Incentive Compensation Plans

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

As of September 30, 2016, 57,300 options are outstanding at option prices based on the market value of the underlying shares on the date the options were granted. Options granted under all plans vest 20% per year. All options expire ten years from the date of grant. Vested options of retirees expire on the earlier of the scheduled expiration date or three months after the retirement date.

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

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

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

A total of 7,011 RSU’s were issued to the participants of the 2013 LTIP in the first quarter of 2016 for the three year performance period ended December 31, 2015.

In the nine months ended September 30, 2016, the Company granted 3,894 restricted shares. 1,872 shares were issued to directors and 1,000 shares were issued to employees that have a one-year vesting period. 1,022 shares were issued to an employee with a four year vesting period.

The fair value of each option award is estimated on the date of grant using the Black-Scholes model. Expected volatilities are based on historical volatilities of the Company’s common stock. The Company uses historical data to estimate option exercise and post-vesting termination behavior. The expected term of options granted is based on historical data and represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of stock options granted during the nine months ended September 30, 2016 was determined at the date of grant using the Black-Scholes stock option-pricing model and the following assumptions:

	Nine Months Ended
	September 30, 2016		September 30, 2015
Expected average risk-free rate		2.24%		2.04%
Expected average life		10.00 years		10.00 years
Expected volatility		41.00%		42.00%
Expected dividend yield		2.33%		2.10%

The weighted-average fair value of options granted was $13.95 for the nine months ended September 30, 2016 and $13.13 for the nine months ended September 30, 2015.

Following is activity under the plans during the nine months ended September 30, 2016:

Stock options	Options Outstanding		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value (in 000’s)
Options outstanding, January 1, 2016		86,220	$	20.27
Forfeited or cancelled		-		-
Exercised		(35,420)		20.59
Granted		6,500		37.78
Options outstanding, September 30, 2016		57,300	$	22.05		3.88	$	1,294
Vested or expected to vest at September 30, 2016		57,300	$	22.05		3.88	$	1,294
Exercisable at September 30, 2016		39,500	$	17.30		1.87	$	1,080

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Proceeds of options exercised	$	175	$	154	$	667	$	1,559
Related tax benefit recognized		46		21		158		151
Intrinsic value of options exercised		196		121		684		941

As of September 30, 2016, there was $185,000 of total unrecognized compensation costs related to unvested stock options granted under the Company’s equity plans. The cost is expected to be recognized over a weighted-average period of 3.43 years.

At September 30, 2016, 75,468 RSU’s and 12,161 stock grants were outstanding. Compensation expense is recognized over the performance period based on the achievements of targets as established with the plan documents. A total expense of $970,000 was recorded during the nine months ended September 30, 2016 compared to an expense of $730,000 for the same period in 2015. There was approximately $541,000 included within other liabilities at September 30, 2016 related to the STIP.

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

Unvested at January 1, 2016		74,545	$	25.86		10,927	$	30.98
Granted		24,526		39.30		10,905		23.39
Vested		(7,011)		19.19		(9,171)		22.50
Forfeited		(16,592)		19.19		(500)		32.00
Unvested at September 30, 2016		75,468	$	32.31		12,161	$	32.77

The maximum amount of compensation expense that may be recorded for the 2016 STIP and the 2014, 2015 and 2016 LTIPs at September 30, 2016 is approximately $3.6 million. However, the estimated expense expected to be recorded as of September 30, 2016; based on the performance measures in the plans, is $2.3 million of which $917,000 is unrecognized at September 30, 2016 and will be recognized over the remaining performance periods.