excess cash in order to increase yields by investing in securities instead of holding lower earning cash balances. The increase in securities also provides collateral for various borrowing opportunities with the Federal Reserve Bank, FHLB and various correspondent banks.

Total loans, excluding loans held for sale, decreased $44,226 from $424,864 at December 31, 2010 to $380,638 at September 30, 2011. The decline in outstanding loan balances is mainly due to the lower volume of new originations due to the current economy, normal loan pay downs, and the charge-off of non-performing loans. Additionally, the Corporation has been successful in moving non-performing loans off the balance sheet via note sales. The Corporation’s loan originations are expected to remain subdued through year-end as lending staff continues to focus internally on current problem credits.

Total deposits decreased $13,091 from $465,076 at December 31, 2010 to $451,985 at September 30, 2011. This decrease is mainly due to an increase in non-interest bearing deposits, offset by a decline in CDARs balances. This has occurred, as previously mentioned, because of Management’s initiatives to reduce the Corporation’s overall reliance on wholesale funding.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

On an as-needed basis, the Corporation has the ability to utilize a variety of alternative funding sources in order to reduce funding costs or create improved funding structures. However, with its stable deposit base and adequate cash balances, there has been less emphasis on the utilization of borrowed funds. Total FHLB advances decreased $7,686, resulting in a balance of $50,816 at September 30, 2011. Additional reliance on borrowings outside of normal deposit growth may increase the Corporation’s overall cost of funds; however, Management intends to continue to reduce its exposure to high cost FHLB advances.

The Corporation utilizes a matched funding methodology for its borrowing and deposit activities. This is done by matching the rates, terms and expected cash flows of its loans to the various liability products. This matching principle is used to not only provide funding, but also as a means of mitigating interest rate risk associated with originating longer-term fixed-rate loans. Additional reliance on borrowings outside of normal deposit growth may increase the Corporation’s overall cost of funds.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2011 AND SEPTEMBER 30, 2010

Net Income (Loss). The Corporation reported net income of $276 for the three month period ended September 30, 2011, compared to a net loss of $9,059 for the same period in 2010. The improvement in profitability was mainly attributed to reduced provision expense and reduced salary and benefit expense, offset by a decline in net interest income.

Net Interest Income. Net interest income of $4,328 decreased from the $5,154 reported for the three months ended September 30, 2010. This change is mainly due to the year-over-year reduction in earning assets on the balance sheet. Average year-to-date assets at the Bank through September decreased from $653,916 in 2010 to $571,453 in September 2011, a reduction of $82,463 or 12.5%. The Company’s smaller balance sheet is attributed to a lack of quality loan opportunities, but is also attributed to Management’s initiatives designed to reduce the overall size of the balance sheet in order to improve capital ratios. Management has also focused on deleveraging the balance sheet, specifically by reducing FHLB borrowings, while reducing the dependency in CDARS deposit balances.

Net interest margin was 3.36% for the third quarter 2011, compared to 3.59% for the third quarter 2010. The change in margin is attributed to the decreased levels of short-term cash balances compared to the prior year, offset by declining yields on interest earning assets.

Continued lower loan origination volume and the reduced balance sheet funding requirements have allowed management to focus on tactically addressing the structure of deposits. Non-interest bearing balances increased to $69,535 from $63,695 at December 31, 2010. The Bank continues to focus on core deposit generation as part of its focus to increase exposure to consumer markets while reducing its reliance on public funds. Though funding costs remain low, it is likely that some retail deposit costs will increase as various deposit specials are offered to consumers in order to grow those accounts. However, the Corporation has been able to reduce its overall long-term borrowings through the FHLB by replacing those advances with customer deposits. Tactically, the Corporation is de-leveraging the balance sheet through reductions in large time deposits and FHLB advances.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

The Asset/Liability Management Committee, which is responsible for determining deposit rates, continues to closely monitor the Bank’s cost of funds to take advantage of pricing and cash flow opportunities. Additionally, because of the increased competition in the Bank’s primary marketplace, management has continued to recognize the importance of offering special rates on certain deposit products. These special deposit rates tend to negatively affect the Corporation’s net interest margin. It is likely that these rates will continue to be offered to secure liquidity while maintaining market share.

Provision and Allowance for Loan Losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents management’s assessment of the losses known and inherent in the Bank’s loan portfolio. All lending activity contains associated risks of loan losses and the Bank recognizes these credit risks as a necessary element of its business activity.

The provision for loan losses totaled $625 for the three months ended September 30, 2011, compared to $4,531 for the same period in 2010. This decline from the previous year’s quarter is mainly attributed to the overall improvement in credit quality within the Bank’s loan portfolios. Other contributing factors include improvement in delinquencies, improved workout results and stabilized real estate values, after periods of decline, within the Bank’s market area. Additionally, Management has been successful in entering into contracts to sell certain problem notes, which has, in those instances, reduced the need for additional reserves. Management maintains an allowance for loan losses at a level to absorb management’s estimate of probable inherent credit losses in its portfolio.

In the third quarter of 2010, Management provided substantial additional loan loss reserves in order to address valuations in its commercial real estate portfolio due to declining economic conditions. During the current quarter, analysis has indicated an improvement in credit risk due to reduced problem loans, reduced nonaccrual loans, and reduced delinquency rates. The main reason for the improvement in credit quality is due to positive results from workout activities, charge-offs of bad loans and increased collection efforts. Additionally, some improvement in the Bank’s market area in the real estate sector has allowed for quicker sale of notes and OREO at reasonable pricing. On a quarterly basis, Management completes a rigorous loan quality review on its problem credits to determine if additional reserves are needed for expected future credit losses. The allowance for loan losses was $10,195, or 2.68% of total loans at September 30, 2011, compared to $12,727, or 2.84% of total loans at September 30, 2010. Net charge-offs for the third quarter were $1,785 and totaled $5,888 year-to-date in 2011. Through September 30, 2011 annualized net charge-offs were 2.00%.

Non-accrual loans at September 30, 2011 were $12,506, a decrease of $1,300 from September 30, 2010 and a decline of $4,061 from December 31, 2010. The majority of non-accrual balances are attributed to loans in the investment real estate sector that were not generating sufficient cash flow to service the debt. Management continues to focus on workout related activity to reduce non-accrual and substandard but performing loans. Delinquent loans over thirty days decreased to 2.79% of total loans at September 30, 2011 from 4.01% at December 31, 2010, and down from the 3.64% reported at June 30, 2011. The improving delinquency trends are due to improved collection results and, as noted above, due to the improvement in non-accrual loans. Delinquent loans continue to be mainly attributed to the real estate investment and commercial portfolios.

During the third quarter, $3,398 of the loans that were restructured, qualified as restructured troubled debt. Management will continue to monitor the credit quality of the loan portfolio and may recognize additional provisions in the future if needed to maintain the allowance for loan losses at an appropriate level.

Noninterest Income. Total noninterest income for the quarter was $1,329, down from $1,711 in the third quarter 2010. This decline is mainly attributed to the reduction four major categories: a reduction in gains recognized on security sales; a reduction in gain on loan sales; an increase in losses on the disposition of assets; and a reduction in data processing service fees. During the third quarter no security sales took place, but management may elect to restructure its investment portfolios in future periods. Loans sales were down compared to the prior year as the economic climate has reduced opportunities in the residential real estate market. Increased losses on mainly OREO properties were due to the increased amount of transactions as the workout process on various credits are completed. Finally, the Corporation exited the data processing business during the third quarter which accounts for the decrease in data processing revenue. However, these declines were offset by the reduced operating costs that supported that business line.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

Noninterest Expense. The total noninterest expense of $4,995 for the third quarter represented a decline of $1,247, or 20.0%, from the three months ended September 30, 2010. The decrease in operating expense is attributed to a reduction in salary and benefits expense, a decline in occupancy and equipment costs, a reduction in FDIC deposit insurance premiums, and a decline in loan and collection expenses.

The decline in salary and benefits expense is attributed to the reduction in force Management conducted early in the third quarter. Additional salary and benefit cost reductions are expected going forward as the second phase of the corporate restructure and branch closures are expected to be completed by month-end October 2011. Occupancy and equipment cost are also down, due to reductions in depreciation expense and lower maintenance costs of computer and other equipment. FDIC insurance has declined compared to prior periods due to the overall reduced size of the balance sheet. The Corporation has also experienced a decline in loan and collection expenses as the overall size of the problem loan portfolio has been reduced.

Income Taxes. The Corporation recorded a tax credit totaling $239 for the three months ended September 30, 2011, compared to tax expense of $5,151 in the same period in 2010. In 2010, Management recognized a full allowance on the net deferred tax asset. Management is maintaining its full allowance tax position each quarter.

COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 AND SEPTEMBER 30, 2010

Net Income (Loss). The Corporation reported net loss of $1,547 for the nine month period ended September 30, 2011, compared to a loss of $11,975 for the same period in 2010. The improvement in profitability was mainly attributed to reduced provision expense and reduced recognition of other-than-temporary impairment. Additionally, noninterest revenue increased due to the decline in OTTI as noted above, and, non-interest expense declined due to the reduction in salary and benefits expense.

Net Interest Income. Net interest income represents the amount by which interest income on interest-earning assets exceeds interest expense on interest-bearing liabilities. Net interest income is the largest component of the Corporation’s income, and is affected by the interest rate environment and the volume and the composition of interest-earning assets and interest-bearing liabilities.

Net interest income was $13,428 for the nine month period ended September 30, 2011, and $16,010 for the same period in 2010. The decline in net interest income is mainly attributed to lower interest earning assets when compared to the same period in 2010. The Corporation has been reducing its balance sheet in order to increase capital ratios, but has also experienced a decline in loan originations due to the challenging economic environment. In lieu of increasing loan balances, Management has allocated excess cash balances into its security portfolio in order to increase yield on earning assets while providing collateral to fund future borrowing ability.

As noted, the Corporation has been able to reduce its overall borrowings, mainly through the FHLB, by paying down debt with cash generated from the declining loan portfolio, and from an increase in retail deposits. Deposits normally are less expensive than borrowing which contributes to the stable net interest margin the Bank has experienced. Net interest margin for the third quarter remained stable at 3.36%. This is a slight decline from the 3.50% and 3.38% for the first two quarters of 2011, and is attributed to some increases on the overall cost of deposits and lower yields on earning assets.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

Provision and Allowance for Loan Losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan losses to an amount that represents Management’s assessment of the losses known and inherent in the Bank’s loan portfolio. All lending activity contains associated risks of loan losses and the Bank recognizes these credit risks as a necessary element of its business activity.

The provision for loan losses totaled $3,836 for the nine months ended September 30, 2011, compared to $9,878 for the same period in 2010. This decline in provision expense from the previous year is mainly attributed to the overall improvement in credit quality within the Bank’s loan portfolios. Overall, problem loans have declined since year-end 2010, and delinquencies are down. Management maintains an allowance for loan losses at a level to absorb management’s estimate of probable inherent credit losses in its portfolio.

The allowance for loan losses was $10,195, or 2.68% of total loans at September 30, 2011, compared to $12,247, or 2.88% of total loans at December 31, 2010. Net charge-offs for the nine month period ended September 30, 2011 were $5,888, which were mainly attributed to commercial real estate loans. Management will continue to monitor the credit quality of the loan portfolio and may recognize additional provisions in the future if needed to maintain the allowance for loan losses at an appropriate level.

Noninterest Income. Total noninterest income increased $637 for the nine months ended September 30, 2011, compared to the same period in 2010. The increase was primarily attributable to the decline OTTI in losses offset by losses on securities sold. Other non-interest expense categories were generally flat when compared to the prior year periods.

Noninterest Expense. The total noninterest expense of $16,247 for the third quarter represented a decline of $1,220, or 7.0%, from the nine month period ended September 30, 2010. The decrease in operating expense is attributed to a reduction in salary and benefits expense, a decline in occupancy and equipment costs, a reduction in FDIC deposit insurance premiums, and a decline in loan and collection expenses.

Income Taxes. The Corporation recorded a tax credit totaling $531 for the nine months ended September 30, 2011, compared to tax expense of $4,580 in the same period in 2010. In 2010, Management recognized a full allowance on the net deferred tax asset, and continues to record a full valuation allowance.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

LIQUIDITY

Liquidity is the ability of the Corporation to fund customers’ needs for borrowing and deposit withdrawals. The purpose of liquidity management is to assure sufficient cash flow to meet all of the financial commitments and to capitalize on opportunities for business expansion. This ability depends on the financial strength, asset quality and types of deposit and investment instruments offered by the Corporation to its customers. The Corporation’s principal sources of funds are deposits, loan and security repayments, maturities of securities, sales of securities available for sale 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 and mortgage-backed security prepayments are more influenced by interest rates, general economic conditions, and competition. The Corporation maintains investments in liquid assets based upon management’s assessment of (1) need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets and (4) objectives of the asset/liability management program.

Cash and cash equivalents increased $8,769 to $42,290 at September 30, 2011 as compared to December 31, 2010. The Bank continues to offer a number of retail deposit programs to increase core deposits while reducing reliance on large depositors and CDARS deposits. Cash and equivalents represented 7.8% of total assets at September 30, 2011 and 5.9% of total assets at December 31, 2010. The Corporation has the ability to borrow funds from the Federal Home Loan Bank and the Federal Reserve Bank should the Corporation need to supplement its future liquidity needs. Management believes the Corporation’s liquidity position is adequate based on its current level of cash, cash equivalents, core deposits, the stability of its other funding sources, and the support provided by its capital base.

CAPITAL RESOURCES

Total shareholders’ equity decreased $514 between December 31, 2010 and September 30, 2011 to $36,900. The decrease is primarily due to period losses of $1,547 offset by a decrease in accumulated other comprehensive loss.

Tier 1 capital is shareholders’ equity excluding the unrealized gain or loss on securities and intangible assets. Total capital includes Tier 1 capital plus the allowance for loan losses, not to exceed 1.25% of risk-weighted assets. Risk-weighted assets are the Corporation’s total assets after such assets are assessed for risk and assigned a weighting factor defined by regulation based on their inherent risk.

The Corporation and its subsidiaries are required to meet certain published regulatory capital requirements. Additionally, the Bank is required to meet other capital requirements imposed via written agreements with FDIC and ODFI. The published requirements for the Bank are a total risk-based capital ratio of 8.0%, at least half of which must be Tier 1 capital to be considered well capitalized. Per the written agreements, the Bank is required to reach a tier-1 capital level of 9% and a total risk-based capital level of 13%. The Bank has not met the required guidelines at September 30, 2011, but continues to analyze various strategic options in order to increase capital levels. The Bank’s tier-1 capital ratio at September 30, 2011 was 6.50%, while its total risk-based capital ratio was 9.92%.

For regulatory purposes, Tier-1 capital at the bank level is calculated based on allowable capital divided by average quarterly assets. Average quarterly assets at the Bank for the quarter ended September 30, 2011 were $556,413. At that asset level, the Bank would be required to hold $50,077 in allowable capital to meet its regulatory requirements under the consent order. This targeted capital is $13,884 more than the current level. Due to changing assets levels the targeted amount of capital needed to reach the 9% capital is likely to change each reporting period. Total risk-weighted assets at quarter-end were $418,145. At that level, the Bank would require $12,878 of risk-based capital to meet the requirements as outlined in the written regulatory agreements.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

The following table sets forth the Corporation’s obligations and commitments to make future payments under contract as of September 30, 2011.


	Payment Due by Year
			Less than 1						More than
Contractual Obligations	Total		year		1-3 years		3-5 years		5 years

FHLB advances	$	50,816	$	31,000	$	10,856	$	6,273	$	2,687
Federal funds purchased and other short-term borrowings		1,296		1,296		—		—		—
Operating lease obligations		3,595		663		1,535		889		508
Loan and line of credit commitments		67,624		35,165		—		—		32,459


Total Contractual Obligations	$	123,331	$	68,124	$	12,391	$	7,162	$	35,654


Item 3.		Quantitative and Qualitative Disclosure About Market Risk

ASSET AND LIABILITY MANAGEMENT AND MARKET RISK

The Corporation’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. Interest rate risk is the possibility that the Corporation’s financial condition will be adversely affected due to movements in interest rates. The income of financial institutions is primarily derived from the excess of interest earned on interest-earning assets over the interest paid on interest-bearing liabilities. Accordingly, the Corporation places great importance on monitoring and controlling interest rate risk. The measurement and analysis of the exposure of the Corporation’s primary operating subsidiary, The Delaware County Bank and Trust Company, to changes in the interest rate environment are referred to as asset/liability management. One method used to analyze the Corporation’s sensitivity to changes in interest rates is the “net portfolio value” (“NPV”) methodology.

NPV is generally considered to be the present value of the difference between expected incoming cash flows on interest-earning and other assets and expected outgoing cash flows on interest-bearing and other liabilities. For example, the asset/liability model that the Corporation currently employs attempts to measure the change in NPV for a variety of interest rate scenarios, typically for up and down parallel shifts of 100 to 400 basis points in market rates.

The Corporation’s Annual Report includes a table depicting the changes in the Corporation’s interest rate risk as of December 31, 2010, as measured by changes in NPV for instantaneous and sustained parallel shifts of -100 to +400 basis points in market interest rates. Management believes that no events have occurred since December 31, 2010 that would significantly change their ratio of rate sensitive assets to rate sensitive liabilities.

The Corporation’s NPV is more sensitive to rising rates than declining rates. From an overall perspective, such difference in sensitivity occurs principally because, as rates rise, borrowers do not prepay fixed-rate loans as quickly as they do when interest rates are declining. Thus, in a rising interest rate environment, because the Corporation has fixed-rate loans in its loan portfolio, the amount of interest the Corporation would receive on its loans would increase relatively slowly as loans are slowly prepaid and new loans at higher rates are made. Moreover, the interest the Corporation would pay on its deposits would increase rapidly because the Corporation’s deposits generally have shorter periods for repricing.

DCB FINANCIAL CORP
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except per share data)

The Corporation can utilize various tools to reduce exposure to changes in interest rates including offering floating versus fixed rate products, or utilizing interest rate swaps. Additional consideration should also be given to today’s current interest rate levels. Several deposit products are within 200 basis points of zero percent and other products within 300 basis points. Should rates decline, fewer liabilities could be repriced down to offset potentially lower yields on loans. Thus, decreases could also impact future earnings and the Corporation’s NPV.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the NPV approach. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and mortgage-backed securities and early withdrawal levels from certificates of deposit would likely deviate significantly from those assumed in making risk calculations.


Item 4.		Controls and Procedures

The Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of September 30, 2011, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2011, in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation’s periodic SEC filings.

There was no change in the Corporation’s internal control over financial reporting that occurred during the Corporation’s fiscal quarter ended September 30, 2011, that has materially affected, or is reasonably likely to materially affect, the Corporation’s internal control over financial reporting, except with respect to controls related to determination of fair value and evaluation of other-than-temporary impairment of collateralized debt obligations.

DCB FINANCIAL CORP
FORM 10-Q
Quarter ended September 30, 2011

PART II — OTHER INFORMATION


Item 1 — Legal Proceedings:

There are no matters required to be reported under this item.


Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds:

ISSUER PURCHASES OF EQUITY SECURITIES

(a)

(b)

(c)

(d)

Maximum Number

Total Number of

(or Approximate

Shares (or Units)

Dollar Value) of

Total Number

Purchased as Part

Shares (or Units) that

of Shares (or

Average Price

of Publicly

May Yet Be

Units)

Paid per Share

Announced Plans

Purchased Under the

Period

Purchased

(or Unit)

or Programs⁽¹⁾

Plans or Programs

Month #l 7/1/2011 to 7/31/2011

—

Month #2 8/1/2011 to 8/31/2011

—

Month #3 9/1/2011 to 9/30/2011

—

Total

—

184,907


(1)		On August 16, 2007, the Company announced a repurchase program which authorizes the repurchase of up to 200,000 of its common shares over a two year period commencing August 15, 2007.

DCB FINANCIAL CORP

FORM 10-Q
Quarter ended September 30, 2011
PART II — OTHER INFORMATION


Item 3 — Defaults Upon Senior Securities:

There are no matters required to be reported under this item.


Item 4 — Submission of Matters to a Vote of Security Holders:

There are no matters required to be reported under this item.


Item 5 — Other Information:

There are no matters required to be reported under this item.


Item 6 — Exhibits:

Exhibits — The following exhibits are filed as a part of this report:


Exhibit No.		Exhibit

	3.1	Amended and Restated Articles of Incorporation of DCB Financial Corp, incorporated by reference to the Company’s Report on Form 10-Q filed with the Commission on November 14, 2003.

	3.2	Amended and Restated Articles of Incorporation of DCB Financial Corp, incorporated by reference to the Company’s Report on Form 10-Q filed with the Commission on November 14, 2003.

	31.1	Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

	31.2	Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

	32.1	Certification pursuant to 18 U.S.C. 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002

	32.2	Certification pursuant to 18 U.S.C. 1350, as enacted pursuant to section 906 of the Sarbanes-Oxley Act of 2002


	Page

PART I — FINANCIAL INFORMATION

ITEM 1 — Financial Statements

Condensed Consolidated Balance Sheets		3

Condensed Consolidated Statements of Operations		4

Condensed Consolidated Statements of Comprehensive Income (Loss)		5

Condensed Consolidated Statements of Cash Flows		6

Notes to the Condensed Consolidated Financial Statements		7

ITEM 1A — Risk Factors		34

ITEM 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		35

ITEM 3 — Quantitative and Qualitative Disclosures About Market Risk		43

ITEM 4 — Controls and Procedures		44

PART II — OTHER INFORMATION		45

SIGNATURES		47

EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT


	DCB FINANCIAL CORP (Registrant)
Date: November 14, 2011	/s/ Ronald J. Seiffert
	Ronald J. Seiffert
	President and Chief Executive Officer

Date: November 14, 2011	/s/ John A. Ustaszewski
	John A. Ustaszewski
	Senior Vice President and Chief Financial Officer


	September 30, 2011		December 31, 2010

Commercial and industrial	$	132,203	$	155,410
Commercial real estate		139,257		152,374
Residential real estate and home equity		88,619		93,646
Consumer and credit card		20,544		23,411

		380,623		424,841
Add: Net deferred loan origination costs		15		23


Total loans receivable	$	380,638	$	424,864


EXHIBIT
NUMBER		DESCRIPTION

	3.1	Amended and Restated Articles of Incorporation of DCB Financial Corp, incorporated by reference to the Company’s Report on Form 10-Q filed with the Commission on November 14, 2003.

	3.2	Amended and Restated Articles of Incorporation of DCB Financial Corp, incorporated by reference to the Company’s Report on Form 10-Q filed with the Commission on November 14, 2003.

	31.1	Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

	31.2	Certification of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

	32.1	Certification pursuant to 18 U.S.C. 1350, as enacted Pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

	32.2	Certification pursuant to 18 U.S.C. 1350, as enacted Pursuant to section 906 of the Sarbanes-Oxley Act of 2002.