10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

or

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

For the transition period from ________ to ________

Commission File Number:   000-27905

MutualFirst Financial, Inc.

(Exact name of registrant specified in its charter)

Maryland	35-2085640
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
110 East Charles Street
Muncie, Indiana	47305
(Address of principal executive offices)	(Zip Code)

(765) 747-2800

(Registrant’s telephone number, including area code)

None

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No 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 x  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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)	Smaller reporting company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

The number of shares of the Registrant’s common stock, with $.01 par value, outstanding as of November 6, 2011 was 6,987,586.

FORM 10 – Q

MutualFirst Financial, Inc.

INDEX

PART I – FINANCIAL INFORMATION		Page Number
Item 1.	Financial Statements
	Consolidated Condensed Balance Sheets	3
	Consolidated Condensed Statements of Income	4
	Consolidated Condensed Statement of Stockholders’ Equity	5
	Consolidated Condensed Statements of Cash Flows	6
	Notes to Unaudited Consolidated Condensed Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	53
Item 4.	Controls and Procedures	53
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	54
Item 1A.	Risk Factors	54
Item 2.	Unregistered Sales of Equity Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities	54
Item 4.	Submission of Matters to a Vote of Security Holders	54
Item 5.	Other Information	54
Item 6.	Exhibits	54
Signature Page		55
Exhibits		56

2

PART 1     FINANCIAL INFORMATION

ITEM 1.     Financial Statements

MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY

Consolidated Condensed Balance Sheets

	September 30,			December 31,
	2011			2010
	(Unaudited)
Assets
Cash	$	17,740,203		$	9,288,748
Interest-bearing demand deposits		20,106,263			17,531,932
Cash and cash equivalents		37,846,466			26,820,680
Investment securities available for sale		288,529,402			245,165,189
Loans held for sale		1,392,461			10,482,734
Loans		959,706,495			995,273,005
Allowance for loan losses		(16,481,279	)		(16,372,093	)
Net loans		943,225,216			978,900,912
Accounts receivable		25,687,452			2,660,141
Premises and equipment		31,815,878			32,966,112
Federal Home Loan Bank of Indianapolis stock, at cost		14,390,700			16,682,200
Investment in limited partnerships		3,240,713			3,623,564
Cash surrender value of life insurance		46,673,286			45,565,611
Prepaid FDIC premium		3,119,955			4,207,592
Core deposit and other intangibles		3,639,568			4,533,085
Deferred income tax benefit		15,589,875			20,030,022
Income tax receivable		2,741,258			1,412,938
Other assets		14,717,362			13,850,761
Total assets	$	1,432,609,592		$	1,406,901,541
Liabilities
Deposits
Non-interest-bearing	$	131,646,557		$	113,454,542
Interest bearing		1,046,474,511			1,008,114,181
Total deposits		1,178,121,068			1,121,568,723
Federal Home Loan Bank advances		94,634,420			128,537,407
Other borrowings		12,604,302			13,167,316
Other liabilities		13,950,658			12,488,073
Total liabilities		1,299,310,448			1,275,761,519
Commitments and Contingent Liabilities
Stockholders' Equity
Preferred stock, $.01 par value
Authorized  --- 5,000,000 shares Issued and outstanding --- 28,923 and 32,382 shares, respectively; liquidation preference $1,000 per share		289			324
Common stock, $.01 par value
Authorized --- 20,000,000 shares Issued and outstanding ---6,987,586 and 6,984,754 shares, respectively		69,876			69,847
Additional paid-in capital - preferred stock		28,922,711			31,829,779
Additional paid-in capital - common stock		71,553,457			72,424,460
Retained earnings		31,123,946			31,757,156
Accumulated other comprehensive income (loss)		2,343,871			(3,988,158	)
Unearned employee stock ownership plan (ESOP) shares		(715,006	)		(953,386	)
Total stockholders' equity		133,299,144			131,140,022
Total liabilities and stockholders' equity	$	1,432,609,592		$	1,406,901,541

See notes to consolidated condensed financial statements.

3

MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY

Consolidated Condensed Statements of Income

(Unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30
	2011			2010			2011			2010
Interest Income
Loans receivable, including fees	$	12,991,790		$	14,908,465		$	40,091,062		$	45,651,477
Investment securities:
Mortgage-backed securities		1,963,266			1,420,310			5,804,669			4,489,600
Federal Home Loan Bank stock		107,239			69,677			315,180			255,481
Other investments		170,205			278,768			459,617			829,343
Deposits with financial institutions		16,891			48,068			68,505			146,933
Total interest income		15,249,391			16,725,288			46,739,033			51,372,834
Interest Expense
Passbook savings		26,713			34,596			98,362			104,524
Certificates of deposit		3,458,636			4,123,081			11,006,387			12,623,190
Daily Money Market accounts		127,628			157,984			370,300			460,905
Demand and NOW accounts		291,675			242,598			885,872			697,529
Federal Home Loan Bank advances		741,230			1,319,229			2,485,575			4,802,345
Other interest expense		207,921			233,067			628,164			703,318
Total interest expense		4,853,803			6,110,555			15,474,660			19,391,811
Net Interest Income		10,395,588			10,614,733			31,264,373			31,981,023
Provision for losses on loans		3,200,000			2,225,000			9,100,000			5,275,000
Net Interest Income After Provision for Loan Losses		7,195,588			8,389,733			22,164,373			26,706,023
Other Income
Service fee income		1,862,120			1,829,034			5,192,782			5,456,161
Net realized gain (loss) on sale of securities		1,763,960			(380,786	)		1,839,316			(60,510	)
Equity in losses of limited partnerships		(106,614	)		(127,617	)		(255,893	)		(382,449	)
Commissions		878,886			896,291			2,834,601			2,919,960
Net gains on sales of loans		244,867			845,967			685,571			1,409,654
Net servicing fees  (loss)		(336,711	)		33,722			(292,465	)		101,927
Increase in cash surrender value of life insurance		345,772			630,289			1,070,733			1,385,474
Loss on sale of other real estate and repossessed assets		(22,127	)		(159,471	)		(358,264	)		(698,602	)
Other-than-temporary losses on securities
Total other-than-temporary losses		0			(98,575	)		(723,338	)		(2,136,555	)
Portion of loss recognized in other comprehensive income (before taxes)		0			0			529,896			1,310,285
Net impairment losses recognized in earnings		0			(98,575	)		(193,442	)		(826,270	)
Other income		34,034			14,862			100,555			173,658
Total other income		4,664,187			3,483,716			10,623,494			9,479,003
Other Expenses
Salaries and employee benefits		5,240,059			5,314,547			16,103,385			15,982,278
Net occupancy expenses		582,515			628,593			1,917,019			1,871,424
Equipment expenses		504,574			480,364			1,486,945			1,459,569
Data processing fees		373,318			363,035			1,153,319			1,161,504
Automated teller machine		240,693			294,474			776,018			869,944
Deposit insurance		330,182			465,230			1,169,883			1,364,521
Professional fees		433,123			305,954			1,169,000			891,404
Advertising and promotion		453,258			296,000			1,053,040			899,984
Software subscriptions and maintenance		338,050			377,081			968,687			1,176,902
Intangible amortization		279,600			327,408			893,517			1,033,368
Other real estate and repossessed assets		279,155			148,037			746,257			689,519
Other expenses		981,955			972,880			2,801,255			2,853,566
Total other expenses		10,036,482			9,973,603			30,238,325			30,253,983
Income Before Income Tax		1,823,293			1,899,846			2,549,542			5,931,043
Income tax expense		375,000			279,000			114,000			1,192,000
Net Income		1,448,293			1,620,846			2,435,542			4,739,043
Preferred stock dividends and accretion		851,891			450,766			1,753,423			1,352,298
Net Income Available to Common Shareholders	$	596,402		$	1,170,080		$	682,119		$	3,386,745
Basic earnings per common share	$	0.09		$	0.17		$	0.10		$	0.49
Diluted earnings per common share	$	0.09		$	0.17		$	0.10		$	0.49
Dividends per common share	$	0.06		$	0.06		$	0.18		$	0.18

See notes to consolidated condensed financial statements.

4

MUTUALFIRST FINANCIAL, INC. AND SUBSIDIARY

Consolidated Condensed Statement of Stockholders' Equity

For the Period Ended September 30, 2011

(Unaudited)

	Common Stock							Preferred Stock															Accumulated
					Additional									Additional									Other			Unearned
	Shares				paid-in			Shares						paid-in			Comprehensive			Retained			Comprehensive			ESOP
	Outstanding		Amount		capital			Outstanding			Amount			capital			Income			Earnings			Income (Loss)			shares			Total
Balances, January 1, 2011		6,984,754	$	69,847	$	72,424,460			32,382		$	324		$	31,829,779					$	31,757,156		$	(3,988,158	)	$	(953,386	)	$	131,140,022
Comprehensive income
Net income for the period																	$	2,435,542			2,435,542									2,435,542
Other comprehensive income, net of tax
Net unrealized gain on securities																		6,438,501					$	6,438,501						6,438,501
Net unrealized loss on derivatives																		(106,472	)					(106,472	)					(106,472	)
Comprehensive income																	$	8,767,571
ESOP shares earned						(26,802	)																				238,380			211,578
Accretion of discount on preferred stock															551,897						(551,897	)								0
Share-based compensation						39,086																								39,086
Stock options exercised		2,832		29		16,907																								16,936
Preferred stock issued									28,923			289			28,922,711															28,923,000
Stock and warrants repurchased and retired						(900,194	)		(32,382	)		(324	)		(32,381,676	)														(33,282,194	)
Cash dividends ($.18 per common share)																					(1,257,555	)								(1,257,555	)
Cash dividends - preferred stock																					(1,259,300	)								(1,259,300	)
Balances, September 30, 2011		6,987,586	$	69,876	$	71,553,457			28,923		$	289		$	28,922,711					$	31,123,946		$	2,343,871		$	(715,006	)	$	133,299,144

See notes to consolidated condensed financial statements.

5

MutualFirst Financial, Inc.

Consolidated Condensed Statements of Cash Flows

(Unaudited)

	Nine Months Ended
	September 30,
	2011			2010
Operating Activities
Net income	$	2,435,542		$	4,739,043
Items not requiring (providing) cash
Provision for loan losses		9,100,000			5,275,000
Depreciation and amortization		4,648,322			4,144,698
Deferred income tax		(336,001	)		1,263,518
Loans originated for sale		(16,976,214	)		(50,035,868	)
Proceeds from sales of loans held for sale		26,354,926			43,682,702
(Gain) loss on sale:
Loans held for sale		(685,571	)		(1,409,654	)
Securities
Available for sale		(1,839,316	)		(2,411,640	)
Held to maturity		-			2,472,145
Other real estate and repossessed assets		358,264			698,602
Premises and equipment		43,638			918
Loss on other-than-temporary impairment, securities		193,442			826,270
Other equity adjustments		255,287			166,147
Change in
Prepaid FDIC premium		1,087,637			1,265,132
Interest receivable and other assets		(21,986,526	)		873,189
Interest payable and other liabilities		720,707			1,316,833
Cash value of life insurance		(1,070,733	)		(1,385,474	)
Other adjustments		2,216,450			1,791,427
Net cash provided by operating activities		4,519,854			13,272,988
Investing Activities
Net change in interest earning assets		-			(3,005,727	)
Purchases of securities
Available for sale		(119,349,447	)		(184,766,963	)
Proceeds from maturities and paydowns of securities:
Available for sale		29,713,680			38,833,694
Held to maturity		-			1,533,526
Proceeds from sale of securities
Available for sale		56,436,547			81,803,318
Held to maturity		-			3,775,034
Redemption of Federal Home Loan Bank Stock		2,291,500			-
Net change in loans		18,458,267			48,897,854
Purchases of premises and equipment		(451,639	)		(561,031	)
Proceeds from sale of premises and equipment		-			500
Proceeds from real estate owned sales		3,395,621			3,344,020
Other investing activities		(36,942	)		-
Net cash used in investing activities		(9,542,413	)		(10,145,775	)
Financing Activities
Net change in
Noninterest-bearing, interest-bearing demand and savings deposits		60,709,596			51,237,964
Certificates of deposit		(4,157,251	)		30,420,429
Proceeds from FHLB advances		47,600,000			20,000,000
Repayment of FHLB advances		(81,374,530	)		(64,863,001	)
Repayment of other borrowings		(595,299	)		(796,176	)
Preferred stock issued		28,923,000			-
Stock/warrants repurchased		(33,282,194	)		-
Cash dividends paid		(2,516,855	)		(2,471,580	)
Other financing activities		741,878			591,917
Net cash provided by financing activities		16,048,345			34,119,553
Net Change in Cash and Cash Equivalents		11,025,786			37,246,766
Cash and Cash Equivalents, Beginning of Year		26,820,680			46,340,897
Cash and Cash Equivalents, End of Year	$	37,846,466		$	83,587,663
Additional Cash Flows Information
Interest paid	$	15,131,947		$	19,503,456
Income tax paid		200,000			350,000
Transfers from loans to foreclosed real estate		7,343,974			6,111,047
Mortgage servicing rights capitalized		397,131			380,815

See notes to consolidated condensed financial statements.

6

MutualFirst Financial, Inc. and Subsidiaries

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Table dollars in thousands)

(Unaudited)

Note 1:  Basis of Presentation

The consolidated condensed financial statements include the accounts of MutualFirst Financial, Inc. (the “Company”), its wholly owned subsidiary MutualBank, a federally chartered savings bank (“Mutual” or the “Bank”), Mutual’s wholly owned subsidiaries, First MFSB Corporation, Mishawaka Financial Services, and Mutual Federal Investment Company (“MFIC”), and MFIC majority owned subsidiary, Mutual Federal REIT, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2010 filed with the Securities and Exchange Commission.

The interim consolidated financial statements at September 30, 2011, have not been audited by independent accountants, but in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

The Consolidated Condensed Balance Sheet of the Company as of December 31, 2010 has been derived from the Audited Consolidated Balance Sheet of the Company as of that date.

Note 2: Earnings (loss) per share

Earnings per share were computed as follows: (Dollars in thousands except per share data)

	Three Months Ended September 30,
	2011							2010
				Weighted-							Weighted-
				Average		Per-Share					Average		Per-Share
	Income			Shares		Amount		Income			Shares		Amount
	(000's)							(000's)
Basic Earnings Per Share
Net income	$	1,448			6,911,597			$	1,621			6,877,481
Dividends and accretion on preferred stock*		(852	)						(451	)
Income available to common shareholders	$	596			6,911,597	$	0.09	$	1,170			6,877,481	$	0.17
Effect of Dilutive securities
Stock options and RRP grants					15,836							9,723
Diluted Earnings Per Share
Income available to common stockholders and assumed conversions	$	596			6,927,433	$	0.09	$	1,170			6,887,204	$	0.17

	Nine Months Ended September 30,
	2011							2010
				Weighted-							Weighted-
				Average		Per-Share					Average		Per-Share
	Income			Shares		Amount		Income			Shares		Amount
	(000's)							(000's)
Basic Earnings Per Share
Net income	$	2,435			6,902,676			$	4,739			6,869,547
Dividends and accretion on preferred stock*		(1,753	)						(1,352	)
Income available to common shareholders	$	682			6,902,676	$	0.10	$	3,387			6,869,547	$	0.49
Effect of Dilutive securities
Stock options and RRP grants					89,753							8,136
Diluted Earnings Per Share
Income available to common stockholders and assume dconversions	$	682			6,992,429	$	0.10	$	3,387			6,877,683	$	0.49

* Preferred stock accretion was accelerated during the third quarter 2011 due to the payoff of the TARP-related securities.

Options for 499,637 and 570,718 shares and warrants for 0 and 625,135 shares were not included in the calculation above due to being anti-dilutive to earnings per share as of September 30, 2011 and 2010, respectively.

7

Note 3:  Impact of Accounting Pronouncements

In January 2010, the FASB issued an Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair Value Measurements.  This update provides additional guidance relating to fair value measurement disclosures.  Specifically, companies are required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy including when such transfers were recognized and the reasons for those transfers.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  Additionally, the FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard was effective at the beginning of 2010, except for the detailed Level 3 disclosures, which became effective at the beginning of 2011.  The Company adopted this accounting pronouncement, as required, and the adoption did not have a material impact on the statements taken as a whole.

In July 2010, the FASB issued an updated (ASU) No. 2010-20, Receivables (Topic 310):  Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  This update provides guidance to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses.  This update became effective for the Company for the first interim or annual reporting period ending on or after December 15, 2010 and did not have a material impact on the statements taken as a whole.

In April 2011, FASB issued ASU No. 2011-02: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The standard is intended to provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring.  The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and are to be applied retrospectively to the beginning of the annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired.  Early adoption is permitted.  The Company has adopted this ASU and it did not have an impact on the financial statements as a whole.

In April 2011, FASB issued ASU No. 2011-03:  Reconsideration of Effective Control for Repurchase Agreements.  The amendments in this ASU remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee.  The amendments in this ASU also eliminate the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets.

The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011.  The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  The Company does not anticipate that this ASU will have a material effect on its financial statements.

In May 2011, FASB issued ASU No. 2011-04:  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed.  This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS.

8

The amendments 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 Company does not anticipate that this ASU will have a material effect on its financial statements.

In June 2011, FASB issued ASU No. 2011-05:  Amendments to Topic 220, Comprehensive Income.  Under the amendments in this ASU, an entity has 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.  This ASU eliminates the option to present the components of other comprehensive income as a part of the statement of changes in stockholders’ equity.  The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

The amendments in this ASU should be applied retrospectively.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption is permitted, because compliance with the amendments is already permitted.  The amendments do not require any transition disclosures.

9

Note 4: Investments

The amortized cost and approximate fair values of securities as of September 30, 2011 and December 31, 2010 are as follows.

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Loss			Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	150,061	$	5,307	$	-		$	155,368
Collateralized mortgage obligations
Government sponsored agencies		99,215		3,667		-			102,882
Federal Agencies		3,998		7		-			4,005
Municipals		3,365		257		-			3,622
Small Business Administration		13		-		-			13
Corporate obligations		27,414		-		(4,775	)		22,639
Total	$	284,066	$	9,238	$	(4,775	)	$	288,529

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Loss			Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	119,017	$	1,076	$	(1,818	)	$	118,275
Collateralized mortgage obligations
Government sponsored agencies		112,615		1,251		(1,642	)		112,224
Federal agencies		7,925		-		(104	)		7,821
Municipals		2,460		33		(11	)		2,482
Small Business Administration		16		-		-			16
Corporate obligations		6,888		-		(4,243	)		2,645
Marketable equity securities		1,723		-		(21	)		1,702
Total	$	250,644	$	2,360	$	(7,839	)	$	245,165

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The amortized cost and fair value of available-for-sale securities at September 30, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
	Amortized		Fair
Description Securities	Cost		Value
Security obligations due
One to five years	$	13,044	$	12,801
Five to ten years		8,616		8,334
After ten years		13,117		9,131
		34,777		30,266
Mortgage-backed securities		150,061		155,368
Collateralized mortgage obligations		99,215		102,882
Small Business Administration		13		13
Totals	$	284,066	$	288,529

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1.5 million at September 30, 2011.

Gross gains of $1,857,000 and $2,900,000 resulting from sales of securities were realized for the nine months ended September 30, 2011 and 2010, respectively.  There were $18,000 and $2,900,000 in realized losses on the sale of securities during this same nine months ended 2011 and 2010, respectively.  Other-than-temporary impairment losses were recognized on securities for the nine months ended September 30, 2011 and 2010 of $193,000 and $826,000, respectively.

Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at September 30, 2011, was $22.6 million, a decrease from $141.3 million at December 31, 2010, which is approximately 8% and 58%, respectively, of the Bank's portfolio.  The Bank has continued to see an improvement since year-end due to increased values driven by lower market interest rates.

Based on evaluation of available evidence, management believes that the unrealized losses on those securities are temporary.

Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

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The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that 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 more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Corporate obligations	$	20,086	$	(589	)	$	2,553	$	(4,186	)	$	22,639	$	(4,775	)
Total temporarily impaired securities	$	20,086	$	(589	)	$	2,553	$	(4,186	)	$	22,639	$	(4,775	)

	December 31, 2010
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Mortgage-backed securities
Government sponsored agencies	$	69,971	$	(1,818	)	$	-	$	-		$	69,971	$	(1,818	)
Collateralized mortgage obligations
Government sponsored agencies		58,466		(1,642	)		-		-			58,466		(1,642	)
Federal agencies		7,821		(104	)		-		-			7,821		(104	)
Municipals		661		(11	)		-		-			661		(11	)
Corporate obligations		-		-			2,645		(4,243	)		2,645		(4,243	)
Marketable equity securities		-		-			1,702		(21	)		1,702		(21	)
Total temporarily impaired securities	$	136,919	$	(3,575	)	$	4,347	$	(4,264	)	$	141,266	$	(7,839	)

Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)

The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2011.

Corporate Obligations

The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities.  The unrealized losses were primarily caused by (a) a decrease in performance and regulatory capital at the underlying banks resulting from exposure to subprime mortgages and (b) a sector downgrade by several industry analysts.  The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security).  The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis.  The credit loss was 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 Company does not intend to sell the investments and it is likely the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at September 30, 2011.

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MutualBank evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis.  During the quarter ended September 30, 2011, the Bank’s evaluation indicated no other-than-temporary impairment.  Impairment on securities is determined after analyzing the estimated cash flows to be received, underlying collateral and determining the amount of additional losses needed in the individual pools to create a shortfall in interest or principal payments.  All trust preferred securities were valued using a discounted cash flow analysis as of September 30, 2011.

Other-than-temporary Impairment

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities.  Where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model.  Where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model.

The Company routinely conducts reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred.  Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities.  While all securities are considered, the securities currently impacted by other-than-temporary impairment testing are pooled trust preferred securities.  For each pooled trust preferred security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred.  Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary.

The Bank’s trust preferred securities valuation was done with assistance of an independent third party.  The approach to determining fair value involved several steps including:

· Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;

· Collateral performance projections for each piece of collateral in the trust preferred security;

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· Terms of the trust preferred structure, as laid out in the indenture; and

· Discounted cash flow modeling.

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities.  The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis.  There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market.  The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security.  Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

 The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions.  For collateral that has already defaulted, the Company assumed no recovery.  For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies.  Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

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Pooled Trust Preferred Securities.MutualFirst Financial, Inc. has a current amortized cost in pooled trust preferred securities of $6.7 million, which had an original par value of $10.3 million.  These securities have a current fair value of $2.6 million.  The following table provides additional information related to the Bank’s investment in trust preferred securities as of September 30, 2011:

Deal	Class		Original Par		Book Value		Fair Value		Unrealized Loss		Recognized Losses 2011		Lowest Rating	Number of Banks/Insurance Companies Currently Performing		Actual Deferrals/Defaults (as % of original collateral)			Total Projected Defaults (as a % of performing collateral)a			Excess Subordination (after taking into account best estimate of future deferrals/defaultsb
(Dollars in thousands)
Alesco Preferred Funding IX		A2A	$	1,000	$	899	$	417	$	482	$	-	CCC-		42		16.72	%		25.84	%		37.51	%
Alesco Preferred Funding XVII		C1		1,000		-		-		-		100	C
Preferred Term Securities XIII		B1		1,000		822		252		570		25	Ca		44		30.74	%		22.48	%		0.00	%
Preferred Term Securities XVIII		C		1,000		917		272		645		-	Ca		51		24.26	%		13.82	%		4.53	%
Preferred Term Securities XXVII		C1		1,000		710		158		552		-	C		33		28.14	%		23.52	%		0.69	%
U.S. Capital Funding I		B1		3,000		2,891		1,216		1,675		-	Caa1		31		15.90	%		15.55	%		1.62	%
U.S. Capital Funding III		B1		1,000		500		238		262		-	Ca		31		24.94	%		14.12	%		0.00	%
U.S. Capital Funding V		B1		1,300		-		-		-		68	C
Total			$	10,300	$	6,739	$	2,553	$	4,186	$	193

(a) A 10% recovery is applied to all projected defaults, other than insurance defaults.  A 15% recovery is applied to all projected insurance defaults.  No recovery is applied to current defaults.

(b) Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.

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Credit Losses Recognized on Investments

Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.

The following tables provide information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income.

	Accumulated Credit Losses
	Three Months Ended
	2011			2010
Credit losses on debt securities held
Beginning of period	$	(3,567	)	$	(3,350	)
Net additions related to increases in previously recognized other-than-temporary losses		-			(9	)
As of September 30,	$	(3,567	)	$	(3,359	)
	Accumulated Credit Losses
	Nine Months Ended
	2011			2010
Credit losses on debt securities held
Beginning of year	$	(3,374	)	$	(2,957	)
Net additions related to increases in previously recognized other-than-temporary losses		(193	)		(402	)
As of September 30,	$	(3,567	)	$	(3,359	)

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Note 5:  Accumulated Other Comprehensive Income

Other comprehensive income components and related taxes for the nine months ended September 30 were as follows:

	2011			2010
Net unrealized gain on securities available-for-sale	$	11,724		$	3,130
Net unrealized gain (loss) on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		(136	)		(1,257	)
Net unrealized loss on derivative used for cash flow hedges		(162	)		(536	)
Less: reclassification adjustment for realized (gain) loss included in income		(1,646	)		887
Other comprehensive income, before tax effect		9,780			2,224
Tax expense		3,448			783
Other comprehensive income	$	6,332		$	1,441

The components of accumulated other comprehensive gain (loss), included in stockholders’ equity are as follows:

	September 30,			December 31,
	2011			2010
Net unrealized gain (loss) on securities available-for-sale	$	8,650		$	(1,236	)
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		(4,186	)		(4,243	)
Net unrealized loss on derivative used for cash flow hedges		(501	)		(339	)
Net unrealized loss relating to defined benefit plan liability		(251	)		(251	)
		3,712			(6,069	)
Tax expense (benefit)		1,368			(2,081	)
Net-of-tax amount	$	2,344		$	(3,988	)

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Note 6: Disclosures About Fair Value of Assets and Liabilities

FASB Codification Topic 820 (ASC 820), Fair Value Measurements and Disclosures, 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.  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

Items Measured at Fair Value on a Recurring Basis

Following is a description of the valuation methodologies and inputs 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.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  The Company uses a third-party provider to provide market prices on its securities.  Level 1 securities include marketable equity securities.  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 mortgage-backed, collateralized mortgage obligations, small business administration, municipal and federal agency, and corporate obligation securities.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

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The following table presents the fair value measurement of assets measured at fair value on a recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2011
Mortgage-backed securities
Government sponsored agencies	$	155,368	$	-	$	155,368	$	-
Collateralized mortgage obligations
Government sponsored agencies		102,882		-		102,882		-
Federal agencies		4,005		-		4,005		-
Municipals		3,622		-		3,622		-
Small Business Administration		13		-		13		-
Corporate obligations		22,639		-		20,086		2,553
Available-for-sale securities	$	288,529	$	-	$	285,976	$	2,553
December 31, 2010
Mortgage-backed securities
Government sponsored agencies	$	118,275	$	-	$	118,275	$	-
Collateralized mortgage obligations
Government sponsored agencies		112,224		-		112,224		-
Federal agencies		7,821		-		7,821		-
Municipals		2,482		-		2,482		-
Small Business Administration		16		-		16		-
Corporate obligations		2,645		-		-		2,645
Marketable equity securities		1,702		1,702		-		-
Available-for-sale securities	$	245,165	$	1,702	$	240,818	$	2,645

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The following is a reconciliation of the beginning and ending balances for the three months ended September 30, 2011 and 2010 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2011			2010
Beginning balance, July 1	$	2,958		$	2,762
Total realized and unrealized gains and losses
Included in net income		-			-
Included in other comprehensive loss		(418	)		(250	)
Purchases, issuances and settlements		13			(75	)
Transfers in/out of Level 3		-			-
Ending balance	$	2,553		$	2,437
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	-		$	-

The following is a reconciliation of the beginning and ending balances for the nine months ended September 30, 2011 and 2010 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2011			2010
Beginning balance, January 1	$	2,645		$	2,539
Total realized and unrealized gains (losses)
Included in net income		(193	)		(401	)
Included in other comprehensive income		57			339
Purchases, issuances and settlements		44			(40	)
Transfers in/out of Level 3		-			-
Ending balance	$	2,553		$	2,437
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	(193	)	$	(401	)

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Items Measured at Fair Value on a Non-Recurring Basis

From time to time, certain assets may be recorded at fair value on a non-recurring basis.  These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period.  The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that Mutual will not collect all principal and interest due according to contractual terms are measured for impairment.  An allowable method for determining the amount of impairment includes estimating fair value using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis.

Other real estate owned is classified within Level 3 of the fair value hierarchy.

Mortgage Servicing Rights

We initially measure our mortgage servicing rights at fair value, and amortize them over the period of estimated net servicing income.  They are periodically assessed for impairment based on fair value at the reporting date.  Mortgage servicing rights do not trade in an active market with readily observable prices.  Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income.  The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds and market discount rates.  The fair value measurements are classified as Level 3.

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The following table presents the fair value measurement of assets measured at fair value on a non-recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2011
Impaired loans	$	7,585	$	-	$	-	$	7,585
Other real estate owned		1,975		-		-		1,975
Mortgage servicing rights		2,634		-		-		2,634
December 31, 2010
Impaired loans	$	15,204	$	-	$	-	$	15,204
Other real estate owned		1,030		-		-		1,030
Mortgage servicing rights		3,349		-		-		3,349
Loans held for sale		5,057		5,057		-		-

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated condensed balance sheets as of September 30, 2011 and December 31, 2010, are as follows:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Assets
Cash and cash equivalents	$	37,846	$	37,846	$	26,821	$	26,821
Loans held for sale		1,392		1,392		10,483		10,483
Loans		943,225		956,992		978,901		997,018
Stock in FHLB		14,391		14,391		16,682		16,682
Interest receivable		4,240		4,240		4,627		4,627
Liabilities
Deposits	$	1,178,121	$	1,138,310	$	1,121,569	$	1,080,131
FHLB advances		94,634		97,455		128,537		133,258
Other borrowings		12,604		13,114		13,167		14,067
Interest payable		652		652		995		995
Advances by borrowers for taxes and insurance		2,403		2,403		1,661		1,661

The following methods and assumptions were used to estimate the fair value of each class of financial instruments listed above:

Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.

Investment and Mortgage-Backed Securities - Fair values are based on quoted market prices and third party analysis.

Loans Held For Sale - Fair values are based on current investor purchase commitments.

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Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

Federal Home Loan Bank Advances - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

Other Borrowings- The fair value of other borrowings are estimated using a discount calculation based on current rates.

Advances by Borrowers for Taxes and Insurance - The fair value approximates carrying value.

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature.  The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The fair value of commitments is immaterial.

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Note 7: Loans

Categories of loans at September 30, 2011 and December 31, 2010 include:

	September 30,			December 31,
	2011			2010
Commercial
Real estate	$	206,510		$	199,517
Construction and development		22,221			49,803
Other		68,232			64,611
		296,963			313,931
Residential Mortgage		458,975			458,019
Consumer loans
Real estate		97,178			103,566
Auto		14,382			16,047
Boat/RV		87,735			102,015
Other		7,341			6,157
		206,636			227,785
Total loans		962,574			999,735
Undisbursed loans in process		(5,336	)		(7,212	)
Unamortized deferred loan costs, net		2,468			2,750
Allowance for loan losses		(16,481	)		(16,372	)
Net loans	$	943,225		$	978,901

The risk characteristics of each loan portfolio segment are as follows:

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

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Construction and Development

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial other

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Residential and Consumer

With respect to residential loans that are secured by 1-4 family residences and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Nonaccrual Loan and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Past due status is based on contractual terms of the loan.  In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

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All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income.  The interest on these 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.

Non-accrual loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 are as follows:

	September 30,		December 31,
	2011		2010
Commercial
Real Estate	$	7,131	$	6,040
Construction and development		5,997		7,399
Other		1,433		1,019
Residential Mortgage		9,099		12,012
Consumer
Real estate		1,675		2,716
Auto		35		16
Boat/RV		449		870
Other		118		111
	$	25,937	$	30,183

An age analysis of Company’s past due loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 is as follows:

	September 30, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	2,850	$	4,573	$	7,131	$	14,554	$	191,956	$	206,510	$	-
Construction and development		820		3,605		5,997		10,422		11,799		22,221		-
Other		1,287		545		1,433		3,265		64,967		68,232		-
Residential Mortgage		8,808		2,862		10,202		21,872		437,103		458,975		1,103
Consumer
Real estate		1,106		767		1,675		3,548		93,630		97,178		-
Auto		88		16		35		139		14,243		14,382		-
Boat/RV		1,722		599		449		2,770		84,965		87,735		-
Other		53		20		118		191		7,150		7,341		-
	$	16,734	$	12,987	$	27,040	$	56,761	$	905,813	$	962,574	$	1,103

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	December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	1,883	$	139	$	6,040	$	8,062	$	191,455	$	199,517	$	-
Construction and development		398		205		7,399		8,002		41,801		49,803		-
Other		4,067		173		1,019		5,259		59,352		64,611		-
Residential Mortgage		10,386		4,367		13,461		28,214		429,805		458,019		1,449
Consumer
Real estate		1,920		1,754		2,755		6,429		97,137		103,566		39
Auto		157		74		21		252		15,795		16,047		4
Boat/RV		3,215		957		924		5,096		96,919		102,015		54
Other		281		60		110		451		5,706		6,157		-
	$	22,307	$	7,729	$	31,729	$	61,765	$	937,970	$	999,735	$	1,546

Impaired Loans.  Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company 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.

Interest on impaired loans is recorded based on the performance of the loan.  All interest received on impaired loans that are on nonaccrual is accounted for on the cash-basis method until qualifying for return to accrual.  Interest is accrued per contract for impaired loans that are performing.

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The following tables present impaired loans for the quarter and year-to-date ended September 30, 2011 and year ended December 31, 2010.

	September 30, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans Quarter		Average Investment in Impaired Loans YTD		Interest Income Recognized Quarter		Interest Income Recognized YTD
Loans without a specific valuation allowance
Commercial
Real Estate	$	3,974	$	4,199	$	-	$	3,349	$	4,890	$	4	$	81
Construction and development		9,739		14,240		-		9,158		11,776		31		227
Other		1,963		1,962		-		1,358		1,972		1		28
Residential Mortgage		4,639		6,130		-		4,765		5,866		47		119
Loans with a specific valuation allowance
Commercial
Real Estate		1,610		2,061		465		1,640		1,648		8		52
Construction and development		3,989		4,189		788		3,985		4,122		24		60
Other		250		250		225		125		250		3		7
Residential Mortgage		-		-		-		-		-		-		-
Total
Commercial	$	21,525	$	26,901	$	1,253	$	19,615	$	24,658	$	71	$	455
Residential	$	4,639	$	6,130	$	225	$	4,765	$	5,866	$	47	$	119

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	December 31, 2010
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real Estate	$	5,222	$	5,699	$	-	$	3,826	$	137
Construction and development		2,241		2,441		-		2,390		27
Other		762		762		-		388		12
Residential Mortgage		6,419		6,419		-		4,580		183
Loans with a specific valuation allowance
Commercial
Real Estate		5,324		5,724		515		5,395		329
Construction and development		6,760		6,760		825		4,238		226
Other		-		-		-
Residential Mortgage		509		509		69		128		-
Total
Commercial	$	20,309	$	21,386	$	1,340	$	16,237	$	731
Residential	$	6,928	$	6,928	$	69	$	4,708	$	183

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2011 and December 31, 2010.

Commercial Loan Grades

Definition of Loan Grades.  Loan grades are numbered 1 through 8.  Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets.  The use and application of these grades by the Bank will be uniform and shall conform to the Bank's policy and OTS regulatory definitions.

Pass.  Pass credits are loans in grades prime through fair.  These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

Special Mention.  Special mention credits have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the institution’s credit position at some future date.  If weaknesses cannot be identified, classifying as special mention is not appropriate.  Special mention credits are NOT adversely classified and do NOT expose the institution to sufficient risk to warrant an adverse classification.  No apparent loss of principal or interest is expected.

Substandard.  Credits which are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged.  Financial statements normally reveal some or all of the following:  poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection.  Credits so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss of the deficiencies are not corrected.

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Doubtful.  An  extension of credit “doubtful” has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.  Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.  A Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.  

Retail Loan Grades

Pass.  Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

Substandard.  Substandard credits are loans that have reason to be considered to have a well defined weakness and placed on non-accrual.  This would include all retail loans over 90 days and troubled debt restructurings which were delinquent at the time of modification.

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September 30, 2011
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other
Pass	$	171,516	$	7,637	$	55,494
Special Mention		13,243		542		4,803
Substandard		19,841		13,917		7,041
Doubtful		1,910		125		894
Total	$	206,510	$	22,221	$	68,232
Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other
Pass	$	444,389	$	94,808	$	14,288	$	86,752	$	7,227
Substandard		14,586		2,370		94		983		114
Total	$	458,975	$	97,178	$	14,382	$	87,735	$	7,341

December 31, 2010
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other
Pass	$	168,855	$	22,046	$	56,587
Special Mention		9,934		10,313		5,471
Substandard		18,190		17,411		1,665
Doubtful		2,538		33		888
Total	$	199,517	$	49,803	$	64,611
Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other
Pass	$	440,296	$	99,041	$	16,031	$	101,097	$	5,977
Substandard		17,723		4,525		16		918		180
Total	$	458,019	$	103,566	$	16,047	$	102,015	$	6,157

Allowance for Loan Losses.  We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio.  Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments.  In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables.  These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.

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The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years.  Management believes the three year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan.  Senior management reviews these conditions quarterly in discussions with our senior credit officers.  To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment.  Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses.  The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio.  Actual losses can vary significantly from the estimated amounts.  Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors.  By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.  Due to the loss of numerous manufacturing jobs in the communities we serve during recent years, including 2010, and the increase in higher risk loans, like consumer and commercial loans, as a percentage of total loans, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses would otherwise indicate.

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The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine-month periods ended September 30, 2011 and year ended December 31, 2010.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses on other segments.

	Three Months Ended September 30, 2011
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	6,957	$	1,638	$	1,195	$	2,135	$	1,656	$	261	$	1,975	$	140	$	15,957
Provision charged to expense		115		500		2,300		100		45		42		90		8		3,200
Losses charged off		249		-		1,768		464		75		46		412		23		3,037
Recoveries		64		-		-		63		1		-		215		18		361
Balance, end of period	$	6,887	$	2,138	$	1,727	$	1,834	$	1,627	$	257	$	1,868	$	143	$	16,481
Ending balance:
Individually evaluated for impairment	$	465	$	225	$	788	$	-	$	-	$	-	$	-	$	-	$	1,478
Collectively evaluated for impairment	$	6,422	$	1,913	$	939	$	1,834	$	1,627	$	257	$	1,868	$	143	$	15,003
Loans:
Ending balance
Individually evaluated for impairment	$	5,584	$	2,213	$	13,728	$	4,639	$	-	$	-	$	-	$	-	$	26,164
Collectively evaluated for impairment	$	200,926	$	66,019	$	8,493	$	454,336	$	97,178	$	14,382	$	87,735	$	7,341	$	936,410

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	Nine Months Ended September 30, 2011
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	7,097	$	1,717	$	1,310	$	2,212	$	1,616	$	250	$	2,008	$	162	$	16,372
Provision charged to expense		515		500		5,130		2,100		254		52		400		149		9,100
Losses charged off		790		79		4,713		2,644		246		71		1,131		199		9,873
Recoveries		65		-		-		166		3		26		591		31		882
Balance, end of period	$	6,887	$	2,138	$	1,727	$	1,834	$	1,627	$	257	$	1,868	$	143	$	16,481
Ending balance:
Individually evaluated for impairment	$	465	$	225	$	788	$	-	$	-	$	-	$	-	$	-	$	1,478
Collectively evaluated for impairment	$	6,422	$	1,913	$	939	$	1,834	$	1,627	$	257	$	1,868	$	143	$	15,003
Loans:
Ending balance
Individually evaluated for impairment	$	5,584	$	2,213	$	13,728	$	4,639	$	-	$	-	$	-	$	-	$	26,164
Collectively evaluated for impairment	$	200,926	$	66,019	$	8,493	$	454,336	$	97,178	$	14,382	$	87,735	$	7,341	$	936,410

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	Year Ended December 31, 2010
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	7,072	$	1,721	$	1,210	$	2,359	$	1,588	$	207	$	2,144	$	113	$	16,414
Provision charged to expense		1,300		180		300		2,900		940		86		1,100		244		7,050
Losses charged off		1,343		209		200		3,345		914		62		1,339		880		8,292
Recoveries		68		25		-		298		2		19		103		685		1,200
Balance, end of period	$	7,097	$	1,717	$	1,310	$	2,212	$	1,616	$	250	$	2,008	$	162	$	16,372
Ending balance:
Individually evaluated for impairment	$	515	$	-	$	825	$	69	$	-	$	-	$	-	$	-	$	1,409
Collectively evaluated for impairment	$	6,582	$	1,717	$	485	$	2,143	$	1,616	$	250	$	2,008	$	162	$	14,963
Loans acquired with deteriorated credit quality	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Loans:
Ending balance
Individually evaluated for impairment	$	10,546	$	762	$	9,001	$	6,928	$	-	$	-	$	-	$	-	$	27,237
Collectively evaluated for impairment	$	188,971	$	63,849	$	40,802	$	451,091	$	103,566	$	16,047	$	102,015	$	6,157	$	972,498

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Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

Information on non-performing assets, including restructured loans, is provided below:

	September 30,
	2011		2010
Non-performing assets
Non-accrual loans	$	25,937	$	30,192
Accruing loans 90 days + past due		1,103		366
Restructured loans		11,883		1,027
Total non-performing loans		38,923		31,585
Real estate owned		6,703		5,686
Other repossessed assets		1,019		1,142
Total non-performing assets	$	46,645	$	38,413

The Company did receive payoff of a $3.6 million performing restructured loan, included in the total non-performing assets above, subsequent to September 30, 2011.

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Troubled Debt Restructurings

Included in certain loan categories of impaired loans are certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties.  These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

Loans retain their accrual status at the time of their modification.  As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained.  If a loan is on accrual at the time of the modification, the loan is evaluated to determine the collection of principal and interest is reasonably assured and generally stays on accrual.

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The following tables provide detail regarding troubled debts restructured in the last three and nine month periods.

Three Months Ended September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	113	$	70
Construction and development		0		-		-
Other		0		-		-
Residential Mortgage		6		463		492
Consumer
Real estate		10		231		231
Auto		1		10		10
Boat/RV		4		134		133
Other		0		-		-

Nine Months Ended September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	113	$	70
Construction and development		2		3,728		3,728
Other		1		103		103
Residential Mortgage		22		2,529		2,598
Consumer
Real estate		22		555		551
Auto		1		10		10
Boat/RV		12		364		357
Other		1		14		1

We have had no defaults of any loans modified as troubled debt restructurings made since October 1, 2010.

Note 8: Preferred Stock

On August 25, 2011, MutualFirst entered into and consummated a Securities Purchase Agreement with the Secretary of the Treasury as part of the Small Business Lending Fund Program (SBLF), pursuant to which the Company (i) sold 28,923 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “SBLF Preferred Stock”) to the Secretary of the Treasury for a purchase price of $28,923,000.  The SBLF Preferred Stock was issued pursuant to the SBLF program, a $30 billion fund established under the Small Business Jobs Act of 2010 that was created to encourage lending to small business by providing capital to qualified community banks with assets of less than $10 billion.  The SBLF Preferred Stock was issued under new Articles Supplementary to the Company’s Charter and has a liquidation preference of $1,000 per share.  

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The SBLF Preferred Stock qualifies as Tier 1 capital.  The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011.  The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QBSL” (as defined in the Purchase Agreement) by the Bank.  The initial dividend rate through September 30, 2011 is 5%.  Based on the Bank’s level of QBSL over the baseline level calculated under the terms of the Purchase Agreement, the dividend rate for the fourth quarter of 2011 is expected to be 5.0%.  For the third through ninth calendar quarters after the closing, the dividend rate may be adjusted to between one percent (1%) and five percent (5%) per annum, to reflect the amount of change in the Bank’s level of QBSL.  For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between one percent (1%) and seven percent (7%) based upon the increase in QBSL as compared to the baseline.  After four and one half years from issuance, the dividend rate will increase to 9% (including a quarterly lending incentive fee of 0.5%).

The SBLF Preferred Stock is non-voting, except in limited circumstances.  In the event that the Company misses five dividend payments, whether or not consecutive, the holder of the SBLF Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s Board of Directors.  In the event that the Company misses six dividend payments, whether or not consecutive, and if the then outstanding aggregate liquidation amount of the SBLF Preferred Stock is at least $25,000,000, then the holder of the SBLF Preferred Stock will have the right to designate two directors to the Board of Directors of the Company.

The SBLF Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of its federal banking regulator.

The SBLF Preferred Stock was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.  The Company has agreed to register the SBLF Preferred Stock under certain circumstances set forth in Annex E to the Purchase Agreement.  The SBLF Preferred Stock is not subject to any restrictions on transfer.

As required by the Purchase Agreement, the proceeds from the sale of the SBLF Preferred Stock and additional funds were used to redeem the $32,382,000 in the 32,382 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A issued in 2008 to the Treasury in the Troubled Asset Relief Program (“TARP”), plus the accrued dividends owed on the TARP preferred shares. 

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As part of the 2008 TARP transaction, the Company issued a warrant (Warrant) to Treasury to purchase 625,135 shares of the Company’s common stock for $7.77 per share over a 10-year term.  The Company also purchased the Warrant from Treasury for a purchase price of $900,000.

The terms of the SBLF Preferred Stock impose limits on the ability of the Company to pay dividends and repurchase shares of common stock.  Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

Under the terms of the SBLF Preferred Stock, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Company’s Tier 1 Capital would be at least 90% of the Signing Date Tier 1 Capital, as set forth in the Certificate of Designation relating to the SBLF Preferred Stock, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”).  The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of issuance and ending on the tenth anniversary, by 10% for each one percent increase in QSBL over the baseline level.

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

General

MutualFirst Financial, Inc., a Maryland corporation (the “Company”), was organized in September 1999.  On December 29, 1999, it acquired the common stock of MutualBank (“Mutual” or the “Bank”) upon the conversion of Mutual from a federal mutual savings bank to a federal stock savings bank.

Mutual was originally organized in 1889 and currently conducts its business from thirty-two full service financial centers located in Delaware, Elkhart, Grant, Kosciusko, Randolph, St. Joseph and Wabash counties, Indiana, with its main office located in Muncie.   Mutual also has trust offices in Carmel and Crawfordsville, Indiana and a loan origination office in New Buffalo, Michigan.  Mutual’s principal business consists of attracting deposits from the general public and originating fixed and variable rate loans secured primarily by first mortgage liens on residential and commercial real estate, consumer goods, and business assets.  Mutual’s deposit accounts are insured by the Federal Deposit Insurance Corporation up to applicable limits.

Mutual subsidiaries include, Mutual Federal Investment Company (“MFIC”) and Mishawaka Financial Services.  MFIC is a Nevada corporation holding approximately $244 million in investments.  MFIC currently owns one subsidiary, Mutual Federal REIT.  The assets of Mutual Federal REIT consist of approximately $68 million in one-to four-family mortgage loans.  Mishawaka Financial Services is engaged in the sale of life and health insurance to customers of the Bank.

The Bank operates under a unitary thrift charter and is regulated by the Office of the Comptroller of the Currency.  MutualBank recently applied to change charters to a state commercial bank that would be regulated by the Indiana Department of Financial Institutions and the FDIC.  The Company

The following should be read in conjunction with the Management’s Discussion and Analysis in the Company’s December 31, 2010 Annual Report on Form 10-K.

Critical Accounting Policies

The notes to the consolidated financial statements contain a summary of the Company’s significant accounting policies presented on pages 67 to 72 of the Annual Report on Form 10-K for the year ended December 31, 2010.  Certain of these policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain.  Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of foreclosed assets, mortgage servicing rights and intangible assets.

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Allowance for Loan Losses

The allowance for loan losses is a significant estimate that can and does change based on management’s assumptions about specific borrowers and current general economic and business conditions, among other factors.  Management reviews the adequacy of the allowance for loan losses on at least a quarterly basis.  The evaluation by management includes consideration of past loss experience, changes in the composition of the loan portfolio, the current condition and amount of loans outstanding, identified problem loans and the probability of collecting all amounts due.

The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions.  A worsening or protracted economic decline would increase the likelihood of additional losses due to credit and market risk and could create the need for additional loss reserves.

Foreclosed Assets

Foreclosed assets are carried at the lower of cost or fair value less estimated selling costs.  Management estimates the fair value of the properties based on current appraisal information.  Fair value estimates are particularly susceptible to significant changes in the economic environment, market conditions, and real estate market.  A worsening or protracted economic decline would increase the likelihood of a decline in property values and could create the need to write down the properties through current operations.

Management recently reviewed the Bank’s processes for foreclosed properties and deemed they are in compliance with regulations and state laws.

Mortgage Servicing Rights

Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other assets in the consolidated balance sheet.  The value of the capitalized servicing rights represents the fair value of the right to service loans in the portfolio.  Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests.  The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance.  Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans.  The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value.  For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates.  Impairment, if any, is recognized through a valuation allowance and is recorded as a reduction in loan servicing fee income.

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Intangible Assets

The Company periodically assesses the potential impairment of its core deposit intangible.  If actual external conditions and future operating results differ from the Company’s judgments, impairment and/or increased amortization charges may be necessary to reduce the carrying value of these assets to the appropriate value.  

Securities

Under FASB Codification Topic 320 (ASC 320), Investments-Debt and Equity Securities, investment securities must be classified as held-to-maturity, available-for-sale or trading.  Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held-to-maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held-to-maturity are classified as available-for-sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income.

The fair values of the Company’s securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of the Company’s fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatilities.

The Company evaluates securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if an other-than-temporary impairment (OTTI) exists pursuant to guidelines established in ASC 320.  In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial conditions and near-term prospects of the issuer, and the ability and intent of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.

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If management determines that an investment experienced an OTTI, management must then determine the amount of the OTTI to be recognized in earnings.  For investments in debt securities, if management does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors.  The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings.  The amount of the OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes.  The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment.  If management intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in shareholders’ equity) and not recognized in income until the security is ultimately sold.

For our investment in marketable equity securities, management evaluates the severity and duration of the impairment and the near term prospects of the issuer in our consideration of whether the securities are other than temporarily impaired.  Based upon that evaluation the Company does not consider our equity securities to be other than temporarily impaired.  If other than temporary impairment is identified that impairment is recognized in earnings.

The Company from time to time may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.

Income Tax Accounting

We file a consolidated federal income tax return.  The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return.  Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.

Forward Looking Statements

This quarterly report on Form 10-Q contains statements which constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements may appear in a number of places in this Form 10-Q and include statements regarding the intent, belief, outlook, estimate or expectations of the Company, its directors or its officers primarily with respect to future events and the future financial performance of the Company.  Readers of this Form 10-Q are cautioned that any such forward looking statements are not guarantees of future events or performance and involve risk and uncertainties, and that actual results may differ materially from those in the forward looking statements as a result of various factors.  The accompanying information contained in this Form 10-Q identifies important factors that could cause such differences.  These factors include changes in interest rates; the loss of deposits and loan demand to competitors; substantial changes in financial markets; changes in real estate values and the real estate market; or regulatory changes.

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The Company does not undertake – and specifically disclaims any obligation – to publicly release the result of any revisions which may be made to 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

The Company’s results of operations depend primarily on the level of net interest income, which is the difference between the interest income earned on interest-earning assets, such as loans and investments, and costs incurred with respect to interest-bearing liabilities, primarily deposits and borrowings. The structure of our interest-earning assets versus the structure of interest-bearing liabilities along with the shape of the yield curve has a direct impact on our net interest income.

Historically, our interest-earning assets have been longer term in nature (i.e., fixed-rate mortgage loans) and interest-bearing liabilities have been shorter term (i.e., certificates of deposit, regular savings accounts, etc.). This structure would generally impact net interest income favorably in a decreasing rate environment, assuming a normally shaped yield curve, as the rates on interest-bearing liabilities would decrease more rapidly than rates on the interest-earning assets.  Conversely, in an increasing rate environment, assuming a normally shaped yield curve, net interest income would be generally impacted unfavorably as rates on interest-earning assets would increase at a slower rate than rates on interest-bearing liabilities.  The Company’s interest rate risk exposure has been reduced due to changes in the loan composition, by increasing the percentage of loans with adjustable rates and reducing the average duration of the loan portfolio.  This decline in Mutual’s liability sensitive exposure should provide for less net portfolio value volatility with future rate movements.

It has been the Company’s strategic objective to change the repricing structure of its interest-earning assets from longer term to shorter term to better match the structure of our interest-bearing liabilities, and thereby reduce the impact interest rate changes have on our net interest income.  Historically, strategies employed to accomplish this objective have been to increase the origination of variable rate commercial loans and shorter term consumer loans and to sell longer term mortgage loans. The percentage of consumer and commercial loans to total loans has increased from 44% at the end of 2004 to 52% as of September 30, 2011.  As we continue to increase our investment in business-related loans, which are considered to entail greater risks than one-to four- family residential loans, in order to help offset the pressure on our net interest margin, our provision for loan losses has increased to reflect this increased risk.  On the liability side of the balance sheet, the Company is employing strategies to increase the balance of core deposit accounts by restructuring the current checking account offerings while continuing to provide low cost checking and money market accounts. The percentage of core deposits to total deposits was 43% at September 30, 2011, compared to 36% at the end of 2004.  The remaining total deposits are mostly retail certificates of deposit, which continue to provide stable funding for the Company.  These are ongoing strategies that are dependent on current market conditions and competition.

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During the first nine months of 2011, in keeping with its strategic objective to reduce interest rate risk exposure, the Company also sold $26.1 million of long term fixed rate loans that were originated as held for sale, which reduced potential earning assets and therefore had a negative impact on net interest income.  The negative impact was offset by recognizing a gain on the sale of these loans of $686,000 and by using a portion of the proceeds to make purchases in the investment portfolio.

Another important source of revenue for the Company is non-interest income.  Non-interest income is primarily made up of recurring income from service fee income on checking accounts and commissions from the Company’s trust and brokerage business.  Non-interest income also includes gains on sale of loans and investments and increases in cash surrender value of life insurance.  Overall, the Company continues to anticipate less service fee income off of deposit accounts than in previous periods due to continued regulatory change, including limitations on interchange fee income.  The Company’s trust business is a source of recurring revenue that may fluctuate depending on movements in the stock market.  The Company’s objective is to increase non-interest income by growing its trust and wealth management area, but in the short run non-interest expense may increase as proper infrastructure is put in place to support a higher level of non-interest income.

Financial Condition

Assets increased $25.7 million as of September 30, 2011 compared to December 31, 2010, primarily due to the $43.4 million increase in investment securities and the $23.9 million increase in other assets, which was primarily due to a securities trade occurring in the third quarter, but not settling until early in the fourth quarter.  These increases were partially offset by the $44.7 million decrease in gross loans held for investment and sale.  The increase in investment securities was in shorter term government agency mortgage- backed securities, and was primarily funded by proceeds from loan payments and increased deposits.  In the third quarter of 2011, gross loans held for investment decreased $5.7 million as consumer loans decreased $6.7 million and commercial loans decreased $2.0 million.  These decreases were partially offset by increases in mortgage loans of $3.0 million in the third quarter of 2011.

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Allowance for loan losses increased by $109,000, to $16.5 million as of September 30, 2011 compared to December 31, 2010.  Net charge offs in the third quarter were $2.7 million, or 1.11% of total loans on an annualized basis.  Net charge offs for the first nine months of 2011 was $9.0 million, or 1.24% of total loans on an annualized basis. The allowance for loan losses to non-performing loans as of September 30, 2011 was 42.34% compared to 42.16% as of December 31, 2010.  The allowance for loan losses to total loans as of September 30, 2011 was 1.72%, an increase from December 31, 2010.

Deposits increased by $56.6 million as the Bank has seen increased activity in all of its markets for core deposit relationships in 2011.  The increase in deposits has been primarily in core transactional accounts which increased $60.7 million while certificates of deposit decreased $4.2 million in the nine months ended of 2011. Core transactional deposits increased to 43% of the Bank’s total deposits as of September 30, 2011 compared to 40% as of December 31, 2010. The increase in deposits allowed the Bank to retire higher rate maturing debt, mainly FHLB advances, of $33.9 million in the first nine months of 2011.

Stockholders’ equity was $133.3 million at September 30, 2011, an increase of $2.2 million from December 31, 2010. The increase was due primarily to unrealized gains on securities of $6.3 million and net income of $2.4 million. This increase was partially offset by a $4.4 million reduction in capital as a result of paying off TARP-related securities, including redeeming the warrants, netted against receipt of funds through participation in the Small Business Lending Fund (SBLF).  Other decreases in capital were dividend payments of $1.3 million to common shareholders and $1.3 million to preferred shareholders.  The Company’s tangible book value per share as of September 30, 2011 increased to $14.42 compared to $13.49 as of December 31, 2010 and the tangible common equity ratio was 7.20% as of September 30, 2011 compared to 6.93% as of December 31, 2010.  The Bank’s risk-based capital ratio was well in excess of “well-capitalized” levels as defined by all regulatory standards as of September 30, 2011.

Comparison of the Operating Results

Net interest income before the provision for loan losses decreased $220,000 for the quarter ended September 30, 2011 compared to the same period in 2010.  The decrease was a result of a decline in average earning assets of $8.3 million comparing the third quarter of 2011 with the same period in 2010.  On a linked quarter basis, net interest income before the provision for loan losses decreased $159,000 primarily due to average earning assets decreasing by $20.4 million.

The provision for loan losses for the third quarter of 2011 increased to $3.2 million compared to $2.2 million during last year’s comparable period.  The increase was attributable to increases in historical loss factors which were impacted by the increased charge offs in the third quarter of 2011.  Non-performing loans to total loans at September 30, 2011 was 4.06% compared to 3.90% at December 31, 2010.  Non-performing assets to total assets were 3.26% at September 30, 2011 compared to 3.20% at December 31, 2010.  Net charge offs for the third quarter of 2011 were $2.7 million, or 1.11% of loans on an annualized basis compared to $2.0 million, or .78% of loans on an annualized basis in the third quarter of 2010.

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The following is a summary of changes in non-interest (other) income:

	Three Months Ended						Amount			Percent
Non-Interest Income	9/30/2011			9/30/2010			Change			Change
Service fee income	$	1,862		$	1,829		$	33			1.8	%
Net realized gain (loss) on sale of securities		1,764			(381	)		2,145			-563.0	%
Equity in losses of limited partnerships		(107	)		(127	)		20			-15.7	%
Commissions		879			896			(17	)		-1.9	%
Net gains on sales of loans		245			846			(601	)		-71.0	%
Net servicing fees		(337	)		34			(371	)		-1091.2	%
Increase in cash surrender value of life insurance		346			630			(284	)		-45.1	%
Loss on sale of other real estate and repossessed assets		(22	)		(159	)		137			-86.2	%
Net other-than-temporary losses on securities		-			(99	)		99			-100.0	%
Other income		34			15			19			126.7	%
Total Non-Interest Income	$	4,664		$	3,484		$	1,180			33.9	%

Non-interest income for the third quarter of 2011 was $4.7 million, an increase of $1.2 million compared to the third quarter of 2010.  Gain on sale of investments increased due to sales of securities totaling $51.7 million.  This increase was partially offset by a decrease in gain on loan sales as a result of decreased mortgage banking activity; and a decrease in mortgage servicing fees primarily due to a $355,000 impairment on mortgage servicing rights due to the decreased interest rates and increased prepayment speeds in the third quarter of 2011.  The increase in cash surrender value of life insurance decreased primarily due a non-recurring policy benefit that the Company received in the third quarter of 2010.  On a linked quarter basis, non-interest income increased $1.3 million, primarily due to the same reasons mentioned above.

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The following is a summary of changes in non-interest (other) expense:

	Three Months Ended				Amount			Percent
Non-Interest Expense	9/30/2011		9/30/2010		Change			Change
Salaries and employee benefits	$	5,240	$	5,315	$	(75	)		-1.4	%
Net occupancy expenses		582		629		(47	)		-7.5	%
Equipment expenses		505		480		25			5.2	%
Data processing fees		373		363		10			2.8	%
Automated teller machine		241		295		(54	)		-18.3	%
Deposit insurance		330		465		(135	)		-29.0	%
Professional fees		433		306		127			41.5	%
Advertising and promotion		453		296		157			53.0	%
Software subscriptions and publications		338		377		(39	)		-10.3	%
Intangible amortization		280		327		(47	)		-14.4	%
Repossessed assets expense		279		148		131			88.5	%
Other expenses		982		973		9			0.9	%
Total Non-Interest Expense	$	10,036	$	9,974	$	62			0.6	%

Non-interest expense increased $62,000 when comparing the third quarter of 2011 with that of 2010.  FDIC expense related to deposit insurance decreased due to the new FDIC fee structure.  Occupancy and ATM expense decreased but was offset by increased repossessed assets expense and increased professional fees due to increased costs associated with foreclosures and repossessions.

Income tax expense increased by $96,000 for the three months ended September 30, 2011, compared to the same period in 2010.  The effective tax rate increased to 20.6% from 14.7% due to increased taxable income and decreased percentage of low income housing tax credits for the third quarter of 2011 compared to the third quarter of 2010, respectively.

Comparison of the Operating Results for the Nine Months

Net interest income before the provision for loan losses decreased $717,000 for the nine months ended of 2011 compared to the same period in 2010.  The decrease was a result of the decline in the net interest margin from 3.22% in the first nine months of 2010 to 3.18% in the first nine months of 2011 and a decline in average earning assets of $10.9 million.

The provision for loan losses for the first nine months of 2011 increased to $9.1 million compared to $5.3 million during last year’s comparable period.  The increase was primarily due to the impact of net charge offs of $9.0 million in the first nine months of 2011 compared to net charge offs of $5.2 million in the same period in 2010.  Non-performing loans to total loans at September 30, 2011 were 4.06% compared to 3.90% at December 31, 2010.  Non-performing loans increased $94,000 as of September 30, 2011 compared to December 31, 2010 as a result of an increase in restructured loans of $4.8 million, partially offset by a decline in nonaccrual loans of $4.2 million and a decline of $443,000 in accruing loans 90 days or more.  All restructured loans were performing as of September 30, 2011.  In October 2011, one restructured loan had a large pay down of $3.6 million which is not reflected in the quarter end ratios.  Non-performing assets to total assets were 3.26% at September 30, 2011 compared to 3.20% at December 31, 2010.  The increase in non-performing assets was mainly due to the increase in restructured loan balances as of September 30, 2011.

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The following is a summary of changes in non-interest (other) income:

	Nine Months Ended						Amount			Percent
Non-Interest Income	9/30/2011			9/30/2010			Change			Change
Service fee income	$	5,193		$	5,456		$	(263	)		-4.8	%
Net realized gain (loss) on sale of securities		1,839			(61	)		1,900			-3114.8	%
Equity in losses of limited partnerships		(256	)		(382	)		126			-33.0	%
Commissions		2,835			2,920			(85	)		-2.9	%
Net gains on sales of loans		685			1,410			(725	)		-51.4	%
Net servicing fees		(293	)		102			(395	)		-387.3	%
Increase in cash surrender value of life insurance		1,071			1,385			(314	)		-22.7	%
Loss on sale of other real estate and repossessed assets		(358	)		(699	)		341			-48.8	%
Net other-than-temporary losses on securities		(193	)		(826	)		633			-76.6	%
Other income		100			174			(74	)		-42.5	%
Total Non-Interest Income	$	10,623		$	9,479		$	1,144			12.1	%

Non-interest income for the nine months ended of 2011 was $10.6 million, an increase of $1.1 million compared to the same period of 2010.  Increases in gain on sale of investments was largely due to increased sales in investment securities and the stabilization of values for trust preferred securities which resulted in a decrease in other-than-temporary-impairment.  Other declines in non-interest income included service charges on deposit accounts, which decreased primarily due to regulatory changes, and gain on loan sales which decreased mainly due to decreased loan production.

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The following is a summary of changes in non-interest (other) expense:

	Nine Months Ended				Amount			Percent
Non-Interest Expense	9/30/2011		9/30/2010		Change			Change
Salaries and employee benefits	$	16,103	$	15,982	$	121			0.8	%
Net occupancy expenses		1,917		1,871		46			2.5	%
Equipment expenses		1,487		1,460		27			1.8	%
Data processing fees		1,153		1,162		(9	)		-0.8	%
Automated teller machine		776		870		(94	)		-10.8	%
Deposit insurance		1,170		1,365		(195	)		-14.3	%
Professional fees		1,169		891		278			31.2	%
Advertising and promotion		1,053		900		153			17.0	%
Software subscriptions and publications		969		1,177		(208	)		-17.7	%
Intangible amortization		894		1,033		(139	)		-13.5	%
Repossessed assets expense		746		690		56			8.1	%
Other expenses		2,801		2,853		(52	)		-1.8	%
Total Non-Interest Expense	$	30,238	$	30,254	$	(16	)		-0.1	%

Non-interest expense decreased $16,000 when comparing the first nine months of 2011 with that of 2010.  FDIC expense related to deposit insurance decreased in the first nine months of 2011 compared to the same period in 2010 primarily due to the new fee structure.  Salaries and benefits increased during the nine months of 2011 compared to the same period in 2010.  This increase was primarily due to less compensation deferrals because of decreased loan production and a significant increase in the state unemployment tax rate that took effect during the first part of the year.  Software subscriptions and publications expense decreased but was offset by an increase in professional fees as we continue to have increased legal costs for loss mitigation.

For the nine-month period ended September 30, 2011, income tax expense decreased $1.1 million compared to the same period in 2010. The effective tax rate also decreased from 20.1% to 4.5% due to a decrease in taxable income compared to the low income housing credits when comparing the first nine months of 2011 to the same period in 2010.

Liquidity and Capital Resources

The standard measure of liquidity for savings associations is the ratio of cash and eligible investments to a certain percentage of the net-withdrawable savings accounts and borrowings due within one year.  As of September 30, 2011, Mutual had liquid assets of $332.2 million and a liquidity ratio of 26.50% compared to 22.44% at December 31, 2010. This elevated level of liquidity is primarily a result of increased cash and investment portfolio due to the growth in deposits in the first nine months of 2011.  Higher levels of liquidity do not generate as much income as loans, in general; however, management believes it is prudent to have additional liquidity at this time.  The liquidity ratio will fluctuate throughout the year as excess liquidity is used to originate loans and pay down FHLB advances as they mature.  The Company believes the current available liquidity will be sufficient to meet the needs of the Company for the foreseeable future.

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Mutual continues to maintain capital ratios which exceed “well-capitalized” levels as defined pursuant to all regulatory standards as of September 30, 2011.  Mutual’s current total regulatory capital ratios as of September 30, 2011 are core capital, 8.91%; Tier I risk-based capital, 12.82%; and total risk-based capital, 14.07%.  This is compared to the December 31, 2010 ratios of: core capital, 9.18%; Tier I risk-based capital, 12.54%; and total risked-based capital, 13.79%.  Risk-based capital improved from December 31, 2010 due to changes in the balance sheet that reduced risk-weighted assets.

ITEM 3 - Quantitative and Qualitative Disclosures about Market Risk

Presented below as of September 30, 2011 and 2010, is an analysis of Mutual’s interest rate risk as measured by changes in Mutual’s net portfolio value (“NPV”) assuming an instantaneous and sustained parallel shift in the yield curve, in 100 basis point increments.

September 30, 2011

Net Portfolio Value

Changes												NPV as % of PV of Assets
In Rates			$ Amount			$ Change			% Change			NPV Ratio			Change
	+300	bp		186,866			-14,382			-7	%		13.77	%		-13	bp
	+200	bp		195,462			-5,786			-3	%		14.09	%		20	bp
	+100	bp		200,696			-552			0	%		14.16	%		26	bp
	0	bp		201,248									13.89	%
	-100	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)
	-200	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)
	-300	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)

September 30, 2010

Net Portfolio Value

Changes												NPV as % of PV of Assets
In Rates			$ Amount			$ Change			% Change			NPV Ratio			Change
	+300	bp		176,863			-21,696			-11	%		12.83	%		-68	bp
	+200	bp		187,574			-10,984			-6	%		13.31	%		-20	bp
	+100	bp		195,618			-2,940			-1	%		13.58	%		8	bp
	0	bp		198,558									13.50	%
	-100	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)
	-200	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)
	-300	bp		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)		n/m	(1)
n/m(1) - not meaningful because certain market interest rates would be below zero at that level of rate shock.

52

The analysis at September 30, 2011, indicates that there have been no material changes in market interest rates, other than previously discussed, for Mutual’s interest rate sensitivity instruments which would cause a material change in the market risk exposures that affect the quantitative and qualitative risk disclosures as presented in item 7A of the Company’s annual report on Form 10-K for the period ended December 31, 2010.  The low level of interest rate risk exposure of Mutual is primarily due to the current structure of the balance sheet and the continuous sale of originated long term fixed-rate loans.

ITEM - 4 Controls and Procedures.

(a) An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a -15(c) under the Securities Exchange Act of 1934 (the “Act”), as of September 30, 2011 was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period preceding the filing of this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and the Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a – 15(f) under the Act) that occurred during the quarter ended September 30, 2011 that have materially affected, or are likely to materially affect our internal control over financial reporting.

The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all errors and fraud.  A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure is met.  Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.  The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future.  The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company’s business.  While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures.

53

PART II.    OTHER INFORMATION

Item 1.   Legal Proceedings

None.

Item 1A.   Risk Factors

The following risk factor represents changes and additions to, and should be read in conjunction with “Item 1A. Risk Factors” contained in the Annual Report on Form 10-K for the year ended December 31, 2010.

Item 2.  Registered sales of Equity Securities and use of Proceeds

On August 13, 2008 the Company’s Board of Directors authorized management to repurchase an additional 5% of the Company’s outstanding stock, or approximately 350,000 shares.  Information on the shares purchased during the first quarter of 2011 is as follows.

					Total Number of		Maximum Number of
					Shares Purchased		Shares that May Yet
	Total Number of		Average Price		As Part of Publicly		Be Purchased
	Shares Purchased		Per Share		Announced Plan		Under the Plan
								330,000
July 1, 2011 - July 31, 2011		-	$	0.00		-		330,000
August 1, 2011 - August 31, 2011		-		0.00		-		330,000
September 1, 2011 - September 30, 2011		-		0.00		-		330,000

(1)  Amount represents the number of shares available to be repurchased under the plan as of June 30, 2011

Item 3.    Defaults Upon Senior Securities.

None.

Item 4.   Reserved.

Item 5.    Other Information.

None.

Item 6.    Exhibits.

Index to Exhibits

Number Description

31.1  Rule 13a – 14(a) Certification – Chief Executive Officer

31.2  Rule 13a – 14(a) Certification – Chief Financial Officer

32 Certificate of the Chief Executive Officer and Chief Financial Officer pursuant to U. S. C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2003.

54

SIGNATURES

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

	MutualFirst Financial, Inc.
Date: November 10, 2011	By:  /s/  David W. Heeter
	David W. Heeter
	President and Chief Executive Officer
Date: November 10, 2011	By:  /s/  Christopher D. Cook
	Christopher D. Cook
	Senior Vice President, Treasurer and Chief Financial Officer

 

55

EX-31.1

CERTIFICATIONS                                                                Exhibit 31.1

I, David W. Heeter certify that:

1. I have reviewed this report on Form 10-Q of MutualFirst Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)  designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; and

c)  evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

e)  disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies and material weaknesses in the design or operation of internal control which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 10, 2011

/s/ David W. Heeter

David W. Heeter,

President and Chief Executive Officer

EX-31.2

CERTIFICATIONS                                                                Exhibit 31.2

I, Christopher D. Cook, certify that:

1. I have reviewed this report on Form 10-Q of MutualFirst Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the consolidated financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

a)  designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; and

c)  evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

e)  disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect the registrant’s internal control over financial reporting;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies and material weaknesses in the design or operation of internal control which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  November 10, 2011

/s/ Christopher D. Cook

Christopher D. Cook,

Senior Vice President, Treasurer and Chief Financial Officer

 

EX-32

EXHIBIT 32

SECTION 1350 CERTIFICATION

Each of the undersigned hereby certifies in his capacity as an officer of MutualFirst Financial, Inc. (the “Registrant”) that the quarterly report of the Registrant on Form 10-Q for the period ended September 30, 2011, fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the consolidated financial condition of the Registrant at the end of such period and the results of operations of the Registrant for such period.

Date:  November 10, 2011	By: /s/ David W. Heeter
	David W. Heeter
	President and Chief Executive Officer
Date:  November 10, 2011	By: /s/ Christopher D. Cook
	Christopher D. Cook
	Senior Vice President, Treasurer and Chief Financial Officer
	(Principal Financial and Accounting Officer)

 

XML

Consolidated Condensed Balance Sheets (Parenthetical) (USD $)	Sep. 30, 2011	Dec. 31, 2010
Preferred stock, par value	$ 0.01	$ 0.01
Preferred stock, Authorized	5,000,000	5,000,000
Preferred stock, Issued	28,923	32,382
Preferred stock, outstanding	28,923	32,382
Preferred stock, liquidation preference	$ 1,000	$ 1,000
Common stock, par value	$ 0.01	$ 0.01
Common stock, Authorized	20,000,000	20,000,000
Common stock, Issued	6,987,586	6,984,754
Common stock, outstanding	6,987,586	6,984,754

XML

Consolidated Condensed Statements of Income (USD $)	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
Interest Income
Loans receivable, including fees	$ 12,991,790	$ 14,908,465	$ 40,091,062	$ 45,651,477
Investment securities:
Mortgage-backed securities	1,963,266	1,420,310	5,804,669	4,489,600
Federal Home Loan Bank stock	107,239	69,677	315,180	255,481
Other investments	170,205	278,768	459,617	829,343
Deposits with financial institutions	16,891	48,068	68,505	146,933
Total interest income	15,249,391	16,725,288	46,739,033	51,372,834
Interest Expense
Passbook savings	26,713	34,596	98,362	104,524
Certificates of deposit	3,458,636	4,123,081	11,006,387	12,623,190
Daily Money Market accounts	127,628	157,984	370,300	460,905
Demand and NOW accounts	291,675	242,598	885,872	697,529
Federal Home Loan Bank advances	741,230	1,319,229	2,485,575	4,802,345
Other interest expense	207,921	233,067	628,164	703,318
Total interest expense	4,853,803	6,110,555	15,474,660	19,391,811
Net Interest Income	10,395,588	10,614,733	31,264,373	31,981,023
Provision for losses on loans	3,200,000	2,225,000	9,100,000	5,275,000
Net Interest Income After Provision for Loan Losses	7,195,588	8,389,733	22,164,373	26,706,023
Other Income
Service fee income	1,862,120	1,829,034	5,192,782	5,456,161
Net realized gain (loss) on sale of securities	1,763,960	(380,786)	1,839,316	(60,510)
Equity in losses of limited partnerships	(106,614)	(127,617)	(255,893)	(382,449)
Commissions	878,886	896,291	2,834,601	2,919,960
Net gains on sales of loans	244,867	845,967	685,571	1,409,654
Net servicing fees (loss)	(336,711)	33,722	(292,465)	101,927
Increase in cash surrender value of life insurance	345,772	630,289	1,070,733	1,385,474
Loss on sale of other real estate and repossessed assets	(22,127)	(159,471)	(358,264)	(698,602)
Other-than-temporary losses on securities
Total other-than-temporary losses	0	(98,575)	(723,338)	(2,136,555)
Portion of loss recognized in other comprehensive income (before taxes)	0	0	529,896	1,310,285
Net impairment losses recognized in earnings	0	(98,575)	(193,442)	(826,270)
Other income	34,034	14,862	100,555	173,658
Total other income	4,664,187	3,483,716	10,623,494	9,479,003
Other Expenses
Salaries and employee benefits	5,240,059	5,314,547	16,103,385	15,982,278
Net occupancy expenses	582,515	628,593	1,917,019	1,871,424
Equipment expenses	504,574	480,364	1,486,945	1,459,569
Data processing fees	373,318	363,035	1,153,319	1,161,504
Automated teller machine	240,693	294,474	776,018	869,944
Deposit insurance	330,182	465,230	1,169,883	1,364,521
Professional fees	433,123	305,954	1,169,000	891,404
Advertising and promotion	453,258	296,000	1,053,040	899,984
Software subscriptions and maintenance	338,050	377,081	968,687	1,176,902
Intangible amortization	279,600	327,408	893,517	1,033,368
Other real estate and repossessed assets	279,155	148,037	746,257	689,519
Other expenses	981,955	972,880	2,801,255	2,853,566
Total other expenses	10,036,482	9,973,603	30,238,325	30,253,983
Income Before Income Tax	1,823,293	1,899,846	2,549,542	5,931,043
Income tax expense	375,000	279,000	114,000	1,192,000
Net Income	1,448,293	1,620,846	2,435,542	4,739,043
Preferred stock dividends and accretion	851,891	450,766	1,753,423	1,352,298
Net Income Available to Common Shareholders	$ 596,402	$ 1,170,080	$ 682,119	$ 3,386,745
Basic earnings per common share	$ 0.09	$ 0.17	$ 0.10	$ 0.49
Diluted earnings per common share	$ 0.09	$ 0.17	$ 0.10	$ 0.49
Dividends per common share	$ 0.06	$ 0.06	$ 0.18	$ 0.18

XML

Document and Entity Information	9 Months Ended
	Sep. 30, 2011	Nov. 06, 2011
Document Type	10-Q
Amendment Flag	false
Document Period End Date	Sep. 30, 2011
Document Fiscal Year Focus	2011
Document Fiscal Period Focus	Q3
Trading Symbol	MFSF
Entity Registrant Name	MUTUALFIRST FINANCIAL INC
Entity Central Index Key	0001094810
Current Fiscal Year End Date	--12-31
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding		6,987,586

XML

Accumulated Other Comprehensive Income

9 Months Ended

Sep. 30, 2011

Accumulated Other Comprehensive Income

Note 5:  Accumulated Other Comprehensive Income

Other comprehensive income components and related taxes for the nine months ended September 30 were as follows:

	2011			2010
Net unrealized gain on securities available-for-sale	$	11,724		$	3,130
Net unrealized gain (loss) on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		(136	)		(1,257	)
Net unrealized loss on derivative used for cash flow hedges		(162	)		(536	)
Less: reclassification adjustment for realized (gain) loss included in income		(1,646	)		887
Other comprehensive income, before tax effect		9,780			2,224
Tax expense		3,448			783
Other comprehensive income	$	6,332		$	1,441

The components of accumulated other comprehensive gain (loss), included in stockholders’ equity are as follows:

	September 30,			December 31,
	2011			2010
Net unrealized gain (loss) on securities available-for-sale	$	8,650		$	(1,236	)
Net unrealized loss on securities available-for-sale for which a portion of an other-than-temporary impairment has been recognized in income		(4,186	)		(4,243	)
Net unrealized loss on derivative used for cash flow hedges		(501	)		(339	)
Net unrealized loss relating to defined benefit plan liability		(251	)		(251	)
		3,712			(6,069	)
Tax expense (benefit)		1,368			(2,081	)
Net-of-tax amount	$	2,344		$	(3,988	)

XML

Basis of Presentation

9 Months Ended

Sep. 30, 2011

Basis of Presentation

Note 1:  Basis of Presentation

The consolidated condensed financial statements include the accounts of MutualFirst Financial, Inc. (the “Company”), its wholly owned subsidiary MutualBank, a federally chartered savings bank (“Mutual” or the “Bank”), Mutual’s wholly owned subsidiaries, First MFSB Corporation, Mishawaka Financial Services, and Mutual Federal Investment Company (“MFIC”), and MFIC majority owned subsidiary, Mutual Federal REIT, Inc. All significant inter-company accounts and transactions have been eliminated in consolidation.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. These consolidated condensed financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K annual report for 2010 filed with the Securities and Exchange Commission.

The interim consolidated financial statements at September 30, 2011, have not been audited by independent accountants, but in the opinion of management, reflect all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flows for such periods. The results of operations for the period are not necessarily indicative of the results to be expected for the full year.

The Consolidated Condensed Balance Sheet of the Company as of December 31, 2010 has been derived from the Audited Consolidated Balance Sheet of the Company as of that date.

XML

Loans

9 Months Ended

Sep. 30, 2011

Loans

Note 7: Loans

Categories of loans at September 30, 2011 and December 31, 2010 include:

	September 30,			December 31,
	2011			2010
Commercial
Real estate	$	206,510		$	199,517
Construction and development		22,221			49,803
Other		68,232			64,611
		296,963			313,931
Residential Mortgage		458,975			458,019
Consumer loans
Real estate		97,178			103,566
Auto		14,382			16,047
Boat/RV		87,735			102,015
Other		7,341			6,157
		206,636			227,785
Total loans		962,574			999,735
Undisbursed loans in process		(5,336	)		(7,212	)
Unamortized deferred loan costs, net		2,468			2,750
Allowance for loan losses		(16,481	)		(16,372	)
Net loans	$	943,225		$	978,901

The risk characteristics of each loan portfolio segment are as follows:

Commercial real estate

These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. As a general rule, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans.

Construction and Development

Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analyses of absorption and lease rates and financial analyses of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Commercial other

Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Residential and Consumer

With respect to residential loans that are secured by 1-4 family residences and are primarily owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires PMI if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer loans are secured by consumer assets such as automobiles or recreational vehicles. Some consumer loans are unsecured such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Nonaccrual Loan and Past Due Loans.  Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due.  The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Past due status is based on contractual terms of the loan.  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 collected for loans that are placed on nonaccrual or charged off is reversed against interest income.  The interest on these 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.

Non-accrual loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 are as follows:

	September 30,		December 31,
	2011		2010
Commercial
Real Estate	$	7,131	$	6,040
Construction and development		5,997		7,399
Other		1,433		1,019
Residential Mortgage		9,099		12,012
Consumer
Real estate		1,675		2,716
Auto		35		16
Boat/RV		449		870
Other		118		111
	$	25,937	$	30,183

An age analysis of Company’s past due loans, segregated by class of loans, as of September 30, 2011 and December 31, 2010 is as follows:

	September 30, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	2,850	$	4,573	$	7,131	$	14,554	$	191,956	$	206,510	$	-
Construction and development		820		3,605		5,997		10,422		11,799		22,221		-
Other		1,287		545		1,433		3,265		64,967		68,232		-
Residential Mortgage		8,808		2,862		10,202		21,872		437,103		458,975		1,103
Consumer
Real estate		1,106		767		1,675		3,548		93,630		97,178		-
Auto		88		16		35		139		14,243		14,382		-
Boat/RV		1,722		599		449		2,770		84,965		87,735		-
Other		53		20		118		191		7,150		7,341		-
	$	16,734	$	12,987	$	27,040	$	56,761	$	905,813	$	962,574	$	1,103

	December 31, 2010
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days and Accruing
Commercial
Real Estate	$	1,883	$	139	$	6,040	$	8,062	$	191,455	$	199,517	$	-
Construction and development		398		205		7,399		8,002		41,801		49,803		-
Other		4,067		173		1,019		5,259		59,352		64,611		-
Residential Mortgage		10,386		4,367		13,461		28,214		429,805		458,019		1,449
Consumer
Real estate		1,920		1,754		2,755		6,429		97,137		103,566		39
Auto		157		74		21		252		15,795		16,047		4
Boat/RV		3,215		957		924		5,096		96,919		102,015		54
Other		281		60		110		451		5,706		6,157		-
	$	22,307	$	7,729	$	31,729	$	61,765	$	937,970	$	999,735	$	1,546

Impaired Loans.  Loans are considered impaired in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company 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.

Interest on impaired loans is recorded based on the performance of the loan.  All interest received on impaired loans that are on nonaccrual is accounted for on the cash-basis method until qualifying for return to accrual.  Interest is accrued per contract for impaired loans that are performing.

The following tables present impaired loans for the quarter and year-to-date ended September 30, 2011 and year ended December 31, 2010.

	September 30, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans Quarter		Average Investment in Impaired Loans YTD		Interest Income Recognized Quarter		Interest Income Recognized YTD
Loans without a specific valuation allowance
Commercial
Real Estate	$	3,974	$	4,199	$	-	$	3,349	$	4,890	$	4	$	81
Construction and development		9,739		14,240		-		9,158		11,776		31		227
Other		1,963		1,962		-		1,358		1,972		1		28
Residential Mortgage		4,639		6,130		-		4,765		5,866		47		119
Loans with a specific valuation allowance
Commercial
Real Estate		1,610		2,061		465		1,640		1,648		8		52
Construction and development		3,989		4,189		788		3,985		4,122		24		60
Other		250		250		225		125		250		3		7
Residential Mortgage		-		-		-		-		-		-		-
Total
Commercial	$	21,525	$	26,901	$	1,253	$	19,615	$	24,658	$	71	$	455
Residential	$	4,639	$	6,130	$	225	$	4,765	$	5,866	$	47	$	119

	December 31, 2010
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized
Loans without a specific valuation allowance
Commercial
Real Estate	$	5,222	$	5,699	$	-	$	3,826	$	137
Construction and development		2,241		2,441		-		2,390		27
Other		762		762		-		388		12
Residential Mortgage		6,419		6,419		-		4,580		183
Loans with a specific valuation allowance
Commercial
Real Estate		5,324		5,724		515		5,395		329
Construction and development		6,760		6,760		825		4,238		226
Other		-		-		-
Residential Mortgage		509		509		69		128		-
Total
Commercial	$	20,309	$	21,386	$	1,340	$	16,237	$	731
Residential	$	6,928	$	6,928	$	69	$	4,708	$	183

The following information presents the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of September 30, 2011 and December 31, 2010.

Commercial Loan Grades

Definition of Loan Grades.  Loan grades are numbered 1 through 8.  Grades 1-4 are "pass" credits, grade 5 [Special Mention] loans are "criticized" assets, and grades 6 [Substandard], 7 [Doubtful] and 8 [Loss] are "classified" assets.  The use and application of these grades by the Bank will be uniform and shall conform to the Bank's policy and OTS regulatory definitions.

Pass.  Pass credits are loans in grades prime through fair.  These are at least considered to be credits with acceptable risks and would be granted in the normal course of lending operations.

Special Mention.  Special mention credits have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credits or in the institution’s credit position at some future date.  If weaknesses cannot be identified, classifying as special mention is not appropriate.  Special mention credits are NOT adversely classified and do NOT expose the institution to sufficient risk to warrant an adverse classification.  No apparent loss of principal or interest is expected.

Substandard.  Credits which are inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged.  Financial statements normally reveal some or all of the following:  poor trends, lack of earnings and cash flow, excessive debt, lack of liquidity, and the absence of creditor protection.  Credits so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss of the deficiencies are not corrected.

Doubtful.  An  extension of credit “doubtful” has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors that may work to the advantage and strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.  Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral, and refinancing plans.  A Doubtful classification for an entire credit should be avoided when collection of a specific portion appears highly probable with the adequately secured portion graded Substandard.  

Retail Loan Grades

Pass.  Pass credits are loans that are currently performing as agreed and are not troubled debt restructurings.

Substandard.  Substandard credits are loans that have reason to be considered to have a well defined weakness and placed on non-accrual.  This would include all retail loans over 90 days and troubled debt restructurings which were delinquent at the time of modification.

September 30, 2011
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other
Pass	$	171,516	$	7,637	$	55,494
Special Mention		13,243		542		4,803
Substandard		19,841		13,917		7,041
Doubtful		1,910		125		894
Total	$	206,510	$	22,221	$	68,232
Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other
Pass	$	444,389	$	94,808	$	14,288	$	86,752	$	7,227
Substandard		14,586		2,370		94		983		114
Total	$	458,975	$	97,178	$	14,382	$	87,735	$	7,341

December 31, 2010
Commercial Credit Exposure Credit Risk Profile
Internal Rating	Real estate		Construction and Development		Other
Pass	$	168,855	$	22,046	$	56,587
Special Mention		9,934		10,313		5,471
Substandard		18,190		17,411		1,665
Doubtful		2,538		33		888
Total	$	199,517	$	49,803	$	64,611
Retail Credit Exposure Credit Risk Profile
	Mortgage		Consumer
	Residential		Real Estate		Auto		Boat/RV		Other
Pass	$	440,296	$	99,041	$	16,031	$	101,097	$	5,977
Substandard		17,723		4,525		16		918		180
Total	$	458,019	$	103,566	$	16,047	$	102,015	$	6,157

Allowance for Loan Losses.  We maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated losses inherent in the loan portfolio.  Our methodology for assessing the appropriateness of the allowance consists of several key elements, including the general allowance and specific allowances for identified problem loans and portfolio segments.  In addition, the allowance incorporates the results of measuring impaired loans as provided in FASB ASC 310, Receivables.  These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.

The general allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of such loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the general allowance. Loss factors are based on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.  The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior three years.  Management believes the three year historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed.

The appropriateness of the allowance is reviewed by management based upon its evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in non-performing loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan.  Senior management reviews these conditions quarterly in discussions with our senior credit officers.  To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of such condition may be reflected as a specific allowance applicable to such credit or portfolio segment.  Where any of these conditions is not evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s evaluation of the loss related to this condition is reflected in the general allowance for loan losses.  The evaluation of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty because they are not identified with specific problem credits or portfolio segments.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio.  Actual losses can vary significantly from the estimated amounts.  Our methodology as described permits adjustments to any loss factor used in the computation of the general allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors.  By assessing the probable incurred losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.  Due to the loss of numerous manufacturing jobs in the communities we serve during recent years, including 2010, and the increase in higher risk loans, like consumer and commercial loans, as a percentage of total loans, management has concluded that our allowance for loan losses should be greater than historical loss experience and specifically identified losses would otherwise indicate.

The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine-month periods ended September 30, 2011 and year ended December 31, 2010.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses on other segments.

	Three Months Ended September 30, 2011
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	6,957	$	1,638	$	1,195	$	2,135	$	1,656	$	261	$	1,975	$	140	$	15,957
Provision charged to expense		115		500		2,300		100		45		42		90		8		3,200
Losses charged off		249		-		1,768		464		75		46		412		23		3,037
Recoveries		64		-		-		63		1		-		215		18		361
Balance, end of period	$	6,887	$	2,138	$	1,727	$	1,834	$	1,627	$	257	$	1,868	$	143	$	16,481
Ending balance:
Individually evaluated for impairment	$	465	$	225	$	788	$	-	$	-	$	-	$	-	$	-	$	1,478
Collectively evaluated for impairment	$	6,422	$	1,913	$	939	$	1,834	$	1,627	$	257	$	1,868	$	143	$	15,003
Loans:
Ending balance
Individually evaluated for impairment	$	5,584	$	2,213	$	13,728	$	4,639	$	-	$	-	$	-	$	-	$	26,164
Collectively evaluated for impairment	$	200,926	$	66,019	$	8,493	$	454,336	$	97,178	$	14,382	$	87,735	$	7,341	$	936,410

	Nine Months Ended September 30, 2011
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	7,097	$	1,717	$	1,310	$	2,212	$	1,616	$	250	$	2,008	$	162	$	16,372
Provision charged to expense		515		500		5,130		2,100		254		52		400		149		9,100
Losses charged off		790		79		4,713		2,644		246		71		1,131		199		9,873
Recoveries		65		-		-		166		3		26		591		31		882
Balance, end of period	$	6,887	$	2,138	$	1,727	$	1,834	$	1,627	$	257	$	1,868	$	143	$	16,481
Ending balance:
Individually evaluated for impairment	$	465	$	225	$	788	$	-	$	-	$	-	$	-	$	-	$	1,478
Collectively evaluated for impairment	$	6,422	$	1,913	$	939	$	1,834	$	1,627	$	257	$	1,868	$	143	$	15,003
Loans:
Ending balance
Individually evaluated for impairment	$	5,584	$	2,213	$	13,728	$	4,639	$	-	$	-	$	-	$	-	$	26,164
Collectively evaluated for impairment	$	200,926	$	66,019	$	8,493	$	454,336	$	97,178	$	14,382	$	87,735	$	7,341	$	936,410

	Year Ended December 31, 2010
	Commercial						Mortgage		Consumer
	Real Estate		Other		Construction and Development		Residential		Real Estate		Auto		Boat/RV		Other		Total
Allowance for loan losses:
Balance, beginning of year	$	7,072	$	1,721	$	1,210	$	2,359	$	1,588	$	207	$	2,144	$	113	$	16,414
Provision charged to expense		1,300		180		300		2,900		940		86		1,100		244		7,050
Losses charged off		1,343		209		200		3,345		914		62		1,339		880		8,292
Recoveries		68		25		-		298		2		19		103		685		1,200
Balance, end of period	$	7,097	$	1,717	$	1,310	$	2,212	$	1,616	$	250	$	2,008	$	162	$	16,372
Ending balance:
Individually evaluated for impairment	$	515	$	-	$	825	$	69	$	-	$	-	$	-	$	-	$	1,409
Collectively evaluated for impairment	$	6,582	$	1,717	$	485	$	2,143	$	1,616	$	250	$	2,008	$	162	$	14,963
Loans acquired with deteriorated credit quality	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Loans:
Ending balance
Individually evaluated for impairment	$	10,546	$	762	$	9,001	$	6,928	$	-	$	-	$	-	$	-	$	27,237
Collectively evaluated for impairment	$	188,971	$	63,849	$	40,802	$	451,091	$	103,566	$	16,047	$	102,015	$	6,157	$	972,498

Management’s general practice is to proactively charge down loans individually evaluated for impairment to the fair value of the underlying collateral.

For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered to be solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.

The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.

Information on non-performing assets, including restructured loans, is provided below:

	September 30,
	2011		2010
Non-performing assets
Non-accrual loans	$	25,937	$	30,192
Accruing loans 90 days + past due		1,103		366
Restructured loans		11,883		1,027
Total non-performing loans		38,923		31,585
Real estate owned		6,703		5,686
Other repossessed assets		1,019		1,142
Total non-performing assets	$	46,645	$	38,413

The Company did receive payoff of a $3.6 million performing restructured loan, included in the total non-performing assets above, subsequent to September 30, 2011.

Troubled Debt Restructurings

Included in certain loan categories of impaired loans are certain loans that have been modified in a troubled debt restructuring, where economic concessions have been granted to borrowers who have experienced financial difficulties.  These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  Modifications of terms for our loans and their inclusion as troubled debt restructurings are based on individual facts and circumstances.

When we modify loans in a troubled debt restructuring, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or use the current fair value of the collateral, less selling costs for collateral dependent loans. If we determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific reserve or a charge-off to the allowance.

Loans retain their accrual status at the time of their modification.  As a result, if a loan is on nonaccrual at the time it is modified, it stays as nonaccrual until a period of satisfactory performance, generally six months, is obtained.  If a loan is on accrual at the time of the modification, the loan is evaluated to determine the collection of principal and interest is reasonably assured and generally stays on accrual.

The following tables provide detail regarding troubled debts restructured in the last three and nine month periods.

Three Months Ended September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	113	$	70
Construction and development		0		-		-
Other		0		-		-
Residential Mortgage		6		463		492
Consumer
Real estate		10		231		231
Auto		1		10		10
Boat/RV		4		134		133
Other		0		-		-

Nine Months Ended September 30, 2011
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	No. of Loans		Recorded Balance		Recorded Balance
Commercial
Real Estate		1	$	113	$	70
Construction and development		2		3,728		3,728
Other		1		103		103
Residential Mortgage		22		2,529		2,598
Consumer
Real estate		22		555		551
Auto		1		10		10
Boat/RV		12		364		357
Other		1		14		1

We have had no defaults of any loans modified as troubled debt restructurings made since October 1, 2010.

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Preferred Stock

9 Months Ended

Sep. 30, 2011

Preferred Stock

Note 8: Preferred Stock

On August 25, 2011, MutualFirst entered into and consummated a Securities Purchase Agreement with the Secretary of the Treasury as part of the Small Business Lending Fund Program (SBLF), pursuant to which the Company (i) sold 28,923 shares of the Company’s Senior Non-Cumulative Perpetual Preferred Stock, Series A (the “SBLF Preferred Stock”) to the Secretary of the Treasury for a purchase price of $28,923,000.  The SBLF Preferred Stock was issued pursuant to the SBLF program, a $30 billion fund established under the Small Business Jobs Act of 2010 that was created to encourage lending to small business by providing capital to qualified community banks with assets of less than $10 billion.  The SBLF Preferred Stock was issued under new Articles Supplementary to the Company’s Charter and has a liquidation preference of $1,000 per share.  

The SBLF Preferred Stock qualifies as Tier 1 capital.  The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1, beginning October 1, 2011.  The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis during the first 10 quarters during which the SBLF Preferred Stock is outstanding, based upon changes in the level of “Qualified Small Business Lending” or “QBSL” (as defined in the Purchase Agreement) by the Bank.  The initial dividend rate through September 30, 2011 is 5%.  Based on the Bank’s level of QBSL over the baseline level calculated under the terms of the Purchase Agreement, the dividend rate for the fourth quarter of 2011 is expected to be 5.0%.  For the third through ninth calendar quarters after the closing, the dividend rate may be adjusted to between one percent (1%) and five percent (5%) per annum, to reflect the amount of change in the Bank’s level of QBSL.  For the tenth calendar quarter through four and one half years after issuance, the dividend rate will be fixed at between one percent (1%) and seven percent (7%) based upon the increase in QBSL as compared to the baseline.  After four and one half years from issuance, the dividend rate will increase to 9% (including a quarterly lending incentive fee of 0.5%).

The SBLF Preferred Stock is non-voting, except in limited circumstances.  In the event that the Company misses five dividend payments, whether or not consecutive, the holder of the SBLF Preferred Stock will have the right, but not the obligation, to appoint a representative as an observer on the Company’s Board of Directors.  In the event that the Company misses six dividend payments, whether or not consecutive, and if the then outstanding aggregate liquidation amount of the SBLF Preferred Stock is at least $25,000,000, then the holder of the SBLF Preferred Stock will have the right to designate two directors to the Board of Directors of the Company.

The SBLF Preferred Stock may be redeemed at any time at the Company’s option, at a redemption price of 100% of the liquidation amount plus accrued but unpaid dividends to the date of redemption for the current period, subject to the approval of its federal banking regulator.

The SBLF Preferred Stock was issued in a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.  The Company has agreed to register the SBLF Preferred Stock under certain circumstances set forth in Annex E to the Purchase Agreement.  The SBLF Preferred Stock is not subject to any restrictions on transfer.

As required by the Purchase Agreement, the proceeds from the sale of the SBLF Preferred Stock and additional funds were used to redeem the $32,382,000 in the 32,382 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A issued in 2008 to the Treasury in the Troubled Asset Relief Program (“TARP”), plus the accrued dividends owed on the TARP preferred shares. 

As part of the 2008 TARP transaction, the Company issued a warrant (Warrant) to Treasury to purchase 625,135 shares of the Company’s common stock for $7.77 per share over a 10-year term.  The Company also purchased the Warrant from Treasury for a purchase price of $900,000.

The terms of the SBLF Preferred Stock impose limits on the ability of the Company to pay dividends and repurchase shares of common stock.  Under the terms of the SBLF Preferred Stock, no repurchases may be effected, and no dividends may be declared or paid on preferred shares ranking pari passu with the SBLF Preferred Stock, junior preferred shares, or other junior securities (including the common stock) during the current quarter and for the next three quarters following the failure to declare and pay dividends on the SBLF Preferred Stock, except that, in any such quarter in which the dividend is paid, dividend payments on shares ranking pari passu may be paid to the extent necessary to avoid any resulting material covenant breach.

Under the terms of the SBLF Preferred Stock, the Company may only declare and pay a dividend on the common stock or other stock junior to the SBLF Preferred Stock, or repurchase shares of any such class or series of stock, if, after payment of such dividend, the dollar amount of the Company’s Tier 1 Capital would be at least 90% of the Signing Date Tier 1 Capital, as set forth in the Certificate of Designation relating to the SBLF Preferred Stock, excluding any subsequent net charge-offs and any redemption of the SBLF Preferred Stock (the “Tier 1 Dividend Threshold”).  The Tier 1 Dividend Threshold is subject to reduction, beginning on the second anniversary of issuance and ending on the tenth anniversary, by 10% for each one percent increase in QSBL over the baseline level.

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Disclosures About Fair Value of Assets and Liabilities

9 Months Ended

Sep. 30, 2011

Disclosures About Fair Value of Assets and Liabilities

Note 6: Disclosures About Fair Value of Assets and Liabilities

FASB Codification Topic 820 (ASC 820), Fair Value Measurements and Disclosures, 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.  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

Items Measured at Fair Value on a Recurring Basis

Following is a description of the valuation methodologies and inputs 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.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  The Company uses a third-party provider to provide market prices on its securities.  Level 1 securities include marketable equity securities.  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 mortgage-backed, collateralized mortgage obligations, small business administration, municipal and federal agency, and corporate obligation securities.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain corporate obligation securities.

Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (Level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities relationship to other benchmark quoted investment securities. Any investment security not valued based upon the methods above are considered Level 3.

The following table presents the fair value measurement of assets measured at fair value on a recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2011
Mortgage-backed securities
Government sponsored agencies	$	155,368	$	-	$	155,368	$	-
Collateralized mortgage obligations
Government sponsored agencies		102,882		-		102,882		-
Federal agencies		4,005		-		4,005		-
Municipals		3,622		-		3,622		-
Small Business Administration		13		-		13		-
Corporate obligations		22,639		-		20,086		2,553
Available-for-sale securities	$	288,529	$	-	$	285,976	$	2,553
December 31, 2010
Mortgage-backed securities
Government sponsored agencies	$	118,275	$	-	$	118,275	$	-
Collateralized mortgage obligations
Government sponsored agencies		112,224		-		112,224		-
Federal agencies		7,821		-		7,821		-
Municipals		2,482		-		2,482		-
Small Business Administration		16		-		16		-
Corporate obligations		2,645		-		-		2,645
Marketable equity securities		1,702		1,702		-		-
Available-for-sale securities	$	245,165	$	1,702	$	240,818	$	2,645

The following is a reconciliation of the beginning and ending balances for the three months ended September 30, 2011 and 2010 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2011			2010
Beginning balance, July 1	$	2,958		$	2,762
Total realized and unrealized gains and losses
Included in net income		-			-
Included in other comprehensive loss		(418	)		(250	)
Purchases, issuances and settlements		13			(75	)
Transfers in/out of Level 3		-			-
Ending balance	$	2,553		$	2,437
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	-		$	-

The following is a reconciliation of the beginning and ending balances for the nine months ended September 30, 2011 and 2010 of recurring fair value measurements recognized in the accompanying balance sheet using significant unobservable (Level 3) inputs:

	2011			2010
Beginning balance, January 1	$	2,645		$	2,539
Total realized and unrealized gains (losses)
Included in net income		(193	)		(401	)
Included in other comprehensive income		57			339
Purchases, issuances and settlements		44			(40	)
Transfers in/out of Level 3		-			-
Ending balance	$	2,553		$	2,437
Total gains or losses for the period included in net income attributable to the change in unrealized gains or losses related to assets and liabilities still held at the reporting date	$	(193	)	$	(401	)

Items Measured at Fair Value on a Non-Recurring Basis

From time to time, certain assets may be recorded at fair value on a non-recurring basis.  These non-recurring fair value adjustments typically are a result of the application of lower of cost or fair value accounting or a write-down occurring during the period.  The following is a description of the valuation methodologies used for certain assets that are recorded at fair value.

Impaired Loans (Collateral Dependent)

Loans for which it is probable that Mutual will not collect all principal and interest due according to contractual terms are measured for impairment.  An allowable method for determining the amount of impairment includes estimating fair value using the fair value of the collateral for collateral dependent loans.

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized.  This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value.

Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

Other Real Estate Owned

The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis.

Other real estate owned is classified within Level 3 of the fair value hierarchy.

Mortgage Servicing Rights

We initially measure our mortgage servicing rights at fair value, and amortize them over the period of estimated net servicing income.  They are periodically assessed for impairment based on fair value at the reporting date.  Mortgage servicing rights do not trade in an active market with readily observable prices.  Accordingly, the fair value is estimated based on a valuation model which calculates the present value of estimated future net servicing income.  The model incorporates assumptions that market participants use in estimating future net servicing income, including estimates of prepayment speeds and market discount rates.  The fair value measurements are classified as Level 3.

The following table presents the fair value measurement of assets measured at fair value on a non-recurring basis and the level within the ASC 820 fair value hierarchy used for such fair value measurements:

			Fair Value Measurements Using
	Fair Value		Level 1		Level 2		Level 3
September 30, 2011
Impaired loans	$	7,585	$	-	$	-	$	7,585
Other real estate owned		1,975		-		-		1,975
Mortgage servicing rights		2,634		-		-		2,634
December 31, 2010
Impaired loans	$	15,204	$	-	$	-	$	15,204
Other real estate owned		1,030		-		-		1,030
Mortgage servicing rights		3,349		-		-		3,349
Loans held for sale		5,057		5,057		-		-

The estimated fair values of the Company’s financial instruments not carried at fair value in the consolidated condensed balance sheets as of September 30, 2011 and December 31, 2010, are as follows:

	September 30, 2011				December 31, 2010
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Assets
Cash and cash equivalents	$	37,846	$	37,846	$	26,821	$	26,821
Loans held for sale		1,392		1,392		10,483		10,483
Loans		943,225		956,992		978,901		997,018
Stock in FHLB		14,391		14,391		16,682		16,682
Interest receivable		4,240		4,240		4,627		4,627
Liabilities
Deposits	$	1,178,121	$	1,138,310	$	1,121,569	$	1,080,131
FHLB advances		94,634		97,455		128,537		133,258
Other borrowings		12,604		13,114		13,167		14,067
Interest payable		652		652		995		995
Advances by borrowers for taxes and insurance		2,403		2,403		1,661		1,661

The following methods and assumptions were used to estimate the fair value of each class of financial instruments listed above:

Cash and Cash Equivalents - The fair value of cash and cash equivalents approximates carrying value.

Investment and Mortgage-Backed Securities - Fair values are based on quoted market prices and third party analysis.

Loans Held For Sale - Fair values are based on current investor purchase commitments.

Loans - The fair value for loans is estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

FHLB Stock - Fair value of FHLB stock is based on the price at which it may be resold to the FHLB.

Interest Receivable/Payable - The fair values of interest receivable/payable approximate carrying values.

Deposits - The fair values of noninterest-bearing, interest-bearing demand and savings accounts are equal to the amount payable on demand at the balance sheet date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on such time deposits.

Federal Home Loan Bank Advances - The fair value of these borrowings are estimated using a discounted cash flow calculation, based on current rates for similar debt for periods comparable to the remaining terms to maturity of these advances.

Other Borrowings- The fair value of other borrowings are estimated using a discount calculation based on current rates.

Advances by Borrowers for Taxes and Insurance - The fair value approximates carrying value.

Off-Balance Sheet Commitments - Commitments include commitments to purchase and originate mortgage loans, commitments to sell mortgage loans, and standby letters of credit and are generally of a short-term nature.  The fair values of such commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The fair value of commitments is immaterial.

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Consolidated Condensed Statement of Stockholders' Equity (Parenthetical) (USD $)	3 Months Ended		9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010	Sep. 30, 2011	Sep. 30, 2010
Cash dividends, per common share	$ 0.06	$ 0.06	$ 0.18	$ 0.18

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Earnings (loss) per share

9 Months Ended

Sep. 30, 2011

Earnings (loss) per share

Note 2: Earnings (loss) per share

Earnings per share were computed as follows: (Dollars in thousands except per share data)

	Three Months Ended September 30,
	2011							2010
				Weighted-							Weighted-
				Average		Per-Share					Average		Per-Share
	Income			Shares		Amount		Income			Shares		Amount
	(000's)							(000's)
Basic Earnings Per Share
Net income	$	1,448			6,911,597			$	1,621			6,877,481
Dividends and accretion on preferred stock*		(852	)						(451	)
Income available to common shareholders	$	596			6,911,597	$	0.09	$	1,170			6,877,481	$	0.17
Effect of Dilutive securities
Stock options and RRP grants					15,836							9,723
Diluted Earnings Per Share
Income available to common stockholders and assumed conversions	$	596			6,927,433	$	0.09	$	1,170			6,887,204	$	0.17

	Nine Months Ended September 30,
	2011							2010
				Weighted-							Weighted-
				Average		Per-Share					Average		Per-Share
	Income			Shares		Amount		Income			Shares		Amount
	(000's)							(000's)
Basic Earnings Per Share
Net income	$	2,435			6,902,676			$	4,739			6,869,547
Dividends and accretion on preferred stock*		(1,753	)						(1,352	)
Income available to common shareholders	$	682			6,902,676	$	0.10	$	3,387			6,869,547	$	0.49
Effect of Dilutive securities
Stock options and RRP grants					89,753							8,136
Diluted Earnings Per Share
Income available to common stockholders and assume dconversions	$	682			6,992,429	$	0.10	$	3,387			6,877,683	$	0.49

* Preferred stock accretion was accelerated during the third quarter 2011 due to the payoff of the TARP-related securities.

Options for 499,637 and 570,718 shares and warrants for 0 and 625,135 shares were not included in the calculation above due to being anti-dilutive to earnings per share as of September 30, 2011 and 2010, respectively.

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Impact of Accounting Pronouncements

9 Months Ended

Sep. 30, 2011

Impact of Accounting Pronouncements

Note 3:  Impact of Accounting Pronouncements

In January 2010, the FASB issued an Accounting Standards Update (ASU) No. 2010-06, Fair Value Measurements and Disclosures (Topic 820):  Improving Disclosures about Fair Value Measurements.  This update provides additional guidance relating to fair value measurement disclosures.  Specifically, companies are required to separately disclose significant transfers into and out of Level 1 and Level 2 measurements in the fair value hierarchy including when such transfers were recognized and the reasons for those transfers.  For Level 3 fair value measurements, the new guidance requires presentation of separate information about purchases, sales, issuances and settlements.  Additionally, the FASB also clarified existing fair value measurement disclosure requirements relating to the level of disaggregation, inputs, and valuation techniques.  This accounting standard was effective at the beginning of 2010, except for the detailed Level 3 disclosures, which became effective at the beginning of 2011.  The Company adopted this accounting pronouncement, as required, and the adoption did not have a material impact on the statements taken as a whole.

In July 2010, the FASB issued an updated (ASU) No. 2010-20, Receivables (Topic 310):  Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  This update provides guidance to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses.  This update became effective for the Company for the first interim or annual reporting period ending on or after December 15, 2010 and did not have a material impact on the statements taken as a whole.

In April 2011, FASB issued ASU No. 2011-02: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.  The standard is intended to provide additional guidance to assist creditors in determining whether a restructuring of a receivable meets the criteria to be considered a troubled debt restructuring.  The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011, and are to be applied retrospectively to the beginning of the annual period of adoption.  As a result of applying these amendments, an entity may identify receivables that are newly considered impaired.  Early adoption is permitted.  The Company has adopted this ASU and it did not have an impact on the financial statements as a whole.

In April 2011, FASB issued ASU No. 2011-03:  Reconsideration of Effective Control for Repurchase Agreements.  The amendments in this ASU remove from the assessment of effective control the criterion relating to the transferor’s ability to repurchase or redeem financial assets on substantially the agreed terms, even in the event of default by the transferee.  The amendments in this ASU also eliminate the requirement to demonstrate that the transferor possesses adequate collateral to fund substantially all the cost of purchasing replacement financial assets.

The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011.  The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  Early adoption is not permitted.  The Company does not anticipate that this ASU will have a material effect on its financial statements.

In May 2011, FASB issued ASU No. 2011-04:  Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.  The amendments in this ASU generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed.  This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS.

The amendments 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 Company does not anticipate that this ASU will have a material effect on its financial statements.

In June 2011, FASB issued ASU No. 2011-05:  Amendments to Topic 220, Comprehensive Income.  Under the amendments in this ASU, an entity has 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.  This ASU eliminates the option to present the components of other comprehensive income as a part of the statement of changes in stockholders’ equity.  The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.

The amendments in this ASU should be applied retrospectively.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption is permitted, because compliance with the amendments is already permitted.  The amendments do not require any transition disclosures.

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Investments

9 Months Ended

Sep. 30, 2011

Investments

Note 4: Investments

The amortized cost and approximate fair values of securities as of September 30, 2011 and December 31, 2010 are as follows.

	September 30, 2011
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Loss			Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	150,061	$	5,307	$	-		$	155,368
Collateralized mortgage obligations
Government sponsored agencies		99,215		3,667		-			102,882
Federal Agencies		3,998		7		-			4,005
Municipals		3,365		257		-			3,622
Small Business Administration		13		-		-			13
Corporate obligations		27,414		-		(4,775	)		22,639
Total	$	284,066	$	9,238	$	(4,775	)	$	288,529

	December 31, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Loss			Value
Available for Sale Securities
Mortgage-backed securities
Government sponsored agencies	$	119,017	$	1,076	$	(1,818	)	$	118,275
Collateralized mortgage obligations
Government sponsored agencies		112,615		1,251		(1,642	)		112,224
Federal agencies		7,925		-		(104	)		7,821
Municipals		2,460		33		(11	)		2,482
Small Business Administration		16		-		-			16
Corporate obligations		6,888		-		(4,243	)		2,645
Marketable equity securities		1,723		-		(21	)		1,702
Total	$	250,644	$	2,360	$	(7,839	)	$	245,165

The amortized cost and fair value of available-for-sale securities at September 30, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale
	Amortized		Fair
Description Securities	Cost		Value
Security obligations due
One to five years	$	13,044	$	12,801
Five to ten years		8,616		8,334
After ten years		13,117		9,131
		34,777		30,266
Mortgage-backed securities		150,061		155,368
Collateralized mortgage obligations		99,215		102,882
Small Business Administration		13		13
Totals	$	284,066	$	288,529

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $1.5 million at September 30, 2011.

Gross gains of $1,857,000 and $2,900,000 resulting from sales of securities were realized for the nine months ended September 30, 2011 and 2010, respectively.  There were $18,000 and $2,900,000 in realized losses on the sale of securities during this same nine months ended 2011 and 2010, respectively.  Other-than-temporary impairment losses were recognized on securities for the nine months ended September 30, 2011 and 2010 of $193,000 and $826,000, respectively.

Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost.  Total fair value of these investments at September 30, 2011, was $22.6 million, a decrease from $141.3 million at December 31, 2010, which is approximately 8% and 58%, respectively, of the Bank's portfolio.  The Bank has continued to see an improvement since year-end due to increased values driven by lower market interest rates.

Based on evaluation of available evidence, management believes that the unrealized losses on those securities are temporary.

Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that 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 more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Corporate obligations	$	20,086	$	(589	)	$	2,553	$	(4,186	)	$	22,639	$	(4,775	)
Total temporarily impaired securities	$	20,086	$	(589	)	$	2,553	$	(4,186	)	$	22,639	$	(4,775	)

	December 31, 2010
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
Available for Sale
Mortgage-backed securities
Government sponsored agencies	$	69,971	$	(1,818	)	$	-	$	-		$	69,971	$	(1,818	)
Collateralized mortgage obligations
Government sponsored agencies		58,466		(1,642	)		-		-			58,466		(1,642	)
Federal agencies		7,821		(104	)		-		-			7,821		(104	)
Municipals		661		(11	)		-		-			661		(11	)
Corporate obligations		-		-			2,645		(4,243	)		2,645		(4,243	)
Marketable equity securities		-		-			1,702		(21	)		1,702		(21	)
Total temporarily impaired securities	$	136,919	$	(3,575	)	$	4,347	$	(4,264	)	$	141,266	$	(7,839	)

Mortgage-Backed Securities (MBS) and Collateralized Mortgage Obligations (CMO)

The unrealized losses on the Company’s investment in MBSs and CMOs were caused by interest rate changes.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is more likely than not the Company will not be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2011.

Corporate Obligations

The Company’s unrealized loss on investments in corporate obligations primarily relates to investments in pooled trust preferred securities.  The unrealized losses were primarily caused by (a) a decrease in performance and regulatory capital at the underlying banks resulting from exposure to subprime mortgages and (b) a sector downgrade by several industry analysts.  The Company currently expects some of the securities to settle at a price less than the amortized cost basis of the investment (that is, the Company expects to recover less than the entire amortized cost basis of the security).  The Company has recognized a loss equal to the credit loss for these securities, establishing a new, lower amortized cost basis.  The credit loss was 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 Company does not intend to sell the investments and it is likely the Company will not be required to sell the investments before recovery of its new, lower amortized cost basis, which may be maturity, it does not consider the remainder of the investments to be other-than-temporarily impaired at September 30, 2011.

MutualBank evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis.  During the quarter ended September 30, 2011, the Bank’s evaluation indicated no other-than-temporary impairment.  Impairment on securities is determined after analyzing the estimated cash flows to be received, underlying collateral and determining the amount of additional losses needed in the individual pools to create a shortfall in interest or principal payments.  All trust preferred securities were valued using a discounted cash flow analysis as of September 30, 2011.

Other-than-temporary Impairment

Upon acquisition of a security, the Company decides whether it is within the scope of the accounting guidance for beneficial interests in securitized financial assets or will be evaluated for impairment under the accounting guidance for investments in debt and equity securities.

The accounting guidance for beneficial interests in securitized financial assets provides incremental impairment guidance for a subset of the debt securities within the scope of the guidance for investments in debt and equity securities.  Where the security is a beneficial interest in securitized financial assets, the Company uses the beneficial interests in securitized financial asset impairment model.  Where the security is not a beneficial interest in securitized financial assets, the Company uses the debt and equity securities impairment model.

The Company routinely conducts reviews to identify and evaluate each investment security to determine whether an other-than-temporary impairment has occurred.  Economic models are used to determine whether an other-than-temporary impairment has occurred on these securities.  While all securities are considered, the securities currently impacted by other-than-temporary impairment testing are pooled trust preferred securities.  For each pooled trust preferred security in the investment portfolio (including but not limited to those whose fair value is less than their amortized cost basis), an extensive, regular review is conducted to determine if an other-than-temporary impairment has occurred.  Various inputs to the economic models are used to determine if an unrealized loss is other-than-temporary.

The Bank’s trust preferred securities valuation was done with assistance of an independent third party.  The approach to determining fair value involved several steps including:

· Detailed credit and structural evaluation of each piece of collateral in the trust preferred securities;

· Collateral performance projections for each piece of collateral in the trust preferred security;

· Terms of the trust preferred structure, as laid out in the indenture; and

· Discounted cash flow modeling.

MutualFirst Financial uses market-based yield indicators as a baseline for determining appropriate discount rates, and then adjusts the resulting discount rates on the basis of its credit and structural analysis of specific trust preferred securities.  The primary focus is on the returns a fixed income investor would require in order to allocate capital on a risk adjusted basis.  There is currently no active market for pooled trust preferred securities; however, the Company looks principally to market yields for stand-alone trust preferred securities issued by banks, thrifts and insurance companies for which there is an active and liquid market.  The next step is to make a series of adjustments to reflect the differences that exist between these products (both credit and structural) and, most importantly, to reflect idiosyncratic credit performance differences (both actual and projected) between these products and the underlying collateral in the specific trust preferred security.  Importantly, as part of the analysis described above, MutualFirst considers the fact that structured instruments frequently exhibit leverage not present in stand-alone instruments, and make adjustments as necessary to reflect this additional risk.

 The default and recovery probabilities for each piece of collateral were formed based on the evaluation of the collateral credit and a review of historical industry default data and current/near-term operating conditions.  For collateral that has already defaulted, the Company assumed no recovery.  For collateral that was in deferral, the Company assumed a recovery of 10% of par for banks, thrifts or other depository institutions, and 15% of par for insurance companies.  Although the Company conservatively assumed that the majority of the deferring collateral continues to defer and eventually defaults, we also recognize there is a possibility that some deferring collateral may become current at some point in the future.

Pooled Trust Preferred Securities.MutualFirst Financial, Inc. has a current amortized cost in pooled trust preferred securities of $6.7 million, which had an original par value of $10.3 million.  These securities have a current fair value of $2.6 million.  The following table provides additional information related to the Bank’s investment in trust preferred securities as of September 30, 2011:

Deal	Class		Original Par		Book Value		Fair Value		Unrealized Loss		Recognized Losses 2011		Lowest Rating	Number of Banks/Insurance Companies Currently Performing		Actual Deferrals/Defaults (as % of original collateral)			Total Projected Defaults (as a % of performing collateral)a			Excess Subordination (after taking into account best estimate of future deferrals/defaultsb
(Dollars in thousands)
Alesco Preferred Funding IX		A2A	$	1,000	$	899	$	417	$	482	$	-	CCC-		42		16.72	%		25.84	%		37.51	%
Alesco Preferred Funding XVII		C1		1,000		-		-		-		100	C
Preferred Term Securities XIII		B1		1,000		822		252		570		25	Ca		44		30.74	%		22.48	%		0.00	%
Preferred Term Securities XVIII		C		1,000		917		272		645		-	Ca		51		24.26	%		13.82	%		4.53	%
Preferred Term Securities XXVII		C1		1,000		710		158		552		-	C		33		28.14	%		23.52	%		0.69	%
U.S. Capital Funding I		B1		3,000		2,891		1,216		1,675		-	Caa1		31		15.90	%		15.55	%		1.62	%
U.S. Capital Funding III		B1		1,000		500		238		262		-	Ca		31		24.94	%		14.12	%		0.00	%
U.S. Capital Funding V		B1		1,300		-		-		-		68	C
Total			$	10,300	$	6,739	$	2,553	$	4,186	$	193

(a) A 10% recovery is applied to all projected defaults, other than insurance defaults.  A 15% recovery is applied to all projected insurance defaults.  No recovery is applied to current defaults.

(b) Excess subordination represents the additional defaults in excess of both current and projected defaults that the CDO can absorb before the bond experiences any credit impairment. Excess subordinated percentage is calculated by (a) determining what percentage of defaults a deal can experience before the bond has credit impairment, and (b) subtracting from this default breakage percentage both total current and expected future default percentages.

Credit Losses Recognized on Investments

Certain debt securities have experienced fair value deterioration due to credit losses, as well as due to other market factors, but are not otherwise other-than-temporarily impaired.

The following tables provide information about debt securities for which only a credit loss was recognized in income and other losses are recorded in other comprehensive income.

	Accumulated Credit Losses
	Three Months Ended
	2011			2010
Credit losses on debt securities held
Beginning of period	$	(3,567	)	$	(3,350	)
Net additions related to increases in previously recognized other-than-temporary losses		-			(9	)
As of September 30,	$	(3,567	)	$	(3,359	)
	Accumulated Credit Losses
	Nine Months Ended
	2011			2010
Credit losses on debt securities held
Beginning of year	$	(3,374	)	$	(2,957	)
Net additions related to increases in previously recognized other-than-temporary losses		(193	)		(402	)
As of September 30,	$	(3,567	)	$	(3,359	)

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Consolidated Condensed Statement of Stockholders' Equity (USD $)	Total	Common Stock	Additional paid-in capital	Preferred Stock	Additional paid-in capitals	Comprehensive Income	Retained Earnings	Accumulated Other Comprehensive Income (Loss)	Unearned ESOP shares
Beginning Balance at Dec. 31, 2010	$ 131,140,022	$ 69,847	$ 72,424,460	$ 324	$ 31,829,779		$ 31,757,156	$ (3,988,158)	$ (953,386)
Beginning Balance (in shares) at Dec. 31, 2010		6,984,754		32,382
Comprehensive income
Net income for the period	2,435,542					2,435,542	2,435,542
Other comprehensive income, net of tax
Net unrealized gain on securities	6,438,501					6,438,501		6,438,501
Net unrealized loss on derivatives	(106,472)					(106,472)		(106,472)
Comprehensive income						8,767,571
ESOP shares earned	211,578		(26,802)						238,380
Accretion of discount on preferred stock	0				551,897		(551,897)
Share-based compensation	39,086		39,086
Stock options exercised (in shares)		2,832
Stock options exercised	16,936	29	16,907
Preferred stock issued (in shares)				28,923
Preferred stock issued	28,923,000			289	28,922,711
Stock and warrants repurchased and retired (Shares)				(32,382)
Stock and warrants repurchased and retired	(33,282,194)		(900,194)	(324)	(32,381,676)
Cash dividends ($.18 per common share)	(1,257,555)						(1,257,555)
Cash dividends - preferred stock	(1,259,300)						(1,259,300)
Ending Balance at Sep. 30, 2011	$ 133,299,144	$ 69,876	$ 71,553,457	$ 289	$ 28,922,711		$ 31,123,946	$ 2,343,871	$ (715,006)
Ending Balance (in shares) at Sep. 30, 2011		6,987,586		28,923

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Consolidated Condensed Statements of Cash Flows (USD $)	9 Months Ended
	Sep. 30, 2011	Sep. 30, 2010
Operating Activities
Net income	$ 2,435,542	$ 4,739,043
Items not requiring (providing) cash
Provision for loan losses	9,100,000	5,275,000
Depreciation and amortization	4,648,322	4,144,698
Deferred income tax	(336,001)	1,263,518
Loans originated for sale	(16,976,214)	(50,035,868)
Proceeds from sales of loans held for sale	26,354,926	43,682,702
(Gain) loss on sale:
Loans held for sale	(685,571)	(1,409,654)
Securities
Available for sale	(1,839,316)	(2,411,640)
Held to maturity		2,472,145
Other real estate and repossessed assets	358,264	698,602
Premises and equipment	43,638	918
Loss on other-than-temporary impairment, securities	193,442	826,270
Other equity adjustments	255,287	166,147
Change in
Prepaid FDIC premium	1,087,637	1,265,132
Interest receivable and other assets	(21,986,526)	873,189
Interest payable and other liabilities	720,707	1,316,833
Cash value of life insurance	(1,070,733)	(1,385,474)
Other adjustments	2,216,450	1,791,427
Net cash provided by operating activities	4,519,854	13,272,988
Investing Activities
Net change in interest earning assets		(3,005,727)
Purchases of securities
Available for sale	(119,349,447)	(184,766,963)
Proceeds from maturities and paydowns of securities:
Available for sale	29,713,680	38,833,694
Held to maturity		1,533,526
Proceeds from sale of securities
Available for sale	56,436,547	81,803,318
Held to maturity		3,775,034
Redemption of Federal Home Loan Bank Stock	2,291,500
Net change in loans	18,458,267	48,897,854
Purchases of premises and equipment	(451,639)	(561,031)
Proceeds from sale of premises and equipment		500
Proceeds from real estate owned sales	3,395,621	3,344,020
Other investing activities	(36,942)
Net cash used in investing activities	(9,542,413)	(10,145,775)
Net change in
Noninterest-bearing, interest-bearing demand and savings deposits	60,709,596	51,237,964
Certificates of deposit	(4,157,251)	30,420,429
Proceeds from FHLB advances	47,600,000	20,000,000
Repayment of FHLB advances	(81,374,530)	(64,863,001)
Repayment of other borrowings	(595,299)	(796,176)
Preferred stock issued	28,923,000
Stock/warrants repurchased	(33,282,194)
Cash dividends paid	(2,516,855)	(2,471,580)
Other financing activities	741,878	591,917
Net cash provided by financing activities	16,048,345	34,119,553
Net Change in Cash and Cash Equivalents	11,025,786	37,246,766
Cash and Cash Equivalents, Beginning of Year	26,820,680	46,340,897
Cash and Cash Equivalents, End of Year	37,846,466	83,587,663
Additional Cash Flows Information
Interest paid	15,131,947	19,503,456
Income tax paid	200,000	350,000
Transfers from loans to foreclosed real estate	7,343,974	6,111,047
Mortgage servicing rights capitalized	$ 397,131	$ 380,815

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Consolidated Condensed Balance Sheets (USD $)	Sep. 30, 2011	Dec. 31, 2010
Assets
Cash	$ 17,740,203	$ 9,288,748
Interest-bearing demand deposits	20,106,263	17,531,932
Cash and cash equivalents	37,846,466	26,820,680
Investment securities available for sale	288,529,402	245,165,189
Loans held for sale	1,392,461	10,482,734
Loans	959,706,495	995,273,005
Allowance for loan losses	(16,481,279)	(16,372,093)
Net loans	943,225,216	978,900,912
Accounts receivable	25,687,452	2,660,141
Premises and equipment	31,815,878	32,966,112
Federal Home Loan Bank of Indianapolis stock, at cost	14,390,700	16,682,200
Investment in limited partnerships	3,240,713	3,623,564
Cash surrender value of life insurance	46,673,286	45,565,611
Prepaid FDIC premium	3,119,955	4,207,592
Core deposit and other intangibles	3,639,568	4,533,085
Deferred income tax benefit	15,589,875	20,030,022
Income tax receivable	2,741,258	1,412,938
Other assets	14,717,362	13,850,761
Total assets	1,432,609,592	1,406,901,541
Deposits
Non-interest-bearing	131,646,557	113,454,542
Interest bearing	1,046,474,511	1,008,114,181
Total deposits	1,178,121,068	1,121,568,723
Federal Home Loan Bank advances	94,634,420	128,537,407
Other borrowings	12,604,302	13,167,316
Other liabilities	13,950,658	12,488,073
Total liabilities	1,299,310,448	1,275,761,519
Commitments and Contingent Liabilities
Stockholders' Equity
Preferred stock, $.01 par value Authorized --- 5,000,000 shares Issued and outstanding --- 28,923 and 32,382 shares, respectively; liquidation preference $1,000 per share	289	324
Common stock, $.01 par value Authorized --- 20,000,000 shares Issued and outstanding ---6,987,586 and 6,984,754 shares, respectively	69,876	69,847
Additional paid-in capital - preferred stock	28,922,711	31,829,779
Additional paid-in capital - common stock	71,553,457	72,424,460
Retained earnings	31,123,946	31,757,156
Accumulated other comprehensive income (loss)	2,343,871	(3,988,158)
Unearned employee stock ownership plan (ESOP) shares	(715,006)	(953,386)
Total stockholders' equity	133,299,144	131,140,022
Total liabilities and stockholders' equity	$ 1,432,609,592	$ 1,406,901,541